When, How and Why AE Firms Recognize Revenue

In the AE industry, time is money. As a professional service, AE firms provide clients with key deliverables in a defined timeline, and fees are driven primarily by the amount of human resources that must be devoted to those efforts to get them to completion. Time is money when we bill hourly, and time is money when we have a fixed fee and we need to maximize dollars per hour.

So the key question when deciding when, how, and why to recognize revenue is when have we really earned our pay?

Here are some ways AE firms recognize revenue, with focus on how these methods are used, when they recognize revenue, and why a firm would use that method.

Billed

The ‘simplest’ approach to revenue recognition is to recognize it when we bill our clients for our services. Our efforts are recognized based on what is collectible from our clients. Accounting can be dated in the month of the invoice, or in the month the work was performed. The latter is generally preferred as it more closely matches when the costs for that revenue were incurred. Firms choose this method when they are small, have limited accounting resources, their deliverable schedules are closely tied to billing amounts, most services are billed hourly, they wish to be very conservative about revenue recognition, or they are using non-AE-specific accounting software that does not allow other options.

Billed + WIP

In the billed plus WIP (Work in Progress) approach, we recognize revenue based on what we’ve invoiced our clients, plus work we have performed on projects that we believe is chargeable but we have not yet invoiced. Most good AE-specific accounting software uses this method as a baseline and may expand into other methods. In this method we get a real-time picture of revenue even between billing cycles, which, in conjunction with real-time job cost accounting provides significant benefits to project managers. This allows us to recognize revenue for additional services as they are performed, provides visibility to project managers about how much time has been incurred since our last billing, and allows an opportunity to review the reasonability of our work in progress before billing.

This method is employed by medium to large firms with experienced accounting teams and engaged project managers. It works well for firms who either do a lot of time & expense work for their clients (so fees are very directly related to time), or who are able to bill projects on a very regular basis (every month) and bill relatively close to their physical percent completion. (We are actually 80% complete, we send a bill for 80% complete.)

This method has the added benefit of putting a keen focus on capturing potential scope change, since we are closely reviewing our time and outstanding WIP.

Percent Complete of Contract

Percent Complete of Contract, or ‘Earned’ revenue, is the GAAP-compliant approach to recognizing revenue on long-term contracts. It is used by large design-build firms, construction management firms, and firms with very large revenues. Firms that leverage the best practice of billing their clients based upon these percentages of completion have the luxury of getting this type of accounting even when using the Billed + WIP method above. But for many firms, and for various reasons, the percentages billed to the client may vary significantly from the percentages complete. In those cases this method is used.

Project Managers estimate their percent complete on contracts, typically at the phase level. This should be done by estimating the amount of work still required to complete the contract, to derive the estimated cost to complete. This is then divided into the project’s budget and subtracted from 100% to derive the percent complete.

This is important for firms that “front-load” their fees for cash-flow reasons, firms that have sporadically spaced “milestone” billings, and firms falling under strict audit guidelines for government contracts executed as percent complete or fixed fee contracts.

The drawbacks to this approach are that it can only be done periodically (not real-time), it’s an additional accounting process, and it’s easy for project managers to be overly optimistic about their completion, particularly when a client doesn’t have to agree with it and send a check. Sometimes PMs spend more time recognizing revenue than getting bills out to their clients to get paid.

Hybrids, Formulas and Other Use Cases

Consultant billings can cause headaches for accurately recognizing costs and revenues for prime contractors. When using Billed or Billed + WIP it’s simplest to bill the client based on the costs incurred from those consultants for easy matching. But consultant revenue could also be keyed to billable costs using a revenue formula while labor is set to Billed + WIP.

Time and Expense contracts often have not-to-exceed amounts. Ideally these contracts are designed to allow for a work stoppage while additional services are negotiated. But often they are more restrictive, or we want to provide a courtesy credit for minor overages, and we may want to cap revenue at the contract amount on these types of projects. This cap can also be employed to suspend the recognition of additional service revenues until a contract amount is established. While a convenience from an accounting perspective, often it’s recommended that WIP over the contract be carefully reviewed by PMs to ensure that additional services are captured rather than swept under the rug.

Revenue formulas could also be used to provide a conservative cushion in our revenue, such as recognizing WIP at only 95% of its full value.

What’s Right for Your Firm?

I like to think of three main areas to consider when helping firms make this decision: functional, regulatory, and accounting.

From a functional perspective we want a method that is both easy and transparent, for our accounting staff as well as project managers and principals. When they view a report showing how profitable their project is, do the numbers make sense to them on an intuitive level? Are we minimizing the amount of administrative time it takes to get reasonably accurate project profits? Is there a material difference for our firm between the different methods? I encourage firms not to over-engineer their process, particularly since the biggest impact of revenue recognition methods is on the period in which revenue is recognized, not the amount of revenue actually earned by the time the project is over.

Some firms operate in stricter regulatory environments than others, and may be compelled to use a particular method by their clients or regulatory agencies, and may be required to use various methods on various projects. In these environments, what are our particular requirements? How often are we required to report information this way? Do we want our primary reporting to reflect information this way or is it an annual exercise we want to report outside of our primary accounting system or via a reversing adjustment?

From an accounting perspective, how do want to see this information reported at the top levels of our organization? Do we need a particular method on some or all projects in order to see the macro view of our business in a digestible way? How experienced is our accounting staff at understanding and auditing revenue transactions? Based on our business model, which method will result in the most consistent and predictable accumulation of revenue? Choose wisely and stick with the same approach over a long period of time to get the best results from any approach.

In summary, AE firms choose various revenue recognition methods depending on their size, marketplace, contract types, fee structures, timing of services, accounting expertise, and accounting software. Take a close look at how your business model and team relates to these approaches, and contact a trusted advisor to discuss a path to the most transparent and efficient approach for you!

Ajera was designed to manage the full project lifecycle for A&E firms. A single system controls all aspects of project management and accounting with real-time project information shared across the firm. To learn more visit Deltek Ajera or contact us to schedule a personalized demo.

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