Why do you need to do CVRs?
Cost Value Reconciliations (CVR’s) are used across the construction sector and are the industry norm.
In managing construction projects, Cost Value Reconciliations (CVRs) play a crucial role in establishing profitability, monitoring performance, and identifying potential issues. To prepare a comprehensive CVR, it’s essential to recognise value accurately and consistently throughout the project lifecycle, and include a scenario management section (Best/Worst/Most likely). Accurate value recognition and consistent reporting can influence the amount of profit and loss reported. Calculating construction costs involves input and output methods, and it’s important to consider under measure and over measure, as well as advanced payments and retention. Regular cost meetings can help monitor project progress and address potential issues early on.
Accounting Rules
Both FRS105 and FRS102 have sections covering Construction, below are the rules from FRS102
23.17 When the outcome of a construction contract can be estimated reliably, an entity shall recognise contract revenue and contract costs associated with the construction contract as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period (often referred to as the percentage of completion method). Reliable estimation of the outcome requires reliable estimates of the stage of completion, future costs and collectability of billings.
23.22 An entity shall determine the stage of completion of a transaction or contract using the method that measures most reliably the work performed. Possible methods include: (a) the proportion that costs incurred for work performed to date bear to the estimated total costs. Costs incurred for work performed to date do not include costs relating to future activity, such as for materials or prepayments; (b) surveys of work performed; and (c) completion of a physical proportion of the contract work or the completion of a proportion of the service contract. Progress payments and advances received from customers often do not reflect the work performed.
Horror Stories
Carillion
Not producing CVR’s correctly can cause even the largest construction companies to fail
CIOB (Chartered Institute of Building) Global Review May 2018
“Accounting tricks”: How Carillion duped the market – Global Construction Review
Carillion used a variety of techniques to hide its ailing health and its “aggressive accounting” was only exposed when it revealed an £845m financial black hole in July 2017, MPs have concluded.
The UK’s second biggest construction firm before its January 2018 collapse consistently overestimated the profitability of its projects, counted as revenue uncertain cash that clients had not signed off, and hid its mounting debt to suppliers so as to appear more financially sound than it really was.
Carillion had a turnover of £5.2bn, Balfour Beaty held the top spot at £8.2bn
Mark Smith Groundworks
Its not just big companies, small Subcontractors need to do CVR’s too
Mark Smith v HMRC [2012] TC02321
https://financeandtax.decisions.tribunals.gov.uk//Aspx/view.aspx?id=6797
Mark Smith was trading as a builder who provided ground works for construction companies. He had an in house surveyor who produced his applications for payment, the clients surveyor certified the valuation within 3 weeks and the accountant recognised the value when certified. The contracts were fixed price and lasted up to 12 months, The business started as a Sole Trader and was subsequently incorporated.
HMRC opened an enquiry in 2001/2002.
The central issue before the tribunal related to Mark Smiths computation of profits.
(1)2000/01: additional profits of £43,189 giving rise to tax of £17,275.60
(2)2001/02: additional profits of £65,205 giving rise to tax of £24,972.02
(3)2002/03: additional profits of £73,889 giving rise to tax of £27,737.86
(4)2003/04:additional profits of £70,023 giving rise to tax of £27,503.41
(5)2004/05: additional profits of £70,000 giving rise to tax of 27,704.18
(6)2005/06: additional profits of £65,240 giving rise to tax of £26,735.44
(7)2006/07: additional profits of £45,541 giving rise to tax of £18,671.81
There was also a penalty determination in respect of 2004/05 in an amount of £8,311
What are the elements of a CVR?
Cost = Expenses incurred in a construction project
Value = Value of work undertaken (Revenue that can be recognised)
Profit – Value – Cost
Monthly Reporting Cycles
Reporting date is the month end cut off date
The CVR has 3 main sections
- Final Position
- To Date Position
- Period Position
Overarching principles
- Prepared on the basis of when Value is earned and cost incurred, not based on cash received/paid
- Prudence Concept
- Value – not overstated
- Costs – not understated
- The Final Position
- Needs to be based on the same scope of work, same program and duration
- Consider
- Measure (for example brick laying)
- Variations
- Claims such as delays
- Ignore
- Retentions unless the client is likely to retain it
- Bonuses until achieved and agreed
- Gain Share on Cost Reimbursable contracts
- Liquidated Damages unless the client is likely to apply them
“A subcontractor liability is the cumulative assessment of the subcontract cost that is due to them under the terms of their subcontract up to the month end cut off date”
Input Method – To Date Position
Cost to Date/Total Final Cost = Completion %
20000/100000 = 20%
Total Final Value x Completion % = Value to Date
Output Method – To Date Position
This based on the internal valuation
With this method its important to correct for any under to over measure based on timing
Problem areas are milestone payments and front loaded prelims as well as advance payments and retentions
Profit Recognition
Value to Date – Cost to Date = Profit to Date
Some Construction Companies don’t recognise any profit under more than 20% of the contract has been completed because they take the view that the outcome of the project isn’t certain
In addition any future losses are recognised immediately rather than carrying them forward and distorting profitability.
Terminology
Preliminaries – The easiest way to define preliminaries in construction is as a group of items necessary for a construction company or contractor to complete a project but that won’t become a part of the finished work—site overhead, scaffolding, powering the site, etc.
Enabling Works – these costs cover activities from site preparation, creation of access routes, and the installation of facilities like security fencing, ramps, and placing of signs.
Provisional Sums – A provisional sum is an allowance included in a construction contract to cover the estimated cost of certain work. The work covered by a provisional sum is usually specified in the contract documents. Provisional sums are usually used for work that is difficult to estimate, such as earthworks or specialist services.
How do you prepare a CVR?
Accounting Records
Its likely you will start with your accounting records, you will probably have a Job Costing System that will show you
- Applications for Payments/Authenticated Receipts/Self Billing/Certified Work
- Subcontract payments and invoices
- Wages
- Materials
- Overheads
- Budgets/Estimates
Adjustments
The accounts will cut of at the end of a month but will need adjusting
- Cost Accruals
- Internal v’s External Valuations
Basically you need to consider all the points in the previous section – What are the elements of a CVR
The end result needs to meet the requirements of the accounting standards…
Reliable estimation of the outcome requires reliable estimates of the stage of completion, future costs and collectability of billings.
steve@bicknells.net