The Pay Application That Looks Better Than the Job
You are the project manager for a general contractor on a $2,400,000 lump-sum office fit-out with 10% retention. At the end of month 6 the owner's representative has approved a pay application showing $1,440,000 billed to date (gross). Your job cost report shows $1,350,000 in incurred and committed cost, and your superintendent's current cost-to-complete worksheet puts total cost at completion at $2,520,000. The schedule shows the job 52% complete by activity. Cash is tight: the owner pays 45 days after approval of each pay application, and you have been using the overbilling as working capital to mobilize the next job. Your accountant asks whether she can book a profit on this job this quarter.
1. Using the cost-to-complete figures, compute percent complete, earned revenue, projected gross margin, and your current over/under billing position. What are the numbers telling you?
Read the worked answer
Percent complete by cost = $1,350,000 ÷ $2,520,000 = 53.6%
Earned revenue = 53.6% × $2,400,000 = ~$1,285,700
Margin on work earned to date = $1,285,700 − $1,350,000 = −$64,300
Projected gross margin at completion = $2,400,000 − $2,520,000 = −$120,000
Billing position = $1,440,000 gross billed − $1,285,700 earned = ~$154,300 overbilled (net of retention you have billed $1,296,000, still ahead of earned value).
Three things follow:
- The job is upside down already. Cost is being consumed faster than revenue is being earned, and the $120,000 projected overrun is a known loss, not a risk.
- Cost-based completion (53.6%) is running ahead of schedule-based completion (52%). That divergence is the signature of a productivity or buyout problem, not a billing problem.
- Overbilling is a liability, not an asset. It is cash you have collected for work you have not performed. It will unwind as earned revenue catches up to the contract price, and because cost is running $120,000 above revenue, the final months of the job will consume cash rather than generate it.
2. The accountant wants to book a profit for the quarter. What do you tell her, and what do you do about the cash cushion?
Read the worked answer
Tell her no - and go further: the job should carry an accrued loss of $120,000 in the current period.
- Under the usual construction accounting convention, an anticipated loss on a contract is recognized in full as soon as it becomes evident, not spread over the remaining work. Booking profit on a job with a known cost overrun misstates both earnings and the balance sheet.
- The overbilling is already sitting on the books as a liability (billings in excess of costs and estimated earnings). Do not let anyone reclassify it as margin.
- Practically: model the cash curve. The $154,000 cushion reverses between roughly 70% and 100% completion. That is a cash hole landing right when you are mobilizing the next job. Do not use this overbilling to fund mobilization, and do not let it fund distributions.
- Fix the underlying problem now: re-forecast cost-to-complete monthly, review the buyout on remaining packages, and find out whether the overrun is labor productivity, a bad subcontract, or a scope gap.
3. The owner's representative asks to audit the schedule of values because billings appear to run ahead of installed work. How do you respond?
Read the worked answer
Cooperate fully and fix it prospectively - you cannot defend a front-loaded schedule of values.
- Most contracts require each pay application to reflect the value of work actually in place. A certified application for $1,440,000 against $1,285,700 of earned value is, at minimum, a billing dispute and, at worst, a false certification problem if you signed a certification of accuracy.
- Do not stonewall. Produce the cost report, the SOV backup, and a reconciliation showing installed quantities. Propose an adjusted SOV going forward that tracks earned value, and accept a reduced current billing if the owner insists.
- Recognize the leverage shift: once the owner's rep documents overbilling, every future pay application gets scrutinized, retention release gets held, and in any later dispute the overbilling becomes evidence that your numbers cannot be trusted - including on the change orders you will need.
- Internally: whoever is certifying pay apps ahead of installed work needs to stop, regardless of the cash pressure.