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New Revenue Recognition Standards for Government Contractors (Second in the Series)

Category: Articles

By Robert N. Gray, CPA 

During 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers.  The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  To achieve the core principle, an entity should follow a five step process:

  1. Identify the contract with a customer;
  2. Identify the performance obligations in the contract;
  3. Determine the transaction price;
  4. Allocate the transaction price; and
  5. Recognize revenue when or as the entity satisfies a performance obligation. 

In our first article, we presented an overview of the new financial accounting and reporting standard and discussed the impact it may have on government contractors.  In this article, we will briefly discuss the first two steps above: identify the contract and the performance obligations. 

Performance Obligations 

Under the new standard, revenue is recognized as a contractor performs its obligation to deliver goods and/or services to a customer.  At contract inception, therefore, a contractor must identify each distinct performance obligation in a contract. A single contract could have more than one performance obligation. 

Distinct Goods or Services 

In order for a promised good or service to be distinct, it must be separately identifiable from other promises in the contract.  Factors that indicate a promised good or service is distinct include: (a) the good or service is not input to produce or deliver the combined output specified by the customer; (b) the good or service does not significantly modify or customize another good or service promised in the contract, and (c) the good or service is not highly dependent on or highly interrelated with other promised goods or services in the contract. 

Combining Contracts 

Sometimes parties enter into multiple contracts at or near the same time. When this happens, a contractor may have to combine the separate contracts and treat them as a single contract if (a) the contracts are negotiated with a single commercial objective, (b) the amount of consideration in one contract depends on the other contract, or (c) the goods or services promised are a single performance obligation. 

Contract Modifications 

Contract modifications that have been approved as to change in scope and price must be evaluated to see whether a modification constitutes a separate contract with new deliverables, or simply an amendment to the contract.  

Principal vs. Agent 

Sometimes a contractor sells goods or services but contracts with another entity to deliver the goods or services.  An entity is acting as a principal if it delivers the goods or services itself.  The delivery of the goods or services is its performance obligation. A principal recognizes revenue equal to the gross amount of consideration to be exchanged for providing the goods or services. The contractor, however, is an agent if the contractor arranges for someone else to deliver the goods or services.  An agent’s performance obligation is simply to arrange for the delivery of the goods or services by another party.  An agent recognizes, as revenue, the fee or commission expected to be received for arranging the delivery of the goods or services. 

Guidance and Consistency 

ASU 2014-09 provides considerable guidance to help an entity work through the maze of identifying contracts and performance obligations as discussed above, given the entity’s specific facts and circumstances.  Most contractors provide goods and/or services that are similar from contract to contract.  Accordingly, once the contractor understands ASU 2014-09 and decides that certain accounting in a particular situation is appropriate, the contractor will generally have to be consistent in applying that accounting in contractual arrangement for other contracts with similar facts and circumstances. 

Example 

Assume a contractor agrees to design and install an IT system for a customer under a fixed price arrangement priced to cover direct and indirect costs plus a profit of 10%.  In addition, the contractor agrees to acquire the IT equipment for the customer for the price of the equipment plus a material handling fee of 4%. 

Under current accounting standards, the contractor might conclude it has one contract for which revenue is recognized using percentage-of-completion for the design, installation and equipment.  Under ASU 2014-09, however, the contractor must address whether it has one or more performance obligations under the contract. 

The contractor may decide its typical contract involves only designing and installing IT systems for its customer, and it would only agree to acquire the equipment as an accommodation to a customer.  Based on this assessment, the contractor may conclude it has two distinct performance obligations for which revenue is computed separately – IT design and installation for which a percentage-of-completion method might be used, and equipment acquisition for which revenue might be recognized upon delivery of the equipment. Further, the contractor may want to assess it is acting as an agent for acquisition of the equipment, and thus its revenue is simply the handling fee for the service.  

However, if acquiring the equipment was a typical service for customers as part of providing an IT system, the contractor may conclude that the design, installation and equipment acquisition are highly interrelated and thus one performance obligation – to deliver an IT system -- for which revenue might be computed using a percentage-of-completion method. 

Effective Date 

ASU 2014-09 is currently effective for the 2017 financial statements of public companies, and for the 2018 financial statements of non-public companies.  However, the FASB has agreed to propose a one year deferral.  Effective dates for 2018 and 2019 financial statements may seem the distant future at the present time, but given the complexity and extent of the ASU, contractors should begin understanding its requirements and assessing the impact on the accounting for their contracts. 

Future articles in this series will discuss (a) determining and allocating the contract price, and (b) measuring the progress on meeting performance obligations and recognizing contract revenue. 

Robert N. Gray, CPA, is a shareholder in Rubino & Company, Chartered. Mr. Gray oversees the accounting and auditing practice for the firm and serves as the firm’s Director of Quality Control.  He has over 40 years of public accounting experience and serves clients in a wide range of industries throughout the mid-Atlantic region.  

Rubino & Company plans additional articles, webinars and seminars to help our clients work through the new requirements to ensure timely and cost-efficient implementation of the new requirements.  If you have questions about this topic, please do not hesitate to contact us.

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