In this blog post I will be discussing some of the main items of the WIP Accounting Schedule: Percentage of Completion, Job Cost, Earned Revenue, Backlog, Fade, and Percentage of Completion vs. Completed Contracts. There are many benefits to a WIP accounting schedule, including taking into account the many unique and varying factors that make up your business.
Percentage of Completion (POC):
Percentage of Completion is an accounting method to recognize contract/job costs and the corresponding revenue over the performance period of a “long term” contract. The general rule is that a long term contract is a contract that is not performed entirely within a single accounting period/year. Don’t get this confused, most companies that use Percentage of Completion will use the phrase “long term” for all projects that are multi-month projects. Percentage of Completion method is best used by commercial construction companies and large-scale equipment manufacturers. It can also be used for many other business types if the business owner wants to track the status of the job on monthly/weekly basis. The main purpose of Percentage of Completion is to recognize the revenue when the expense is incurred. This is required by the matching principle of accounting. To account for the job properly, business owners need to earn the revenue as the job is in progress. The formula to Percentage of Completion is Job Cost divided by Cost at Job Completion or Budgeted Cost.
There are many things that go into the Job Cost. It is every important to make sure that you include only the cost that is related to the job. In simple terms, job cost is the cost charged to a job, work order, etc. The cost may be direct or an allocated cost. Job cost is recognized when it is incurred. Here are the common types of expense that factor into the job cost: direct labor, direct material, equipment rental, general conditions, vehicle cost, allocation of indirect overhead, estimating warrant expenses. The three main costs that most jobs have, regardless of industry, are Material, Labor, and Equipment costs. Material cost is when the material is received. Labor is when the actual work is done. Equipment is when the equipment was acutely used.
The Percentage of Completion allows a business owner to look at the job and decided whether they are going to hit the budget or not. This report is very crucial to many business owners when it comes to making decisions. Since all the factors that go into the job cost are controllable, this report will help the business owner to work with the foreman that is on the job, to make better decisions and to make sure they are not going to go over budget. For example:
Contract amount: $10,000
Budgeted Cost: $5,000
Job cost to date: $4,000
Percentage of Completion: 80%
Based on this scenario the Percentage of Completion is 80%, but if the business owner or the job foreman believes that they are only 60% completed, this means that they will go over the budget if they continue on this path.
Once the Percentage of Completion is calculated, you can now calculate the earned revenue.
Earned Revenue is used to make sure the business is using the matching principle of accounting, which recognizes revenue when the expenses have been incurred. To Calculate Earned Revenue, business owner would need the contract amount. Once the Percentage of Completion amount has been calculated, we would need to multiply it by the contract amount to see how much revenue we should recognize on our profit and loss statement. For example:
Contract amount: $10,000
Budgeted Cost: $5,000
Job cost to date: $3,000
Percentage of Completion: 60% (3,000/5,000)
Earned Revenue: 6,000 (60% X 10,000)
Earned Revenue totaled up to $6,000 based on a 60% Percentage of Completion and $10,000 contract amount.
Percentage of Completion vs. Completed Contracts:
The difference between the Percentage of Completion and Completed Contracts is that Percentage of Completion recognizes revenue based on how much cost has been incurred. Completed Contracts only recognized revenue when the job is actually completed. Completed jobs can also follow the matching principle by deferring the expenses as an asset account until the job has been completed and invoiced.
In simple words, backlog is the signed contract value minus earned revenue. This tells the business owner how much more revenue he/she can recognize on the Profit and Loss Statement. Backlog is good for forecasting revenue, job costs, but should NEVER be used to forecast cash collections. Why? Revenue does not equal billings or cash. To forecast cash collections you need the contract summary and billing schedule. It is critical that owners understand that backlog is not the amount left to bill.
Fade (slippage) is basically the reduction in the amount of job margin (dollars not %) from your last estimate of job margin, also known as “Performance to Estimate” (PTE). Example, you bid a job, with expected cost of $100,000 and sell it for $150,000. You expect a job margin of $50,000. Later, the expected cost of the project increases to $110,000 (with no change in scope). Your PTE (fade) is -$10,000.
Work In Progress Schedules can be one of the most valuable tools that a business owner can use to control his/her business on a weekly/monthly basis. These blogs outlined the most essential key points you need to know about these schedules. Understanding these items makes the Work In Progress Schedule a lot easier to create, read, and understand. TGG builds and maintains these items on a weekly and monthly basis for our clients. We can help you implement these tools into your business.Written by: Adriat Markos TGG Accounting