Key takeaways
- Recording project costs as expenses is not just a matter of wrong numbers. The effects spread to equity, tax, loan conditions and the auditor's opinion.
- In an example where WIP is misstated by THB 500 million, the tax and penalty burden could total around THB 254 million, or about 2.54 times the tax assessed.
- If found in the same year, reverse the entry; if found across years, restate retrospectively under TAS 8.
- Prevent it with approval by the PM or QS, a monthly checklist and a quarterly reconciliation to the BOQ.
In property development, recording project costs during construction (work in progress, WIP) reflects the company's true financial position and performance. If costs that should be assets are recorded immediately as expenses, the impact is not limited to the figures in the financial statements. It becomes a chain of problems affecting tax, banks, auditors and long-term confidence.
Where the problem starts: incorrect accounting entries
When a company pays construction costs to a contractor, the entry should be an asset in the WIP account and should not affect the income statement until revenue is recognised on ownership transfer.
Correct entry
Dr WIP – Residential Project THB 100 million
Cr Cash / Accounts Payable THB 100 million
Incorrect entry
Dr Construction Expense THB 100 million
Cr Cash / Accounts Payable THB 100 million
As a result, the income statement immediately shows an additional loss of THB 100 million, even though that money is still held as unfinished construction work and is not an expense whose economic benefit has been used up.
The seven knock-on effects
1. Equity turns negative sooner than it should
Accumulated losses increase by the amount of the misrecorded WIP, so equity is understated, while WIP on the asset side is understated by the same amount. The consequences include:
- Company law: Section 1172 of the Civil and Commercial Code provides that if a company loses half of its capital, the directors must call a general meeting without delay to inform the shareholders. Check your duties with legal counsel when this applies.
- Loan conditions (bank covenant): Net worth below the required level may constitute an event of default.
- Credibility: Customers, employees and business partners may lose confidence in the company's financial stability.
2. WIP in the financial statements is understated
By transfer day, the WIP used as the base for calculating COGS is lower than the true figure. COGS per square metre is therefore understated, gross profit is overstated, and corporate income tax in the transfer year is higher than necessary.
3. Phantom profit and the tax burden
Recording WIP as an expense in the construction year makes that year's loss excessive and creates a tax loss carry-forward larger than the entitlement should be. By the transfer year, cost of sales is understated, which raises taxable profit. At the CIT rate of 20%, WIP misrecorded by THB 500 million involves tax of THB 100 million. The net result depends on how far the carried-forward loss can still be used.
4. Breach of loan covenants
- Minimum net worth: Equity falls below the specified level.
- Debt-to-equity ratio: When equity is negative, the ratio loses its usual meaning, and whether it breaches the covenant depends on the wording of the agreement.
- Interest coverage ratio: EBIT is abnormally low because of the over-recorded expenses.
Consequently, the bank may request an explanation and restated financial statements. The company must negotiate a waiver of the conditions and, in the worst case, the bank may demand early repayment of the entire loan (loan acceleration).
5. The auditor's opinion
If WIP is found to be materially understated (material misstatement), the auditor may issue a qualified opinion or, if the effect is pervasive across the financial statements, an adverse opinion. The bank may refuse to accept the financial statements, and the Revenue Department may select the company for an in-depth audit.
6. Retrospective tax assessment
When an anomaly is found, such as an unusually high loss compared with BOQ progress, the officer may audit retrospectively, reclassify the expenses back to WIP, disallow losses already used, and levy tax together with penalties and surcharges. The audit period depends on the type of tax and the facts of each case, so check with a tax adviser.
Example of the burden from WIP misrecorded by THB 500 million Assume the loss has been fully used to offset profit, with a surcharge of 1.5% per month for 3 years and a penalty of 1 times the tax.
| Back corporate income tax: 500 × 20% | THB 100 million |
| Surcharge: 100 × 1.5% × 36 months | THB 54 million |
| Penalty: 100% | THB 100 million |
| Approximate total | THB 254 million |
The rates in the example are for illustration. An actual calculation must be checked against the Revenue Code and the penalty-reduction rules in force at the time.
7. Distortion of the loss carry-forward
Tax losses arising from the misrecording increase the carry-forward beyond what is due. If they are used to offset tax in a profitable year and the Revenue Department finds the error later, that portion of the loss will be cancelled, and the company must pay additional tax together with penalties and surcharges, in the same way as in item 6.
Severity of the impact
| Level | Impact |
|---|---|
| Mild | Equity is unusually low, which affects the company's image |
| Medium | Loan covenant triggered, requiring a waiver to be negotiated |
| Medium | The auditor issues a qualified opinion, and there are costs of restating |
| Severe | Corporate income tax overpaid in the year revenue is recognised |
| Severe | Retrospective tax assessment with penalties and surcharges |
| Critical | The bank demands early repayment of the entire loan |
Remedies and prevention
Found in the same accounting year
If found before the annual closing, reverse the entry immediately: Dr WIP – Residential Project / Cr Construction Expense, for the amount misrecorded. The financial statements will again show the correct position before the audit.
Found across accounting periods (prior period error)
Follow TAS 8 on accounting policies, changes in accounting estimates and errors: restate the financial statements retrospectively, disclose in the notes to the financial statements, inform the auditor and the bank, and consider filing additional tax returns with a tax adviser.
Long-term preventive measures
- Every contractor invoice is approved by the project manager or QS before being recorded
- Use a WIP capitalisation checklist to check completeness every month
- Reconcile the WIP balance to progress against the BOQ every quarter
- The CFO reviews the WIP schedule before the annual closing
Conclusion
The burden in the example above works out at about THB 0.51 per THB 1 of misrecorded WIP, and about THB 2.54 per THB 1 of tax assessed. This does not include the effects on credit and credibility. It is therefore a risk for which project management must put tight internal controls in place. Setting up accurate accounting systems from the start is always worth more than fixing problems later.