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Contract Accounting Standards: Everything You Need to Know

Contract accounting is an essential process that companies use to maintain accurate financial statements and comply with Generally Accepted Accounting Principles (GAAP). It is the process of recognizing, measuring, and recording revenue and expenses associated with a contract. Contract accounting standards provide guidance and rules for companies to follow when accounting for contracts.

The Financial Accounting Standards Board (FASB) in the United States and the International Accounting Standards Board (IASB) have established contract accounting standards that companies must comply with. These standards ensure that companies record revenue and expenses accurately, providing a clear picture of their financial performance.

In 2014, FASB and IASB issued new and converged revenue recognition standards, which impacted how companies recognize and report revenue in their financial statements. The new standards aimed to provide more extensive and improved transparency into the nature and amount of revenue that a company generates from contracts.

Under the new standards, companies must follow a five-step approach when recognizing revenue from a contract:

1. Identify the Contract: The company must identify the terms of the contract with the customer and determine whether it is enforceable.

2. Identify the Performance Obligations: The company must identify the goods or services that it is required to provide to the customer under the contract.

3. Determine the Transaction Price: The company must determine the amount of revenue it will receive from the customer.

4. Allocate the Transaction Price: The company must allocate the transaction price to each performance obligation identified in step 2.

5. Recognize Revenue: The company must recognize revenue when it satisfies each performance obligation.

The new standards also require companies to disclose more information about their contracts in their financial statements. This information includes the timing and amount of revenue recognized, performance obligations, and significant judgments made in applying the standards.

Contract accounting standards also cover other aspects of accounting for contracts, such as contract costs and changes to contract terms. Companies need to account for contract costs such as direct labor, material, and overhead costs incurred to fulfill their obligations under the contract. If a company changes the terms of a contract, the accounting treatment of the contract may also need to be adjusted.

Companies must ensure that they comply with contract accounting standards to avoid financial misstatements, penalties, and reputational damage. Failure to comply with the standards can result in inaccurate financial statements, which can mislead investors, creditors, and other stakeholders.

In conclusion, contract accounting standards provide companies with guidance on how to account for their contracts accurately. The new revenue recognition standards require companies to follow a five-step approach, allocating transaction prices to each performance obligation, and recognizing revenue when the performance obligation is met. Companies should ensure that they comply with these standards to provide accurate financial statements and maintain their credibility in the business world.