On The Horizon - March 5, 2013

Author:Ms Grant Thornton's Audit Practice Group
Profession:Grant Thornton LLP

Current practice issue

Application of contract accounting, especially percentage-of-completion

Although contract accounting arose decades ago in the context of construction contracts, it may also be applied in other limited circumstances. Many entities enter into long-term contracts to provide any number of services, including services to construct or produce a tangible product, professional services in a software arrangement, and general consulting services. An important question in each case is what revenue recognition guidance applies. The answer first depends on whether the contract is within the scope of the contract accounting guidance in FASB Accounting Standards Codification® (ASC) 605-35, Revenue Recognition: Construction-Type and Production-Type Contracts.

ASC 605-35-15-6(j) states, and the SEC staff has reiterated, that entities should not apply the guidance in ASC 605-35 to service arrangements that are not included within its scope. Accordingly, an entity should apply the percentage-of-completion method only if a contract is determined to be within the scope of ASC 605-35. If a long-term service contract is outside the scope of ASC 605-35, the entity should apply a proportional performance or a completed performance model to account for the service arrangement. Under a proportional performance model, costs are generally expensed as incurred, and, as a result, applying the proportional performance model will not result in a constant margin percentage as under the percentage-of-completion method.

Contracts within the scope of ASC 605-35

ASC 605-35-15-3 lists the types of arrangements within the scope of contract accounting, which are generally construction-type or production-type contracts where services are performed to customer specifications. In addition, contract accounting is required for arrangements covering the delivery of software or a software system that includes significant production, modification, or customization of the software. Separate contracts to provide services essential to the construction or production of tangible property (for example, design, engineering, procurement, and construction management) should also be accounted for using the guidance of ASC 605-35. Third-party requirements (such as government or regulatory agency) are considered customer-specifications when evaluating the applicability of contract accounting to an arrangement.

Contracts outside the scope of ASC 605-35

ASC 605-35-15-6 lists...

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