Accelerating Losses

In construction accounting, we recognize revenue on what’s called the percentage of completion method on a cost-to-cost basis (there are other methods, that one’s just the most common). All that means is that we estimate the cost to finish the job, and if 37% of those costs are in, we recognize 37% of the profit on the job.

One principle of accounting under this method is that we have to recognize losses as soon as we know they are there. It’s kind of a raw deal, but such is the conservatism of generally accepted accounting practices. If, for instance on that job that’s 37% done, we discovered that we would lose $10,000, we’d have to recognize the entire $10k as loss right now, not just 37% of it.

range showing work in process calculation

On Job1, we estimate a profit, so we recognize 69% of the revenue to match the 69% of the costs that we’ve incurred. On Job2, since we estimate a loss of $15,000, we recognize only enough revenue to realize the entire loss. The percent complete formula is Actual Cost divided by Estimated Cost.

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11 thoughts on “Accelerating Losses

  1. Dick,
    Thats amazing
    You are the first accountant I know who has admited that there is a loss and somehow hasn’t magically turned it into a profit ?


  2. Sure makes the bottom line line look bad espicially when you are forecasting for the bonding agent and the bank for your line of credit.

  3. So the big question is how you establish the % complete; and how reasonable it is:

    If it’s because you expended 30% of a unit price bid item, and you’re costs are running 35% of the total expected revenue, then
    1. Maybe the overrun is simply because you haven’t amortized all of the fixed costs of performing all the unit price work, or
    2. Maybe the quantity will underrun or overrun–either way you file a claim if the varience is more than the amount fixed under the GCs

    If it’s because you’re measuring a Lump-Sum, then the question is, how are you measuring it? It’s pretty tough to gauge how much of a “Construct One Building” if all you’ve done is the expensive foundation work.

    Also, what if your item was bid as if it was on the critical path (i.e., you bid it carrying a pro-rata amount of your time-related overhead costs in addition to the directs), but now it’s not–or vice-versa.

    Long and short is PMs are always playing games with the monthly cost accounting reports.

  4. John, the percent complete is usually derived from a Schedule of Values. The General Contractor lists out (at the beginning of the job) all the sub work and the cost and relative percentage of each. For instance, concrete work may be 19%, framing carpentry may be 21%, kitchen appliances may be 3%. It is then easy to walk through, see that the concrete work is half done, the framing is 1/10 done, add all that up and get the overall percent complete. There are standard AIA forms, AGC forms and others for doing this.

  5. Wally,

    I think that the concept of a schedule of values is to use it as a payment tool, not a forecast of final cost. The contractor establishes a schedule of values so he has a way of getting paid (and to asure the owner that he’s not getting paid too quickly). I don’t know of any contractor that uses the SOV to forecast final cost–there’s too many variables.

  6. Percentage of competion is standard practice up here in Canada too. When I was writing my accounting exams if I was unsure as to what method to use I just chose the method that sucked the most. In accounting you can almost never go wrong with chosing to do that which invariably means that you aren’t getting a raise this year either…

  7. Hi Dick;

    I have been using your blog to find answers to Excel questions I have had. I had never explored it until today and after reading your profile I thought I would at least write a thank you note. I teach accounting at UNO so we are probably neighbors in some sense.


    Burch Kealey

  8. Burch: I got my BSBA from UNO. My friend, Michele, is getting her accounting degree there now. She’s the one that never goes to class but shows up and aces all the tests. What classes do you teach?

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