Chapter 34 Quiz — Construction Finance and Accounting

B. The four inputs are contract amount, total estimated cost at completion, cost incurred to date, and amount billed to date. Everything else — estimated gross profit, gross profit percentage, percent complete, revenue earned, gross profit earned, and the over/(under) billing — is a mechanical consequence. Three of the four inputs are verifiable against the general ledger and the contract file. Total estimated cost at completion is a forecast, produced by a project manager, and it is where every construction accounting problem in history has lived.

B. Percent complete = $9,120,000 ÷ $15,200,000 = 60.00%. Revenue earned = $16,000,000 × 0.60 = $9,600,000. Check the gross profit two ways: $9,600,000 − $9,120,000 = $480,000`, and `estimated gross profit of $800,000 × 0.60 = $480,000 ✓. If those two disagree, you have an arithmetic error, not an accounting question.

B. $10,240,000 − $9,600,000 = $640,000 over-billed. Over-billing is money collected for work not yet performed, so it is a current liability — a loan from the owner, repayable in work rather than in cash. Note what it is not: it is not revenue and it is not profit. Billings do not appear anywhere in the percentage-of-completion profit calculation.

C. Leaving the gap out keeps the denominator of the percent-complete calculation too small, so percent complete comes out too high. Revenue earned is contract × percent complete, so revenue is overstated — and because the job's expected profit has also shrunk by $1,400,000, the overstatement of gross profit is larger still. She has not absorbed anything. She has borrowed from a future period and told nobody.

B. If a job's true cost at completion has risen and the forecast has not been updated, the denominator stays too small, percent complete comes out too high, and revenue earned comes out too high — while billings, which are driven by physical progress an owner's representative verified in the field, do not move. The gap opens between them and appears on the WIP as an under-billing. Of the four causes of under-billing — timing, unbilled change work, poor billing discipline, and an unrecognized cost overrun — only the first is benign.

B. The largest single-period fade on that job is $180,000 on a $22,400,000 contract — eight tenths of one percent, and easy to explain away. Read the cumulative column instead. A job that fades in every period for five periods is not experiencing five unrelated events. It is experiencing one thing, released at the rate the organization will tolerate rather than the rate it was discovered. That pattern is precisely what a surety underwriter asks for multiple years of WIP schedules in order to see.

C. $4,000,000 ÷ $9,430,000 = 42.4%. One bad estimate, one unrecovered delay, or one uninsured event consumes almost half the company's annual net income. That ratio is the entire argument for forecasting discipline: at a low-single-digit net margin, cost control is not administration, it is the business.

B. Working-capital turnover measures how much annual volume each dollar of liquidity carries. Many underwriters get uncomfortable somewhere around fifteen to twenty times — thresholds vary by surety, sector, and market — so 20.2× is at or slightly past the edge. Note that Kestrel's program is conservatively supported at 7.4 times working capital. The obligations the surety has guaranteed and the volume the company is actually running are two different questions, and people confuse them constantly.

C. An audit confirms contract amounts with owners, tests cost to date against the ledger, confirms billings, and challenges the total estimated cost at completion on every significant contract. That last procedure is the one that catches an optimistic forecast, which is why hidden fade surfaces at the year-end audit at so many contractors. An audit does not merely cost more. It removes the place the problem was hiding. No audit is a guarantee of accuracy; it provides reasonable, not absolute, assurance.

B. $336,000 + $290,000 = $626,000. An anticipated loss on a contract is not spread across the remaining work: the entire estimated loss is charged to income in the period it becomes known, and the profit previously recognized reverses.

Option C is the fade — `$480,000 − $(290,000) = $770,000` — and it is a different number for a different purpose. The $144,000 gap between the fade and the charge is profit that had not yet been recognized on the old forecast; it never touches the income statement because it was never there. Learn that distinction. It is the one people get wrong in the room.

False. Profit under percentage-of-completion is driven by percent complete and estimated gross profit; billings do not appear in the calculation at all. Both have earned exactly 50 percent of their expected gross profit. Job B has more cash, which is a different thing — and that cash is an advance against work Job B has promised and not performed.

False. Over-billed jobs are summed and reported as a current liability; under-billed jobs are summed and reported as a current asset. They never net. Kestrel's balance sheet at January 31, Year 2 shows $2,915,920 of over-billings and $818,000 of under-billings; the net figure of $2,097,920 appears only on the WIP schedule.

False. Fade is the decline in a job's estimated gross profit from one reporting period to the next. A job can fade $400,000 and still finish profitably. What fade measures is not the outcome — it is the quality of the forecast that produced the outcome, which is why a surety looks at it before almost anything else.

False. It is a credit line the surety can withdraw, and its withdrawal is correlated with the contractor's need for it — the surety reduces the program at exactly the moment fade appears, which is the moment the contractor most needs to replace backlog. Every capacity heuristic in §34.7 describes a relationship, not a contract.

False. You should be able to name, for every gain on your WIP, the specific event that produced it — a settled claim, a favorable buyout, a released contingency whose named risks passed without occurring. Fair Oaks Water Plant Expansion's $150,000 gain at 95 percent complete has exactly such an explanation. "The job is going well" is not an event, and consistent late gains across many jobs mean the WIP has been understating profit and management has been steering on bad information in the other direction.

The cost-to-complete forecast sets total estimated cost at completion, which is the denominator of the percent-complete calculation. Percent complete sets the revenue and gross profit the company recognizes this period, which flow into the income statement and, through the over/under-billing lines, onto the balance sheet. Those statements go to the surety, which sizes and prices the program against working capital, net worth, and — most heavily — the pattern of fade across several years of WIP schedules. Every dollar of revenue and profit the company reports this period was computed from a number a project manager produced.

1. Timing — the billing cycle closed just before a big cost hit; it fixes itself next month.
2. Poor billing discipline — a schedule of values that does not track how cost incurs, or a project manager under-billing to avoid an argument; self-inflicted and correctable this month.
3. Unbilled change work — you are performing changes that are not approved and cannot yet be billed; unpriced, unfunded work you are financing, and the entitlement clock may be running.
4. An unrecognized cost overrun — the estimate moved and nobody admitted it; the worst, because the under-billing is not a billing problem at all and the reported revenue is already wrong.

• Remaining to bill = $16,510,000 − $16,014,700 = $495,300
• Remaining cost to complete = $15,470,000 − $14,696,500 = $773,500
• Net cash consumption to finish = $495,300 − $773,500 = $(278,200)

A good job with the best margin on the schedule will still consume $278,200 of cash before it finishes. That is the lesson: over-billing is not a cushion, it is an advance, and the back end of every over-billed job is funded by the company rather than by the job. Multiply that across six or eight contracts closing out in the same two quarters and you have §34.8's Step 5 — the reason a contractor must book new work faster than it finishes old work purely to stay liquid. That is not a strategy. It is a treadmill.

• At $120,000,000: `(60 ÷ 365) × $114,000,000 = $18,739,726` of cash tied up in work.
• At $165,000,000: `(60 ÷ 365) × $156,750,000 = $25,767,123`.
• Incremental working capital required: $7,027,397.
• Incremental profit produced: $45,000,000 × 0.025 = $1,125,000.

The growth demanded roughly $7,000,000 of additional liquidity and returned about $1,100,000. The other $5,900,000 has to come from the line of credit, retained earnings, slower payment to subcontractors, or over-billing — and none of those is free or infinite. A company growing at that rate is financing that many more front-end cash troughs simultaneously, every year, and the faster it grows the further behind it falls. That is why fast-growing contractors fail and slow-growing ones do not, and it has nothing to do with how well they build.

(a) $23,500,000 − $22,325,000 = $1,175,000`; `÷ $23,500,000 = 5.00% (b) $14,511,250 ÷ $22,325,000 = 65.00% (c) $23,500,000 × 0.65 = $15,275,000 (d) $15,275,000 − $14,511,250 = $763,750` (check: `$1,175,000 × 0.65 = $763,750 ✓) (e) $15,510,000 − $15,275,000 = $235,000 over-billed (f) $1,175,000 − $1,410,000 = $(235,000) of fade. The margin fell from 6.00 percent to 5.00 percent in one period. (g) Remaining to bill = $23,500,000 − $15,510,000 = $7,990,000`; `remaining cost = $22,325,000 − $14,511,250 = $7,813,750; net cash generation of $176,250 over the remaining life — barely positive.

Yes, it belongs on the agenda — not because of the cash position, which is roughly neutral, but because a full percentage point of margin disappeared in a single period at 65 percent complete, and that is exactly the point in a job's life when the remaining cost is committed enough to be knowable and unfinished enough to still be wrong. Ask what moved, when it moved, and how much of the remaining $7,813,750 is committed by subcontract versus estimated.

(a) - Working capital = $27,600,000 − $19,200,000 = $8,400,000 - Current ratio = $27,600,000 ÷ $19,200,000 = 1.44 - Working-capital turnover = $118,000,000 ÷ $8,400,000 = 14.0× - Aggregate ÷ working capital = $95,000,000 ÷ $8,400,000 = 11.3×

Both multiples sit inside the ranges most underwriters are comfortable with. This is a company with room.

(b) The full estimated loss is recognized now and the recognized profit reverses: - Charge to income = $610,000 + $240,000 = $850,000 - New working capital = $8,400,000 − $850,000 = $7,550,000 - New current ratio = $27,600,000 ÷ ($19,200,000 + $850,000) = $27,600,000 ÷ $20,050,000 = 1.38 - New working-capital turnover = $118,000,000 ÷ $7,550,000 = 15.6×

(c) At roughly 10 to 20 times working capital, $850,000 of lost liquidity corresponds to something on the order of $8,500,000 to $17,000,000 of supportable aggregate program — hedged, because every surety applies its own view and the multiple moves with market, sector, and history.

Why the arithmetic understates it: the ratio movement is modest and survivable, but what the underwriter actually prices is whether this company knows what is happening inside its own jobs — and a profitable job that becomes a loss job in one period is evidence that it does not. Confidence is not a line on the balance sheet, and it is the thing that gets withdrawn first.