Revenue Recognition Considerations for Engineering Firms

Audit|Professional Services

By Patti Giudici

In August 2017, the FASB issued guidance for engineering firms in connection with the implementation of ASU 2014-09 and the five-step model.

Step One requires firms to determine whether or not there are multiple contracts. An important consideration specific to engineering firms is to evaluate change orders and determine if the change order is a new and separate contract or if it is a modification of an existing contract.

Step Two requires firms to identify performance obligations. Engineering firms may provide multiple activities on behalf of a customer, including but not limited to design, implementation and service activities. The various activities need to be reviewed to determine if there is significant integration. Firms will also need to determine the contract term and termination provisions within the contract. If a termination clause is included in the contract and there is no consideration exchanged to exercise the provision, the term of the contract will end after the good or service has been provided to the customer.

Step Three requires firms to identify the transaction price. In conjunction with this step, variable consideration needs to be reviewed. Contract incentives, including bonus payments and penalties for a delay in the completion of a project, are examples of variable consideration specific to engineering firms. These entities are required to estimate variable consideration using one of two approaches, the expected value method and the most likely amount method. The expected value method takes into consideration a weighting of probable amounts, while the most likely amount method identifies one amount that has the largest potential outcome. Prior experience can be used to assist in estimating the potential outcomes for variable consideration. If firms and their customers have not agreed to a price for a change order, the transaction price for the change order would be considered variable consideration.

Step Four requires firms to allocate the transaction price to the performance obligations. Transaction price is allocated based on the relative standalone selling price for each of the performance obligations. If this price is not directly observable, an estimate will be made using approaches like cost plus margin. Discounts would also need to be reviewed to determine whether the discount should be attributed to a specific performance obligation or the overall contract.

Step Five is the recognition of revenue. In most cases, firms will use an overtime methodology for revenue recognition. The most common method will be an input method based on resources used or hours expended. If there is no reasonable methodology to determine the amount of progress that has been expended, revenue recognition will be deferred until progress can be quantified. This concept is similar in nature to the percentage-of-completion method defined in ASC 605 under the existing guidance.

Please contact the Schneider Downs Audit and Assurance Department for additional information regarding ASU 2014-09 or visit the Our Thoughts On blog for similar articles. 

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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