When a building contract is heading for a loss
How a contractor spots a contract heading for an overall loss, recognises the expected loss in its books, and updates its budget and its client.
By Achekam · · 4 min read · For Construction businesses in South Africa, Nigeria, Kenya
Nobody prices a job to lose money. The loss arrives quietly: rock where the geotechnical report said clay, steel prices that moved after the tender closed, a subcontractor who walked off site and had to be replaced at a premium, a programme that slipped into the rainy season. Each problem is explained away on its own. Then the quantity surveyor updates the cost to complete and the arithmetic is unavoidable: the contract will cost more than the client will pay.
What a contractor does at that moment, in its books and in its planning, decides whether the loss is contained or whether it grows unnoticed until the final account. This article sets out both.
Spotting the loss in revised estimates
A loss can only be recognised once someone has looked for it. AccountingTools advises that on long jobs the cost accountant should periodically compare accumulated job costs with the job budget and warn management early if costs are running ahead of projections. It notes that this gives management time to control costs or to approach the customer about a billing increase.
In practice, that means a monthly forecast for every significant contract:
- Revenue. The contract value, plus approved variations.
- Cost to date. From the ledger, agreed to supplier and subcontractor statements.
- Cost to complete. From the quantity surveyor or site agent, built up from the remaining work, not simply the original budget less what has been spent.
- Forecast result. Revenue minus cost to date minus cost to complete.
The danger is the third line. A cost to complete that is just the unspent budget assumes the rest of the job will go exactly to plan, which is precisely the assumption that has already failed.
Recognising the whole expected loss at once
AccountingTools states that when revised estimates show an overall loss on a construction contract, the contractor recognises the entire expected loss immediately. Not the share of the loss that relates to work done so far: all of it, in the period in which the loss becomes apparent.
That can feel harsh. A contract that is a third complete, with a loss forecast for the whole job, takes the whole loss now, even though most of the work that will cause it has not yet been done. The logic is that the books should not carry a contract at a value the contractor no longer expects to recover.
The accounting framework gets there by a particular route. ACCA explains that for performance obligations satisfied over time, the stage of completion is needed to calculate revenue to date, but IFRS 15 does not require the estimated profit or loss on the contract to be calculated except to determine whether the contract is onerous. A contract heading for an overall loss is the case where that calculation matters. ACCA's article on contract assets and liabilities under IFRS 15 explains how the revenue side is measured. Your accountant will decide exactly how the expected loss is measured and presented under the framework you report on.
Change orders in the revised contract value
Before concluding that a contract is loss-making, be sure the revenue side is complete. AccountingTools explains that approved construction change orders must be incorporated into revised contract values and cost estimates, while pending change orders may need separate tracking.
Approved variations go into the forecast revenue, with their costs in the cost to complete. Pending variations, still being argued, should be listed separately, with an honest view of how likely each is to be approved. A forecast that includes every variation the contractor hopes to recover is not a forecast; it is a negotiating position.
The journal and the budget update
Once the expected loss is agreed with your accountant, it is recorded with a manual journal. In Achekam a business can post manual journals; an unbalanced journal, or one dated in a closed month, is refused; and a posted journal is corrected only by a reversal. Typically the journal charges the expected loss to an expense account and credits a provision, which is then used up as the remaining costs are incurred. Your accountant will set the accounts and wording.
The budget should change too. A business can set a budget per account and period in Achekam and compare it with actual figures from its ledger. Revise the contract's cost budgets to the new cost to complete, so that from now on the comparison shows whether the revised forecast is holding, rather than measuring the job against a tender budget everyone knows is dead.
Management accounts then show an income statement for the period beside the period before, and a balance sheet at period end, built from the business's own journals and exportable as PDF or CSV. The month the loss is recognised will look bad. That is accurate, and it is better than a series of surprises later.
Talking to the client before the loss grows
The accounting is the easy part. The commercial response is harder and more valuable. Once the loss is known:
- Review every variation, delay and instruction for entitlement under the contract, and submit claims promptly.
- Talk to the client early. A client who hears about cost pressure while there is still room to change the specification or the programme may agree changes that reduce the loss.
- Tighten cost control on the remaining work: approvals for every purchase, weekly cost reports.
- Record what went wrong, so the next tender is priced on the lesson.
For making sure the job carries all its real costs, see which site and overhead costs belong to each job; for recovering what the client owes, read a progress claim valued below the work done.
A loss recognised early is a problem the business can manage. A loss discovered at the final account is one it simply has to absorb.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
