The construction industry operates within a complex financial framework, and recent accounting changes like ASC 606 (Revenue from Contracts with Customers) have introduced significant implications for contractors, particularly in the realm of surety bonding. Surety providers rely heavily on accurate financial reporting to assess a contractor’s financial health and bonding capacity. This blog explores how new accounting standards impact contractors and their ability to secure surety bonds.
Overview of ASC 606
ASC 606 fundamentally changes how revenue is recognized in long-term contracts. Previously, contractors could recognize revenue as it was billed. Under ASC 606, contractors must:
- Identify the contract and its performance obligations.
- Determine the transaction price.
- Allocate the transaction price to each performance obligation.
- Recognize revenue as performance obligations are satisfied.
This shift requires a deeper understanding of contract specifics, including milestones, progress measurements, and potential variable considerations like bonuses or penalties.
Impacts on Financial Statements
Revenue Recognition Timing
ASC 606 emphasizes recognizing revenue based on progress toward fulfilling a performance obligation. For contractors, this often means revenue is tied to completed work rather than invoicing. As a result:
- Reported revenue may decrease in early stages of a project but increase later.
- Financial statements could show fluctuations, impacting metrics like profit margins and cash flow.
Balance Sheet Changes
Contractors may see changes in how costs and revenue are classified:
- Unbilled work might appear as “contract assets” rather than accounts receivable.
- Advances from customers may be classified as “contract liabilities.”
These shifts can complicate comparisons with prior financial statements or competitors not yet fully compliant with ASC 606.
Surety Provider Perspectives
Surety companies evaluate contractors based on financial health indicators, including:
- Working Capital: A reduction in current assets due to new classifications can lower working capital, potentially limiting bonding capacity.
- Profitability Trends: Delays in revenue recognition can obscure the contractor’s actual profitability, raising concerns about financial stability.
- Consistency: Frequent accounting adjustments might make it harder for sureties to assess a contractor’s risk profile accurately.
Practical Steps for Contractors
1. Strengthen Financial Reporting
Sureties value transparency and consistency. Contractors should:
- Prepare detailed WIP (Work-in-Progress) reports that align with ASC 606 requirements.
- Clearly explain any variances due to the new accounting standards.
2. Partner with a Construction-Savvy CPA
Accountants with experience in the construction industry can:
- Ensure compliance with ASC 606.
- Help contractors present financials in a way that supports bonding applications.
3. Educate Your Surety
Proactively communicate how ASC 606 impacts your financial statements. Provide:
- A summary of the standard’s implications.
- Adjusted metrics to help sureties better evaluate your financial health.
Conclusion
Adapting to ASC 606 is more than an accounting exercise; it’s a strategic move that directly affects your bonding capacity and business reputation. By understanding the nuances of the new standard and presenting your financials clearly, you can maintain strong relationships with your surety provider and ensure access to the bonding capacity needed for future growth.
At Payless Taxes, we specialize in helping contractors regain control of their finances through expert bookkeeping and tailored job costing solutions. Don’t let financial chaos hold you back—reach out today and let’s build a stronger foundation for your business!