New complexities for the construction industry follow the Revenue Recognition Accounting Standard issued on May 28, 2014. Many professionals in the construction industry who rely on financial statements are observing this change closely because it involves new definitions, terminology, and disclosures. In addition, performance obligations become the foundation to recognizing revenue.
JUST ONE ACCOUNTANT’S OPINION
I am excited for the changes and new standards presented to the accounting profession and to contractors, which I hope will add consistency and accuracy to the recognition of revenue in the industry. The jury is still out as accountants decipher over 700 pages of new standards. Some leaders in the construction industry feel there is still room for interpretation.
My biggest frustration with accounting is that while there are so many rules and regulations to follow, we still lack consistency from company to company. Accountants are great at following rules and regulations all day long. However, I realize that when I’m given rules with options or room for interpretation, I feel it is my obligation to creatively find the path best for my company.
WHAT DID YOU EXPECT?
Clear expectations of a project start with the construction contract. Contracts must clearly define each performance obligation in detail, so that all project stakeholders understand the project expectations. It is too risky for financial managers to make estimates with minimal data and limited information; this is also known as guessing, and many of us continue to do it for various reasons.
Today, we must consider total revenue and total cost. Add variables like change orders, weather, price fluctuations, labor efficiency variances, and so on. Then add the challenge of predicting the timing of all the transactions. We ask project managers for projection assistance but then we make personal predictions that the PMs are either too optimistic or too pessimistic. Let’s not carry subjective predictions on our shoulders, but rather ensure contracts clearly define obligations and end this guessing game.
PROJECT MASTER CONTRACT
Perhaps I am oversimplifying the change required, but it really does start by simply taking a new look at our contracts. This great opportunity for the construction industry demands that we work with legal professionals to develop a sound detailed schedule to which accountants can apply the new ruling without guessing.
Another question: If there is one performance obligation or many sub performance obligations for the entire project, then why not indicate the expectations up front? It should be relatively simple to have a project’s “Master Contract” indicate detailed information regarding each performance obligation. Would then the industry respond with a detailed “Performance Obligation Schedule” that is part of the contract? For example, identify when and how much revenue to recognize at each performance obligation which will be used to complete financial statements, taxes, etc. and stop the percent complete guesswork.
GET IT ALL OUT ON THE TABLE
The entire project should be spelled out like an amortization schedule for a loan. Everyone is aware of the interest being paid, the rate, terms, timing, etc., and the contract should do the same. Imagine the clarity it would provide all the stakeholders of the project, including surety, lender, companies, owner, GC, Subs, IRS, CPA, state, and local officials.
We do the same thing over and over expecting different results. Is that not a definition of insanity? We know we will have variation, change orders, claims, delays, and unforeseen issues in general. Why not plan for those and include them in a job schedule so everything is visible? Insurance requirements and policies should be transparent. And look at the entire policy, because that’s what you need to review when the “you-know-what” hits the fan. So consider the mountain of scenarios and questions that could arise and develop an action plan for each. Incorporating these in the contract will not only reduce claims and disputes but improve efficiency for all the contract stakeholders.
All parties involved should be aware of each other’s performance obligation. Contracts between owner, GC, sub, suppliers, and even insurance companies should be fully disclosed. And all contracts for the entire life of the project should consistently reflect these obligations. But many rarely ask for all the information. Are they afraid to ask for the information? Is this an invasion of privacy? The unspoken reality is that if they dig too deep they will most likely not get the work. Many sign the contract without really knowing their full obligation. Like downloading an app to your phone and agreeing to the terms without reading.
To remain competitive, one must keep some information close-to-the-vest. What is fair to disclose? What is important to disclose? What is considered business intelligence of the company? Profit margins, bids, the contract deal points?
Maybe we need levels of contract security; for example, Level 1 is confidential information between owner and GC; Level 2 is for insurance information needed by the subcontractors; Level 3 captures information needed by all; Level 4 is for specific scopes of work related to each subcontractor and Level 5 for warranty obligation, and so on. Would that outline the rules of the game and establish some agreed-upon fair play, while establishing expectations and mutual trust?
As financial managers we must take the guessing game out of our role. All stakeholders of a project should be involved in the contract; perhaps each participant has a different level of exposure, but full transparency is usually the best method in the long run. In any relationship or partnership, better results are achieved when roles, responsibilities, and expectations are clearly defined at the beginning. For best success, it’s valuable to discuss and plan for the unknown, and then see odds of survival dramatically increase. ■
Editor’s Note: In June, the Construction Financial Management Association (CFMA) presented a webinar, “It’s Here: The New Revenue Recognition Standard,” led by construction industry experts Timothy Wilson, CPA, CCIFP, partner of BKD LLP, and Michael Sobolewski, CPA, partner of PricewaterhouseCoopers. The recording is at: www.prolibraries.com/player/?libname=cfma&sessionID=473
About The Author Timothy M. Gray, CPA, CCIFP, is a market development manager for Viewpoint Construction Software in Portland, Oregon, where he is responsible for educating construction industry professionals on the use of software and technology. Tim has more than 22 years of professional accounting experience, with a focus on the construction industry.
Modern Contractor Solutions, September 2014
Did you enjoy this article?
Subscribe to the FREE Digital Edition of Modern Contractor Solutions Magazine!