John Geraci, Managing Partner and Matt Touma, Manager talk about the importance of revenue recognition for construction companies, and the benefit of job costing. In the video, they talk about how it is important for business owners to be able to understand their financials and being able to leverage them their benefits.
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Transcription for the Video
(John Geraci) I’m here with Matt Touma today from our Accounting and Auditing Department here at LGA and I wanted to spend a few minutes talking about revenue recognition in the construction space and just how important it can be to business owners who are trying to understand their financial statements but maybe haven’t converted to a system that makes sense yet. So, if we could just spend a couple of minutes just talking about that.
(Matt Touma) I think the main revenue recognition policy, everyone is familiar with is percentage of completion. It’s at its core the best way to match revenue and expenses over the course of a long-term contract. It does apply to other long-term contract businesses, but construction’s where you see it the most.
(John Geraci) Yeah, and a lot of clients, they have a tendency to do sort of a hybrid where sometimes it’s cash basis, sometimes it’s accrual basis, but it’s only a accrual basis to the extent that they’ve billed a customers for their recording accounts receivable, but that’s not enough is it?
(Matt Touma) Accrual as great, but with long-term contracts, the expenses and the timing of the billings doesn’t always match up. So, what happens is you get this roller coaster effective, huge profits in one month and a huge loss the next month. That’s not realistic to how the business is actually going over the course of that contract. So what that does is, it eliminates the issues of the time at the billings and mismatching the revenue and expenses. And it allows you to kind of use cost as the driver. What happens is now we assign a margin to what we think we’re going to make on the contract as a whole. And as we incur, the costs we’re allowed to take some of that margin in at that time versus being kind of limited by when the buildings are actually allowed, and that eliminates that roller coaster, and creates more of a gradual, you know, profit margin across the whole contract.
(John Geraci) And that’s very important because right now with the economy is strong as it is, everybody’s making money, it seems like in the construction space. And what you want to do is prepare for a time where the margins do start to get squeezed on your contracts. And so, if you don’t have this accounting method implemented today, when the tide starts to turn, and contracts get tighter, you could lose a lot of money if you’re not accounting for these contract costs more timely.
(Matt Touma) It can be so valuable to a bunch of different places across the organization, whether it be project managers or the owner of the business. It gives a lot more information. Information is power, right? So, it gives the ability for everyone to see a little bit more into the jobs as it’s going versus doing it, you know, sometimes people just do it at the end of the year and that’s great for the financial statements, but the benefit of doing it continually, can really have a lot of benefits across. Just even be able to head off problems with jobs and get ahead of things or fix problems or it’s kind of a continual process, not something where you said in forget it. With a profit margin, you kind of have to keep your eye on having jobs doing as a whole.
(John Geraci) Yeah, makes sense. And obviously what it does is you is, you indicated is it allows you to run some interference if a job is going sideways more timely. So, you can have, if you have added scope conversations that need to be occurring, you actually are aware that that’s happening and can do something about it before it’s too late.
(Matt Touma) Exactly, getting the buy in from a bunch of different levels of the organization from the PM’s up to the accounting is important and it’s valuable too. It’s a lot of people in a lot of work sometimes, but bringing the PM’s in, the people on the job, into the conversation, all of a sudden now they get the benefit of this accounting method that now they get to use that to kind of help the jobs along.
(John Geraci) Makes a lot of sense. So, if you’re finding yourselves, dealing with some of these situations, we want you to reach out, talk to LGA, reach out to Matt and see if we can get you on the right track.