6 ACCOUNTING HAS A MEASURE! Forecast company’s future cash needsBid on gov’t contractQualify for bondingApproval for a loanLimit tax liabilityRecognize achievem’t of managersCash budgetPro-forma statementsFinancial statementsIncome tax returnPerformance reports, balanced scorecard
7 ACCOUNTING’S TIME FRAME HistoricalReports forExternalUsersForecastsAnd Plans forInternal UsersNOW
9 PERSPECTIVES ON CONSTRUCTION JOBWIN CONTRACT CONTROL: FINISH(USAGE, COSTS, (PAYMENT)SUBCONTRACTORS,SAFETY, RISKS)COMPANYCO-ORDINATION:BIDDING,PURCHASING,TRAINING,SCHEDULINGFINANCIAL REPORTS:FOR BORROWING,TAX SAVING, INSURING,BONDING, TAX PAYING
10 ACCOUNTING IS BUILT ON BUSINESS TRANSACTIONS Owners contribute capital to their companyWorkers wages are paidEquipment and supplies are purchased for cashEquipment and supplies are purchased on creditElectric, telephone, water bills are paidAdvertising is paid forSubcontractors complete and bill for their workContract work is completedContractor bills for work completedContractor receives payment for work done
11 TRANSACTIONS AFFECT CONTRACTOR ACCOUNTS 100: Assets200: Liabilities300: Contractor Equity (net worth)400: Contract and Fee Revenue500: Direct Costs of Construction600: Indirect Costs of Construction700: Operating Expenses800: Financing Expenses900: Income Taxes and Other Expenses
12 SETTING UP INDIVIDUAL ACCOUNTS Class “100”: All assetsClass “150”: All fixed assetsClass “155”: All company vehiclesClass “155.3”: Earth movers
13 ACCOUNTING RECORDS / REPORTS Records are the raw materials of accountsSpecific itemsBasic dataItems are limited on a record (7-8 or less)Examples:Time cardsMaterials receiptsEquipm’t maintenanceReports are well- organized sets of information for a period of timeReports are a summary of accountsExamples:Costs for the weekBalance sheetCash flow budget
14 JOB TIME PERIOD RECORD DATE UNITS CODE ITEM COST/UNIT TOTAL EXAMPLE OF RECORDJOB TIME PERIODRECORDDATEUNITSCODEITEMCOST/UNITTOTAL
15 WHAT ITEMS SHOULD GO INTO THESE RECORDS? Equipment ControlPurchase OrderPersonal Time Card
16 EQUIPMENT RECORDS EQUIPMENT USAGE JOB RECORD EQUIPMENT RECORD PLANJOBRECORDACQUISITIONEQUIPMENTRECORD(IDENTIFICATION)EQUIPMENTUSAGEDEPRECIATION FOREXTERNAL REPORTING
17 RECORDS AND REPORTS RECORDS REPORTS COST AND INPUT DATA MANAGEMENT DECISIONMAKINGRECORDSREPORTSEXTERNALANALYSIS
18 MODULE 2 ACCOUNTING METHODS INCOME RECOGNITION IN CONSTRUCTION CONSTRUCTION ACCOUNTINGMODULE 2ACCOUNTING METHODSINCOME RECOGNITIONIN CONSTRUCTION
19 ACCOUNTING RECORDS AND THE BUSINESS CYCLE BANKACCOUNTESTIMATESFOR JOBSRECORDSFOR JOBSCHART OFACCOUNTSCHECKPAYMENTSCASHCOLLECTIONEQUIPM’TRECORDCREDITSALESCREDITCOLLECTIONSCASH ONHANDPERCENTAGE OFCOMPLETIONADJUSTMENTS(1)Ready towork(2)Doing thejob(3)Completingthe jobFINANCIALSTATEMENTS(4) Later events
20 HOW FINANCIAL INFORMATION IS REPORTED TO OTHERS TRANSACTIONSJOURNALSINCOMESTATEMENTLEDGERSBALANCESHEETCASH FLOWSTATEMENTHOW FINANCIAL INFORMATION IS REPORTED TO OTHERS
21 THE ACCOUNTING THAT CONSTRUCTION MANAGERS CARE ABOUT They’re calling again!Is there a check inside?
22 Contractors have their building projects (3 houses completed) 20042005and Accountants have their time periods1.75 houses completed in 20041.25 houses completed in 2005
23 CASH FLOW IS NOT NET INCOME! Work is done and we bill customers.-Lots of income to report, but how much cash?-Liberal credit: slower collection of cashWe borrow money and use our credit line.- Lots of cash inflow, but how much income?- Later: interest expense and cash outflowWe pay for insurance and rent in advance.- Cash payments now, expenses reported laterWe record depreciation on our equipment.- Report of expenses, but no effect on cashWe save money by failing to replace equipment on time.- Future breakdowns and inefficiency, cash outflowWe save costs by finishing a project ahead of schedule.- Possible overtime costs, contract incentives
24 REVENUE RECOGNITIONWhen the goods are delivered, the services provided or the contract finished.When a percentage of the project costs is incurred (for a partially completed project).Not when the cash is received!Not just when the project is fully completed.
25 COMPLETED-CONTRACT METHOD Used mostly by subcontractorsFor small and quick jobsRecognize revenue, costs and incomewhen the job is completed.PERCENTAGE-OF-COMPLETION METHODUsed mostly by general contractorsFor jobs that last for 2+ reporting periodsRecognize some revenue, cost and incomeat each billing date andat the end of each year or quarterRecognize revenue gradually as work phasesare finished or as project costs are incurred.
26 EXAMPLE OF PERCENTAGE-OF-COMPLETION Contract price: $1,000,000Estimated cost of project: $800,000Assumed a fixed price contract.Plan:Year One: Cost $400,000, Revenue $500,000Year Two: Cost $400,000, Revenue $500,000What really happened:Year One: Cost $450,000, Revenue = ?Year Two: Cost $400,000, Revenue = ?If more work was really done, then calculatepercentage as (450,000/850,000) = 52.9%.Revenue in Year One will be $529,000.
27 KEY ACCOUNTING EVENTS At what point do we Recognize revenue and costs Work is doneBill the customer (pay req)Collect cashAt what point do weRecognize revenueand costsRecognize profit
28 YEAR-END ADJUSTMENTS FOR UNFINISHED WORK ASSET ACCOUNTS:Contract Receivable (when work is billed)Retainage (when work is billed and funds retained)Cost in Excess of Billings (any unbilled work)LIABILITY ACCOUNTS:* Billings in Excess of Cost (any overbilled work)Example: Contractor submits invoice of $100,000 for payment on projectthat has a 10% retainage provision. Because of front-loading, thecontractor overbilled $15,000 for work not yet finished.Accounting: Contract Receivable $90,000 and Retainage $10,000Contract Revenue for $85,000 and Billings in Excess ofCost $15,000.
29 CONSTRUCTION ACCOUNTING MODULE 3BALANCE SHEET TOPICS
30 BALANCE SHEET POINTS It shows a specific date (December 31, 2004) Different accounts are measured in different ways (look atcash compared with inventory and equipment)Assets are resources available for future businessLiabilities show how much others are financing usEquity shows how much the contractor finances itselfAssets - Liabilities must = EquityAccounts are ordered by their liquidity (how quickly canthe account be converted to cash)Assets and liabilities are separated into current (to beconverted in one year) and non-currentThe balance sheet can be converted into a common-sizeformat (see next slide)
31 ANY OLD CONTRACTOR BALANCE SHEET DECEMBER 31, 2004 (with common size conversions) Current Assets: dollars %Cash $Accts ReceivableConstr’n in Process$Fixed Assets:Buildings $Equipment$Total Assets $==== ===Current Liabilities: $ %Accts Payable $Long-Term Debt$$Equity:Capital Stock $Retained EarnTotal Liab+Eq.$==== ====
32 COMMON-SIZE BALANCE SHEET (Conversion of Figure 25-1 into common size)February 28, X2 and X1X2 X1Current liabilities:Accounts payablePayroll taxes payableCurrent note payableTotalLong-term liabilities:Long-term noteNet worth:Retained earningsCurrent net incomeTotalTotal liab. & net worth==== ====X X1Current assets:CashAccts. ReceivableReserve for bad debts (1.5) (0.6)InventoryTotal current assetsFixed assets:Equip. & machineryAccum. Depreciation (15.4) (1.1)Net fixed assetsTotal assets==== ====
33 BALANCE SHEET Assets (100) Current assets: Cash Receivables billed Date of Balance SheetAssets (100)Current assets:CashReceivables billedRetainageCost in excess of billingsConstruction in processPrepaid expensesLong-lived assets:LandBuildingsEquipmentLess Accum. DepreciationLong-term investmentsDepositsLiabilities (200)Current liabilities:Accounts payableAccrued wages, interest, taxesCurrent maturities on LTDBillings in excess of costLong-term liabilitiesLong term debt (e.g. mortgage)Deferred income taxShareholder loanOwners’ equity / Net worth (300)Capital stockAdditional paid-in capitalRetained earnings
34 TRIAL BALANCE (Date) ACCOUNTS DEBIT CREDIT Current assets Long-lived assetsAccumulated depreciationOther assetsCurrent liabilitiesLong-term debtOwners’ equityRetained earningsFee and contract revenuesDirect costs of constructionOperating expensesProvision for income taxTOTALS
35 TYPES OF CURRENT ASSETS CASHSECURITYINVESTMENTSACCOUNTSRECEIVABLE
36 BUSINESS DECISIONS Purchase or rent our equipment? (Purchase = Asset and Liability, Rent = Expense only)“Keep off the balance sheet at any cost!” Then rent it,or form another company to hold the equipment.2. Make an investment in real estate assets?(Again, there will be an asset and a liability, and somefinancial ratios will suffer)Should the contractor’s property be owned by thecontractor itself? By the shareholders? By another company?(Someone still has a debt! Will the contractor look better?)If shareholders pay some of the contractor’s bills, shouldthey do this as a loan to the company or as a contribution?(Making a loan may save some taxes, but it will not impressa bank unless the loan is converted into equity. Anyway,the bank will force the shareholder loan to be subordinated.
37 BALANCE SHEET RATIOS Current ratio: Leverage ratio: (Ability to meet obligations)Current Assets / Current Liabilities(example: $180,000 / $60,000 = 3.00)Leverage ratio:(How much does the contractor borrow?)Total Liabilities / Total Equity(example: $160,000 / $100,000 = 1.60)
38 INCOME STATEMENT TOPICS CONSTRUCTION ACCOUNTINGMODULE 4INCOME STATEMENT TOPICS
39 INCOME STATEMENT POINTS Stated for a period of time (3 months, 1 year)Recognizes the revenue and related costs for work thathas been completedShows a series of “bottom line” company performance(gross profit, operating profit, net profit)Net income becomes part of the company’s retainedearnings (it belongs to the company’s owners)Net income is not cash flow (invoices are paid later)The “income tax provision” is not the tax that is paidThis statement can be prepared at any level of activity(project, region, contractor as a whole)Some results are subject to judgment calls (how muchwork was done, how big will our losses be)Will the owners pay themselves via salaries (expenses)or via distributions (taxed twice)?
40 INCOME (EARNINGS) STATEMENT For year/quarter ended (date)Gross revenue (sales, fees)Less Returns & allowances= Net salesLess Direct costs of construction= Gross profitLess Operating expenses (administrative, selling)= Operating profitLess Interest and other non-operating expenses= Profit before income taxesLess Income tax provision (not the actual tax payment)= Net profit / Net earningsSee how many kinds of profit we have to study!
41 Net profit after taxes $ 125 2.4 ANY OLD CONTRACTOR INCOME STATEMENT FOR YEAR ENDED DEC 31, 2004 (with common-size conversions)dollars %Contract revenue $5,Cost of construction 4,Gross profit $1,Operating expensesOperating profit $Income tax provisionNet profit after taxes $
43 CASH (PROFIT) PLANNING Experience can be a useful predictor. But--* The demand for new buildings may rise or fall.* Interest rates may rise or fall.* Approvals of new construction may be delayed or frozen.Estimate the timing of cash flows on company’s projects.* What is the desired minimum balance?* What are the routine inflows and outflows?* Are there any special events affecting cash flow?Estimate the profitability of company’s projects.* More profitable: higher cash inflow.* Review both the amount and per cent of profit.
44 HOW PROFITABLE ARE OUR JOBS? Not all jobs are equally profitable.- high end: commercial, pricey condos, homes- low end: government, low income apartmentsMake sure we know how our costs and expenses arise:- Direct costs: related to the building process- Selling & Operational expenses: support activities- Which support activities are done on which jobs?Example: half our contract work is in commercial buildings,half in apartments. Are our selling expenses split 50:50between these two kinds of jobs? What about staff timeat headquarters?
45 DO “FIXED COSTS” STAY FIXED? Next Year Right NowSky boxEnd zone seatsFlyGulfstreamFly coach
46 THE COST AND PROFIT OF DOWNSIZING One thing for sure: company revenues will fall.What about costs and expenses?- Building costs will also fall.- Operating expenses? Office salaries, maybe.Office rent and property tax, maybe not.So: don’t expect to improve profit margin by downsizing!HOW TO ASSIGN OPERATING EXPENSESTO THE COMPANY’S LINES OF BUSINESS:It’s better not to do it at all. “But we put them in our bids!”Look at the revenue each line generates? “Want enemies?”Study the way each line affects our operating expenses?- Some office staff may be dedicated to one work area.- Some expenses are based on number of workers on jobs.- We’ll discuss other approaches later in the course.
47 INCOME STATEMENT RATIOS Receivables turnover:(How quickly do we collect from customers?)Total Invoices / Receivables Balance(example: $5,200,000 / $85,000 = 61.2)(Note: This contractor collects about every 6 days)Return on total assets:(Rate of return for the amount of money invested)Net Profit after Taxes / Total Assets(example: $25,000 / $260,000 = or 9.6%)(Note: This is a high rate of return for a contractor.Usually it is in the 3-5% range.)
48 MORE INCOME STATEMENT RATIOS Operating expenses to sales:(Is our front office out of control?)Total Operating Expenses / Total Contractor Revenue(example: $50,000 / $500,000 = 0.10 or 10%)(Note: This is at the high end. Contractors should stay below 10%.)Gross margin on contract work:(Rate of return on work finished)Gross Profit / Total Contractor Revenue(example: $60,000 / $500,000 = 0.12 or 12%)(Note: This is a desirable rate of return for a contractor.The largest contractors have gross margins around 10%.)
49 OTHER IMPORTANT RATIOS Quick (Acid-test) ratio:(Ability to pay obligations due very soon)Current Assets minus Inventory / Current Liabilities(example: $130 / $60 = 2.17)(Note: This is a very strong result. Usually it is closer to 1.00.And the acid-test working capital is equal to $70.)Investment in fixed assets:(Amount invested by the contractor itself)Buildings and Equipment / Total Equity(example: $80,000 / $100,000 = 0.8)(Note: The higher the result, the better for the contractor)
50 * * * * CAN YOU SPOT A TREND? OPERATING EXPENSES TO TOTAL SALES 25.0 20.015.0*10.0Dec ‘04Jan ‘05Feb ‘05Mar ‘05CAN YOU SPOT A TREND?
51 AGING OF RECEIVABLES TYPICAL TERMS: NET IN 15 DAYS (OR 30 / 60) $25,000.00$ 30,000.00$ 75,000.00$130,000.00TOTALS10,000.0020,000.005,000.0035,000.00DUNECRISP$ 5,000.0025,000.00BELTOWER$ 10,000.00$ 40,000.00$50,000.00ACROBAT31-60 PAST1-30 PASTCURRENTTOTALCUSTOMERPERCENT19.23%23.08%57.69%100.0%TYPICAL TERMS: NET IN 15 DAYS (OR 30 / 60)DISCOUNT TERMS: 1% OR 2% IN 10 DAYSEXAMPLE: INVOICE FOR $10,000.00TERMS: 1% IN 10 DAYS, NET IN 30 DAYSBILLED ON JAN. 18, PAID ON JAN. 27HOW MUCH WILL WE RECEIVE ON JAN. 27?
52 AVERAGE DAYS IN ACCOUNTS RECEIVABLE DEC 31, 2000BALANCESHEETACCOUNTS RECEIVABLEENDING BALANCETOTAL SALES IN PERIODINCOMESTATEMENT*NO. OF DAYS IN PERIOD(90 for quarter, 365 for year)TIME PERIOD
53 MOVING AVERAGE ANALYSIS OF AVERAGE DAYS RECEIVABLES YEARMONTHENDING A/RSALESMOV. AV.2000OCTOBER$35,000$60,000NOVEMBER40,00070,000DECEMBER30,00075,0002001JANUARY50,00060,000FEBRUARY45,00065,000MARCHALWAYS USE THE MOST RECENT TIME PERIOD(Example: for a 90-day average ending in January 2001,take the results for November 2000 to January 2001)
54 INCOMPLETE EVENTS EVENT TEMPORARY ACCOUNT No collection on a sale Billed receivables (asset)Advance deposits for a Prepaid expenses (deferrals)serviceAdvance from customer Deferred revenue (liability)Unused supplies Supplies inventory / expenseInterest owed but not due Accrued interest (liability)Wages owed but not due Accrued wagesProperty taxes owed Accrued property taxesbut not duePrepaid property taxes Prepaid taxes (deferred asset)Future bad debts Bad debt reserve / allowance(offset to Accounts receivable)
55 CONSTRUCTION ACCOUNTING MODULE 5CASH FLOW TOPICS
56 HOW CASH FLOW WORKS ADVANCES CAPITAL SALES FEES LOANS PAYROLL SUPPLIERSUTILITIESTAXESLOAN INTERESTEQUIPMENTSHORT-TERM INVESTING(MINIMUM CASH BALANCE
58 CASH FLOW CYCLE START CASH COLLECT CASH BUY MATERIALS BILLINGS Checking accountMoney marketCurrencySTARTCASHCOLLECT CASHBUY MATERIALSHow long to completethe cycle?What can we do toshorten the cycle?BILLINGS(ACCOUNTSRECEIVABLEPAY LABORPAY OTHERCOSTSWORK INPROGRESS
59 CASH BUDGETING AND MANAGEMENT BUSINESS PLANDESIRED CASH BALANCECASH MOVEMENT(CONTROLS)CASH BUDGETNEEDCASH?YESCREDIT LINEN OOPERATIONS
60 CASH FLOW BUDGETING OPERATING PLAN COMPARE PLAN DESIRED CASH INFLOWS CASH BALANCECASH INFLOWSAND OUTFLOWSNEEDCASH?NOYESCREDIT LINE
62 A SENSIBLE CASH PLAN * Assumes normal operating cycles, not best cases (receipts may be delayed, payments cannot be).* Takes advantage of opportunities to save cash(special purchases, finishing ahead of schedule).* Accounts for seasonal changes (weather, demand).* Measures the likelihood of collection from customers.* Remains alert to deadlines and adaptable to delays.* Builds in smooth routines for making payments andfor drawing on line of credit.* Tries to prevent unpleasant surprises!
63 CASH FLOW FOR CONTRACTORS: MAINLY FROM PROJECTS GI9C61B2FAH584DELETTER = phaseNUMERAL = weeks27
66 PERCENTAGE CONTRACTORS, INC. STATEMENT OF CASH FLOWS Dec 31, 20x4Cash flow from operating activities:Net income $626,600Adjusted for Depreciation Expense ,800Change in Contract Receivables (461,400)Change in Inventory Balances ,400Change in Accounts Payable (45,400)Net cash provided by operating activities $297,000Cash flow from investing activities:Acquisition of equipment $(140,000)Cash flow from financing activities:Payments on capital equipment leases $ (85,000)Proceeds of a bank loan ,000Net cash provided by financing activities $ 15,000Net increase in cash during 20x4 $172,000Beginning cash balance, Jan 1, 20x ,000Cash balance, Dec. 31, 20x4 $282,000