Before ASC 606, Revenue from Contracts with Customers, was adopted, different industries used different methods for reporting income even when they were accounting for similar transactions. Standardizing transactions is an important step, but now that all public and private companies must use the same accounting methods for reporting revenue, companies need to make certain adjustments.
ASC 606 is designed to standardize reporting for the delivery of the goods or services promised in a contract. It replaces all existing transaction- and industry-specific guidance.
The standard uses different terminology from previous versions, describing the delivery of promised goods as a “performance obligation.” One contract may include several performance obligations, each of which must be identified and tracked separately. Keep in mind that while lease contracts, insurance contracts, financial instruments, guarantees, and nonmonetary exchanges generally are excluded from ASC 606, there may be other guidance that affects these types of agreements.
For construction companies, the changes are especially far-reaching because they affect some documents that are commonly created during the life of a project, including change orders. This is not a simple semantic change. Any of these documents may qualify as a performance order, which requires every contract to be carefully examined.
ASC 606 – Five Steps For Recognizing Revenue
Step 1: Identifying the contract with the customer
This step involves recognizing each of the enforceable rights and obligations the parties have to each other. The seller promises to deliver goods and services, and the customer promises payment and determines when payment is to be made. The contract may be either written or oral, in accordance with customary business practices.
Step 2: Identifying the performance obligations within the contract
You generally do not need to draft separate contracts for two performance obligations if they are for essentially the same goods or services. However, separate contracts may be needed if the promised goods or services are substantially different.
Step 3: Determining the transaction price
The transaction price may be set in the contract, or the contract may state that the selling price will be based on certain variables.
Step 4. Allocating the transaction price to the performance obligations
This step requires you to estimate all variables in the selling price, including ones that may not be apparent.
Step 5. Recognizing revenue as the performance obligations are satisfied
Once control over the promised goods or services is delivered to the customer, you have met your performance obligation. Sometimes, control is handed over in stages, such as when a particular phase of a project is completed. When that happens, ASC 606 requires the seller to choose an appropriate way to measure progress relating to when the obligation will be completed.
There are myriad subtleties involved in each of these steps. Incentives like discounts, bonuses for meeting performance deadlines, high material costs and the impact of state and local taxes all need to be considered. In addition, the way performance obligations are stipulated in contracts also has an impact. Each of these items, and many others, must be reviewed under the ASC 606 guidelines.
Construction company leaders need to review all existing contracts to be sure their financial reports are in compliance with ASC 606. This process will need time and planning and require changes to certain processes and procedures. Keep in mind that all future contracts must be compliant as well.
As a Certified Construction Industry Financial Professional (CCIFP), Randy G. Brammer, CPA offers assurance and consulting to general contractors, subcontractors, suppliers, structural contractors, building owners, and real estate developers. Contact Randy about questions regarding ASC 606.