- introduction
To standardize revenue accounting and improve the quality of accounting information, in accordance with the "Enterprise Accounting Standards - Basic Standards," the Ministry of Finance issued "Enterprise Accounting Standard No. 14 - Revenue" (Caihui [2017] No. 22, hereinafter referred to as the New Revenue Standard) in 2017, along with related application guidelines, interpretations, and regulations. Non-listed enterprises implementing enterprise accounting standards are required to implement them from January 1, 2021; however, enterprises are allowed to implement them ahead of schedule. The "Enterprise Accounting Standard No. 14 - Revenue" (Caihui [2006] No. 3) and "Enterprise Accounting Standard No. 15 - Construction Contracts" (Caihui [2006] No. 3) issued by the Ministry of Finance in 2006 are no longer valid.
- Industry characteristics and current status of revenue recognition for design companies
The design company belongs to the modern service industry and is a third-level unit under the State Administration for Market Regulation. It occupies a leading position in the entire industry chain and is a knowledge-intensive and technology-intensive light-asset enterprise.
(I) Industry Characteristics of Design Consulting Companies
1. The main cost of design projects is labor cost
. The design industry is a knowledge-intensive and technology-intensive industry. Design products have a unique, non-reproducible nature, differing from general commodity production methods. They typically manifest as planning schemes, design and construction drawings, etc. Because the project outcomes of the design industry reflect advanced concepts and the application and promotion of new technologies, technical personnel are the core productivity of the enterprise. Labor costs constitute the main part of the overall project cost, while other costs are relatively small.
- Project personnel have overlapping time periods
A design project requires collaboration from multiple professionals in related fields. Architectural projects primarily involve five disciplines: architecture, structure, plumbing, HVAC, and electrical engineering, emphasizing teamwork and full participation. However, once these professionals form a project team, they may also be responsible for other projects within the same discipline at the same time, resulting in significant time overlap.
- Design contracts are generally short-term and have low total amounts.
Design work is generally divided into several stages, including conceptual design, schematic design, preliminary design, construction drawing design, and construction coordination. The contract typically specifies each stage and the overall design period. Design companies typically handle larger-scale and longer-term projects compared to the design portion of the project. The design itself has a shorter timeframe; from planning to design scheme and construction drawing completion, it usually doesn't exceed one year, and the design fee represents a relatively small percentage of the overall project cost. However, with the advancement of EPC projects, design and construction are now largely synchronized, thus shortening the overall project duration but extending the traditional design timeframe.
- Current Status of Revenue Recognition for Design Consulting Firms
Currently, design companies recognize revenue based on the issuance of VAT invoices or receipt of design fees. This current method, to some extent, causes delays in accounting information and accounting processing.
Secondly, due to the short design contract cycles and overlapping timeframes, it is difficult to account for labor costs and other costs on a project-by-project basis. Therefore, the design company has consistently used the accounting method of transferring costs at the end of the accounting period without separating them by project
. This results in discrepancies in the timing of asset and profit recognition, reducing the comparability of accounting information and compromising the accuracy of the description of operating results. Thirdly, the design company's finance department has insufficient involvement in the business processes. The operations department signs contracts, and the design and production departments implement design and production. The internal control systems at each stage need to be strengthened. Finance personnel cannot obtain timely information on project production progress and payment collection times, thus failing to strictly adhere to the standards for timely revenue recognition.
- Key features of the new revenue standard
- The new revenue standard introduces a unified model, which applies to the recognition and measurement of revenue from the sale of goods, provision of services, construction contracts, and other revenue-related matters.
- The new revenue standard establishes a revenue recognition model, known as the "five-step method": Step 1, identify the contract entered into with the customer; Step 2, identify the individual performance obligations in the contract; Step 3, determine the transaction price; Step 4, allocate the transaction price to the individual performance obligations; Step 5, recognize revenue when each performance obligation is fulfilled.
- The new revenue recognition standard differs from the old one. The old standard primarily used the transfer of risks and rewards as a prerequisite for revenue recognition, while the new standard uses the transfer of control as a prerequisite. Gaining control of a product means being able to dominate its use and obtain substantially all of its economic benefits.
- Discussion on specific methods for revenue recognition
The design company's main business is architectural design. Upon fulfilling its contractual obligations at each stage, submitting design deliverables to the client, and obtaining confirmation documents, revenue is recognized based on the corresponding performance stage amount stipulated in the contract. However, there are also cases where the design contract is signed only after the design phase has ended and the construction drawing phase has commenced. In such cases, it is necessary to further determine how to account for the costs and expenses incurred in the project according to the revenue standard. If the design company determines, based on the actual situation, that the project will ultimately result in a contract and compensation, then the costs and expenses incurred before the contract signing can be recognized as contract performance costs in accordance with the new revenue standard. If the design company ultimately fails to sign a contract with the client, and the costs incurred in the early stages cannot be compensated, then the relevant expenditures incurred in the project need to be expensed.
1. Revenue is recognized in stages based on contract milestones and the amount received. Advance payments received by the company during the business acceptance stage are not recognized as revenue.
2. Supporting documents for revenue recognition at each stage:
External evidence for revenue recognition at each stage includes: confirmation letter signed by the client, and audit documents approved by third parties (including but not limited to audit, approval, filing, and completion acceptance reports issued by government planning, construction and other competent authorities and review agencies).
Contractually agreed milestones | Performance phase | Contract settlement node | Settlement amount and percentage | Revenue recognition progress at this stage | Cumulative Revenue Recognition Progress | External evidence | Department and time of evidence submission |
1 | Business takeover phase | This contract shall become effective upon signature and seal by both parties, and the client shall pay the designer a certain percentage of the total contract amount as an advance payment within n days of the designer commencing the design process. | a | 0 | 0 | contract | Operations Department? Before the 20th of each month? |
2 | Scheme design phase | Within n days after the design proposal is approved and confirmed by the client, the client shall pay the designer a certain percentage of the total contract amount. | b | a+b | a+b | This mainly includes the client's confirmation letter regarding the design deliverables and approval documents issued by relevant government departments; | Planning Department? Before the 20th of each month |
3 | Preliminary design phase | Within n days after the preliminary design of the plan is completed and approved by the expert meeting and the planning committee, the client shall pay the designer a certain percentage of the contract amount. | c | c | a+b+c | This mainly includes the client's confirmation letter regarding the preliminary design deliverables, the completion of the information disclosure work and its confirmation by the client, and approval documents issued by relevant government departments. | Production Department? Before the 20th of each month |
4 | Construction drawings
Stage | Within n days after the completion of the subsequent construction drawing design review and material selection confirmation, the client shall pay the designer a certain percentage of the contract amount. | d | d | a+b+c+d | This mainly includes a confirmation letter issued by Party A and a "Certificate of Approval for Construction Drawings" issued by the reviewing unit; | Production Department? Before the 20th of each month |
5 | Construction coordination phase | Within n days after the project's completion and acceptance, the client shall pay the remaining design fee to the designer. | e | e | a+b+c+d+e | This mainly includes the confirmation letter issued by Party A, the project completion and acceptance report, and the project settlement documents. | Production Department? Before the 20th of each month |
3. Payments collected by the design company on behalf of third parties, as well as payments expected to be refunded to clients, should be accounted for as contract liabilities and not included in the transaction price.
- in conclusion
During the implementation of the new revenue standard, design companies primarily rely on contracts for revenue recognition. Therefore, to improve the quality of accounting information, design companies should strengthen contract management and make their foundations more solid and detailed in order to more objectively and accurately reflect the company's operating processes and results.
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