TROUBLED PROJECTS

During the accounting review, another comment caught your attention. The manager mentioned that one of the large POC consulting projects with National Bank seemed to be running well behind schedule. Their originally planned completion dates were getting near, and more than 90% of the cost had been expended. However, there was discussion with the project manager that the project was just about three-fourths complete and the client was not satisfied with the recent deliverables.

The original price in the contract was for $240M to complete a 1-year project to modernize Nationals retail banking mobile application and the estimated cost of the project was $180M.The payments were negotiated to be made in three equal payments. The first $80M was paid at the end of month 4 (after completion of requirements definition).The second payment was made at the 8-months mark when the design phase ended. At the end of December, the project had been running for 9 months. CPC had collected $160M (the first two payments) from the client.The cost incurred was $130M and the total revenue recognized was $173.3M.

You have called a meeting with the project management team and it is March 15^th and you are reviewing any concerns that may need to be addressed or clarified in the upcoming quarter close for the first quarter. Through the QCM (quarterly certification of management) meetings with the business unit leaders and accounting you have gathered the following information.

- According to the project manager, the project had an original cost estimate of $180M including $10M of contingency yielding a 25% gross profit margin.Through February, the team has expended $160M and in the past two months has been running at $15M/month which is primarily labor (internal and contractor) spending. He believes that by the end of March the project will have incurred $175M.This would leave only $5M of to-go cost based on the original estimates. He has estimated that completion of the project would require 4 additional months (after March) and additional cost of $60M for a total revised cost to complete of $235M.

During your meeting with the project manager and a discussion of how the project has overrun the original estimates by a whopping $55M ($65M if you include the expenditure of contingency) you learn that there was some ambiguity in the original agreement and scope of the project. The client had some systems that interface with the mobile application which were not included in the original statement of work (SOW).National Bank believes the additional work on the additional interfaces should be included in the original price, but it is clear that this workload was not part of the original work and cost estimates. The CAPC project manager believes the additional interface work has added about $40M of cost and that they should pay for this. The balance of the overrun ($15-25M) was a result of some poor design work done early in the project that needed to be re-done. The project manager believes the client should pay $55M for this additional scope, but the client has already indicated in informal discussions that they have no additional funding for the project and any additional funding would require a Board approval.

-As you meet subsequently and privately with the services business unit CFO, he tells you that there are too many issues with this and the project is being suspended until an agreement canbe reached with the client. The client learns of this and refuses to make any more payments and is threatening to take legal action if the project isnt completed on time because they have deadlines to release the new application. The CAPC services business unit CFO believes the project managers estimates on additional cost to complete are reasonable and has met with the client who agrees they should pay something additional, but no agreement on the amount. Given this, he thinks we need to just stay the course on the current accounting and start client negotiations in April, after the current accounting close for 1Q is completed. He says there is no way to get client approval (which would require their Boards support) in the next two weeks.

With two weeks to go in the quarter you schedule a meeting with the services unit General Manager to discuss the current situation and options. In preparation, you feel it is important to understand the following:

1. Under standard POC accounting, what would be the revenue, cost and gross-profit recognized for the life of the project (inception-to-date) at the end of March if no changes are made to the project completion estimates (PCE or EAC estimates at completion)? What would they be if the project managers estimates of spending are accurate and the PCE is revised? What would that mean the 1Q entries would be? Even with the suspension of the project, it is estimated that $175M will be spent through March.
2. How do you feel about the Services CFOs suggestion to make the accounting entries for March and 1Q based on the original project plan (consistent with figures you calculated in #1 above)? He is concerned that we dont have any firm estimates for the cost to complete or for what additional the client might pay. Therefore, we should base the accounting entries on what we do know.
3. What would you propose to the CFO as the correct accounting for the first quarter? Does the argument that we dont have clarity on the projects future justify continuing with the current POC accounting?What are the critical pieces of information needed and what actions are required within the remaining two weeks of the quarter?
4. In your meeting with the Services General Manager, how do you suggest the services team, the client team and the project manager handle the situation with the project and the client in the coming weeks? Lay out a specific plan with alternatives and options.
5. How does the current behavior limit the organizations ability to recognize and correct these systemic issues in general?