At the beginning of 2019, Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) jointly implemented the Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers. Essentially, ASC 606 now requires forms to recognize revenue from contracts with customers when goods or services are transferred. For professional services firms that use their expertise to sell their time, this has a significant impact on how firms recognize revenue.
About FASB ASC 606
With the new guidelines in ASC 606, firms must recognize revenue in their income statement during the period in which the revenue is earned and not when it is billed. Since professional services firms manage projects that can span across multiple periods, they might not bill until the project is complete. As a result, firms must use a form of percent complete for the project to determine how much revenue to state on their income statement for that period. For example, if during a specific period a firm completes 25% of the project, they must recognize 25% of the revenue that will be earned from the contract for that period.
There are three distinct ways to calculate percent complete:
- Billing Percent Complete
- Financial Percent Complete
- Physical Percent Complete
Billing Percent Complete
Using billing percent complete is the most common method. Typically, this is driven by the project manager during the invoicing process. There are two options:
- Overall percent applied to the total contract value
- Percent complete by phase used to invoice based on the various components of scope/deliverables and these phases are broken down using either internal or external contract value
For many firms, this also drives revenue or earnings. Furthermore, it is recommended for people to review the current FASB 606 regulations. This will explain why earning what you invoiced may not be an acceptable solution any longer.
Financial Percent Complete
Another common technique is the financial percent complete. The formula for this method is job to date/job to date + estimate to complete. This indicates how much of the total estimate at completion has been spent or burned. When applied to the contract value, we can calculate revenue. Deltek Vision can facilitate this calculation using Resource Planning.
Physical Percent Complete
Lastly, physical percent complete can be utilized. This is usually calculated when the user or project manager has entered and can provide the following:
- Compared to financial percent complete, indicated whether the project’s progress is tracking with the financial burn
- When begin to drive earned value
- Have control earnings based upon contractual stipulations such as deliverables which can accelerate or slow down earnings and at the same time drive Work in Process (WIP) in tandem but that is separate from invoicing
Which Form is Right for Your Firm?
Let’s do some homework. Using a project your firm is executing, calculate/stipulate all three forms of percent complete and compare them. Then write a business case elaborating on the project’s health from these three statistics. You might surprise yourself with the results.