Accounting standards for reporting contract losses and construction claims
Last week the first circuit detailed the accounting standards applicable to long term construction projects in In re Stone & Webster, Inc., Securities Litigation. Download file
The court explained the three methods of recognizing profits on contracts under generally accepted accounting principles (GAAP): percentage-of-completion accounting, completed-contract method,zero-profit-margin approach. But the court also observed that contract losses should be recognized as soon as they become evident:
'When the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract should be made.' Such provision for losses should be made 'in the period in which they become evident.'
The full amount of a "probable" loss should be taken as a charge against income if the amount of the loss 'can be reasonably estimated,' If the amount of the loss cannot be reasonably estimated, 'disclosure of the contingency shall [instead] be made . . . indicating the nature of the contingency and . . . giving an estimate of the possible loss or range of loss' where possible.(citations omitted)
When a significant contract claim is made by a contractor, the owner's counsel should obtain through discovery the contractor's financial statement and the work papers of the contractor's auditor. These documents may undermine the contractor's credibility about when it knew it was being damaged and would experience an owner caused loss.