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Common Problems in Applying Contract Accounting Rules Issue Type of Error Correct Accounting Accumulation of Contract The cash method is used to Accrual accounting should be used to recognize all Costs accumulate costs, and there may contract costs, and those costs must be allocated to be significant unrecorded liabilities the appropriate individual contract cost records. that affect cost records for contracts in progress. Costs recognized in the Contract costs must be recognized both in total in disbursement or voucher register the general ledger accounts and individually for each are not properly allocated to profit center. The profit center is normally each individual contract cost records. individual contract. Amounts posted to general ledger control accounts (normally, expense accounts by major category, or in some cases a construction-in-progress account) should agree in total to amounts posted to subsidiary ledgers (the individual contract cost records). Certain categories of direct costs All direct costs associated with the construction are not properly allocated to activity should be allocated to individual contract individual contract cost records. cost records. Indirect overhead costs are All indirect costs associated with a construction incorrectly allocated to contract contract should be allocated to individual contract costs. cost records. See Exhibit 4-5. Production period interest may Both GAAP and tax rules require the capitalization of need to be capitalized, but is not. construction period interest. GAAP requires the capitalization of production period interest to the extent that cash receipts on a contract do not exceed production costs. See the discussion in section 402. Issue Revenue Recognition Type of Error Correct Accounting Incorrect selection of the In most situations, the percentage-of-completion completed-contract method. method should be used. Failure to exclude uninstalled In general, uninstalled materials charged to a material when performing a contract (unless they were specifically fabricated for cost-to-cost percentage of the contract) should be excluded from actual costs completion evaluation. before computing cost-to-cost percentage of completion. Total estimated contract cost may Total estimated cost of a contract must be adjusted not reflect adequate overhead to reflect management's best estimates of the actual costs, additional costs due to cost to complete the contract. This adjustment must problems encountered on the be made before a cost-to-cost percentage of contract, increased costs due to completion calculation can be made. inflation, etc. Loss Contracts Failure to accrue for loss contracts. When the estimated total cost of a contract is projected to exceed the corresponding contract price, a loss accrual is required, regardless of which accounting method is used. Unused Materials Incorrectly transferring unused Unused materials at the completion of a job should materials back to the warehouse or be transferred back to inventory or to the next job at to the next job at cost, even if it the lower of cost or net realizable value. exceeds market; or expensing the cost of unused materials to the completed job and therefore carrying the inventory at a zero cost. Issue Retentions Type of Error Correct Accounting Failure to record retentions since Retentions should be recorded as billed. In addition, they represent receivables that will they should be reported separately in the accounting not be collected until a project is records from progress bills currently due so that complete. agings will be correct. Investments in Joint Using the cost method to account Investments which can be controlled by the Ventures, Partnerships, or for such investments regardless of contractor should generally be consolidated. Other Entities the appropriate method. Investments over which the contractor can exert significant influence should normally be accounted for using the equity method. The cost method is appropriate for all other investments. Deferred Taxes Failure to identify temporary Tax law and GAAP rules for contractors may vary differences between book and significantly, and deferred tax accounting is taxable income. necessary for all temporary differences between book and taxable income. See section 409.