To preview their Oct. 16, 2019, presentation at the PICPA Construction Industry Conference, John Bieber of National Glass & Metal Co. Inc. and Tony Stagliano of CBIZ Inc. joined us to discuss the ways in which treatment of the revenue recognition standard is unique to the construction industry, plus differences for public and private contractors.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor 

Podcast Transcript

Revenue recognition is a major undertaking for all segments of the accounting industry, but it has specific repercussions for CPAs and others in the construction industry. On October 16th at the PICPA Construction Industry Conference, today's guests, John Bieber of National Glass & Metal Company Inc. and Tony Stagliano of CBIZ Inc., will host a presentation seeking to enlighten attendees on what provisions of revenue recognition will have the largest impact on construction CPAs, and what practical expedients can make the adjustment less painful. Today, they're offering us a sneak peek at their session.

Can you share with us a couple ways by which treatment of the revenue recognition standard is unique to the construction industry?

[Stagliano] First of all, it's revenue from contracts with customers, which covers everybody, the whole industry, all CPAs in public practice and otherwise, accountants everywhere. This is the biggest change in accounting treatment in probably the history of construction and accounting, period.

It's a lot to digest, and we're not going to try to do that here. We're just going to give you some of the highlights. First of all, contractors have to satisfy performance obligations. The work they do is over time, not as a point in time, and it's based on estimates. Most other industries don't have to deal with estimates on a continual basis. Construction does. This pronouncement drills down along the estimates that have to be handled and how they should be treated from an accounting perspective.

There are possibilities of multiple performance obligations. That means one contract could have several pieces to it and you may have to treat each piece as a separate contract on your schedule of contracts. That's another wrinkle.

Cost can now be categorized in several areas. Before, we always talked about direct and indirect costs, and general administrative costs, as three big categories. Today, with the new pronouncement, revenue recognition, cost can be contract costs. You can have incremental costs, which need to be defined later, capitalized cost and fulfillment costs, which goes to the terminology throughout this pronouncement. The changes have been significant.

[Bieber] We've been preparing for this presentation not only for the PICPA, but Tony and I have been putting on presentations for CFMA at the national conference this past summer in Las Vegas, at regional conferences, and even at a local chapter level, and they've all been varying length. We've put a lot of time into studying this new pronouncement and the many amendments that went into it.

I guess despite three years' worth of amendments, primarily from 2014 to 2016, many of them impacting the construction industry, as Tony said, we still wound up with many new terms that need to be understood and evaluated, as to whether a term or a treatment applies to your construction organization. Truthfully, most of the time Tony and I spent together prepping for these presentations, was not as much reading the pronouncement and trying to understand the pronouncement. It was more trying to understand how they impacted my particular construction company.

Because there are things, depending on which particular trade you're involved in, whether you be a general contractor or an electrical or HVAC sub, heavy highway, there's different issues that impact these different specific trades.

The answer for one construction company isn't going to be the same necessarily as the answer for another construction company. Depends on all kinds of things, including the specific type of work you do, and type of contracts, such as T&M versus fixed price contracts.

We've got a lot of potential to impact the construction industry. The couple of ways that I guess I wound up focusing on for the operation here, and I think there are also two issues, two or three issues that apply to most contractors, is an evaluation of something called variable consideration. There is one of the new terms Tony alluded to. Which basically, variable consideration is a change order, a claim, some kind of incentive clause in your contract.

Bottom line: you have to figure out whether this applies to you or not because it definitely has the impact of changing what you include in your contract value, on your contracts, and progress schedule.

Another biggie for both my company and, I think, a lot of folks is this treatment of uninstalled materials or stored materials. The approach is much more involved than under the old guidance, which was 605. That's a big area for a lot of folks.

Then, the third is this concept of transfer control, which you would think, on the surface, that shouldn't be that difficult. That's a physical concept, isn't it? It's not just a physical concept, it's a legal concept.

[Stagliano] What we're going to do in our session is boil this down into layman's language, I'll use that term, and give you more or less the way you really can look at these things. Two keys: one is the term that's used throughout, and I'll get this out of the way before we get to the other questions, is, “Is it significant?” That's a new term. They're not using the word material anymore. They're using the word significant throughout the document. Not only in amounts, but in judgment. Significant judgment will be required.

As we go through, that permeates the agreement. We're going to try to cut through the hard parts of that and give people a Cliff Notes version of how you can understand it and document. That's the next key word besides significant. Document your position. I've always been taught in public accounting anyhow, if you don't document, you didn't do it.

Our contractors, when their CPAs come in, they say, did you understand this part of the pronouncement? Yes. Here it is. We wrote it up and we've documented, “This is our position.”

[Bieber] It's certainly got to be more than you as the external CPA coming in to review or audit the financial statements. It's more than just, “Alright, did you look at this?” You can't just simply say, "Yeah, I looked at it. I don't think it applies to us or, if it does at all, it's not material." It's not as simple as throwing that out there.

As you take a look at it, and you may have addressed it to a point there in that question, but would you say there's one or two provisions that will have the biggest impact on construction professionals? Is there anything that jumps out?

[Bieber] For me, probably it'd be the variable consideration, which again is a new concept that, the term includes outstanding change order requests, claims, which is really a legal title, I guess, liquidated damages, incentive payments for early completion – all these things come under the umbrella of variable consideration.

In the past, what you did with, say, an outstanding change order, if your company was financially strong balance sheet-wise, I think most of us just took the position, “We're not going to recognize it as part of our current contract value until we actually have a signed change order in hand,” as an example. We're not going to recognize a claim until we've actually got some indication that, yeah, there's going to be a settlement somewhere in this range.

For the most part, you played it conservative and you just said, hey, when we actually get the money, that's when we'll recognize that additional ... this new guy basically instructs you to create a probability model of the likelihood of various outcomes to your particular issue, which may be something along the lines of, okay, with this particular general contractor that we as a subcontractor have business with, what's our record of successfully getting change orders issued to us for the amounts we've requested? Or, does that really differ from, who's the owner that GC is dealing with?

You really have to get very specific and create this probability model in Excel, and that basically determines how much of that unknown issue you're supposed to include in your contract value, on your contracts in progress schedule.

That's probably the issue that I see as most involved because not only do you have to present this probability model, but you've got to somehow, within your processes and systems in the company, have captured the information on which you're making your assumptions. It's certainly not something you want to do off the top of your head.

That's the most involved that I see. Second most would be uninstalled materials, not nearly as difficult an issue, but there are changes in the standards as to when you include uninstalled materials in your cost to date on a percentage of completion calculation, and when you exclude it from that percentage of completion calculation.

[Stagliano] I've asked one of my fellow partners who was on the FASB transition resource group. They were practitioners, basically, in the industry, to try to bring – I don't want to say the word common sense – but practical application of some of this pronouncement on different issues.

When I raised the question about the word “material,” which doesn't seem to get mentioned much, but the word “significant” is throughout, he indicated to me, he says, “FASB made it clear in the beginning. They're going to say it has to be significant in order to apply the different things that we're talking about, but they're not going to put it in every paragraph about every topic.”

I said it once, and that's enough, basically. The word “significant” is very, very important, when you look at any of this stuff, to see if it applies, again, and document that it is or it isn't significant, and follow through.

John, there was one other thing I thought was really outstanding. I'm just going to mention it. I might ask you to discuss it. One of the unintended positive consequences I think that's come out of this pronouncement, and I think you'll agree with me, is this chief financial manager in the company, you being the CFO, you probably understand your company better because you had to dive into your contract clauses and provisions, and look at these different variable interest things and multiple performance obligation terminologies, and so forth. And on top of that, improve your communication with your field people, your project managers, and estimators, because you had to bring them up to speed and educate them because they're the ones where the rubber meets the road, and need to be communicating stuff back to you.

I think it's a benefit to everybody. It's a pain, in a way, of a pronouncement, but I think it's going to have business implications that'll be much better.

[Bieber] No, I agree. There's definitely topics that I just need information I don't normally get in order to make some of these decisions. Like the role of many CFMs, when you join a construction company, your accounting hat turns out to be five or 10 percent of your job, but a lot of the times, you get to spend pretending you're a lawyer looking through the contracts you're being issued, and the subcontracts that you're issuing.

Diving through contracts is nothing new. This 606 is just going to add quite a few things that I'll be reviewing for, in those contracts. More importantly, yeah, the communication with project managers, as an example, and, in some cases, owners who have the best handle on the specifics of the company's operation, it's going to force you ... if you're not already there and having those kinds of conversations with the project manager, it's going to force those conversations to happen.

You're now going to need them for more than just giving you updates monthly on where the profitability of the ongoing jobs stand. You always have really needed them for more, but I know firsthand that that communication doesn't happen naturally in a lot of construction companies.

What about practical expedients? Are there any practical expedients that can make application of revenue recognition easier for CPAs in construction?

[Bieber] There's a few items. During our presentation, we're going to talk about really a few issues that won't apply if contract performance is scheduled to be less than one year. Not a lot. Regarding the year of transition, which we all have facing us now, there are two different transition methods in the year that you adopt this new standard. One is much easier than the other, and I expect most people to use that particular method that's available. We'll certainly drill into that as well.

There are some organizations out there, including accounting firms, that have taken a stab at creating a decision tree, checklist type tools, that can be helpful. At the end of the day, one thing we haven't mentioned is that 606 is a principles-based pronouncement. It's not the old rules-based approach that was used for just about every accounting decision we've made in the past.

As a principles-based pronouncement, you can get your hands on one of these tools that are out there to ... a decision tree checklist, and go, if yes, this, if no, this, and go through the paces, such as trying to analyze uninstalled materials. At the end of the day, there are a lot of gray areas with principles-based accounting. Some of these conclusions you come to may differ from what a decision tree will lead you to.

Certainly makes that more challenging. We all loved our rules where it was a straightforward yes or no answer in 99% of the issues that came up. Really, your best approach is to formally document your review of each contract as it comes in. Certainly adding to that contract abstract, a review of these new issues or terms in 606, that would need to be analyzed if they're present in the contract.

That takes the importance of jumping on that new contract that comes in the door and reviewing it, that certainly takes that up a whole notch in terms of importance. It's clearly your starting point to this whole process of evaluating 606.

[Stagliano] A practical expedients list is referred to in the literature, and there aren't that many of them. I run across them and I write them down. I knew what they were, and I decided to do a word search on the document itself, and found out that no, I think I found all of them.

We'll go through that, each one of them, so that people can employ the practical expedient. Again, if it's significant. Just because it exists doesn't mean it has to be done because the pronouncement indicates it does. It has to be significant.

Is there a difference between how the standard will affect public versus non-public contractors?

[Bieber] I think the biggest, most obvious difference is that the public companies have already adopted this thing for accounting year 2018, versus all the private companies, which is certainly the majority of construction companies, got a one-year reprieve on this. We're all newly dealing with it for 2019. That said, compliance with 606 is not optional. There's no little GAAP, as it's been called, for private companies. 606 is GAAP, period. You're either doing this in accordance with GAAP, which means following 606, or you're not going to get a clean GAAP opinion from your outside CPA firm.

Public companies certainly have more extensive disclosures being in that SEC world and during our presentation we're going to review some of those approaches to footnote and balance sheet presentations, that we're seeing on these earlier public company financial statements.

One thing that we've noticed already is there's no consistency, or not a lot of consistency, between these different publicly owned companies. They're really taking different approaches and different interpretations to what these disclosures need to look like and include, even with the balance sheet captions.

That actually, more than you would expect, changes the balance sheet presentation with 606. Kind of interesting. We'll see. Hopefully, sooner or later this thing will settle out. That could take several years, it would appear, before there's commonality in how the industry is handling this thing.

[Stagliano] Yeah, it's one of the things we did, and we'll do it in this presentation is, indicate ... we just looked at 10 of the public companies, and there's only about 30 public construction engineering companies out there. The other millions maybe of other construction entities, are not publicly held. At least we're using them as a way to follow what's being done in the SEC world.

We have an analysis of the various items of ... from reviewing 10 of the companies' 10Ks, which is their SEC reporting at the end of 2018 and 2019. We got some basis for making some comparisons, and we can editorialize what we think is really going to shake out in practice as it comes along. You'll find it interesting, I'm sure.

We've been talking about revenue recognition here, but lease accounting is huge in the accounting industry, and it's on people's minds as well. To touch on that, what sort of discussions will contractors have to have with creditors, in connection to lease accounting, in order to acclimate them to the new practices?

[Bieber] Lease accounting on the surface is going to have more applicability to equipment-intensive types of contractors, such as a heavy highway contractor who might have a whole lot of equipment leased. On the surface, it doesn't have a lot of issue with a lot of smaller contractors, that maybe only lease one tractor-trailer, or a car or two, something like that.

However, even with that, if you're a company that has financial covenants, say a debt-to-equity ratio with your bank, that you have trouble passing every year, or perhaps don't have trouble passing, but use as a basis for deciding what distributions to make to the stockholders at the end of the year, it, even with a few leases, could be enough to change that approach.

The thing – to try to take a positive approach to this – I like about it, and I'm doing here at National Glass, is are we going to have a joint meeting with our banker, our bonding company and agent, our outside CPA, have one meeting with all those parties, all your financial partners in one room, and basically, yes, give a little education on this lease accounting, as well as the 606, while you have them, educate them what it's about, what impact it's going to have on your company. Maybe go so far as to take your most recently issued financial statement and layer on top of it what's 606 in the lease accounting standards, how that would've changed that last balance sheet that you've published.

I think it'll be a lot easier for people to understand, “Okay, this really does have some impact.” With the bank, it might mean, “Hey, based on that, yeah, we should tweak that financial covenant to recognize that you're going to have these additional liabilities on your balance sheet.

Bottom line is, in an effort to have no surprises for your bank or bonding company, which is always not a welcome thing when there are some surprises when that statement file gets issued, you don't want to be at the last minute asking for a waiver on a financial covenant because that makes for an ugly footnote. Just the general goodwill of getting the parties together. I've done this before a couple times here, and it's always very well-received. The outside parties, bank bonding company, your CPA, they're all thrilled that you got them all together in the same room. They get to meet each other.

I think it's a really positive outcome as a result of both of these new topics that have come up. With your bonding company, there's a lot of talk of recession coming, but there's an awful lot of companies that have possibly the strongest backlog they've had in a lot of years, or ever. Certainly, this industry has not seen any sign of a recession that I have heard about. It's very important to keep particularly your bonding company apprised of what your backlog is, what are maybe some outstanding bids that are out there that you feel you had a real good chance of getting.

Then, basically laying it all out for them so they can in turn support you and identify, “Okay, if you're going to do this level of work in the coming year or two, we ask you to leave this amount of equity in the company.” That's really important to have those conversations. You never want to present an opportunity to your bonding company, that you're thrilled about, you just got this big job, and they're saying, “That's going to be tough for us to write that bond.”

That's not a conversation that you ever want to have. It's just, I think, a real great opportunity to make a positive of this, strengthen your relationships with your outside parties, which you probably don't see or talk to often enough, and try to make accounting sound really interesting to them for five minutes.

[Stagliano] Now the elephant in the room: the AICPA and others have asked for a delay of another year to implement this. Back in December, Russell Golden, who is the chairman of the FASB, said we will not be providing a last-minute reprieve. That was back in December. They've subsequently yielded to pressure and it appears now, they've already said they're going to postpone the lease provision for at least one more year. They haven't come out with the terms yet.

It's not just that, there've been so many, between 606, now the leasing, and everybody that files taxes has had to deal with the most significant change in the tax laws since 1986, which is a long time ago. When you think about FASB and construction, 81-1 was back in 1981. It's the biggest change since 1981.

It’s a lot of change, big change and not just in our industry. They're going to come up with a final white paper, they're going to send it out to the public, indicating what their provision and their extensions are going to be. Not just on leasing, but hedging, credit loss, impairment, long-term insurance contract standards, etc.

They got a lot on their plate. The bottom line is they're going to extend it for one more year at least, which is a good thing. 606, we haven't been down the road yet. We're talking about it like it happened, and it's not until the end of 2019. Until we do it, we haven't done it.

There'll be things we come up against that we didn't anticipate.