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Top Six Accounting Errors Construction Companies Make
Financial statements are both a tool used to manage a business and a required deliverable for a lender or bonding company. All construction company owners have to deal with them, and it is crucial for the individuals responsible for the final internal review to know what potential errors could be lurking.
Here are six common errors that can wreak havoc on financial statements prepared using generally accepted accounting principles.
- 1. Improper Job Cost and Billing Cutoff
Most companies utilize the accrual basis of accounting. When using the accrual method, revenues are recorded when earned and costs are recognized when incurred, and billings that differ from revenues earned give rise to over- or under-billings. Cutoff errors arise when costs incurred are omitted during the financial reporting period, or when incorrect billings are utilized in the calculations. Procedures can be implemented to avoid these errors.
- 2. Failure to Record 100 Percent of Loss on Contracts in the Period
Generally accepted accounting principles require that a loss on a contract be recognized 100% at the time a loss is determined. Avoid this error by monitoring the detailed job cost schedule.
- 3. Inaccurate Application of Overhead to Jobs
Most contractors use a calculated overhead rate to allocate indirect costs to individual jobs. Indirect costs can include, but are not limited to rent, utilities, depreciation, office salaries, etc. If this rate is not monitored, a significant over- or under-allocation of costs could occur.
- 4. Misstatement of Estimated Job Costs
Errors occur most often due to poor estimating/forecasting, inaccurate actual cost accumulation, or improper treatment of change orders. Since estimated job costs generally drive the calculation of earned revenue for a period, a misstatement can lead to errors in revenue recognition. Monthly comparisons of estimated costs to actual costs and projected costs to complete can help reduce estimating errors.
- 5. Improper Treatment of Change Orders
While change orders are great opportunities, the accounting rules for dealing with them are complex, and improper treatment can cause an overstatement of profit resulting in profit fade as the job progresses. Implementing procedures for recognizing approved change orders can reduce the risk of errors.
- 6. Improper Treatment of Joint Ventures
Joint ventures can be great opportunities; however, accounting for them is often misunderstood. Due to varying methods that are acceptable for recording joint venture activity, it is important to evaluate the methodology and alternatives at the beginning of the activity.
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