April 5, 2021

Construction accounting today - FASB addresses contract revenue recognition

Construction companies are well advised to follow Generally Accepted Accounting Principles (GAAP) when preparing their financial statements. If you’re doing so, it’s important to keep up with any relevant guidance issued by the Financial Accounting Standards Board (FASB).

A couple of recent FASB releases, Accounting Standards Codification (ASC) 606-10-65 and ASC 910-10-15-4, seek to help businesses transition into compliance with various rules under Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606).

Retroactive Application

Private companies that haven’t issued financial statements as of June 3, 2020, will need to comply with the latest guidance for 2020 financial statements and beyond. You may retroactively apply the newly issued guidance as far back as 2017 financial statements, however. Under ASC 606-10-65, there are two ways to apply updates retroactively:

1. Retrospective for each period with expedients. This approach uses standard retrospective reporting for accounting changes governed by ASC 250-10-45-5. It provides that the first period being reported retrospectively holds in its assets and liabilities a cumulative effect of all previous periods — with an offset to retained earnings or other equity. Each period thereafter is reported with its effects of the change in standalone documents.

The FASB has added “expedients” intended to make this guidance easier to put in place. First, if contracts begin and end within the same year, their accounting treatment under GAAP doesn’t need to be changed. For completed contracts that had variable considerations (such as bonuses or other incentive payments), the contractor may report the actual amount paid rather than going back and estimating how much could have been earned in each previous period.

Also, the requirements of ASC 606-10-50-13 to summarize estimated forecasted payments coming from deliverables in the future need not be stated retroactively to periods already ended.

2. Retrospective with cumulative reporting. This approach provides that a construction company take the cumulative effect of the years leading up to the year of application of the new standard as an adjustment to equity. This way, the business has a choice of whether to include all contracts in the retroactive grouping or just the contracts that aren’t completed.

Along with using this approach, the company must indicate explicitly how each financial statement line item was affected by the application of the new principle — in other words, the value of what it was before and what it is after the application of the change. In the notes of its financial statements, the business must describe the nature and context for any large changes in account values.

4 Contract Types

In the past, there have been many variations on the definition of construction contracts for GAAP purposes. These include guaranteed maximum price, incentive-based, and time and materials. Under ASC 910-10-15-4, the FASB has simplified the definitions into four types of contracts:

  1. Fixed price. Another term indicating this type of contract is “lump sum.” These contracts can have terms whereby the contract price may be adjusted as it progresses for changing economic conditions and fluctuations in materials prices. They may also have various incentives for contractor performance, including containing costs or hitting schedule targets.
  2. Unit price. This type of contract is one in which the contractor and owner agree to a price per unit of installation, per foot or per some item of deliverable. The duration of the contract may be dependent on the number of units of installation, so it may be in effect open-ended.
  3. Cost. These contracts include reimbursable costs plus a fee payable to the contractor. Because costs can vary widely, the contractor isn’t responsible for the costs involved. Materials, delivery and hauling costs are accumulated and passed over to the owner for payment, plus a fee payable to the contractor for overseeing and performing the work. The fee payable to the contractor on top of the costs can be fixed or it can vary based on different incentives.
  4. Time and materials. This style of contract assigns an hourly rate that’s agreed on by the owner and contractor. It includes a supplementary payment of the materials costs. The materials can be paid for at a markup or at cost, and the time rate of pay to the contractor is established in advance. A guaranteed maximum price contract is now included in this contract type, though these contracts have a set of distinctive characteristics.

Catching up

As your construction company’s accounting staff is no doubt aware, the ongoing impact of ASU No. 2014-09 on revenue recognition is significant — especially for contractors seeking to increase bonding capacity or undergoing an audit for a larger project. Your CPA can provide invaluable assistance in catching up with the latest FASB guidance and revising your GAAP-compliant financial statements accordingly.

Effective date extended for reporting leases

Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), requires companies complying with Generally Accepted Accounting Principles to report on their balance sheets the assets and liabilities associated with leasing office space, vehicles and other assets. This includes reporting “embedded” leases that may lie hidden in a nonlease agreement.

In June 2020, the FASB extended the effective date for ASU 2016-02 for privately held businesses. The updated lease guidance now goes into effect for fiscal years beginning after December 15, 2021 (or interim periods beginning after December 15, 2022). The deferral is likely welcome news for many contractors who have been trying to get a handle on the complex new rules while grappling with the COVID-19 crisis.

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