Accounting for Uninstalled Materials Under ASC 606

In industries like construction and manufacturing, it is common for materials to be delivered to a customer’s site well before they are installed or integrated into the final product. These are known as uninstalled materials. The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, established a framework that changed how companies account for these items. The guidance determines the precise moment to recognize revenue for materials that a customer possesses but which the seller has not yet put into place as part of a larger service contract.

The Principle of Control Transfer

Under ASC 606, revenue is recognized when a company transfers control of promised goods or services to a customer. Control is the ability to direct the use of, and obtain substantially all remaining benefits from, an asset. This means the customer can decide how to use the asset and can prevent others from using it. The standard provides several indicators to help determine when control has passed from the seller to the customer.

Indicators of control transfer include the customer having legal title and physical possession of the asset. Other signs are that the customer has assumed the risks and rewards of ownership, meaning they bear the risk of loss if the asset is damaged, has an unconditional obligation to pay, and has accepted the asset. No single indicator is determinative, and they are evaluated together to assess the transfer of control.

The framework focuses on which party directs the asset’s use, not just who holds the risks and rewards. For instance, a customer may have physical possession of equipment, but if the seller can redirect it to another project, control has not fully transferred. The assessment requires judgment based on the contract’s terms and economic substance.

Criteria for Revenue Recognition of Uninstalled Materials

ASC 606 provides a practical expedient for uninstalled materials that are part of a larger installation contract. This allows a company to recognize revenue equal to the cost of the materials before installation is complete, resulting in zero profit on the materials at that time. To apply this, several criteria outlined in the standard must be met.

• The customer is expected to obtain control of the goods significantly before receiving the related installation services.
• The cost of the transferred materials is significant relative to the total expected costs of the contract.
• The seller procured the goods from a third party and was not significantly involved in their design or manufacture.
• The materials are part of a single performance obligation with the installation service, not a distinct good.

Consider a construction company building a custom warehouse. The contract requires specialized steel beams ordered from a third-party manufacturer, representing 40% of the total project cost. The beams are delivered to the customer’s site six months before installation. In this scenario, the company assesses the criteria. The customer has physical possession and legal title long before installation, the cost is significant, and the company did not design the beams. Assuming the beams and installation are a single performance obligation, the company could recognize revenue equal to the cost of the beams upon delivery.

Accounting Treatment When Criteria Are Not Met

If the criteria are not met, the seller cannot recognize revenue for the materials until control is transferred to the customer. This transfer usually happens upon installation or as progress is made on the service. The costs incurred to acquire the materials must be recorded as an asset on the seller’s balance sheet.

This asset is classified as inventory if the materials are generic, or as a contract asset if they are specific to the contract with no alternative use. These costs remain on the seller’s balance sheet. They are excluded from calculations used to measure progress toward completing the contract until they are installed.

This approach prevents a company from overstating revenue in a reporting period. By capitalizing the costs, the financial statements reflect that the seller still controls the economic benefits of the materials. Only when the materials are installed or integrated into the project to satisfy the performance obligation are the costs moved from the balance sheet to the income statement as cost of goods sold, with corresponding revenue recognized.

Identifying Performance Obligations

Identifying the performance obligations in a contract is a key step in applying ASC 606. A performance obligation is a promise to transfer a good or service to a customer. A company must determine if a contract contains a single obligation or multiple distinct ones, as this impacts the timing of revenue recognition.

For an item like uninstalled materials to be distinct from an installation service, it must meet two criteria. First, the customer can benefit from the good on its own or with other resources. Second, the promise to transfer the good is separately identifiable from other promises in the contract. For example, if a customer can buy materials from the seller and hire another company for installation, the materials are likely distinct.