It's December X3 and you just started a new project. You’ve incurred (and recorded) costs on the project but didn’t get around to billing the customer/project owner until January X4. By now you know this scenario will lead to an underbilling, as demonstrated by scenario (1) above. Costs of $25,000 were recorded with no billings, which resulted in an underbilling of $31,071. By December 31, X3, the project was 7.1% complete. This all tells me that the project just started, so it’s too soon to tell how it will finish. So, the risk isn’t really tied to the total estimated cost. I just want to know what those costs were for. Was it for material, labor, and/or subcontract costs? If it was for a wide array of items, it’s likely that you’ve started construction and just didn’t around to progress billing the customer/project owner. I like to look at subsequent activity (billings and costs), in this case, January X4 and February X4 activity to verify this. Billing activity is expected to balance out with costs so it’s not as skewed as it was as of December 31 X3. If that appears to be the case, it’s not as big of a concern. You just didn’t get around to sending out a progress billing.
Now, if the $25,000 was for pre-construction costs, bidding, bonds, etc. the outcome is a little different. Such costs are often incurred before construction begins. In our example construction may begin the following year or several months down the line. In this case, I typically “capitalize” these costs, as required by generally accepted accounting principles (GAAP), which moves the costs from the income statement to the balance sheet. I’ll credit cost and debit a current asset account (pre-construction costs). This takes the project out of the work in progress (WIP) report, so there are no costs or underbillings. What we have instead is a current asset on the books for $25,000. This amount is to be amortized over the life of the project evenly according to GAAP. If the amount is immaterial, and the project is likely to last less than or a little longer than year, I just expense the entire amount the following year.
Note: This is a standard scenario(s) I come across. Your scenario may be different. I advise you to consult with your CPA or accounting professional for further guidance.
Thanks!
Ara