FASB Revenue Recognition Proposal
Update on the FASB Revenue Recognition Proposal
The model for revenue recognition in construction is changing
with the Financial Accounting Standards Board (FASB) May 28, 2014
release of Accounting Standards Update (ASU) 2014-09, Revenue
from Contracts with Customers (Topic 606). Since 2008, FASB and the
International Accounting Standards Board (IASB) have been working
jointly on developing a single principles-based model
for recognizing revenue, with a goal of improving consistency of
requirements, comparability of revenue recognition practices, and
usefulness of disclosures.Throughout the FASB process, NASBP, the
Construction Financial Management Association (CFMA) and other
interested organizations have been very involved in providing input on
the impact of the new standard. The ASU eliminates all existing revenue
recognition guidance under both U.S. Generally Accepted Accounting Principles
(GAAP) and International Financial Reporting Standards (IFRS),
including industry-specific guidance, and significantly expands
revenue recognition disclosures.
The required disclosure changes will include both quantitative and
qualitative information about the amount, timing, and uncertainty
of revenue from contracts with customers and the significant judgments
used. There is limited relief offered to nonpublic companies
on some of the qualitative disclosures.
There are some myths that have been rolling around the construction
industry related to the changes in revenue recognition. Hopefully, many
of these myths can be put to rest with the issuance
of the final standard. Read more details about the final standard, by clicking here.
The FASB Standard on Revenue Recognition was released. Click here.
Comments that CFMA provided March 13, 2012 to FASB included NASBP perspectives and input
NASBP participated in the CFMA committee process of formulating comments on the FASB revised proposal for the revenue recognition standard. NASBP member Darrin Weber, CPA, CIC, of IMA, Inc. in Dallas, TX, represented NASBP and provided the perspectives of bond producers in that process. NASBP and CFMA agreed that it would be more effective to communicate their concerns and comments to FASB in one comment letter. Click here to review those March 2012 comments. To access FASB's revised Exposure Draft on Revenue Recognition, click here. The Industry Relations Committee and NASBP would like to thank Darrin for his time and effort to assure that NASBP and NASBP bond producers' perspectives have been provided to FASB.
On November 14, 2011 FASB/IASB Re-exposed the Revenue Recognition Proposal
On November 14, 2011 FASB/IASB re-exposed the Revenue Recognition Proposal. To access a recent article making the announcement, click here. The construction and surety industries will be reviewing the re-exposed proposal to determine if our concerns have been addressed. FASB/IASB have announced that comments on the re-exposed proposal were due Tuesday, March 13, 2012. Click here to view the comments that CFMA provided March 13, 2012 to FASB that include NASBP perspectives and input.
Background on Issue
The following is a commentary and update by Darrin Weber of IMA of Texas, Inc., Chairman of the NASBP Risk Management and Insurance Committee and the NASBP representative appointed to work with a Construction Financial Management Association (CFMA) task force analyzing the revenue recognition standard that was proposed in 2010. NASBP is indebted to Darrin and to Jerry Henderson of BKD, LLP for their extraordinary leadership and the considerable efforts they expended in analyzing and in educating the construction and surety communities about the FASB Revenue Recognition proposal. Below are Darrin Weber's points about the 2010 proposal that will be helpful in NASBP's review of the November 14, 2011 Re-exposed proposal.
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have proposed new standards for revenue recognition in an Exposure Draft issued in June 2010. The new standards are an effort to reconcile and converge disparate accounting standards and practices on revenue recognition. The rules have significant implications for construction firms, as the new standard recognizes revenue at the performance obligation level, a departure from the approach of the percentage completion method, which has long-prevailed in and is grounded in the realities of the construction industry for the past 20 years. Originally, FASB/IASB planned to publish the final revised standard in June 2011, but recently moved the publication date to the third or fourth quarter of 2011. FASB/IASB has made no announcement indicating when the final revised standard would go into effect.
The National Association of Surety Bond Producers (NASBP) took a keen interest and commented on the new standards on Oct. 13, 2010 on behalf of its membership firms. NASBP is urging the boards to consider preserving in the new standard to include the tenets of ASC 605-35, formally known as SOP 81-1, which represents the Percentage of Completion Method (PCM) currently implemented in revenue recognition for most construction firms. In addition, NASBP asked that the boards consider delaying the adoption of the new standard for private businesses for a period of time (two years) to understand and fully implement the changes.
FASB Revenue Recognition Roundtable Meeting Held November 23, 2010
The construction and technology industries have a major stake in how the final standard could change their business and accounting practices. To hear from these industries, the FASB hosted the Revenue Recognition Roundtable Meeting on Nov. 23, 2010 in Stanford, CA. In attendance were representatives from the Construction Financial Management Association (CFMA), Microsoft, eBay, Apple, Intel, Cisco Systems, and a myriad of other public companies that are involved in the process and concerned about how the method for recognizing revenue may change. Also in attendance were the FASB and ISAB board members and staff members who are drafting the new standard.
The boards allowed me to attend the Stanford session as an observer representing the NASBP and the construction industry.
The Revenue Recognition Roundtable went well for us as the construction industry. Our voices were heard, and there was meaningful discussion on four key areas that are critically important to our business:
1) Recognizing Revenue - Goods or Service
Currently, long-term construction contracts follow two generally accepted accounting methods: percentage-of-completion (PCM) method and completed contract method (CCM).
The new accounting standard, as written in the Exposure Draft, could have eliminated PCM for long-term contracts because it follows the principal that companies should recognize revenue only from the transfer of “goods”. If construction were considered a good, then revenue would need to be recognized upon delivery to the customer which is similar to the CCM which, in my opinion, is a step in the wrong direction.
At the roundtable, participants made significant progress voicing these concerns. There was much discussion on whether construction projects are a good or a service. For example, is a custom-produced fabricated product for a building considered a good or service?
Since the roundtable, the FASB has taken these concerns to heart. FASB’s project manager reports that they are considering, as a solution, recommending that the boards split the model between goods and services. For goods, the standard would consider the transfer of control of ownership to be the trigger for recognizing revenue. Construction services could be defined as “the continuous transfer of a benefit to a customer through the performance of a task or series of tasks under a contract.” Under this definition, a construction contract would be considered a continuous delivery, and it would be considered a service under the new standard. In this case, revenue could be recognized ratably (or basically CCM). I believe that this eventual outcome would establish a suitable compromise for the construction industry.
2) Single Performance Obligation?
Under the Exposure Draft, revenue under a contract would be recognized when distinct “performance obligations” are satisfied. There was much discussion around whether a construction contract constitutes a single performance obligation or several performance obligations. It is most desirable, for the construction industry, that a contract is a continuous delivery and constitutes a single performance obligation. Other industries such as technology, however, are requesting that contracts contain multiple performance obligations.
Since the meeting, FASB’s project manager reports that the boards are still working to clarify how and when to separate the components of a construction contract, with a stated objective of breaking up a contract to report useful profit margins and report the pattern of transfer of benefit to the customer. The boards are considering the following guidance for when to separate a performance obligation:
- Separate a good or service if the entity regularly sells a virtually identical good or service;
- If an entity does not sell the good or service separately, then an entity must use judgment and consider the following when evaluating when to break up a contract:
- Timing of transfer
- Function
- Risks
As the timing, function and risks of almost all aspects of most construction projects are irrevocably linked, under this guidance, most construction contracts would result in one performance obligation. Each job is unique. This eventual outcome would retain the 81-1 principal of measuring progress using the method that best depicts performance, meaning it would be similar to percentage of completion.
3) Construction Claims and Bonuses
Significant time was spent on discussed on handling claims resulting after completion of “projects”, whether construction or technological. Many of the technology companies are struggling with handling of warranty/maintenance recalls related to software and hardware that are not working properly. Accounting for technology companies related to these costs is more complicated than the construction industry. I believe the new pronouncement will allow the construction industry to expense maintenance/warranty expenses as they occur on completed work.
4) Retrospective Application
Much debate was held about whether or not there will be a mandatory retroactive application of the new accounting standard, which would require companies to go back and change their accounting for the prior two years. This could be a burdensome issue, especially for smaller private companies that don’t have the resources to perform changes to their books. At the roundtable, participants asked that private companies be exempt from retroactive application.
Closing Thoughts
I believe that the new standards will be more principles-based and that the final standard will take into account and hopefully solve four of the major concerns expressed by the construction industry. I’m hopeful that the construction industry will have the ability to provide comments and input on the rule’s implementation during late summer of 2011. NASBP will be distributing the draft to NASBP members when it is released. Please don’t miss your opportunity to respond to the proposed draft when it is released next year!
The author of this article is Darrin Weber of Risk Pro Partners in Dallas, Texas.
For more information about NASBP’s involvement with the FASB revenue recognition proposal, view the tabs at the top of this page.