Contractor Billings: Management, Strategy, & Effects on the Financial Statements Wiss & Company, LLP

Buyers and Sellers who are considering an acquisition or disposition of a business need to be aware of the consequences of a mid-contract transfer of any contracts required to be accounted for under the PCM for federal income tax purposes. Attention should be given to whether the transaction engaged in by Buyer and Seller is a fully taxable asset acquisition, non-taxable transaction, or partially both. The type of transaction will affect how the contract is treated post-acquisition, as well as the tax considerations for both Buyer and Seller. In this case Buyer will recognize $50 of revenue under the contract and is expected to incur $35 of additional costs, projecting a $15 profit, where it would have expected to recognize a $15 loss without the payment. It is important to understand the risks of both contract assets and contract liabilities and the implications they can have on project success.

Billings in Excess of Costs/Unearned Revenue are the billings to date which have not yet been recognized as contract revenue. To safeguard against underbilling and overbilling issues, contractors should calculate various ratios specific to these accounts to determine if there are potential risks, including risks to net job borrow, underbilling analysis and cash to overbillings analysis. Logicfest January 31, 2014 It looks like a nasty accounting trick at first blush, but it actually makes a lot of sense. Until a job is complete, the revenue collected for it can be considered a liability — costs will have to come out of it, the client might not be satisfied and demand a refund, etc. Many construction companies charge customers the full cost of a project upfront. Projected Revenue is the total estimated revenue the Project Manager expects the project to receive, including change orders.

work in process

Large underbillings can cause financial backers (banks, investors, etc.) to withdraw their support for a project or a company. Since the ledger may include 70% of the costs ($ 70,000) and only 20% of the billings ($ 28,000), an adjustment must be made for the margin to reflect 50% of the job. The problem in this situation is not a loss in the current job but the user has not invoiced the same percentage of the billings in comparison to the costs that have been incurred. The percent complete method will create general ledger transactions and show a percentage of the profits within each month. For example, if a job is 50% complete and it has a budgeted cost of $100,000 and a budgeted income of $140,000, the P&L report should reflect 50% of the profit. To truly understand a contractor’s financial statement and to gain insight into the company’s strength and viability, users of this data must focus on ratios specific to the construction industry.

A contract asset is defined in Topic 606 as an entity’s right to consideration in exchange for goods or services the entity has transferred to a customer, conditional on something other than the passage of time. Backlog is the amount of work a contractor cost in excess of billings asset has in signed contracts that are either in progress or have yet to start. Although every contractor varies, contractors that perform fixed priced contracts should have backlog gross profit of 50% or more of the next year’s overhead costs.

The basics of the percentage of completion method

Contractors should, therefore, be net overbilled; otherwise, there could be a significant negative impact on cash flow. Conversely, many of the largest failures in contractor history resulted from the contractor overbilling on projects and then using the overbilling to fund loss projects, or distributing the additional funds for other ventures. Therefore, the optimal scenario for a contractor is to have in cash the total amount of overbilling on all projects. If a contractor does not meet this cash-to-overbillings ratio, it is more likely to experience future difficulty funding the projects that were overbilled.

WIPs are also used to track contract value, costs both incurred and projected, and to help reveal negative trends before they become bigger problems. Moreover, the values of multiple projects can be aggregated together to measure company-wide performance. Companies that employ long term contracts, such as those in the manufacturing and construction industry use a type of ‘accrual basis accounting’ called Percentage of Completion . The concept behind accrual basis accounting is that as every cubic yard of cement is poured, and as each nail is hammered in, cost is continuously being accrued in both materials and labor and therefore, revenue is also increasing. Even though no cash has changed hands, revenue is considered to have been accrued based on future billings to be paid.

Related to Costs in Excess of Billings

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It must include not only numbers next to the expense categories but also percentages of revenue next to the number.

Costs in excess of billings as an asset

Invoices may be generated and posted subsequent to the actual month in which the transaction was incurred. In a case such as this, subsequent billings should offset any unbilled receivables. These amounts should be billed as soon as possible in accordance with contractual terms. In Example 2 on the other hand, Transferee will only receive $20 in payments ($100 contract price minus $80 previously received by Seller) but will recognize $50 in taxable income and must incur $35 to complete the contract. In a non-taxable transfer, the concept of a payment between transferor and transferee related to the contracts does not appear to exist.

• The government or prime contractor may retain a portion of the amount due to the contractor until the contract is completed in a manner that is satisfactory to them.
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• Our final step was to combine what he earned in salary and profit for the eleven months reviewed.
• The understanding is that the work will be completed within a reasonable period of time.

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Percentage of Completion (POC) Accounting

As you can see, building a WIP is fairly simple provided you have accurate financials, and by running regular WIP reporting, before and during construction, you’ll always know where you stand. The next step is to consider your billings and to define yourEarned Revenue to Datewhich is the Percentage of Completion multiplied by the Projected Revenue. Now that we’ve identified why WIPs are so important in construction accounting, let’s take a look at how to put one together. Simply fill out the form for a guided tour from one of our time tracking experts. Indirect cost means any cost not directly identified with a single final cost objective, but identified with two or more final cost objectives or with at least one intermediate cost objective. Be sure to allocate the workmen’s compensation insurance, vehicle and equipment insurance, depreciation, payroll taxes, benefits, safety and training to the indirect or general conditions as appropriate.