ARB held its 2019 Construction and Real Estate Workshop on October 24, 2019.
“We had several changes affecting the construction and real estate industry to discuss this year, and we were pleased to see familiar and new faces at our workshop. It’s a lot to cover, and, thanks to everyone involved, we were successful in providing important tax and accounting matters and updates to attendees,” said David Jean, ARB’s Construction and Real Estate Practice Leader.
Here’s a look at some top takeaways from the revenue recognition presentation from our workshop.
The Financial Accounting Standards Board (FASB) updated revenue recognition guidance in the codified collection of accounting standards used for most financial statements, US Generally Accepted Accounting Standards (US GAAP).
The revenue recognition update is effective in 2019 for nonpublic companies, so it applies to open contracts at December 31, 2018. Companies can apply guidance either retrospectively to each prior reporting period or as a cumulative-effect adjustment on beginning retained earnings in the year of adoption. Generally, people will use the simpler cumulative effect. Most will not see substantive changes to equity, but others may be surprised. An assessment is still needed.
Key financial measures and ratios may be impacted, including expectations, earn-outs, bonuses, and covenant compliance, as well as surety and bank underwriting. It may require potential revision of accounting processes and internal controls, to include increased judgment and use of estimates. IT systems may need to be adjusted to capture additional data used to make revenue transaction estimates and to support disclosures.
According to the FASB, the core principle of the update is to “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” So, record what you earn when you earn it. There are five steps to the revenue recognition process.
1. Identify the contract(s) with the customer.
A contract includes legally enforceable approval and commitment of the parties, established rights of parties and payment terms, commercial substance, and probable payment (considering the ability and intent of the customer). The contract can be oral or implied if all items above are met.
2. Identify the separate performance obligations
Separate performance obligations are “distinct” promises to provide goods or services to a customer in a contract. Evaluate whether a promised good or service in the contract is separately identifiable from other promises in the contract. An obligation is not separately identifiable if it is highly dependent on / interrelated with the rest of the contract.
3. Determine the transaction price.
Take into account the basic contract price, options, unapproved change orders, claims, penalty provisions, incentive provisions, discounts/refunds/rebates, and any financing component. Estimates of variable consideration are required, and consideration of all reasonably available information (historical, current, and forecast) is required. Identify a reasonable number of possible consideration amounts, update estimates on an ongoing basis, and approach estimate of variable consideration similar to pricing / bid-and-proposal processes.
4. Allocate price to performance obligations.
Allocate the full price based on relative values of each obligation.
5. Recognize revenue when (or as) the entity satisfies a performance obligation
So, recognize revenue when: the entity has a right to payment of cost and profit for work completed, when the customer has legal title to the asset, when the entity has transferred physical possession of the asset, when the customer has the significant risks and rewards of ownership of the asset, and/or the customer has accepted the asset.
There will certainly be accounting changes, financial statement reclassifications, and changes in disclosure. When in doubt about new revenue recognition requirements, contact your CPA.
ARB’s construction and real estate advisory services team can confidently meet the tax, compliance, bonding, and operational challenges unique to your industry. For more information on the workshop topics or other construction and real estate tax and accounting needs, contact us today.