wip

Secrets of Bonding #57: (4 of 4) Work In Process Schedules – Own Them!

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WIP Schedule, Effect on Balance Sheet Analysis

Now we pull it all together.

Here again is our sample contract.

Contract Price / Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000     /        10%            /$550,000 /    $350,000      /  $700,000

What did we determine so far?

  1. We found that the job is 33% complete.
  2. The profit % has slipped from 10% to 4.5%
  3. The contract is Overbilled by $187,000

In addition to generating some discussion (What’s going on with this project?), these facts have an effect on the financial analysis and bond worthiness of the account. They could result in the bonding line being reduced and future bonds being declined.

How does this happen?

Remember the Overbillings are dollars the contractor has in hand, but at this stage of the project they are undeserved.  The dollars are comprised of costs and profits, and the profits are unearned at this point.

So where are these “undeserved funds” on the balance sheet?  There is no entry by that name on the Balance Sheet.  These dollars are sitting in the cash account, along with other cash owned by the company.  These dollars are not yet earned or deserved, yet they are sitting in the account looking normal.

The solution is to reconcile (recognize) the undeserved funds by creating a corresponding liability that offsets the Overbilling cash asset. This Current Liability will be called Billings in Excess of Costs and Estimated Earnings. In short, this is referred to as Overbillings.

In this case, there will be a $187,000 Overbilling Current Liability to offset the undeserved funds in the cash account (Current Asset).  This removes the extent to which the Overbillings inflated the Working Capital calculation (Current Assets minus Current Liabilities).

In an Underbilled situation, a Current Asset called “Costs and Estimated Earnings in Excess of Billings” would appear.  (Notice that it sounds like the opposite of the Overbilling title.) This adds to Working Capital by reflecting the earned funds that have not been collected because the billings are not current.

Here are some CPA comments regarding WIP schedules and their importance:

http://www.reacpa.com/the-contract-schedule

Conclusion: The analysis described in this series is critically important for contractors and their surety.  However, the analysis is impossible if the contractor does not keep valid records of the costs attributed to each individual project and then periodically re-estimate the Remaining Costs to Complete based on the actual realities experienced.

Watch for #58 – a Bonus Edition!

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

 

 

 

Secrets of Bonding #55: (2 of 4) Work In Process Schedules – Own Them!

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Finding the Degree of Completion

When analyzing the financial condition of construction companies, the Work in Process schedule is always a required item.

Much of this evaluation keys into the degree or percentage of completion of each project. When you read a WIP schedule there may be no column heading for this number, but it is easy to calculate. Noteworthy: There are some inaccurate ways to determine this percentage, so you will want to figure it yourself in any event.

Formula to find the % of Completion:
Divide the Costs Incurred to Date into the Total Costs to Complete. The percentage of the total costs that have been incurred so far is the degree of completion for that project. If the Total Costs to Complete are not shown, you may need to add the Costs Incurred to Date to the Remaining Costs in order to find the Total Costs. The degree of completion is based on a cost analysis because until you incur your last cost, you are not finished – regardless of the status of the billings.bookkeeper2

Common misconceptions about the % of completion:

1. The % of completion is based on the degree of Billings. (No, it is based on an analysis of the costs.)
2. It is always based on the original contract amount. (No, the Current Revised contract amount is used if a plus or minus change occurred.)
3. It is based on the original estimate of total costs. (Incorrect, the Current Revised Estimate of Total Costs is always used.)

With all this in mind, what is the degree of completion on this contract?

Contract Price / Original % GP /      Billed    / Costs to Date / Remaining Costs
$1,100,000     /          10%          /$550,000 /  $350,000     /    $700,000

Raise your hand if you got 50%.

OK, that’s wrong… The typical short WIP schedule doesn’t show everything. It may not give you the Current Estimate of TOTAL Costs. First, you must find that.

So $350,000 + $700,000 = $1,050,000 Current Estimate of Total Costs

350,000 / 1,050,000 = .333 or 33.3% Did I hear someone say “Why didn’t I pay more attention in math class?!”

So the project is 33% complete based on the portion of the total costs that have been incurred so far.

Knowing the percentage of completion is important for a number of reasons. From a project management viewpoint, it is normal for the contractor to establish a projected timetable to assure on-time completion of the project. By periodically reviewing the degree of completion, the project manager can confirm they are on track. There may be financial rewards for early completion or a punishment, “liquidated damages,” if they’re late.

There are other important uses for the % of completion. We’ll go over them in the next segment… with the haunting title: “3 of 4!”

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it! 

Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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