Making CPAs and Contractors Surety Underwriting Savvy

By Robert Mercado of CBIZ

Surety is a form of credit, not insurance. CPAs are the translators between a contractor’s books and an underwriter’s risk lens. When financial statements and contract schedules anticipate a surety’s adjustments, bonding capacity improves and surprises diminish. Below are CPA-specific angles that routinely move the needle: what to know about surety credit (bonding capacity), how assurance level affects bond lines, why GAAP beats tax-basis for most programs, and the red flags CPAs and contractors can accidentally create.

What CPAs and contractors should (but often don’t) know about surety credit

Surety credit rests on adjusted working capital, equity, job performance, and cash flow reliability. The headline number isn’t GAAP current assets minus current liabilities—it’s bondable working capital after conservative disallowances. Expect underwriters to haircut or exclude:

Aged receivables (especially greater than 90 days, although underwriters may have their own criteria for determining what is aged), related-party balances, and shareholder/affiliate receivables
Underbillings tied to unapproved change orders or weak documentation
Inventory and prepaid expenses that aren’t readily convertible to cash

The work-in-progress (WIP) schedule for projects in various stages of completion is the heart of the surety’s file. Sureties scrutinize job-level gross margins, cost-to-complete estimates, profit fade, and whether billings align with performance. A robust WIP package includes reconciliations to the general ledger, clear treatment of change orders (approved vs. unapproved), claims, and contingencies, plus a completed-contracts schedule to show historical margin integrity.

Practical tip: Present a reconciliation from GAAP working capital to bondable working capital and accompany the statements with a short narrative on backlog quality, cash flow drivers (retention timing, pay-when-paid clauses), and bank support. It signals you understand the underwriting model and reduces the surety’s need to “correct” the picture.

Compiled vs. reviewed vs. audited: why assurance level changes bonding limits

Compiled statements: The CPA compiles management’s information without providing assurance. Compiled financial statements may not always include the explanatory footnotes required by GAAP. For small programs or emerging contractors, a well-prepared compilation with strong WIP detail and notes can open the door, but bonding capacity is typically modest because the underwriter bears more information risk.
Reviewed statements: Limited (negative) assurance via inquiries and analytics. For many small-to-mid-market contractors, an industry-savvy review is the sweet spot: it provides an incremental level of credibility at a lower cost than an audit, while including the disclosures and WIP information sureties rely on. Reviews often support meaningfully higher single and aggregate limits than compilations do.
Audited statements: Reasonable assurance with testing, confirmations (e.g., receivables), inventory procedures when relevant, and deeper WIP scrutiny. Larger programs and more complex contractors usually need audits to achieve top-end capacity. The audit’s value isn’t just the opinion; it’s the depth of evidence on revenue recognition, cost-to-complete, contingencies, and compliance with covenants.

Across all levels, construction specialization matters. A compilation or review report issued by a construction industry-focused CPA over financial statements outperforms an audit performed by a CPA that is not construction industry-focused that may have lacked robust audit procedures around job-costing.

Tax-basis vs. GAAP: what sureties prefer and why

Sureties generally prefer GAAP financials with revenue recognized under the cost-to-complete framework (ASC 606), supported by a rigorous WIP disclosure requirement.

GAAP:

Matches revenue and cost recognition to project progress
Surfaces over/underbillings, margin fades, and cost-to-complete accuracy
Provides comparability across periods and contractors

Tax-basis statements often aim to minimize taxable income and may use methods that defer revenue (e.g., completed contract for tax), obscuring economic performance and inflating year-end liquidity. That can confuse the surety’s view of sustainable working capital and cash flow. If tax-basis reporting is required for other reasons, mitigate the drawbacks by:

Providing a GAAP-style WIP package with clear tie-outs
Reconciling tax-basis income to a GAAP-like view at the job and consolidated levels
Explaining material timing differences (retention, over/underbillings, long-term contracts, credits, etc.)

Some sureties will work with tax-basis statements when the WIP package and disclosures provide GAAP-like transparency. But for growing programs, GAAP with strong WIP is the most direct path to higher bond lines.

Red flags CPAs and contractors inadvertently create (and how to avoid them)

Stale or error-prone WIP: Out-of-date costs, math errors, or unexplained margin fade undermine credibility. Lock down controls and reconcile WIP to the general ledger each reporting period.
Underbilling without a story: Large underbillings tied to unapproved change orders or soft scope suggest collection risk. Separate approved from unapproved change orders and support the recoverability.
Aggressive revenue on claims/change orders: Recognizing revenue without enforceable rights draws scrutiny. Disclose methodology and constraints.
Accounts receivable quality issues: Aged receivables and retainage concentrations in distressed customers. Provide aging, retainage breakout, and subsequent (to the statement date)-collection analysis.
Leverage and covenant blind spots: Short-term debt, expiring lines, or covenant breaches not addressed in notes. Disclose debt availability and maturities, as well as covenant waivers and compliance as of and/or subsequent to the statement date.
One-time items inflating results: Credits (e.g., pandemic-era programs) or gains presented as recurring operating income. Present them separately, disclose one-time nature, and discuss normalization.
Lease accounting missteps: Missing or misclassified lease liabilities that quietly weaken ratios. Ensure completeness and clarity on lease terms and impacts.
Missing joint venture/variable interest entity detail: Unconsolidated joint ventures or guarantees left in the shadows. Provide corresponding information and disclosure of contingent obligations.
Thin disclosures and sparse footnotes: Surety underwriters read footnotes first. Include the footnotes required by GAAP, such as revenue policies, WIP methods, significant estimates, contingencies, and subsequent events.

Bottom line: In surety, clarity compounds. Construction-savvy financial statements, a disciplined WIP, and a proactive reconciliation to bondable working capital can materially expand a contractor’s capacity by improving the underwriter’s perception of the contractor’s financial acumen and understanding of the underwriting model. CPAs and contractors should work to anticipate the underwriter’s adjustments, spotlight durable cash flow, and remove ambiguity, so the surety can confidently say yes.

Robert Mercado is a Managing Director within CBIZ’s Assurance Services Division and serves as the Construction Assurance Group Leader and New England Regional Construction Leader. He has more than 30 years of experience conducting, reviewing, and analyzing financial information for contractors, manufacturers, and service corporations. Robert is the co-author of the AICPA’s Construction Contractor: Accounting and Auditing and Construction Contractors Advanced Issues Training Manuals. He can be reached at [email protected].