A work in progress (WIP) statement records the information necessary for the percentage of completion calculations and provides crucial information about the total value and progress of work completed. In most cases, revenue is considered earned after a service is complete or product ownership is transferred. If revenue recognition, however, is delayed until the end of a contract, tying revenues to their direct costs can become more complicated.
The solution? Using a ‘percentage of completion’ method to recognize revenue.
Contract revenue is tied to costs, but this isn’t always true for contract billings. Often, contract elements are billed in advance or delayed by agreement, causing variances between actual billed revenue and earned revenue that require an adjusting entry. Since the percentage of completion method adjusts billed revenue to reflect earned revenue, billings are posted to revenues and are later adjusted to reflect the correct earned revenue amount.
Long-term contracts have estimates for both sides of a contract: costs and revenues. Therefore, determining the percent of completion requires both total actual and total estimated cost numbers to accurately calculate a percentage.
For example:
- Percent complete = actual costs to date / total estimated costs
The percent complete is then applied to the total estimated revenue to determine earned revenue to date.
- Earned revenue to date = percent complete * total estimated revenue
Then, the earned revenue to date is compared to the billings on contract to date, and the difference is either added to or subtracted from the revenue.
- Over-/under-billed revenue = total billings on contract – earned revenue to date
The over-/under-billed revenue accounts are balance sheet accounts often referred to as billings in excess of costs (a liability account associated with over-billings) or costs in excess of billings (an asset account that is associated with under-billings). With this information, an underwriter will view a project as a cash flow liability or may foresee trouble down the line if projects are consistently under-billed.
Are you concerned about what a surety underwriter will uncover when examining your WIP report? Cabbage’s solutions and services can help you address potential problems before your bond agency takes matters into its own hands. For more information, contact us today.