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For several years, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been working toward converging US GAAP with International Financial Reporting standards (IFRS).  The convergence efforts are expected to produce substantial changes to current US GAAP with wide-ranging implications for preparers and users of financial statements of nonpublic entities.  And this is taking place with what seems to be limited regard for the views of preparers and users concerning the benefits of and need for such changes.  One such proposed change being discussed involves revenue recognition for long-term contracts.

Current Practice:  A contractor currently recognizes revenue and gross profit from its contracts using the percentage-of-completion method, in accordance with US GAAP.  As such, revenue and gross profit from each contract are recognized each reporting period based on contract costs incurred, labor hours, or other measures of progress.

Proposed Changes and Impact:  FASB has proposed an accounting standard that would establish a single revenue standard that would apply across various industries and capital markets.  The proposed guidance is based on the principle that revenue from contracts should be recognized when an entity transfers goods and services to the customer, satisfying its contractual performance obligations.  However, for long term contracts, revenue could be recognized during the contract period (rather than at the end of the contract) if the customer controls the work in process.  A contractor would satisfy a performance obligation over time if at least one of the following two criteria is met:

The contractor's performance creates or enhances an asset that the customer controls as the asset is created or enhanced, or
The contractor's performance does not create an asset with alternative use to the contractor, and at least one of the following is met:
The customer receives a benefit as the contractor performs each task;
A second contractor would not need to re-perform the task(s) performed to date if that second contractor were to fulfill the remaining obligation to the customer without the benefit of any inventory controlled by the original contractor; or
The contractor has a right to payment for performance to date.
A contractor would recognize revenue for a performance obligation satisfied over time using the costs incurred, labor hours, or other inputs that can reasonably measure progress toward successful completion of the performance obligation.  Thus, a contractor will have to review each of its contracts in terms of its performance obligations and re-assess the propriety of the bases used to measure contact progress, giving consideration to the new guidance when finalized.  It appears, however, the result may be revenue recognition that approximates revenue determined under current percentage of completion methods rules.  Thus, the adverse impact of this proposed accounting change will likely be far less for contractors than initially thought when it was originally proposed.

Effective Dates:  FASB has a goal to issue a final standard by the end of 2011.  No likely effective date has been indicated, but FASB staff members have suggested the effective date could be at least two years from the issue dated to allow companies to absorb the impact.  There will likely be a requirement to restate prior year information presented after the effective date.

In our next article, we will visit the proposed changes being considered for leases and financial statement presentation.

 Robert N. Gray, CPA is a Shareholder with Rubino & McGeehin and can be reached at rgray@rubino.com for more information related to this topic.