5 Steps to Remain Successful & Compliant in 2017

After years of work, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have issued ASU 2014-09, the Revised Revenue Recognition Model. The model is intended to harmonize what had been a collection of over 200 specialized revenue recognition systems under United States Generally Accepted Accounting Principles (GAAP), and provide a more principle-based framework for business in different countries or in situations not covered by the previous arrangement. While these revised standards should make revenue recognition both more consistent and more flexible in the long run, adoption and application will unquestionably present some challenges, particularly for construction companies.

Because the model represents a significant departure from the previous regime, FASB decided to defer the original effective date by a year. Accordingly, public entities will apply it to annual reporting periods beginning after December 15, 2017. Nonpublic entities have another year, and will be expected to put the model into effect after December 15, 2018. For companies with calendar year fiscal years, this effectively means that the new rules go into effect January 1, 2018, for public entities, and January 1, 2019, for nonpublic ones. Transitioning to the new standard will require companies to review their internal processes and metrics and make guided judgments concerning revenue that will power the entire recognition process. All in all, the goal is a consistent, conceptual structure for determining and allocating revenue, rather than the previous, rules-based arrangement. At a fundamental level, the model breaks down the recognition process into five distinct steps:

1. Identify the contract with a customer—A contract is defined as “an agreement between two or more parties that creates enforceable rights and obligations.” In other words, the creation of the obligation, rather than the actual transfer of funds, is the defining activity. There are additional provisions for combining contracts, as well as modifying them with change orders in projects.
2. Identify the performance obligations in the contract—The next step, identifying the contract’s performance obligations, is guided by another definition, “a promise in a contract with a customer to transfer a good or service to a customer.” The term “performance obligation” is a new one created for this standard. A contract may have several independent obligations, or may have just one, despite specifying several independent activities.
3. Determine the transaction price—The third element, the transaction price, is a function of numerous items besides cash consideration, including the time value of money, variable and noncash consideration, discounts, rebates, commissions and other factors.
4. Allocate the transaction price to the performance obligations in the contract—Next, a transaction price needs to be allocated to each performance obligation. The metric here is the standalone selling price for each separate good or service. This can be calculated based on what competitors are selling the same product or service for, on a cost-plus-reasonable-margin basis or a residual basis in variable markets.
5. Recognize revenue when the entity satisfies a performance obligation—Finally, revenue is recognized as the point when control of the good or service is transferred to the customer, or when the customer has the ability to direct the use of or receive the benefits of the goods or service. Typically, control passes and revenue is recognized at a contractually specified point in time. However, there are specific situations in which this isn’t the case. Where control transfer is less clear, revenue is recognized over time using one of several different general measures of progress, such as costs incurred.

In the context of the updated revenue recognition rules, construction presents several new challenges. One is change orders, which may be treated as new, distinct goods or services requiring new contracts. A change order may also mean replacing an existing contract with a new one or continuing with the existing one. Each has a different impact on revenue recognition. Other elements of construction projects may require new revenue treatment. Transitioning to the new system can require either a full or modified retrospective method. The impact of the transition will affect virtually every aspect of a company’s operations.

The key to managing the transition is to get out in front of it. Create an internal team specifically charged with oversight of the implementation, a review of current contracts (or at least a meaningful subset of them) and, when appropriate, guidance from a professional advisor or auditor on particularly complex aspects of the process.