ASC 606-Revenue Recognition-Uninstalled Materials

Living in a Material World

We’ve worked with the revenue recognition standard under ASC 606, Revenue from Contracts with Customers, for a few years now. How’s it going? Pretty good? Well, now may be an excellent time to reexamine a somewhat dubious but significant area of the standard.

This article will examine revenue recognition for materials cost related to a construction contract. Specifically, we will discuss critical factors that impact how a contractor who uses the cost-to-cost input method recognizes revenue associated with uninstalled materials.

The FASB has an underlying concern that cost-to-cost revenue recognition could result in an overstatement of revenue. ASC 606-10-55-21 points out a potential shortcoming of the cost-to-cost method input method. There may not be a direct relationship between the cost charged to the contract (the input) and the transfer of control of goods or services to the customer, resulting in an overstatement of revenue. For example, significant uninstalled materials charged to job cost may not be indicative of progress toward project completion and thus result in an overstatement of revenue.

It’s a Matter of Control. ASC 606-10-25-23 states that entities (contractors) recognize revenue as it satisfies performance obligations by transferring a promised good or service (i.e., an asset) to the customer. It further states that assets are transferred when (or as) the customer obtains control of the asset.

Under ASC 606, depending on when control of the materials passes to the customer, uninstalled materials are accounted for and presented in one of three ways:

  1. When Control has not Passed. Generic uninstalled materials, even those transferred or delivered directly to the job site, for which control has not been transferred to the customer, should be accounted for as inventory on the contractor’s balance sheet in accordance with ASC 330. Contract revenue (including profit) and cost are not recognized if control has not passed to the customer.
  2. When Control has Transferred, but Materials Not Installed. When control of the uninstalled materials (located in the contractor’s shop or at the job site) has passed to the customer, but the materials remain uninstalled, the contractor may recognize contract revenue, but only to the extent of the cost of the materials. No profit can be recognized before installation. ASC 606-10-55-21suggests that such an adjustment to the cost-to-cost input method may be required in the following circumstance:
    • When a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation. In those circumstances, the best depiction of the entity’s performance may be to adjust the input method to recognize revenue only to the extent of that cost incurred. For example, a faithful depiction of an entity’s performance might be to recognize revenue at an amount equal to the cost of a good used to satisfy a performance obligation if the entity expects at contract inception that all of the following conditions would be met:
      1. The good is not distinct.
      2. The customer is expected to obtain control of the good significantly before receiving the services related to the good.
      3. The cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation.
      4. The entity procures the good from a third party and is not significantly involved in designing and manufacturing the good.

    An excellent example of how to account for uninstalled materials when control of the materials has passed to the contract owner is found at Example 19- ASC 606-10-55-187 through 192.

  3. Control has Transferred, and Materials are Installed. The contractor may include the cost of the materials in the input method and fully recognize the cost and revenue, including profit.

Transfer of Control. ASC 606-10-25-25 states that:

(c)ontrol of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

When, exactly, does control of materials transfer to the customer? Unfortunately, there is no simple answer. Like many things in life, the answer is maybe yes, maybe no, it ain’t necessarily so.

In short, control of the materials transfers to the customer when ownership transfers to the customer. And in our federalistic system, property ownership laws vary from state to state. It varies and is, therefore, complicated. Depending on the jurisdiction, ownership of the materials may transfer upon delivery to the job site; the transfer may be upon billing the materials, or the ownership transfer may be upon collection of the billing. And lien laws come into play that may determine the point when material ownership transfers from the contractor to the customer. The contract itself may stipulate when the transfer of ownership happens. Sorry, there is no boilerplate black-letter answer. Nevertheless, to properly recognize and account for revenue, it is essential to understand at what point ownership of the materials passes to the customer.

Because of this complexity, you should only travel this path when required. That is when doing so is necessary because it significantly affects revenue measurement which may not be indicative of progress toward project completion.

What About Material Designed and Manufactured by the Contractor?

Such materials should be charged directly to contract costs, and revenue (including all profit) should be recognized using standard cost-to-cost percentage of completion computations.

What About General Contractors or Prime Contractors?

Even general or prime contractors may find they are not exempt from the rules related to uninstalled materials. If the general or prime contractor has subcontractors with significant uninstalled materials whose costs are then billed to the general or prime contractor, those pay items may have to be excluded from their percentage of completion calculation in the manner discussed above.

Revenue Recognition For Contractors

Does it Seem Easier Now?

Now that contractors have a few years of practical experience working with the revenue recognition standards under ASC 606, does it seem a bit friendlier than expected? Perhaps so. Or maybe it seems that way because we’ve been working with it for a while now.

We thought this would be an excellent time to review a few significant tenants of the standard. After working with ASC 606 for a time, a refresher of pivotal provisions may help solidify our understanding. So briefly–here we go.

Remember the five steps?

  1. Identify the contract(s) with a customer
  2. Identify the performance obligation(s)
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligations
  5. Recognize revenue when (or as) performance obligations are satisfied.
  1. Identify the Contract. For a contractor, identification of a contract is usually the easy part. It’s in the name– right? Unfortunately, a contractor’s contract may be a mountain of documents, including the core contract, specs, drawings, and many change orders. Or depending on the nature of the contractor’s business, it may be very sketchy and driven by purchase orders. Nevertheless, if there’s a meeting of the minds between two or more parties and it creates enforceable rights and obligations – you have a contract. However, to recognize revenue under ASC 606, all of the following must be met:

    • It has the approval and commitment of the parties
    • Rights are identified
    • Payment terms are identified
    • It has commercial substance, and
    • The collectibility of substantially all consideration is probable. Probable means it is likely to be collected.

    What does “likely to be collected” mean? From a practical viewpoint, if the likelihood of collection is 75% or better, many practicing accountants consider the probable threshold met.

    When should the contractor reassess collectability? Question 10 of the FASB’s Revenue Recognition Implementation Q&As (January 2020) (FASB Q&A) addressed this question. There must be a significant change in the customer’s ability to pay before the contractor reassess whether revenue recognition must stop.

  2. Identify the performance obligation(s). Are the costs of pre-production activities included in the percentage of completion (POC) measurement? For example, consider the cost of mobilizing equipment, labor mobilization, and construction of a temporary site office. Do those activities provide goods or services impacting POC revenue recognition? Also, what about pre-construction design services? Do such cost activities transfer a service measured under the POC calculation?

    The FASB Q&A attempts to shed some light on this. Question 16 is as follows: How should an entity assess whether pre-production activities are a promised good or service (or included in the measure of progress toward complete satisfaction of a performance obligation that is satisfied over time)?

    The pre-production activity will enter into the POC measurement if the activity is a promised good or service. However, if the activity does not transfer a good or service to the customer, it is not included in the POC measurement.

    Whether or not to include pre-production activities in the POC measurement is a matter of judgment. Consider whether there has been a transfer of goods or services to the customer. Suppose mobilization is a line item on the schedule of value, whereby the company has the right to payment for its cost plus a reasonable profit. In that case, mobilization represents progress toward completion because it is a contractual promised good or service, as evidenced in the contractual schedule of values.

    On the other hand, if the site office is not included in the schedule of value, its cost probably doesn’t transfer a good or service to the contract owner. Therefore, it would not be a cost included in the POC revenue measurement.

    An acid test that the FASB Q&A offers is whether control of the good or service is ever transferred to the customer. The overriding question is whether the customer simultaneously receives and consumes the benefits provided by the construction company. For example, if pre-construction design drawings are provided to the contract owner, the owner has received and consumed the benefit. This is because he has the drawings in hand and under his control. Therefore, the cost of the design services would impact the POC calculation.

  3. Determine the transaction price. Due to the nature of construction contracts, estimating total revenue at completion is complex. Much of the complexity relates to variable consideration. Variable consideration can take many forms. For example, variability can relate to performance bonuses, incentive payments, liquidated damages, unpriced change orders, and contract claims.

    ASC 606 provides two methods for estimating variable consideration.

    1. Expected value approach
    2. Most likely amount approach

    The choice of approach is not an election. Instead, the company can select whichever method is expected to predict the amount better.

    After estimating variable consideration, the company must consider the revenue recognition restraints. Then, based on an evaluation of those restraints, variable consideration is included in the transaction price when it is probable that a significant reversal of cumulative revenue recognized will not occur or when the uncertainty is resolved. In other words, the contractor includes the amount they expect to be entitled to in the transaction price.

  4. Allocate the transaction price to the performance obligations. This step is required if you identify more than one performance obligation embedded in the construction contract. In that case, the contract price will be allocated between the several performance obligations.

    On the other hand, the contractor may find that many complex tasks in a contract intertwine into a single performance obligation. This happens when the contractor provides a significant service of integrating a complex set of tasks and components into a single project.

  5. Recognize revenue when (or as) performance obligations are satisfied. For a contractor, the question is, at inception, will revenue recognition be over-time or at a point in time? To decide this, the company must first determine if the revenue stream meets the over time recognition criteria. If not, then revenue is recognized at a point in time by default.

    ASC 606 provides three criteria to determine if control of a good or service transfers to the customer over time. If any of the criteria described below are met, revenue recognition is over time. If none of the criteria below are met, revenue is recognized at a point in time.

    1. The customer simultaneously receives and consumes the benefits as the company performs.
    2. The customer controls the asset as it is created or enhanced by the company.
    3. The company creates or enhances an asset that has no alternative use to the company, and the company has a right to be paid for work completed to date.

    An example of the first criterion noted above would be hauling services. If the customer contracted for materials to be hauled from Nashville to Memphis, it’s likely that the customer simultaneously receives and consumes benefits as the trucker performs (over time). Why? If the truck breaks down at Bucksnort 60 miles up Interstate 40, the customer could (theoretically, anyway) hire another nearby trucker to haul the materials for the remainder of the route. The replacement trucker would obviously not be required to repeat the trip from Nashville to Bucksnort. That means the customer both received and consumed the benefit of the materials being hauled from Nashville to Bucksnort.

    An example of the second criterion would be a commercial building constructed on real property owned by the customer (contract owner). As the contract owner is progress billed, he accepts control of the asset as work is completed in stages. That’s the justification for percentage-of-completion revenue recognition and, for that matter, progress billing. It’s revenue recognition over time.

    The third criterion can be illustrated as follows. The contractor has a long-term contract with the U.S. Department of Energy for civil construction on a project unique to the Department’s classified purpose. Therefore, the contractor has no alternative use for the asset under construction. Additionally, if the DOE halted construction after 50% completion, the contractor has a contractual right to payment for the work completed. Accordingly, revenue recognition will be measured over time.

Variable Consideration (It’s Probable)

ASC 606, Revenues from Contracts with Customers

For most privately-held construction companies, ASC 606, Revenues from Contracts with Customers, has been effective for over two years. For many construction companies, the transition to ASC 606 was not too bad, but it did make subtle changes in certain areas that continue to raise questions. One of those areas is estimating the contract price, i.e., total estimated consideration due under the long-term contract. ASC 606-10-32-2 states:

“An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both”.

What’s The Transaction Price?

ASC 606-10-32-4 defines the transaction price as:

“For the purpose of determining the transaction price, an entity shall assume that the goods or services will be transferred to the customer as promised in accordance with the existing contract and that the contract will not be canceled, renewed, or modified”.

In other words, contractual options to modify a contract are ignored when determining the transaction price.

The transaction price consist of 1) fixed consideration, 2) variable consideration, 3) financing components, 4) noncash consideration, and 5) consideration payable to the customer.

The area that seems to be the most contentious and has a significant impact on many contractors is variable consideration.

What is Variable Consideration?

ASC 606-10-32-5 states:

“If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.”.

So, the amount of consideration the company expects to receive should be estimated. Variable consideration is not fixed but is based on uncertain events. For a contractor, variable consideration may include unit-priced contracts (price per unit is fixed, but the quantities are uncertain), incentive bonuses, liquidated damages, shared savings, change orders, and claims.

ASC 606 is a principles-based standard that requires contractors to reasonably estimate profit for variable considerations, even at the early stages of a contract. The amount of variable consideration is determined at the beginning of the contract and is updated each reporting period. It may result in adjustments to the contract amount for incentive bonuses before the contract is complete, recognition of change orders before a formal change order is finalized, and adjustment to the contract price for claims before the claim resolution process is concluded.

Probability Analysis

Variable consideration is included in the contract amount based on a probability analysis that a significant revenue reversal will not occur in a subsequent period. This probability is based on certain revenue constraints.

Probability Analysis

Under ASC 606-10-32-8, variable consideration is determined under one of the following probability methods:

  1. Expected value approach
  2. Most likely amount approach

The expected value approach is based on the sum of probability-weighted amounts in a range of multiple expected consideration possibilities. The most likely amount approach is used, generally, when there are two possibilities. The possibility that is most likely is chosen as the variable consideration amount.

These two methods are not elections but are determined based on the facts and circumstances. Therefore, the expected value approach may be used on one contract, and the most likely amount approach used on another contract within the same year. However, the method chosen for a particular contract should be consistently applied throughout that contract.

Constraints to Revenue Recognition

ASC 606-10-32-11 states:

“An entity shall include in the transaction price some or all of an amount of variable consideration estimated in accordance with paragraph 606-10-32-8 only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved”.

Under ASC 606-10-32-12, when assessing probabilities that a significant reversal in the amount of cumulative revenue will not occur, the contractor should consider both the likelihood and magnitude of the following constraints to revenue recognition:

  1. Factors outside the contractor’s influence:
    • Market volatility
    • Weather conditions
    • Settled through adjudication or arbitration
      1. This would generally increase the degree of uncertainty regarding the amount of consideration, causing a delay in revenue recognition until the uncertainty is resolved.
  2. Length of time to resolve an uncertainty.
  3. The contractor’s experience with similar contracts
  4. The contractor’s history of offering a broad range of price concessions with similar contracts
  5. The contract has a broad range of possible consideration outcomes
  6. Other restraints not listed but apply to the contractor’s situation


Probable is defined in the ASC 606-10-20 as “The future event or events are likely to occur.”

The probability of a significant revenue reversal not occurring in a subsequent period is a matter of judgment regarding the restraints, but generally, in our opinion, the confidence level should be 75% or better. Therefore, it is considered a high bar to reach.

  1. For example, you adjust the contract amount to include:
    • Incentive bonuses for early completion if you are 75%+ confident that the revenue recognized will not reverse later.
    • Pending/unsigned or unpriced change orders if you are 75%+ confident that significant revenue will not reverse.
    • Same with claims, liquidated damages, shared savings, etc.
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