Content Area D, Conducting Accounting Functions, is 32% of the Business and Finance exam, the largest single area. Many of those questions assume you can read a balance sheet and an income statement and know where a given item belongs. This page covers the statements, the two accounting methods, and the construction-specific items (retainage, overbillings and underbillings) that trip people up.
The accounting equation
Assets = Liabilities + Owner's equity
Every statement question ultimately rests on this. If total assets are $850,000 and total liabilities are $510,000, owner's equity is $850,000 − $510,000 = $340,000.
The main statements
| Statement | Shows | Time frame |
|---|---|---|
| Balance sheet | Assets, liabilities and equity | A single date ("as of December 31") |
| Income statement (profit and loss) | Revenue, costs and expenses, net income | A period ("for the year ended December 31") |
| Statement of cash flows | Cash in and out from operating, investing and financing activities | A period |
| Statement of owner's equity (or retained earnings) | Changes in equity: income, distributions, contributions | A period |
The balance sheet is a snapshot. The income statement is a movie. That distinction is a frequent exam question.
The balance sheet
Classification table
| Item | Classification |
|---|---|
| Cash | Current asset |
| Accounts receivable (contract receivables) | Current asset |
| Retainage receivable | Current asset |
| Underbillings (costs and estimated earnings in excess of billings) | Current asset |
| Inventory, prepaid insurance | Current asset |
| Equipment, vehicles, buildings (net of depreciation) | Fixed (long-term) asset |
| Land | Fixed asset, not depreciated |
| Accounts payable | Current liability |
| Retainage payable (held from subs) | Current liability |
| Overbillings (billings in excess of costs and estimated earnings) | Current liability |
| Accrued payroll and payroll taxes | Current liability |
| Current portion of long-term debt | Current liability |
| Long-term notes and equipment loans (beyond 12 months) | Long-term liability |
| Owner's capital, retained earnings | Equity |
Current means within one year. This classification feeds directly into financial ratios like the current ratio and working capital.
The income statement
Worked example
Coastline Builders, LLC for the year:
| Line | Amount | % of revenue |
|---|---|---|
| Contract revenue | $2,400,000 | 100.0% |
| Cost of construction (direct job costs) | ($1,980,000) | 82.5% |
| Gross profit | $420,000 | 17.5% |
| General and administrative overhead | ($300,000) | 12.5% |
| Operating income | $120,000 | 5.0% |
| Interest expense | ($15,000) | 0.6% |
| Net income before taxes | $105,000 | 4.4% |
- Gross profit margin = gross profit ÷ revenue = $420,000 ÷ $2,400,000 = 17.5%
- Net profit margin (pre-tax) = $105,000 ÷ $2,400,000 = 4.4%
A common wrong answer subtracts overhead when computing gross profit. Gross profit is revenue minus direct (job) costs only.
Loan payments
On a loan payment, only the interest is an expense on the income statement. The principal portion reduces the loan balance on the balance sheet.
Cash method vs. accrual method
| Cash method | Accrual method | |
|---|---|---|
| Revenue recorded | When cash is received | When earned |
| Expenses recorded | When paid | When incurred |
| Matches revenue and costs | Poorly | Well |
| Shows receivables and payables | No | Yes |
Example
A contractor finishes and bills a $50,000 job on December 15 and collects on January 20. It bought $18,000 of materials on account in December and paid the supplier in January.
- Cash method: nothing on this year's income statement; $50,000 revenue and $18,000 expense next year.
- Accrual method: $50,000 revenue and $18,000 expense this year; $50,000 accounts receivable and $18,000 accounts payable on the December 31 balance sheet.
When materials are bought on credit under accrual accounting, the entry increases job cost (or inventory) and increases accounts payable.
Construction-specific items
Retainage
Retainage withheld by the owner is the contractor's retainage receivable, an asset. Retainage the contractor withholds from its subs is retainage payable, a liability. See retainage for Florida's rules.
Overbillings and underbillings
Under the percentage-of-completion method, revenue is earned as work progresses, but billings follow the contract's pay schedule. The two rarely match.
Worked example. A $1,000,000 contract has estimated total costs of $800,000. Costs to date are $400,000.
Step 1. Percent complete (cost-to-cost). $400,000 ÷ $800,000 = 50% Step 2. Earned revenue. 50% × $1,000,000 = $500,000 Step 3. Compare to billings. The contractor has billed $560,000. Step 4. Difference. $560,000 − $500,000 = $60,000 overbilled
An overbilling (billings in excess of costs and estimated earnings) is a current liability: the contractor has been paid for work it still owes. If billings had been $470,000, the $30,000 difference would be an underbilling, a current asset.
Heavy overbillings can make cash look healthy while the work is still owed. Heavy underbillings can signal billing delays or cost overruns. Sureties look closely at both.
Long-term contracts and taxes
For federal income tax, 26 U.S.C. 460 generally requires the percentage-of-completion method for long-term contracts, with exceptions (including certain home construction and smaller contractor contracts). The details are beyond most B&F questions, but know the method exists for tax as well as book purposes.
Statement of cash flows
| Section | Examples |
|---|---|
| Operating | Collections from customers, payments to subs and suppliers, payroll |
| Investing | Buying or selling equipment |
| Financing | Borrowing or repaying loan principal, owner contributions and draws |
Depreciation is added back to net income in the operating section (indirect method) because it is not a cash outflow. See depreciation.
Quick review
- Balance sheet = point in time; income statement = period.
- Assets = liabilities + equity.
- Overbilling = liability; underbilling = asset.
- Cash method records when cash moves; accrual records when earned or incurred.
- Gross profit = revenue minus direct costs.
Practice reading statements
Our Florida Business and Finance Exam Prep includes original balance sheet, income statement and over/underbilling questions with worked solutions, and 90 days of practice across the full exam. Also see job costing and estimating and the B&F exam overview.
Practice questions
Which financial statement shows a company's assets, liabilities, and equity at a specific point in time?
- AIncome statement
- BStatement of cash flows
- CBalance sheet
- DJob cost report
Show answer
Answer: C. The balance sheet is a snapshot on a given date. The income statement covers a period of time (revenue and expenses).
Source: Standard accounting principles
Which of the following is classified as a current asset?
- AConstruction equipment
- BLand
- CA 5-year note payable
- DAccounts receivable
Show answer
Answer: D. Current assets are expected to convert to cash within one year (cash, AR, inventory, prepaids). Equipment and land are long-term (fixed) assets; a note payable is a liability.
Source: Standard accounting principles
Total assets $850,000; total liabilities $510,000. What is owner's equity?
- A$1,360,000
- B$340,000
- C$510,000
- D$0.60
Show answer
Answer: B. Equity = assets − liabilities = 850,000 − 510,000 = $340,000. Adding them is a common mistake.
Source: Standard accounting principles
Under the cash method of accounting, an expense is recorded when:
- AThe bill is received
- BIt is paid
- CThe work is performed
- DThe job is completed
Show answer
Answer: B. The cash method records expenses when paid and income when received. Recording on receipt of the bill or when incurred is accrual accounting.
Source: Standard accounting principles
Billings in excess of costs and estimated earnings (overbilling) on a percentage-of-completion job appear on the balance sheet as:
- AA current asset
- BA current liability
- CRevenue on the income statement
- DOwner's equity
Show answer
Answer: B. Overbillings mean the contractor billed more than it has earned, so the excess is owed in future work—a liability. Underbillings (costs and earnings in excess of billings) are the current asset.
Source: Standard accounting principles
On a contractor's balance sheet, 'costs and estimated earnings in excess of billings' (an underbilling) is classified as:
- AA current asset
- BA current liability
- COwner's equity
- DContract revenue on the income statement
Show answer
Answer: A. An underbilling means the contractor has earned more than it has billed, a right to future billing, so it is a current asset. The opposite, billings in excess of costs and estimated earnings, is a current liability.
Source: Standard construction accounting principle (calculation verified in Python)
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