Any construction contractor knows the importance of the work-in-process, otherwise known as the WIP, schedule. While often times it is easy to just look at the final outputs of the WIP schedule such as the revenue and gross profit on a job, it is important to understand the inputs into these calculations on the WIP and how cost changes or efficiencies on a job ultimately impact revenue recognition.
The WIP schedule utilizes the percentage-of-completion method of accounting for long-term contracts. Long-term contracts are contracts which last longer than one year and therefore span over multiple accounting periods. Under the percentage-of-completion method, the amount of revenue recognized on a contract is measured by the relationship of costs already incurred to the total of costs already incurred and future costs expected to be incurred (ASC 606-10-65-1). The output of this calculation is a percentage that represents the percent complete of a job. This percentage is then multiplied by the contract amount to arrive at the total revenue for a job.
The calculation described in the previous paragraph presents three key drivers over revenue recognized on a contract: contract amount, costs incurred to date, and total costs estimated at contract completion. The contract amount can change as a result of change orders or amendments to the existing contract. While executing a change order will ultimately change the amount of revenue recognized on a contract over its life, it is important to remember that this revenue will not be recognized immediately but rather over the remainder of the contract term in accordance with the percent complete.
Job costs determine the percent complete; therefore, monitoring job costs as well as having a process in place for estimating future job costs remain vital. Some challenges that project managers face when estimating project costs include:
- Gathering project data from multiple stakeholders
- Financial data not stored or calculated in the same way
- Changing project scope and customer beliefs
Construction contractors should consider these factors as well as other unique factors from job-to-job when developing cost estimates. More accurate job cost estimates not only result in more precise revenue recognized over the life of a contract but also more seamless execution of the contract.