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December 9, 2020

ASC 606: A 5-Steps to Keeping Up With New Construction Accounting Rules

Posted by Ryan Prindiville

Construction hat accounting rules ASC 606

One of the most significant changes in the modern construction industry came in an unexpected form – new accounting rules. When ASC 606 took effect in 2018, it forced everyone in the construction industry, no matter how large or small, to fundamentally change how they approach revenue, accounting and their overall operating model.

ASC 606 changed how contractors traditionally report revenue. Instead of using either the completed contract method (CCM) or the percentage of completion method (PCM), contractors must now use what’s known as a “performance obligation.” It’s the most important aspect of these new rules, but it’s also a complex and unfamiliar concept to construction accountants trained in the previous standards.

To help these accountants properly record revenue under ASC 606, the Financial Accounting Standards Board (the creator of the rules) outlined a five-step process. Here’s a condensed version:

1. Identify the Contracts

Recognizing revenue starts by identifying every legal agreement through which a company expects to collect money. That seems simple, but construction projects often involve multiple parties and multiple contracts with one party, which must then be grouped under one contract or segmented out based on performance obligation. Deciding whether to record change orders as part of an existing contract or new contract makes things even more complicated. Nonetheless, accountants must now connect every cent of revenue to a contract.

2. Identify the Performance Obligations

Each contract has at least one (but possibly more) performance obligation. For example, a contractor hired to build an office tower and an adjacent parking structure can consider each of those obligations separately. Conversely, a contractor hired to renovate a whole house can’t consider individual jobs (plumbing, electrical, landscaping, etc.) to each be separate performance obligations.

3. Calculate the Transaction Price

With the terms of the contract established, accountants can determine the expected revenue from that contract, at least in theory. In practice, variable considerations make it difficult to pin down an exact number. Things like incentives/penalties, change orders, or changes in material costs can all impact a project’s profitability. Financing agreements can also affect how accountants record the transaction price.

4. Allocate the Price

This step involves connecting the transaction price identified in step three to the performance obligations from step two. According to the language of ASC 606, contractors should base the price on the “relative standalone price” of each good or service included.

5. Recognize the Revenue

Finally, the contractor records revenue only once a performance obligation has been met. That can get complicated with ongoing projects – like a series of homes built as part of a new development. In that case, the contractor needs to include provisions in the contract identifying when and under what conditions they expect payment.

If you struggle to follow this process or make sense of ASC 606, you’re hardly alone. These rules caught many companies off-guard, and the process outlined above has significant grey areas. Still, these are mandatory regulations you must adhere to, and you can face penalties if you’re not in compliance.

Check out this easy-to-follow checklist from Armanino’s technical accounting and audit experts to ensure your organization will be ready.

Read more about, Streamlining Retainage Billing in the Construction Industry.

If you have questions about how ASC 606 affects your organization, our accounting and construction industry experts are here to help. Feel free to contact us and we can bring you up to speed.

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