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📊 Revenue Recognition for Construction

Revenue recognition in construction is complex. ASC 606 changed the rules. Here's what you need to know.

Key Principle

Revenue recognition determines when you report income—not when you get paid. Getting it wrong affects your financials, taxes, and bonding.

ASC 606 Overview​

The 5-Step Model​

ASC 606 requires a 5-step process:

  1. Identify the contract with a customer
  2. Identify performance obligations in the contract
  3. Determine the transaction price
  4. Allocate transaction price to performance obligations
  5. Recognize revenue when obligations are satisfied

What Changed for Construction​

AreaOld RulesASC 606
Variable considerationRecognized when resolvedEstimate and include
Contract modificationsCase-by-caseSpecific guidance
Claims/unapproved COsConservativeInclude if probable
Uninstalled materialsVariousSpecific rules
Multiple contractsJudgmentCombination criteria

Step 1: Identify the Contract​

Contract Requirements​

A contract exists when all criteria are met:

  • Parties approved the contract
  • Rights and payment terms identified
  • Commercial substance exists
  • Collection is probable

Combining Contracts​

Combine contracts if:

  • Negotiated as a single package, OR
  • Consideration depends on other contract, OR
  • Goods/services are a single performance obligation

Example: Base building contract + tenant improvement contract negotiated together may be combined.

Contract Modifications​

Account for modification as:

  • Separate contract (if adds distinct goods/services at standalone price)
  • Termination of old + new contract
  • Cumulative catch-up adjustment

Step 2: Identify Performance Obligations​

What's a Performance Obligation?​

A promise to transfer a distinct good or service.

Construction considerations:

  • Is it a single project or multiple phases?
  • Can phases be sold separately?
  • Does customer benefit from each phase independently?

Most Construction Contracts = One Obligation​

Typically, a construction contract is a single performance obligation because:

  • The contractor provides significant integration
  • Each component modifies the others
  • Outputs are highly interrelated

Step 3: Determine Transaction Price​

Variable Consideration​

Include estimates for:

  • Incentive payments
  • Penalties
  • Claims
  • Unpriced change orders
  • Awards

Two estimation methods:

  • Expected value (probability-weighted)
  • Most likely amount

Constraint: Only include amounts where reversal is not probable.

Change Orders​

StatusInclude in Price?
Approved and pricedYes - full amount
Approved, price pendingYes - estimated amount
Unapproved but probableYes - estimated amount
DisputedJudgment required

Claims​

Include in transaction price if:

  • Legal basis for claim
  • Probable of recovery
  • Amount can be estimated

Be conservative. Only include claims you'd defend in court.

Step 4: Allocate to Performance Obligations​

Single Performance Obligation​

If the entire contract is one performance obligation (most construction), allocate entire transaction price to that obligation.

Multiple Performance Obligations​

If distinct obligations exist:

  • Allocate based on standalone selling prices
  • Use observable prices if available
  • Estimate if not observable

Step 5: Recognize Revenue​

Over Time vs. Point in Time​

Construction typically recognizes over time because:

  • Customer controls work in progress, OR
  • Asset has no alternative use + enforceable right to payment

Measuring Progress​

Input methods:

  • Cost-to-cost (most common)
  • Labor hours
  • Machine hours

Output methods:

  • Units delivered
  • Surveys of work performed
  • Milestones achieved

Cost-to-Cost Method​

Most construction uses cost-to-cost:

% Complete = Costs to Date / Estimated Total Costs

Revenue to Date = % Complete × Transaction Price

Current Period Revenue = Revenue to Date - Prior Period Revenue

What Costs to Include​

Include:

  • Direct labor
  • Direct materials (installed)
  • Subcontractor costs
  • Equipment costs
  • Allocated indirect costs

Exclude (expense as incurred):

  • General & administrative
  • Wasted materials
  • Abnormal costs
  • Uninstalled materials (see below)

Special Topics​

Uninstalled Materials​

General rule: Exclude from % complete calculation until installed.

Exception: If material is distinct, significant, and control transferred:

  • Recognize revenue equal to cost
  • Zero margin until installed

Example: HVAC equipment delivered but not installed - may recognize cost amount, not full margin.

Losses on Contracts​

When total estimated costs exceed transaction price:

  • Recognize entire loss immediately
  • Don't wait until contract complete
  • Review loss estimates each period

Contract Assets and Liabilities​

SituationResult
Revenue > BillingsContract Asset (Underbilling)
Billings > RevenueContract Liability (Overbilling)

Presentation:

  • Net by contract
  • Present as asset or liability based on net position

Practical Application​

Monthly Revenue Recognition Process​

  1. Update cost estimates for each project
  2. Calculate % complete (cost-to-cost)
  3. Apply % to transaction price = Revenue to date
  4. Compare to prior months = Current month revenue
  5. Compare to billings = Over/underbilling
  6. Review for losses on any contracts

Example Calculation​

Contract Information:

  • Contract price: $10,000,000
  • Estimated total cost: $8,500,000
  • Costs to date: $4,250,000
  • Prior period revenue: $4,000,000
  • Billed to date: $4,500,000

Calculation:

% Complete: $4,250,000 ÷ $8,500,000 = 50%

Revenue to date: 50% × $10,000,000 = $5,000,000

Current period revenue: $5,000,000 - $4,000,000 = $1,000,000

Overbilling: $4,500,000 - $5,000,000 = ($500,000) → Underbilled

Disclosure Requirements​

Required Disclosures​

  • Disaggregation of revenue
  • Contract balances
  • Performance obligations
  • Significant judgments
  • Costs to obtain/fulfill contracts

Construction-Specific​

  • Revenue by project type
  • Revenue by geography
  • Revenue recognized from prior period obligations
  • Remaining performance obligations

Common Mistakes​

1. Not Updating Estimates​

Problem: Using old cost estimates Impact: Misstated revenue and profit Solution: Monthly estimate reviews

2. Aggressive Change Order Recognition​

Problem: Counting unapproved changes too early Impact: Revenue reversal later Solution: Conservative inclusion criteria

3. Ignoring Variable Consideration Constraint​

Problem: Including amounts likely to reverse Impact: Audit adjustments Solution: Apply constraint conservatively

4. Inconsistent Cost Inclusion​

Problem: Different costs included in % complete vs estimate Impact: Distorted completion percentage Solution: Consistent methodology