Embracing construction accounting principles allows contractors to make better decisions, optimize project performance, and maintain financial stability. This includes determining cost and profitability, choosing the right revenue recognition method, and preparing tax returns.
Because construction is project-centric and production is decentralized, contractors need a way to track and categorize transactions specific to each job. This is called job costing.
Job Costing
Tracking all the expenses that go into a construction project is essential for contractors. The most efficient way to do this is by using job costing, which breaks costs into three categories: materials, labor and overhead.
Each task associated with a job is assigned a unique cost code that tracks each dollar spent. The number of codes used varies depending on how detailed a company wants to be with tracking.
For example, a company can create a code for each phase of pouring concrete in a building’s foundation, or it can be broader and use code such as “laying the foundation.” The information gleaned from these codes allows managers to compare actual costs against estimated costs and identify inefficiencies like overspending on labor or excessively high material prices.
Profit and Loss Report
A profit and loss report is a financial statement that details total construction revenue and expenses. It’s a vital tool for evaluating whether or not your company is profitable.
Contractors can choose from several methods of recognizing their revenues and expenses. The cash method recognizes income when payment is received and expenses when bills are paid. However, this type of accounting has a major drawback. It can lead to accurate and timely financial statements, hindering proactive decision-making.
Another popular choice is the accrual method of accounting. It allows contractors to record the income they expect from billed work, even if it has not been received. Moreover, it will enable them to track recurring costs like equipment and overhead, which are not easily tied to individual projects.
General Ledger
Unlike other businesses that operate with stable monthly costs, construction companies often work on per-project pricing. This can create a challenge for bookkeeping for construction companies because the firm must carefully record every expense and income to generate reliable financial statements.
In addition to requiring specialized invoicing and accounting software, construction firms must handle different billing methods for each project. These include time and materials, unit price, cost-plus contracts, and varying tax requirements for each state.
The general ledger is a record of all business transactions using double-entry accounting. This means that each account must have a debit balance and a credit balance to provide accurate financial statements. A good accounting system can help you create and manage the general ledger to avoid mistakes that can lead to inaccurate statements and costly tax penalties.
Accounts Payable
Accounting for daily business transactions is crucial for any construction company. This includes separating personal expenses from company costs and recording invoices, receipts, equipment rental, employee wages, subcontractor payments, etc. This information is vital to building a solid foundation for the company to grow.
Since construction companies’ production occurs on different job sites, they face many challenges when tracking costs and revenue. A robust financial management system can reduce manual effort and improve accuracy, improving the profitability of each project. Additionally, accounting for work-in-progress is important because it allows companies to identify and resolve problems early on, saving them time and money in the long run. The right financial reporting methods also help construction contractors meet the requirements of their contracting customers.
Accounts Receivable
Construction companies must accurately track and record both expenses and incoming payments. The complexities of the industry and the decentralized nature of production make this especially challenging.
Large construction projects can take months or even years to complete, so accurate accounting is crucial. Contractors typically report expenditures related to these projects as a work-in-progress account within the property, plant and equipment section of their balance sheets.
Construction accounting uses different methods for tracking revenues and expenses, including cash accounting, unit price contracts, guaranteed maximum price contracts and cost-plus contracts. Some construction companies prefer to use a combination of these, depending on the specific circumstances of each project and the company’s overall financial goals. Some may also use a cloud-based financial management system that supports job costing and other accounting processes.
