Time for a demonstration! Even if you're pretty familiar with how WIP works, it's always helpful to run different scenarios using the WIP template.
I've included a snip-it of a WIP report below that we'll be going over to track one job from inception to close. This should help demonstrate the process of how WIP is recorded throughout the life of the project until close. So let's start!
Job #1:
Contract Price: $10,000
Contract Cost: $5,000
Gross Profit: 50%
Duration: 3 years
Note: I've kept the contract price and estimated cost the same for simplicity's sake.
Year 1: In year one, the project is overbilled by $250, liability. This means that more gross profit was initially recognized through billings and costs than what should've been recognized based on total project estimates. So, even though you billed $750, you only earned $500 in revenue.
Year 2: In year two, the project is underbilled by $500, an asset. This means that less gross profit was initially recognized through billings and costs than what should've been recognized based on total project estimates. Now that we're into the second year, we'll need to consider prior year revenues and costs to calculate current year revenue.
I created a table right below the WIP report to illustrate how prior year revenue, costs, and WIP are factored in.
Cost in year 2 is the current cost to date less prior year cost to date, $3,250. Now the revenue piece requires a bit more work. For current year billings, you'll subtract the billed to date amount by the prior year billed to date amount, which gives us $5,750. Since we have a balance in WIP from the previous year, we'll need to adjust the initial balance to give us $500 in underbillings by year 2. I split it out into two parts here for illustration purposes. We would need to debit overbillings by $250, leaving a zero balance in that account, and debit underbillings for $500. What that ulitmately does is add $750 ($250 + $500) to your current year billings of $5,750 which results in $6,500 in revenue recognized.
Year 3: In year three, the project is closed! All the costs have been incurred and the total contract price has been billed out. As I'm sure you all know by now, in year 3, this job wouldn't be on the WIP report (there's no WIP). It would be presented with closed jobs but I've left it here for illustration.
Now, to calculate total costs, you'll subtract cost to date by the prior year costs, leaving you with $1,500 in costs. For current year billings, you would subtract the billed to date amount through the end of year 3 by prior year billings, leaving you with $3,500. We're not done! We have a balance of $500 in underbillings that we need to bring down to zero becaue the job is complete. Therefore, we credit underbillings and debit revenue, which decreases our billings for the current year to $3,000.
Did we do it right?! Let's look at the totals in cells T9 and U9. $10,000 in revenue recognized over three years and $5,000 in costs incurred...which matches our contract price and estimated cost!
Year 1: Revenue $500 Cost $250
Year 2: Revenue $6,500 Cost $3,250
Year 3: Revenue $3,000 Cost $1,500
We did it!
WIP on a monthly basis: If you maintain WIP on a monthly basis, the general themes discussed above apply. The main idea is to keep adjusting WIP to zero for each job that closes, leaving you with no WIP for that particular job. Your "prior year" costs and billings become "prior period" (all the months through the past month) costs and billings.
Hope that helped! Feel free to reach out with questions or comments!
I've also recorded a video for this lesson:
Thanks!
Ara
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