The most painful aspects of ASC 606 implementation are behind us now, as many companies have completed at least two fiscal years of reporting under the new guidance. While some portions of ASC 606 were specific to initial implementation, there are certain provisions that will remain perpetually relevant. Here are three key items that we especially recommend for contractors to pay attention to at each year-end.
Numerous forms of variable consideration can arise throughout the course of a contract, including pending change orders, early-pay discounts, incentive bonuses, and liquidated damages. ASC 606 requires judgment to be exercised when determining the appropriate treatment for variable consideration. In particular, management is expected to estimate the amount of revenue associated with the pending items that is probable of collection, and then incorporate the amount of revenue deemed probable into the accounting for the job. Depending on the nature of the pending items, this could serve to either increase or decrease the contract value.
A company may have certain instances in which materials are procured but not yet installed on a project as of year-end. The prescribed accounting for uninstalled materials depends on the nature of the materials. A common interpretation is as follows:
- If a company retains control of the materials and the materials are of a standard nature such that they could be used on other projects, then the cost of the materials is excluded from job-to-date (JTD) costs and recognized as inventory on the company’s balance sheet.
- If control of the uninstalled materials transferred to the customer as of year-end, or if the materials are of such a customized nature that they could only be used on that specific project, then the uninstalled materials are included within JTD costs and revenue is recognized to the extent of the cost incurred (i.e. no gross margin is recognized).
- If the company was involved in the design or customization of the materials, then receipt of the materials is itself considered to be reflective of job progress, and the uninstalled materials are thus treated as a normal job cost (i.e. the cost is included in JTD cost, and gross margin is generated off of it).
Costs of Waste and Rework
While hopefully rare, certain cases inevitably arise in which projects incur additional costs for waste and rework. ASC 606 makes a key distinction between costs that represent progress toward completing performance obligations and costs that do not, thus indicating the importance of a direct link between the amount of revenue recognized and the degree to which the underlying performance obligation has been satisfied. Because the costs of waste and rework do not represent actual progress toward project completion, they should be excluded from the percent complete calculation used in determining revenue recognition.
The key takeaway here is to develop a year-end process to review for significant instances of variable consideration, uninstalled materials, and costs of waste and rework. By (a) raising awareness with both your accounting and your project management teams as to the relevance of these items, and (b) ensuring that these two teams meet together periodically to identify and discuss them, you will be well on your way to smooth compliance with ASC 606 from year to year.
McKonly & Asbury’s construction team recently held a Construction Accounting and Industry Update webinar to get attendees up to speed on the most important updates and opportunities available; be sure to watch the full presentation if you missed it! For more information on these services and more, be sure to visit our construction services page and don’t hesitate to reach out to Tim Showers, Manager and key member of our Construction Industry practice at email@example.com.