Identifying the Contracts With the Customer

11.1.01 FASB ASC 606-10-25-9 indicates that when two or more contracts are entered into at or near the same time with the same customer, they must be accounted for as a single contract if any of the following criteria are met: (a) the contracts are negotiated as a package with a single commercial objective, (b) the amount of consideration payable under one contract depends on the price or performance under the other contract, or (c) the goods or services promised in the contracts represent a single performance obligation.

11.1.02 FinREC believes one example of when contracts should possibly be combined is when there are separate contracts with the same customer, one for engineering services and the other for construction services, that are issued only a month apart (at or near the same time). If these two contracts are for the design and building of a single capital asset and they would be a single performance obligation had they been in a single contract, these contracts likely should be combined. Judgment is required because additional facts or different circumstances could result in a different conclusion.

11.1.03 It is common in the engineering and construction industry to have contracts that give the customer a right to cancel for convenience or other than for cause but that do not give the contractor similar rights (or that the contractor could not exercise without incurring significant consequences). Engineering and construction customers include such termination clauses to provide them an opportunity to suspend or terminate a project should unforeseen economic or political circumstances occur that significantly affect the return that would be generated by the capital project. However, unlike in industries where contracts are for much smaller value and for a series of services (for example, cellular phone services), engineering and construction contracts are rarely terminated, because partial completion of a capital project or a facility is of little value to the customer, and the customer would incur additional costs that are considered akin to termination penalties (for example, costs of shutting down the work, demobilization, storage and handling of uninstalled materials, as well as restart costs if the customer later desires to complete the project).

11.1.04 FASB ASC 606-10-32-4 states, “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 cancelled, renewed, or modified.”

11.1.05 In an engineering and construction contract, the promise to the customer is often a facility or capital asset, as discussed in the “Identifying the Unit of Account” section in paragraphs 11.2.01–11.2.17.

11.1.06 At the November 2015 TRG meeting, an implementation issue was discussed regarding how to determine the term of the contract when the customer has the unilateral right to terminate a contract and whether termination penalties affect that analysis.

11.1.07 As discussed in paragraphs 50 and 51 of TRG Agenda Ref. No. 48, Customer Options for Additional Goods and Services, Issue 2: Customer Termination Rights and Penalties, FASB and IASB staff recommended that contracts with customer termination provisions should be accounted for the same as contracts with unexercised options when the contract does not include a substantive termination penalty. That is, if the termination penalty is not substantive, this may indicate that the contract term, in accordance with FASB ASC 606, is less than the stated contractual period. TRG Agenda Ref. No. 49, November 2015 Meeting — Summary of Issues Discussed and Next Steps, paragraph 10 states, in part:

11.1.08 FinREC believes that the contractor’s history with terminations for different types of contracts, specific knowledge about the customer, and other facts and circumstances should be considered in assessing the impact of a termination provision on the duration of a contract. The TRG discussion regarding the concept of cancelation rights and renewal options and substantive termination penalties noted in paragraph 4 is applicable in contracts for the provision of a series of recurring goods and services (for example, operations and maintenance contracts). Most engineering and construction contracts are for the design and construction of a facility or capital asset. The contractor has enforceable rights to be compensated for work performed during the execution of the contract and upon termination. The contractor has an enforceable obligation to complete the entire facility. FinREC believes that because a contractor has an ongoing enforceable obligation, often backed by a surety bond or letter of credit, to deliver the full scope of work specified in a contract with a customer, until the scope of work is completed or the customer explicitly terminates the contract, the contractor should reflect this obligation in the accounting and disclosure of remaining unsatisfied performance obligations until such time that the contract is terminated.

11.1.09 The following examples are intended to be illustrative, and different facts and circumstances may change the conclusion. In each example, it is assumed that the contract meets all criteria for existence in accordance with FASB ASC 606-10-25-1.

Example 11-1-1

A customer enters into a contract with an engineering and construction company for the design and construction of a high-tech manufacturing facility. In this example, the customer would incur a substantial economic penalty to cancel for convenience (for example, significant wind-down costs would be incurred and a partially completed facility would be of no use to that customer). As a result, FinREC believes the contract price, in accordance with FASB ASC 606-10-32-4, and duration of the contract are determined based on the defined scope in the contract (design and build a high-tech manufacturing facility), as opposed to a service contract, which would have a term based on the passage of time.

Example 11-1-2

A customer enters into a contract for recurring maintenance services with a contractor. The contract is for an indefinite term and includes a termination provision that allows either party to cancel for convenience upon 30 days’ notice. The contract states that the customer will compensate the contractor in accordance with the terms of the contract for services provided through the termination date. In accordance with the guidance in paragraph 10 of TRG Agenda Ref. No. 49, this contract would be accounted for on a month-to-month basis because there is not a substantial (contractual or economic) termination penalty.

Example 11-1-3

A customer enters into a contract to perform small capital projects at the customer’s facilities for a period of three years, with an option to renew for another three years. The renewal option is assumed not to represent a material right. There is no termination for convenience clause in the contract. FinREC believes that, at inception, the term of this contract is three years because there is no termination for convenience clause (neither party has a right to terminate early except in the case of default).

Identifying the Performance Obligations in the Contract

11.2.01 Paragraphs 14–22 of FASB ASC 606-10-25 discuss how to determine whether promised goods and services in the contract represent performance obligations.

11.2.02 FASB ASC 606-10-25-14 establishes that a contractor should

a.     A good or service (or bundle of goods or services) that is distinct

b.     A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer...

11.2.03 FASB ASC 606-10-25-15 explains that

a.     Each distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in paragraph 606-10-25-27 to be a performance obligation satisfied over time.

b.     In accordance with paragraphs 606-10-25-31 through 25-32, the same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

11.2.04 Determining whether goods and services are distinct is a matter of judgment. Whereas FASB ASC 606-10-25-19a effectively looks to the economic substance of each good or service to determine whether a customer can benefit from that good or service either on its own or with readily available resources or those available to the customer in the marketplace, FASB ASC 606-10-25-19b requires the contractor to evaluate whether the promised good or service in the contract is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract), and FASB ASC 606-10-25-21 provides a nonexclusive list of indicators for the contractor to consider. A contractor’s evaluation of the indicators may vary depending on the specific circumstances of the contract.

11.2.05 In many engineering and construction contracts, the finished deliverable is constructed in a number of phases (for example, front-end engineering and design, detailed engineering, procurement, fabrication, construction or construction management, and validation or start-up) that each include goods or services that normally provide benefit to the customer on their own or together with other readily available resources. Therefore, the contractor’s evaluation regarding whether a promised good or service is or is not distinct will likely depend more on an evaluation of the criteria in FASB ASC 606-10-25-19b — that is, whether those goods or services are distinct within the context of the contract.

11.2.06 FASB ASC 606-10-25-21 includes factors for consideration in determining whether a contractor’s promise to transfer a good or service to a customer is or is not separately identifiable; however, it does not limit a contractor’s consideration only to those factors identified. As a result, an entity’s evaluation of the indicators in FASB ASC 606-10-25-21 will largely be driven by the nature of the transaction and the specific facts and circumstances of the contract. Paragraph BC29 of FASB Accounting Standards Update (ASU) No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, indicates that when evaluating whether the individual goods and services are separately identifiable, "entities should evaluate whether the contract is to deliver (a) multiple goods or services or (b) a combined item or items that is comprised of the individual goods and services promised in the contract." In other words, entities should evaluate whether the individual goods and services are outputs or, instead, inputs to a combined output.

11.2.07 Paragraph BC105 of FASB ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), explains that the principle of "separately identifiable" is based on the notion of separable risks, that is, whether the risk that an entity assumes to fulfill its obligation to transfer one of those promised goods or services to the customer is a risk that is inseparable from the risk relating to the transfer of the other promised goods or services. BC106 of FASB ASU No. 2014-09 further notes that the factors in FASB ASC 606-10-25-21 are based on the same underlying principle of inseparable risks, and that in many cases more than one of the factors might apply to a contract with a customer.

11.2.08 The factor in FASB ASC 606-10-25-21a suggests that a promised good or service in a contract is not distinct from the other promised goods or services where the contract is for the construction of a single, combined output resulting from the contractor’s significant service of integrating the component goods and services in the contract. FinREC believes that an important factor for determining that goods or services should be combined with an integration service into a single performance obligation is that the risk the entity assumes in performing the integration service is inseparable from the risk relating to the transfer of the other promised goods or services. The judgment about the risk an entity assumes with respect to a promised good or service can often be inferred by certain terms of the contract, such as the contract’s acceptance or warranty provisions.

11.2.09 Another important judgment in interpreting FASB ASC 606-10-25-21a is whether the integration service is significant. Paragraph BC107 of FASB ASU No. 2014-09 states that the risk of transferring individual goods or services is inseparable from an integration service because a substantial part of the entity’s promise to a customer is to ensure the individual goods or services are incorporated into the combined output. Paragraph BC107 continues to explain that this factor may be relevant in many construction contracts in which the contractor provides an integration (or contract management) service to manage and coordinate the various construction tasks and to assume the risks associated with the integration of those tasks.

11.2.10 An integration service may be clearly evident when combining a number of subcomponents into a single deliverable (for instance, construction of a single structure). However, many engineering and construction contracts are for the provision of multiple services or structures (such as engineering and construction of a power generation facility). In these arrangements, additional judgment will be required when evaluating whether there is a substantial integration service involved. Although there is generally assumed to be a significant service of integrating engineering with construction to produce a combined output (such as a power plant), FinREC believes that, in some circumstances, the engineering may not be significantly integrated with the construction (such as when engineering and construction are performed in separate and distinct phases for which the customer has the option of awarding construction to a different contractor upon completion of the engineering). Significant judgment is required in making this assessment, and the conclusion should be based on specific facts and circumstances. Careful consideration should be given to the degree of the integration service provided in the context of the contract.

11.2.11 For example, if an engineering and construction company has a unit that provides fabrication services, whether the fabrication services would be a separate performance obligation from construction in a contract would depend on the significance of the integration service. If the fabrication unit is fabricating major sections of a bridge in its own fabrication yard and a substantial part of the construction services involves constructing the bridge by installing the fabricated components to produce the combined output of a single bridge, the fabrication and construction should be considered a single performance obligation if the entity concludes that the risk of fabrication of the individual components of the bridge is inseparable from the risk associated with construction of the bridge.

11.2.12 The factor in FASB ASC 606-10-25-21b suggests that a promised good or service in a contract is not distinct where it significantly modifies or customizes another good or service in the contract. Within the construction industry, although facts and circumstances vary and judgment is required, engineering frequently modifies or customizes each construction project significantly. For example, the construction would be customized because of site condition differences at each location, based on the engineering, for what might otherwise be identical power generation facilities.

11.2.13 The factor in FASB ASC 606-10-25-21c explains that a promised good or service in a contract is not separately identifiable if it is highly dependent upon, or highly interrelated with, other promised goods or services in the contract. Paragraph BC111 of FASB ASU No. 2014-09 states that this indicator was included because, in some cases, it might be unclear whether the entity is providing an integration service or whether the goods or services are significantly modified or customized. It is usually clear whether the factors in items a and b of FASB ASC 606-10-25-21 are met for engineering and construction contracts; therefore, the factor in item c will typically be less important in making the assessment of whether promised goods or services in the contract are not separately identifiable.

11.2.14 If, after having considered the factors in FASB ASC 606-10-25-21, a contractor has determined that promised goods or services are distinct, the contractor would then consider whether those distinct goods or services are substantially the same and have the same pattern of transfer to the customer, as discussed in FASB ASC 606-10-25-14b. In making this determination, the contractor would evaluate whether both of the following criteria from FASB ASC 606-10-25-15 are met:

a.     The distinct good or service in the series that the entity promises to transfer to the customer would meet the criteria in FASB 606-10-25-27 to be a performance obligation satisfied over time.

b.     The same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

11.2.15 BC113 of FASB ASU No. 2014-09 explains that the criteria in FASB ASC 606-10-25-15 were included as part of the definition of performance obligation to simplify the application of the model and to promote consistency in the identification of performance obligations in circumstances in which the entity provides the same good or service consecutively over a period of time. BC114 of FASB ASU No. 2014-09 identifies several examples of repetitive service contracts, including a cleaning contract, transaction processing, or a contract to deliver electricity. Within the engineering and construction industry, an example of a series of services would be an operations and maintenance contract with a manufacturing customer for maintenance services that are substantially the same from day to day.

11.2.16 Arrangements in the engineering and construction industry may include maintenance services. The first critical step in evaluating maintenance-type services is to identify the nature of the arrangement. As discussed in TRG Agenda Ref. No. 16, Stand-Ready Performance Obligations, a promise to provide periodic maintenance, when and if needed, on a customer’s equipment after a pre-established amount of usage, may be considered a "stand-ready" obligation. BC160 of FASB ASU No. 2014-09 supports the view that promises to "stand ready" are evaluated based on increments of time (that is, the act of standing ready) as opposed to the underlying activities of providing goods and services. As discussed in TRG Agenda Ref. No. 39, Application of the Series Provision and Allocation of Variable Consideration, if the contractor determines that the nature of the arrangement is a stand-ready obligation, the maintenance arrangement will generally be accounted for as a series in accordance with FASB ASC 606-10-25-14b (that is, the promise to stand ready is substantially the same from day to day). Consistent with paragraph 32 of TRG Agenda Ref. No. 25, January 2015 Meeting — Summary Memo, arrangements to provide specific maintenance services over a period of time (as opposed to when and if needed) would not be accounted for as stand-ready obligations, and, as a result, are evaluated based on the specified goods and services promised in the contract using the distinct criteria discussed in paragraphs 11.2.01–11.2.15. These arrangements, which may be more common in the engineering and construction industry, may also be accounted for as a series if the types of services performed are substantially the same from day to day and meet the criteria in FASB ASC 606-10-25-15. Regardless of whether the arrangement is considered a series of stand-ready or specified services, the objective for measuring progress over time is to depict the contractor’s performance of satisfying the performance obligation (consistent with question 2 of TRG Agenda Ref. No. 16, it is not appropriate to default to a straight-line revenue attribution method for stand-ready obligations if such attribution would not depict the contractor’s performance.) (See the "Acceptable Measures of Progress" section in paragraphs 11.5.01–11.5.27 for appropriate methods of measuring progress for common types of arrangements in the engineering and construction industry.)

11.2.17 The following example is meant to be illustrative; the actual determination of the performance obligation(s) in a contract should be based on the facts and circumstances of an entity’s specific situation.

Example 11-2-1

E&C Corporation (the contractor) has entered into a contract with State Transit Authority (the customer) to design and construct a commuter rail line and maintain this line along with other lines that are already operational. The maintenance services consist of regularly scheduled maintenance of the rail lines; major overhaul services are not within the scope of this contract. The design and construction work is expected to take five years to complete. The maintenance of the other lines that are already operational will be transitioned from being performed in-house by State Transit Authority to E&C Corp. within one year, and the maintenance portion of the contract will continue for 20 years.

E&C Corp. reviews FASB ASC 606-10-25-19 to 25-21 to identify the performance obligations in this contract. E&C Corp. determines that there are two performance obligations in this contract: (1) the design and construction activity and (2) the maintenance activity, which is a series of distinct services in accordance with FASB ASC 606-10-25-14b.

E&C Corp. concludes that each of the promises in the contract (design, construction, and maintenance services) is capable of being distinct in accordance with FASB ASC 606-10-25-19a. That is, the customer can benefit from the goods and services either on their own or together with other readily available resources. This is evidenced by the fact that other entities regularly sell these services separately to other customers (that is, the customer could receive the design services from one entity and separately contract for the construction or maintenance services from another entity).

However, E&C Corp. concludes that the design and construction services are not separately identifiable (that is, distinct within the context of the contract) in accordance with FASB ASC 606-10-25-19b. This conclusion was reached by considering the indicators in FASB ASC 606-10-25-21. That is, E&C Corp. provides a significant service of integrating the design and construction services into a single output for which the customer has contracted (a commuter rail line). Additionally, the design significantly modifies or customizes construction, and construction is highly interdependent on the design. Therefore, because both criteria in FASB ASC 606-10-25-19 are not met for the design and construction services, E&C Corp. concludes that they should be combined into one performance obligation.

In determining whether the maintenance service is distinct from the design and construction, E&C Corp. concludes that the maintenance services are separately identifiable from the design and construction services in the contract itself (FASB ASC 606-10-25-19b). That is, the maintenance services are not highly integrated with or highly dependent on the design and construction and do not significantly modify or customize the design and construction (FASB ASC 606-10-25-21). Additionally, the maintenance services are determined to be a series of distinct goods and services that are substantially the same and have the same pattern of transfer to the customer, in accordance with paragraphs 14b and 15 of FASB ASC 606-10-25. E&C Corp., therefore, determines that the maintenance services are a series of distinct goods and services accounted for as a single performance obligation and distinct from the design and construction services performance obligation.

Background

11.3.01 Estimating the transaction price of a contract is an involved process that is affected by a variety of uncertainties that depend on the outcome of a series of future events. The estimates must be revised each period throughout the life of the contract when events occur and as uncertainties are resolved. The major factors that must be considered in determining total estimated revenue include (a) the basic contract price, (b) contract options, (c) change orders, (d) claims, and (e) contract provisions for penalty and incentive payments, including award fees and performance incentives.

11.3.02 Engineering and construction contracts often contain provisions for variable consideration from the customer in the form of change orders (including unpriced change orders), claims, back charges, extras, and contract provisions for penalty and incentive payments, including award fees and performance incentives. (See paragraphs 11.3.07–11.3.09 for discussion on the evaluation of the guidance in paragraphs 10–13 of FASB ASC 606-10-25 for contract modification accounting to determine if certain types of variable consideration should be accounted for under the variable consideration guidance.)

11.3.03 Change orders, claims, extras, or back charges are common in construction activity. Modifications of the original contract frequently result from change orders that may be initiated by either the customer or the contractor. The nature of the construction industry, particularly the complexity of some types of projects, is conducive to disputes between the parties that may give rise to claims or back charges. Claims may also arise from unapproved change orders. In addition, customer representatives at a job site sometimes authorize the contractor to do work beyond contract specifications, and this gives rise to claims for extras. The ultimate profitability of a contract often depends on whether appropriate authorization has been obtained and whether modifications to the original contract have been identified, documented, and related amounts collected.

11.3.04 In accordance with FASB ASC 606, entities are required to make estimates of variable consideration in determining the transaction price, subject to the guidance on constraining estimates of variable consideration. In addition, as required by FASB ASC 606-10-32-9, “an entity shall consider all the information (historical, current, and forecast) that is reasonably available to the entity and shall identify a reasonable number of possible consideration amounts.” The information that an entity uses to estimate the amount of variable consideration typically would be similar to the information that the entity’s management uses during the bid-and-proposal process and in establishing prices for promised goods and services. Entities are also required to update their estimates of variable consideration on an ongoing basis.

Incentives and Penalties

11.3.05 All types of contracts may be modified by target penalties and incentives relating to factors such as completion dates, plant capacity on completion of the project, and underruns and overruns of estimated costs. These provisions for incentives and award fees are generally based on (a) the relationship of actual contract costs to an agreed-upon target cost or shared savings or (b) some measure of contract performance in relation to agreed-upon performance targets. Consequently, the contractor's profit is increased when actual costs are less than agreed-upon cost targets or shared savings. Similarly, the profit is increased when actual performance meets or exceeds agreed-upon performance targets. Conversely, the contractor's profit is decreased when actual results (in terms of either cost or performance targets) do not meet the established cost or performance targets.

11.3.06 FinREC believes that the mere existence of contractual provisions for incentives or award fees should not be considered presumptive evidence that such incentives or award fees are to be automatically included in the transaction price. In the case of performance incentives, assessing whether actual performance will produce results that meet targeted performance objectives may require substantial judgment and experience with the types of activities covered by the contract. However, in many circumstances, these estimates of performance relative to targeted performance are similar to the processes used to estimate completion on long-term contracts.

Change Orders

11.3.07 Change orders are modifications of an original contract that effectively change the provisions of the contract without adding new provisions. They may be initiated by either the contractor or the customer, and they include changes in specifications or design, method or manner of performance, facilities, equipment, materials, sites, and period for completion of the work. For some change orders, both scope and price may be unapproved or in dispute. Many change orders are unpriced; that is, the work to be performed is defined, but the adjustment to the contract price is to be negotiated later.

11.3.08 Accounting for change orders depends on the underlying circumstances, which may differ for each change order, depending on the customer, the contract, and the nature of the change. FASB ASC 606-10-25-11 states the following:

11.3.09 In accordance with FASB ASC 606-10-25-11, judgment will be needed to evaluate a change order to determine whether it represents an enforceable obligation that should be accounted for in accordance with the guidance in paragraphs 5–9 of FASB ASC 606-10-32 on estimating variable consideration and paragraphs 11–13 of FASB ASC 606-10-32 on constraining estimates of variable consideration. FinREC believes some factors to consider include the following:

a.     The customer’s written approval of the scope of the change order;

b.     Current contract language that indicates clear and enforceable entitlement relating to the change order;

c.     Separate documentation for the change order costs that are identifiable and reasonable; or

d.     The entity’s favorable experience in negotiating change orders, especially as it relates to the specific type of contract and change order being evaluated

Claims

11.3.10 Claims represent amounts in excess of the agreed contract price that a contractor seeks to collect from customers or others and that are normally a result of customer-caused delays, errors in specifications and designs, contract terminations, disputed or unapproved change orders concerning both scope and price, or other causes of unanticipated additional costs. The contract modification guidance in FASB ASC 606-10-25-11 should be considered to determine whether a claim represents an enforceable obligation that should be accounted for in accordance with paragraphs 5–9 of FASB ASC 606-10-32 on estimating variable consideration and paragraphs 11–13 of FASB ASC 606-10-32 on constraining estimates of variable consideration.

Estimating Variable Consideration

11.3.11 FASB ASC 606-10-32-8 discusses two methods for estimating variable consideration. The choice of method is not intended to be a free choice and is dependent on which method the entity expects to better predict the amount of consideration to which it will be entitled. The two methods are the following:

a.     The expected value method. This method estimates variable consideration based on the sum of probability-weighted amounts in a range of possible consideration amounts. This method may be appropriate when an entity has a large number of contracts with similar characteristics or the range of possible outcomes in any one contract is wide (generally, when there are more than two possible outcomes).

b.     The most likely amount. This method estimates the variable consideration based on the single most likely amount in a range of possible consideration amounts. This method may be appropriate if the estimate of variable consideration has only two possible outcomes (for example, an entity is entitled to all variable consideration upon achieving a performance milestone or none if the performance milestone is not achieved).

The number of possible outcomes should not cause an entity to automatically use any one method, but rather the method selected should be dependent on which method the entity expects to better predict the amount of consideration to which it will be entitled.

11.3.12 FASB ASC 606-10-32-9 requires an entity to apply one method consistently throughout the contract when estimating the amount of variable consideration to which it is entitled. Per FASB ASC 606-10-10-3, the method selected should be applied consistently to contracts with similar characteristics and in similar circumstances. The method should also be applied to types of variable consideration with similar characteristics and in similar circumstances. That is, a single contract may have more than one uncertainty related to variable consideration (for example, a contract with both cost and performance incentives), and depending on the method the entity expects to better predict the amount of consideration to which it is entitled, the entity may therefore use different methods for different uncertainties. In estimating the amount of variable consideration under either of the methods, and as discussed in FASB ASC 606-10-32-9, “an entity shall consider all the information (historical, current, and forecast) that is reasonably available to the entity and shall identify a reasonable number of possible consideration amounts.”

11.3.13 The following examples are meant to be illustrative; the actual determination of the method for estimating variable consideration as stated in FASB ASC 606-10-32-8 should be based on the facts and circumstances of an entity’s specific situation. The following examples also assume for illustrative purposes that the constraint principle for variable consideration has been considered.

Example 11-3-1

A contract is negotiated with a fixed price plus an award fee that is tied directly to delivery by a specified date. The entity has subcontracted a portion of the work. The entity estimates that it will achieve the award fee because the contract is not considered complex, the subcontractor has delivered on similar timelines in the past, and both the entity and subcontractor currently estimate completion up to six months prior to the specified date. In this instance, the entity determines that the expected value method may not provide a predictive estimate of the variable consideration because the contract has only two possible outcomes. The entity’s estimate of the total transaction price is therefore the sum total of the fixed price plus the award fee as the most likely consideration amount.

Example 11-3-2

An entity contracts to build a solar energy plant for a customer and receives an incentive fee from the customer that varies depending on objectively determinable key performance indicators (KPIs) associated with energy savings over a one-year period. The entity has extensive experience determining energy savings under various conditions that impact solar energy. To estimate the incentive fee, management calculates the expected value by using the data available to them to estimate the savings under the various environmental conditions. The entity believes that the estimate determined using this expected value method is predictive of the amount to which it will be entitled because of the wide range of possible outcomes.

Example 11-3-3

An entity contracts to build a road on January 1 with an agreed-upon completion date of June 30. The contract calls for liquidated damages in the event that contractor-caused delays result in the road not being completed by June 30. In this example, significant judgment is needed in terms of which method the entity expects to better predict the amount of consideration to which it will be entitled because, oftentimes, whether the completion date will be met is binary; however, the number of days of liquidated damages (that is, the number of days past the agreed-upon completion date) that will be incurred is often highly variable.

Constraining Estimates of Variable Consideration

11.3.14 After estimating the transaction price using one of the two methods, an entity is required to evaluate the likelihood and magnitude of a reversal of revenue due to a subsequent change in the estimate. FASB ASC 606-10-32-11 discusses when to include variable consideration in the transaction price and notes that “an entity shall include in the transaction price some or all of the variable consideration amount estimated in accordance with FASB ASC 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.”

11.3.15 As discussed in BC215 of FASB ASU No. 2014-09, if the process for estimating variable consideration already incorporates the principles on which the guidance for constraining estimates of variable consideration is based, then it is not necessary for an entity to evaluate the constraint separately from the estimate of variable consideration.

11.3.16 As discussed in FASB ASC 606-10-32-12, when determining the amount of variable consideration to include in the transaction price, the entity should consider both the likelihood and magnitude of a revenue reversal. An estimate of variable consideration is not constrained if the potential reversal of cumulative revenue recognized is not significant. As explained in paragraph 49 of TRG Agenda Ref. No. 25

The levels of revenue reversals that are deemed significant will vary across entities depending on the facts and circumstances. If the entity determines that it is probable that the inclusion of its estimate will not result in a significant revenue reversal, the estimate is included in the transaction price.

11.3.17 As discussed in BC218 of FASB ASU No. 2014-09, when an entity applies the guidance for constraining estimates of variable consideration, the entity might determine that it should not include the entire estimate of the variable consideration in the transaction price because it is not probable that doing so would not result in a significant revenue reversal. FinREC believes that certain types of variable consideration (such as consideration associated with claims or unapproved change orders) may be recorded when settled or received only after consideration of the both the likelihood and magnitude of a revenue reversal. However, the entity might determine that it is probable that including some of the estimate of the variable consideration in the transaction price would not result in a significant revenue reversal. In these instances, the entity should include some, but not all of the variable consideration in the transaction price. That is, subject to first assessing the contract modification guidance for enforceability, the entity is required to estimate the amount of variable consideration applying the constraint guidance and should not default to a conclusion to include no amount of variable consideration in the transaction price without a fulsome analysis.

11.3.18 Factors to consider in assessing the likelihood and magnitude of the revenue reversal (commonly referred to as an entity’s confidence level in assessing the revenue reversal in the analysis that follows) include, but are not limited to, any of the following, as indicated in FASB ASC 606-10-32-12:

11.3.19 The following examples are meant to be illustrative; the actual conclusion should be based on the facts and circumstances of an entity’s specific situation. An entity should also consider positive and mitigating factors that support the assertion that a significant reversal of cumulative revenue recognized will not occur.

Example 11-3-4

An entity has a three-year, fixed-fee contract for $10 million to perform certain environmental clean-up efforts. In addition, the contract price may be increased by up to $2 million if the entity is able to meet two performance targets. Specifically, the entity is entitled to an additional $1.4 million if it completes the work on or before three years from the contract start date. The entity expects, based on history with similar contracts, that it will earn the $1.4 million. The remaining $0.6 million can be earned by the entity if it is able to limit workforce turnover to certain agreed-upon targets as shown in the following table:

This is the first time this entity has worked in this geographical area, and therefore the contractor and client will meet periodically to determine progress toward the workforce turnover criterion.

The entity determined that there is one performance obligation and that satisfaction of that performance obligation occurs over three years as control transfers. The entity uses the cost-to-cost input method to measure progress on the contract.

Although the contractor has not worked in this particular geographical region before, it considers its extensive experience with similar contracts and types of variable consideration when determining what amount, if any, of the $0.6 million incentive fee to include in the transaction price. Based on its history with workforce turnover on similar contracts and its understanding of jobs data in this geographic region, the contractor determines that it is probable that it will limit workforce turnover to less than 3 percent but not less than 1 percent (based on the fact that it does not have experience with the workforce in this particular region).

Therefore, the entity concludes that $0.3 million of the turnover-related variable consideration is the "most likely amount" to which it expects to be entitled and includes that amount in the transaction price when calculating revenue because the entity has also concluded it is not probable that a significant reversal in the amount of cumulative revenue recognized will occur when the uncertainty associated with the variable consideration is subsequently resolved.

The entity reassesses this criterion each reporting period to determine if workforce turnover experience is better or worse. At the end of year two, the contractor is near completion of the contract and it becomes probable, given that the job is so near its conclusion, that turnover on the contract will be less than 1 percent. Therefore, the entity revises its estimate of variable consideration to include the entire $600,000 incentive fee in the transaction price because, at this point, it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when including the entire variable consideration in the transaction price.

The following illustrates the impact of changes in variable consideration in example 11-3-4.

Example 11-3-5

An entity enters into a contract to design and build a pharmaceutical production facility for $100 million. Estimated costs are $90 million. As the contract progresses, due to customer-caused delays (that is, delays outside the control of the contractor), the expected cost of the contract far exceeds original estimates, although the contract will have a positive margin overall. The contractor submits a claim as permitted in the contract to recover "not at fault" costs incurred by the contractor. The customer, in turn, submits a counterclaim. Claims of this nature are typical in these types of contracts and history suggests that resolution in favor of the contractor is probable (although the amounts are often net settled inclusive of the counterclaim and can vary).

Claims (a) are inherently susceptible to factors outside the entity’s influence (most often the judgment of an unrelated third party); (b) can take a long period of time to resolve; and (c) include possible outcomes that often involve a broad range of possible consideration amounts. In addition, claims are often net settled inclusive of customer counterclaims. Although there is evidence in this fact pattern supporting successful resolution of claims, this experience on a stand-alone basis may not be sufficient to support a conclusion that it is probable that the claimed amount of revenue would not be subject to significant reversal when the uncertainty is resolved, and additional factors would need to be considered to make a final determination.

Although oftentimes claim revenue will be recorded in full when amounts are either received or awarded, it could be probable that some portion of the claim will not result in a significant revenue reversal, such as when contractual terms clearly demonstrate an enforceable right to receive payment from a customer for certain situations (such as objectively determinable customer-caused delays).

Updating Estimates of Variable Consideration

11.3.20 Given the long-term nature of many engineering and construction contracts, it is common for circumstances to change throughout the contract. Circumstances change as contract modifications occur, as more experience is acquired, as additional information is obtained, as risks are retired or additional risks are identified, and as performance progresses on the contract. The nature of accounting for long-term contracts is a process of continuous refinements of estimates for changing conditions and new developments. FASB ASC 606-10-32-14 requires that the estimated transaction price be updated for changes in circumstances at each reporting period. As part of updating the transaction price, an entity would evaluate the factors listed in FASB ASC 606-10-32-12. In addition, when updating the estimated transaction price, an entity should consider whether there is a revision to the measure of progress (for example, estimated costs to complete the contract) as stated in FASB ASC 606-10-25-35.

11.3.21 The following example is meant to be illustrative; the determination of the method for updating estimates of variable consideration should be based on the facts and circumstances of an entity’s specific situation.

Example 11-3-6

An entity enters into an engineering, procurement, and construction (EPC) contract for the design and construction of an industrial manufacturing facility for a fixed price of $100 million plus an award or penalty fee of $5 million tied directly to certain objective metrics around quality, schedule, and productivity (that is, the variable fee or penalty could increase or decrease the overall consideration received by the contractor). The contractor was inexperienced in this type of project and potential turnover in key positions was a concern. Accordingly, when bidding the contract, the entity did not expect to successfully attain positive metrics tied to the award fee or penalty and estimated a penalty of $5 million. The most likely transaction price at the start of the contract was therefore $95 million. As the contract neared completion, the contractor became confident that all key metrics were going to be met or exceeded. Based on this updated information, the entity concludes that they will not be in a position of incurring a penalty but rather will benefit from the full potential award, and it is probable that a significant reversal in the cumulative amount of revenue will not occur when the uncertainty is resolved; therefore, the entity includes the $5 million award fee in the transaction price. Accordingly, the most likely transaction price is updated to $105 million, and a cumulative catch-up adjustment in revenue is recorded.

Measuring Progress Toward Complete Satisfaction of a Performance Obligation

11.5.01 In measuring progress toward complete satisfaction of a performance obligation, FASB ASC 606-10-25-31 explains that the objective when measuring progress is to depict an entity’s performance in transferring control of goods or services promised to a customer (that is, the satisfaction of an entity’s performance obligation). For each contract, it is important to assess the nature of the arrangement and determine the distinct goods or services, or series of goods or services, under the guidance in "Identifying the Unit of Account" included in paragraphs 11.1.01–11.1.02 and paragraph 11.2.17 of this guide.

11.5.02 As discussed in FASB ASC 606-10-25-33, there are various appropriate methods of measuring progress that are generally categorized as output methods and input methods. FASB ASC 606-10-55-17 explains that output methods include surveys of performance completed to date, appraisals of results achieved, milestones reached, and units produced or units delivered. FASB ASC 606-10-55-20 explains that input methods include resources consumed, labor hours expended, costs incurred, time lapsed, or machine hours used relative to the total expected inputs to the satisfaction of that performance obligation. Considerations for selecting those methods are discussed in paragraphs 16–21 of FASB ASC 606-10-55. As required in FASB ASC 606-10-25-32, for each performance obligation, the entity should apply a single method of measuring progress that is consistent with the objective in FASB ASC 606-10-25-31 and should apply that method consistent with similar performance obligations and in similar circumstances.

11.5.03 For engineering and construction entities, a careful evaluation of the facts and circumstances is required to determine which method best depicts the entity’s performance in transferring control of goods or services to the customer. The entity should carefully consider the nature of the product or services provided and the terms of the customer contract, such as contract termination rights, the right to demand or retain payments, and the legal title to work in process, in determining the best input or output method for measuring progress toward complete satisfaction of a performance obligation. As noted in FASB ASC 606-10-25-36, a contractor should use one of the recognition-over-time methods only if the contractor can reasonably measure progress.

United States Federal Government Contracts

11.5.04 Engineering and construction contracts with the United States federal government typically provide the government the ability to terminate a contract for convenience, which is the unilateral right to cancel the contract whenever the federal buying agency deems the cancelation is in the public interest. Under a termination for convenience clause, the contractor generally is entitled to recover all costs incurred to the termination date, plus other costs not recovered at termination (such as ongoing costs not able to be discontinued, for example, rental costs), as well as an allowance for profit or fee. The U.S. federal government also typically has the right to the goods produced and in process under the contract at the time of a termination for convenience.

11.5.05 FASB ASC 606-10-55-17 states the following:

11.5.06 BC165 of FASB ASU No. 2014-09 further notes that

11.5.07 A distinction between the cost-to-cost method and an output method such as units-of-delivery is that the cost-to-cost method includes work in process in the measurement toward complete satisfaction of the performance obligation.

11.5.08 A termination for convenience clause that gives the customer the right to the goods produced and in process under the contract at the time of termination may indicate that the customer has effective control over the goods produced and work in progress, even if those goods and work in progress are not in the customer’s physical possession. FinREC believes that in these circumstances an output method, such as units-of-delivery or units-of-production, would not be an appropriate measure of the progress toward complete satisfaction of the performance obligation because an output method would ignore the work in process that belongs to the customer, as discussed in BC165 of FASB ASU No. 2014-09. Therefore, an input method would typically be more appropriate in these circumstances.

11.5.09 Accordingly, the engineering and construction entity would evaluate their specific circumstances to determine whether an input method, such as cost-to-cost, is an appropriate measure of the progress toward complete satisfaction of the performance obligation and faithfully depicts the activity for which control is transferred to the customer.

Engineering and Construction Service Contracts

11.5.10 Because the nature of engineering and construction service contracts varies widely, the selection of the best method of measuring progress toward complete satisfaction of a performance obligation requires knowledge of the services provided to the customer as well as the contractual terms of the performance obligation, particularly those terms involving the timing of service delivery.

11.5.11 FASB ASC 606-10-55-18 states that

11.5.12 An engineering and construction company should consider whether the practical expedient in FASB ASC 606-10-55-18 would be applicable for its service contracts that specify the right to invoice an amount that corresponds directly with the value to the customer of the entity’s performance completed to date. The practical expedient may be appropriate, for example, for an operations and maintenance contract when the amounts invoiced to the customer are based on labor hours incurred.

11.5.13 There are times when this practical expedient may not be appropriate. If a maintenance service contract has variable consideration, such as a significant incentive provision that is assessed and paid by the customer only once or infrequently (upon achievement of contractual milestones, upon contract completion, or only once each year) or with a fixed-price lump-sum construction contract, FinREC believes recognition of revenue based on the right to invoice may not be appropriate. In addition, because many engineering, procurement, and construction contracts result in the "delivery" of an integrated set of outputs (such as a functioning power plant) and the value transferred to date during the project may not correspond directly to the right to consideration from the customer, the use of the practical expedient in FASB ASC 606-10-55-18 may not be appropriate.

11.5.14 For certain service contracts, it may be appropriate to use input methods, such as cost-to-cost or labor hours expended, for measuring progress toward complete satisfaction of a performance obligation, depending on the facts and circumstances. FASB ASC 606-10-55-20 states that, “if the entity’s efforts or inputs are expended evenly throughout the performance period, it may be appropriate for the entity to recognize revenue on a straight-line basis.” FinREC believes the straight-line basis would be expected to be used in limited circumstances in the construction industry. Because most performance obligations in engineering and construction contracts are not satisfied evenly throughout the performance period, the cost-to-cost input method may be more appropriate.

11.5.15 For other service contracts, it may be appropriate to use an output method related to the number of times short-duration homogeneous services are provided to the customer relative to the number of times the services are expected to be performed over the life of the service contract, for measuring progress toward complete satisfaction of a performance obligation.

11.5.16 The following examples are meant to be illustrative of engineering and construction service contracts that management has determined to be a single performance obligation; the actual determination of the method for measuring complete satisfaction of a performance obligation, as stated in FASB ASC 606-10-25-31, should be based on the facts and circumstances of an entity’s specific situation.

Example 11-5-1

An engineering and construction company provides daily maintenance services for a manufacturing facility. These services qualify as a series of distinct services that are substantially the same and that have the same pattern of transfer in accordance with FASB ASC 606-10-25-14b. The company bills monthly for the labor and material costs. The contract has a provision to award and pay an incentive bonus on an annual basis based on certain safety and cost-savings provisions. The criteria in paragraphs 5 and 11 of FASB ASC 606-10-32 related to variable consideration for recognition of an estimated amount of the incentive are met. Because of the annual incentive, the use of the practical expedient in FASB ASC 606-10-55-18 may not be appropriate.

Example 11-5-2

A heavy construction equipment company enters into a contract to provide routine maintenance for a fleet of heavy construction equipment for equal monthly payments over 24 months of service. The company’s performance on this contract (as evidenced by costs incurred) occurs evenly over the period. The company may consider a time-based method, such as straight-line revenue recognition, to be a reasonable depiction of the amount of the entity’s performance and transfer of control of the services to the customer because the efforts are expended evenly throughout the performance period (and not because the same amount is paid to the company each month).

Example 11-5-3

The same heavy construction equipment company, under a different contract with a different customer, provides a major equipment maintenance overhaul on a time and materials basis. In this case, the level of effort necessary for an overhaul and the pattern of performance over time vary depending on the condition of the equipment. In these circumstances, an input method may be a reasonable depiction of the amount of the entity’s performance and transfer of control of the service to the customer.

Use of Units-of-Delivery Method to Measure Progress

11.5.17 If the entity determines that revenue should be recognized over time and the customer has control of the goods as the performance occurs, based on the guidance described in paragraph 11.5.08, a units-of-delivery or units-of-production method that has not been modified to take into account the assets that are created before delivery occurs or production is complete would not result in the best depiction of an entity’s performance because such unmodified methods ignore the work in process for which control has been transferred to the customer. When that work in process is material to the contract, using a units-of-delivery or a units-of-production method would distort the entity’s performance because it would not recognize revenue for the assets that are created before delivery or before production is complete but that are controlled by the customer.

11.5.18 Furthermore, units-of-delivery or units-of-production may not be appropriate for contracts providing design and production services because an equivalent amount of value is not delivered to the customer with each unit. BC166 of FASB ASU No. 2014-09 states that "the Boards also observed that a units-of-delivery or a units-of-production method may not be appropriate if the contract provides both design and production services because, in this case, each item produced or delivered may not transfer an equal amount of value to the customer."

11.5.19 BC166 of FASB ASU No. 2014-09 goes on to state that a units-of-delivery method may be an appropriate method for measuring progress for a long-term manufacturing contract of standard items that individually transfer an equal amount of value to the customer on delivery.

11.5.20 FinREC believes a units-of-delivery method may be appropriate in situations where the entity has a production-only contract, producing homogenous products, and the method would accurately depict the entity’s performance. When selecting a method for measuring progress and considering whether a units-of-delivery method is appropriate, an entity should consider its facts and circumstances and select the method that depicts the entity’s performance and the transfer of control of the goods or services to the customer. For example, for a highway paving contract for which output is cubic yards of pavement laid, a units-of-delivery method may be a reasonable depiction of the amount of the entity’s performance and transfer of control of the goods and services to the customer.

Inputs That Do Not Depict an Entity’s Performance

11.5.21 Paragraphs 20–21 of FASB ASC 606-10-55 provide guidance about measuring progress toward complete satisfaction of a performance obligation using input methods. The paragraphs state that the entity should exclude from an input method the effects of inputs that do not depict the entity’s performance in transferring goods or services to the customer.

Consideration of Significant Inefficiencies in Performance

11.5.22 For entities using a cost-based input method for measuring progress toward complete satisfaction of performance obligations, an adjustment to the measure of progress may be required in certain circumstances. FASB ASC 606-10-55-21a explains that, an entity would not recognize revenue on the basis of costs incurred that are attributable to significant inefficiencies in the entity’s performance that were not reflected in the price of the contract (for example, the costs of unexpected amounts of wasted materials, labor, or other resources which were incurred to fulfill the performance obligation).

11.5.23 Determining which costs represent unexpected “wasted” materials, labor, or other resources requires significant judgment and varies depending upon the facts and circumstances. Engineering and construction projects normally have some areas of expected inefficiencies, and contingencies are included in the original project forecast for these types of risks.

11.5.24 There are circumstances, however, where unexpected significant inefficiencies may occur that were not considered a risk at the time of entering into the contract, such as extended labor strikes or design or construction execution errors that result in significant wasted resources that may require adjustment to a cost-based input method for measuring progress. These wasted materials should be excluded from the measure of progress toward completion and the costs should be expensed as incurred.

Costs Incurred That Are Not Indicative of Performance

11.5.25 There may also be circumstances in which the cost incurred on an engineering and construction contract is not proportionate to the entity’s progress in satisfying the performance obligation. For example, engineering and construction entities may enter into contracts where they procure equipment and material. The procurement alone of those products likely would not be indicative of the entity’s performance, unless the company has the right to payment for the cost for the procurement plus a reasonable profit, such that the procurement itself represents progress toward completion.

11.5.26 FASB ASC 606-10-55-21 explains that an entity should exclude from an input method the effects of any input that does not depict the entity’s performance in transferring control of goods or services to the customer. FASB ASC 606-10-55-21b explains that when a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation, the best depiction of the entity’s performance may be to adjust the input method to recognize revenue only to the extent of the 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 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 (but the entity is acting as a principal in accordance with paragraphs 606-10-55-36 through 55-40).

11.5.27 For these types of contracts, if a contractor is using a cost-based input method for measuring progress toward complete satisfaction of performance obligations and the purchase of the material meets the conditions in FASB ASC 606-10-55-21b, an entity should exclude the costs incurred for the product from the measurement of progress for the performance obligation in accordance with the objective of measuring progress in FASB ASC 606-10-25-31. Refer to the “Uninstalled Materials” section in paragraphs 11.5.28–11.5.38 for further discussion of application of the criteria in FASB ASC 606-10-55-21.

11.5.28 A typical construction project will require a wide range of different goods to be assembled by a contractor to produce a combined unit of output (that is, a single performance obligation). These goods may include standard materials such as steel, concrete, and copper wire, as well as components that require a high level of customization to fit the requirements of the asset, such as a turbine generator for a power plant or specifically designed and fabricated pipe modules for a refinery. Such goods are often procured from third parties on an as-needed basis throughout the duration of the contract. In most cases, construction contractors attempt to schedule the receipt of those goods shortly before integrating them into the project. However, in some cases, due to extended lead times or delay of installation timing, materials may arrive on the job site in advance of the contractor’s ability to install them and such materials may be significant. In these cases, the contractor should consider whether the inclusion of these uninstalled materials would result in the recording of revenue prematurely.

11.5.29 In the engineering and construction industry, many entities apply a costs-incurred (for example, cost-to-cost) method to measure progress in satisfying a performance obligation. However, in certain instances the cost incurred may not be proportionate to the entity’s progress in satisfying the performance obligation. For example, in a performance obligation composed of goods and services, the customer may obtain control of the goods before the entity provides the services related to those goods (that is, goods are delivered to a construction site, but the entity has not yet integrated the goods into the overall project; hence, “uninstalled materials”).

11.5.30 FASB ASC 606-10-55-21b provides four criteria that, if all are met, may indicate a cost incurred is not proportionate to the entity’s progress in satisfying the performance obligation and, therefore, 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. These criteria are as follows:

1.     The good is not distinct.

2.     The customer is expected to obtain control of the good significantly before receiving 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 (but the entity is acting as a principal in accordance with paragraphs 606-10-55-36 through 55-40).

11.5.31 A careful evaluation of the facts and circumstances is required to determine whether the exclusion from the input method of goods that meet these criteria would be a better depiction of the measure of progress towards completion of a performance obligation. FinREC believes that such an evaluation should be performed at inception and throughout the duration of the contract.

11.5.32 The first criterion in FASB ASC 606-10-55-21b1 relates to whether the materials procured are distinct. FinREC believes that in most cases, the procurement of materials necessary to complete a performance obligation would not typically be considered a performance obligation on its own, but such an evaluation should be made. In the situation in which materials can be readily used by the contractor in other construction projects without incurring significant costs to modify the items, FinREC believes such inventoriable materials should be considered for inclusion as an uninstalled material if control has transferred to the customer and the other criteria in FASB ASC 606-10-55-21b are met.

11.5.33 Items procured to complete a performance obligation may not immediately transfer into the control of the customer. Certain of these types of costs may qualify as an inventoriable cost under FASB ASC 330, Inventory. For example, as part of a contract with a customer, a contractor orders inventoriable materials such as steel, concrete, and copper wire. These materials are not unique to this contract and can be used on other construction contracts. Materials for this contract normally arrive at the job site shortly before the contractor is expected to install these materials (that is, at inception, materials were not expected to arrive significantly in advance of installation); however, unexpected delays occur (such as weather, force majeure, technical challenges, and so on) and, as a result, these materials are now at the job site significantly in advance of the revised installation timing. In these circumstances, the contractor may determine that the customer has not obtained control of these goods, even though the goods are physically at the job site. Such standard inventoriable materials, however, can be readily used by the contractor in other construction projects without incurring significant costs. An evaluation should be performed to determine when the control of these materials might transfer to the customer. In some cases, the transfer of control may occur when the item is installed. In other cases, a transfer of control might occur prior to installation if, for example, a security interest in the materials passes to the owner through billing of the specific materials procured. FinREC believes that when control has not transferred to the customer, it would be appropriate for the contractor to recognize the goods as inventory as they meet the definition of such in FASB ASC 330.

11.5.34 In BC171 of FASB ASU No. 2014-09, “the Boards observed that if a customer obtains control of the goods before they are installed by an entity, then it would be inappropriate for the entity to continue to recognize the goods as inventory.” If a customer obtains control of the goods before they are installed by an entity, FinREC believes it would be appropriate to evaluate whether the other criteria listed in items 2–4 in paragraph 21b of FASB ASC 606-10-55 are met.

11.5.35 The criteria in items 2 and 3 of paragraph 21b of FASB ASC 606-10-55 indicate that if a customer is expected to obtain control of a good significantly before receiving the services related to that good (installing the item in the project) and the cost of the transferred good is significant relative to the total expected costs, those costs do not depict the entity’s performance in satisfying the single performance obligation, and therefore should be excluded from the measure of progress.

11.5.36 Based on the criteria in item 4 of paragraph 21b of FASB ASC 606-10-55, if the contractor is significantly involved in the design and manufacturing of an item, even if the item is procured from a third-party manufacturer, then the procurement of such specifically designed materials would represent progress toward satisfying a performance obligation. This is often the case when an integrated engineering and construction company designs materials that are fabricated for a specific project by a third party, such as prefabricated concrete walls of a nuclear power plant.

11.5.37 The boards concluded in BC171 of FASB ASU No. 2014-09 that, if it is determined that uninstalled materials meet all of the criteria in paragraph 21b of FASB ASC 606-10-55, the contractor should recognize revenue for the transfer of the goods but only in an amount equal to the cost of those goods. In those circumstances, the contractor also should exclude the costs of the goods from the cost-to-cost calculation to be consistent with the cost-to-cost methodology.

11.5.38 If a good was originally determined to have met the criteria in FASB ASC 606-10-55-21b and revenue was recorded equal to cost upon receipt of the item, the contractor should determine the appropriate accounting once that item is installed in the project. Such an evaluation would require significant judgment about which conclusion best depicts the entity’s performance in the contract. FinREC believes that in some cases it may be appropriate to include the cost of the materials in the cost-to-cost calculation as the materials are installed (resulting in a cumulative catch-up adjustment representing margin on the performance of the installation), when to do so would result in a faithful depiction of the progress made toward satisfaction of the performance obligation. This may be the case, for example, when a large amount of pipe, or conduit, or copper wire is installed over an extended period of time. In other cases, FinREC believes it may be appropriate to exclude the costs from the cost-to-cost calculation for the entire duration of the contract, because to include the costs in the cost-to-cost calculation might result in a distortion of the progress made toward satisfaction of the performance obligation in a single accounting period. This might be the case if there was a single asset that is significant to the overall contract that is installed at a single point in time. See further discussion in the “Acceptable Measures of Progress” section in paragraphs 11.5.01–11.5.27.

11.7.02 The determination of remaining performance obligations is driven by the same measurement guidance as revenue recognition. Therefore, the reporting entity should apply its accounting policy for determining contract term, transaction price, and constraint on transaction price for variable consideration in determining remaining performance obligations, as well as revenue recognition under FASB ASC 606.

11.7.03 For generally accepted accounting principles (GAAP) disclosures regarding remaining performance obligations, the measurement should be performed as of the end of the reporting period as required by FASB ASC 606-10-50-13a.

11.7.04 Prior to creating disclosures, an engineering or construction entity should determine whether it is a public business entity, as there are certain required disclosures that will be optional for those entities that do not meet the definition of a public business entity.

11.7.05 An entity must first understand its sources of revenue. The presentation of the income statement should indicate those revenues that are from contracts within the scope of FASB ASC 606 (that is, revenue from contracts with customers) and those revenues from other sources. If the amounts of revenue that are from other sources are material to the financial statements and not presented separately on the income statement as other revenue, they should be disclosed separately in the notes to the financial statements. The disclosure should include appropriate information as applicable under FASB ASC 606, for revenues from contracts with customers; and other relevant guidance, for revenue from other sources.

Disaggregating Revenue

11.7.06 Prior to creating revenue recognition disclosures, the level of disaggregation of revenue should be determined. FASB ASC 606-10-50-2 provides guidance on satisfying the overall disclosure objective, stating that "an entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have substantially different characteristics." FASB ASC 606-10-50-5 provides the requirements for disclosure of disaggregated revenue, and paragraphs 89–91 of FASB ASC 606-10-55 provide examples of appropriate categories for disaggregation, as noted in paragraph 11.7.09. Although entities that do not meet the definition of a public business entity may elect not to apply certain quantitative disclosures in such guidance, at a minimum entities should disaggregate revenue according to the timing of transfer of goods or services (that is, over time and point in time) and disclose qualitative information about how economic factors affect the nature, amount, timing, and uncertainty of revenues and cash flows. Many engineering and construction entities may find it easier to prepare presentation and disclosures after revenue is disaggregated and therefore even entities that are neither a public business entity nor a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market that report under U.S. GAAP may choose to disaggregate revenue when there are significant differences in revenue sources.

11.7.07 FASB ASC 606 does not modify the criteria for reporting operating segments under FASB ASC 280, Segment Reporting.

11.7.08 Disaggregation of revenue does not mean disclosing individual contract information that is often requested by sureties. Engineering and construction entities that are not public business entities and that primarily focus on a single market may not find it necessary to further disaggregate revenue to achieve the objectives described in FASB ASC 606-10-50-1.

11.7.09 Public business entities and other entities that disclose disaggregated revenue beyond the categories of revenue recognized at a point in time and over time should consider financial information that they disclose outside the financial statements, such as presentations to investors and the information that management uses to make financial decisions for the entity in determining the appropriate categories of revenue as discussed in FASB ASC 606-10-55-90. FASB ASC 606-10-55-91 provides the following categories that might be an appropriate basis for determining the categories for disaggregation of revenue:

a.     Type of good or service (for example, major product lines)

b.     Geographical region (for example, country or region)

c.     Market or type of customer (for example, government and nongovernment customers)

d.     Type of contract (for example, fixed-price and time-and-materials contracts)

e.     Contract duration (for example, short-term and long-term contracts)

f.     Timing of transfer of goods or services (for example, revenue from goods or services transferred to customers at a point in time and revenue from goods or services transferred over time)

g.     Sales channels (for example, goods sold directly to consumers and goods sold through intermediaries)

11.7.10 For engineering and construction entities, common categories of disaggregated revenue include residential and commercial contracts, revenue from public sources (governments, and so on) and private sources, geographic region, and contract duration. If the construction contractor reports segment information in its financial statements, FASB ASC 606-10-50-6 requires the entity to disclose sufficient information to enable users of financial statements to understand the relationship between the disclosure of disaggregated revenue (in accordance with FASB ASC 606-10-50-5) and revenue information that is disclosed for each reportable segment.

11.7.11 When creating disclosures, it is important to consider the needs of the users of the financial statements. The objective of the disclosures is to provide the most useful information and therefore to aggregate or disaggregate disclosures in a way that does not obscure information by providing too little or too much information. Finding the ideal balance for disclosures will require careful evaluation of all sources of revenue, including how judgments that are used to recognize revenue may differ amongst different types of revenue.

Backlog — Remaining Performance Obligations

11.7.12 Code of Federal Regulations (CFR) Title 17, Part 229.101, Item 101(c)(viii), Narrative Description of Business — Backlog, states:

11.7.13 As required by SEC regulations [17 CFR 229.101(c), Narrative Description of Business], to the extent material to an understanding of the registrant’s business taken as a whole, such backlog information should be disclosed for the registrant’s dominant segment or each reportable segment about which financial information is presented in the financial statements.

11.7.14 In the narrative description of business, as stated in paragraph 11.7.13, SEC regulations require public entities to disclose backlog orders (contracts with customers) by significant business segment as of a recent date and as of a comparable date in the preceding fiscal year. In addition, SEC regulations require disclosure of the portion of the backlog that is not reasonably expected to be filled within the current fiscal year, and seasonal or other material aspects of the backlog.

11.7.15 SEC regulations, via 17 CFR 229.101(c)(viii), permits the reporting entity to define the date that it determines the disclosure of backlog on a comparative basis over the reporting periods. This date may or may not be the fiscal year end or quarter ended date. On a prospective basis, SEC reporting of backlog will typically be limited to two time bands — backlog expected to be fulfilled in the current period and aggregate remaining backlog.

11.7.16 There are no changes to the required SEC disclosures described in paragraphs 11.7.12–11.7.15; however, there may be additional disclosures required under FASB ASC 606. FASB ASC 606-10-50-13 defines remaining performance obligations as “performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period.” Backlog, as defined by the SEC, may be similar to remaining performance obligations, as defined by FASB 606-10-50-13; however, where applicable, FinREC believes management’s discussion and analysis should include a description of the differences between the remaining performance obligations total (GAAP number) and the backlog total (non-GAAP number).

11.7.17 Dependent upon the uncertainty of remaining performance obligations relating to engineering and construction entity contracts, entities should consider disclosing qualitative information, including accounting policies and assumptions applied, in defining the events that cause the contingent scope of work to become a component of quantified remaining performance obligations and revenue recognition. These disclosures may need to include a description of the impact that certain contractual terms (such as termination provisions, options for additional goods and services, and variable consideration) have on various types of contracts (for example, U.S. government services, and operations and maintenance type). Where applicable, separate disclosure of the dollar amount of contingent remaining performance obligations may be appropriate to meet the objectives under FASB ASC 606. In preparing such disclosures, consideration should also be given to the qualitative and quantitative disclosure requirements under the existing SEC regulation [17 CFR 229.101(c)(viii)], which states “there may be included as firm orders government orders that are firm but not yet funded and contracts awarded but not yet signed, provided an appropriate statement is added to explain the nature of such orders and the amount thereof.”

11.7.18 For public entities, FASB 606-10-50-13(a) requires disclosure of the aggregate amount of transaction price allocated to all of its remaining performance obligations that are not satisfied (or partially satisfied) as of the end of the reporting period. FASB ASC 606-10-50-14 allows an entity to not make this disclosure if either the performance obligation is part of a contract with an expected duration of one year or less (overall contract duration — not the period from the balance sheet date to completion of the contract) or the entity’s right to consideration from the customer is an amount that corresponds directly with the value to the customer of the entity’s performance completed to date as explained in FASB ASC 606-10-55-18. FASB ASC 606-10-50-15 requires that the entity disclose the application of the optional exemptions in paragraphs 14 and 14A of FASB ASC 606-10-50, and whether any consideration from contracts with customers is not included in the transaction price and not included in the remaining performance obligations disclosure, such as constrained variable consideration. In assessing the optional exemptions in paragraphs 14 and 14A of FASB ASC 606-10-50, the entity should carefully consider the nature of its remaining performance obligations and the level of effort necessary to identify the contracts and performance obligations that could be excluded under the optional exemption.

11.7.19 FASB ASC 606-10-50-13b also requires public entities to disclose when the entity expects to recognize as revenue the aggregate amount of its remaining performance obligations, by either presenting the disclosure on a quantitative basis using time bands that are most appropriate for the duration of the remaining performance obligation or by using qualitative information. As there are no changes to the required SEC disclosures described in paragraphs 11.7.12–11.7.15, FASB ASC 606-10-50-13b may expand the disclosure regarding backlog required under 17 CFR 229.101(c)(viii) when time bands are used because the disclosure under FASB ASC 606 will likely include time bands representing multiple future periods.

11.7.20 Entities reporting segment information should consider the disclosure of remaining performance obligations allocable to the segments.

11.7.21 Certain exemptions are provided in FASB ASC 606 to simplify the disclosure requirements for entities that are neither a public business entity nor a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market that report under U.S. GAAP. However, such engineering and construction entities may consider the needs of surety and sometimes other users of their financial statements regarding remaining performance obligations in the decision to make the election to not provide the disclosure and electing to apply the practical expedients permitted for remaining performance obligations disclosure.

Revenue Recognition Policies

11.7.22 Once an appropriate level of disaggregation has been arrived at for revenues, a construction contractor can begin to disclose the general revenue recognition policies applied to each category of revenue.

11.7.23 To understand the revenue recognition policy, users of the financial statement will need to understand the significant contract terms, judgments, and elections, and changes in such judgments, made for each category of revenue. These disclosures will include the following:

a.     As required by FASB ASC 606-10-50-12c, the nature of the good or service promised in the contract (that is, the nature of the performance obligations), highlighting any performance obligations to arrange for another party to transfer goods or services (that is, if the entity is acting as an agent).

b.     As required by FASB ASC 606-10-50-20b, the methods, inputs and assumptions used to determine whether an estimate of variable consideration, such as expectations about the ability to receive bonuses for on time delivery, is constrained.

c.     As required by FASB ASC 606-10-50-18a, the method of recognizing revenue, over time or at a point in time, including the event or activity that triggers recognition, such as when services are rendered or when construction is completed. For revenue recognized over time, the entity also must disclose the method for determining the portion of revenue recognized based on an input or output method. Examples include recognition based on costs, labor hours incurred, or units installed.

d.     As required by paragraphs 12b, 12d, and 12e of FASB ASC 606-10-50, implied and explicit contract terms, including the terms of payments and variable consideration as well as obligations for returns, refunds, and warranties.

11.7.24 Public business entities have additional disclosures that are required. These same disclosures may be elected by entities that are not public business entities. These disclosures include the following:

a.     Information about remaining performance obligations as required by paragraphs 13–15 of FASB ASC 606-10-50 and further described in paragraph 11.7.18.

b.     As required by paragraphs 18b and 19 of FASB ASC 606-10-50, explanations of why the method of recognizing revenue over time faithfully reflects the transfer of the goods or services; or for revenue recognized at a point in time, the judgments used to determine when the customer obtains control of the goods or services.

c.     As required by paragraph 20 of FASB ASC 606-10-50, information about the methods, inputs, and assumptions used for all of the following:

i.     Determine the transaction price, which includes, but is not limited to, estimating variable consideration, adjusting the consideration for the effects of the time value of money, and measuring noncash consideration.

ii.     Assess whether an estimate of variable consideration is constrained.

iii.     Allocate the transaction price, including estimating stand-alone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable).

iv.     Measure obligations for returns, refunds, and other similar obligations.

d.     As required by FASB ASC 606-10-50-22, the election to use the practical expedient for not recognizing a financing component within a contract.

11.7.25 The objective of the disclosures for changes in the entity’s contract balances is to assist financial statement users in understanding the nature, amount, timing, and uncertainty of revenue and cash flows that result from revenues from contracts with customers. Given the complexity of the billing-to-performance relationship embedded in long-term construction contracts, specifically with regard to work-in-progress subject to retentions, contracts with termination clauses, milestone payments which may not align with performance, and revisions in estimates, understanding the relationship between revenue and changes in contract balances is critical to users of the financial statements as it provides greater transparency about revenues and cash flows in relation to current period performance.

11.7.26 As stated in FASB ASC 606-10-45-3, “a contract asset is an entity's right to consideration in exchange for goods or services that the entity has transferred to a customer.”

11.7.27 FASB ASC 606-10-45-4 states that “[a] receivable is an entity's right to consideration that is unconditional. A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.”

11.7.28 As such, in accordance with FASB ASC 606-10-45-1, the entity should separately present any unconditional rights to consideration as a receivable. Any such material reclasses from contract assets to receivables should be considered in addressing the requirements of FASB ASC 606-10-50-10 related to the explanation of significant changes in contract assets and liabilities during the reporting period.

11.7.29 FASB ASC 606-10-45-2 states that

11.7.30 Presentation of a contract as a contract asset or a contract liability was discussed at the October 2014 TRG meeting. Paragraph 12 of TRG Agenda Ref. No. 11, October 2014 Meeting — Summary of Issues Discussed and Next Steps, discussed how an entity should determine the presentation of a contract that contains multiple performance obligations, as follows:

11.7.31 Thus, in accordance with the discussion at the October 2014 TRG meeting on presentation of a contract as a contract asset or a contract liability, engineering and construction companies should aggregate performance obligations at the contract level when determining the total contract asset balance and total contract liability balance for both presentation and disclosure purposes. Entities should also consider the appropriate classification (current versus noncurrent) of each contract asset and each contract liability.

11.7.32 Retention receivables should be carefully assessed to determine whether retentions are subject to restrictive conditions, such as fulfillment guarantees. Where retentions are subject to conditions other than passage of time, such as fulfillment guarantees, future performance, or achievement of stated milestones, amounts related to retention receivables would continue to be classified as a contract asset until such time that the right to payment becomes unconditional.

11.7.33 Where construction contracts include termination clauses such that the contractor has the right to payment, including profit, for work performed to date upon customer termination, the inherent condition to payment may relate solely to passage of time (such as, time and materials, or cost-reimbursable type contracts where no milestone or performance-based billing requirements exist), and as a result, FinREC believes unbilled work-in-progress should be reclassified to unbilled receivables.

11.7.34 Revisions in estimates of the percentage of completion are changes in accounting estimates, as defined in FASB ASC 250, Accounting Changes and Error Corrections. Although estimating is a continuous and normal process for contractors, FASB ASC 250-10-50-4, ASC 606-10-50-10, and ASC 606-10-50-8 require disclosure of the effect of revisions if the effect is material. The impacts of revisions in accounting estimates on contract balances should be considered in the entity’s revenue disclosures to provide relevant information about the timing of revenue recognition that was not a result of performance in the current period.

11.7.35 Considering the objective of the required disclosures related to the impact of revenue transactions on contract balances, the entity should provide qualitative and quantitative disclosures to provide clarity to users of the financial statements with regard to the complexity of the billing to performance relationships embedded in long-term construction contracts and how the entity’s performance in the period affects revenue and cash flows.

11.7.36 FASB ASC 606-10-65-1 allows two alternatives for transitioning in the first year the entity reports revenue under FASB ASC 606. FASB ASC 606-10-65-1i requires additional disclosures if the guidance in FASB ASC 606 is applied retrospectively with the cumulative effect of initially applying as an adjustment to the opening balance of retained earnings of the annual reporting period that includes the date of initial application.

11.7.38 FASB ASC 340-40-25-1 explains that the costs of obtaining a contract should be recognized as an asset if the costs are incremental and expected to be recovered. FASB ASC 340-40-25-2 states, "the incremental costs of obtaining a specific contract are those costs that the entity would not have incurred if the contract had not been obtained." For example, commissions paid to sales personnel, if incurred solely as a result of obtaining the contract, would be eligible for capitalization as long as they are expected to be recovered. However, costs such as salaries related to personnel working on a proposal would most likely not be capitalized, as such costs would not be incremental because the costs would be incurred even if the contract was not obtained, unless the costs are explicitly chargeable to the customer under the contract (as described in FASB ASC 340-40-25-3). An entity is precluded from deferring costs merely to normalize profit margins throughout a contract by allocating revenue and costs evenly over the life of the contract.

11.7.39 As a practical expedient, FASB ASC 340-40-25-4 notes that an entity may recognize the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the entity otherwise would have recognized is one year or less.

11.7.40 FASB ASC 340-40-25-5 states that costs to fulfill a contract that are not addressed under other authoritative literature would be recognized as an asset only if they meet all of the following criteria:

a.     The costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (for example, costs relating to services provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved).

b.     The costs will generate or enhance resources that will be used in satisfying (or in continuing to satisfy) performance obligations in the future.

c.     The costs are expected to be recovered.

11.7.41 FASB ASC 340-40-25-6 states the following:

11.7.42 As discussed in FASB ASC 340-40-25-5, only costs incurred for resources that directly relate to a contract (or anticipated contract) that generate or enhance resources of the entity that will be used to satisfy future performance obligations and are expected to be recovered are eligible for capitalization.

11.7.43 Pre-contract costs, or costs incurred in anticipation of a contract, may arise in a variety of situations. Costs may be incurred in anticipation of a specific contract (or anticipated follow-on order) that will result in no future benefit unless the contract is obtained.

11.7.44 Precontract costs may consist of the following:

a.     Engineering, design, mobilization, or other services performed on the basis of commitments or other such indications of interest

b.     Costs for production equipment and materials relating to specific anticipated contracts (for example, costs for the purchase of equipment, materials, or supplies)

c.     Costs incurred to acquire or produce goods in excess of contractual requirements in anticipation of follow-on orders for the same item

d.     Start-up or mobilization costs incurred for anticipated but unidentified contracts

11.7.45 Precontract costs that are incurred for a specific anticipated contract, such as engineering, design, mobilization, or other services or production equipment, materials, or supplies should first be evaluated for capitalization under other authoritative literature, such as FASB ASC 330 on inventory, FASB ASC 360 on property, plant, and equipment, or FASB ASC 985 on software. Pre-contract costs incurred for a specific anticipated contract that are not addressed under other authoritative literature would be recognized as an asset only if they meet all the criteria in paragraph 5 of FASB ASC 340-40-25 (for example, direct labor, direct materials, costs explicitly chargeable to the customer under the contract).

11.7.46 Similarly, costs to fulfill a contract that are incurred prior to when the customer obtains control (as contemplated in paragraphs 23–25 of FASB ASC 606-10-25) of the good or service are first assessed to determine if they are within the scope of other standards (such as FASB ASC 330 on inventory, FASB ASC 360 property, plant, and equipment, or FASB ASC 985 on software), in which case, the entity should account for such costs in accordance with those standards (either capitalize or expense) as explained in FASB ASC 340-40-15-3. For example, costs incurred to acquire or produce goods in excess of contractual requirements for an existing contract in anticipation of future orders for the same items would likely be evaluated under FASB ASC 330 on inventory.

11.7.47 For engineering and construction contracts, costs that relate directly to a contract could include direct labor, direct materials, and allocations of costs that are explicitly chargeable to the customer under the contract and other costs that were incurred only because the entity entered into the contract (for example, subcontractor arrangements). As discussed in FASB ASC 340-40-25-8a, general and administrative costs are expensed as incurred if they are not explicitly chargeable to the customer under the contract.

11.7.48 Contracts with the U.S. federal government may provide the contractor with the explicit ability, usually through the provisions of the Federal Acquisition Regulations, to charge general and administrative costs directly to the U.S. federal government. In such circumstances, the entity would then apply the criteria in FASB ASC 340-40-25-5 to determine if recording an asset for these costs is appropriate. Contracts with commercial entities or direct foreign government sales (that is, not a contract structured as a foreign military sale through the U.S. federal government), should be carefully evaluated to determine if general and administrative costs are explicitly chargeable or recoverable under the terms of the contract.

11.7.49 FASB ASC 340-40-25-8b explains that costs of "wasted" materials, labor, or other resources to fulfill a contract that were not reflected in the price of the contract should be expensed when incurred. Higher quantities or costs compared to the original budget does not necessarily equate to wasted materials, labor, or other resources. Determining which costs are "wasted" will require significant judgment and vary depending on the facts and circumstances. A simplistic example to illustrate the concept: If incorrect materials are used by mistake and need to be replaced due to a construction error, the "wasted" materials would result in immediate expense, presuming the materials could not be used elsewhere. However, in another situation, an engineer may be more efficient as more drawings are produced. This does not necessarily result in the earlier engineering drawings incurring "wasted" labor. Rather, efficiency gains simply reduce costs going forward.

11.7.50 For performance obligations that are satisfied over time as control is transferred, the accounting for costs to fulfill a contract will generally be recognized as costs of goods sold when incurred, regardless of the method used to measure progress toward completion.

11.7.51 For example, entities measuring progress towards complete satisfaction of a performance obligation satisfied over time using a cost-to-cost measure will generally not have inventoried costs. In accordance with FASB ASC 606- 10-55-17, when selecting a method for measuring progress, the entity should consider whether the method would faithfully depict the entity’s performance toward complete satisfaction of the performance obligation. For example, an output method would not faithfully depict an entity’s performance in satisfying a performance obligation if at the end of the reporting period the entity has work in process controlled by the customer that is not included in the measurement of the output. This represents a change from the accounting prior to adoption of FASB ASC 606. See also the "Acceptable Measures of Progress" section in paragraphs 11.5.01–11.5.27.

11.7.52 When using an input method to measure progress toward satisfaction of a performance obligation, a contractor should exclude from the input method the effects of any inputs that do not depict the entity’s performance in accordance with the guidance in FASB ASC 606-10-55-21.

Learning or Start-Up Costs

11.7.53 Certain types of contracts often have learning or start-up costs that are sometimes incurred in connection with the performance of a contract or a group of contracts. As discussed in BC312 of FASB ASU No. 2014-09, a learning curve is the effect of efficiencies realized over time when an entity’s costs of performing a task (or producing a unit) declines in relation to how many times the entity performs that task (or produces that unit).

11.7.54 Such costs usually consist of materials, labor, overhead, rework, or other special costs that must be incurred to complete the existing contract or contracts in progress and are distinguished from research and development costs. As a cost activity matures over its life cycle, the expectation is that these costs would decline over time. These costs are often anticipated and contemplated between the contractor and customer, and considered in negotiating and establishing the aggregate contract price. Consistent with BC313–BC314 of FASB ASU No. 2014-09, if an entity has a single performance obligation to deliver a specified number of units and the performance obligation is satisfied over time, it may be appropriate for an entity to select a method under FASB ASC 606 (such as cost-to-cost) that results in the entity recognizing more revenue and expense for the early units produced relative to the later units.

11.7.55 For example, assume a contractor is engaged to construct a 10-story building. The contractor determined there is a single performance obligation that is satisfied over time and revenue will be recognized using an input measure (for example, a cost-to-cost input method). The bottom floors of the building are expected to cost more than the top floors due to the learning curve costs involved. Therefore, the contractor will recognize more revenue and contract costs for the first components produced as compared to the later components.

11.7.56 In accordance with the requirements of FASB ASC 340-40-25-5a, start-up or learning costs incurred for anticipated but unidentified contracts would most likely not be capitalized before a specific contract was identified.

11.7.57 Contractors may incur mobilization costs to move personnel, equipment, and supplies to the project site. Contractors may also incur on-site pre-construction costs in the form of temporary facilities for a construction project (such as offices, construction parking areas, access roads, and utilities). These pre-construction costs often establish facilities on the customer’s property, and the related requirements for these facilities are specified in the contractual arrangements with the customer.

11.7.58 Once the contractor commences performance for a performance obligation satisfied over time, contract costs incurred to satisfy the performance obligation will generally not be eligible for capitalization and should be expensed when incurred in accordance with paragraph 8c or 8d of FASB ASC 340-40-25. Contractors should analyze mobilization and pre-construction activities to determine whether they are incurred while satisfying a performance obligation(s) to a customer. For example, when mobilization or pre-construction fulfillment activities are a necessary part of satisfying a performance obligation(s) and control is continuously transferred to the customer, FinREC believes that the related costs should be recognized as costs of goods sold as incurred. Otherwise, these costs should be capitalized as fulfillment costs if all the criteria in FASB ASC 340-40-25-5 are met.

11.7.59 In accordance with FASB ASC 340-40-35-1, assets recognized for incremental costs of obtaining a contract or fulfillment costs should be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. For example, if the contractor measures progress toward satisfaction of the performance obligation(s) using the cost-to-cost input method, the amount of costs of obtaining or fulfilling a contract that qualify for capitalization should be amortized in proportion to the construction costs incurred.

11.7.60 In addition, FASB ASC 340-40-35-2 requires that "an entity shall update the amortization to reflect a significant change in the entity’s expected timing of transfer to the customer of the goods or services to which the asset relates." FASB ASC 250-10 requires such a change to be accounted for as a change in accounting estimate. Such change could be indicative of impairment of the related assets, and entities should evaluate the facts and circumstances to determine the appropriate conclusions.

11.7.61 For assets accounted for in paragraphs 1–7 of FASB ASC 340-40-25, contractors should recognize an impairment loss when the condition in FASB ASC 340-40-35-3 is met. For example, if a contract is terminated prior to amortization of related costs, an impairment loss should be recognized unless the contractor expects to recover the costs as part of the termination settlement.

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