In May, the Financial Accounting Standards Board and International Accounting Standards Board issued their long-awaited converged standard on revenue recognition, which have significant implications for the engineering and construction industry. This affects companies applying U.S. GAAP and IFRS who have typically been using industry guidance when accounting for revenue, according to PricewaterhouseCoopers LLP, or PwC, a company offering audit and assurance, tax and consulting services.
These new standards on how you recognize revenue have caught a segment of the E&C sector off guard. During the recent Webinar hosted by PwC only about five percent of participants said they were “very prepared” for the changes while about 35% said they were “somewhat prepared.” Forty-four percent said they were “not prepared” or “unsure.”
Recognizing revenue is going to basically come down to a 5-step process that includes:
- Identifying the contract and contract modifications
- Identifying separate performance obligations
- Determining the transaction price
- Allocating the transaction price
When asked which step will have the greatest impact on them, 33% of respondents to the informal poll during the webinar said “identifying separate performance obligations.” Companies will have to use judgement in determining whether all promises in a contract should be bundled together. For example, if a customer can benefit from the good or service on its own or in conjunction with resources readily available, and the contractor’s promise to deliver the good or service is separable from other promises in the contract, then those goods and services could be separate performance obligations.
The combined standards provide guidance on many aspects of construction contracts including estimating variable consideration, award fees, claims, the time value of money, allocating consideration, and measure of progress. The standard also addresses the incremental costs of contracts and the costs to fulfill contracts. For example the board decided that if you incur incremental costs in fulfilling a contract, the costs have to be capitalized and amortized over the period of benefit from the contract, according to Dusty Stallings, partner at PwC, National Professional Services Group.
There was even guidance on product warranties with two items pointed out specifically by Stallings as requiring special diligence. For standard warranties you should ensure there isn’t any service element within the warranty that goes beyond ensuring the product performs as intended. If there is a service element it has to be accounted for separately from the warranty. Also, if you offer a service and an insurance-type warranty, but you can’t figure out how much is attributable to each, then you may need to treat it all as a service warranty, accounted for over the period you’ll provide the service.
Accounting for loss contracts, something more familiar to the E&C sector than to others, became a sticky topic for the boards and they eventually took it out of the revenue standard. They did however decide to keep the existing guidance on onerous contracts for those industries that were already scoped into that guidance.
The webinar participants thought the standard would have the most impact on their financial reporting and their processes. You can find detailed explanations covering the entire impact of the new standard, right here.