Currently, the Financial Accounting Standards Board (FASB) regulations suggest three ways for recognizing percentage of completion (POC), or progress billing, on a project:
1) Cost-to-cost (CTC), which is measured by costs incurred as a portion of estimated costs.
2) Effort expended (EE), which is a physical measurement of the work performed (sometimes called “physical completion”).
3) Units installed (UI), which measures POC based on the quantity of material installed to date as a portion of the expected material in place at project completion.
The Table shows an example of how revenue is recognized using the CTC method versus the EE method. American Society of Testing and Materials (ASTM International) “Standard Practice E2691 for Job Productivity Measurement” outlines how to measure and report recognized revenue with the EE method, which is shown in columns G, H, and I. The key to the EE method outlined in the JPM standard is using the actual effort expended to complete the project based on observed percentage completion of the work put in place, not just the hours or dollars spent.
Most recently, in the 2010 Exposure Draft of FASB’s proposal 605, the Board proposed a comprehensive revenue recognition model for both U.S. generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), stating that a company should recognize revenue to depict the transfer of goods or services to a customer in an amount that reflects the consideration expected to be exchanged for those goods or services. In other words, the owner or customer will be paying for what FASB calls “fulfilled performance obligations,” rather than the traditional approach of paying for progress of construction with a pegging factor, such as hours worked, percentage of cost incurred, or quantity of material installed.
This change will take effect starting with publically traded companies for any projects with a completion date in 2015 and forward. This means electrical contractors doing work for owners that are required to follow this regulation will need to change their own reporting and billing methods to match the new requirements.
While it likely will be met by the contracting community with a mixture of concern and confusion, this revision can help contractors recognize and bill for activities that historically had to be hidden as part of their cost codes and schedule of values line items — and for which they did not get paid. In addition, on projects where the physical completion of the work outpaces costs incurred, using the CTC and UI methods, contractors cannot recognize the completion that is the result of increased productivity. Therefore, rather than fear the changes, contractors should embrace them and prepare to use them to their advantage.
So what does this mean in normal construction English? It simply means you will have to track the work you are providing in chunks of deliverable value transferred (they call this performance obligation). The new regulations will encourage construction owners and developers to pay for outcome of the construction, not just output. So let’s say you do one of the following activities:
4) Preparation for installation (i.e., layout and benchmarks, gathering tools and equipment)
7) Value engineering
You will get paid for them as you deliver these intangible goods and transfer the value to the project, independent of how much time or cost you spent on them.
In today’s environment, contractors have to hide all these activities in their labor units. Because they can’t invoice these advance activities to the project (remember at this time in the project, there is no installation; therefore, the GC will not recognize the labor, and you can’t get paid for the intangible work you have performed), contractors often frontload the job by buying and dumping the material on the job site to improve their cash flow and benefit from razor-sharp margins on the material.
What’s wrong with that, you ask? Well, have you seen your job site lately? Does it look like what is shown in Photo 1 and Photo 2? When you have too much material on your job site, you waste labor to move stuff around when it’s needed. This could cost you as much as 40% of your labor cost due to lack of productive work. With the new FASB regulation, you can actually get paid for the pre-job and non-installation activities if you can track them and show how they contribute to fulfilling performance obligations in the project.
What can’t you do as you did before? You can’t recognize the following activities, for example, as revenue:
1) Material delivered to the job site
2) Standard non-job-dedicated prefab material
4) Wasted labor activities that don’t contribute to completion of the project (e.g., material handling, trade interference, stacking, etc.)
As you can see, the old tricks may have to change. You can only recognize these activities as a cost and not revenue. Is this good for the subcontractor community? Definitely. Using the EE method will allow you to include these types of tasks in the breakdown, as long as there is a measurement in place to substantiate their completion.