New Revenue Recognition Standard Disclosure Examples for Construction Companies

As we move into March, most private construction companies are probably well underway with their financial statement audits and reviews.  This year is the year that ASC 606, “Revenue from Contracts with Customers,” is required to be implemented by private companies.  A multitude of articles have been written discussing the impact and implementation issues concerning the adoption of this standard for the construction industries.  What I thought might be helpful right now, as companies are working on their year-end financial reporting, is to provide some examples of the required financial statement disclosures for the new standard.

Revenue Recognition – An Example of Required Financial Statement Disclosures

The financial statement disclosure language below is an example and is not meant to satisfy the required disclosure requirements for all construction companies.  Each company will need to evaluate its financial statement disclosures individually, based on its own unique facts and circumstances.

Contract Revenue and Cost Recognition - The Company adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606) effective January 1, 2019.  Topic 606 was adopted on a modified retrospective basis, and the Company determined that there was no cumulative effect to retained earnings as of January 1, 2019 that was required to be disclosed as a result of adopting the standard.

Topic 606 provides a five-step model for recognizing revenue from contracts:

• Identify the contract with the customer
• Identify the performance obligations within the contract
• Determine the transaction price
• Allocate the transaction price to the performance obligations
• Recognize revenue when (or as) the performance obligations are satisfied

Most of the Company’s long-term contracts are considered to have a single performance obligation.  Although multiple promises to transfer individual goods or services may exist, they are not typically distinct within the context of the contracts because the contract promises are interrelated or they require the Company to perform critical integration so that the customer receives a completed project.  Warranties provided under the Company’s contracts with customers are assurance-type and are included as elements of the single performance obligations.  Under previous revenue recognition guidance, the Company also generally accounted for its long-term contracts as single units of account (i.e., a single performance obligation).

Most of the Company’s revenues are recognized primarily under various types of long-term construction contracts, including those for which revenues are based on either a fixed price, time and materials or cost-plus-fee basis, and primarily over time as performance obligations are satisfied due to the continuous transfer of control to the project owner or other customer.  Significant contracts typically have durations of three months to three years.  Revenues from fixed price contracts, including a portion of estimated profit, are recognized as services are provided, based on costs incurred and estimated total contract costs, using the percentage-of-completion method.  If at any time, the estimate of contract profitability indicates an anticipated loss on a contract, the Company will recognize the total loss in the reporting period that it is identified and for which an amount can be estimated.  Revenues from time and materials contracts are recognized when the related services are provided to the customer.

Contracts are often modified through change orders to account for changes in scope.  The Company evaluates each change order to determine whether the change in scope creates an additional performance obligation.  Due to the integrated nature of the existing work and the extended scope of work, these contract modifications are generally not determined to result in separate performance obligations.

The transaction price for a contract represents the amount of consideration to which the Company expects to be entitled in exchange for the promised goods or services in the contract.  The consideration in the contract may be fixed, variable, or both, in nature. Variable consideration may include incentives, liquidated damages, change order requests, and requests for claims.  The Company estimates variable consideration using one of two prescribed methods, depending on which method better predicts the amount of variable consideration to which the Company will be entitled.  The expected value method estimates variable consideration based on the sum of probability-weighted amounts in a range of possible consideration amounts, whereas the most likely amount method estimates the variable consideration based on the single most likely amount among a range of possible consideration amounts.

The Company considers all relevant information when estimating variable consideration and includes some or all of an amount of variable consideration estimated, only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

The Company’s contracts may include retention provisions to provide assurance to customers that the Company will perform in accordance with the contract terms and if the retention provisions are not considered a financing benefit.  The balances billed but not paid pursuant to these provisions generally are due upon completion and acceptance of the project by the customer.  As a result, the Company has determined that there are no significant financing components in contracts at December 31, 2019 and 2018.

The Company’s contracts typically do not create an asset with an alternative use to the Company and provide an enforceable right to payment for progress completed to date, including profit, at all times throughout the duration of the contract.  As a result, the Company transfers control of a good or service over time, and therefore recognizes revenue over time as the performance obligation in the contract is satisfied.  The Company uses a cost-to-cost input method to measure progress relative to the satisfaction of a performance obligation, because the Company considers this input method to be the best available measure of progress toward satisfying performance obligations.  Contract costs include direct labor and related payroll costs, permanent materials, subcontractor costs, consumables and indirect costs, such as equipment, insurance and tools.  The Company evaluates the total estimated costs to complete for each performance obligation periodically; and it is possible that the estimate will be revised in the near term. Such changes in the total estimated cost of satisfying a performance obligation may result in a cumulative adjustment to revenue recognition in the period in which the revision is known.  If the estimated cost to satisfy a performance obligation results in a contract loss, a provision for loss is made in the period in which the loss becomes known.

Contractual completion is defined according to the specific terms of individual construction or service contracts with customers.  The Company considers contracts to be complete for accounting purposes when final acceptance has been received from the customer, contract warranty periods have been fulfilled, and no significant disputes, obligations or undisposed assets remain outstanding related to the contract.

Contract assets are defined in the new standard to include amounts that represent the rights to receive payment for goods or services that have been transferred to the project owner, with the rights conditional upon something other than the passage of time.  Contract liabilities are defined in the new Revenue Recognition standard to include the amounts that reflect obligations to provide goods or services for which payment has been received.  Accordingly, the amounts presented in prior balance sheets that were identified as “costs and estimated earnings in excess of billings” and “billings in excess of costs and estimated earnings” are now reflected in the line items titled “contract assets” and “contract liabilities.”  These are the only amounts recorded in contract assets and contract liabilities at December 31, 2019 and 2018.

The financial statements reflect the recognition of variable consideration related to pending change orders and claims on contract values.  In each case, the Company has evaluated the underlying contractual terms related to these items and determined that a contract modification has occurred based on the Company’s legal basis and enforceable rights under the contract.  The Company has constrained the estimates of variable consideration to include only those amounts for which it is probable that a significant reversal of cumulative contract revenue recognized will not result when the uncertainty associated with the variable consideration is subsequently resolved.

The Company continually records variable consideration in the form of pending change orders in connection with performance of the Company’s contracts.  Pending change orders are work changes where the revision has been ordered or agreed to, but the associated quantity or price have not been agreed to, and therefore judgement regarding eventual collection is required.