By Hyrum Davis, CPA, Manager, Assurance & Advisory
ASL Construction Group
When it comes to construction accounting, a good healthy work in progress (WIP) schedule rules the day. A WIP schedule is designed to match costs with revenue and smooth out reported gross profits, in addition to bringing financial statements in conformity with US GAAP. A healthy WIP schedule gives users important information to help them understand and analyze job performance. However, a lot of this information is based on estimates and the WIP schedule is only as good as the estimated information going into it. This begs the question, what are key indications that inputs of a WIP schedule may be incorrect? Here are some things to consider:
- Gross Profit Percent – The gross profit percentage can vary from job to job. Assessing these variances can help users determine the types of jobs that are more profitable and maximize net income. It can also help provide insight into scope changes and provide an opportunity to minimize losses by negotiating change orders into the job contracts. However, it is important to understand the inputs. Otherwise, one can be misled with bad data and draw the wrong conclusion. Significant variances could be an indication that the WIP schedule is missing key data inputs or has poor estimates. The contract amount may not be including all change orders put in place or the estimated costs were poorly assessed. Failing to include all change orders in the total contract can make it look like profitable jobs are unprofitable. Similarly, low estimated costs can lead users to believe jobs are profitable, when in reality, they are not.
- Percentage of completion – This key metric is great to track job status and see what jobs are wrapping up and what jobs are just starting, which is helpful for predicting future revenues. Regular assessment of actual costs compared to estimated costs can help Companies identify inefficiencies and look for opportunities to improve. It can also help identify poor initial inputs to the WIP schedule. When jobs become more than 100% complete, this can indicate that estimated costs were not properly assessed. It is important for this estimate to be fine-tuned. If estimated costs are too low then this can cut into margins. While on the other hand if estimated costs are assessed too high, then this can result in overbids on projects and reduce the ability to bring in new work.
Although a WIP schedule is often a challenge to prepare, a healthy schedule can help make crucial decisions for all users of the financial statements. Hopefully, the above considerations will start the thought process into making sure the WIP schedule is fed with the best inputs possible. The ASL Construction Group is happy to assist you with any questions about your WIP schedule.