October 21, 2010

Financial Standards Accounting Board

401 Merritt 7

P.O. Box 5116

Norwalk, CT 06856-5116

Attention: Technical Director – File Reference No. 1820-100 FASB

I appreciate the opportunity to provide the comments below on FASB and ISAB’s Exposure Draft on Revenue Recognition: Revenue from contracts with customers (ASC 605).

I am a CPA and owner of a public accounting firm which specializes in services for the construction industry. I am a certified construction industry financial professional and a construction risk and insurance specialist which demonstrates my interest and dedication to the construction industry.  Most of my clients are small to mid-sized, closely held construction companies.  Our services include consulting, audits, reviews, compilations and corporate tax preparation.  It is my desire to ensure that high quality accounting practices in the construction industry are maintained. 

I believe the board’s efforts to create a single standard to apply to most industries is beneficial to public companies on an international level and in particular investors.  However, the indirect consequence to over 95% of contractors (which are privately held) would be subjective and complex accounting rules with undue burdens.

I believe the most practical way for management to run their companies and to supply information to the sureties is to supply financial statements on the Percentage of Completion method.

Many agree that SOP81-1 should be updated but not rewritten --there will be greater diversity in reporting with the new rules.

Responses to specific Exposure Draft questions:

Question 2:  The Boards propose that an entity should identify the performance obligations to be accounted for separately on the basis of whether the promised good or service is distinct. Paragraph 23 proposes a principle for determining when a good or service is distinct. Do you agree with that principle? If not, what principle would you specify for identifying separate performance obligations and why?

The users of financial statements for the privately held construction company have made it clear that if a contractor reported their contracts in performance obligations they would require them to be re-aggregated.

I have concerns about our clients accounting for contracts in any structure other than as a whole.  Even though components could be priced or sold separately that is not how construction companies bid, manage, account, analyze and report their contracts.  All aspects of the contract are highly interrelated including change orders.  Any change to this method of accounting at the contract level would be subjective, costly and would not have any benefit for our clients or more importantly the users of their financial statements

I further believe that it is not practical to apply a principle-based approach to disaggregation of construction contracts. The application will most likely not be consistent and confusing to the users of the financial statements.  The concept of various performance obligations appears to be too subjective.

 If two companies with similar contract types accountant for performance obligations differently, assign different margins, and account for performance bonuses differently how will an independent accountant determine if both companies (with potentially materially different financial results) have financial statements that are both fairly stated?  It appears based off our tort system that litigation towards CPA’s will rise even if we adequately document and disclose within the new principal based standards.

Question 5:  Paragraph 43 proposes that the transaction price should reflect the customer’s credit risk if its effects on the transaction price can be reasonably estimated. Do you agree that the customer’s credit risk should affect how much revenue an entity recognises when it satisfies a performance obligation rather than whether the entity recognises revenue? If not, why?

Credit risk should not be reflected in revenues.

Current practices are adequate. Typically, management discloses that accounts receivable include amounts that may not be collected and according to typical industry standards an aging of accounts receivable are disclosed.    Bad debts are currently deductible at the point they are deemed uncollectible and written off, or an allowance for bad debt is disclosed.

Reflecting credit risk in the initial measurement of revenue would be an unnecessary complexity and would likely confuse financial statement users.  The proposed approach would be too subjective to apply and to audit.

Most construction companies have very low margins and would not accept a contract which they had doubts about the credit risk of the owner.  Most construction companies perform their services under contract terms that typically allow the Company a lien interest on the work until paid.  Most companies believe that their contract acceptance and collection policies are adequate to minimize the potential credit risk.

Question 6:  Paragraphs 44 and 45 propose that an entity should adjust the amount of promised consideration to reflect the time value of money if the contract includes a material financing component (whether explicit or implicit). Do you agree? If not, why?

Not typically applicable to our small to midsize contractors that have contracts with durations of 3 to 18 months.  I do not feel consideration of the time value of money would be practical or of any benefit.  Most contractors with longer contract durations consider the completion date in their various estimates. This would also add to the complexity of preparing and understanding financial statements of the small privately held company.

Materiality and the length of time considered significant before or after the transfer of goods should be clearly defined. Would materiality to be measured as a basis of the financial statements as a whole or on the contract level?

Question 7:  Paragraph 50 proposes that an entity should allocate the transaction price to all separate performance obligations in a contract in proportion to the standalone selling price (estimated if necessary) of the good or service underlying each of those performance obligations. Do you agree? If not, when and why would that approach not be appropriate, and how should the transaction price be allocated in such cases?

Please see comments to question #2.  All components of a construction contract are highly interrelated and are not bid in relation to standalone selling prices.  I believe it should be rare to report contracts in performance obligations for construction contracts.

Question 9:  Paragraph 58 proposes the costs that relate directly to a contract for the purposes of (a) recognising an asset for resources that the entity would use to satisfy performance obligations in a contract and (b) any additional liability recognised for an onerous performance obligation. Do you agree with the costs specified? If not, what costs would you include or exclude and why?

Overall agreement with the costs specified.   Please see the following “other comments” regarding onerous performance obligations.

Questions 11:  Disclosures

Question number #11 It appears that the disclosure is similar to our current backlog disclosure.  However, it would appear to be incomplete and would not reconcile to other supplemental financial statement information if it only includes contracts with durations greater than one year.

Question 13:  Do you agree that an entity should apply the proposed guidance retrospectively (that is, as if the entity had always applied the proposed guidance to all contracts in existence during any reporting periods presented)? If not, why? Is there an alternative transition method that would preserve trend information about revenue but at a lower cost? If so, please explain the alternative and why you think it is better?

No. I feel that it would be beneficial to the users but at an enormous cost for contractors that typically have significant work-in-progress schedules.  The additional costs and subjectivity of applying the principals would far outweigh any benefit.

However, for smaller contractors this is somewhat less applicable as it is not common to have more than 1 year reported retrospectively.

Any new standards should have ample implementation time with a particular date that new contracts will be accounted for under new standards.  For instance if the retrospective period is 2 years then companies should have ample time to implement new accountings systems and run dual accounting systems which would be a minimum of 3 years.

Question 14:  The proposed implementation guidance is intended to assist an entity in applying the principles in the proposed guidance. Do you think that the implementation guidance is sufficient to make the proposals operational? If not, what additional guidance do you suggest?

More examples would be needed after any modifications to the final rulings before an implementation guide would be practical.

Question 18:  [FASB only] - Should any of the proposed guidance be different for nonpublic entities (private companies and not-for-profit organisations)? If so, which requirement(s) and why?

I believe very strongly that nonpublic companies should not apply the proposed standards.

I am aware this creates more diversity in reporting if private companies are allowed different standards.  However, the proposed rules are not practical for the privately held small and medium sized contractors. 

As a public accountant, I believe that most contractors should have simple enough rules that allow them to prepare their financial statements in an affordable manner and in a manner that their users understand and trust.

My most important concern is the primary user of their financial statements.  Sureties have told us they will not accept the new standards.   A dual method of accounting to be in compliance with GAAP, with no perceived benefit, at an enormous cost will leave no practical choice but to not be in compliance with the new rules.

Most of our clients do not have the resources to:

            Maintain a dual system of accounting

Train or hire new staff

            Repurchase their software applications

            Pay additional fees for the preparation of their financial statements

It is likely that with the complexity of the new standards that our contractors will not record transactions properly. Many small to medium sized business do not have staff with the accounting and finance background needed to understand and apply the new proposed rules.  

If I assist our clients in applying the new standards extensively I will lose my independence.  With the new standards there may be fewer qualified CPA’s available and that will also drive up costs.

Other concerns –

Onerous performance obligation – I believe that onerous obligations should only be recognized on the basis of the entire contract, primarily because the transaction price allocated to performance obligations is highly subjective and all activities for a given project are highly interrelated and have overall risks which are inseparable.  In addition the users of the financial statements are only interested in the performance of the contract overall.

Bonus’s and penalties- these items should be excluded from the contract revenue until such time are realization is reasonably assured.  Current practices are less subjective than the proposed changes.

Income tax reporting – may become more complex

In conclusion, I respectfully request that private companies be exempt from  the proposed rules and allowed the continued use of the percentage of completion method, which is a well established industry standard that our contractors use internally, is incorporated in their information systems, and has nearly 30 years of well established guidance on this method.

I thank you for allowing me to comment and for your consideration. 

Sincerely,

Lisa Tonsfeldt, CPA, CCIFP, CRIS

Morris & Tonsfeldt CPAs