Download Common Problems in Applying Contract Accounting Rules

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.