As soon as your firm wins a project, the project planning begins, and both the project and accounting teams become interested. The project management team schedules, executes, and authorizes client billing for the project, and the accounting team recognizes the revenue generated from completed work on the project.
But what determines the amount and method the project team must approve to get billed, and the amount of revenue that the accounting team is supposed to book? It’s the contract fee type. Let’s look at a few of the common contract fee types you might come across in an AEC firm.
For example, if you’re dealing with a Cost Plus contract type (also known as Time and Material), this means all time and expenses charged to the project are to be billed and accounted for as revenue. On the other hand, if a contract is written as a Cost Plus Maximum contract, this will function as a Cost-Plus contract, but the amount of time and expense will be limited to a certain value.
Those are pretty straight forward, but the next set of contract types can get a little tricky – so I’ll provide an example for each.
For Lump Sum or Fixed Price contracts, these specify a fixed amount that will be paid for services based on a percentage of completion, regardless of the time and expense attributed to fulfilling the service.
So, let’s say you have a fixed price contract of $10,000. Based on this contract, you will bill $10,000 for services rendered. Whether it costs $5,000 or $11,000 to complete the work, your firm will receive the fixed price of $10,000.
As work is executed, a percent complete invoice can be generated. When a percentage of the work completed is selected, an invoice of percent complete multiplied by $10,000 is sent for payment.
Only one more to go! For Cost Plus Fixed Fee contracts, these projects are built to reimburse your firm for two items: the cost of services and a fixed fee that is pre-defined by the contract. Here’s what I mean:
Imagine that you’re planning for an upcoming project, and your team’s salaries average $50 per hour. Since the project is estimated at 100 hours – the labor cost calculates as $5,000. Next, you’ll account for the cost to run the business. In this example, it’s 1.8 times the cost of your payroll, so your overhead calculates as $5,000 X 1.8 = $9,000. This makes your total cost $14,000 ($5,000 + $9,000).
Now for the fixed fee part. Your client gives you a fixed fee of $1,000, which brings your total cost plus fixed fee to $15,000 for the contract ($14,000 + $1,000).
This is the project overview part you need to be able to communicate. By understanding which fee type you’re working under, you can monitor the time and expense project details and alert the Project Manager when charges are approaching the contract fee limit. This can be a tremendous benefit to the project management team since it helps avoid project overruns that can be detrimental to the profitability of a project.
Once you’ve captured the time and expense details, it’s important to understand the meaning of revenue: Revenue, is the booking of income that is derived from completed work. In understanding the point at which your accounting team recognizes revenue, you can provide the proper revenue value they need for posting.