Private company contractors: 3 Steps to begin gathering disclosure information under Topic 606 before year’s end

As you have likely heard, disclosures for revenue recognition have been significantly expanded under Topic 606, and for calendar year-end entities, these disclosures will be required in the December 31, 2019 financial statements. The objective of the disclosure requirements in Topic 606 is for an entity to disclose enough information to enable users of the financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

While private entities are provided the option to reduce or omit some of the disclosures required for public companies, there are still a number of minimum disclosures required that will require some level – and in some cases a significant level – of information gathering. The list below describes three key steps to begin gathering that information.

Step 1: Determine the adoption approach and analyze contracts for changes under Topic 606

Entities can elect either (i) the full retrospective method or (ii) the modified retrospective method of adoption. Under the full retrospective method, all reporting periods in the financial statements would need to be restated under Topic 606. Under the modified retrospective method, only the current reporting period would be required to be presented under Topic 606, with a cumulative effect adjustment to the equity balance at the date of adoption.

Industry observation: Of the two options, the modified retrospective method has overwhelmingly been favored by public company contractors. Under this election, contractors have made use of a practical expedient to analyze only open contracts that existed at January 1, 2019 to determine the impacts of Topic 606. If revenue recognition for any of these contracts changes from previous guidance, disclosures are required that detail the amount by which each line item in the financial statements is affected in the current period by the guidance in Topic 606 compared to the guidance that was in effect before the transition.

A sample disclosure under the modified retrospective method of adoption, where there are changes under Topic 606 compared to previous guidance, is provided in Exhibit I below.

Step 2: Gather information for disclosures surrounding the entity’s contracts with customers

The majority of the disclosure requirements relates to an entity’s contracts with its customers. These disclosures include (i) disaggregation of revenue, (ii) information about contract asset and liability balances, and (iii) information about the entity’s performance obligations.

• Disaggregation of revenue: Private companies are required to disclose the amount of revenue earned from performance obligations that are satisfied over time and those that are satisfied at a point in time. In addition, private entities should disclose qualitative information about how economic factors (for example, type of customer, type of contract, and customer geographical location) affect the nature, amount, timing, and uncertainty of revenue and cash flows.

Industry observation: Contractors should begin taking “inventory” of the different types of contracts performed and whether the revenue is recognized at a point in time (similar to previous guidance for completed contract) or over time (similar to previous guidance for percentage of completion).

Further, as disaggregated revenue information may be presented in a tabular format, contractors may find it easier to disclose the required information quantitatively as opposed to qualitatively. A sample disclosure of disaggregated revenue in tabular format is provided in Exhibit II below.

• Contract Balances: Private entities are required to disclose the opening and closing balances of contract assets, liabilities, and receivables that are not otherwise separately presented or disclosed.

Industry observation: Many contractors already present contract assets or liabilities under different names on the face of the financial statements (for example, contract assets are often identified as costs in excess of billings and contract liabilities are often identified as billings in excess of costs). If different names are shown on the face of the statements, disclosures in the notes should be sufficient for users of the financial statements to identify contract assets or liabilities. If presented on the face of the statements as contract assets and contract liabilities, this information need not be duplicated in the notes to the financial statements.

• Performance Obligations: Private entities are required to disclose information about the nature of performance obligations, specifically (i) when the entity typically satisfies its performance obligations; (ii) significant payment terms (e.g., when payment is typically due, whether the consideration amount is variable, and whether the estimate of variable consideration is constrained); (iii) the nature of the goods or services that it has promised to transfer; and (iv) types of warranties and related obligations.

Industry observation: Contractors should determine if single or multiple performance obligations exist within its contracts and should identify the significant payment terms within the different types of contracts. Further, contractors should begin to identify types of variable consideration (such as claims, unapproved change orders, liquidated damages, awards, and bonuses) and information to disclose the methods, inputs, and assumptions used to evaluate whether an estimate of variable consideration is constrained. This information should include the factors the entity uses in determining the amount of variable consideration that was deemed probable of not being reversed, such as (i) the entity’s experience with similar contracts; and (ii) a range of possible consideration amounts.

Step 3: Gather information about significant judgments used

Topic 606 requires entities to disclose significant judgments affecting the determination of the amount and timing of revenue from contracts with customers, and any changes in those judgments. For performance obligations satisfied over time, entities will need to disclose (i) the method used to recognize revenue (ii) whether that method is an input method or an output method, and (iii) how that method was applied.

Industry observation: If the contractor chooses to recognize revenue over time, either the input or output method will need to be described. Input methods include options such as labor hours, labor dollars, machine hours and costs incurred (the costs incurred input method is similar to previous guidance for cost-to-cost method of percentage of completion). Output methods include options such as surveys of goods or services transferred to date, appraisals of results achieved, milestones reached, and units produced or delivered. Contractors should document their decision-making process and factors utilized in determining the best depiction of the transfer of goods to the customer.

If you have questions about Topic 606 information gathering, disclosure requirements or would like assistance demystifying the nuances of the new tax law, please contact our office or your Bonadio representative.

Exhibit I: Sample Disclosure under Modified Retrospective Method

Exhibit II – Sample Disclosure for Revenue Disaggregation

Revenue by product offering, contract type, and revenue recognition methodology were as follows for the years ending December 31:

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.