Caring for your construction workforce

We have talked about the two recent GAAP updates for years now: 1) changes to the lease accounting and 2) changes to revenue recognition standards. We have speculated what the outcomes are going to be and how they will affect the financial statements, requirements for certain ratio calculations and the like, and finally we have some answers! Both standards were finalized and published, and will be in effect in 2019 and 2020. The new rules for both require more than a couple of hours of reading and can be very confusing.

Two questions we have heard recently: Are the changes intertwined? And do we now need to consider the new revenue recognition standard when we implement the new lease accounting? The answer is a resounding NO!

The new GAAP for revenue recognition is very clear about this: it specifically carves out lease contracts. As a matter of fact, accounting applied by lessors will not change significantly when the new lease rules come into effect. If you are a lessor, you will continue to classify the majority of operating leases as operating leases, and will recognize lease income for those leases on a straight-line basis over the term of the lease. However, if you find the new rules confusing, your BerryDunn team is standing by to help you get the answers you need.

The good news? When it comes to revenue recognition, tax law isn’t changing. The bad news? Thanks to new revenue recognition rules, book to tax differences are changing. And because tax prep generally starts with book income, this means that the construction industry, among others, will need to start changing their thinking about tax liability, too.

The goal of the new rules is to establish standards for reporting useful information in financial statements about the nature, amount, timing, and uncertainty of revenue from long-term contracts with customers. The standards aim to clarify the principles for recognizing revenue. You can apply standards consistently across various transactions, industries, and capital markets — in order to improve financial reporting by creating common guidance for U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The core principle is that you should recognize revenue in an amount and at a time that aligns with expectations for the actual amount to be earned when it is actually earned (i.e., when the goods or services are delivered). That’s different from what we do today. Here are some areas affected by the changes:

Uninstalled materials

Under current GAAP, the costs of uninstalled materials, if constructed specifically for the job, are included in the job cost. Under the new GAAP, contractors will recognize the revenue only to the extent of the cost or will capitalize them as inventory—you will recognize profits later. For tax purposes, uninstalled materials are still included in the job cost. You will have to recognize profits for tax purposes sooner than for book purposes.

Multiple performance obligations

Under the new GAAP, you may have to segregate one contract into two or more performance obligations — those revenues are recognized separately. For tax purposes, it is very difficult to segregate a contract (it requires a tax commissioner’s prior written consent) so a contractor might have to show one contract for tax purposes and two or three contracts for book purposes. For example, if you have a contract for a design build project and generally bid separately for the design phase and construction phase of this type of project, you might have to separate this contract into two performance obligations. For tax purposes, you will continue to treat this project as a single contract. These contracts most likely will have different profit margins and you will have to recognize revenue at a different pace.

 Variable consideration

Under current GAAP, contractors can’t recognize revenue on bonus payments until they are realized, usually at the end of the project. Under the new GAAP, contractors need to gauge the probability of the bonus payments’ being received and may have to include some or all of the bonus payments in the contract price — you will have to recognize revenue sooner. For tax purposes, variable considerations are included in the contract price when contractors can reasonably expect to collect them. The general practice is that tax follows what you record for books for the total contract price. Does this mean that you have to recognize revenue for tax purposes sooner, too? Or will it create a book to tax difference, subject to judgement? The IRS may be issuing some guidance on these issues.

Deferred taxes

With changes in book to tax differences due to changes in timing of when you recognize profits, there will also be a change in deferred taxes.

After implementing the new GAAP, you will need to segregate items like variable consideration and uninstalled materials. Even if your tax method doesn’t change, will you need to maintain and provide the information needed for tax return purposes? More companies might ask the IRS for permission to make accounting method changes for federal income tax purposes. The IRS may consider allowing an automatic method change in order to help companies conform more easily to the new standards. The IRS will also provide guidance on how the new revenue recognition rules affect tax reporting.  

Accounting for GAAP purposes isn’t the same thing as accounting for tax purposes. But when it comes to the new revenue recognition rules, things can get complicated. To learn more about accounting method changes you might need to make, get in touch with your BerryDunn team today and see how the rules may affect your company.

What are the top three areas of improvement right now for your business? In this third article of our series, we will focus on how to increase business value by aligning values, decreasing risk, and improving what we call the “four C’s”: human capital, structural capital, social capital, and consumer capital.

To back up for a minute, value acceleration is the process of helping clients increase the value of their business and build liquidity into their lives. Previously, we looked at the Discover stage, in which business owners take inventory of their personal, financial, and business goals and assemble information into a prioritized action plan. Here, we are going to focus on the Prepare stage of the value acceleration process.

Aligning values may sound like an abstract concept, but it has a real world impact on business performance and profitability. For example, if a business has multiple owners with different future plans, the company can be pulled in two competing directions. Another example of poor alignment would be if a shareholder’s business plans (such as expanding the asset base to drive revenue) compete with personal plans (such as pulling money out of the business to fund retirement). Friction creates problems. The first step in the Prepare stage is therefore to reduce friction by aligning values.

Reducing risk

Personal risk creates business risk, and business risk creates personal risk. For example, if a business owner suddenly needs cash to fund unexpected medical bills, planned business expansion may be delayed to provide liquidity to the owner. If a key employee unexpectedly quits, the business owner may have to carve time away from their personal life to juggle new responsibilities. 

Business owners should therefore seek to reduce risk in their personal lives, (e.g., life insurance, use of wills, time management planning) and in their business, (e.g., employee contracts, customer contracts, supplier and customer diversification).

Intangible value and the four C's

Now more than ever, the value of a business is driven by intangible value rather than tangible asset value. One study found that intangible asset value made up 87% of S&P 500 market value in 2015 (up from 17% in 1975). Therefore, we look at how to increase business value by increasing intangible asset value and, specifically, the four C’s of intangible asset value: human capital, structural capital, social capital, and consumer capital. 

Here are two ways you can increase intangible asset value. First of all, do a cost-benefit analysis before implementing any strategies to boost intangible asset value. Second, to avoid employee burnout, break planned improvements into 90-day increments with specific targets.

At BerryDunn, we often diagram company performance on the underlying drivers of the 4 C’s (below). We use this tool to identify and assess the areas for greatest potential improvements:

By aligning values, decreasing risk, and improving the four C’s, business owners can achieve a spike in cash flow and business value, and obtain liquidity to fund their plans outside of their business.

If you are interested in learning more about value acceleration, please contact the business valuation services team. We would be happy to meet with you, answer any questions you may have, and provide you with information on upcoming value acceleration presentations.

This is our second of five articles addressing the many aspects of business valuation. In the first article, we presented an overview of the three stages of the value acceleration process (Discover, Prepare, and Decide). In this article we are going to look more closely at the Discover stage of the process.

In the Discover stage, business owners take inventory of their personal, financial, and business goals, noting ways to increase alignment and reduce risk. The objective of the Discover stage is to gather data and assemble information into a prioritized action plan, using the following general framework.

Every client we have talked to so far has plans and priorities outside of their business. Accordingly, the first topic in the Discover stage is to explore your personal plans and how they may affect business goals and operations. What do you want to do next in your personal life? How will you get it done?

Another area to explore is your personal financial plan, and how this interacts with your personal goals and business plans. What do you currently have? How much do you need to fund your other goals?

The third leg of the value acceleration “three-legged stool” is business goals. How much can the business contribute to your other goals? How much do you need from your business? What are the strengths and weaknesses of your business? How do these compare to other businesses? How can business value be enhanced? A business valuation can help you to answer these questions.

A business valuation can clarify the standing of your business regarding the qualities buyers find attractive. Relevant business attractiveness factors include the following:

• Market factors, such as barriers to entry, competitive advantages, market leadership, economic prosperity, and market growth
• Forecast factors, such as potential profit and revenue growth, revenue stream predictability, and whether or not revenue comes from recurring sources
• Business factors, such as years of operation, management strength, customer loyalty, branding, customer database, intellectual property/technology, staff contracts, location, business owner reliance, marketing systems, and business systems

Your company’s performance in these areas may lead to a gap between what your business is worth and what it could be worth. Armed with the information from this assessment, you can prepare a plan to address this “value gap” and look toward your plans for the future.

If you are interested in learning more about value acceleration, please contact the business valuation services team. We would be happy to meet with you, answer any questions you may have, and provide you with information on upcoming value acceleration presentations.

Next up in our value acceleration series is all about what we call the four C's of the value acceleration process. 

This is the first article in our five-article series that reviews the art and science of business valuation. The series is based on an in-person program we offer from time to time.  

Did you know that just 12 months after selling, three out of four business owners surveyed “profoundly regretted” their decision? Situations like these highlight the importance of the value acceleration process, which focuses on increasing value and aligning business, personal, and financial goals. Through this process, business owners will be better prepared for business transitions, and therefore be significantly more satisfied with their decisions.

Here is a high-level overview of the value acceleration process. This process has three stages, diagrammed here:

The Discover stage is also called the “triggering event.” This is where business owners take inventory of their situation, focusing on risk reduction and alignment of their business, personal, and financial goals. The information gleaned in this stage is then compiled into a prioritized action plan utilized in future stages.

In the Prepare stage, business owners follow through on business improvement and personal/financial planning action items formed in the discover stage. Examples of action items include the following:

• Addressing weaknesses identified in the Discover stage, in the business, or in personal financial planning
• Protecting value through planning documents and making sure appropriate insurance is in place
• Analyzing and prioritizing projects to improve the value of the business, as identified in Discover stage
• Developing strategies to increase liquidity and retirement savings

The last stage in the process is the Decide stage. At this point, business owners choose between continuing to drive additional value into the business or to sell it.

Through the value acceleration process, we help business owners build value into their businesses and liquidity into their lives.

If you are interested in learning more about value acceleration, please contact the business valuation services team. We would be happy to meet with you, answer any questions you may have, and provide you with information on upcoming value acceleration presentations.

Read more! In our next installment of the value acceleration blog series, we cover the Discover stage.