ASC 606: Revenue Recognition: “Percentage-of-Completion” to “Over Time”
TRANSFER OF CONTROL
ASC 606 provides different guidance about revenue recognition because it explains things differently about completion of contracts. Instead of thinking about revenue recognition based on being able to estimate the contract value and duration, it considers it in terms of “performance obligations” and how they transfer control.
The new revenue guidance under ASC 606 introduces “transfer of control” to determine when to recognize revenue for completed work. “Transfer of control” means when the work becomes the customer’s to own and take possession of. Depending on the contract, it can happen either at a single “point in time” or “over time”.
Transfer of control to occur at a “point in time” when all the following are true:
- the customer doesn’t receive and utilize the benefits from the work until the end of contract
- the contractor creates or improves an asset that’s under their own control
- if the contract falls apart, the contractor will be able to make other use of the asset — plus the contractor doesn’t have an enforceable right to payment until contract completion
Transfer of control is “over time” when any of the following conditions are met:
- the customer obtains and utilizes benefits from the work performed as the contractor performs it
- the contractor creates or improves an asset under the customer’s control
- the contractor can’t make use of the asset they create separately from the contract, and they have an enforceable right to payment for work completed
Transfer “over time,” the customer will generally hold legal title and, therefore, ongoing use and benefit of the asset. This will usually mean the contractor can bill the customer for the value they’re adding to the customer’s property as they’re adding it. In this way, recognizing revenue “over time” under ASC 606 is very similar to using the percentage-of-completion method.
If a non-public company has both types of revenues: point-in-time and over time, disclosure requirements under ASC 606 require presenting and disclosing each separately. (Either on the face of the financial statements or in the footnote disclosures.)
RECOGNIZING REVENUE “OVER TIME” UNDER ASC 606
Under the new revenue recognition guidance, contracts that transfer control “over time” would use a percentage of completion to determine how much of each performance obligation’s price is earned. Under the five-step model, it requires construction companies first to identify the performance obligations in the contract (could be multiple performance obligations) and allocate a transaction price to each one. That would mean the percentage of completion is applied to each performance obligation rather than to a total contract price.
Options for calculating percent complete are very similar between the old ASC 605 and the newer ASC 606. The construction company can make an election for an output method (units produced, estimated completion) or an input method (incurred costs, labor hours used).
ASC 606 provides guidance when companies use a percentage-of-completion method. First, construction companies must use the same percentage-of-completion measure for all performance obligations under the same contract. Second, they should use a measure that reflects the percentage or portion transferred into the control of the customer.
If a construction company uses an input method (including cost-to-cost), they have to exclude unproductive inputs when calculating progress this includes defective materials or wasted labor. They also need to adjust for “uninstalled materials,”which has a special definition under the new guidance. Construction companies can recognize revenue for these materials in an amount equal to their cost, using the “zero-profit carve-out method” when they transfer control.
While many characteristics of a percentage-of-completion method remain the same under ASC 606, the new guidance does need to be considered seriously. Some of the major conceptual changes regarding performance obligations impact how it will be used. Construction companies need to consider advanced points of guidance as well, just as with previous GAAP guidance and IRS reporting requirements. Construction companies should work closely with their construction savvy CPA for guidance on their situation and any assistance needed in interpreting individual contracts.