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BCN 3753 CONSTRUCTION ACCOUNTING Instructor: Paul J. Schlachter Ph. D., C.M.A. Credit Manager Florida Export Finance Corp.

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Presentation on theme: "BCN 3753 CONSTRUCTION ACCOUNTING Instructor: Paul J. Schlachter Ph. D., C.M.A. Credit Manager Florida Export Finance Corp."— Presentation transcript:

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2 BCN 3753 CONSTRUCTION ACCOUNTING Instructor: Paul J. Schlachter Ph. D., C.M.A. Credit Manager Florida Export Finance Corp. E-mail: schlacht@fiu.eduschlacht@fiu.edu http://cba.fiu.edu/acg/schlacht Saturday mornings, 11:20 am – 2:00 pm

3 MODULE 1 CONSTRUCTION ACCOUNTING ACCOUNTING SYSTEMS AND RECORDS

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

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

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

7 ACCOUNTING HAS A MEASURE! Forecast companys future cash needs Bid on govt contract Qualify for bonding Approval for a loan Limit tax liability Recognize achievemt of managers Cash budget Pro-forma statements Financial statements Income tax return Performance reports, balanced scorecard

8 ACCOUNTINGS TIME FRAME NOW 200320042005 Historical Reports for External Users Forecasts And Plans for Internal Users

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

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

11 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

12 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

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

14 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 –Equipmt 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

15 DATEUNITSCODEITEMCOST/ UNIT TOTAL JOB TIME PERIOD RECORD EXAMPLE OF RECORD

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

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

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

19 MODULE 2 CONSTRUCTION ACCOUNTING ACCOUNTING METHODS INCOME RECOGNITION IN CONSTRUCTION

20 ACCOUNTING RECORDS AND THE BUSINESS CYCLE BANK ACCOUNT CASH ON HAND FINANCIAL STATEMENTS ESTIMATES FOR JOBS RECORDS FOR JOBS CHART OF ACCOUNTS (1) Ready to work PERCENTAGE OF COMPLETION EQUIPMT RECORD CHECK PAYMENTS CASH COLLECTION (2) Doing the job CREDIT SALES CREDIT COLLECTIONS ADJUSTMENTS (3) Completing the job (4) Later events

21 TRANSACTIONS JOURNALS LEDGERS BALANCE SHEET INCOME STATEMENT CASH FLOW STATEMENT HOW FINANCIAL INFORMATION IS REPORTED TO OTHERS

22 THE ACCOUNTING THAT CONSTRUCTION MANAGERS CARE ABOUT Theyre calling again! Is there a check inside?

23 Contractors have their building projects (3 houses completed) and Accountants have their time periods 1.75 houses completed in 2004 1.25 houses completed in 2005 20042005

24 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

25 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.

26 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 revenue gradually as work phases are finished or as project costs are incurred. Recognize some revenue, cost and income at each billing date and at the end of each year or quarter

27 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.

28 KEY ACCOUNTING EVENTS Work is done Bill the customer (pay req) Collect cash At what point do we Recognize revenue and costs Recognize profit

29 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.

30 MODULE 3 CONSTRUCTION ACCOUNTING BALANCE SHEET TOPICS

31 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)

32 ANY OLD CONTRACTOR BALANCE SHEET DECEMBER 31, 2004 (with common size conversions) Current Assets:dollars % Cash$ 4517.3 Accts Receivable 8532.7 Constrn in Process 5019.2 $180 69.2 Fixed Assets: Buildings$ 5019.2 Equipment 3011.5 $ 8030.7 Total Assets$260 100.0 ======= Current Liabilities: $ % Accts Payable$6023.1 Long-Term Debt $10038.5 $16061.6 Equity: Capital Stock$5019.2 Retained Earn. 5019.2 Total Liab+Eq.$260 100.0====

33 COMMON-SIZE BALANCE SHEET (Conversion of Figure 25-1 into common size) February 28, X2 and X1 X2 X1 Current assets: Cash 6.3 11.1 Accts. Receivable 55.4 46.5 Reserve for bad debts (1.5) (0.6) Inventory 8.2 5.9 Total current assets 68.5 62.8 Fixed assets: Equip. & machinery 46.9 38.3 Accum. Depreciation (15.4) (1.1) Net fixed assets 31.5 37.2 Total assets 100.0 100.0 ==== ==== X2X1 Current liabilities: Accounts payable 1.4 1.1 Payroll taxes payable 1.9 0 Current note payable 28.6 26.0 Total 31.9 27.1 Long-term liabilities: Long-term note 3.9 36.3 Net worth: Retained earnings 55.3 33.5 Current net income 8.9 3.1 Total 64.2 36.6 Total liab. & net worth 100.0 100.0 ==== ====

34 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 Date of Balance Sheet

35 TRIAL BALANCE (Date) ACCOUNTSDEBITCREDIT 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

36 TYPES OF CURRENT ASSETS CASH SECURITY INVESTMENTS ACCOUNTS RECEIVABLE

37 BUSINESS DECISIONS 1.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) 3.Should the contractors property be owned by the contractor itself? By the shareholders? By another company? (Someone still has a debt! Will the contractor look better?) 4.If shareholders pay some of the contractors 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.

38 BALANCE SHEET RATIOS Current 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)

39 MODULE 4 CONSTRUCTION ACCOUNTING INCOME STATEMENT TOPICS

40 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 companys retained earnings (it belongs to the companys 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)?

41 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!

42 ANY OLD CONTRACTOR INCOME STATEMENT FOR YEAR ENDED DEC 31, 2004 (with common-size conversions) dollars % Contract revenue$5,200100.0 Cost of construction 4,200 80.8 Gross profit$1,000 19.2 Operating expenses 800 15.4 Operating profit$ 200 3.8 Income tax provision 75 1.4 Net profit after taxes$ 125 2.4

43 THIS YEAR COMMON SIZE % FORE- CAST COMMON SIZE % GROSS SALES$ 1,000,000 100.0$2,000,000100 - DIRECT COSTS 900 00090.01,600,00080 = GROSS PROFIT$ 100,000 10.0$400,00020 - SELLING EXPENSES 15,000 1.5400002 = SELLING PROFIT$ 85,000 8.5$360,00018 -ADMINISTRATIVE EXPENSES 60,000 6.020000010 = NET PROFIT$ 25,000 2.5$160,0008 CALCULATING PROFITABILITY

44 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 companys 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 companys projects. * More profitable: higher cash inflow. * Review both the amount and per cent of profit.

45 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?

46 DO FIXED COSTS STAY FIXED? Next YearRight Now Sky box End zone seats Fly coach Fly Gulfstream

47 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: dont expect to improve profit margin by downsizing! HOW TO ASSIGN OPERATING EXPENSES TO THE COMPANYS LINES OF BUSINESS: 1.Its better not to do it at all. But we put them in our bids! 2.Look at the revenue each line generates? Want enemies? 3.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. - Well discuss other approaches later in the course.

48 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 = 0.096 or 9.6%) (Note: This is a high rate of return for a contractor. Usually it is in the 3-5% range.)

49 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%.)

50 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)

51 OPERATING EXPENSES TO TOTAL SALES Dec 04Jan 05Feb 05Mar 05 10.0 15.0 20.0 25.0 * * * * CAN YOU SPOT A TREND?

52 $25,000.00$ 30,000.00$ 75,000.00$130,000.00TOTALS 10,000.00 20,000.00 5,000.00 35,000.00DUNE 10,000.00 20,000.00CRISP $ 5,000.00 20,000.00 25,000.00BELTOWER $ 10,000.00$ 40,000.00$50,000.00ACROBAT 31-60 PAST1-30 PASTCURRENTTOTALCUSTOMER PERCENT19.23%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? AGING OF RECEIVABLES

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

54 YEARMONTHENDING A/RSALES 2000OCTOBER$35,000$60,000 NOVEMBER 40,000 70,000 DECEMBER 30,000 75,000 2001JANUARY50,000 60,000 FEBRUARY45,000 65,000 MARCH50,000 60,000 MOV. AV. 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) MOVING AVERAGE ANALYSIS OF AVERAGE DAYS RECEIVABLES

55 INCOMPLETE EVENTS EVENTTEMPORARY ACCOUNT No collection on a saleBilled receivables (asset) Advance deposits for aPrepaid expenses (deferrals) service Advance from customerDeferred revenue (liability) Unused suppliesSupplies inventory / expense Interest owed but not dueAccrued interest (liability) Wages owed but not dueAccrued wages Property taxes owedAccrued property taxes but not due Prepaid property taxesPrepaid taxes (deferred asset) Future bad debtsBad debt reserve / allowance (offset to Accounts receivable)

56 MODULE 5 CONSTRUCTION ACCOUNTING CASH FLOW TOPICS

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

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

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

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

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

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

63 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!

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

65 CASH FLOW FOR CONTRACTORS: MAINLY FROM PROJECTS PHASE COST per phase WEEKS 1-4 WEEKS 5-8 A$80,000$80,000 B 60,000 0$60,000 C 90,000 0 60,000 D 50,000 50,000 E 70,000 20,000 40,000 F100,000 40,000 60,000 G 45,000 0 0 H160,000 0 0 I 40,000 0 0 Plus Overhead @ $2,500 / week $10,000$10,000 Total Cost$200,000$230,000

66 MONTHLY OPERATING CASH BUDGET WEEK123 4 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

67 PERCENTAGE CONTRACTORS, INC. STATEMENT OF CASH FLOWS Dec 31, 20x4 Cash flow from operating activities: Net income$626,600 Adjusted for Depreciation Expense 167,800 Change in Contract Receivables (461,400) Change in Inventory Balances 9,400 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 100,000 Net cash provided by financing activities$ 15,000 Net increase in cash during 20x4$172,000 Beginning cash balance, Jan 1, 20x4 110,000 Cash balance, Dec. 31, 20x4$282,000


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