GVA » Topics » Critical Accounting Estimates

These excerpts taken from the GVA 10-K filed Feb 26, 2008.
Critical Accounting Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience; however, actual amounts could differ from those estimates.

Certain of our accounting policies and estimates require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from construction contracts, the valuation of certain assets and insurance estimates. We evaluate all of our estimates and judgments on an on-going basis.

Revenue Recognition for Construction Contracts: Our contracts with our customers are primarily either “fixed unit price” or “fixed price.” Under fixed unit price contracts, we are committed to provide materials or services required by a project at fixed unit prices (for example, dollars per cubic yard of concrete poured or cubic yards of earth excavated). While the fixed unit price contract shifts the risk of estimating the quantity of units required for a particular project to the customer, any increase in our unit cost over the expected unit cost in the bid, whether due to inflation, inefficiency, faulty estimates or other factors, is borne by us unless otherwise provided in the contract. Fixed price contracts are priced on a lump-sum basis under which we bear the risk that we may not be able to perform all the work profitably for the specified contract amount. The percentage of fixed price contracts in our backlog increased from approximately 68.0% at December 31, 2006 to approximately 72.0% at December 31, 2007. All state and federal government contracts and many of our other contracts provide for termination of the contract for the convenience of the party contracting with us, with provisions to pay us for work performed through the date of termination.
We use the percentage of completion accounting method for construction contracts in accordance with the American Institute of Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Revenue and earnings on construction contracts, including construction joint ventures, are recognized using the percentage of completion method in the ratio of costs incurred to estimated final costs. Revenue in an amount equal to cost incurred is recognized prior to contracts reaching 25% completion. The related profit is deferred until the period in which such percentage completion is attained. It is our judgment that until a project reaches 25% completion, there is insufficient information to determine what the estimated profit on the project will be with a reasonable level of assurance. In the case of large complex design/build projects we may continue to defer profit recognition beyond the point of 25% completion based on an evaluation of specific project risks. The factors considered in this evaluation of risk associated with each design/build project include the stage of design completion, the stage of construction completion, status of outstanding purchase orders and subcontracts, certainty of quantities, certainty of schedule and the relationship with the owner.

Revenue from contract claims is recognized when we have a signed settlement agreement and payment is assured. Revenue from contract change orders, which occur in most large projects, is recognized when the owner has agreed to the change order in writing. Provisions are recognized in the statements of income for the full amount of estimated losses on uncompleted contracts whenever evidence indicates that the estimated total cost of a contract exceeds its estimated total revenue. Contract cost consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct overhead costs and equipment expense (primarily depreciation, fuel, maintenance and repairs). Depreciation is provided using accelerated methods for construction equipment. Contract cost is recorded as incurred and revisions in contract revenue and cost estimates are reflected when known. The completion threshold for the start of contract profit recognition is applied to all percentage of completion projects unless and until we project a loss on the project, in which case the estimated loss is immediately recognized.
 
The accuracy of our revenue and profit recognition in a given period is almost solely dependent on the accuracy of our estimates of the cost to complete each project. Our cost estimates for all of our significant projects use a highly detailed “bottom up” approach and we believe our experience allows us to provide materially reliable estimates. There are a number of factors that can contribute to changes in estimates of contract cost and profitability. The most significant of these include the completeness and accuracy of the original bid, costs associated with added scope changes, extended overhead due primarily to owner and weather delays, subcontractor performance issues, changes in productivity expectations, site conditions that differ from those assumed in the original bid (to the extent contract remedies are unavailable), the availability and skill level of workers in the geographic location of the project and a change in the availability and proximity of equipment and materials. The foregoing factors as well as the stage of completion of contracts in process and the mix of contracts at different margins may cause fluctuations in gross profit between periods and these fluctuations may be significant. Substantial changes in cost estimates, particularly in our larger, more complex projects have had and can in future periods have a significant effect on our profitability.
 
Valuation of Real Estate Held for Development and Sale and other Long Lived Assets: Real Estate held for development and sale and other long-lived assets, which include property, equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We assess impairment of long-lived assets in accordance with FAS No. 144, “Impairment of Long-Lived Assets” (“FAS 144”). Circumstances which could trigger an impairment review include, but are not limited to: significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; or current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.
 
Recoverability is assessed based on the carrying amount of the asset and its fair value, which is generally determined based on the sum of the cash flows expected to result from the use and eventual disposal of the asset. An impairment loss is recognized in the Statement of Income when the carrying amount is not recoverable and exceeds fair value. In 2007, our analysis determined that a $3.0 million portion of our real estate held for development and sale was impaired. As a result, we recorded this amount as an impairment charge in the quarter ended December 31, 2007.

The process of estimating future cash flows related to an asset involves significant judgment, including future cash inflows related to the use or eventual sale of the asset and future cash outflows related to the development or use of the asset.  Although we believe the estimates and assumptions we used in testing for impairment are reasonable and supportable, significant changes in any one of our assumptions could produce a significantly different result.
 
Insurance estimates: We carry insurance policies to cover various risks, primarily general liability and workers compensation, under which we are liable to reimburse the insurance company for a portion of each claim paid. The amounts that we are liable for generally range from the first $250,000 to $1.0 million per occurrence. We accrue for the estimated ultimate liability for incurred losses, both reported and unreported, using actuarial methods based on historic trends modified, if necessary, by recent events. Changes in our loss assumptions caused by changes in actual experience would result in a change in our assessment of the ultimate liability that could have a material effect on our operating results and financial position.
 
Critical Accounting Estimates




 


The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Our estimates, judgments and assumptions are
continually evaluated based on available information and experience; however,
actual amounts could differ from those estimates.



Certain
of our accounting policies and estimates require higher degrees of judgment than
others in their application. These include the recognition of revenue and
earnings from construction contracts, the valuation of certain assets
and insurance estimates. We evaluate all of our estimates and judgments on an
on-going basis.



Revenue Recognition for Construction
Contracts
: Our contracts with our customers are primarily either
“fixed unit price” or “fixed price.” Under fixed unit price contracts, we are
committed to provide materials or services required by a project at fixed unit
prices (for example, dollars per cubic yard of concrete poured or cubic yards of
earth excavated). While the fixed unit price contract shifts the risk of
estimating the quantity of units required for a particular project to the
customer, any increase in our unit cost over the expected unit cost in the bid,
whether due to inflation, inefficiency, faulty estimates or other factors, is
borne by us unless otherwise provided in the contract. Fixed price contracts are
priced on a lump-sum basis under which we bear the risk that we may not be able
to perform all the work profitably for the specified contract amount. The
percentage of fixed price contracts in our backlog increased from approximately
68.0% at December 31, 2006 to approximately 72.0% at December 31, 2007. All
state and federal government contracts and many of our other contracts provide
for termination of the contract for the convenience of the party contracting
with us, with provisions to pay us for work performed through the date of
termination.


We use
the percentage of completion accounting method for construction contracts in
accordance with the American Institute of Certified Public Accountants Statement
of Position 81-1, “Accounting for Performance of Construction-Type and Certain
Production-Type Contracts.” Revenue and earnings on construction contracts,
including construction joint ventures, are recognized using the percentage
of completion method in the ratio of costs incurred to estimated final costs.
Revenue in an amount equal to cost incurred is recognized prior to contracts
reaching 25% completion. The related profit is deferred until the period in
which such percentage completion is attained. It is our judgment that until a
project reaches 25% completion, there is insufficient information to
determine what the estimated profit on the project will be with a reasonable
level of assurance. In the case of large complex design/build projects we may
continue to defer profit recognition beyond the point of 25% completion based on
an evaluation of specific project risks. The factors considered in this
evaluation of risk associated with each design/build project include the
stage of design completion, the stage of construction completion, status of
outstanding purchase orders and subcontracts, certainty of quantities, certainty
of schedule and the relationship with the owner.



Revenue
from contract claims is recognized when we have a signed settlement agreement
and payment is assured. Revenue from contract change orders, which occur in most
large projects, is recognized when the owner has agreed to the change order in
writing. Provisions are recognized in the statements of income for the full
amount of estimated losses on uncompleted contracts whenever evidence indicates
that the estimated total cost of a contract exceeds its estimated total revenue.
Contract cost consists of direct costs on contracts, including labor and
materials, amounts payable to subcontractors, direct overhead costs and
equipment expense (primarily depreciation, fuel, maintenance and repairs).
Depreciation is provided using accelerated methods for construction equipment.
Contract cost is recorded as incurred and revisions in contract revenue and cost
estimates are reflected when known. The completion threshold for the start
of contract profit recognition is applied to all percentage of completion
projects unless and until we project a loss on the project, in which case the
estimated loss is immediately recognized.

 

The
accuracy of our revenue and profit recognition in a given period is almost
solely dependent on the accuracy of our estimates of the cost to complete each
project. Our cost estimates for all of our significant projects use a highly
detailed “bottom up” approach
and we believe our
experience allows us to provide materially reliable estimates.
 There are
a number of factors that can contribute to changes in estimates of contract cost
and profitability. The most significant of these include the completeness and
accuracy of the original bid, costs associated with added scope changes,
extended overhead due primarily to owner and weather delays, subcontractor
performance issues, changes in productivity expectations, site conditions that
differ from those assumed in the original bid (to the extent contract remedies
are unavailable), the availability and skill level of workers in the geographic
location of the project and a change in the availability and proximity of
equipment and materials. The foregoing factors as well as the stage of
completion of contracts in process and the mix of contracts at different margins
may cause fluctuations in gross profit between periods and these fluctuations
may be significant. Substantial changes in cost estimates, particularly
in our larger, more complex projects have had and can in future
periods have a significant effect on our profitability.


 



Valuation of Real
Estate Held for Development and Sale and other Long Lived
Assets: 
Real
Estate held for development and sale and other long-lived assets, which
include property, equipment and intangible assets, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.
We assess impairment of long-lived
assets in accordance with
FAS No. 144,
“Impairment
of Long-Lived Assets”
(“FAS 144”). Circumstances which could trigger an impairment review include, but are not limited to: significant decreases in
the market price of
the
asset
; significant adverse
changes in the business climate or legal factors; accumulation of costs
significantly in excess of the amount originally expected for the acquisition or
construction of the asset; current period cash flow or 
operating losses combined with a history of losses
or a forecast of continuing losses associated with the use of the asset; or
current expectation that the asset will more likely than not be sold or disposed
of significantly before the end of its estimated useful
life.

 

Recoverability is assessed based on the carrying amount of
the asset and its fair value, which is generally determined based on the sum of
the cash flows expected to result from the use
and eventual disposal of the asset. An
impairment loss is recognized in the Statement of
Income when the carrying amount is not recoverable
and exceeds fair value. In 2007, our analysis determined
that a $3.0 million portion of our real estate held for development and
sale was impaired. As a result, we recorded this amount as an impairment
charge in the quarter ended December 31, 2007.



The process of estimating future cash
flows related to an asset involves significant judgment, including future cash
inflows related to the use or eventual sale of the asset and future cash
outflows related to the development or use of the asset.  Although we
believe the estimates and assumptions we used in testing for impairment are
reasonable and supportable, significant changes in any one of our assumptions
could produce a significantly different result.

 

Insurance estimates: We
carry insurance policies to cover various risks, primarily general liability and
workers compensation, under which we are liable to reimburse the insurance
company for a portion of each claim paid. The amounts that we are liable for
generally range from the first $250,000 to $1.0 million per occurrence. We
accrue for the estimated ultimate liability for incurred losses, both reported
and unreported, using actuarial methods based on historic trends modified, if
necessary, by recent events. Changes in our loss assumptions caused by changes
in actual experience would result in a change in our assessment of the ultimate
liability that could have a material effect on our operating results and
financial position.





 



This excerpt taken from the GVA 10-K filed Mar 4, 2005.
Critical Accounting Estimates

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience; however actual amounts could differ from those estimates.

      Certain of our accounting policies and estimates require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from construction contracts, accounting for

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construction joint ventures, the valuation of long-lived assets and insurance estimates. We evaluate all of our estimates and judgments on an on-going basis.

      Revenue Recognition for Construction Contracts: The majority of our contracts with our customers are either “fixed unit price” or “fixed price”. Under fixed unit price contracts, we are committed to provide materials or services required by a project at fixed unit prices (for example, dollars per cubic yard of concrete poured or cubic yards of earth excavated). While the fixed unit price contract shifts the risk of estimating the quantity of units required for a particular project to the customer, any increase in our unit cost over the expected unit cost in the bid, whether due to inflation, inefficiency, faulty estimates or other factors, is borne by us unless otherwise provided in the contract. Fixed price contracts are priced on a lump-sum basis under which we bear the risk that we may not be able to perform all the work profitably for the specified contract amount. The percentage of fixed price contracts in our backlog has increased from approximately 51.0% at December 31, 2003 to approximately 58.0% at December 31, 2004. All state and federal government contracts and many of our other contracts provide for termination of the contract for the convenience of the party contracting with us, with provisions to pay us for work performed through the date of termination.

      We use the percentage of completion accounting method for construction contracts in accordance with the American Institute of Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Revenue and earnings on construction contracts, including construction joint ventures, are recognized on the percentage of completion method in the ratio of costs incurred to estimated final costs. Revenue in an amount equal to cost incurred is recognized prior to contracts reaching 25% completion. The related profit is deferred until the period in which such percentage completion is attained. It is our judgment that until a project reaches 25% completion, there is insufficient information to determine what the estimated profit on the project will be with a reasonable level of assurance. Revenue from contract claims is recognized when we have a signed settlement agreement and payment is assured. Revenue from contract change orders, which occur in most large projects, is recognized when the owner has agreed to the change order in writing. Provisions are recognized in the statement of income for the full amount of estimated losses on uncompleted contracts whenever evidence indicates that the estimated total cost of a contract exceeds its estimated total revenue. Contract cost consists of direct costs on contracts, including labor and materials, amounts payable to subcontractors, direct overhead costs and equipment expense (primarily depreciation, fuel, maintenance and repairs). Depreciation is provided using accelerated methods for construction equipment. Contract cost is recorded as incurred and revisions in contract revenue and cost estimates are reflected in the accounting period when known. The 25% threshold is applied to all percentage of completion projects without exception unless and until we project a loss on the project, in which case the estimated loss is immediately recognized.

      The accuracy of our revenue and profit recognition in a given period is almost solely dependent on the accuracy of our estimates of the cost to complete each project. Our cost estimates for all of our significant projects use a highly detailed “bottom up” approach and we believe our experience allows us to produce materially reliable estimates. However, our projects can be highly complex and in almost every case the profit margin estimates for a project will either increase or decrease to some extent from the amount that was originally estimated at the time of bid. Because we have many projects of varying levels of complexity and size in process at any given time (during 2004 we worked on over 4,600 projects) these changes in estimates can offset each other without materially impacting our overall profitability. However, large changes in cost estimates, particularly in the bigger, more complex projects in our Heavy Construction Division, can have a more significant effect on profitability.

      There are a number of factors that can contribute to changes in estimates of contract cost and profitability. The most significant of these include the completeness and accuracy of the original bid, recognition of costs associated with added scope changes, extended overhead due to owner and weather delays, subcontractor performance issues, changes in productivity expectations, site conditions that differ from those assumed in the original bid (to the extent contract remedies are unavailable), the availability and skill level of workers in the geographic location of the project and a change in the availability and proximity of materials. The foregoing factors as well as the stage of completion of contracts in process and the mix of contracts at

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different margins may cause fluctuations in gross profit between periods and these fluctuations may be significant.

      Construction Joint Ventures and Other Variable Interest Entities: As described in Note 5 of the “Notes to the Consolidated Financial Statements” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” under “Joint Ventures,” we participate in various construction joint venture partnerships in order to share expertise, risk and resources for certain highly complex projects.

      We have determined that certain of the construction joint ventures as well as certain other partnerships in which we participate are variable interest entities as defined by Financial Accounting Standards Board Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities” (“FIN 46”) and we have consolidated those for which we are the primary beneficiary on a prospective basis effective January 1, 2004 (see Note 5 of the “Notes to the Consolidated Financial Statements”). Consistent with industry practice and Emerging Issues Task Force Issue 00-01, “Investor Balance Sheet and Income Statement Display under the Equity Method for Investments in Certain Partnerships and Other Ventures”, we account for our share of the operations of construction joint ventures in which we have determined we are not the primary beneficiary on a pro rata basis in the consolidated statements of income and as a single line item in the consolidated balance sheets.

      Determining whether an entity is a Variable Interest Entity (“VIE”) and whether we are the primary beneficiary involves a substantial amount of estimation and judgment, including estimates of the amount and timing of future cash flows. Although we believe that the estimates and judgments we used are reasonable and supportable, the use of different assumptions and estimates could produce a different result. The decision as to whether or not to consolidate a joint venture has an impact on the amount of recorded revenue, contract costs, assets and liabilities but has little or no impact on recorded net income.

      Valuation of Long-Lived Assets: Long-lived assets, which include property, equipment and acquired identifiable intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment evaluations involve management estimates of asset useful lives and future cash flows. Actual useful lives and cash flows could be different from those estimated by management and this could have a material effect on our operating results and financial position.

      Additionally, we had approximately $27.9 million in goodwill at December 31, 2004, $18.0 million relating to HCD and $9.9 million relating to our Branch Division. We perform goodwill impairment tests on an annual basis and more frequently when events and circumstances occur that indicate a possible impairment of goodwill. In determining whether there is an impairment of goodwill, we calculate the estimated fair value of the reporting unit in which the goodwill is recorded using a discounted future cash flow method. We then compare the resulting fair value to the net book value of the reporting unit, including goodwill. If the net book value of a reporting unit exceeds its fair value, we would measure the amount of the impairment loss by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. To the extent that the carrying amount of a reporting unit’s goodwill exceeds its implied fair value, we recognize a goodwill impairment loss. We performed our annual impairment test in 2004 and we determined that no impairment had occurred. The discounted future cash flow method used in the first step of our impairment test involves significant estimates including future cash inflows from estimated revenues, future cash outflows from estimated project cost and general and administrative costs, estimates of timing of collection and payment of various items and future growth rates as well as discount rate and terminal value assumptions. Although we believe the estimates and assumptions that we used in testing for impairment are reasonable and supportable, significant changes in any one of these assumptions could produce a significantly different result.

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