Proposed Changes to How Construction Companies Present Retainage, Overbillings, and Underbillings

The construction industry is on the brink of impactful changes in financial reporting practices. The Financial Accounting Standards Board (FASB) is considering modifications that could change the way companies in the construction industry present retainage, overbillings and underbillings.

These proposed changes aim to address ongoing challenges faced by construction firms in presenting their financial information clearly and effectively.

Current Accounting Practices Under ASC 606

Since the implementation of Accounting Standards Codification (ASC) 606 in 2018 for public companies and 2019 for private companies, construction businesses have been required to present retainage, overbillings and underbillings as part of their contract assets and liabilities on a contract by contract basis.

The current accounting treatment involves:

• Retainage: Funds withheld by clients until specific project milestones are met. Depending on the contract terms, this may be recorded as a contract asset or a receivable.
• Overbillings: Instances in which a company bills more than the revenue recognized.
• Underbillings: Instances in which a company bills less than revenue recognized.
• Netting: ASC 606 requires that overbillings and underbillings be netted against retainage on a contract-by-contract basis, presenting a net amount as either a contract asset or liability.

Here’s an example to illustrate the current netting process. Let’s say your company has a construction project with a total contract value of $1,000,000. You have completed 60% of the work ($600,000 in revenue recognized) but have billed the client $650,000. The client is withholding $100,000 as retainage.

Under current ASC 606 rules:

• Overbilling: $650,000 (billed) – $600,000 (revenue recognized) = $50,000
• Retainage: $100,000
• Net position: $100,000 (retainage) – $50,000 (overbilling) = $50,000 contract asset

While this netting process aims to provide a concise view of a company’s overall contract position, it has inadvertently created several challenges for the construction industry. The lack of detailed presentation can make it difficult for users to accurately assess a company’s financial health and project status. This leads to complications in areas such as obtaining bonding or financing, and making informed business decisions.

Challenges with Current Practices

The current treatment of retainage, overbillings and underbillings has resulted in confusion and complications for construction companies and users of their financial statements.

Some of the key challenges include:

• Lack of clarity: Financial institutions and bonding companies may struggle to extract the information they need from the net contract assets and liabilities. This makes it difficult to determine a company’s true financial position.
• Complex reporting: The requirement complicates financial reporting, creating a more time-consuming process that can be prone to errors.
• Stakeholder confusion: Users of financial statements may find it difficult to assess a construction company’s performance and financial health due to the lack of straightforward presentation.
• Impact on bonding and lending: The current presentation method can complicate the process of obtaining bonds or loans, as surety providers and lenders may struggle to accurately assess a company’s financial standing.

These challenges have prompted the FASB‘s Private Company Council (PCC) to consider changes that would better serve the construction industry.

Proposed Changes by FASB

In response to industry feedback, the FASB and PCC are exploring alternatives to the current presentation method for retainage, overbillings and underbillings — specifically for private companies in the construction industry.

The proposed changes include:

• Distinct Presentation: Providing private companies in the construction industry with an option for presenting conditional retainage, overbillings and underbillings gross on the balance sheet.
• Enhanced Disclosure Requirements: Consideration of additional disclosures to provide more comprehensive information regarding a company’s contract positions and related financial aspects.

Using our previous example, under the proposed changes, the balance sheet might show:

• Retainage receivable: $100,000 (as a separate asset)
• Overbillings: $50,000 (as a separate liability)

This clearer presentation would allow stakeholders to quickly assess the company’s position regarding retainage and billing status.

Potential Impact on Construction Companies

If implemented, these proposed changes could have significant implications for private construction companies:

• Improved clarity of financial statements: The separate presentation of retainage, overbillings and underbillings would provide a clearer picture of a company’s financial position, benefiting both internal management and external stakeholders.
• Enhanced stakeholder understanding: Banks, bonding companies and investors would be able to more easily assess a company’s financial health and project status.
• Streamlined bonding and lending processes: Clearer financial statements could potentially expedite the process of obtaining bonds and loans, as surety providers and lenders would have a more straightforward view of a company’s financial standing.
• Transition challenges: Companies may face initial hurdles in adapting their accounting systems and processes to accommodate the new presentation method. Although positive overall, this could involve software updates and staff training.
• Improved decision-making: With clearer financial information, company management may be better equipped to make informed decisions about project bidding, cash flow management and overall financial strategy.

The Importance of Timely Financial Reporting

Regardless of the specific accounting standards in place, timely and accurate financial reporting is crucial for construction companies.

It enables:

• Effective cash flow management
• Informed decision-making on project bidding and resource allocation
• Timely tax planning and compliance
• Stronger relationships with banks, bonding companies and other financial partners

As these proposed changes unfold, maintaining up-to-date books and records will be more important than ever to ensure a smooth transition to any new standards.

What Happens Next?

The FASB is currently in the early stages of assessing this proposal, with a timeline that includes:

1. Feedback collection: The FASB is gathering input from stakeholders through the end of the current year.
2. Analysis and deliberation: Following the feedback period, the FASB will analyze responses and deliberate on the final form of the changes.
3. Potential implementation: The earliest implementation date is projected for Q4 2025, although this timeline might shift based on the feedback received.

We encourage construction industry professionals to stay engaged in this process. Your feedback can play a crucial role in shaping the future of construction accounting standards. To provide your input, visit the FASB Private Company Council (PCC) contact page.

Stay On Top of Your Construction Accounting Processes

The FASB’s proposed changes represent a shift towards increasing clarity and transparency in financial reporting. By understanding these proposals and their implications, you can prepare your construction company to tackle these changes.

Not sure how the FASB’s proposed construction accounting changes might impact you? James Moore can help. Our team of experienced construction CPAs can analyze your current accounting processes and walk you through the proposals and how to prepare your team.

Contact your advisor to start your preparations today.

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