How Does ASC 606 Apply to Construction Contractors?
ASC 606 establishes the U.S. GAAP framework for recognizing revenue from contracts with customers.
For construction contractors, applying ASC 606 often requires management to evaluate:
the contract;
performance obligations;
transaction price;
variable consideration;
change orders and contract modifications;
whether revenue is recognized over time;
how progress is measured;
contract assets and liabilities; and
the estimates supporting project profitability.
The core principle is straightforward:
Revenue should reflect the transfer of promised goods or services to the customer in an amount that reflects the consideration the contractor expects to receive.
The application can be much more complex.
Why ASC 606 Matters to Contractors
Construction contracts often extend across multiple accounting periods.
During that time, the contractor may:
incur costs;
perform work;
bill the customer;
collect cash;
execute change orders;
revise estimates; and
experience changes in project profitability.
Those events do not always occur at the same time.
ASC 606 provides the framework for determining when revenue has actually been earned.
That is why revenue recognition is closely connected to WIP reporting.
Billing Does Not Determine Revenue
One of the most important concepts is that invoicing does not automatically determine revenue.
A contractor may bill ahead of performance.
Or it may perform work before billing.
For example:
Billings to date: $1.2 million
Earned revenue to date: $1 million
The contractor may be approximately $200,000 overbilled.
Alternatively:
Billings to date: $800,000
Earned revenue to date: $1 million
The contractor may be approximately $200,000 underbilled.
ASC 606 focuses on performance under the contract rather than simply the billing schedule.
Related Resource: Why Billing Is Not the Same as Revenue in Construction →
The Five-Step ASC 606 Model
ASC 606 uses a five-step model.
1. Identify the Contract With the Customer
The contractor first determines whether an arrangement qualifies as a contract under the guidance.
That generally requires factors such as:
approval and commitment of the parties;
identifiable rights;
identifiable payment terms;
commercial substance; and
probable collection of the consideration the contractor expects to receive.
Construction contracts may be written, oral, or implied by customary business practices depending on the facts.
2. Identify the Performance Obligations
The contractor determines which promised goods or services represent separate performance obligations.
In construction, this analysis can require judgment.
A contract may include:
design;
engineering;
construction;
installation;
procurement;
project management;
maintenance; or
other promised services.
Those promises are not automatically separate performance obligations simply because they appear as separate line items in the contract.
Management must evaluate whether promised goods or services are distinct under the accounting guidance.
Construction Contracts Often Have One Performance Obligation
Many construction contracts involve highly integrated goods and services that combine into one overall project.
For example, a contractor may provide:
project management;
labor;
materials;
subcontractor coordination; and
installation
to deliver one completed building improvement.
Even though many individual activities occur, they may collectively represent one performance obligation.
Other contracts may contain multiple performance obligations.
The conclusion depends on the contractual promises and how they are integrated.
3. Determine the Transaction Price
The transaction price is the amount of consideration the contractor expects to be entitled to in exchange for transferring promised goods or services.
It may include:
fixed contract price;
approved change orders;
incentive payments;
bonuses;
penalties;
claims;
liquidated damages;
price adjustments; and
other forms of variable consideration.
The transaction price can therefore change during the life of the project.
Variable Consideration Requires Judgment
Construction contracts frequently contain amounts that are not fixed.
Examples include:
performance bonuses;
schedule incentives;
penalties;
claims;
shared savings;
unit-price adjustments; and
other contingent amounts.
ASC 606 requires contractors to estimate variable consideration and apply a constraint so revenue is not recognized to an extent that creates a significant risk of future reversal.
That makes documentation and judgment especially important.
4. Allocate the Transaction Price
If a contract contains more than one performance obligation, the transaction price generally needs to be allocated among those obligations.
The allocation is usually based on relative standalone selling prices.
For many contractors with a single performance obligation, this step may be relatively straightforward.
For more complex contracts, allocation can require significant analysis.
5. Recognize Revenue When or As Performance Obligations Are Satisfied
The final step is determining when revenue should be recognized.
A performance obligation is satisfied either:
over time; or
at a point in time.
For many construction contractors, the central question is whether the contract qualifies for over-time revenue recognition.
When Can Construction Revenue Be Recognized Over Time?
A contractor may recognize revenue over time when one of the ASC 606 criteria is met.
One criterion that is especially relevant in construction involves situations where:
the contractor's performance creates or enhances an asset that the customer controls as it is created or enhanced.
Another may apply when:
the contractor's performance creates an asset with no alternative use to the contractor; and
the contractor has an enforceable right to payment for performance completed to date.
The specific contract terms and legal rights matter.
This determination should not be made simply because a project lasts longer than one year.
What Does “No Alternative Use” Mean?
An asset may have no alternative use when contractual or practical restrictions prevent the contractor from redirecting it to another customer.
A highly customized project built specifically for one customer may meet this condition.
But that alone is not sufficient.
The contractor must also evaluate whether it has an enforceable right to payment for performance completed to date.
Contract language and applicable law can matter significantly.
What Is an Enforceable Right to Payment?
The analysis generally considers whether the contractor would be entitled to compensation for performance completed to date if the customer terminated the contract for reasons other than the contractor's failure to perform.
That right may need to compensate the contractor for:
costs incurred; and
a reasonable profit margin on work performed.
This is a legal and contractual analysis, not simply an accounting assumption.
How Is Progress Measured?
If revenue is recognized over time, the contractor must select a method that faithfully depicts progress toward satisfying the performance obligation.
Methods generally fall into two categories:
input methods
and
output methods.
Construction contractors frequently use cost-to-cost input methods, but the method should reflect the economics of the specific contract.
What Is the Cost-to-Cost Method?
Under a simplified cost-to-cost approach:
Costs incurred to date ÷ Estimated total cost = Percentage complete
That percentage may then be applied to the transaction price to estimate earned revenue.
For example:
Contract price: $4 million
Estimated total cost: $3.2 million
Cost incurred to date: $1.6 million
Percentage complete: 50%
Simplified earned revenue:
$2 million
Expected gross profit:
$800,000
Gross profit recognized to date may then reflect the project's progress and applicable accounting requirements.
Cost-to-Cost Is Only as Good as the Estimate
The method depends heavily on estimated total cost.
If estimated remaining cost is understated:
percentage complete may be overstated;
revenue may be recognized too quickly;
gross profit may be overstated; and
WIP balances may be misleading.
This is why monthly cost-to-complete estimates are so important.
Related Resource: What Costs Should Be Included in a Construction WIP Schedule? →
Some Costs May Need Special Treatment
Not every dollar of cost necessarily depicts project progress equally well.
Certain costs may require separate consideration when determining the appropriate measure of progress.
Depending on the facts, examples could include:
significant uninstalled materials;
inefficiencies;
wasted materials;
abnormal labor;
mobilization;
or other costs that do not proportionately reflect performance.
The accounting should faithfully depict actual progress.
How Do Change Orders Affect ASC 606?
Construction contracts change frequently.
A change order may affect:
contract scope;
contract price;
estimated project cost;
performance obligations;
transaction price; and
revenue recognition.
The accounting depends partly on whether the modification:
adds distinct goods or services;
is priced at standalone selling prices;
changes an existing performance obligation; or
creates a new performance obligation.
Not every change order receives the same accounting treatment.
Approved Change Orders Are Usually Easier to Evaluate
Once both scope and price are approved, the accounting analysis is generally more straightforward.
Management can evaluate:
revised contract value;
revised estimated cost;
effect on project margin;
effect on revenue recognized; and
effect on billing.
But even an approved change order can change the economics of the existing project significantly.
Unapproved Change Orders Require More Judgment
Contractors frequently begin additional work before final pricing or written approval is complete.
That creates questions such as:
Has the scope been approved?
Is the price approved?
Is collection probable?
Is the contractor entitled to additional compensation?
Does the amount represent variable consideration?
Should it be included in transaction price?
How should associated costs be treated?
These questions can directly affect revenue and margin.
Claims Can Also Affect Transaction Price
Contractors may seek additional compensation for:
owner-caused delays;
scope disputes;
differing site conditions;
acceleration;
design issues; or
other contractual matters.
Recognizing expected claim amounts as revenue can require careful evaluation of enforceability, probability, and the variable-consideration constraint.
Management should avoid treating every requested amount as earned revenue simply because a claim has been submitted.
What Are Contract Assets?
A contract asset can arise when the contractor has recognized revenue but its right to payment is still conditional on something other than the passage of time.
In construction terminology, this may resemble what contractors historically describe as an underbilling, depending on the facts.
For example:
Earned revenue: $1.5 million
Billings: $1.3 million
The difference may contribute to a contract asset.
The exact balance-sheet classification depends on the underlying rights and contractual facts.
What Are Contract Liabilities?
A contract liability generally arises when the customer has paid, or the contractor has an unconditional right to consideration, before the related performance obligation has been satisfied.
In construction terminology, this can resemble an overbilling.
For example:
Billings: $1.7 million
Earned revenue: $1.5 million
The $200,000 difference may contribute to a contract liability.
Again, the specific financial statement presentation depends on the facts and applicable GAAP.
Contract Assets Are Not the Same as Accounts Receivable
An account receivable generally represents an unconditional right to payment, subject only to the passage of time.
A contract asset involves a right that remains conditional.
That distinction matters for:
balance-sheet presentation;
disclosures;
collections analysis; and
financial statement interpretation.
Estimated Losses Require Prompt Attention
If updated project estimates indicate that a contract is expected to generate an overall loss, the contractor may need to recognize the expected loss before the project is completed.
This is another reason WIP cannot rely on outdated project estimates.
Management needs to identify deteriorating projects quickly.
Related Resource: What Causes Job Margins to Fade? →
How Does ASC 606 Affect WIP?
A contractor's WIP schedule often operationalizes many of the judgments underlying revenue recognition.
It may incorporate:
transaction price;
approved changes;
estimated total cost;
progress;
revenue recognized;
billings;
contract assets;
contract liabilities; and
expected gross profit.
WIP therefore serves as an important bridge between:
project operations
and
GAAP financial reporting.
How Does ASC 606 Affect Bonding and Banking?
Sureties and lenders often rely on financial statements and WIP information to evaluate contractor performance.
Revenue recognition affects:
reported revenue;
gross profit;
equity;
working capital;
current assets and liabilities;
backlog interpretation; and
project trends.
Poor revenue-recognition processes can therefore affect more than accounting compliance.
They can affect how outside stakeholders understand the contractor's financial position.
Documentation Matters
Contractors should maintain documentation supporting significant revenue-recognition judgments.
That may include:
executed contracts;
amendments;
change orders;
customer correspondence;
project budgets;
cost-to-complete estimates;
WIP schedules;
billing records;
project-manager updates;
claims;
and relevant accounting conclusions.
The more complex the contract, the more important documentation becomes.
Review Revenue Recognition Monthly
Revenue recognition should not be treated solely as a year-end CPA adjustment.
For contractors with significant active projects, management should incorporate revenue recognition into the monthly close.
That typically requires coordination among:
accounting;
project management;
operations;
estimating;
and finance leadership.
Changes in project economics should flow into financial reporting promptly.
Common ASC 606 Mistakes in Construction
Common problems can include:
treating billings as revenue;
failing to identify performance obligations;
automatically assuming every contract qualifies for over-time recognition;
using outdated cost-to-complete estimates;
ignoring variable consideration;
recognizing unapproved change orders too aggressively;
failing to update transaction price;
not evaluating contract modifications properly;
confusing accounts receivable with contract assets;
failing to reconcile WIP to the general ledger; and
applying revenue-recognition conclusions inconsistently across projects.
The accounting needs to reflect the actual contractual and operational facts.
Questions Contractors Should Ask
For significant contracts, management should be able to answer:
What are the performance obligations?
Is revenue recognized over time or at a point in time?
Why?
How is progress measured?
Is the cost-to-complete estimate current?
What variable consideration is included?
Are change orders reflected appropriately?
Are claims being accounted for consistently?
What contract assets exist?
What contract liabilities exist?
Does WIP reconcile to the financial statements?
Are significant judgments documented?
If these questions cannot be answered, the revenue-recognition process may need attention.
The Bottom Line
ASC 606 gives construction contractors a framework for determining when and how revenue should be recognized based on performance under customer contracts.
Applying it may require contractors to evaluate:
contracts
performance obligations
transaction price
variable consideration
change orders
claims
over-time recognition
measures of progress
estimated total cost
contract assets
and
contract liabilities.
For many contractors, the accounting ultimately depends on strong operational information.
Accurate project estimates produce better WIP.
Better WIP supports more reliable revenue recognition.
And more reliable revenue recognition produces financial statements that better reflect the economics of the business.
How Bilotta & Company Can Help
Bilotta & Company, CPAs, LLC works with construction contractors on revenue recognition, WIP reporting, job costing, financial statement assurance, accounting, tax, cash-flow forecasting, and financial leadership.
Through our Contractor Compass® Financial Stewardship program, we help contractors connect project operations to recurring financial reporting and decision-making.
That includes strengthening the processes supporting:
job costing
cost to complete
WIP
revenue recognition
billing
cash flow
and
forecasting.
Our Financial Stewardship as a Service® rhythm is:
Close → Analyze → Forecast → Decide.
ASC 606 establishes the accounting framework.
A strong monthly financial process provides the information needed to apply it well.
Related Resource: Why Billing Is Not the Same as Revenue in Construction →
Related Resource: What Is a Construction WIP Schedule? →
Related Resource: What Costs Should Be Included in a Construction WIP Schedule? →
Visit the Construction Contractor Financial Resource Center →
This article is provided for general educational purposes and should not be considered accounting, tax, legal, bonding, lending, or financial advice for a specific contractor or construction contract. Revenue-recognition conclusions depend on the specific contract terms and circumstances.