Underbillings and overbillings refer to the difference between the revenue recognized by a contractor and the revenue billed to the customer for work that has been completed but not yet billed or paid for. These terms are often used in the context of a Work-in-Progress (WIP) report.
An underbilling occurs when the amount billed to the customer is less than the amount of revenue recognized by the contractor for the work that has been completed. This can happen when the contractor has not yet submitted an invoice for work that has been completed, or when the customer has not yet paid an invoice. Underbillings are also known as deferred revenue or unearned revenue.
An overbilling occurs when the amount billed to the customer is more than the amount of revenue recognized by the contractor for the work that has been completed. This can happen when the contractor has submitted an invoice for work that has not yet been completed, or when there is a billing error. Overbillings are also known as unbilled revenue. To calculate underbillings and overbillings in a WIP report, contractors compare the amount of revenue recognized to the amount of revenue billed. If the amount recognized is greater than the amount billed, the result is an underbilling. If the amount billed is greater than the amount recognized, the result is an overbilling.
For example, let's say a contractor has recognized $100,000 in revenue for a project but has only billed the customer $90,000. This would result in an underbilling of $10,000. Conversely, if the contractor has billed the customer $110,000 for the same project but has only recognized $100,000 in revenue, this would result in an overbilling of $10,000. Monitoring underbillings and overbillings in a WIP report is important for contractors because it helps them manage cash flow, track project profitability, and identify any potential billing errors or disputes with customers.
How under and overbilling tie into a percentage of completion financial statement Under and overbillings are directly tied to the Percentage of Completion (POC) financial statement, which is used to report the revenue and expenses associated with long-term projects that extend over more than one accounting period.
In a POC statement, the percentage of completion is calculated by dividing the costs incurred to date by the total estimated costs of the project. This percentage is then used to determine the amount of revenue that should be recognized for the project based on the work that has been completed. If the revenue recognized to date is less than the revenue that should have been recognized based on the percentage of completion, an underbilling occurs. Conversely, if the revenue recognized to date is more than the revenue that should have been recognized based on the percentage of completion, an overbilling occurs. Underbillings and overbillings are typically reported as separate line items on the POC statement, along with the actual revenue recognized to date and the estimated revenue that should be recognized for the entire project. The net effect of underbillings and overbillings is to adjust the revenue recognized to date to the amount of revenue that should have been recognized based on the percentage of completion.
For example, let's say a contractor has incurred $50,000 in costs for a project that is estimated to cost $100,000 in total. Based on this, the percentage of completion would be 50%, and the revenue recognized to date should be 50% of the total estimated revenue for the project.
If the contractor has only billed the customer for $40,000 of the work completed, this would result in an underbilling of $10,000. To adjust the revenue recognized to date to the correct amount based on the percentage of completion, the underbilling of $10,000 would be added to the actual revenue recognized to date.
In this example, if the actual revenue recognized to date was $45,000, the adjusted revenue recognized to date would be $55,000, which is 50% of the total estimated revenue for the project. This adjustment ensures that the revenue recognized on the POC statement accurately reflects the percentage of completion and the work that has been completed to date.
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