Original air date: Sept. 20, 2017 Rebroadcast and recording info at http://www.mhmcpa.com Long-term construction contracts typically use the percentage-of-completion (POC) accounting method. A change in the profit margin for a long-term POC contract could be a cause of a concern, and if not addressed, may result in restatement of your financial statements. In this webinar, we will help you identify when a change in profit margin results from an error versus a change in estimate.

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CBIZ & MHM
Executive Education Series™
Construction – Error vs Change in Estimate
When Applying PCM Accounting to Long-
Term Construction Contracts
David LaRosa, Tony Hakes
September 20 and October 4, 2017

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About Us
• Together, CBIZ & MHM are a Top Ten accounting provider
• Offices in most major markets
• Tax, audit and attest and advisory services
• Over 2,900 professionals nationwide
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accounting firms
MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that provides audit, review and attest services, and works closely with CBIZ, a business consulting,
tax and financial services provider. CBIZ and MHM are members of Kreston International Limited, a global network of independent accounting firms.

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Disclaimer
The information in this Executive Education Series
course is a brief summary and may not include all
the details relevant to your situation.
Please contact your service provider to further
discuss the impact on your business.

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Presenters
David has 20 years of experience in public accounting servicing a
diversified client base of construction, manufacturing and real estate
companies. He is a member of the national construction industry
services group. He is the treasurer and member of the executive
committee of Associated Builders and Contractors of Eastern
Pennsylvania (ABC) and serves on the education committees for ABC and
the General Building Contractors Association of Philadelphia.
610-862-2398 • dlarosa@cbiz.com
DAVID LAROSA, CPA
MHM Shareholder

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Presenters
Tony Hakes, CCIFP, is a Lead Managing Director and Shareholder in the
Phoenix office of CBIZ & MHM, is the practice leader for the firm’s
Construction Industry Services Group, and also serves as the Attest
Practice Leader for the Phoenix office.
Tony has served a variety of clients, including GCs, heavy/civil
contractors, engineering firms, specialty contractors and real-estate
developers. He is a member of the AGC Financial Issues Committee, the
CFMA’s Emerging Issues Committee and chairs the Revenue Recognition
subcommittee of CFMA’s Emerging Issues Committee. Tony has been a
member of CFMA’s Valley of the Sun Chapter since 2003 and has served
as a board member, officer, and chair/member of various committees.
Tony is currently a board member for the Arizona chapter of the AGC.
602.650.6225 • ahakes@cbiz.com
TONY HAKES, CPA, CGMA, CCIFP
CBIZ Lead Managing Director
MHM Shareholder

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Agenda
Summary of PCM Accounting and Estimating
02
01
04
05
Identifying Contracts with Possible Errors
Applying changes to contracts in the financial statements
Questions
Factors to Avoid a Restatement03

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SUMMARY OF PCM ACCOUNTING AND ESTIMATING

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Summary of PCM Accounting and Estimating
Use of PCM is required by GAAP except in rare
circumstances
Conditions required to exist for use of PCM Method:
1) Reasonably dependable estimates can be made
2) The contract clearly specifies the enforceable rights of
both the contractor and the buyer, the consideration to
be exchanged, and the manner and terms of settlement
3) The buyer can be expected to satisfy its obligations under
the contract
4) The contractor can be expected to perform its contractual
obligations

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Summary of PCM Accounting and Estimating
Estimates
Position of FASB ASC 605-35-25-58 and 25-66 is essentially that:
(a) there is a basic presumption that construction contractors have the ability to
make estimates in the normal course of business and
(b) overcoming that presumption should be on a contract-by-contract basis and
requires specific persuasive evidence of inherent hazards.
Two characteristics of inherent hazards:
1. Occurrence of unusual events that would not be considered in the ordinary
preparation of contract estimates
2. They would not be expected to recur frequently given
the contractor’s normal business environment.

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IDENTIFYING CONTRACTS WITH POSSIBLE ERRORS

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Identifying Contracts with Possible Errors
Types of Errors in Estimating Contracts
Lookback Testing
Common explanation seen in working papers for profit fade –
• The estimate was not good
• We couldn’t get a change order for cost overruns
• Sequencing of the work caused delays
In each case more information is needed to determine the root
cause of fade. Let’s examine when the estimate was not good.

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Identifying Contracts with Possible Errors
Common Mistakes by Estimators
1. Missed items in bid (This is costly especially when a lump sum project is
awarded)
2. Wrong unit costs
3. Missed details on the construction plans such as sequencing
4. Incomplete costs left out such as logistics cost and taxes. Projects
performed in new locations or countries can be subject to local or VAT
taxes that can be a significant cost to the project.
5. General conditions are not properly calculated. General conditions or
preliminaries can run from 8% to 20% depending on the type and size of
projects.
6. Wrong man-hour productivity assumptions

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Lookback Testing
Look for contracts in which the gross margin changed by more than 20% for a
subcontractor and 10% for a general contractor from this originally estimated
gross margin. Changes this significant would indicate there was most likely an
error in the original estimate unless there is a corresponding change in the
contract value due to change orders. Need to perform extra inquiry and audit
procedures for changes when gross margin changes this significantly.
TRANSPARENCY!
Identifying Contracts with Possible Errors

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Identifying Contracts with Possible Errors
Internal Control Considerations
Management often is able to demonstrate good reason for a change in
accounting estimate. What constitutes a good reason and the adequacy of
support for management’s contention that there has been a change in
circumstances that warrants a change in accounting estimate are a matter of
judgement. Internal control deficiencies may indicate the revision would
more appropriately be deemed a correction of an error.

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FACTORS TO AVOID RESTATEMENT

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Factors to Avoid Restatement
Factors to Consider
1. Users are generally focused on the balance sheet
2. Magnitude in comparison to overall company contract revenues
3. Magnitude in relationship to the potential affects on:
Debt and equity covenants
Earnings trends
Management compensation
Character of the misstatement
Motivation of management
Future transaction involved with possible investors

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APPLYING CHANGES TO CONTRACTS IN THE
FINANCIAL STATEMENTS

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Applying Changes to Contracts in the Financial Statements
Change in Accounting Estimate
ASC 250-10-45-17 requires a change in accounting estimate to be
accounted for in the period the change occurs if the change
affects that period only or in the period of change and future
periods if the change affects both. A change in accounting
estimate shall not be accounted for by restating or
retrospectively adjusting amounts reported in financial
statements of prior periods or by reporting pro forma amounts
for prior periods.

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Applying Changes to Contracts in the Financial Statements
Correction of an Error
ASC 250-10-45-23 - Any error in the financial statements of a
prior period discovered after the financial statements are issued
or are available to be issued shall be reported as a error
correction, by restating the prior period financial statements.
Restatement requires all of the following:
a. The cumulative effect of the error on periods prior to those presented
shall be reflected in the carrying amounts of assets and liabilities as of
the beginning of the first period presented.
b. An offsetting adjustment, if any, shall be made to the opening balance
of retained earnings (or other appropriate components of equity or net
assets in the statement of financial position) for that period.
c. Financial statements for each individual prior period presented shall be
adjusted to reflect correction of the period-specific effects of the error.

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Applying Changes to Contracts in the Financial Statements
Example
Contract Estimated Estimated Estimated Earned Cumulative Gross
Amount Costs Gross Profit GP % Revenues Costs Profit
First Year Ending December 31, 2015
10,000,000$ 6,000,000$ 4,000,000$ 40% 5,000,000$ 3,000,000$ 2,000,000$
Second and Final Year Ending December 31, 2016
10,000,000$ 8,000,000$ 2,000,000$ 20% 10,000,000$ 8,000,000$ 2,000,000$
Job Recasted in 2015
10,000,000$ 8,000,000$ 2,000,000$ 20% 3,750,000$ 3,000,000$ 750,000$
Overstated Earned Revenues and GP in 2015 1,250,000$ 1,250,000$
XYZ CONSTRUCTION COMPANY, an S- Corp.

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Applying Changes to Contracts in the Financial Statements
Example (continued)
2016 Income Statement if change in estimate
Earned revenues 5,000,000$
Costs of earned revenues 5,000,000
Gross Profit -$

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Applying Changes to Contracts in the Financial Statements
Example (continued)
Assume Change in Estimate
Example Disclosure in the 2016 financial statements
Because of inefficiencies not known at the end of year one on a certain
contract, it was later determined that estimated total contract costs should
have been $8,000,000 instead of originally estimated at $6,000,000 and the
earned revenues and gross profit on the contract during the year ended
December 31, 2015 should have been $3,750,000 and $750,000 instead of
$5,000,000 and $2,000,000, respectively.

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Applying Changes to Contracts in the Financial Statements
Example (continued)
Assume Correction of an Error
Restatement of financial statements
During 2016, The Company determined that estimated total contract costs on
a contract should have been $8,000,000 instead of as originally estimated at
$6,000,000 and the earned revenues and gross profit on the contract during
the year ended December 31, 2015 should have been $3,750,000 and
$750,000 instead of $5,000,000 and $2,000,000, respectively. The Company
has restated its balance sheet, statement of income, changes in equity and
cash flows for the year then ended December 31, 2015, including the
cumulative impact of the corrected error at January 1, 2016 as an adjustment
to retained earnings.

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Applying Changes to Contracts in the Financial Statements
Example (continued)
Assume Correction of an Error
Retained
Earnings
Balance as of December 31, 2014 5,000,000$
Net Income (As restated) 750,000
Balance as of December 31, 2015 (As Restated) 5,750,000
Net Income 1,250,000
Balance as of December 31, 2016 7,000,000$
XYZ Construction Company
Statement of Changes in Equity

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QUESTIONS

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If You Enjoyed This Webinar…
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• 10/6: Accounting for Indirect Costs in Construction Contracts
• 10/17: Jousting with the IRS – Handling Federal Tax Controversy from Audit through
Litigation
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