Within the same month, we found two very different WIP problems with two different clients. At a construction subcontractor, one account never moved when it should have, because preconstruction costs sat flat even though the business was incurring costs every month. At an energy-services company, another account moved in the wrong direction by six figures, with an indirect cost allocation into WIP overstated by roughly $100,000.
In the second case, the overstatement was also likely inflating reported revenue and net income, which raised another concern: taxable income may have been recognized earlier than it should have been.
Your own WIP schedule may hold similar discrepancies, and catching them early can help you avoid overstated income, unexpected tax costs, and cash flow problems.
What Is Construction WIP Accounting Supposed to Show?
If you inherited a WIP schedule without ever being walked through it, the idea behind it is simpler than it looks. Construction WIP accounting connects what is happening on each job with what the financial statements report.
A WIP schedule helps determine how much revenue and profit have been earned on each active job by comparing costs incurred to date with expected total costs. If a project is 40 percent complete under the company’s appropriate measure of progress, the financial statements should generally reflect that level of earned revenue, even if billing doesn’t line up with progress.
When earned revenue exceeds billings, the difference may appear as an asset, often described as underbilling or costs in excess of billings. When billings exceed earned revenue, the difference is generally presented as a liability or overbilling.
What Happens When a WIP Account Stops Moving?
At the construction subcontractor, the Cost in Excess account holding preconstruction costs was not moving month to month, even though costs were presumably being incurred every month.
Instead of reflecting that expected activity, the balance sat static between quarterly reliefs, which raised questions about whether the interim financial statements were reflecting WIP accurately.
We recommended letting the account accumulate monthly as costs come in and then relieving it on the company’s normal quarterly cadence. That keeps the account current and creates a regular checkpoint before errors carry into later periods, although which preconstruction costs qualify for this treatment is still worth confirming with your CPA.
What Happens When Too Much Cost Gets Allocated to WIP?
At the second company, WIP was moving, but too much indirect cost appeared to be flowing into it.
Indirect costs can include project management, insurance, labor burden, equipment support, and other expenses that benefit multiple jobs. Contractors typically allocate them using a defined method such as direct labor, labor hours, or total direct costs.
At the energy-services company, the allocation looked overstated by roughly $100,000. In a cost-to-cost revenue recognition model, that matters because costs incurred help determine project progress. If too much cost is pushed into WIP, a project can appear further complete than it really is, which can pull revenue and profit into the current period too early.
We recommended truing up the indirect cost allocation at least quarterly so the WIP balance reflects the actual cost pool and the company’s established allocation method.
Can an Overstated WIP Balance Increase Your Tax Bill?
An overstated WIP balance can increase your tax bill if the WIP error also increases taxable income under the company’s tax accounting method.
Construction companies don’t all recognize taxable income the same way. Depending on the contract and taxpayer, methods can include percentage of completion and certain exempt contract methods.
Under a percentage-of-completion method, project progress affects when income is recognized. If an incorrect cost allocation makes a project appear further complete and that error carries into the tax calculation, taxable income may also be accelerated.
That’s where the cash problem can appear. Recognizing taxable income before the customer pays can be normal for contractors, but if a WIP error accelerates income that otherwise would have been recognized later, the company may also pay the related tax earlier, using working capital sooner than necessary.
For this client, the roughly $100,000 overstatement was worth raising with the CPA before year-end. The exact tax effect depends on the company’s tax method and overall tax position.
Why Should You True Up Your WIP Schedule Regularly?
WIP relies on inputs that change as projects move forward. Estimated costs change, change orders get approved, margins move, indirect cost pools grow, and billing positions shift.
For the two companies in these examples, one recurring quarterly calendar reminder for a WIP true-up would have surfaced both issues before they compounded. We build that review into the close calendar and cover four areas:
- Costs to date: We confirm project costs and applicable preconstruction costs agree with the general ledger.
- Cost estimates: We update estimated costs to complete when project conditions change.
- Indirect allocations: We compare the amount applied to WIP with the actual cost pool and allocation method.
- Financial statement tie-out: We reconcile earned revenue, billings, and WIP balances back to the general ledger and balance sheet.
FAQs About Construction WIP Accounting
Who should be involved in reviewing the WIP schedule?
Finance and project operations should review the WIP schedule together. Accounting validates the numbers, while project managers confirm that costs to complete, change orders, and progress estimates match field conditions.
What happens if a project is projected to lose money?
Under GAAP, the full anticipated contract loss is generally recognized once it becomes probable. Regular cost-to-complete updates help prevent stale estimates from hiding a loss.
How do sureties view large underbillings?
Sureties often scrutinize large or growing underbillings because they can signal billing delays, unapproved change orders, or unrecoverable costs. Strong documentation and current estimates make them easier to support.
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Janine Smith is a Consulting CFO with TGG. She has a wealth of experience in accounting process development and management, supervising both TGG staff and client’s internal staff (banking, AR, AP, inventory management, payroll), and working with many different types of accounting software. She has worked with clients to develop KPIs that fit their current needs and coached them to support the goals of the business. One of her favorite tasks is budget development and using that as a tool to help organizations meet their goals.