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BCN 3753 CONSTRUCTION ACCOUNTING

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1 BCN 3753 CONSTRUCTION ACCOUNTING
Saturday mornings, 11:20 am – 2:00 pm Instructor: Paul J. Schlachter Ph. D., C.M.A. Credit Manager Florida Export Finance Corp.

2 CONSTRUCTION ACCOUNTING
MODULE 1 ACCOUNTING SYSTEMS AND RECORDS

3 OUR ORGANIZATION GROWTH REPUTATION PROFITS INFLUENCE
GOALS OF OUTSIDE PARTIES: RETURN ON INVESTMENT REPAYMENT OF LOANS MEANS: STANDARD REPORTS ACCEPTED PRINCIPLES REGULATIONS CONTRACTOR’S GOALS: GROWTH REPUTATION PROFITS INFLUENCE MEANS: STRATEGY TECHNIQUES PERFORMANCE MEASURES

4 FUNCTIONS IN AN ORGANIZATION
PLANNING STAFFING KNOW-HOW PRODUCTS SERVICES CONTROL DELIVERY MARKETING ACCOUNTING

5 ORGANIZATIONAL TOOL Long-range projects (capital investment)
Everyday operations Company resources (physical, human, financial) PLANNING CO-ORDINATION CONTROL TRACKING REPORTING (before) (during) (after)

6 ACCOUNTING HAS A MEASURE!
Forecast company’s future cash needs Bid on gov’t contract Qualify for bonding Approval for a loan Limit tax liability Recognize achievem’t of managers Cash budget Pro-forma statements Financial statements Income tax return Performance reports, balanced scorecard

7 ACCOUNTING’S TIME FRAME
Historical Reports for External Users Forecasts And Plans for Internal Users NOW

8 SIFTING, FILTERING, ANALYZING
Sales Building costs Company Data Profitability Productivity

9 PERSPECTIVES ON CONSTRUCTION
JOB WIN CONTRACT CONTROL: FINISH (USAGE, COSTS, (PAYMENT) SUBCONTRACTORS, SAFETY, RISKS) COMPANY CO-ORDINATION: BIDDING, PURCHASING, TRAINING, SCHEDULING FINANCIAL REPORTS: FOR BORROWING, TAX SAVING, INSURING, BONDING, TAX PAYING

10 ACCOUNTING IS BUILT ON BUSINESS TRANSACTIONS
Owners contribute capital to their company Workers wages are paid Equipment and supplies are purchased for cash Equipment and supplies are purchased on credit Electric, telephone, water bills are paid Advertising is paid for Subcontractors complete and bill for their work Contract work is completed Contractor bills for work completed Contractor receives payment for work done

11 TRANSACTIONS AFFECT CONTRACTOR ACCOUNTS
100: Assets 200: Liabilities 300: Contractor Equity (net worth) 400: Contract and Fee Revenue 500: Direct Costs of Construction 600: Indirect Costs of Construction 700: Operating Expenses 800: Financing Expenses 900: Income Taxes and Other Expenses

12 SETTING UP INDIVIDUAL ACCOUNTS
Class “100”: All assets Class “150”: All fixed assets Class “155”: All company vehicles Class “155.3”: Earth movers

13 ACCOUNTING RECORDS / REPORTS
Records are the raw materials of accounts Specific items Basic data Items are limited on a record (7-8 or less) Examples: Time cards Materials receipts Equipm’t maintenance Reports are well- organized sets of information for a period of time Reports are a summary of accounts Examples: Costs for the week Balance sheet Cash flow budget

14 JOB TIME PERIOD RECORD DATE UNITS CODE ITEM COST/UNIT TOTAL
EXAMPLE OF RECORD JOB TIME PERIOD RECORD DATE UNITS CODE ITEM COST/UNIT TOTAL

15 WHAT ITEMS SHOULD GO INTO THESE RECORDS?
Equipment Control Purchase Order Personal Time Card

16 EQUIPMENT RECORDS EQUIPMENT USAGE JOB RECORD EQUIPMENT RECORD
PLAN JOB RECORD ACQUISITION EQUIPMENT RECORD (IDENTIFICATION) EQUIPMENT USAGE DEPRECIATION FOR EXTERNAL REPORTING

17 RECORDS AND REPORTS RECORDS REPORTS COST AND INPUT DATA MANAGEMENT
DECISION MAKING RECORDS REPORTS EXTERNAL ANALYSIS

18 MODULE 2 ACCOUNTING METHODS INCOME RECOGNITION IN CONSTRUCTION
CONSTRUCTION ACCOUNTING MODULE 2 ACCOUNTING METHODS INCOME RECOGNITION IN CONSTRUCTION

19 ACCOUNTING RECORDS AND THE BUSINESS CYCLE
BANK ACCOUNT ESTIMATES FOR JOBS RECORDS FOR JOBS CHART OF ACCOUNTS CHECK PAYMENTS CASH COLLECTION EQUIPM’T RECORD CREDIT SALES CREDIT COLLECTIONS CASH ON HAND PERCENTAGE OF COMPLETION ADJUSTMENTS (1) Ready to work (2) Doing the job (3) Completing the job FINANCIAL STATEMENTS (4) Later events

20 HOW FINANCIAL INFORMATION IS REPORTED TO OTHERS
TRANSACTIONS JOURNALS INCOME STATEMENT LEDGERS BALANCE SHEET CASH FLOW STATEMENT HOW 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)
2004 2005 and Accountants have their time periods 1.75 houses completed in 2004 1.25 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 cash We borrow money and use our credit line. - Lots of cash inflow, but how much income? - Later: interest expense and cash outflow We pay for insurance and rent in advance. - Cash payments now, expenses reported later We record depreciation on our equipment. - Report of expenses, but no effect on cash We save money by failing to replace equipment on time. - Future breakdowns and inefficiency, cash outflow We save costs by finishing a project ahead of schedule. - Possible overtime costs, contract incentives

24 REVENUE RECOGNITION When 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 subcontractors For small and quick jobs Recognize revenue, costs and income when the job is completed . PERCENTAGE-OF-COMPLETION METHOD Used mostly by general contractors For jobs that last for 2+ reporting periods Recognize some revenue, cost and income at each billing date and at the end of each year or quarter Recognize revenue gradually as work phases are finished or as project costs are incurred.

26 EXAMPLE OF PERCENTAGE-OF-COMPLETION
Contract price: $1,000,000 Estimated cost of project: $800,000 Assumed a fixed price contract. Plan: Year One: Cost $400,000, Revenue $500,000 Year Two: Cost $400,000, Revenue $500,000 What really happened: Year One: Cost $450,000, Revenue = ? Year Two: Cost $400,000, Revenue = ? If more work was really done, then calculate percentage 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 done Bill the customer (pay req) Collect cash At what point do we Recognize revenue and costs Recognize 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 project that has a 10% retainage provision. Because of front-loading, the contractor overbilled $15,000 for work not yet finished. Accounting: Contract Receivable $90,000 and Retainage $10,000 Contract Revenue for $85,000 and Billings in Excess of Cost $15,000.

29 CONSTRUCTION ACCOUNTING
MODULE 3 BALANCE SHEET TOPICS

30 BALANCE SHEET POINTS It shows a specific date (December 31, 2004)
Different accounts are measured in different ways (look at cash compared with inventory and equipment) Assets are resources available for future business Liabilities show how much others are financing us Equity shows how much the contractor finances itself Assets - Liabilities must = Equity Accounts are ordered by their liquidity (how quickly can the account be converted to cash) Assets and liabilities are separated into current (to be converted in one year) and non-current The balance sheet can be converted into a common-size format (see next slide)

31 ANY OLD CONTRACTOR BALANCE SHEET DECEMBER 31, 2004 (with common size conversions)
Current Assets: dollars % Cash $ Accts Receivable Constr’n in Process $ Fixed Assets: Buildings $ Equipment $ Total Assets $ ==== === Current Liabilities: $ % Accts Payable $ Long-Term Debt $ $ Equity: Capital Stock $ Retained Earn Total Liab+Eq.$ ==== ====

32 COMMON-SIZE BALANCE SHEET
(Conversion of Figure 25-1 into common size) February 28, X2 and X1 X2 X1 Current liabilities: Accounts payable Payroll taxes payable Current note payable Total Long-term liabilities: Long-term note Net worth: Retained earnings Current net income Total Total liab. & net worth ==== ==== X X1 Current assets: Cash Accts. Receivable Reserve for bad debts (1.5) (0.6) Inventory Total current assets Fixed assets: Equip. & machinery Accum. Depreciation (15.4) (1.1) Net fixed assets Total assets ==== ====

33 BALANCE SHEET Assets (100) Current assets: Cash Receivables billed
Date of Balance Sheet Assets (100) Current assets: Cash Receivables billed Retainage Cost in excess of billings Construction in process Prepaid expenses Long-lived assets: Land Buildings Equipment Less Accum. Depreciation Long-term investments Deposits Liabilities (200) Current liabilities: Accounts payable Accrued wages, interest, taxes Current maturities on LTD Billings in excess of cost Long-term liabilities Long term debt (e.g. mortgage) Deferred income tax Shareholder loan Owners’ equity / Net worth (300) Capital stock Additional paid-in capital Retained earnings

34 TRIAL BALANCE (Date) ACCOUNTS DEBIT CREDIT Current assets
Long-lived assets Accumulated depreciation Other assets Current liabilities Long-term debt Owners’ equity Retained earnings Fee and contract revenues Direct costs of construction Operating expenses Provision for income tax TOTALS

35 TYPES OF CURRENT ASSETS
CASH SECURITY INVESTMENTS ACCOUNTS RECEIVABLE

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 some financial ratios will suffer) Should the contractor’s property be owned by the contractor 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, should they do this as a loan to the company or as a contribution? (Making a loan may save some taxes, but it will not impress a 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 ACCOUNTING MODULE 4 INCOME STATEMENT TOPICS

39 INCOME STATEMENT POINTS
Stated for a period of time (3 months, 1 year) Recognizes the revenue and related costs for work that has been completed Shows a series of “bottom line” company performance (gross profit, operating profit, net profit) Net income becomes part of the company’s retained earnings (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 paid This statement can be prepared at any level of activity (project, region, contractor as a whole) Some results are subject to judgment calls (how much work 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 sales Less Direct costs of construction = Gross profit Less Operating expenses (administrative, selling) = Operating profit Less Interest and other non-operating expenses = Profit before income taxes Less Income tax provision (not the actual tax payment) = Net profit / Net earnings See 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 expenses Operating profit $ Income tax provision Net profit after taxes $

42 CALCULATING PROFITABILITY
THIS YEAR COMMON SIZE % FORE- CAST GROSS SALES $ 1,000,000 100.0 $2,000,000 100 - DIRECT COSTS 90.0 1,600,000 80 = GROSS PROFIT $ 100,000 10.0 $400,000 20 - SELLING EXPENSES 15,000 1.5 40000 2 = SELLING PROFIT $ ,000 8.5 $360,000 18 ADMINISTRATIVE EXPENSES 60,000 6.0 200000 10 = NET PROFIT $ ,000 2.5 $160,000 8

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 apartments Make 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 50:50 between these two kinds of jobs? What about staff time at headquarters?

45 DO “FIXED COSTS” STAY FIXED?
Next Year Right Now Sky box End zone seats Fly Gulfstream Fly 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 EXPENSES TO 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
20.0 15.0 * 10.0 Dec ‘04 Jan ‘05 Feb ‘05 Mar ‘05 CAN 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 $130,000.00 TOTALS 10,000.00 20,000.00 5,000.00 35,000.00 DUNE CRISP $ 5,000.00 25,000.00 BELTOWER $ 10,000.00 $ 40,000.00 $50,000.00 ACROBAT 31-60 PAST 1-30 PAST CURRENT TOTAL CUSTOMER PERCENT 19.23% 23.08% 57.69% 100.0% TYPICAL TERMS: NET IN 15 DAYS (OR 30 / 60) DISCOUNT TERMS: 1% OR 2% IN 10 DAYS EXAMPLE: INVOICE FOR $10,000.00 TERMS: 1% IN 10 DAYS, NET IN 30 DAYS BILLED ON JAN. 18, PAID ON JAN. 27 HOW MUCH WILL WE RECEIVE ON JAN. 27?

52 AVERAGE DAYS IN ACCOUNTS RECEIVABLE
DEC 31, 2000 BALANCE SHEET ACCOUNTS RECEIVABLE ENDING BALANCE TOTAL SALES IN PERIOD INCOME STATEMENT * NO. OF DAYS IN PERIOD (90 for quarter, 365 for year) TIME PERIOD

53 MOVING AVERAGE ANALYSIS OF AVERAGE DAYS RECEIVABLES
YEAR MONTH ENDING A/R SALES MOV. AV. 2000 OCTOBER $35,000 $60,000 NOVEMBER 40,000 70,000 DECEMBER 30,000 75,000 2001 JANUARY 50,000 60,000 FEBRUARY 45,000 65,000 MARCH ALWAYS 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) service Advance from customer Deferred revenue (liability) Unused supplies Supplies inventory / expense Interest owed but not due Accrued interest (liability) Wages owed but not due Accrued wages Property taxes owed Accrued property taxes but not due Prepaid property taxes Prepaid taxes (deferred asset) Future bad debts Bad debt reserve / allowance (offset to Accounts receivable)

55 CONSTRUCTION ACCOUNTING
MODULE 5 CASH FLOW TOPICS

56 HOW CASH FLOW WORKS ADVANCES CAPITAL SALES FEES LOANS PAYROLL
SUPPLIERS UTILITIES TAXES LOAN INTEREST EQUIPMENT SHORT-TERM INVESTING (MINIMUM CASH BALANCE

57 CASH FLOW --- OPERATIONAL CYCLE
ORDER MATERIALS PROJECT IN PROCESS PAY: SUPPLIERS WORKERS OTHERS Inventory Accounts Payable WORK FINISHED Contracts Receivable Retainage COLLECT CASH FOR WORK BILLED

58 CASH FLOW CYCLE START CASH COLLECT CASH BUY MATERIALS BILLINGS
Checking account Money market Currency START CASH COLLECT CASH BUY MATERIALS How long to complete the cycle? What can we do to shorten the cycle? BILLINGS (ACCOUNTS RECEIVABLE PAY LABOR PAY OTHER COSTS WORK IN PROGRESS

59 CASH BUDGETING AND MANAGEMENT
BUSINESS PLAN DESIRED CASH BALANCE CASH MOVEMENT (CONTROLS) CASH BUDGET NEED CASH? YES CREDIT LINE N O OPERATIONS

60 CASH FLOW BUDGETING OPERATING PLAN COMPARE PLAN DESIRED CASH INFLOWS
CASH BALANCE CASH INFLOWS AND OUTFLOWS NEED CASH? NO YES CREDIT LINE

61 CASH ACCOUNTS - INTERRELATIONSHIPS
CHECK PAYMENTS (or wire transfers) LEDGER OF ACCOUNTS CHECK REGISTER BANK STATEMENTS EXTERNAL FINANCIAL STATEMENTS

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 and for drawing on line of credit. * Tries to prevent unpleasant surprises!

63 CASH FLOW FOR CONTRACTORS: MAINLY FROM PROJECTS
G I 9 C 6 1 B 2 F A H 5 8 4 D E LETTER = phase NUMERAL = weeks 2 7

64 CASH FLOW FOR CONTRACTORS: MAINLY FROM PROJECTS
PHASE COST per phase WEEKS WEEKS 5-8 A $80,000 $80,000 B 60, $60,000 C 90, ,000 D 50, ,000 E 70, , ,000 F 100, , ,000 G 45, H 160, I 40, Plus $2,500 / week $10,000 $10,000 Total Cost $200,000 $230,000

65 MONTHLY OPERATING CASH BUDGET
WEEK Beginning cash Add Receipts Customers Refunds Shareholders Total cash Less Disbursements Suppliers Payroll: Wages Salaries Utilities Bank fees Total disbursements = Cash available Draw (Repay) bank line Ending cash

66 PERCENTAGE CONTRACTORS, INC. STATEMENT OF CASH FLOWS
Dec 31, 20x4 Cash flow from operating activities: Net income $626,600 Adjusted for Depreciation Expense ,800 Change in Contract Receivables (461,400) Change in Inventory Balances ,400 Change in Accounts Payable (45,400) Net cash provided by operating activities $297,000 Cash 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 ,000 Net cash provided by financing activities $ 15,000 Net increase in cash during 20x4 $172,000 Beginning cash balance, Jan 1, 20x ,000 Cash balance, Dec. 31, 20x4 $282,000


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