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Revenue Recognition Issue 11 – Special Focus: Service
The Service Industry can be complicated in terms of revenue recognition. In professional services, contracts (whether express or implied) may provide that contractors can bill by the hour or by the project, and terms may allow for progress billing during the duration of the contract. In those circumstances, revenue might be recognized as you bill your clients for the work. But other circumstances might not be so simple. Let’s explore an example of complexities that could occur.
A construction company hires an architectural firm to design a customized office building for their customer. The contract permits progress billing but has a cap on fees. The architect works over the course of several months with the construction manager and the customer’s representative to gain a clear understanding as to what is needed and to draft the designs, which again are highly customized to the customer representative’s preferences. Then, the customer representative leaves the company prior to the completion of the design process, and a new rep takes over and moves in different directions under certain aspects of the project.
Does this impact the term over which revenue gets recognized? It depends on the contract.
- Are change orders available? If so, were they approved?
- How do these changes impact the duration and scope of the project?
- Does the customer really control the process?
- How much of these changes were really the architect’s own design views that the customer never accepted in the first place?
The answers to these questions can have a significantly different impact on how revenue on this contract is being recognized. Management needs to understand the contractual relationship before drawing conclusions on how the revenue should be recorded in their financial statements.
Stay tuned for additional alerts in our Revenue Recognition Readiness Check Series. Next in our series we will explore: Nonprofit
Please contact your BMF Advisor for additional information regarding the new standards.
Tax Accounting Method Considerations
The impact of this change hits more than just the financial statements – significant tax changes could also lie ahead. The new standard presents a unique opportunity for companies to revisit their tax methods for revenue recognition. Not only do they need to ensure compliance with the tax rules, but they can also take advantage of tax opportunities and planning around revenue recognition. Companies will need to determine whether the new book methods will be permissible for tax purposes.
In instances where the new methods are permissible, the company could file a Form 3115 to implement the new methods on its tax return. If the new methods are not permissible or if the company chooses to continue using their current tax methods, the new financial accounting changes could affect or create new book-tax differences and deferred taxes related to revenue recognition. Companies will need to consider the information needed to compute these book-tax differences, and whether the information will be available after the changes for financial statement purposes.
It is important to plan ahead to make sure that tax considerations are considered upfront and not an afterthought. Companies should thoroughly assess all their revenue streams and the proper tax methods for each to plan the appropriate actions for successful implementation.
