Managing work-in-progress
Is key in order to have accurate accounting records, from which bonuses are calculated, tax paid and profit extracted.
With partners in an LLP being taxed on their share of profits, and quarterly instalment payments of corporation tax potentially being required in limited companies, ensuring the accurate recognition of profit from on-going projects is essential.
Inaccurate treatment can lead to higher and earlier tax payments and cash flow issues. If retirement proceeds are linked to profitability, having the wrong estimates can prove extremely costly.
There are several key areas to consider when tracking and estimating the profitability of projects:
Variation orders
Many projects incur variations which cause an amendment to the overall fees charged and costs to be incurred. Communication between project team leaders and the accounts department is often the biggest here, but it is important to update profitability projections and budgets to ensure accurate recognition in the financial statements.
Percentage completion
Stages of completion are notoriously difficult to estimate as unforeseen challenges can arise at any time. However, regular updates of project progress should be communicated to the accounts team who can then update for variations and any unexpected issues. Percentage completion is all too often just based on the costs incurred compared to the initial expected costs of a project, whereas the reality is normally that the costs are not incurred on a pro-rated basis.
Estimates to complete
Often linked to percentage completion, but should be considered separately too. Projects may have different stages where costs are higher than others and a common issue is estimating a job is more complete in terms of end results than the time it takes to complete it. Not considering this can cause profit to be recognised too early which then impacts the following accounting period.
Error rates
WIP relies on estimations, so error rates should be applied to provide some margin for error. These are best applied from previous experience of total estimated costs vs actual costs incurred, adjusted for any one-off events or circumstances which may skew the figure. Calculating an average percentage difference between the initial profit estimates and the final outcomes seen in the previous accounting period and applying it to ongoing projects, should make the profit recognised more accurate.
Some practices are able to trace and predict their WIP accurately through the use of spreadsheets and regular dialogue with project managers, however we are seeing an increasing number of applications enter the market to assist firms.
Our Systems Advisory and Digital Transformation team can work with you to establish which, if any, WIP management application is best suited to you and your business, linking into the accounting system accordingly.
Posted in Blog, Property & construction