Upon the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, construction companies have coalesced around their principles to drive consistent application across similar contracts.
At the time this standard was adopted, and more so as time continues to pass, companies have applied a significant amount of judgment on how certain aspects of the revenue standard should be applied to a set of facts and circumstances; none more so than the application related to the accounting for variable consideration — or “step 3” of the revenue recognition model.
Amount of Consideration
The amount of consideration a company would receive for supplying a good or performing a service is referred to as the transaction price within the revenue recognition standard. The transaction price can be fixed — a known amount not subject to change or estimation — or variable — an amount not fixed that requires a level of estimation both at the onset and during the contractual period.1
Within the construction industry, variable consideration is equally as common as fixed consideration and comes in various forms, including change orders (unpriced and unapproved), incentives or claims, and an often-overlooked item within the definition of variable consideration — liquidated damages. These are often overlooked because, historically, many have viewed “consideration” as amounts to be received from a customer for supplying a good or performing a service.
The new revenue recognition standard made it clear that the transaction price is not just amounts received from a customer but also amounts that may have to be paid to a customer within the context of its contract.2 Liquidated damages in many cases are being recognized later than they should be under the revenue recognition standard; therefore, revenue is being overstated.