Unrecorded job costs can really mess with your financial statements and WIP report. I've chalked up an example to help demonstrate this point.
Assume the following scenarios for the same project/job:
Scenario 1:
12/31/X2
Contract Price: $100,000
Estimated Total Cost: $50,000
Cost to Date: $10,000
Billed to Date: $75,000
Scenario 2:
12/31/X2
Contract Price: $100,000
Estimated Total Cost: $50,000
Cost to Date: $35,000
Billed to Date: $75,000
Information from both scenarios have been compiled into the following WIP report, with additional notes and information:
Scenario 1:
AA: Based on the WIP report, only one entry was recorded. The entry recorded overbillings of $55,000 which increased liabilities and decreased revenue.
BB: Total gross profit in this scenario is $10,000.
Scenario 2:
CC: In this scenario, two entries were recorded. The first was to recognize job costs of $25,000 through 12/31, which increased liabilities and increased costs. The second records overbillings of $5,000, which increased liabilities and decreased revenues.
DD: Total gross profit in this scenario is $35,000.
Analysis:
Note: Many areas of the financial statements and WIP are impacted by unrecorded costs but I've chosen to discuss the following two:
Gross Profit: One of the first things you'll notice is the large difference of $25,000 in gross profit between the two scenarios. As you will recall, the main trigger for revenue recognition for construction contractors is costs incurred, assuming percentage of completion. The second scenario simply includes more costs, therefore more revenue is recognized, which increases gross profit.
The difference between two scenarios is largely determined by the high estimated gross profit of 50%. The lower the estimated gross profit, the lower the difference between the two. Try it out for yourselves but pulling up the WIP template!
Overbillings: Overbillings are significantly higher in scenario 1 because the costs to date are significantly lower. The story in this scenario is that you were able to incur $10,000 in costs but bill $75,000. That's assuming 86% gross profit. Seems unlikely in the real world (although you may be saying that about the 50% gross profit in the examples I provided, ha!). Scenario two has less overbillings and appears more believable, and in line with actual operations.
Thus, unrecorded job costs will impact your balance sheet, income statement and WIP report. It's likely to lead to more questions from your CPA or surety! So don't forget to record all costs incurred through your period or year end date!
As always, please let me know if you have any questions. Thanks!
-Ara