Should revenue be recognized at a point in time or over time following the new revenue recognition standard for construction companies?
The new revenue recognition financial accounting standard, ASU 2014-09, Revenue from Contracts with Customers (“ASC 606”) has created significant complications across industries, and these sweeping changes to revenue recognition guidance have often had far-reaching business implications. ASC 606 seriously complicates revenue recognition for the construction industry, forcing financial professionals to reckon with significant judgments and creating financial reporting risk.
The Impact of ASC 606 for Construction Companies
One common concern regarding ASC 606’s impact on revenue recognition for construction companies is the compatibility of ASC 606 with percentage of completion accounting methodology. Percentage of completion accounting is commonly used for long term contracts, especially with regards to common business models in the construction industry. Fortunately for many, the standard does allow this type of approach. However, under the new guidance, this type of billing is considered a contract with multiple performance obligations, that are not distinct, where control transfers over time.
Precise guidance contained in ASC 606 must be applied to determine whether revenue is recognized over time (‘percentage of completion’) or at a point in time.
While the general principle is that revenue is recognized at a point in time, if any of the criteria in ASC 606 is met then revenue should be recognized over time.
Established by both the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), the following criteria are used to determine whether revenue should be recognized at a point in time or over time.
- Does the customer simultaneously receive and consume the benefits provided by the entity’s performance as the entity performs?
- Does the entity’s performance create or enhance an asset that the customer controls as the asset is created or enhanced?
- Does the entity’s performance create an asset with no alternative use to the entity?
- And does the entity have an enforceable right to payment for performance completed to date?
If the answer is “yes” to any of the questions above, then the entity transfers control over time. The entity should then recognize revenue over time, using a method that depicts its performance.
In this instance, the overall principle is that revenue is recognized to the extent that each of the vendor’s performance obligations has been satisfied.
To calculate the amount of revenue that must be recognized, ASC 606 permits either an output method or input methods to be used. An output method results in revenue being recognized based on direct measurement of the value of goods or services transferred to date. Input methods result in revenue being recognized based on measures such as resources consumed, costs incurred or machine hours.
If the answer is “no” to all the questions listed above, then the entity transfers control at a point in time. The entity should then recognize revenue at a point in time at which it transfers control of the good or service to the customer.
The following indicators should be considered to determine whether control of an asset or service has been transferred:
- Does the customer have a present right to payment for the asset?
- Does the customer have legal title to the asset?
- Has the entity transferred physical possession of the asset to the customer?
- Does the customer have significant risks and rewards of ownership of the asset?
- Has the customer accepted the asset?
In the construction industry, where control is often transferred over time, companies will need to implement services with an array of features and functions to support the need.
How Should a Construction Company Handle ASC 606 Revenue Recognition?
SOFTRAX has the solutions to support the complexities caused by ASC 606, that go beyond the basic “plug a percentage in and recognize the amount of revenue” for a transaction.
The robust features and functions within our SOFTRAX Revenue Manager solution allow for bulk processing, a representation of billed versus unbilled amounts for these types of transactions, and an ability to back out previously applied percentages where business conditions dictate. SOFTRAX functions also allow for integration with source systems (such as PSA tools that provide metrics to calculate the percentage of completion) and automatically apply percentages to transactions, in addition to many more features surrounding revenue management.
Native functionality within SOFTRAX Revenue Manager provides companies with ready-made tools to address all the above requirements. The workflow capabilities of the application allow for a variety of checks, validations, and data augmentation actions on incoming transactions to ready these for revenue automation handling.
In this approach, companies can control what level of automation they want and whether there should be thresholds for review versus automatic processing. This is ideal for cases in which orders over $1,000,000 need to have the application’s planned processing path reviewed and approved before stored whereas orders below that amount are automatically processed.
Foundational elements of SOFTRAX Revenue Manager include support for any need to modify aspects of a transaction’s revenue elements in terms of timing, amount available to be recognized, reversal of revenue previously recognized due to exception handling, ability to re-forecast revenue when needed, need to prospectively allocate revenue on an order/contract, or unbundle specific transactions to decouple how it is sold with how its revenue needs to be handled.
Oftentimes, these needs, which require a significant amount of time and resources, go unaddressed until a problem arises. Products such as SOFTRAX Revenue Manager are the solution to get ahead of potential risks before it’s too late.
Contact firstname.lastname@example.org for more information on how SOFTRAX’s services and products are tailored to support the needs of companies within the construction industry.