What makes a contractor and his or her CPA "best in class?" According to Stephen J. Mannhaupt, a member and past chair of the NYSSCPA’s Construction Contractors Committee, they are those who classify as many costs as possible into direct costs when putting a bid together.

In doing so, “you have less subjectivity and can track items better,” Mannhaupt said. “It allows that contractor to measure his actual costs to the estimate costs at the end of the project and evaluate the success of the project.”

Contractors face many challenges when it comes to writing up bids and contracts, which may also cause headaches for the CPAs who use the contracts to create financial statements for their contractor clients. These concerns were the focus of a presentation Mannhaupt gave during the Construction Contractors Accounting, Consulting and Taxation Conference held today at the offices of the NYSSCPA.

Job Costs

Noting that “the financial statements of contractors mainly have to do with costs,” Mannhaupt said it is essential that CPAs “have an understanding of both direct and indirect costs.”

Direct costs are costs that can be correlated to individual jobs such as labor, materials, subcontracts and equipment. “Typically, this is not an issue with accountants and contractors,” Mannhaupt noted, because “if you didn’t have the contract, you wouldn’t have the costs.”

Indirect costs include overhead, such as insurance and supervision costs; labor burden, such as workers comp insurance, payroll taxes, travel and other reimbursable costs; and equipment, Mannhaupt said.

Equipment, Mannhaupt said, is considered a grey area because many contractors believe that once equipment is acquired it becomes an overhead cost. However, there are other costs related to equipment -- depreciation, maintenance, insurance and labor, among them. Rather than placing them in the overhead category, contractors should allocate the equipment costs to the job for which the equipment is being used, Mannhaupt said. That way, they can be considered direct costs.

According to Mannhaupt, all direct costs should be included in the contract. If contractors do not post these costs properly, management won’t know where it stands on a particular job and if there are issues, management cannot resolve them because they don’t have a clear picture of what the job should cost, he said. The CPA who has to file a contractor’s financial statement will not be able to report profit and losses correctly. If the CPA has to do an audit to identify risk, he or she will have an incomplete picture of job costs, Mannhaupt said.

“[CPAs] must make sure contractors are posting their costs properly and that they’re putting costs to the right jobs,” he said. “Make sure there’s a process involved for contractors to allocate costs to jobs so we can do our tests and assess risk.”

Claims and Change Orders

Changes and costs not anticipated at the beginning of a project may occur at any point in, or throughout, the life of a job, prompting contractors to file claims or change orders.

Claims and change orders can create a tricky accounting situation, Mannhaupt said.

A CPA has a better chance of getting a change order approved and included in the contract if it is done early, Mannhaupt said. “It will result in additional revenue if done right away and not at the end of the project.”

However, if the owner rejects the change order, the contractor and CPA can file a claim to recover the additional revenue, Mannhaupt said. In order to successfully file a claim, the contractor must have a detailed analysis of, and support for, the extra costs.

“A contractor can’t just say, ‘Oh the project got delayed but I don’t know why,’” he noted. “Claims have to be based on hard facts and [CPAs] have to be satisfied that the claim is going to be approved before they file it.”

“Take a look at the cost report so that you’re comfortable that the claim will be approved when you issue that financial statement,” Mannhaupt continued. Contractors should get in a habit of planning for a claim so they have a process for it, he said. Once they recognize changes or additional, unanticipated costs, they should start putting those costs aside to be identified later on with the claim.

Anticipated Losses and Impairment

Contractors should also have a process for managing anticipated losses, Mannhaupt said, which could be due to a change in the market or economy that would affect a project. Rather than waiting until the end of a project, he said the entire loss should be recorded in the period when it was recognized, even if the loss hadn’t yet occurred.

For example, if a contractor recognizes an anticipated loss in the first year of a three-year project, the contractor must record that loss in the first year.

Also directly related to a negative change in the marketplace is measuring for impairment. Impairment is when the value of a long-lived item such as equipment or land adversely changes compared to its fair value. The change could be a decline in the asset’s market value, physical damage or change in the extent of its use, Mannhaupt said.

“This is a good time to go through this now as the marketplace is changing and the value of equipment has declined,” he said. “There needs to be an analysis done on items [subject to impairment] when preparing financial statements.”

Idle Equipment and Consolidation

Idle equipment may not be the result of an economic change, but could be costing contractors money and should be accounted for. Costs related to depreciation, insurance, maintenance and storage of idle equipment add up, Mannhaupt said.

These costs can’t be added to direct job costs because they would distort actual project costs and conceal a source of waste, he said. Instead, contractors can buy new equipment at the start of a job and sell it when the job is complete. Or, they can open a separate company that owns the equipment so that the second company can lease the equipment out when it is not being used as a part of a project.

The only thing to watch out for in this case is the possible need to consolidate, he said. According to Mannhaupt, if one company has economic control over the other but no ownership or voting control, the two will have to consolidate based on new Financial Accounting Standards Board’s Interpretation No. 46(R), Consolidation of Variable Interest Entities rules.