Authored by Tom Sheahan and Erik Schuchardt
After navigating the five elements of the revenue recognition process, there are other special considerations for a construction contractor to evaluate when reporting and disclosing revenue from contracts with customers.
Construction contractors should be aware of a number of other unique accounting and reporting items that may or may not differ from existing guidance under U.S. GAAP. Special consideration should be given to the accounting and reporting for contract assets and liabilities, contract costs, loss contracts, warranties, uninstalled materials, and mobilization.
Contract assets and liabilities
A contractor will present a contract in its statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the contractor’s performance and the customer’s performance at the reporting date.
A contract liability exists if the customer has paid consideration or if payment is due as of the reporting date but the contractor has not yet satisfied the performance obligation.
If the contractor has transferred goods or services as of the reporting date but the customer has not yet paid, the contractor would recognize either a contract asset or a receivable. An unconditional right to consideration is presented as a receivable. If a contractor’s right to consideration is conditioned on something other than the passage of time, the contractor would recognize a contract asset. The transfer from a contract asset to an account receivable balance (when the contractor has a right to payment) may not coincide with the timing of the invoice as is required under current guidance.
Costs in excess of billings and billings in excess of costs recognized on the balance sheet under current GAAP should be similar to the contract asset and contract liability recognized under the new standard.
In conjunction with ASC 606, the FASB amended ASC 340-40, Other Assets and Deferred Costs – Contracts with Customers, to provide guidance on other assets and deferred costs related to contracts with customers. This updated standard provides guidance on accounting for costs a contractor incurs in obtaining and fulfilling a contract to provide goods and services to customers for both contracts obtained and contracts under negotiation.
Incremental costs of obtaining a contract
Under ASC 340-40, the incremental costs of obtaining a contract (i.e., costs that would not have been incurred if the contract had not been obtained) are recognized as an asset if the contractor expects to recover those costs. Recovery can be direct (i.e., through reimbursement under the contract) or indirect (i.e., through the margin inherent in the contract). Examples of incremental costs of obtaining a contract may include costs incurred related to contract negotiation, pre-construction, design, engineering, or sales-based commissions.
Costs to fulfill a contract
ASC 340-40 also includes guidance for recognizing costs incurred in fulfilling a contract that are not in the scope of another ASC topic (i.e., inventory, property, plant, equipment). Costs incurred to fulfill a contract include those costs that relate directly to a contract such as materials, labor, subcontracts, allocations of costs that relate directly to the contract, and other costs that are explicitly chargeable to the customer.
Costs to fulfill contracts that are accounted for under ASC 340-40 are divided into two categories: (1) those that give rise to an asset and (2) those that are expensed as incurred. In general, a contractor should recognize an asset related to costs incurred to fulfill a contract if the costs meet all of the following criteria:
- The costs relate directly to a contract or to an anticipated contract that the contractor can specifically identify (e.g., costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).
- The costs generate or enhance resources of the contractor that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.
- The costs are expected to be recovered.
Contractors should expense, as incurred, general and administrative costs, costs of wasted material or labor not reflected in the cost of the contract, costs related to past performance, and costs which cannot be identified as associated with a performance obligation.
Amortization and impairment
Capitalized costs to obtain and fulfill contracts should be amortized on a basis consistent with the pattern of transfer of goods or services to which the asset relates. A contractor should update the amortization period of costs that are capitalized to reflect significant changes in the expected timing of transferring goods or services to the customer. Any such change should be accounted for as a change in estimate on a prospective basis. If a contractor determines that the remaining balance of the unamortized costs exceeds the remaining amount of consideration to be received on the contract, when taking into account any remaining costs to be incurred in fulfilling the contract, the contractor should recognize an impairment charge in profit or loss.
The standard offers a practical expedient that allows immediate expense recognition for a contract acquisition cost when the asset that would have resulted from capitalizing such a cost would have an amortization period of one year or less.
The FASB elected to retain existing guidance in ASC 605-35, with certain amendments, for situations in which a contractor expects to incur a loss, either on a single performance obligation (called an onerous performance obligation) or on an entire contract (called an onerous contract). When current estimates of the amount of consideration that a contractor expects to receive in exchange for transferring promised goods or services to the customer and contract costs indicate a loss, a provision for the entire loss on the performance obligation or the contract shall be made. Provisions for losses shall be made in the period in which they become evident.
Warranties are commonly included in contracts to sell goods or services, whether explicitly stated or implied based on a contractor’s customary business practices. The new accounting standard identifies two types of warranties.
Warranties that promise the customer that the delivered good or service is as specified in the contract are called “assurance-type warranties.” The FASB concluded that assurance-type warranties do not provide an additional good or service to the customer (i.e., they are not separate performance obligations). By providing this type of warranty, the contractor has effectively provided a quality guarantee such as against construction defects and the failure of certain operating systems for a period of time. Under the new accounting standard, the estimated cost of satisfying these warranties is accrued in accordance with the current guidance in ASC 460-10 on guarantees.
Warranties that provide a service to the customer in addition to assurance that the delivered good or service is as specified in the contract are called “service-type warranties.” If the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer beyond fixing defects that existed as the time the goods or services were transferred to the customer, the contractor is providing a service-type warranty. A service-type warranty represents a distinct service that is a separate performance obligation. Therefore, the contractor should allocate a portion of the transaction price to the warranty based on the estimated standalone selling price of the warranty and recognize revenue allocated to the warranty over the period the warranty service is provided.
ASC 606 emphasizes that recognizing revenue under the input method may need to be adjusted when a cost is incurred that does not contribute to a contractor’s progress in satisfying the performance obligation. Costs incurred related to rework, wasted materials, or uninstalled materials should be excluded from the measurement of progress towards the fulfillment of a contractor’s performance obligations. While uninstalled materials are excluded from the measurement of progress, a contractor is permitted under the new accounting standard—subject to certain criteria—to recognize revenue equal to the cost of the uninstalled materials (excluding gross profit). A faithful depiction of a contractor’s performance may allow a contractor to recognize revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the contractor expects at contract inception that all of the following conditions would be met:
- The good is not distinct.
- The customer is expected to obtain control of the good significantly before receiving services related to the good.
- The cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation.
- The contractor procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the contractor is acting as a principal in accordance with paragraphs 606-10-55-36 through 55-40).
Based on the above criteria, a contractor should always exclude costs related to wasted materials, rework, or other significant inefficiencies from its measurement of progress. In contrast, when uninstalled materials meet the above criteria, a contractor is allowed to recognize revenue in an amount equal to the cost of the goods and adjust its measure of progress to exclude such costs from the costs incurred and from the transaction price (i.e., from both the numerator and the denominator of its percentage of completion calculation).
Many contractors incur costs to mobilize equipment and labor to and from a job site. Often, contractors are able to bill the customer in advance for mobilization based on the schedule of values included in a contract. Under ASC 606, mobilization costs do not contribute to a contractor’s progress in satisfying a performance obligation and instead these costs are generally considered contract fulfillment costs that are capitalized on the balance sheet and amortized over the expected duration of the contract. This differs from current practice in which mobilization costs have been included in the determination of percentage of completion and as a result the recognition of revenue.
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