Revenue Recognition in Construction Projects – how to get more consistent cash flow

Revenue recognition in industries such as retail, distribution and manufacturing is pretty straightforward; even in services industries such as Airlines and Logistics, it is even simpler. However, revenue recognition can be incredibly complex and challenging to obtain in the construction industry.

Construction projects are a moving sea of different parts, and they all have different terms and conditions and timelines that can go from a month to several years. All those requirements are a lot to keep track of over an extended period of time, and the longer a project goes, the more complex it becomes. 

Contractors have two choices :

1. whether to recognise the revenue at the end of the project (at a point of time) or;
2. identify it as the project progresses (over time).

A short-term project – this is defined as one that is completed within a single financial year – can quite easily get away with recognising the revenue at the end of the project. However, for long term projects – defined by projects that extend over more than two financial years – the best solution is revenue recognition as the project progresses – this is known as the percentage completion method. 

The percentage completion method is a way of recognising construction revenue that’s based on the amount of work completed on contracts. 

The Accounting Standard AASB 15 (Revenue from Contracts with Customers) contains specific and more precise guidance on the timing of revenue recognition. 

The standard requires specific criteria to assess whether a transfer of control occurs over time or at a point in time to determine the method of recognising revenue.

To be recognised over time based on a percentage-of-completion method, at least ONE of the following must be met:

• The customer receives and consumes the benefits of the contract as the performance occurs (e.g., maintenance service arrangement)
• The performance of the contract creates or enhances a customer-controlled asset (e.g., construction of an asset on the customer’s site)
• The performance does not create an asset with an alternative use to the company, AND the company has an enforceable right to payment for work done to date.

When calculating the amount of revenue to be recognised using a percentage of completion method, either the output method or the input method can be used. The output method results in revenue being recognised on the basics of directly measuring the value of goods and services transferred to date. The input method results in revenue being identified based on measures such as resources consumed, costs incurred, and machine or labour hours.

The calculation of revenue recognising process needs the construction company to ensure that the procedures exist and the accounting system is cable of tracking costs separately by projects within a contract. As well as this, the sales staff and other individuals authorised to enter contracts need to understand the standards, the required information, and the system they are using.

If you feel your business could benefit from reviewing your revenue recognition processes, please reach out to our team at Thrive. We are the construction industry experts. We Listen. We Understand. We Find Solutions.

www.thrivetech.com.au
1300 868 474