A copy of the revenue recognition for Contractors presentation given at the NECA NOW Conference in April 2013.

1. Revenue Recognition
Deep Dive
Presenters: Tim Wilson and Tony Hakes

2.  Revenue recognition is a hot topic for
contractors
 Lenders and sureties are monitoring this
closely
 Very complicated in the construction industry
 General vs. Subcontractor
 Specifics for electrical contractors?

3.  Revised Exposure Draft Issued November 14, 2011 – Revenue
Recognition (Topic 605) Revenue from Contracts with Customers
 Goals
 Develop a common revenue standard for industries, jurisdictions &
capital markets
 Condense 100+ rules into 1 “high quality” standard
 Will ultimately repeal/replace current accounting and reporting
guidance (SOP 81-1 for those familiar with this pronouncement)

4.  Let‟s take a look back to understand how we
got here on revenue recognition for
contractors…….

5. • Revised Exposure Draft comes after receiving substantial comment
letter input from original exposure draft as well as from testimony
gathered at public roundtables from around the globe.
• Still a number of matters that were of consequence and concern to the
construction industry remained.
• 351 comment letters submitted in response to the Revised Exposure
Draft.
• Substantial redeliberations took place throughout most of last Spring
and early Summer.

6. • February 20, 2013, the redeliberations were concluded.
• The final standard/rules are expected to be issued in the second
quarter of 2013.
• Core principle:
• To recognize and record revenue as goods and services are
transferred to the customer (ie – as work is performed).
• Sounds similar to what we have been doing for 30+ years, but…
• A number of matters that are of consequence and concern to the
construction industry exist.

8. An entity shall recognize revenue to depict the
transfer of goods or services to customers in an
amount that reflects the consideration the entity
receives, or expects to receive, in exchange for
those goods or services.

9. Recognize revenue as performance
obligations are satisfied
Allocate transaction price to
performance obligations
Determine the transaction price
Identify separate performance
obligations in the contract 2
3
4
5
(These steps are
unchanged from
original exposure
draft)
Proposed Recognition Model – Steps Involved
Identify contract with the customer 1
Rev. Rec. Exposure Draft

10.  Four criteria for existence of a contract
– Commercial substance
– Approval by both parties
– Identifiable rights regarding assets to be
transferred
– Identifiable payment terms (even if amount is
uncertain)

11.  Combination of Contracts
– Contracts negotiated as a package
– Amount paid on one contract depends on the
price or performance on the other contract(s)
– Goods or services promised are one
performance obligation
– Segmenting –
– Inherent in identification of separate
performance obligations if more than one
exists in the contract

12.  Goods and services accounted for as a single
performance obligation if risks are inseparable
 The goods or services are highly interrelated and the
entity provides a significant „integration‟ service
 The entity significantly modifies the goods or
services as negotiated specifically with the customer
 Providing the goods or services requires common
resources that cannot be reasonably separated
 What does this mean for electrical contractors?

13.  In all other cases, account for a good or service
separately if:
 It is distinct (i.e. is sold separately or has utility on its
own), and
 It has a different pattern of transfer
 In some cases, a whole contract may be one
performance obligation
 What about change orders?

14.  Transaction price:
 The amount of consideration to which an entity
expects to be entitled to receive in exchange
for transferring goods or services
 Time and material vs. fixed price?
 Variable consideration (constraint concept):
 Exact guidance to come with final standard.

15.  Time value of money
 Discounting required only if there is a
significant financing component
 One year practical expedient
 Collectability
 Estimate bad debt and present separately as a
component of SG&A expenses.

16.  Allocate the amount an entity expects to
receive in exchange for satisfying each
separate performance obligation.
 Use standalone selling prices of goods or
services (estimated if necessary).

17.  If the performance obligation(s) satisfied over
time, effectively follow percentage-of-
completion method
 entity‟s performance creates or enhances an asset that
the customer controls, or
 another entity would not need to re-perform work
completed to date, or
 entity has right to payment for work completed to date
 Time and material jobs?

18.  Measuring progress toward completion
 Objective: depict the value of performance to date
 Output methods or input methods permitted
 If input method used, must exclude inputs that do
not depict performance (owner provided materials,
waste, uninstalled materials – key for electrical
contractors)
 Zero margin may be appropriate in some
circumstances (e.g. early stage of contract,
uninstalled materials)

19.  Got a lot of things right that we were
expecting
 How a performance obligation is defined
 Clarifying continuous transfer criteria
 No preference for inputs vs. outputs methods on
measuring progress
 Relief from disclosures for non-public entities
 But…

20. • There are some areas that are problematic in the
standard
• Examples include:
– Claims and unapproved change orders
– Time value of money
– Collectibility
– Onerous Performance Obligations
– Exclusion of inputs that are not reflective of progress
towards completion
– Uninstalled materials

21. • Requirement for recognition:
– Refer to the 4 criteria for contract existence
– Key: Approval by both parties
– Electrical contractors make changes on the fly….
– Expected revision to final standard:
– Contract modifications, including a contract claim, would be
approved when the modification creates or changes the
enforceable rights and obligations of the parties to the contract.

22.  If approved as to scope, even if un-priced,
Company will be able to recognize estimated
margin on change orders.
 What does this mean?
 More focus on treatment of “approved as to
scope”?
 More focus on rationale for estimated margin?

23. • Views on claims
– Some argue that a literal reading of the Revised
Exposure Draft is a “claim killer” meaning no
revenue and only costs are recognized when
claims arise until agreement is reached
– Others argue that proper interpretation of the
Revised Exposure Draft permits claim revenues
and costs to be recognized.

24. • Unpriced Change Orders
• Old Rule – reflect if the recovery is probable and reasonably
estimated
• New Rule – reflect when the contractor expects the price change
will be approved and creates enforceable rights
• Claims
• Old Rule – reflect when probable and estimable up to the extent
of costs incurred – no margin until realized
• New Rule – include in transaction price when “reasonably
assured” of being entitled to receive the claim

25. • Requirement for application/discounting:
• Transaction/contract price adjusted to reflect the time
value of money if a significant financing component
exists.
• Considerations:
• Expected length of time between delivery of goods and
services and receipt of payment.
• Whether amount of payment would differ substantially
if cash payment was received in accordance with
typical credit terms.

26. • Exception:
• Expectation at contract inception,
• Period between payment and performance < 1
year
• Applicable to contracts > 1 year in duration if
period between performance and payment is < 1
year

27. • Retention:
• Will depend on contract terms and normal practices.
• It is unclear whether the right of offset would exist or
not; therefore, financing of retention receivables would
not necessarily be able to be offset against retentions
payable.
• Overbillings:
• Also unclear if concept is intended to be applied to
contracts with significant under or over billings.

28. • Interplay with onerous performance obligation
criteria
– Measure against contract revenue. Contract revenue excludes interest
income if net financing component is deemed to exist in contract. In
this situation, you could have a contract with thin margins, but still
with an overall profit; however, after applying the TV$ criteria in
connection with the onerous performance obligation criteria, you could
end up having to accrue a loss when the overall economic arrangement
is actually a profit!
– The inverse is true as well!

29. Current New
Accounting Accounting
Contract amount 1,000,000$ $917,000 **
Estimated direct materials and labor (800,000) (800,000)
Overhead applied (160,000) (160,000)
Gross profit (loss) on contract 40,000$ (43,000)$
** Discounted @ 6%
Terms: Project requires completion of all work within a 24-month
period with payments of $500,000 each occurring at the end of the
12th and 24th months.

30. • Collectibility criteria, as written, are based on more
than just the customer‟s inherent inability to pay.
• It also refers to the risk that a Company will not be
able to collect from its customer(s) the amounts that
it expects to be entitled.
• What does this mean in practical application?
• Choosing not to pursue certain amounts due from customers.
• Gross up of revenue beyond “real” revenue offset by gross up of
bad debts expense.
• Past practices may have focused on only recognizing revenue based
on expected collections

31. Current New
Presentation Presentation
Contract revenues 63,000,000$ 63,000,000$
Cost of contract revenues 52,500,000 52,500,000
Gross profit 10,500,000 10,500,000
SG&A expense 7,500,000 7,250,000
Bad debt expense - 250,000
Total SG&A expenses 7,500,000 7,500,000
Income from operations 3,000,000 3,000,000
Other income (expense) (100,000) (100,000)
Net income 2,900,000$ 2,900,000$
ABC CONSTRUCTION, INC.
STATEMENT OF COMPREHENSIVE INCOME
Year Ended December 31, 201X

32.  Requirement is to exclude costs of inputs that are not
reflective of contract progress
 When using an input method, an entity shall exclude
the effects of any inputs that do not depict the transfer
of control of goods or services to the customer (e.g. the
costs of wasted material or labor).
 Arguably, the first dollar of labor on re-work should
theoretically be expensed as incurred and not included
in the measure of contract revenue
 Expected revision:
 Exclude such cost if performance would be distorted

33. • Requirement is to exclude the cost of
uninstalled materials that are not reflective of
contract progress
– Language in Revised Exposure Draft was
inaccurate
– Desire to eliminate profit recognition on
uninstalled materials (believed to be the intent)
– Effect on financial statements if such costs can be
billed?
– Effect on bonding/underwriting?

34. Forecasted
Contract Amts
Contract amount 1,000,000$
Estimated direct materials and labor (800,000)
Overhead applied (80,000)
Gross profit on contract 120,000$
Terms: Project requires installation of 10 pre-fabricated units that will
be constructed offsite prior to installation. Duration of contract is
estimated at 9 months and contract price is $1,000,000.

35. Current New
Accounting Accounting
Direct materials and labor to date 400,000$ 400,000$
Overhead applied 40,000 40,000
Total costs incurred to date 440,000 440,000
Less: Cost of uninstalled materials - (440,000)
Adjusted total costs incurred to date 440,000$ -$
Percentage complete - cost-to-cost method 50.00% 0.00%
Revenue recognized 500,000$ -$
Gross Profit recognized 60,000$ -$
Contract billings 600,000$ 600,000$
Contract under (over) billings (100,000)$ (600,000)$
After 3 months, 5 of the pre-fabricatd units have been constructed offsite at
the contractor's warehouse. None of the units have been installed.

36. Current New
Accounting Accounting
Contracts receivable (asset) 600,000$ 600,000$
Inventory (asset) - 440,000
Contract over billings (liability) 100,000$ 600,000$
Contract revenues (revenue) 500,000$ -$
Contract costs (cost of revenue) 440,000$ -$
Selected financial statement line items:

37.  As with SOP 81-1, contractors would accrue an anticipated loss
once identified
 However, proposed standard would not require that losses be
accrued on contracts of less than year duration

38. • Like so many other aspects of the standard, the challenge lies
with the interplay between various provisions.
• An onerous performance obligation is one where the cost of
settling the performance obligation is more than the transaction
price (ie – loss contract)
• The transaction price includes amounts the entity expects to be
entitled
• “Expects to be entitled” can include claim revenue.
• So…

39.  So…
 Even if you don‟t yet recognize the claim revenue , you would/
could count the claim revenue in the transaction price and in
doing so, defer a loss that should have been recognized

40. • Other items:
– Variable/contingent consideration
– Disclosures – new
– Effect on employee performance incentives
– Effective date and transition

41. • Constraint concept:
– Constrain the cumulative amount of revenue
recognized that should not be subject to significant
reversal.
– Assessment will be qualitative.
– Need to assess all facts and circumstances of risks
of revenue reversal.
– Uncertain future events.
– Magnitude of reversal if uncertain events were to occur.

42. • Application of constraint concept:
– When are/will the following be recognized on a
contract:
– Performance award incentive for early completion
– Performance award incentive for quality of construction
– Performance award incentive for attaining LEED Platinum
Cert.
– Performance award penalty (contract reduction) for delays
– Performance award penalty (contract reduction) for lower
quality material substitution

43. • Disaggregation of revenue by category
– Type of good or service
– Country or region
– Type of customer
– Type of contract
– Reconciliation of contract balances and costs
– Narrative disclosures

44. • Bank covenant requirements
• Earnings metrics
• Excess cash flow payments
• Employee Performance Incentives – bonuses
based on revenues and/or net income

45. Forecasted
Contract Amts
Base contract amount (excluding incentive) 1,200,000$
Estimated direct materials and labor (980,000)
Overhead applied (147,000)
Gross profit on contract 73,000$
Terms: $1.2M project for refurbishment of an existing office building with
target minimum LEED Gold Certification upon completion. Performance
incentive award of $200,000 if LEED Platinum Certification is obtained upon
completion. Expected project duration: 2.5 years.

46. Contract Contract
Current Accounting - Year 1 Incep. to Date Current Year
Direct materials and labor to date 400,000$ 400,000$
Overhead applied 60,000 60,000
Adjusted total costs incurred to date 460,000$ 460,000$
Percentage complete - cost-to-cost method 40.82% 40.82%
Revenue recognized 489,796$ 489,796$
Gross Profit recognized 29,796$ 29,796$
Contract Contract
Current Accounting - Year 2 Incep. to Date Current Year
Direct materials and labor to date 880,000$ 480,000$
Overhead applied 132,000 72,000
Adjusted total costs incurred to date 1,012,000$ 552,000$
Percentage complete - cost-to-cost method 89.80% 48.98%
Base revenue recognized 1,077,551$ 587,755$
Incentive revenue recognized 150,000 150,000
Revenue recognized 1,227,551$ 737,755$
Gross Profit recognized 215,551$ 185,755$
The first 2 years (assume project start on day 1 of fiscal year) of project completion precedes
required adoption of new revenue recognition standard/rules.

47. Contract Contract
New Accounting - Year 3 Incep. to Date Current Year
Direct materials and labor to date 980,000$ 100,000$
Overhead applied 147,000 15,000
Adjusted total costs incurred to date 1,127,000$ 115,000$
Percentage complete - cost-to-cost method 100.00% 10.20%
Base revenue recognized 1,200,000$ 122,449$
Incentive revenue recognized 200,000 200,000
Revenue recognized 1,400,000$ 322,449$
Gross Profit recognized 273,000$ 207,449$
Assume new accounting guidance for revenue recognition is required on day 1 of the
beginning of the 3rd year of the contract. The transition effect of the contract on the
contractor's financial statements is recorded as an adjustment to beginning equity. The
results of the contract are reflected in the income statement for year 3 based on the new
accounting guidance - potential for reporting a portion of incentive revenue twice.

48. • January 1, 2018: effective date for non-public
entities
• Early adoption is not permitted
• Transition
– Retrospective application – restate prior periods
upon adoption, or
– Apply to existing contracts in progress on the
effective date and new contracts going forward
– Requires cumulative effect adjustment and certain
additional transition disclosures.

49. Additional Discussion Material –
FASB‟s Private Company
Reporting AICPA‟s Framework
for SMEs
--as time permits

50. • „Exceptions‟ to US GAAP for non-public
companies
• Opportunities to reduce complexities/costs
• Serve needs of users
• Without sacrificing
– Quality
– Fundamental level of comparability

51. • 6 differential factors
• Key issues on their agenda:
• Variable interest entities
• Interest rate swaps
• Intangibles including goodwill
• Uncertain tax positions

52. • Other comprehensive basis of accounting
• Non-GAAP
• Simpler and not as rules-based
• Work in progress
• Concerns:
• Acceptance by users
• Consistency in application

53. • NASBP Survey on SMEs
• 100+ responses
• 90% are unsure of what it is
• Majority believes a SME is less than $50 million
• 51% said they would not accept this report
• 72% said this framework would not be as consistent
and reliable as GAAP
• 81% said it would impact credit capacity and pricing

54. Questions???

55. Tim Wilson, CPA, CCIFP
National Industry Partner
BKD, LLP
1201 Walnut, Suite 1700
Kansas City, MO 64106
twilson@bkd.com
(816) 701-0208
Anthony M. Hakes, CPA, CCIFP
A/E/C Market Leader-Phoenix
Mayer Hoffman McCann, P.C.
3101 N. Central Ave., Suite 300
Phoenix, AZ 85012
ahakes@cbiz.com
(602) 650-6225