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CFMA Central VA Chapter November 13, 2014

Presented By:Kevin Branner, CPA, PrincipalChris Frye, CPA, ManagerConstruction Industry Services TeamYount, Hyde & Barbour, P.C.

Kevin Branner, CPA, Principal is the Leader of Yount, Hyde & Barbour’s Construction Industry Services Team. He has been with the firm for 23 years, where he began his career after receiving a bachelor’s degree from Randolph-Macon College. Kevin is the immediate past president of the Central VA chapter of Construction Financial Management Association, as well as past president of the Construction Industry CPAs/Consultants Association. He is also active in the following construction trade associations: ABC, AGC, ASA, and NAHB.

Chris Frye, CPA, is a Manager in YHB’s Construction Industry Service Team. Chris joined Yount, Hyde and Barbour, P.C. in 2004 after graduating from Virginia Tech. During his time with the firm, he has focused his efforts on providing audit, review, compilation and tax services to clients in a variety of industries, including construction and real estate. Chris also specializes in assisting clients with strategic performance management, including the implementation of dashboards and overall process improvements. He is also active in the following construction trade associations: ABC, AGC, ASA, and NAHB.

Any tax advice contained in this presentation is not intended or written to be used, and cannot be used for the purpose of avoiding penalties imposed by the IRS or any other state or local jurisdiction.

This presentation is for educational purposes and should not be construed as tax or legal advice.

Revenue Recognition Standard Affordable Care Act Update Tax Update (or lack thereof) Questions

FASB Accounting Standard Update No. 2014-09

Revenue from Contracts with Customers (Topic 606)

Standard applies to all transactions which relate to and include:

Contract Customer

Terminology has changed – first step is to gain understanding of the new language of revenue recognition

New Terminology Performance obligation Transfer of “control” Contract asset Variable consideration Constraint Distinct Transaction price Onerous contract

Industry guidance from SOP 81-1 will no longer be relevant. Decisions relative to revenue and, to some degree, costs

will be guided by the principles of ASU 2014-09. The FASB expects industry practice guidance to be

developed but it will not be under the authority of the FASB. AICPA has formed multiple industry groups to address and modify

current audit and accounting guides – these will not be GAAP unless designated by FASB. Engineering and Construction Task Force

Possible additional guidance resulting from FASB/IASB deliberations with Revenue Recognition Transition Resource Group

Most construction contracts will have revenue recognized at the contract level

Percentage of completion will be the method used

Cost to cost is an acceptable input method for determining the percent complete

Loss accrual in current practice will not change

An entity should recognize revenue to depict the transfer of promised 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.

An entity should recognize revenue to depict the transfer of promised 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.

Basic Observations On the surface the five step process does not seem

overly complex and arguably, it appears to include much of what is currently done to determine revenue recognition.

However, each of the five steps will require significant judgments by management and auditor in applying the underlying principles included in the new guidance.

The transfer of “control” to the customer becomes the driving issue in evaluating the appropriateness of revenue recognition under the new guidance. Currently, the evaluation of “risk and reward” often

drives the determination of revenue recognition. While it remains an important consideration, it is no longer determinant under the new guidance.

Issue 1. Change Orders (including unpriced change orders) Current Standards –

Change orders are accounted for as a modification of the original contract. Current standards provide 3 different methods to time measurement and recognition.

Change orders with agreement on scope but no agreement on price are accounted for under claim recognition guidance.

New standard guidance is “Contract Modification” Determination of whether the change order is a new contract, a new

performance obligation that is distinct, or a change in the original agreement [JUDGEMENT]

The conclusion regarding the above will change timing of recognition, presentation, and possibly disclosures

May require evaluation under new “Variable Consideration” standard [JUDGEMENT]

A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract.

Examples of potential contract modifications – Approved change orders Unapproved change orders Field directives Liquidated damages Equitable adjustments Claims Follow-on contracts

There are two paths to consider when evaluating the accounting related to a modification.

An entity shall account for a contract modification as a separate contract if both of the following conditions are present: The scope of the contract increases because it results in the

addition of promised goods or services that are distinct, [JUDGEMENT] and

The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling prices of the additional promised goods and services and any appropriate adjustment to that price to reflect the circumstances of the particular contract. (The construction industry lacks observable standalone pricing data.) [JUDGEMENT]

This standard may require certain change orders to be accounted for as if they are a separate contract. Software may need revision so it facilitates combining of jobs for

certain reports that are treated separately for revenue recognition

Sureties will want to see the combined effect of all contracts under a single surety bond

How will this standard impact recognition & reporting? The separate contract from the contract modification

will require consideration whether it contains more than one performance obligation that is distinct

The separate contract will require separate accounting tracking of costs, billings, and revenue recognition

The separate contract will be reported separate from the original contract on the contract schedule

If the job is bonded, the surety will have to combine the contracts to monitor their exposure

It is likely that tax reporting will not qualify for separate reporting and book/tax timing differences can arise.

If a contract modification is not accounted for as a separate contract, an entity shall account for the promised goods or services not yet transferred at the date of contract modification in whichever of the following ways is applicable:

An entity shall account for the contract modification as if it were a termination of the existing contract and the creation of a new contract, if the remaining goods or services are distinct from the goods or services transferred on or before the date of the contract modification. [JUDGEMENT] Rare for the construction industry

An entity shall account for the contract modification as if it were part of the existing contract if the remaining goods or services are not distinct, and, therefore, form part of a single performance obligation that is partially satisfied at the date of the contract modification. Catch-up accounting for the revised contract and percent

complete

Issue 2. Claims Current standards

Four conditions precedent to recognize claim revenue Not carried into the new standard

Pre-resolution revenue recognition limited to costs incurred New standard - guidance is “Contract Modification”

Determination of whether the claim is a new contract, a new performance obligation that is distinct, or a change in the original agreement. [JUDGEMENT]

The conclusion regarding the above will change timing of recognition, presentation, and possibly disclosures.

May require evaluation under new “Variable Consideration” standard May require evaluation under new “Financing” standard Margin can be recognized if estimated recovery exceeds costs

Issue 3. Combining Contracts Current standards

Allows combining contracts but rules based criteria are very difficult to satisfy.

New standard Two or more contracts entered into at or near the same time with the

same customer (including contracts with parties related to the customer) are combined and accounted for as one contract if one or more of the following conditions are met:

The contracts are negotiated as a package with a single commercial objective

The amount of consideration to be paid in one contract depends on the price or performance of the other contract

The goods or services promised are a single performance obligation

Issue 3. Combining Contracts Combining standard conditions changed from “may” to “will” which will

require more activity in assessing whether combining is appropriate Guidance creates more opportunity to measure multiple contracts in a single

step. Goes against surety separate risk on single projects but this third-party risk

is not part of the criteria for combining. Will require evaluation including proper treatment when multiple contracts

with a single customer exist. Note that the decision to combine contracts occurs before the evaluation of

performance obligations. Note that these standards are similar but not identical for tax qualifications for

combining contracts which will lead to more book/tax timing differences

Current practice evaluates “profit centers” which typically are the entire contract.

A performance obligation is a promise in a contract with a customer to transfer to the customer either:

A good or service (or bundle of goods or services) that is distinct. This is the standard that permits multiple performance

obligations to be bundled and reported on a total contract basis – same as current practice.

A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Generally explicit but may also include promises that are

implied by an entity’s customary business practices, published policies or specific statements, if at the time of entering into the contract those promises create a valid expectation of the customer that the entity will transfer a good or service to the customer.

A promised good or service is considered distinct if both of these conditions are met:

The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct).[JUDGEMENT] This assessment requires the

contractor and its auditor to understand the customer’s business and capacities

The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the good or service is distinct within the context of the contract). [JUDGEMENT]

Determining whether the good or service is “distinct within the context of the contract” is a critical aspect of identifying the performance obligations. Factors that indicate that an entity’s promise to transfer a good or service to a customer is separately identifiable include but are not limited to:

The entity does not provide a significant service of integrating the goods or services into the bundle of goods or services that the customer has contracted for. Most construction contracts will include an integration of a

bundle of services. The good or service does not significantly modify or

customize another good or service promised in the contract. Most construction contracts will include modification or

customizing. The good or service is not highly dependent on, or highly

interrelated with, other goods or services promised in the contract. Most construction contracts will be dependent and

interrelated with other goods or services.

If a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct.

In some cases, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation. The construction industry will likely adopt a practice

that the presumption is that the goods or services are not distinct and are therefore combined and the contract is reported as a single performance obligation — unless there is evidence to the contrary.

Each contract will be required to be evaluated.

Contracts that provide both services and productDesign/Build contractEPC contracts

IDIQ contracts Contracts with separate deliverables Add-on change orders

The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring promised goods or services to a customer. Issues that impact the determination of the transaction price include:

Variable consideration Constraining estimates of variable consideration The existence of a significant financing component in

the contract Non-cash consideration Consideration payable to a customer Materials provided by the customer

Often, part of the contractual consideration related to a good or service is variable in nature or contingent on future events. (not an all inclusive list): Unapproved change orders Unpriced change orders Performance bonuses — signing bonus, early completion, savings

sharing, etc. Project performance terms Unit pricing Economic price adjustments Latent defects Claims Discounts Refunds/Rebates Royalties

An entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled:

Expected value – the expected value is the sum of probability weighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large number of contracts with similar characteristics. [JUDGEMENT]

Most likely amount – the most likely amount is the single most likely amount in a range of possible consideration amounts (that is, the single most likely outcome of the contract). The most likely amount may be an appropriate estimate of an amount of variable consideration if the contract has only two possible outcomes. [JUDGEMENT]

The objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. To meet the allocation objective, an entity shall allocate the

transaction price to each performance obligation in the contract on a relative stand-alone selling price basis. Relative selling price is best evidenced by the observable

price of a good or service when sold separately in similar circumstances and to similar customers.

If a stand-alone selling price is not directly observable, an entity shall estimate the standalone selling price. [JUDGEMENT]

An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. [JUDGEMENT]

Control of an asset refers to the customer’s ability to direct the use of and obtain substantially all of the remaining benefits from the asset. Indicators that a customer has obtained control are as follows:

The entity has a right to payment for the asset. The entity transferred legal title to the asset. The entity transferred physical possession of the asset. The customer has the significant risk and reward of ownership. The customer has accepted the asset.

An entity transfers control of a good or service over time and satisfies a performance obligation and recognizes revenue over time if one of the following criteria are met:

The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.

The entity’s performance creates or enhances an asset (WIP) that the customer controls as the asset is created or enhanced.

The entity’s performance does not create an asset with an alternative use to the entity and the entity has a right to payment for performance completed to date.

Similar to current practice – Percentage of Completion Output measurement

Units of delivery or production Milestones

Generally create audit challenges Input measurement

Cost to cost Labor – cost or hours

Measurement should be reflective of transfer of control of the asset to the customer.

Zero margin in early stages of completion is acceptable

Current standards Method A

Revenue, costs and gross profit recognized based on percent complete

Method B Gross profit recognized based on percent complete. Revenue

equals costs incurred plus gross profit recognized New standard

Revenue for performance obligations satisfied over time is recognized on percent complete

Costs are recognized as incurred Gross profit is the difference and may not be equal to estimated

gross profit times the percent complete

Uninstalled costsCurrent standards –

Uninstalled materials that are not modified for the specifications of the contract are excluded from costs incurred in the PCM calculation. Effectively, revenue is recognized equal to the cost of the uninstalled materials.

New standard If including the cost of uninstalled materials are significant

in relation to total contract costs – [JUDGEMENT] Excluded from cost to cost PCM measurement Revenue recognized equal to costs incurred (zero profit

method) at the time control is transferred to the customer

Exclude costs that do not contribute to performance

When a cost incurred does not contribute to an entities progress in satisfying the performance obligation [JUDGEMENT]

Wasted materials Significant inefficiencies in the entities performance

that were not reflected in the contract price Owner provided materials

Excluded costs are treated a period costs Will these be reflected in the contract schedule?

Disclosures The objective of the disclosure requirements

(Topic 606) is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The disclosure requirements found in the new

revenue recognition guidance are significantly in excess of what is currently required under U.S. GAAP.

DisclosuresAn entity shall disclose qualitative and

quantitative information about all of the following: Its contracts with customers The significant judgments, and changes in the

judgments made in applying the guidance in Topic 606 to those contracts

Any assets recognized from the costs to obtain or fulfill a contract with a customer

Disclosures Contracts with customers Disaggregation of revenue Contract balances Performance obligations Transaction price allocated to the remaining

performance obligations Significant judgments in the application of the

guidance in Topic 606 Determining the transaction price and the

amounts allocated to performance obligations Practical expedients adopted

Effective Date of Adoption (Public Entity)For a public entity, the amendments in

Topic 606 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.

Early application is not permitted.

Effective Date of Adoption (Nonpublic entities) The amendments in Topic 606 are effective for annual reporting

periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply the guidance in Topic

606 earlier, however, only as of the following: An annual reporting period beginning after December 15,

2016, including interim periods within that reporting period (public company effective date)

An annual reporting period beginning after December 15, 2016 and interim periods with annual periods beginning after December 15, 2017

An annual reporting period beginning after December 15, 2017, including interim periods within that reporting period

Transition The FASB has allowed two methods for transition:

Retrospectively to each prior reporting period presented. Practical expedients provided

Retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial adoption. Certain disclosures are required: The amount by which each financial statement

line item is affected in the current reporting period by the application of Topic 606 as compared to the guidance that was in effect before the change.

An explanation of the reasons for significant changes.

Transition and Implementation What do sureties expect? What do bankers expect? What do investors expect? What are your peers likely to do?

The impact from the adoption of the new revenue recognition standard will likely be complex and far-reaching and involve many different functions within an organization. Information systems may require adjustment. Standard contracts and other sales agreements should

be evaluated in light of the changes. Sales incentives/commissions should be considered. Internal control processes may need updating. Executive compensation arrangements Debt covenants Tax Implications Software enhancements to support

Transition and Implementation Start early. With the long “on-ramp” that FASB has

allowed for, it is easy for entities to get lulled into a false sense of security. Large public companies with three-year P&L presentations face the most time pressure.

Consider the use of an implementation team (financial and operations) approach working with auditors and/or professional advisors.

Watch for further education opportunities from the FASB Revenue Recognition Implementation Group.

Watch for guidance from AICPA Follow CFMA publications, conferences and webinars

1. Effective dates.2. Am I an applicable large employer?3. What are my responsibilities?4. Reporting requirements.5. What should I do now?

Employer mandate and potential shared responsibility payment is effective in either 2015 or 2016.

2015 if 100 or more full-time equivalent employees. 2016 if 50-99 full-time equivalent employees. No responsibility if less than 50 full-time equivalent

employees.

Calculation must be done based on prior calendar year to determine if the 100 or 50 FTE threshold is exceeded.

A full-time employee is any employee who averages 30 or more hours per week or who works 130 or more hours in a month.

Must also determine full-time equivalent portion of part-time work force.

In initial year, FTE’s can be determined based on any six consecutive month period from the prior year.

Seasonal employee (less than 120 days) exception. Cannot use subsidiaries or create new entities to fall under the

threshold. IRS “controlled-group” rules apply.

ResponsibilitiesEmployers with more than 100 full-time employees must offer coverage to at least 70% of full-time employees in 2015.Employers with more than 50 full-time employees must offer coverage to at least 95% of full-time employees in 2016.Coverage must be affordable and meet minimum value requirements.

ConsequencesPenalty will be $2,000 per worker, excluding the first 80 full-time employees (2015) and first 30 full-time employees (2016).If offering unaffordable coverage (employee share > 9.5% of household income), must pay a $3,000 penalty for each full-time employee who receives a government subsidy to purchase insurance through an exchange.Also subject to $3,000 penalty if plan does not meet minimum value requirements (60% cost sharing).

Reporting requirements beginning in 2015 for applicable large employers (optional filing in 2014).

Information return 1095-C is given to the employee noting whether coverage was offered and lowest cost monthly premium for self-only coverage. Must be provided to employees by February 1 of subsequent year.

1094-C is the transmittal return used to file. Additional information on 1095-C for self-insured plans.

1095-B and 1094-B is filed by the insurance carrier. Form 1095-B goes to the covered person noting number of months covered and persons covered. Form 1094-B is the transmittal return.

Employers with 50 – 99 FTE’s must still adhere to reporting requirements in 2015.

1. Assemble your payroll data for 2014.

2. Determine if you meet the requirements for applicable large employer status in 2015.

3. Determine the appropriate measurement period.

4. Calculate FTE’s for 2015.

5. Determine if insurance coverage is adequate and affordable.

6. Play or pay?

1. Will Congress address extenders in the “lame duck” session?

2. Unless Congress acts, the Section 179 deduction will be reduced from $500,000 to $25,000 for 2014.

3. Bonus depreciation has gone away.

4. R&D credit expired. Will it be renewed?

5. Items could be passed in 2015 but retroactively reinstated.

6. Tax planning becomes difficult.

New Repair RegulationsTaxpayers with depreciable assets, materials, supplies, repairs, maintenance, and property improvements will be affected.Fixed assets vs. materials and supplies. Repair vs. betterment.Temporary regulations could have been adopted for the 2012 and 2013 tax years. Final regulations effective 1/1/2014.2014 tax return may require Form 3115 for accounting method change.Election statements could be needed as well (de minimus rule).

Kevin Branner, CPA, PrincipalYount, Hyde & Barbour, P.C.Kevin.Branner@yhbcpa.com

540-662-3417

Chris Frye, CPA Yount, Hyde & Barbour, P.C.

Chris.Frye@yhbcpa.com540-662-3417