Changes to long-term contract accounting will affect the way contractors recognize revenue
For over 30 years, the accounting principles governing accounting for construction-type contracts have been primarily centralized to one piece of guidance; Financial Accounting Standards Board (FASB) Statement of Position (SOP) 81-1. However, this long-standing pronouncement will be superseded in the near future due to the ongoing push for convergence of accounting principles generally accepted in the United States (GAAP) and international accounting standards. Presently, the push for convergence of accounting principles over revenue recognition is a top priority for the FASB and the International Accounting Standards Board (IASB). One of the most significant differences in accounting principles per GAAP versus international standards is that of recognizing revenue on long-term construction type contracts.
In the initial exposure draft of proposed accounting standards update to revenue recognition, revenue would be recognized on a contract when a performance obligation is satisfied by transferring a promised good or service to a customer. The timing of the transfer of a good or service would be determined by when the customer obtains control over that good or service. Control would be defined as the customer having the ability to direct use of and receive benefit from the good or service provided. Further, the exposure draft also proposed that construction-type contracts be broken down into separate identifiable performance obligations for goods or services that are distinct. The combination of these proposed standards would, of course, eliminate the use of percentage completion methodologies for revenue recognition all together. Due to these and other provisions present in the initial exposure draft, nearly 1,000 comment letters were submitted to the FASB, expressing opinion and seeking clarification.
In response, modifications were made to the initial exposure draft. Instead of revenue being recognized when a performance obligation is satisfied, revenue would be recognized over time, so long as performance creates or enhances an asset, and that performance does not create an asset with an alternative use. In other words, under a typical construction-type contract, revenue would be recognized as work is performed and the customer’s asset is being enhanced, which is much more similar to current practice. Also, a modification was made to address the fact that for many construction-type contracts, the entire contract is a single deliverable and cannot be broken into separate performance obligations. Therefore, the standard was modified to allow for goods or services that are not distinct to be bundled into a single performance obligation if certain requirements are met.
While this convergence is imminent, contractors still have time to understand the new accounting principles and determine what effect they will have on the accounting and financial reporting. The first exposure draft that detailed proposed changes in accounting principles was released in 2010. Since then, due in large part to concerns voiced by those in the construction industry, the exposure draft was modified and then re-exposed for comment twice. Final accounting standard changes are not expected until 2013, with an effective date no earlier than fiscal years beginning on or after January 1, 2015. As for transition from the old standard to the new, the most recent draft of the new standard calls for retrospective implementation, however this has not been finalized.
The convergence of revenue recognition principles to international accounting standards is a complex matter and an onerous task, which includes much more details and provisions than outlined above. However, with the help of competent advisors, construction contractors will be able to modify their approach to contract accounting with minimal headaches along the way.
By Jake Dopson, assurance senior manager, CPA, CCIFP