Across all industries, financial statements provide valuable information about a company. Internally, the statements are a good way to keep track of where issues might arise throughout the year, ideally, catching a problem before it becomes expensive to solve. Externally, accurate financial statement presentation is the proof banks, bonding companies, and any other third party will want to see to determine if they will grant your company the line of credit, loan, or bonding coverage that you’re applying for. At least once a year, depending on the laws surrounding the industry or location of the business, business owners provide stakeholders with a comprehensive financial statement presentation.
Uniqueness of Construction Financial Statement Presentation
The construction industry has specific methods for recognizing revenue, resulting in unique financial statement presentation. Construction companies may, in some instances, use the completed contract method to recognize revenue. This method accounts for revenue related to contracts by recognizing all revenue and costs when the contract, or job, is complete. Until the job is complete, all job activity is reported on the balance sheet.
More common in the construction industry, however, is the use of a different, two-step process to recognize revenue related to contracts. This two-step process for recognizing revenue is called the percentage-of-completion method. It is generally the preferred method for contractors because it depicts the best representation of contract-related activity over a period of time, rather than at a single point in time (completed contract method).
Financial Statement Presentation – Two-Step Process
Financial statement presentation for the construction industry is unique because revenue is often determined using the percentage-of-completion method. In most instances, this is the only acceptable accounting method for financial statement presentation in accordance with generally accepting accounting principles (GAAP). The two-step process looks like this:
Costs incurred / Estimated total contract costs = % Complete
The next step is to take your % Complete and multiply it by your total contact price. This equals your revenue earned for the reporting period.
The revenue earned number, however, is only as accurate as the other three numbers going into the two-step process: costs incurred, estimated total contract costs and total contract price. These numbers are all represented on your work-in-progress (WIP) schedules. WIP schedules are a crucial component in the financial health of a construction company. To read more about the importance and purpose of WIP schedules, click here.
WIP Schedule Tie-Out to Financial Statements
In addition to costs incurred, estimated total contract costs and total contract price, your WIP schedule should also have costs-in-excess of billings (CIE) and billings-in-excess of costs (BIE) amounts that tie back to the balance sheet. CIE are also referred to as “underbillings”, while BIE are referred to as “overbillings.” CIE and BIE are terms specific to the construction industry. CIE and BIE are shown as asset and liability accounts, respectively, on your company’s balance sheet.
It is very important to make a journal entry at the end of each reporting period to reflect the appropriate amount of CIE and BIE. The difference between the CIE and BIE amount, or the “plug” in the journal entry, is a WIP Adjustment account, which is a revenue account. This amount on the income statement could be a credit or debit balance, depending on your net CIE/BIE position. Earnings and costs on the WIP schedule should tie back to the income statement for the specified period of time.
It is vital to manage your CIE and BIE because they are critical for your Company’s cash flow, project management, and overall profitability.
Corrigan Krause Specializes in Construction Accounting
Corrigan Krause has an entire team dedicated to the construction industry. For more information on becoming a client of the Construction Services team at Corrigan Krause, email firstname.lastname@example.org. To join our Construction Services newsletter, click here.