Understanding Contract Costs in Audits of Contractors
Posted on 12.14.15
By Brett Sinsabaugh, Business Assurance & Advisory Services Supervisor | Real Estate & Construction Team
A detailed understanding of contract costs for contractors is important for effective contract management and job valuation. Understanding contract costs also enhances internal financial recordkeeping and external financial reporting. Financial statement end users such as commercial banks, sureties, and management rely on contractor audited financial statements to make key business decisions based on underlying costs.
Common Types of Costs (301, PPC)
Direct contract costs are identifiable costs that relate directly to a construction job. Common costs include material, labor, and subcontractor costs.
Indirect costs are those costs not solely applicable to a certain job but must be allocated to an individual contract or job. Overhead is a common indirect cost for construction contracts. Other common indirect costs include supervision, safety costs, equipment, indirect labor, supplies, and depreciation. The Financial Accounting Standards Board (“FASB”) states that indirect costs should be allocated by a systematic and rational method. Common allocation methods include those “based on direct labor costs, direct labor hours, or a combination of direct labor and material costs” (FASB).
Construction period interest.
Construction period interest is a product of financing on construction projects and is the interest on such debt.
Precontract or preconstruction costs are construction costs that are incurred prior to the start of the contract or for anticipated future costs. FASB has specific guidelines for evaluating these costs and the appropriate accounting treatment for such criteria. Common preconstruction costs include:
- Equipment, supplies, and material costs
- Architectural costs
- Engineering costs,
- Other start-up costs incurred in anticipation of contracts
Another important contract related item when understanding contract costs is liquidated damages. Liquidated damages are essentially penalties due to delays or not meeting a deadline as specified in the contract. These damages are nonexclusive to contractors as they may apply to owners as well. Per PPC, such owner delays “can result in additional costs to the contractor for such items as nonproductive workers and supervisors, additional overhead, and costs associated with starting and stopping work” (203.25, PPC). When reviewing liquidated damages, it’s important to include these amounts in estimated costs to complete while valuating contracts in progress. Incurred and expected costs must be understood and included in estimated costs to complete, as well as their impact on job profitability (304.28, PPC).
To ensure proper contract profitability, a strong understanding on contract costs must be achieved. For more information regarding contract costs for contractors as well as their impact financial statements, please contact a Business Assurance and Advisory member of the Keiter Real Estate and Construction Industry team or firstname.lastname@example.org | 804.747.0000.
- “203 Important Contract Clauses: Construction Contractors.” Thomson Reuters/PPC.
- “301 GAAP for Construction Contractors.” Thomson Reuters/PPC.
- “304 Revenue Recognition Methods.” Thomson Reuters/PPC.
- FASB ASC 605-35-25-37
Brett’s client focus is primarily in the real estate and construction industry. Brett is a member of the Firm’s Real Estate and Construction industry team. Brett received his Bachelor of Arts from Christopher Newport University and received his post baccalaureate certificate in Accounting from Virginia Commonwealth University. Read more of Brett's accounting insights here.