Accounting Standards Codification (ASC) 606- Revenue Recognition, among other things, changed the way we present financial statements. Today's lesson will focus on the changes in presenting over/underbillings and retainage; what I consider to be one of the biggest changes.
The introduction of contract assets and contract liabilities changed how we think of assets and liabilities unique to the construction industry. Concepts such as time and obligations reshaped the way we think of balances in the balance sheet. Ultimately, if the lifespan of an asset or liability balance is based on something other than the passage of time; the performance of a future obligation, estimations, or other factors, it is either a contract asset or contract liability,
As with other accounting standards, ASC-606 is open to different interpretations. The following lesson is based on my interpretation.
Underbillings and Ovebillings:
Prior to ASC-606 (under ASC-605), underbillings and overbillings were presented as separate line items under current assets and current liabilities, respectively (see diagram below, under "BEFORE"). When ASC-606 rolled around, the concept of contract assets and contract liabilities changed prior presentation. This didn't necessarily change the way we calculated underbillings and overbillings, just what we call them in the balance sheet. Ultimately, underbillings became categorized under contract assets and overbillings under contract liabilities, and presented accordingly (see diagram below, under "AFTER").
In our example below, contract assets is composed entirely of underbillings and contract liabilities are composed entirely of overbillings. Meaning the company does not have any other contract assets or contract liabilities so all that changed were the names of the line items and not the balances. However, there are other contract assets and liabilities that companies often have. The most notable being retainage.
Retainage:
ASC-606 introduced the concepts of unconditional retainage receivable and conditional retainage receivable. In the past, all retainage receivable was treated the same and was presented under contracts receivable. That's not the case anymore.
Unconditional Retainage- If collection of retainage is based solely on the passage of time, then it is considered unconditional. For example, if you've completed the work to the standard of the project owner or general contractor and your obligations under the contract have been fulfilled, retainage on that project is unconditional. You've done your part and now you just have to sit and wait (passage of time only) to collect that retainage.
Conditional Retainage- If collection of retainage is based on something else, other than the passage of time, it is considered conditional. For example, if you have an open job that is not substantially complete and requires more work on your part, your obligations under that contract have not been fulfilled, as a result, retainage receivable on that job is likely conditional. You can't just sit and wait for the money to come in. You have to do more work to be entitled to collect that money.
Why do we need to differentiate between the scenarios above? Because it determines if you should classify retainage under contracts receivable, contract assets, or contract liabilities. Unconditional retainage is included under contracts receivable. Conditional retainage is included in either contract assets or contract liabilities.
So, how do you determine if conditional retainage is included under contract assets or contract liabilities? I'll address that in the next lesson!
Thanks!
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