Revenue Recognition For Construction Companies + Examples

Revenue Recognition

Revenue recognition for construction companies has been a hot topic lately. The new revenue recognition standard, ASC 606, was released in 2014 and applies to all industries, including the construction industry. 

However, specific considerations need to be taken into account when applying this new revenue recognition standard to the construction industry. This article will explore those considerations and provide some revenue recognition examples for construction companies.

 

What Is The New Standard Of Revenue Recognition?

The new revenue recognition standard, ASC 606, was released by the Financial Accounting Standards Board (FASB) in 2014. This new standard provides guidance on how to recognize revenue from contracts with customers. The main goal of this new revenue recognition standard is to provide a more consistent and transparent revenue recognition practice across all industries.

This new standard changed the revenue recognition criteria from when revenue can be recognized to when revenue should be recognized. This means that revenue can only be realized when it meets the following criteria:

  • Customer has been provided with the good or service
  • Customer has paid for the good or service
  • Reasonable assurance that the company will receive payment for the good or service

 

How Does This New Standard Apply to the Construction Industry?

The revenue recognition process for construction companies is generally the same as it is for other industries. However, some specific considerations need to be considered when applying this new revenue recognition standard to the construction industry.

Construction projects often span multiple accounting periods. This means that revenue from a construction project can be recognized over multiple accounting periods. Therefore, construction companies need to use the percentage of completion method. This method estimates revenue based on the percent of work that has been completed.

Another consideration is construction projects are often subject to change orders. A change order is an amendment to a construction contract that results in a change in the project’s scope, price, or schedule. When a change order occurs, the revenue recognition process may need to be adjusted accordingly.

 

New Revenue Recognition Examples

Here are a few examples of how the new revenue recognition works.

Example 1: Percentage of Completion Method

Construction Company A has a contract to build a new office building for $10 million. The project is expected to take two years to complete. Construction Company A uses the percentage of completion method to estimate revenue from this project.

In year one, Construction Company A completes 50% of the project. This means that Construction Company A can recognize $5 million in revenue from the project in year one. In year two, Construction Company A completes the remaining 50% of the project and can recognize an additional $5 million in revenue.

Example 2: Change Order

Construction Company B has a contract to build a new school for $20 million. The project is expected to take two years to complete. Partway through the project, the school district decides to add an extra wing to the school. This results in a change order for $5 million.

Construction Company B will need to adjust its revenue recognition process for this project. In year one, Construction Company B completes 50% of the original scope of work. This means that Construction Company B can recognize $10 million in revenue from the project in year one. In year two, Construction Company B completes the remaining 50% of the original scope of work and the additional work from the change order. This means that Construction Company B can recognize an additional $15 million in revenue in year two.

Example 3: Deferred Revenue

Construction Company C has a contract to build a new shopping mall for $30 million. The project is expected to take two years to complete. Therefore, construction Company C uses the percentage of completion method to estimate revenue from this project.

In year one, Construction Company C completes 60% of the project. This means that Construction Company C can recognize $18 million in revenue from the project in year one. In year two, Construction Company C completes the remaining 40% of the project and can recognize an additional $12 million in revenue.

However, the shopping mall will not be open to the public until after the completion of construction. This means that Construction Company C will not receive payment for the project until after it is completed. As a result, Construction Company C will need to defer $30 million of revenue from this project until after it is completed.

These are just a few examples of how revenue recognition works for construction companies under the new revenue recognition standard. For more information on how this new standard applies to your business, please consult with your accountant or financial advisor.