ASC 606 has reshaped revenue recognition in the homebuilding industry, introducing new challenges around contracts, pricing, and timelines. Explore this article to understand how these changes impact your business.
ASC 606 has reshaped how homebuilders recognize and report revenue, introducing significant challenges due to the unique characteristics of home construction contracts. With their long timelines, variable pricing, and multiple performance obligations, these contracts often don’t align with traditional methods of revenue recognition. Under ASC 606, revenue must be recognized when control of the property (the home) transfers to the buyer—an event that may not coincide with the completion of construction. In this article, we delve into the top four ways ASC 606 impacts homebuilders, highlighting how the far-reaching implications affect both revenue timing and financial reporting. Understanding these changes is crucial for homebuilders seeking to navigate compliance while maintaining financial clarity and growth.
Timing of Revenue Recognition
Under previous revenue recognition rules, homebuilders typically recognized revenue either upon completion of the home or when the title was transferred to the buyer. This was a straightforward process, as it largely depended on the timing of the home delivery or sale. However, the introduction of ASC 606 brought more complexity to the process, especially for homes that are built over an extended period.
Under the new standard, revenue recognition depends on whether the sale involves a simple, off-the-shelf home or a more customized, long-term project.
For homes that are sold under relatively simple contracts, with little to no customization, revenue is generally recognized at a single point in time—usually when control of the home transfers to the buyer, which typically occurs at closing. However, for homes built under longer-term contracts or custom projects, ASC 606 requires revenue to be recognized over time, as construction progresses. This approach is used when the home is tailored for a specific customer and cannot be repurposed or sold to others. The decision to use point-in-time or over-time recognition depends on the nature of the contract, impacting how and when homebuilders report revenue, earnings, and cash flow.
Performance Obligations and Contract Modifications
Under ASC 606, homebuilders must identify the performance obligations in their contracts, which are the distinct goods or services promised to the customer. A key challenge is determining when multiple performance obligations exist within a single contract. For example, if a contract involves both home construction and optional upgrades (such as a premium kitchen or custom flooring), the builder must assess whether these upgrades should be treated as separate obligations that require individual accounting.
Similarly, warranties and future repairs may need to be recognized separately, depending on whether they are assurance-type (which do not require separate accounting) or service-type (which are treated as separate performance obligations and revenue must be recognized over the term of the warranty).
In cases where homebuilders sell bundled packages, such as land and home construction, ASC 606 requires these components to be unbundled and accounted for separately. The total contract price must be allocated to each component based on its relative standalone price. Additionally, if there are changes in the scope of the contract—such as customer requests for design alterations or added features—homebuilders must assess whether these changes should be considered contract modifications. If the change introduces a new, distinct service, it may be treated as a separate contract, subject to its own revenue recognition rules. This can complicate revenue recognition and financial reporting, especially when pricing adjustments are necessary.
ASC 606 places a strong emphasis on the existence of an enforceable contract. For homebuilders, this is particularly important if the sale involves seller financing. In such cases, the builder must assess whether the terms of the financing meet the criteria for revenue recognition. If it is not probable that payments will be collected, the contract may fail to meet the definition of an enforceable agreement, delaying or preventing revenue recognition.
Variable Consideration
Many homebuilding contracts involve variable considerations, such as bonuses or penalties tied to performance, upgrades, or changes to the scope of the project. Under ASC 606, homebuilders must estimate the transaction price by considering potential adjustments due to these variabilities, and then determine the likelihood that these adjustments will be realized. For instance, if a buyer requests multiple upgrades to a home during construction, the builder must estimate the additional consideration the buyer will pay. This must be included in the total transaction price, with revenue recognized as the performance obligations are satisfied. Builders must also reassess the estimate of variable consideration if additional changes are made to the contract over time.
Capitalization of Costs
Under ASC 606, homebuilders must capitalize certain costs associated with their contracts, which can significantly impact their financial statements, particularly the balance sheet. Costs directly tied to the construction of the home, such as materials and labor, are typically capitalized. However, expenses like advertising, sales overhead, and model homes are not eligible for capitalization under ASC 606 (per ASC 340-40, Other Assets and Deferred Costs—Contracts with Customers). On the other hand, furniture and equipment used in sales offices or model homes may be capitalized under ASC 360, which governs Property, Plant, and Equipment. In addition, costs incurred to obtain contracts—such as sales commissions—and costs directly related to fulfilling contracts—such as construction materials and labor—must be capitalized and amortized over the life of the contract. This means that instead of being exposed immediately on the income statement, these costs are recorded on the balance sheet and gradually expensed over time. As a result, homebuilders will need to implement more detailed tracking systems to ensure accurate capitalization and amortization, which could become an administrative burden if not properly integrated into their accounting systems.
Conclusion
Although ASC 606 presents its challenges, homebuilders can effectively manage its implementation with careful planning and strategic foresight. By carefully reviewing customer contracts to identify performance obligations, estimate variable consideration, and pinpoint the correct timing for revenue recognition, builders can stay proactive in addressing compliance issues. Consulting with Applied Accountancy provides expert guidance in contract analysis. Our team is dedicated to helping homebuilders enhance accuracy, ensure full compliance and drive long-term business success.
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