Last month I wrote about the revised exposure draft relating to revenue recognition that was issued in November 2011. This month I want to expand on that discussion and focus in on three commonly asked questions related to the revised exposure draft and how it either differs or is consistent from how contractors currently recognized revenue under the old SOP 81-1.
Will Contractors still be able to use the percentage of completion method for recognizing revenue?
Yes, under the current exposure draft contractors will still be able to use percentage of completion for recognizing revenue. Some people interpreted that the percentage of completion method of recognizing revenue was eliminated in the first exposure draft issued in June 2010.
What does the new term “Performance Obligation” mean & why is it important?
A “Performance Obligation” is a promise to deliver a good or service. It is important because a contractor has to be able to identify and determine if each of their contracts has separate performance obligations or just one. Historically, in most cases, contractors have treated their contracts as one performance obligation and recognized the revenue on the entire contract. If under the new exposure draft, it is determined that there are more than one performance obligations under the contract, each performance obligation needs to be treated separately for revenue recognition purposes.
Is a change order a separate “Performance Obligation” or can it be combined with the original contract?
It depends. In most cases, contractors will be able to combine change orders with the original contract. However, there will be situations where change orders will be treated as a separate contract.
Contractors need to be prepared for the new standard and the impact that it could have to how they do business. Contractors need to understand that every contract and change order needs to be reviewed to determine if there are multiple performance obligations, and if so, what does that mean. The Next time, I will continue to discuss some of the specific changes in the current exposure draft vs. how contractors currently recognize revenue.