Overbillings/Billings in excess of costs and estimated revenues/Contract Liabilities:
Just because your billings are higher than your costs, doesn't necessarily mean you have an overbilling. That's right! You can be billed "ahead" but have an underbilling. So that begs the question, what is an overbilling?
If you've read the lesson on underbillings, you'll know that gross profit is one of the main drivers of revenue recognition for construction contractors, which means there's more to construction accounting than costs and billings. Overbillings are accounting's way of saying "Hey not so fast!".
Revenue recognition for construction contractors is about balance. If you say you're going to make 30% profit on the project from beginning to end, then that's how much you'll recognize (assuming your estimate is accurate), over the duration of the project. If you try to recognize more, you'll get hit with an overbilling. An overbilling, unlike an underbilling, reduces your revenue and creates a liability. On the face of it, it doesn't help out your balance sheet or income statement, because it increases your liabilities and decreases your income. Enough of that, let's move on to an example.
Example:
We have a project with a contract price of $100,000 and estimated total estimated cost of $70,000 that will take three years to complete.
Year 1 (Open):
Costs Incurred: $25,000
Billings to Date: $30,000
Year 2 (Open):
Costs Incurred: $33,000
Billings to Date: $52,000
Year 3 (Closed):
Costs Incurred: $70,000
Billings to Date: $100,000
Job Schedules, Year 1 - 3:
Notice by year end of Year 1, we have more billings than costs, but we have an underbilling. The reason is that if you calculate gross profit on just billings and costs, gross profit is 17%. But, according to your estimate, the job has 30% gross profit! If you remember on our lesson on underbillings, WIP is going to bump up your revenues through underbillings to help you get to 30%.
In Year 2, however, we have a different scenario. Gross profit based on billings and costs through year end is 37%. You tried to recognize 7% more gross profit, when you're not supposed to. You said 30%, so again, you'll recognize 30%. Overillings of $4,857, reduces your revenue to match gross profit for the Year 2 with your estimate.
In Year 3, the project closes at the original estimated amount. Great job!
The moral of the story is that overbillings prevent you from recognizing more profit than you should, based on your estimate. We'll cover why overbillings aren't really a bad thing in a future lesson.
As always, please let me know if you have any questions. Thanks!
-Ara
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