Construction Industry Updates on FASB and Tax Legislation
As the construction industry continues to grow and transform, the regulations that govern the business evolve as well. One of the biggest changes to accounting standards over the last couple years is revenue recognition from contracts with customers. During 2015, Financial Accounting Standards Board (FASB) continued the lengthy process of implementing the new standards for revenue recognition, ASU 2014-09 Revenue From Contracts With Customers. Below is a discussion of key implementation issues in this statute, as well as a summary of other industry news.
Revenue Recognition Updates
Performance obligation determination
Most contractors probably see performance obligations in terms of individual contracts, but there are now exceptions to this general rule. Some of the exceptions involve the concepts of separately identifiable, significant integration service, and interdependence and will require the separation of some contracts into multiple performance obligations. Further guidance will be necessary with issues like defining when a significant change order becomes a new performance obligation, how to separate uninstalled materials from the main performance obligation, and several aspects of warranty contracts.
Principal versus agent
A typical contract to build a structure constitutes a “principal” relationship, with the contractor accepting risk for the project. However, under construction management contracts, the customer retains the risk. FASB has identified the principal-versus-agent problem as a topic that will receive attention and guidance during 2016.
Implementation guidance suggests that performance obligations must be reviewed at inception of the contract. This review covers materials that will remain uninstalled for a portion of time and tracks these amounts as separate performance obligations without a profit margin. The result will be similar to current general accepted accounting principles that require uninstalled materials to be excluded from the calculation of percent complete for gross profit recognition.
Treating variable consideration in contracts
Construction contracts typically provide an overall price. In addition to the stated amount, modifiers such as variable price concessions, quality incentives, early completion bonuses, or liquidated damages may impact the final contract amount. These forms of variable consideration will be included under two possible methods: the most likely method (specific outcomes) or the expected value method (a range of outcomes). For circumstances with specific outcomes, the single most likely outcome will be included in total estimated revenue, but when there is a range of outcomes a weighted average will be included in revenue.
Comparability of statements
The new standards of revenue recognition will be adopted on a prospective basis. The overriding concept is that revenue will be recognized as control is transferred, and this will most often result in recognizing revenue at a similar rate as the old standards. Comparability to prior periods could be an issue for those contractors who find significant differences. Performance indicators such as working capital, equity, and operating income are likely to remain comparable for most contractors. The new standards will restate all periods presented under the new standards, giving contractors the ability to explain the impacts on their operations.
The current effective date for public entities begins after December 15, 2017, and for private entities after December 15, 2018. Companies will find that the way revenue is calculated is different; however, the end result will be similar.
Tax issues may emerge from the financial accounting revenue recognition proposals. Because the guidance affects the timing of financial statement income recognition, the timing of taxable income recognition may also be impacted. If contractors make changes in their financial reporting, they must formally secure IRS approval to adopt the method change.
Anticipating these issues, the IRS issued Notice 2015-40. This notice requested public comment on how the new revenue recognition standards will affect the taxpayer’s methods of accounting. The Association of General Contractors of America (AGC) submitted comments in September of 2015 in which they pointed out that the new revenue recognition standards effectively eliminate the percentage of completion method for financial reporting purposes. Though the IRS has now received public comment, it has not yet presented findings.
Section 179D — commercial energy efficient deduction
This provision allows governmental agencies to pass the deduction to the primary designer. This contractor-favorable law was extended for two years (2015 – 2016) as a result of the Protecting Americans from Tax Hikes (PATH) Act of 2015. The AGC supported changes to extend this benefit to both nonprofits and tribal organizations, which were not included in the PATH legislation.
Section 199 — Domestic Production Activities Deduction
On August 27, 2015, proposed regulations were issued that would make the contractor eligible for the DPAD deduction if the owner has capitalized the costs of his work. The current regulations require a substantial renovation test to determine if the contractor’s activities rise to the level that would allow for the current additional 9 percent deduction of qualified production activities income. AGC commented that the proposed regulations should retain the current rules or implement a safe harbor threshold of $5,000. The AGC also commented that the new proposed regulations are burdensome on contractors who are not well positioned to make this determination.
How we can help
CLA can help you understand how these changes impact your organization, so that you can adapt to these standards and embrace the changes with confidence. You can focus on the responsibilities of running your business when you are confident that the professionals you work with thoroughly understand the industry and will be beside you every step of the way.