The Basics of Construction Accounting

  • January 11, 2022
  • admin@ohi

Accounting procedures and practices differ according to the type of business and practices adopted by organizations across sectors. In the construction industry, firms and contractors face unique challenges when it comes to accounting, as accounting for the construction sector is different from regular accounting practices. Construction industry does not have any fixed business structure with contractors making up the bulk of the construction workforce. Accounting In construction is very important for the business, and it is important for the proper functioning of the business, and to assure good profits form the organization. 

As such, accounting for construction industry involves monitoring of different categories of costs such as cost involved in tools and equipment, delivery of materials to the job site, clearing of excess material when a job is completed etc.

Construction companies need to have a grasp of the basics of construction accounting to enable them in tracking the expenses accurately thereby resulting in improved profits, better management of their cash flows and to increase their bottom line. Accounting for construction can become a very major aspect for any business and assistance is often required. 

Structure and Methods of Construction Accounting- An Overview

Let us now shed light upon the fundamental question of “What is construction accounting?”

Complete guide to accounting for construction – in simple terms is a form of project accounting in which costs are assigned to specific contracts. Separate jobs are assigned in the accounting system for each construction project and the costs are marked up to the project by adding them to that unique job number for which the costs are incurred. This process helps the people responsible for a construction project to keep track of all the expenses incurred and the possible expenses which are likely to be incurred in the near future. It allows the construction agency to formulate and chalk out an effective budget.

In addition, a number of indirect costs are also charged to construction projects (such as supervision, equipment rentals, insurance etc.) and revenue generated under the contract may be based on the completed contract method.

The usual rules of revenue realization under the Generally Accepted Accounting Principles (GAAP) do not necessarily apply to long-term construction contracts. To present a more accurate picture of a construction company’s or a contractor’s financial performance – GAAP rules allow revenues and costs to be recognized as construction progresses under the following two methods of accounting for construction:

  • Percentage of Completion Method – which is used primarily based upon the length and complexity of construction projects
  • Completed Contract Method – where revenue is recognized when the project is nearly or completely finished. This method is usually applied in the residential construction industry

These two methods are the most reliable methods of construction accounting for general contractors, developers and sub-contractors.

Key Construction Accounting Best Practices 

Some construction accounting practices are fundamental to warranting accurate, reliable, and meaningful data. These are:

Completed Contract

One of the most common practices in construction accounting, the completed contract method mandates making income financial statements post construction completion. It is instrumental when the project is not long, and its average gross profit is not even a million dollars.

Percentage Completion

This accounting is lucrative and essential for the projects that would go on for a long duration. Unlike the aforementioned method, the revenues as well as the investment amount are calculated into a financial statement annually. It endeavours to tally the expenditure and the income incurred in the project and establish the profits and losses for each task.

Job Costing

Job cost accounting for construction involves two objectives, i.e.

  • Assignment of production costs, i.e., deciding the investment for a task
  • Tracing the practical investment in those jobs

Its purpose is to establish an estimated cost of the construction and then compare it with the actual costs. Often, job costs are compared to the estimate established at the beginning of the project to see how accurate the prediction and calculations were to track progress on the job.

Software Accounting

Using accounting software while bookkeeping for construction companies is a cost-efficient time-saving way to decrease human efforts and increase accuracy. Not only bookkeeping, but the usage of software in the industry has revolutionized the approach to accounting. Now, the accounting work has become simpler and faster, along with becoming highly accurate. Construction accounting methods can be found in most software accounting options. 

Common Accounting Reports

Accounting for construction company involves making various reports. Some of them are listed below.

  • Accounts Receivable Aging – The report includes the pending payments. These payments already have the invoices made. Thus, it helps to track late payments and devise collection strategies
  • Accounts Payable Aging – This accounting report has details of the monies that the construction company owes to other merchants/traders
  • Profit and Loss/Income Statement – The report entails a tally of the expenditure of the project and the revenue that the project made. It gives an insight into how much the company lost or profited through the construction project
  • Balance Sheet – The balance sheet consists of the information of the shared value that the company holds and the assets, alongside liabilities like debts
  • Cash Balance or Cash Flow Report – It is kind of a periodic report that contains the details of the money that was received against the money that was spent in a particular time frame. The statement is conducive to judging the future expenses of the project

Outsource Construction Accounting Activities

For an ease of doing, businesses can choose to outsource their accounting activities to OHI. We have worked with a wide range of construction companies including general contractors, developers, sub-contractors, construction related services companies and more. We understand the intricacies involved in construction accounting even in basic accounting functions such as accounts payable. Our good understanding of construction accounting concepts such as job-codes, cost-codes, and milestone based billing, draw contracts, change orders, holdbacks, and among others helps us migrate even in relatively complex projects in a short time frame. Outsourced accounting is a very good solution for any business to keep running comfortably, and make the business function smoothly without any major issues. 

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