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Virginia Tech and VSCPA Accounting and Auditing Conference


Issues in Financial Reporting ... Effective Now and it effects most all contractors is some fashion ... Implementation issues related to Leasing Transactions ... – PowerPoint PPT presentation

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Title: Virginia Tech and VSCPA Accounting and Auditing Conference

Virginia Tech and VSCPA Accounting and Auditing
  • Construction Accounting and Auditing Update 2006
  • By C. Michael Wade , CPA and Director of
    Contractors Financial Consulting Services Group
  • Brown Edwards and Company,L.L.P.

Construction Accounting and Auditing Update for
  • Introduction
  • Name and firm
  • Practice area and experience
  • Format of the presentation
  • Questions after the presentation please

Construction Accounting and Auditing Update for
  • State of the Industry
  • View point of Ken Simonson Economist for AGC
  • Residential real estate markets are cooling due
    to higher costs
  • Commercial activity is increasing including the
    Richmond district
  • Construction starts are slow in residential up in
  • Steel increases continue for the future
  • Other commodities on the rise
  • Delivery delays continue also

Construction Accounting and Auditing Update for
  • Update on the Virginia Department of
  • Public wants better transportation but no tax
  • Budget approved but no long term for
  • VDOTs 6 year program has significant cuts
    from the original plan passed by Warner
  • Virginia relies on Federal Gov. for funding 70
    with other states average of 42
  • Senate and House cannot agree on common plan
  • The general assembly is still trying to come up
    with something
  • September 27,2006 special general assembly
    session and nine new transportation bills will be

Construction Accounting and Auditing Update for
  • A few statistics from CFMA
  • Legal form 64 S corps, 25 C Corps and 11 other
  • Source of work 67 private and 33 public
  • Top 5 challenges of contractors ( percent listed,
  • Health care costs 71 ranked 3rd
  • Trained field personnel 66 ranked 1st
  • Workers Compensation costs 48 ranked 5th
  • Future work 47 ranked 2nd
  • Insurance costs 44 not ranked
  • Shortage of project managers ranked 4th

Construction Accounting and Auditing Update for
  • Views from the IRS on the Industry
  • IRS has release new industry guide March 2005
  • Criminal investigations involving contractors in
    2005 .256
  • IRS has web site with industry specialization
    including construction

Construction Accounting and Auditing Update for
  • Surety update and the Bond Market
  • Bond Market
  • Industry only bonding 40 of their work on the
  • Heavy highway bonds more than 80
  • Sampled contractors indicate bond credit remained
    the same as in 2004 ( for 2005 year)
  • General contractors are bonding less than 20 of
    subcontractors costs
  • Most contractors only using 1 surety company.
    Approximately 6 of the industry is uses more
    than one surety company in their programs

Construction Accounting and Auditing Update for
  • Surety Market
  • For 2006 continued tough underwriting guidelines
    for questionable financial results
  • Middle market contractors lt100,000 no sign of
  • Surety will be competitive for them
  • No significant price pressure ..some increases
  • Indemnity still negotiable
  • Mega contractors are viewed as most risky due to
    losses in the pass
  • Surety promises to sue CPAs on misleading
    financial statements

Construction Accounting and Auditing Update for
  • Accounting Principles New and Old
  • Percentage of Completion vs. CCM
  • PCM used when reasonable and dependable estimates
    exist with certain conditions
  • Contractual and estimates can be obtained
  • CCM use is narrow
  • Cannot obtain reasonable estimates under certain
    circumstances and
  • Financial position and operating results are not
    significantly different from PCM

  • 1.16

Construction Accounting and Auditing Update for
  • Accounting method vs. tax methods
  • Accounting methods
  • PCM
  • CCM
  • Tax methods
  • PCM
  • CCM
  • Cash method
  • Accrual method
  • Tax methods used in financial statements are
    under OCBOA rules

Construction Accounting and Auditing Update for
  • Provision for Losses on Uncompleted Contracts
  • The most ignored rule in construction accounting
  • This accounting principle carries the highest
    risk with surety companies
  • 80 of suits by sureties deal with this principle
    in some form
  • The calculation
  • Total projected loss loss to date contingency
    loss accrual on the financial statement presented
  • Accrual current liability and cost included in
    contract revenues earned

Construction Accounting and Auditing Update for
  • Indirect cost allocations
  • Cost need to be allocated to Cost of Revenues
    earned and preferably by contract
  • Classification of accounts between direct and
    indirect creat the most problems
  • Allocations need to be systematic and rational
  • Allocation methods are many
  • Presentation of these cost outside of Cost of
    Revenues earned cause sureties the most problem
    in estimating true profitability of jobs

Construction Accounting and Auditing Update for
  • Unbilled Receivable Issues
  • Many accountants do not address
  • IRS will address in audits along with cost
    capitalized with these costs ( not GAAP)
  • The issue is cutoff and consistency with use
  • Many times under billing are due to unbilled
  • It is best separate unbilled amounts for bonding
  • Special disclosure needed in the financial
    statement and policy footnote

Construction Accounting and Auditing Update for
  • Retainage issues
  • Recording is sometimes overlooked
  • Classification between short term and long term
    is an issue with bonding company
  • Do not forget the retainages associated with
  • Need to disclose amounts in the financial
    statement as part of receivable disclosure

Construction Accounting and Auditing Update for
  • Contingency accruals
  • Contract price contingencies
  • GAAP Accounting basic contract plus contract
    options, change orders , claims, provisions for
    penalties and incentives. Requires judgment in
    assessing probable outcomes
  • Tax- as a general rule everything is included
    even though the all events test has not been
    met. Look back will make up the difference in
    the year it is realized.

Construction Accounting and Auditing Update for
  • Contract Costing Rules
  • GAAP Accounting need to consider warranties,
    project guarantees, maintenance and other service
    agreements as accruable under contract costs (
    cost must be foreseen to be put in estimated
    costs to complete on contracts)
  • Tax cannot accrue as part of contract cost or
    others and will be disallowed until cost
  • Contingency costs are not deductible for tax

Construction Accounting and Auditing Update for
  • Issues in Financial Reporting Observed By Peer
  • Lack of Contractor statement terminology still
    being found
  • Backlog disclosure footnote ( recommended)
  • 90 day receivables and composition of AR
  • Retainage disclosures and subcontractors amounts
  • Provision for losses on contracts not addressed
  • Policy statement of costs and allocated costs
  • Revenue policy footnote
  • Related party disclosure and FIN 46 not addressed
  • Statement of Income not reconciled to job
    schedules in work papers ( a real surety risk)
  • Calculation for PCM not GAAP under SOP 81-1

  • 1.40

Construction Accounting and Auditing Update for
  • New FASB affecting the Industry
  • FASB 157 Fair Value Measurements
  • Guidance on measuring Fair Value Only
  • FMV is price that would be received to sell an
    asset or paid to transfer a liability in an
    orderly transaction between market participants
    at the measurement date
  • Differences between entry price and exit price
    under FAS 141
  • Assets measured highest and best use
  • Liabilities measured with nonperformance
  • Directly effects FMV determination for Business
    combinations FAS 141
  • Valuation techniques 1. market 2. Income 3. Cost
  • Input to valuation 1. observable and 2.
    unobservable inputs
  • Must prioritize inputs and consider 3 different
  • Effective for F/S issued after November 17, 2007
    for fiscal years beginning after that date.

Construction Accounting and Auditing Update for
  • FAS 154 Accounting Changes and Corrections of
  • Supercedes APB 20 and FAS 3 for accounting
  • Old rules required cumulative effect of the
    change in year of change as separate line on the
    income statement
  • New rules require retrospective restatement of
    prior years for all statements presented or from
    the earliest practical measurement date
  • Change in depreciation, amortization or depletion
    method is now a change in accounting estimate
    effected by a change in accounting principle (
    should only change in recognition of changes in
    estimated future benefits of the asset, patterns
    of consumption , or for information available
    about the future benefits)
  • Old rules for correction of errors and changes in
    accounting estimates are the same as old APB 20
  • Effective for fiscal years beginning after

Construction Accounting and Auditing Update for
  • FAS 153 Exchanges or Non monetary Assets ( amends
    APB 29)
  • APB 29 stated exchanges of non monetary assets
    should be measured based fair market value of the
    assets exchanged ( resulting in possible gain or
    loss) with a general exception for similar
    production assets
  • The new rule eliminates the old exception and
    replaces it with a new exception pertaining only
    to assets that do not have commercial
  • New definition- commercial substance means
    future cash flows of the entity are expected to
    change as a result of the exchange
  • This rule will effect and encompass PPE and other
    intangible assets( example under old rules a
    truck for a tractor was exempt now it is not if
    there is commercial substance)
  • Effective for fiscal years beginning after

Construction Accounting and Auditing Update for
  • Example
  • New asset FMV ( selling price) 10,000
  • Old asset FMV (appraisal or credit) 3,000
  • Cash or note pay for new 7,000
  • Cost basis of old 8,000
  • Acc depr of old 7,000
  • Basis 1,000
  • EntryCost of new asset 10,000
  • Acc deprec of old 7,000
  • Cost of old asset 8,000
  • Cash or note payable 7,000
  • Gain on disposition 2,000 (

Construction Accounting and Auditing Update for
  • FAS 151 Inventory Costs ( amends ARB 43 chapter
  • Applies consistent application of abnormal
    inventory as period expenses ( idle costs,
    spoilage, rehandling and double freight costs)
  • Old rules were unclear and could be interpreted
    and used differently ( possible capital vs.
    period costs)
  • This statement formalized consistently in the
    international and US community
  • Better defines capital vs. period costs also
  • Effect on contractors defines a little more the
    rules for inventory capitalization particularly
    in quarry operations or manufacturing operations)
  • Effective for fiscal years beginning after

Construction Accounting and Auditing Update for
  • FAS 146 Accounting for Costs Associated with Exit
    or Disposal Activities ( nullifies EITF 94-3
    related to employee termination benefits and
    certain costs for restructuring)
  • Old rule states. Liability was recognized at the
    date of an entitys commitment to an exit plan.
  • New rule says liability recognized when the
    liability is incurred
  • Conclusion liability is not recognized at the
    date of commitment to a plan
  • Effect on contractors if businesses are sold or
    liquidated regarding employee liabilities or
    restructure costs (FAS141)
  • Effective for fiscal years ending after 12/30/2002

Construction Accounting and Auditing Update for
  • FAS 144 Accounting for Impairment or Disposal of
    Long-Lived Assets (supersedes FAS 121 and APB 30)
  • Two types of Long Lived assets to evaluate
  • LL Assets held and used
  • For LL assets to be held the rule is .impairment
    loss is recognized if the carry amount is not
    recoverable from its undiscounted cash flows.
    which is measured by the difference of carrying
    amount of the asset and the fair market value
  • This rule eliminates goodwill for consideration
  • Probability weighed cash flow estimated approach
    can be used to determine FMV
  • Assets identified as not being used but not for
    sale ( out of date or business changed)
  • You still must depreciate the assets

Construction Accounting and Auditing Update for
  • LL Assets to be sold
  • Value of LL assets held for disposal is the lower
    of the carry amount or FMV less cost of sale
  • LL Assets disposed of other than by sale
  • Requires depreciation to be abandoned
  • Impairment loss be recognized at date of exchange
    of similar asset or distributed to owners or spin
    off (measured by carry valve vs. FMV)
  • CPAs need to inquire about the status of
    equipment to apply this standard
  • Effective date for fiscal years ending on or
    after 12/15/2001

Construction Accounting and Auditing Update for
  • FAS 143 Accounting for Asset Retirement
  • Statement addresses the recording of obligations
    associated with the retirement of long lived
    assets and the associated retirement costs
  • Statement applies to all entities
  • It applies to the legal obligations associated
    with retirement of LL assets that result from
    acquisition, construction, development and the
    normal operations of LL assets
  • A legal obligation is a obligation that a party
    is required to settle as a result of laws,
    statute, ordinance or written or oral contract.
  • Obligations are to be recorded at FMV in the
    period it is incurred if a reasonable estimate
    can be made
  • This can be tricky in determining the period it
    is incurred
  • If you sold or retired at this moment Would you
    have an obligation?
  • For contractors it may include environmental
    clean up etc on sale of related assets
  • Concrete and quarry operations. Evaluate and
    book clean up for environmental and reclamation
  • Effective date way back when fiscal years
    beginning after 6/15/2002

Construction Accounting and Auditing Update for
  • FAS 142 Goodwill and Other Intangible Assets
    (Super cedes APB 17)
  • Goodwill and other intangible assets no longer
  • Impairment is now tested annually for fair value
  • A two step process (1) screen for impairment (2)
    measures the impairment
  • Other intangible assets that have finite useful
    lives will continue to be amortized over their
    useful lives
  • Unamortized intangible assets( have no finite
    life) must be tested annually by comparison of
    FMV to carry value
  • Specialized disclosures require changes in carry
    value, segregation of amortized and non amortized
    assets and 5 year amortization disclosure
  • Effective date way back when .. Fiscal years
    beginning after 6/30/2001

Construction Accounting and Auditing Update for
  • FAS 141 Business Combinations (Super cedes APB 16
    and FAS 38)
  • All business combinations are accounted for by
    the purchase method . Three things to do
  • Determine acquiring entity
  • Determine cost of acquired entity
  • Determine allocation of cost and liabilities of
    acquired entity
  • Three requirements Must now separate other
    intangible assets from Goodwill ( must identify)
  • Much better guidance on identifying the
    intangible assets
  • Disclosures require reasons for business
    combination and allocation of purchase price
  • Allocation rules did not significantly change but
    there are changes ( study the examples)
  • Effective fiscal years ending after 6/30/2001(
    way back when)

  • 2.10

Construction Accounting and Auditing Update for
  • Financial Interpretations ( FINs)
  • FIN 48 Accounting for Uncertainty in Taxes
  • Requires evaluations of uncertain tax positions
    if client is examined by the IRS
  • Need to incorporate the tax effect into the tax
  • Evaluation should be based on the merits of a
    technical tax position
  • General rule -It is greater than 50 chance it
    would happen on examination
  • CPA exposure- IRS examination results in
    additional tax not booked in previous financial
    reports for which you knew of the issue
    misleading financial statements
  • Effective date - NOW

Construction Accounting and Auditing Update for
  • FIN 46R Consolidation of Variable Interest
  • ( A Simple View Point)
  • Rules require three items
  • Identification of variable interest entity (VIE)
  • Identification of variable interest ( form of
  • Identification of primary beneficiary (PB)
  • If all three are present and identifiable then
    VIE is consolidated with the PB
  • FIN46R provides test and rules for identifying
    the three requirements above
  • USE PPC Related Party Program as practice aid (
    Appendix 2E)
  • Effective Now and it effects most all contractors
    is some fashion

Construction Accounting and Auditing Update for
  • Guidance Related to Natural Disasters ( Technical
    Practice Aid TPA section 5400.05)
  • This TPA gives you guidance for the following
  • Classifications in the income statement for
    losses incurred in a natural disaster (ND) ie
    Hurricanes !!!
  • Asset impairment evaluation for ND ( FMV vs carry
  • Liability recognition for non impairment losses
    associated with ND such as additional expenses
    required due to ND ( environmental issues etc)
  • Accounting for insurance recoveries ( income and
  • Additional disclosure requirements

Construction Accounting and Auditing Update for
  • Engagement Risk For Contractors
  • Understanding the Entity and Its Environment
  • Understand the construction industry
  • Know your client and their financial objectives
    and motives objectives
  • Identify the entities business risk
  • Many contractors lack proper internal accounting
    controls ( A significant Fraud Risk Factor)

Construction Accounting and Auditing Update for
  • Auditing Variable Interest Entities
  • December 2003 Issuance of FIN 46R
  • Issues are common to small and medium size
  • Note these related Staff Positions
  • Para. 13 FIN 46 on reporting VINs
  • Calculation of expected losses FIN 46
  • Evaluating holders of equity interest to
    determine if they have direct or indirect
    interests FIN 46R
  • Implementation issues related to Leasing

Construction Accounting and Auditing Update for
  • Provisions in Engagement letters to eliminate
    certain accountants liability with the client
  • AICPA ethics committee issues new ruling
    interpretation ET sec. 101.01
  • Certain types of liability provisions in
    engagement letters violate independence issues(
    i.e. elimination of actual damages from
    negligence or the clients negligence)
  • Other liability provisions would not impair
    independence ( i.e. clients knowing
    misrepresentations or willful misconduct or
    fraudulent behavior
  • Be sure you research unique changes you are
    making to your engagement letters to assure you
    are not jeopardizing your independence

  • 2.20

Construction Accounting and Auditing Update for
  • Internal Control Deficiencies
  • Most common deficiencies noted
  • Considerations of job site visits as it relates
    to controls on the job site
  • Internal control considerations related to
    bidding and estimating
  • Lack of sufficient evidence to support estimated
    cost to complete and controls designed to arrive
    at those estimates
  • Other Issues
  • Lack of competent personnel
  • Documentation related to income recognition

Construction Accounting and Auditing Update for
  • Companies are changing auditors at record rates
  • Be advised to conform to the requirements of AU
    Section 315
  • Get permission from the client to make inquiry
  • Make inquiries with the predecessor
  • Allow review of work papers if needed
  • Association with press releases in todays
    business environment
  • Just a word of caution Dont be associated if

Construction Accounting and Auditing Update for
  • Risk of Fraudulent Reporting and Improper
    Accounting Estimates
  • Review all significant of Contracts ( encouraged
    during review engagements)
  • Job Site visits to determine the status and
    completion percentage of a contract in progress (
    not required by highly recommended)
  • Auditing contract costs
  • Components of contract cost related to original
  • Proper classification of costs between contracts
  • Sufficient audit procedure on contract costs
  • Estimated cost to complete
  • Need to consider types of contracts
  • Fixed price ( high risk)
  • Cost plus ( lower risk)
  • Construction management ( can be high risk based
    on contract)
  • Design build ( more like cost plus) (lower risk
    but depends on contract)

Construction Accounting and Auditing Update for
  • Compilation and Review Engagements
  • Fraud and illegal acts
  • SSARS 12 requires understanding with client in
    the form of an engagement letter
  • Need to include separate paragraph in the
    engagement letter addressing your responsibility
    for detecting fraud
  • Rise in litigation risk in Compilation
    Engagements related to fraud
  • Perform procedures in STRICK CONFORMAMCE with
    SSARS with appropriate documentation
  • Re assess client acceptance and continuance
  • Talk to client about fraud and their risk and
  • Address in engagement letters

Construction Accounting and Auditing Update for
  • Industry Developments
  • Rising Interest rates, Energy costs , debt levels
    and softening housing market
  • Heights risk on issuing financial statements over
    recognition of income and going concern issues
  • Viability and liquidation risk
  • Overvaluation of assets and working capital short
    falls effecting job continuance and provision for
    loss considerations

Construction Accounting and Auditing Update for
  • Inventory obsolescence ( as if effects service
    contractors, quarry operators and manufacturers)
  • Customers with high levels of debts and negative
    working capital issues
  • Signals going concern issues and provision for
    losses on uncompleted contracts
  • Impairment and recoverability of assets
  • Equipment not in use ( FMV write downs)

Construction Accounting and Auditing Update for
  • Layoffs and Lack of Qualified Help
  • Ability of contractor to complete work going
    concern possible
  • Outsourcing ? not considered a big risk to the
    construction industry
  • Raising capital and Baby Boomer Transitions
  • More difficult for the construction industry
  • Consolidators are on the rise again mainly in the
    capital markets
  • Be careful of buyers who do not understand the
  • Observation -Pension plans are being liquidated
    or transitioned in to plans more controllable for
    funding by employers

Construction Accounting and Auditing Update for
  • Mergers and Acquisitions are heating up
  • FAS 141 has changed accounting methods for MA
  • Internal controls are perceived weaker with MA
  • Possibility of worsened financial performance
    with contractors consolidated as in the past
  • Statistic- 80 of buyers are paying more than
    exit price FMV
  • Attacks on IT
  • Fraud risk to accountants
  • Know your clients computer controls

Construction Accounting and Auditing Update for
  • Improper Accounting to be aware of
  • Revenue recognition ( percent complete
  • Accounting for insurance contracts ( self
    insurance arrangements with under funded
  • Business combination accounting ( to much value
    on amortizable intangible assets)
  • New Bankruptcy laws
  • Positives easier collection of debts
  • Negative harder to rid debt under ch. 11
  • Word of caution screen the law firms and get
    approved by the bankruptcy trustee before you
    pick up your pencil!!

  • 2.40

Construction Accounting and Auditing Update for
  • If you have questions or concerns I would be glad
    to talk to you individually
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