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To accrue or not accrue costs at year end with unsigned agreements

We have subcontractors working for us for the first time in 3 years. They have completed about 15% of the work based on a rough estimate. The subcontractor agreement has not been executed and will not be executed until the related contract with the customer is executed. So the question is, if the subcontractors have gone ahead and started the work, knowing that the customer contract has not been signed, do I accrue expenses for the subcontractors at year end for the work they have done so far? We are not recognizing any revenue in 2015 for this contract as the contract is not yet signed and also there are milestones in the contract (the first 1/3 is on signature, the second 2/3s are with milestones). I understand the matching principle indicates that we wouldn't accrue the subcontract costs but it seems odd to not accrue costs knowing that the subcontractors have done work. One item that may be relevant is that the subcontractors know, and indeed it is stated in their contract, that they will not be paid until we are paid. Thanks for any help!

Answers

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

"One item that may be relevant is that the subcontractors know, and indeed it is stated in their contract, that they will not be paid until we are paid."

That is surely a decision and a "way of doing business" that the company can take. It however creates an ETHICAL dilemna (at least for me).

If it were me, at the very least, I would have a provision (with the contractors) that at least I pay them a certain percentage of work done if the contract is not signed. Kind of a way of SHARING THE RISK. At most, I would pay them for the work done and the company bears the risk. The company is benefited if the contract is signed (as you are ahead of the work) and the company bore no risk. All the risk (at least at this point) is on the contractors.

I guess my point is, to accrue or not to accrue is dependent on what I said above and you will be fine doing one or the other.

To me the first question should not be to accrue or not. It should be, is this the way we want to do business and the way we want to deal and treat our contractors? And yes, even if the contractors are aware of the risk.

Lyle Newkirk
Title: CFO
Company: Corrigo Incorporated
(CFO, Corrigo Incorporated) |

I clearly would not pay without a subcontractor agreement. But, you have to ask yourself if it is likely that you will eventually pay and if the payment is for services rendered prior to the end of the year. If so, I would definitely accrue at least for work done then work out getting appropriate signatures.
There is an exception to the above: If somebody from your company told the subcontractors to do the work even though the subcontractor agreement was not executed, you need to look at the facts and see if there is an obligation to pay. If there is that obligation, you should accrue but withhold payment until at least you have an agreement with the subcontractors.

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Lyle, there IS a subcon agreement and it does say that the subcons will NOT get paid until the company is paid.

My comment/response was a call to look beyond "obligation to pay" and look at the moral or ethical ways of doing business.

But that is just me.

Kim Zarraga
Title: Accounting Manager
Company: Bio-Rad Laboratories
(Accounting Manager, Bio-Rad Laboratories) |

The question is do you have a liability at the end of the year? If your sale doesn't happen, you may still have an obligation based on a verbal agreement with your subcontractor to pay for work completed. You should accrue for this liability if it exists.

Anonymous
(Director, Finance and Business Administration) |

Thank you all for your answers so far.

The question is not one of ethics, it is whether or not to accrue at year end.

The subcontractors are very aware of the risk of the customer not signing the agreement and chose to start work anyways (with the company's blessing) without a signed agreement in place.

There is no verbal agreement with our subcontractor to pay for work completed; if we don't get paid, they don't get paid.

So do I accrue at 12/31/2015, given there is no revenue recognized in 2015? But knowing that they did work for a contract which in all likelihood will get signed (it is in final IT approval stages on the customer side)

Thanks.

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

It is! You just choose (or view) it NOT to be. And I should reiterate....you and your company are well within your rights to do so and continue to do business however you want. I am just pointing out that the risk is borne by the contractors and the company has everything to gain without the risk/cost. Even if the contractors are aware of the risk/s.

Please note that this is not a dig on you or your company (I apologize if it appeared that way) but a general commentary on how we treat our employees/contractors or how we do business. (Reference to my comments on a previous discussion about company credit cards).

To answer your question....I recommend accruing.

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Not trying to be holier than thou but I try to question "accepted" business concepts and practices that has evolved to be the "norm". This is part of my skills and strengths as fresh set of eyes for CEOs/Boards. As you can see from my posts, my views are not always mainstream.

As CFOs we have the power to change the norm even if the concept/practice evolved from an innocent beginning. If it involves opening eyes to the ethical aspect, so be it.

Just because the contractors are willing not to be paid or take the risk does NOT mean you should. Again, I apologize.

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

Emerson, you, I and others that post here regularly understand the value of having a CFO from outside a particular industry or sector.

You said it; Fresh Eyes. For some strange reason, and I'm at a loss as to which group or title feels otherwise, but they always want the next CFO to be a clone.

Very foolish.

Jeff McGlaughlin
Title: Corporate Controller
Company: Withheld
(Corporate Controller, Withheld) |

You should accrue. You have a substantive liability with the subcontractor. Though it is not in writing, there is an understanding between both parties that the work will be done and the subcontractor will be paid.

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