Chapter 34 Exercises — Construction Finance and Accounting

Do these with a calculator and a blank table. A work-in-progress schedule is not a document you understand by reading about it; it is a document you understand by footing one and finding out that it does not foot.

Difficulty legend: ⭐ basic · ⭐⭐ applied · ⭐⭐⭐ advanced judgment · ⭐⭐⭐⭐ research and extension

Part A — Conceptual Understanding ⭐

A1. Name the eleven columns of a work-in-progress schedule in order. Then state which four are inputs and which seven are mechanical consequences of those inputs.

A2. Write the cost-to-cost percent-complete formula. Then explain, in one sentence each, why the denominator is not the original budget and not the contract value.

A3. Define over-billing and under-billing using the WIP columns, and state which side of the balance sheet each one lands on. Why do the two never net against each other in the financial statements?

A4. Kestrel's Northgate row shows $721,720 of over-billing. State, in one sentence, what Meridian Health System is actually doing for Kestrel with that money — and in a second sentence, what Kestrel owes in return and in what currency.

A5. Define fade and gain. Then explain why a job can fade $400,000 and still finish profitably, and why an underwriter cares about the fade anyway.

A6. List the four reasons a job can be under-billed. Which one is benign, and which one is the most dangerous? Explain the mechanism by which the dangerous one disguises itself as an under-billing.

A7. Name the three C's of surety underwriting and give one thing an underwriter looks at under each. Which of the three is not measurable from a financial statement?

A8. Distinguish a compilation, a review, and an audit by the level of assurance each provides. State the single audit procedure that matters most to a contractor's WIP schedule, and why sureties want it.

A9. Explain in your own words why the completed-contract method makes a contractor's income statement useless to a surety, using a company that starts long jobs in one year and finishes them in the next.

A10. Kestrel's Year 1 net margin was 2.30 percent on $410,000,000 of revenue. State what a single $4,000,000 loss job represents as a share of the company's net income for that year, and what that ratio tells you about why forecasting discipline is a financial control and not paperwork.

Part B — Applied Analysis ⭐⭐

B1. A project manager reports cost incurred to date of $14,700,000 and total estimated cost at completion of $35,000,000 on a $37,500,000 contract. Her superintendent tells her that a mechanical coordination failure above the third-floor ceilings will cost roughly $1,750,000 to resolve across four levels. She leaves the forecast alone for one more month "to see whether the sub eats part of it." Compute the percent complete she reports, the percent complete she should report, and the dollar amount of revenue the company recognizes that it has not earned. Then state who, outside the company, relies on the difference.

B2. A contractor's WIP schedule shows a $19,600,000 job at 94 percent complete carrying an estimated gross profit percentage of 8.20 percent, against a company average of 4.90 percent. Nothing on the page is arithmetically wrong. Write the three sentences you would say to that project manager, and explain what you expect the answer to be.

B3. Two jobs on the same schedule are each exactly 60 percent complete by cost and each running exactly on budget. Job A is billed at 60 percent of contract. Job B is billed at 71 percent of contract. Which has recognized more gross profit this period? Which has more cash? Which will be harder to finish, and why?

B4. A contractor at $95,000,000 of annual revenue reports $2,900,000 of billings in excess of costs and estimated earnings and $3,400,000 of costs and estimated earnings in excess of billings. Describe what that pattern suggests, name the three follow-up questions you would ask, and say which single document would answer all three.

B5. A job has been reported at 96 percent complete for four consecutive monthly closes. Over those four months its cost incurred to date rose by $192,000 and its total estimated cost at completion rose by $200,000. Confirm that those two figures are consistent with a percent complete that never moves, then explain what the job's revenue earned and gross profit earned did over the same four months — and state what the pattern is actually telling you about the forecast.

B6. Kestrel's working-capital turnover is 20.2× and its months of backlog is 3.9. Nadia Haddad wants to bid three additional public schools this spring to fix the backlog problem. Explain what that decision does to each of the two numbers, and describe the alternative strategy the chapter recommends. Reference the bid/no-bid framework in Chapter 15.

B7. A general contractor's balance sheet shows $9,180,000 of retention receivable from owners and $5,880,000 of retention payable to subcontractors. Explain who is financing whom, compute the net position, and state what that net figure costs the company annually at a revolver rate of 8.5 percent.

Part C — Calculations & Deliverables ⭐⭐–⭐⭐⭐

Exercises C1 through C5 build on one company. Do them in order; each uses the previous answer.

The company

Calder & Wren Construction is a composite regional general contractor doing roughly $142,000,000 a year. It is bonded on a $110,000,000 aggregate / $45,000,000 single-project program. You have just been hired as its first director of project controls. The controller hands you the four input columns of the WIP schedule at the quarter close and goes to lunch.

C1 — Complete the schedule. ⭐⭐

For each job compute estimated gross profit, estimated gross profit percentage, percent complete, revenue earned to date, gross profit earned to date, and over/(under) billing. Verify each row two ways: gross profit earned = revenue earned − cost to date must equal estimated gross profit × percent complete. If they disagree, you have an arithmetic error — find it before you go on.

C2 — Foot it and state the company billing position. ⭐⭐

Total the schedule. Report total contract value, total estimated cost, total estimated gross profit and the company gross profit percentage, aggregate percent complete, total revenue earned, total gross profit earned, and the aggregate billing position shown the way the balance sheet shows it — gross over-billings and gross under-billings separately, then the net.

C3 — Name the job that should worry you, in numbers. ⭐⭐⭐

Identify the one job on this schedule you would put at the top of the operations meeting agenda. Support it with three figures: its margin against the company average, its remaining profit, and its remaining cash position (remaining to bill versus remaining cost to complete). Then write the three questions you would ask that project manager.

C4 — Working capital, the ratios, and months of backlog. ⭐⭐

Here is Calder & Wren's balance sheet at the same date. The over- and under-billing lines are the ones you computed in C2 — check that they tie before you go further.

Calder & Wren has $24,300,000 of contracts signed but not started. Annual revenue is $142,000,000.

Compute working capital, the current ratio, the quick ratio, working-capital turnover, and months of backlog. Then state, in two sentences, what the combination of the last two numbers is telling management to do.

C5 — The bonding-capacity effect of a fade. ⭐⭐⭐

Next quarter, Delacroix Tower fades $900,000: an unresolved subcontractor backcharge lands and the extended general conditions from a four-month overrun get booked. Nothing else on the schedule moves.

Compute (a) the job's new estimated gross profit, (b) the charge to income in the quarter, remembering how an anticipated loss on a contract is recognized, (c) the new working capital and current ratio, and (d) the approximate effect on supportable bonding program, using the 10× to 20× working capital heuristic from §34.7. Then write two sentences on why the arithmetic is the smaller half of the problem.

Part D — Judgment & Ethics ⭐⭐⭐

D1. You believe, honestly, that the remaining cost on your job is $4,500,000. If you report that, the job's estimated gross profit percentage falls below 3 percent, which triggers a review by the vice president of operations and a conversation you do not want. If you report $4,100,000, it does not. You tell yourself you might recover $400,000 in the buyout of the remaining two packages.

Write out the chain that connects the number you type to a decision made by somebody you have never met. Then answer the question the chapter puts plainly: what is the difference between being wrong about a forecast and misstating one, and why does the presence of a third party who relies on it change the character of the act rather than merely its size?

D2. A project manager on your team reports $200,000 of fade at 28 percent complete, with a written cause and a recovery plan. In the operations meeting, the vice president of operations takes ten minutes to explain to the room how this happened and asks him twice how he let it get away from him.

Describe, mechanically, what every other project manager in that room has just learned, and what that lesson will cost the company in eighteen months. Then write the three-sentence response you would want the VP to have given instead — one that is honest about the problem and does not punish the reporting.

D3. Your controller suggests moving $180,000 of cost from a job that is under budget to a job that is over budget, "since the crews were shared anyway and it nets to zero at the company level." Explain why it does not net to zero, naming at least three specific things that get corrupted. Include the effect on next year's estimating database, which is §34.9's closed loop.

D4. A project executive tells you that a claim on a public school job is "worth at least $900,000, we have a good story, and I want it in the WIP as revenue this quarter so the year looks right." Describe what you would say, what you would ask for, and who actually decides the question. Then explain why "we have a good story" is not the standard, and why the specific accounting treatment of contract claims is a question for the company's CPA rather than for you.

D5. You are the CFO. A project manager's cost-to-complete forecast has been within 1 percent on every job for six years. This quarter his number is $600,000 better than the one your project controls group builds independently. Do you take his number, take theirs, or take something else? Defend your answer in terms of what a forecast is — and say what you would do differently if his six-year record were a two-year record.

Part M — Mixed / Interleaved Practice ⭐⭐–⭐⭐⭐

M1 — with Chapter 28. Take a month-6 cost report you have built or seen, with its cost-to-complete forecast. Trace exactly which figure on that report becomes the denominator of the percent-complete calculation, then follow it forward: to revenue earned, to gross profit earned, to the balance sheet line, to the ratio, to the bonding conversation. Write the chain as a numbered list of seven steps. Then state the one control that protects every step.

M2 — with Chapter 32. A schedule of values has been front-loaded so that mobilization and general conditions carry more value than they cost. Describe the effect on (a) the job's cash curve, (b) its over-billing position on the WIP schedule, (c) the company's balance sheet, and (d) what happens in the last 15 percent of the job. Then state the test that separates competent cash management from misrepresentation.

M3 — with Chapter 31 and Chapter 33. Kestrel performed the CO #14 work at a cost of $186,400, could substantiate $121,000, and settled at $142,750 eight weeks later, leaving $43,650 unrecovered. Show where each of those four numbers appears — or fails to appear — on the WIP schedule during those eight weeks, and explain what the Northgate row looked like to Owen Baptiste before the settlement. Then state the WIP consequence of carrying unapproved change work as though it were approved.

M4 — with Chapter 2. Chapter 2 asked whether Kestrel could bid a $58,000,000 job with $50,645,000 of aggregate available in November of Year 1. Redo the capacity question using this chapter's January of Year 2 numbers instead: $115,511,220 of uncompleted bonded work against a $150,000,000 aggregate. Then add the layer Chapter 2 did not have — what happens to that answer if Rivermont Elementary #12 fades another $900,000 next quarter, and why the answer changes more than the arithmetic does.

M5 — with Chapter 30. Earned value uses earned value against actual cost and produces a cost performance index; the WIP schedule uses revenue earned and estimated gross profit. Both claim to tell you whether a job is making money. Build a two-column table comparing what each one measures, what each one misses, and which audience each one serves. Then name the one input both of them share, and state what happens to both when it is wrong.

M6 — with Chapter 24. The chapter argues that a cash-starved contractor is a more dangerous place to work. Lay out the causal chain from a negative working-capital position to an increased incident rate, naming each intermediate step. Then connect it to the third finding of the Northgate scaffold near-miss — the crew running behind under an unwritten "make it up" expectation — and explain why that finding is the one nobody wanted to write down.

Part E — Research & Extension ⭐⭐⭐⭐

E1. Find a real, publicly available set of audited financial statements for a construction company; a publicly traded contractor's annual report is the easiest place to start. Locate the revenue recognition policy note, the contract asset and contract liability balances (older statements may call them costs in excess of billings and billings in excess of costs), and the backlog disclosure. Write two pages: what the company tells you about how it measures progress, what its billing position is, and what its backlog says about the next four quarters. Note honestly which questions the public statements cannot answer, and why a surety gets a document you cannot see.

E2. Contact a surety bond producer or agent in your market. Most will spend half an hour with a student or a young professional, and the trade associations for surety producers and for the surety industry publish educational material that will let you arrive prepared. Ask three questions: what they look at first on a WIP schedule, what makes them decline a contractor they otherwise like, and what a contractor can do in one year to increase a program. Write up what you hear, and mark clearly which parts were that person's own practice rather than an industry rule.

E3. Pull the prequalification package required by a public owner in your jurisdiction — a state department of transportation, a school construction authority, or a large municipality. Find the financial requirements: what statements are required, at what level of assurance, whether a WIP schedule is required, and what consequences the package states for a false submission. Compare two agencies. Note what varies between them and what does not — and bring any question about disclosure, public-records treatment, or debarment exposure to counsel rather than to a textbook, because those rules differ by jurisdiction and change over time.

Selected answers appear in Appendix J. The formulas and ratios used throughout are collected in Appendix A; the terms are defined in Appendix I.