Adapting To ASC 606 Accounting Changes Will Take Longer Than Construction Companies Realize
After going into effect for public companies this fiscal year, Accounting Standards Codification 606 will apply to private companies come January.
The Financial Accounting Standards Board amendment, which unifies revenue recognition strategies for nearly all industries under one model, will do more than change how a company issues its financial statements. It may also impact the way companies handle everything from accounting and sales to employee compensation plans. This means the time to implement may be significantly longer than most companies are anticipating.
“When it comes to figuring out how to go about implementing a standard as complex as 606, it is really important to take the time to assess its impact on the entire organization,” Baker Tilly Senior Manager John Hennessy said. “Some organizations believe that because this is an accounting standard, it must only impact our accounting team, but in reality, this requires a companywide effort to implement.”
At a high level, ASC 606 is broken down into a multistep process that companies must use to determine when and how revenue is recognized. In particular, they must recognize revenue in a manner that is consistent with the transfer of goods or services to the customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This includes breaking down performance obligations, determining the transaction price and allocating the transaction price to the identified performance obligations before revenue can be recognized.
For the construction industry, tracking revenue over time has historically been a part of the accounting process under existing U.S. generally accepted accounting principles, GAAP. Under the percentage of completion method of revenue recognition, general contractors and subcontractors alike recognize revenue based on a measure of progress, which generally are costs incurred as a percentage of total estimated costs.
Due to the nature of the industry — a project takes time to construct and follows a delivery schedule — many construction companies are used to over-time accounting strategies. The new revenue recognition standard may change when the revenue can be recognized, in turn changing how compensation is determined, processes for tracking revenue and how the revenue is reported.
The challenge for contractors will be modifying existing systems and processes to comply with the more complex nuances of ASC 606.
“Areas of a revenue recognition that had previously been defaults for construction companies under existing guidance now require more consideration and in-depth documentation to fit inside the new model,” Hennessy said. “Companies have to now break away from the rule-based guidance that they have known for quite some time and apply the new principles.”
The objective of ASC 606 is to create a unified, principles-based standard on accounting for revenue from customers. In doing so, the FASB and International Accounting Standards Board jointly replaced hundreds of pages of rules-based guidance principally designed for specific industries, including construction, to provide consistent and useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue from contracts with customers.
The converged FASB and IASB standard will improve the comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets.
But the scope of the accounting change, and its potential to radically redefine how businesses recognize revenue, have some companies concerned. Many are overhauling their reporting. IBM plans to spend almost $40M adopting the new standard. The intensity is warranted with the scrutiny regulators will be applying to companies’ financial statements in the year of adoption: a C-suite member of a tech company went to jail in 1999 after falsely reporting $2B of revenue.
“A lot of the fear is in the undertaking of the new standards and the effort to become compliant,” Hennessy said. “Construction is a competitive market, so controlling cost is always on the forefront of our clients' minds."
Deadlines quickly approaching
With less than four months remaining until the new accounting standard is effective for private companies, now is the time for companies to be proactive, Hennessy said. Rather than rush to comply with the new standards, they should spend the time developing a project plan that identifies which areas of the company will be impacted the most from ASC 606.
“Education will be important,” Hennessy said. “You are going to need to have people who are knowledgeable about the standards in various areas of your business because they will have to identify the events or circumstances that may change how you recognize revenue for a particular contract.”
For companies that don't have the expertise required to develop a project plan and work toward compliance, partnering with a third-party, like Baker Tilly, can help a business develop the necessary systems and processes required to transition to ASC 606.
This feature was produced in collaboration between Bisnow Branded Content and Baker Tilly. Bisnow news staff was not involved in the production of this content.