Balance Sheet Bride + WIP Schedule Groom
In this article we will pull together some of the individual concepts that have been discussed and show how they are married in a contractor’s surety bond account.
In article #48 we talked about the different accounting methods that are utilized. We covered how to recognize the Percentage of Completion method and the Accrual method. Accrual may be the one you see most often.
An important characteristic of the Accrual method is that it does not include Underbillings and Overbillings. Do you recall which method* does show these entries? Let’s consider the implications when these entries are not part of the underwriting.
In article #57 we reviewed how the Underbillings and Overbillings affect the Balance Sheet analysis. Sometimes they help, sometimes they hurt. Overbillings are a Current Liability. Their effect on the Balance Sheet is that they reduce Working Capital. We all know that’s bad for bonding purposes. It means less capacity for the client and maybe lower revenues.
Underbillings, on the other hand, are a Current Asset. They increase the Working Capital calculation, and therefore the customer’s bondability. So you want them in the picture, but Accrual financial statements will not show either entry. Is there a solution?
With a correctly prepared WIP schedule in hand we can find the degree of completion, the correct billing amount, and then determine if the company is Under or Overbilled on each project. (If they were Underbilled $3 on one job and Overbilled $1 on another, the balance sheet adjustment would be the net effect: Underbilled $2.)
If a contractor has a Working Capital deficiency and the bonding capacity amount is inadequate, this calculation can help. Bear in mind, it can also serve to reduce the bonding line if the net effect an Overbilled status.
The underlying reality is that, good or bad, these numbers must be known. Larger, more sophisticated contractors often use the Percentage of Completion method * which always includes Under and Overbillings – because they are relevant. They are no less relevant for the Accrual method contractor. On Accrual method financial statements, you should always analyze the WIP schedule to see if any significant Under or Overbillings could affect the Balance Sheet analysis.
The procedure we described is helpful for contractors when managing their projects, and for their underwriters. It provides a sharper analysis and results in better management decisions for all parties.
Don’t miss our next Secret # 59 Bonding Specifications: Boilerplate That Bites
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We have a great group of bonding companies and specialize in this area exclusively. We don’t handle insurance. Steve Golia 856-304-7348