Construction Work in Progress

What is Construction Work in Progress?

Construction work in progress refers to the cost related to the work in progress of each incomplete work related to construction of long term assets and fixed assets. It is a debit balance and is treated as an asset in the future and thereby will be recorded on the assets side of the balance sheet under the head non-current (long term) asset till the construction is not completed. These costs are not depreciated in the books of accounts till the time the asset is fully ready to use and it’s been put into the service of the business.

How to Calculate?

The steps that are required to be followed while calculating construction work in progress are as follows:

Construction-Work-in-Progress

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Source: Construction Work in Progress (wallstreetmojo.com)

#1 – Percentage of Work Completed

It refers to the calculation of the percentage of work completedPercentage Of Work CompletedThe percentage of completion method is an accounting method for recognizing revenue and expenses for long-term projects that span over more than one accounting year. The revenue is recognized yearly as a percentage of work completed during that year. Revenue to be recognized = (Percentage of Work Completed in the given period) * (Total Contract Value) read more to date. The formula for the same is:

Percentage of Work Completed = Actual Costs till Date / Total Estimated Costs

#2 – Earned Revenue to Date

After calculating the percentage of work completed, the percentage is applied to determine the Total estimated Revenue to finally calculate the Earned revenue to date. The formula used is :

Earned Revenue till Date = Percentage of Work Completed * Total Estimated Revenue

#3 – Over/Under Billed Revenue

Now the third step is to calculate the over/under billed revenue where the same is calculated using the below-mentioned formula:

Over/Under Billed Revenue = Total Billings on Contract – Earned Revenue till Date

Example

Suppose we take an example of XYZ Ltd. to whom the seller P Ltd delivered the materials on 1st April 2020 to the job site and charged an amount of $400,000. So the journal entry would be:

Construction Work in Progress example 1

Next, on 5th April 2020, XYZ Ltd received an invoice from the transportation company for delivering materials at $5,000. So the journal entry would be:

Example 1.2

On 14 April 2020, XYZ Ltd. used some of his inventory in constructing the work of a building, and the inventory was priced at $10,000. So the journal entry would be:

Construction Work in Progress example 1.3

On 30th April 2020, seller D Ltd. supplied materials to the job site and charged and invoiced for $80,000. So the journal entry would be:

Example 1.4

On 9th May 2020, XYZ Ltd completed the building’s construction and put it into the service. The finance department summed the costs, and the total costs would be:

  • Seller P Ltd Invoice: $400,000
  • Seller D Ltd Invoice: $80,000
  • Inventory: $10,000
  • Transportation Bill: $5,000
  • Total: $495,000

So the journal entry would be:

Construction Work in Progress example 1.5

Construction Work in Progress Double-Entry

When the costs are added to the construction in progress, the construction in progress account is debitedDebitedDebit is an entry in the books of accounts, which either increases the assets or decreases the liabilities. According to the double-entry system, the total debits should always be equal to the total credits.read more with corresponding credits to accounts payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more, inventory, cash, or bank. When the construction in progress is completed, the corresponding long-term asset accountAsset AccountAsset Accounts are one of the categories in the General Ledger Accounts holding all the credit & debit details of a Company’s assets. The examples include Short-Term Investments, Prepaid Expenses, Supplies, Land, equipment, furniture & fixtures etc. read more gets debited, and Construction in progress account is credited. Hence, the double-entry systemDouble-entry SystemDouble Entry Accounting System is an accounting approach which states that each & every business transaction is recorded in at least 2 accounts, i.e., a Debit & a Credit. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits. read more is given both sides.

Entry to record the purchase of material:

Construction Work in Progress Double-Entry

Entry to record the completion of work:

Construction Work in Progress Double-Entry 2

Advantages

  • It gives a clear vision to the company for its future costs.
  • The construction work in progress helps to control unwanted costs.
  • The construction work in progress account measures all the expenses and allows its users to prevent wastage of money into miscellaneous areas.
  • They help the management to control its risk factors for future events.

Disadvantages

  • There can be some forecasting mistakes that management can make for which there can be mixed planning for future events.
  • Sometimes, there can be huge costs involved in this, which can be a costly arena for the company’s management.
  • The design costs also play a major role, which can affect the financial health of the company.

Conclusion

Construction work in progress is an account that measures everything about the costs, expenses, etc. when the construction is still on, i.e., the construction is still not completed, and the service is not put to use. This account helps the management to predetermine many costs and future billings so that it can plan all its expenses.

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