Q: What justifies a contractor to bill in excess of costs and profit?
A: The contract may allow billings in excess of costs and profit. This is common in many instances to provide contractor with necessary cash to purchase supplies, etc. But any billings in excess early in the project’s completion must then be offset later by billings that fall short of costs and profit as the project reaches completion.
Q: Would you repeat the terminology concerning Cost and Profits in Excess of Billings and Billings in Excess of Cost and Profits?
A: "Percentage of completion" means that revenue is recognized as income at various points of time along the project completion path. Job costs are recognized as they are incurred and, given the ratio of job costs incurred to date to total estimated job costs, a contractor can estimate revenue earned to date.
The balance sheet will have an asset account entitled "costs and profit in excess of billings," meaning that the contractor’s earned revenue – costs and profit – to date is greater than the amount he or she has billed the client for those jobs in progress. A liability account entitled "billings in excess of costs and profit" means that the contractor has billed the customer for work not yet done which is where all contractors would prefer to be, i.e., placing the contractor ahead of the customer on a cash flow basis.
Q: What do you mean by "closed" in 2013?
A: Closed means the contract has been completed. It may have started in prior period but was closed (completed) in the next (or current) period.
Q: Why is the actual cost to date an estimate? This should be labor and materials, which are a cost to the contractor, and then the markup which is, or will be, billed is the profit. How is any of this an estimate?
A: Actual cost to date should be a hard number. But “Total Cost Anticipated” and “Gross Profit to Date” are estimates, as is “Earned Revenue” since “Earned Revenue” is the sum of “Actual Cost” and “Anticipated Profit”.
Q: Sometimes, the Contract Status Report differs from the financial statements we receive. Do you have any suggestions on how to handle the Status Report in these instances?
A: Please ask the accountant for clarification. Any difference is a red flag since the Contract Status Report should be the underlying document supporting financial statement information.
Q: What if the dates of the status report differs from the financial statement date?
A: Different dates assure a mismatch between Status Report information and financial statement numbers. Use whatever is most current, if it comes to that.
Often the lender receives a Contract Status Report either monthly or quarterly. It may not be accompanied by a financial statement for that same period. As long as the lender has verified at least once a year that the Contract Status Report and financial statements are in sync, the lender can use the interim Contract Status Report to track progress to date. It is important to ensure that various individual projects are on time and on budget on a periodic basis.
Q: I work for a small credit union with smaller contractors. We generally don't get financial statements but receive corporate tax returns and require monitoring of the borrower's "WIP". Do you suggest that we start requiring the receipt of financial statements?
A: It is preferable to use accrual financial statements prepared according to GAAP.
Income tax returns are prepared according to the tax code, and they very often show a different income statement than the one prepared according to GAAP. It is possible, however, to convert a tax return income statement to a GAAP income statement using Schedule M-1, Schedule K, and various attachments to the tax return.
Please see our website for two different webcasts we offer on that subject – Business Tax Returns and Ratio Analysis and Business Tax Returns and Cash Flow Analysis.
Q: If you have a contractor that has a large amount in Unbilled Retainage – what does that mean?
A: Unbilled retainage means that the contractor has finished projects, which include amounts retained until the client provides final sign-off or approval, but has not yet billed the clients for the final piece of the project. However, the contractor has already booked the unfilled retainage portions of these contracts or projects as revenue.
Presumably the contractor is waiting for final project approval before he or she bills the clients. At that point, the unbilled retainage becomes billed retainage or simply accounts receivable.
If the balance of unbilled retainage is increasing while revenue remains relatively flat, this may signal problems with project completion and client sign-off and acceptance. However, if the unbilled retainage balance is moving in step with revenue, then there are likely no problems or difficulties.