All too often when meeting with construction clients, I hear the comment: “I think we made money on that job” or “that job should have made money”. With volatility in material pricing, supply chain issues and skilled labour shortages, being able to review accurate and meaningful project profitability reports on a regular basis is more important than ever.
While the accounting side of any business is often just a necessary evil to most, contractors who embrace accounting processes are positioning themselves to be more agile in the market, which allows them to be proactive as they manage their projects. This often leads to better decision making and increased profitability.
Without too much accounting jargon I hope to provide a general overview of the factors in play when recording your project revenue and how it can impact other parts of your operations.
Accounting policies for contractors in Saskatchewan to consider
If you are a contractor that requires bonding, a common requirement from your surety provider is to have a review engagement completed annually with your financial statements and tax return. You will have a choice between two accounting policies in terms of recognizing your project revenue:
- Completed Contract
- Percentage of Completion
The best choice is the one that matches the types of projects you are taking on without causing excessive administrative burden.
As a general rule of thumb if you take on projects that will be completed within 6-8 months from start to finish (i.e.; residential housing) and there is only one deliverable then the completed contract method would be best suited for you. If you are working on projects that are routinely longer than 8 months (larger commercial, industrial, institutional projects) then the percentage of completion method is likely most relevant for you.
Completed Contract Method
This method is straight forward. As the name suggests, project revenue under this method is not recorded until the project has been completed, or substantially complete, based on the terms of the contract. Until the project is complete any progress invoices issued are considered ‘deferred revenue’ (reported as a current liability on the financial statements) and any project expenditures are reported as inventory or sometimes more specifically called ‘work in progress’ or WIP.
Once the project is complete, both the revenues and expenses are recognized into income at that time, and you then have the full picture of how successful that project was within the same reporting period.
Many projects often contain trailing costs or other unforeseen or unbudgeted warranty expenses. It can often make sense to record an allowance for this work at the same time as the project is completed, as these costs can be significant and reasonably estimated.
Percentage of Completion Method
Make no bones about it, this is the more complicated method. However, it will provide you with more consistent revenue numbers which can be very important when negotiating bonding limits or finance agreements.
This method can look different depending on the terms of each project, but at its core the principle is that regardless of what has or hasn’t been invoiced to date, project income (including any expected profit/loss) is recognized based on the specific drivers/measures for each project.
The drivers will vary and can be based on either inputs (costs and efforts expended) or outputs (results achieved) depending on the project. Some examples of drivers include costs incurred vs total expected costs, milestones or units produced.
Understanding which expenditures are costs of the contract versus general and administrative expenses can also be valuable in assessing success as a project is completed.
If you use the percentage of completion method, there has been a change to accounting standards that is going to require more disclosure with year ends beginning on or after January 1, 2022. After that date, you will have to disclose several criteria in the financial statements:
- Method(s) of measuring the degree of completion
- Any uncertainties impacting the measurement of completion
- Specific information for projects in progress at year end including:
- Total costs incurred and recognized in profits to date
- Total advances received
- Total holdbacks withheld
Which method is right for my business?
To borrow a favourite accounting expression: it depends. Each method can be used regardless of any contractual payment terms. Using percentage of completion, along with reviewing financial information on a regular basis, can assist you in being current on your billings which will improve cashflow on the project.
You will also have a better sense of costs to date versus expected costs which can also help identify changes needed to materials or productivity rates used when estimating the next job.
Lastly, understanding which method you use to recognize revenue can be important when having discussions with either your surety provider or any current/future lenders as your financial statements could look very different between the two methods.
Being able to advocate for yourself by explaining the implications can help demonstrate the true strength of your company and develop a stronger sense of trust with your service providers. At the very least, touch base with your accountant who can assist you in telling the full story of your company’s financial performance with lenders, surety, or other potential service providers.
Paul Olenick
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