Accounting for Construction Costs and Income Recognition

1. Accounting for Construction Costs and Income Recognition CON 389

2. Conventions in Accounting • Convention of Consistency • Once a transaction is accounted for in a certain manner, that it continue being accounted for in the same manner. This is required by law. • Governing bodies, such as the IRS and AICPA, have guidelines concerning which methods and how companies are to put together their financial information.

3. Bases of Accounting • Cash Basis • Accrual Basis • That a transaction is recognized as for accounting purposes when an obligation for payment is incurred. Accounting Conventions Cash Accrual Percentage of Completion Completed Contract

4. Cost Progress Curve

5. Recognitionof Income • Percentage of Completion • The percentage-of-completion method recognizes income as work on a contract progresses. • Completed Contract Method • The completed Contract Method recognizes income only when the contract is completed, or substantially so.

6. GAAP TechniquesPercentage of Completion • Cost to Cost Method • Will generally be the method of choice, unless unable to adequately reflect where the job is • Effort Expended Method • Cases where costs are unevenly spread in such a way that the extent of job completion would be inaccurate using the Cost to Cost Method • Units-of-Work Performed Method • Mainly used for civil projects • Physical Observation Method • Final resort when others fail

7. Cost to Cost MethodPercentage of Completion • Calculated Percentage of Completion • Actual Cost of Construction divided by Estimated Cost of Construction times 100% (or may be left in decimal form) • Calculated Revenue to Date • %of Completion times Total Contract Amount • Calculated Profit To Date • Calculated Revenue to Date minus Actual Cost To Date

8. Example Cost to Cost Method • Estimated Revenue or Total Contract Amount = $3,000,000 • Estimated Cost of Construction = $2,750,000 • Actual Construction Cost to Date = $550,000 • Calculate % of Completion: • Calculate Revenue to date: • Calculate Profit to Date:

9. Definitions of CostsApplied to Construction • Direct: A cost that can be specifically identified with a construction job. • Indirect Cost: A cost that can be identified with jobs, but not a specific one. • Overhead Cost: A cost that cannot be identified with or charged to jobs, unless a more arbitrary system is used.

10. Direct Costs • Material • Labor • Subcontractors • Equipment (rentals and installed) • Other

11. Indirect Costs • Indirect Labor • Contract Supervision • Consumables and Tools • Insurances • Other

12. Overhead Costs • General and Administrative Expenses • The President’s Salary • Office Space Cost • Marketing Expenses • Other

13. Loss Disclosure • GAAP • The full loss for a job needs to be accounted for in the first period for which that loss is known. • This is true for Percentage of Completion and Completed Contract. • American Institute of Certified Public Accountants, Construction Contracts Audit and Accounting Guide, p. 110 (paragraph 85 of Statement of Position 81-1) New York, 1997.

14. Impact of Loss Declaration

15. Overbillings, UnderbillingsPercentage of Completion • Earned Revenue - Billings = Costs in Excess (Underbillings), or Billings in Excess (Overbillings) • An overbilling creates a liability. • An underbilling creates an asset. • However we do not want underbillings in most circumstances.