The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2014-09 bringing to a conclusion its project to clarify principles for recognizing revenue. This ASU replaces industry specific revenue recognition guidance including ASC 605-35, formerly known as SOP 81-1, (i.e., percentage of completion accounting), which was the primary revenue recognition standard that the construction industry has followed for the past 33 years.
The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of 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.
To achieve that core principle, an entity should apply the following steps:
1. Identify the contract with a customer
Of significance to the construction industry, the ASU recognizes the concept of contract modifications such as change orders and provides detailed guidance related to modifications including change orders that are approved as to scope or price (or both).
2. Identify the performance obligations in the contract
If an entity promises to transfer more than one good or service to the customer, the entity should account for each promised good or service as a performance obligation only if it is (1) distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer. A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer and the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
3. Determine the transaction price
The transaction price is the amount of consideration to which an entity expects to be entitled. Variable consideration is included only to the extent that it is probable there will not be a significant reversal in the cumulative amount of revenue recognized when the uncertainty related to the variable consideration is resolved.
4. Allocate the transaction price to the performance obligations in the contract
The transaction price is allocated to each performance obligation based on the standalone selling price of each distinct good or service promised in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation
An entity satisfies a performance obligation and recognizes revenue over time if one of the following criteria is met:
a)The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
b)The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
c)The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
For performance obligations satisfied over time, an entity recognizes revenue by selecting an appropriate method for measuring the entity’s progress toward complete satisfaction of that performance obligation. Appropriate methods of measuring progress include output and input methods. It should be noted that when using an input method, an entity should exclude the effects of any inputs that do not depict the entity’s performance in transferring control of goods or services to the customer.
The Exposure Drafts previously issued by the FASB contained a proposal to identify onerous performance obligations in contracts with customers. Based on comments received on the Exposure Drafts, the FASB decided to remove the proposal to identify onerous obligations from the final ASU. Instead, entities applying U.S. GAAP will use the extant guidance for identifying and measuring onerous contracts. For the construction industry, that guidance stipulates that when the current estimate of the consideration that an entity expects to receive in exchange for transferring promised goods or services to the customer and contract cost indicate a loss, a provision for the entire loss on the contract shall be made in the period in which the loss becomes evident.
If a customer has the option to purchase a warranty separately, the warranty is a distinct service which should be accounted for as a performance obligation. A portion of the transaction price should be allocated to that performance obligation. If a customer does not have the option to purchase a warranty separately, an entity should accrue the related warranty cost unless the promised warranty provides the customer with a service in which case the ASU provides further detailed guidance.
Incremental costs of obtaining a contract should be recognized as an asset if an entity expects to recover those costs and subsequently charged to expense over the period during which goods or services are transferred to the customer. These costs may be expensed when incurred if the amortization period is one year or less.
For costs to fulfill a contract, an entity should apply the requirements of other standards within U.S. GAAP if applicable. Otherwise, an entity should recognize an asset if those costs relate directly to a contract (or a specific anticipated contract), generate or enhance resources of the entity that will be used in satisfying performance obligations in the future and are expected to be recovered. Those costs should be amortized in accordance with the pattern of transfer of goods or services to which the asset relates.
The FASB and the International Accounting Standards Board (IASB) have also established a Joint Transition Resource Group (TRG) in order to aid transition to the new standard. The TRG will inform the FASB and the IASB about potential implementation issues. The TRG will also provide stakeholders with an opportunity to learn about ASU 2014-09 from others involved with implementation.
For a public entity, ASU 2014-09 is effective for annual periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted.
For all other entities (nonpublic entities), ASU 2014-09 is effective for annual periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018.
A nonpublic entity may elect to apply this guidance earlier, but only as of the following:
1. An annual reporting period beginning after December 15, 2016, including interim periods within that reporting period
2. An annual reporting period beginning after December 15, 2016, and interim periods within annual periods beginning after December 15, 2017
3. An annual reporting period beginning after December 15, 2017, including interim periods within that reporting period
Entities should apply the amendments in ASU 2014-09 utilizing one of the two retrospective methods outlined in the ASU.
Section A of ASU 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs – Contracts with Customers (Subtopic 340-40) is available here.
Section B of ASU 2014-09, Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables is available here.
Section C of ASU 2014-09 which provides Background Information and Basis for Conclusions is available here.
Readers should not act upon information presented without individual professional consultation.
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