Case Data

American Construction, Inc. (American) enters into three types of contracts during the course of an accounting period. The contracts include new construction of commercial projects, remodeling existing commercial buildings, and retro-fitting industrial plants.

American usually enters into contracts to build commercial structures, but occasionally will build school projects. The cost structures for these two types of contracts are very similar even though one is for private industry and the other for the public. These types of contracts, referred to by the company as commercial work, generate the largest volume of work - most of which is subcontracted. Subcontractors provide labor and equipment for their portion of the work, but American supplies a good portion of the material. The company installs formwork for structural concrete with its own labor force. The company rents incidental equipment for the typical job. This cost is included in job overhead.

Contracts to perform commercial remodel work include labor and materials only for demolition and civil work. The clients enter into a direct contractual relationship with specialty contractors for all other work required by the remodel. Though these contracts are obtained through a lump sum bid, the clients understand the nature of remodel work. They realize the projects will encounter unforeseen work complications necessitating change orders, and are willing to accept and pay for these changes.

Contracts to perform industrial retro-fit projects are for labor only for demolition and civil work. The industrial clients enter into direct contract with each specialty trade. They provide all materials and much of the construction equipment, as needed. This work is done on a time basis; that is, American keeps track of labor time (and cost) and then marks up the job for overhead and profit when billing the client.

Americans management prefers new construction of commercial projects. The work is clean and neat with none of the inherent problems of remodel and retro-fit work. They are in complete control of all phases of the job. Subcontractors work for them and not the client. The projects are long-term in nature and have the potential to generate substantial profit for the company. The only down-side to this market is that Americans competition prefers this type of work, also. Typically, this bid work is very competitive.

The commercial remodel work is messy and many times the clients agent does a poor job scheduling the various trades. However, these schedule delays caused by the client constitute an acceptable change order so American is assured of a decent gross profit from these projects. None of Americans project managers like to manage these jobs because of the constant communication required with the client.

The industrial remodel work generally takes place when the plant is closed in the evenings, on weekends, and during holidays. Who wants to work during those times? Again, Americans project managers and field employees hate these jobs even though the field labor is paid overtime. The good thing is that they are always profitable.

The company experienced rapid growth from 2005 ($4,000,000 in revenue) through 2007 ($14,000,000 in revenue). The increase in growth was largely due to an increase in sales generated by the commercial new work market. The company was unable to sustain this growth during 2008 and revenues slipped to $10,000,000, resulting in a before-tax loss of $50,000 even though most construction projects showed a gross profit.

Americans management wants to determine the cause of this loss. The management decides that a profit center analysis of the company income statement could provide useful information to help answer this question and possibly also provide insight to correct the problem. In addition, the data from the profit center analysis for 2008 along with other financial analysis data could be used to prepare a more realistic operating budget for 2009.

Problems

1. Suppose three profit centers are identified by Americans management commercial new work (CNW), commercial remodel (CR), and industrial retro-fit (IR). Perform a profit center analysis of the 2008 company income statement as shown in Table 4.2 on the next page and fill the cells with red question mark by applying the following information (HINT: You may refer to the Example and Table 4.1 of Study Guide 4 in textbook on Pages 4-9 and 4-10):

Account	CNW	CR	IR
Earnings (3/31/08)	$7,000,000	$2,500,000	$500,000
Cost of Construction
Job Labor	$630,000	$620,000	$350,000
Job Materials	$2,620,000	$1,380,000	0
Subcontracts	$3,200,000	0	0
Job Overhead	200,000	0	0
Total Job Costs	$6,650,000	$2,000,000	$350,000
Gross Profit	$350,000	$500,000	$150,000

Company autos and trucks are driven by the general management, project managers, and site supervisors. All other employees provide their own transportation. Only five vehicles are required to perform new construction projects. Fourteen vehicles are required for commercial remodel projects and six vehicles for industrial retro-fit work.

The communications expense reflects the purchase and maintenance of cell phones used by the managers above.

Interest expense reflects interest on vehicles as well as interest to support work-in-progress. Because of a time lag between the payment of an expense and the receipt of cash, the company is typically in a negative cash flow position throughout most of the job. Money needs to be borrowed (and interest incurred) to pay for job costs.

Insurance expense reflects insurance to own and operate vehicles and to support work-in-progress.

The company rents an additional 4,000 square feet of space to operate ($44,000). The new construction profit center requires 3,000 square feet, and the balance is split equally between the other two profit centers.

Management uses the default base when the above data is not appropriate for allocating an individual company expense account to profit centers.