The accounting industry may be on the verge of a significant change in the coming years. While this change will have an impact on most small and medium-sized businesses, construction companies will want to pay particularly close attention to some of the changes.
Changes to GAAP
The Financial Accounting Standards Board (FASB), the Board that governs Generally Accepted Accounting Principles (GAAP), issued an Exposure Draft (ED) in June 2010, and a revised ED in November 2011, which would supersede the majority of US GAAP’s current revenue recognition guidance, which is primarily industry specific. The revised ED is expected to be issued as a final standard in early 2013, to become effective in 2016 for nonpublic entities. It would require that each contract between a vendor and a customer for the provision of goods and services be analyzed to identify the exchange of rights and obligations between the parties, as follows:
- Identify the contract with the customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations in the contract.
Effects on the Construction Industry
The construction industry has been watching this standard carefully because, in many situations, the continued use of the percentage of completion method is at risk under the proposal. A critical issue in construction will be whether indicators such as physical possession and customer acceptance have occurred.
Other significant changes include a requirement to impute the time value of money into accounting for multi-year contracts where a cash advance is paid up front, as well as a requirement that bad debt expense be shown as a contra-revenue reduction caption rather than an operating expense. In some situations, assets not shown under current GAAP will be recognized from costs incurred to obtain or fulfill contracts. Expanded footnote disclosures on the nature of customer contracts, judgments (or changes) in how performance obligation allocations will be required.
Potential Alternative Financial Reporting Frameworks For Small/Mid-Size Businesses
In response to these changes to GAAP, the AICPA has begun work on its own Financial Reporting Framework for Small and Medium sized entities (FRF-SME). The creation of FRF-SME seems to offer the best hope for an accounting framework that could produce financial statements that provide useful financial reporting benefits without excessive costs and complexities for revenue recognition issues, leases, fair value reporting, tax accounting (FIN 48) and consolidation matters (FIN46). An ED of this was issued in early November 2012 and runs to 250 pages.
In many areas, traditional GAAP is retained under FRF-SME including: operating lease accounting, industry specific revenue recognition policies (such as the percentage of completion method), use of the indirect method for the cash flow statement, and a requirement to separate intangibles from goodwill in a business combination. FRF-SME would be a self-contained set of principles-based standards that would be subject to revision only every 3-4 years. Professional judgment would significantly impact the magnitude of footnote disclosures. The policy footnote would have the following statement:
The accompanying financial statements have been prepared in accordance with the Financial Reporting Framework for Small- and Medium-Sized Entities issued by the American Institute of Certified Public Accountants. This framework, unlike accounting principles generally accepted in the United States of America, generally does not make use of fair value accounting and also provides more flexibility in the areas of accounting for income taxes and consolidations.
The key for FRF-SME to become a reality is to get banks and bonding agents to buy-in and accept this reporting framework. Whether or not this happens remains to be seen. Watch this column for future updates on these important accounting issues.
Roger T. Gingerich, CPA/ABV, CVA is the partner-in-charge of Skoda Minotti’s Real Estate and Construction Group. You can contact Roger by leaving a message below, or by calling 440-449-6800.