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The following article was published in our article directory on March 8, 2014.
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Surety Bonds - The Legal and Accounting Aspects

Article Category: Business

Author Name: Gemma-Leigh Garner

Surety bonds are usually required by government agencies as part of the process in issuing a license to operate a business.

The U.S. government since 1983 has required contractors to get hold of surety bonds under the law known as the Miller Act (40 USC Secs. 3131-3134). The law requires two surety bonds on contracts exceeding $100,000. These are the performance bond and the labor and material payment bond. The bond issuers are in the Treasury List. Almost all 50 states, the District of Columbia and Puerto Rico and most local jurisdictions have enacted similar laws requiring surety bond on public works.

Financial Requirements for Surety Bonds

Accountant's Opinion Page - this discloses whether the statements were prepared according to audit, review, or compilation standards. Companies engage accountants to compile financial statements to help management examine financial results. The accountant's opinion states whether the financial statements were prepared in compliance with generally accepted accounting principles (GAAP) and that his audit was done according to generally accepted auditing standards (GAAS).

Balance Sheet - shows the assets, liabilities and net worth of the businesses of the date of the statement. This helps the surety company to assess the working capital and overall financial condition of the company.

Income Statement - this measures how well the business has performed. This statement tells you what the business made after accounting for revenues gained from sales and/or services and setting them off against expenses and costs distributed for the period. The costs distributed are those portions of fixed assets and other non-fixed assets utilized in the business. This is called depreciation. The surety company analyzes each item, including gross profit on contracts, operating profit, and net profit before and after tax provisions.

Accounts receivable and payable schedules - should reflect aging, indicating the period, maybe weeks, months or years after which the accounts are due and demandable.

Schedule of contracts in progress and contracts completed- shows the financial performance of each contract and offers insight into the potential for future earnings from contracts in progress.

Schedule of general and administrative e expenses - may reveal how well overhead expenses are controlled and managed.

Explanatory footnotes - these qualifications made by the accountant may comprise those for some accounts where there is not enough documentary evidence with which to make a reasonable verification.

Management letter - conveys the CPA findings, observations and recommendations about the contractors business.

The owner must formally declare the contractor in default in case this happens. Surety bonds companies conduct impartial investigations to protect the contractor's legal recourse in case of improper declaration of default. When proper, the surety bonds company's options are: (1) right to re-bid the job for completion; (2) bring in a replacement contractor, or (3) provide financial and/or technical assistance to the existing contractor.

Accounting Methods Involved in Surety Bonds

Complete and accurate accounting systems are extremely important to surety bonds companies. The American Institute of Certified Public Accountants (AICPA) Audit Guide for Construction Contractors recommends the percentage of completion method.

In the percentage of completion accounting method, the developer assigns a percentage of completion for the construction project. If the project is 50% complete, then the developer must recognize 50% of the total fees that will be earned on the project, even if the fees have not been paid.

The other method of construction accounting is the contract completion method where the developer does not recognize any revenue until the project is complete.

Keywords: surety bonds

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