Businesses across all industries are under an obligation to follow generally accepted accounting principles (GAAP) when it comes to handling their finances—and this remains true when choosing a revenue recognition method. However, because of some inherent challenges of being in the construction industry, businesses may face some obstacles when deciding on the revenue recognition method works best for them.

Factors such as long project timelines, variable contract terms, change orders, and fluctuating job costs can make it difficult to match revenue with the actual progress of a project. This increases the importance of selecting a method that accurately reflects the business’s performance while also complying with GAAP. 

What Is Revenue Recognition?

Revenue recognition is when a company’s revenue is documented and recognized only after the final product or service is delivered, and if the company has a reasonable expectation of payment.

In the construction industry specifically, revenue recognition matters because it helps paint a realistic picture of the company’s overall financial health. This is done by recording revenue at the time services have been delivered and the terms of a contract fulfilled. This can also help to improve confidence and trust among clients and other stakeholders while ensuring consistency in accounting practices.

 Revenue Recognition Challenges in Construction

The construction industry sees some unique challenges when it comes to revenue recognition. Consider, for example, that it is not uncommon for a construction project to span many weeks, months, or even years. As a result, these companies may have revenue-generating projects in the works that they’re unable to formally recognize in their accounting for long periods of time. This timing gap can make it harder for contractors to evaluate projects in real time.

Because of the challenges in the construction industry, the most important thing to remember when choosing a revenue recognition method is to keep it consistent. By selecting a single methodology and sticking with it, construction contractors and stakeholders can improve their own accounting compliance while enhancing the accuracy of their recordkeeping.

Additionally, understanding the regulatory landscape surrounding ASC 606 may also be helpful in choosing a method. This standard requires revenue to be documented at the time of delivery of promised goods and services to a client (not necessarily when payment is actually received).

Five Revenue Recognition Methods for Contractors

Construction contractors have a few choices when it comes to their revenue recognition method. The five main options to consider are:

1. Point of Sale Method

Revenue is recognized when the product/service is sold, and the customer accepts possession (most common in retail and other businesses where point of sale transactions is common).

2. Percentage of Completion Method

Revenue is recognized based on the completion status of a project. Most often used in long-term projects; this method requires careful tracking of the project and involves dividing costs incurred by total estimated costs on any given date to reach a calculation. 

3. Cash Method

Revenue is not recognized until the payment for the goods/services is actually received by the business. This method is most common among small businesses that choose to follow cash basis accounting.

4. Installment Method

Revenue is recognized as payments are received in installments over an agreed-upon amount of time. This method is commonly used in larger projects where clients may make multiple payments rather than a single lump sum payment.

5. Completed Contract Method

Revenue is recognized at the time the project or contract terms are completed. Often used in construction, this method is useful for businesses looking for a more conservative option. 

The Bottom Line: Which Method Is Best?

Construction businesses have much to consider when deciding on the revenue recognition method that best suits their needs. Whatever method you choose, the most important thing is to stick with it as much as possible, as this will lead to more consistent accounting.

Corrigan Krause Can Help Construction Companies

If your team has additional questions about choosing a revenue recognition method, then it may be time to reach out to a trusted and experienced accounting professional who can provide more personalized guidance. If you have any questions or would like additional information, click here to learn more about becoming a Corrigan Krause client.