We polled surety and bonding agents to hear their perspective of the impact of revenue recognition on construction contractors
For most companies, the 2019 financial statements will be the first year that revenue recognition is implemented. Users of contractor financial statements, such as lenders and sureties, will see a new presentation and will need to understand how to interpret the statements to assess a contractor’s lending and bonding capacity. Sikich construction leaders, Laura Culp and Drew Long, polled surety and bonding agents to hear their perspective of the impact of revenue recognition on construction contractors and if this change will affect their clients’ bonding.
What is Revenue Recognition?
Revenue recognition establishes a new contract and control-based revenue recognition model and changes the basis for deciding when revenue is recognized over time or at a point in time. The regulations supersede or replace nearly all GAAP revenue recognition guidance.
Viewpoints from the Bonding and Surety Industry
Asked about their concerns about revenue recognition and if this change in constructor’s financial statements would impact their clients’ bonding, here are the responses.
Jeff Ciecko, Area Vice President – Contract Surety at Gallagher
I spoke with several surety carriers I work with to gain further insight into this topic. As they are the ones performing the financial analysis and providing the surety program parameters based on their underwriting of individual cases, naturally they are a valuable resource. The general consensus among the carriers I polled agree there isn’t concern that revenue recognition will have a material impact on their financial underwriting of their contractor clients and, thus, their bonding programs. Overall, we aren’t expecting much change in the impact to income statements. However, we are likely to see some classification changes on balance sheets.
The Work in Progress is where we’ll certainly see change in the presentation, such as how CPA firms will break out the projects. Nonetheless, surety carriers should be able to look holistically at a job the way they have previously, to understand the overall profit derived. I’ve heard some surety carriers are basically waiting to see what changes will take place, while others are already having internal discussions about this—although they have yet to formalize any expectations or implement an overall proactive approach.
Kevin Birch, Regional Area Vice President at CNA Surety
Revenue recognition will not have significant financial impact on contractor’s balance sheets or prior year’s retained earnings. However, the balance sheet components will change with the new standard. While contractors and their outside CPAs may be reluctant to implement the new revenue recognition standards, they need to understand that these standards are Generally Accepted Accounting Principles. Bank agreements require GAAP standard financial statements, so contractors need to confirm any deviation from GAAP is understood and agreed by their bank. Since some of the financial statement presentation and disclosures will be different under revenue recognition, one will need to understand the balance sheet components that have changed.
For example, Contract Assets will include 1) Cost and Earnings in Excess of Billings (underbillings), 2) Retainage and 3) Variable Consideration. In working with National CFMA Committees, there is a great debate about the placement of retainage. The new standard states an asset can be classified as Accounts Receivable if the only remaining condition is passage of time. It’s viewed that some retainage does not meet this test. Therefore, we will see financial statements that have retainage classified as an Accounts Receivable and Contract Asset. Contract Assets will likely be combined and stated at the balance sheet level. As long as there are good footnotes and schedules disclosures, I don’t believe this new standard will have significant impact to the bonding capacity of any contractor.
Ed Sipfle and Chad Teague, Regional Vice President and Contract Underwriting Manager at Merchants Bonding Co.
Interestingly enough, we continue to discuss this topic among peers. At this point, we aren’t overly concerned about the impact of revenue recognition. We would, however, still like to see contracts under the percentage of completion method, so we might need to request this information from our clients. We also will need the traditional contract schedules, such as the completed contract schedule, so we can assess job performance and know when a job is closed out.
At this point, we are going to have to wait to see what impact revenue recognition will have on our clients’ bonding, if any.
Gary Roadruck, Senior Vice President at AssuredPartners, Inc.
Most of my contractors do one type of work, such as sewer or water pipelines, electrical, a single bridge or asphalt paving, so I do not expect much impact from revenue recognition on them. Large contractors performing multi-faceted contracts, which include, say, a bridge and then a roadway, or an elementary school, a middle school and a high school, or maybe a football stadium with clearly defined phases or segments of work, will probably be affected the most. However, I wouldn’t expect even these contractors to have trouble keeping track of the progress, costs and estimated profits on each phase since all of their contracts can be broken down into line-items.
All of the contractors that I represent use sophisticated computer software, developed specifically for contractors. My customers also are all working with professional CPAs, whom I trust to steer them through whatever adjustments are necessary. As I understand the changes, the percentage-of-completion method will still be the underlying approach to revenue recognition, regardless of the contract “segments.” I am expecting to continue to be provided with contract-in-progress schedules showing over/under-billings, costs to complete and profits remaining.
Additionally, the surety underwriters that I work with are all very knowledgeable and well-informed about the upcoming changes. I expect them to be able to understand the overall profitability of their contractors. They normally only take an in-depth look at each contractor once a year at the contractor’s fiscal year-end, so it won’t be that difficult for them. As well, there is so much excess capacity in the surety industry at this time that surety underwriters will be very unlikely to give their contractors a “hard time.” None of them will want to lose an account over an accounting issue.
My expectation is that the contractors that I am privileged to represent will sail right through this long-anticipated revenue recognition change with flying colors.
Brian Mozena, Great Lakes Regional Bond Manager at The Hartford
Although this standard is extremely comprehensive, requiring companies to analyze each of their contracts on an ongoing basis, we don’t expect revenue recognition to have an overwhelming impact on most company’s bonding programs. As with any analysis of a financial statement, the primary objective is to ensure that you have all the information necessary to allow you to evaluate the financials and to compare results to prior periods and forecast into the future. We expect this new Standard will provide additional enhancements to the disclosures contained in financial statements by providing more transparent information to the readers of a company’s financial statement, including their job schedules, which are critical to our underwriting analysis. Given the details involved in this Standard, we anticipate that a learning curve will exist during the implementation process.
Interested in learning more? Contact our experts, who can put you in touch with a bonding agent.