A Guide To Construction Work In Progress (WIP)

A Guide To Construction Work In Progress (WIP)

Introduction to WIP Accounting in Construction

Understanding Work in Progress (WIP) is pivotal in construction accounting. It serves as a compass, guiding businesses through the intricate landscape of ongoing projects’ financial dynamics. WIP accounting meticulously tracks the progress and profitability of each project by tracking actual costs against estimated total costs. This diligent comparison unveils crucial insights, notably identifying overbilling and underbilling scenarios.

How to Calculate and Report WIP

  1. Estimate Projected Costs: Begin by forecasting the total expenses anticipated for project completion.
  2. Compute Percentage Completion: Divide the actual costs incurred to date by the estimated total costs.
  3. Determine Earned Revenue: Multiply the percentage of completion by the total estimated revenue.
  4. Identify Over/Underbilling: Difference between earned revenue and the billed amount minus costs to date.

 

Example:

Consider a project with a contract value of $2,000,000. If $400,000 has been spent to date, and $600,000 billed, with total estimated costs of $1,600,000, the project is 25% complete. The earned revenue is $500,000, and the overbilling amount is $100,000.

Crafting comprehensive WIP reports is imperative, encompassing vital metrics such as total contract value, revenue received, estimated costs, project completion percentage, current costs, and over/underbilling status.

WIP Report Essentials

A comprehensive WIP report should include:

  • Total contract value
  • Revenue received to date
  • Original and revised estimated costs
  • Amount billed to date
  • Project completion percentage
  • Current costs to date
  • Over/underbilling status

Frequency of WIP Reports

The frequency of WIP reports depends on business needs. Regular (weekly or monthly) reports are recommended for timely decision-making.

Common Mistakes to Avoid

  • Not tracking committed costs accurately
  • Incorrect data entry
  • Infrequent reporting
  • Misinterpreting overbilling as profit
  • Delayed expense tracking

Tax Implications of WIP Accounting

Beyond its operational significance, WIP accounting extends its reach into tax realms. Accurate WIP accounting can influence tax liabilities, deductions, and credits, making it a critical component of construction financial strategy.

Case Study: Real-World Application of WIP Accounting

In the realm of accounting, the concept of Work-in-Progress (WIP) accounting plays a pivotal role in capturing the financial status of ongoing projects, particularly in industries like construction. Let’s delve deeper into a practical example to illustrate how WIP accounting principles are applied.

Consider a construction project with a contract value of $3,000,000. As the project progresses, various costs are incurred, and a portion of the work is completed. At a certain point in time, let’s assume that $800,000 has been expended on the project, representing the actual costs incurred to date. Additionally, $1,200,000 has been billed to the client, reflecting the revenue recognized based on the work completed. However, it’s important to note that the project is not yet fully completed, and there are estimated costs of $1,700,000 to be incurred in the future to bring the project to completion.

WIP accounting principles come into play here by providing a systematic approach to account for the project’s financial status. The percentage of completion method is commonly used to determine the extent to which the project is completed. In this case, the percentage of completion can be calculated as follows:

  1. Percentage of Completion = (Actual Costs Incurred to Date / Estimated Total Costs) x 100%

Percentage of Completion = (800,000 / 2,500,000) x 100%

Percentage of Completion = 32%

The percentage of completion (32%) indicates that approximately 32% of the project has been completed. This information is crucial for several reasons:

  1. Revenue Recognition: Based on the percentage of completion, a portion of the $3,000,000 contract value of the client can be recognized as revenue. The revenue recognized up to this point would be $960,000, calculated as follows:

Revenue Recognized = Contract Value x Percentage of Completion

Revenue Recognized = 3,000,000 x 32%

Revenue Recognized = $960,000

  1. Work-in-Progress (WIP) Asset / Liability: The WIP asset represents the costs incurred on the project that have not yet been recognized as revenue. In this case, the WIP asset would be $416,000, calculated as follows:

WIP Asset = Actual Costs Incurred to Date – Revenue Recognized

WIP Asset = 800,000 – 960,000

WIP Asset / Liability = -$160,000 

This WIP asset is reported on the balance sheet as a negative current asset or liability (overbilling), reflecting the overbilling of the works completed. On the opposite end if it is a positive figure, it would be reflecting the value of work 

completed but not yet recognized as revenue.

 

What should you do if your WIP is a positive or negative figure?

Once you have determined whether your WIP value is negative, positive, or zero, we can outline the appropriate next steps.

If your WIP value is zero, congratulations! You are exactly where you should be. No further invoicing actions are needed, but ensure that all outstanding vendor invoices are paid by your clients promptly.

A positive WIP value indicates that you have completed work that has not yet been invoiced. To address this, invoice your client for the construction work in progress value you calculated and ensure they pay the invoice for that billing period. Keep thorough records of all invoices related to this work in progress, as you will need them to calculate your future billed revenue for that line item or phase of work.

Negative WIP values can be more challenging to address, particularly if the value is significantly large. This negative value suggests that you are billing ahead of the actual construction costs for that specific project area. While an increasing bank account may give the appearance of business success and profitability, consistently overbilling on projects poses substantial financial risks and may indicate cash flow issues that require immediate attention. Overbilling is considered a liability on the balance sheet, often referred to as revenue in advance. If not managed properly, revenue in advance can escalate and signal operational issues like project management, etc.

WIP is important

By continuously monitoring the WIP asset and comparing it to the estimated total costs, project managers can assess the project’s profitability and identify any potential cost overruns. This information supports informed decision-making and allows for proactive measures to mitigate financial risks.

The WIP accounting principles provide a structured framework to track the progress of ongoing projects, ensuring accurate financial reporting and enabling effective project management. By leveraging WIP accounting concepts, organizations can gain valuable insights into project profitability, resource allocation, and overall financial performance.

 

ontact Aero Accounting Group Today!

In today’s competitive construction market, mastering WIP accounting is non-negotiable for businesses seeking sustained growth and profitability. At Aero Accounting Group, we are dedicated to providing customized solutions and expert guidance to help you navigate the complexities of WIP accounting. 

By ensuring accurate and timely financial reporting, you can make informed decisions, optimize cash flow, and improve project profitability. Don’t let WIP accounting be a roadblock to your success. 

Contact Aero Accounting Group today and empower your construction enterprise with robust WIP accounting practices that drive financial performance and project success. Together, let’s build a solid foundation for your construction business.

Need help?

Not sure if your current accountant is a good long-term fit? Contact us at Aero Accounting Group today and we’ll help you minimise your taxes and maximise your profits

Leave a Reply

Your email address will not be published. Required fields are marked *