Basics of construction accouting

Richard DeRienzo, CPA

Judith Ventura Enright, CPA

Agenda

• Risks in the Construction Industry

• Headlines

• Financial Reporting

• Percentage of Completion– Example

• Resources

RISKY BUSINESS

Risky Business• Competitive bidding and low margins – generating a profit

while covering costs

• Estimating and job cost – can’t leave costs on the table

• Unique accounting requiring specialized systems – timelyand accurate financial information is critical to make soundbusiness decisions

• Work in a new geographical location - unfamiliar laws,suppliers, and subcontractors, as well managing a projectthat is miles away

Risky Business (continued)

• New types of work – each type of construction takes uniquetalents and specialties

• Contracts with incentive, penalty, or other provisions

• Informal estimating procedures – may influence the abilityof a Company to produce reasonably dependable estimates

• Investment in capital that is often leveraged

Risky Business (continued)

• Unmanaged cash flow (dependent on multiple parties to getpaid)

• Construction company business failures are higher thanother industries

• On unbonded projects, often the lender pays when acontractor fails

Bonding• Purpose – guarantee owner/lender that should the contractor fail

to finish the project, the funds will be available to hirereplacement

• Capacity is based upon financial statements

• Types:– Bid bond

– Contract

– Performance/Completion

– Labor and Material Payment

– Maintenance

– Subcontractor

HEADLINES

FINANCIAL REPORTING

Financial Reporting

• Generally Accepted Methods:– Percentage-of-completion:

• Recognizes income as work on a contract progresses

– Completed-Contract:• Recognized income only when the contract is completed, or substantially so

– The use of either involves three key areas of estimates anduncertainties:

• The extent of progress toward completion

• Contract revenues, and

• Contract costs

Financial Reporting (continued)

• Two methods should not be used for the samecircumstances as acceptable alternatives

• Ordinarily should use percentage-of-completion method,except in two circumstances:– Where reasonably reliable estimates cannot be made; or

– Where the results of using the completed contract method do notdiffer materially from those obtained by using the percentage-of-completion method

Financial Reporting (continued)

• GAAP interpretation:– For entities engaged on a continuing basis in the production and

delivery of goods/services under contractual arrangements and forwhom contracting represents a significant part of their operations,the presumption is that they have the ability to make estimates thatare sufficiently dependable to justify the use of the percentage-of-completion method of accounting.

PERCENTAGE-OF-COMPLETION

Percentage-of-Completion(continued)

• First, need to measure extent of progress toward completion

• Methods:

– Incurred costs to date over estimated total costs of the contract(typical)

– Other measures as may be appropriate “having due regard for workperformed” (i.e. labor dollars, hours of labor)

– Should be applied consistently to all contracts having similarcharacteristics

– Disclosed in the financial statements


• Measures:– Input measures – based on costs and efforts expended (i.e. costs)

• Drawback – relationship of measures to productivity may nothold true due to inefficiencies

– Output measures – based on units produced or delivered, contractmilestones, and value added

• Drawback – measures can often not be established


• Cost to Cost Method:– Total estimated costs (costs to date plus estimated costs to

complete) is significant variable in determining gross profit

– Significant costs of materials purchased but not installed should notbe included in costs incurred

– Estimates must be periodically revised throughout life of contract


• Components of calculation:– Gross Profit = total estimated contract revenue –total estimated

contract cost

– Measurement of extent of progress toward completion (i.e. cost tocost)

– Total costs to date

– Total billings to date


• Two alternatives to calculating earned revenues and cost ofearned revenue, but typically:– Earned Revenue = gross profit earned (based on measurement of

extent of completion) plus costs incurred on the contract during theperiod

– Cost of Earned Revenue = cost incurred during the period

• Losses:– For a contract on which a loss is anticipated, GAAP requires

recognition of the entire anticipated loss as soon as the lossbecomes evident


• Estimating:– Procedures should provide reasonable assurance of a continuing

ability to produce reliable estimates

– Necessary to revise estimates continually as the work progresses

– Change in estimates accounted for in period and prospectively; notas prior period adjustment

EXAMPLE

Construction Resources• Construction Financial Management Association (CFMA) - "The

Source & Resource for Construction Financial Excellence“ –www.cfma.org

• AICPA – Audit and Accounting Guide, Construction Contractors

• FASB – former SOP 81-1 now Accounting Standards CodificationTopic 605

• Internal Revenue Service, “Construction Industry Audit TechniqueGuide”

• Associated General Contractors of America (AGC) – informationon proposed legislation, regulations and industry trends –www.agc.org

Questions?

Contract Description

Contract Price (including

approved change orders)

Current Estimated Total Direct Cost

Estimated Gross Profit (Loss) On

CompletionTotal Direct Cost

To DatePercentage Complete

Total Gross Profit (Loss)

Recognized To Date

Gross Profit (Loss)

Recognized in Previous Fiscal

PeriodsGross Profit (Loss)

Recognized This Period

Total Amount Billed to Date

Including Retainage

Billings in Excess of Costs and Estimated Earnings

Costs and Estimated

Earnings in Excess of Billings

A B C = A-B D E = D/B F = C x E G H = F-G I I-(D+F) (D+F)-I

JOB 1 22,975,301$ 22,906,536$ 68,765$ 10,922,498$ 47.68% 32,789$ -$ 32,789$ 11,499,229$ 543,942$ -$ JOB 2 22,942,319 16,306,341 6,635,978 16,285,677 99.87% 6,627,569 6,620,545 7,024 22,942,319 29,073 - JOB 3 16,777,855 14,649,476 2,128,379 14,649,476 100.00% 2,128,379 2,128,379 - 16,777,855 - - JOB 4 14,457,218 12,519,174 1,938,044 12,499,174 99.84% 1,934,948 1,822,785 112,163 14,457,218 23,096 - JOB 5 13,635,416 12,374,606 1,260,810 11,565,546 93.46% 1,178,377 746,049 432,328 13,604,898 860,975 - JOB 6 13,634,734 9,602,681 4,032,053 9,602,681 100.00% 4,032,053 4,031,173 880 13,634,734 - - JOB 7 13,316,686 12,739,911 576,775 10,680,149 83.83% 483,523 214,392 269,131 12,060,881 897,209 - JOB 8 13,204,635 13,228,429 (23,794) 13,224,770 99.97% (23,794) (23,787) (7) 13,204,635 3,659 - JOB 9 13,181,102 11,028,963 2,152,139 11,003,748 99.77% 2,147,219 1,852,009 295,210 13,181,102 30,135 - JOB 10 11,913,756 11,783,727 130,029 8,377,333 71.09% 92,441 2,961 89,480 9,394,263 924,489 - JOB 11 11,568,859 10,717,881 850,978 10,690,908 99.75% 848,836 745,365 103,471 11,568,859 29,115 - JOB 12 9,490,635 7,484,216 2,006,419 7,484,216 100.00% 2,006,419 2,006,419 - 9,490,635 - - JOB 13 3,798,627 3,715,004 83,623 2,878,618 77.49% 64,796 12 64,784 2,645,846 - 297,568 JOB 14 3,593,040 3,355,730 237,310 3,355,730 100.00% 237,310 255,323 (18,013) 3,593,040 - - JOB 15 3,333,812 3,116,174 217,638 3,068,584 98.47% 214,314 216,479 (2,165) 3,118,066 - 164,832

187,823,995$ 165,528,849$ 22,295,146$ 146,289,108$ 22,005,180$ 20,618,104$ 1,387,076$ 171,173,580$ 3,341,693$ 462,401$ F/S F/S F/S

Certain immaterial differences may exist due to rounding.

ENTIRE CONTRACT

ABC CONSTRUCTION COMPANYANALYSIS OF COMPLETED JOBS AND JOBS IN PROGRESS

DECEMBER 31, 2011

CURRENT FORECAST RECOGNIZED EARNINGS TO DATE

Basics of construction accouting

Economy & Finance

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