Construction accounting is considered a special combination of bookkeeping and financial management. Construction accounting is designed specially to help contractors stay on top of the expenses and profitability of large, individual projects. Effective and accurate accounting is a decisive key to success in the construction industry. And you need the best accounting practices to achieve the goal.
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In this guide, we’ll show you the common concepts and distinct features of construction accounting that you need to take into consideration to discover the ins and outs of construction accounting.
How is construction bookkeeping different?
Despite construction accounting, like all accounting in other industries, having to be built on standard accounting principles, the unique way of construction company operation strikes various challenges and makes construction accounting more complex and difficult.
In addition to standard processes and procedures like accounts payable, accounts receivable, and payroll, construction companies deal with job costing, progress billings, change orders, retainage management, customer deposits, and other anomalies. Accurately tracking expenses and profits puts great difficulty on the contractors’ shoulders because they have to manage various types of costs, including labor costs, equipment, material, marketing and sales, the list goes on.
Below are the key factors in which construction accounting and bookkeeping differ from other types of accounting.
Cost of Goods Sold (COGS)
Cost of goods sold is any costs that are associated with the performance and completion of a project. However, COGs in construction are much more complex than in other brick-and-mortar stores. This includes a wide range of cost types you have to identify and categorize properly. Typically, a contractor or subcontractor often provides a wide range of services - everything from design, engineering, and labor. Thus, tracking different types of costs can be tricky and cause a lot of headaches.
Overheads
Overheads consist of necessary, ongoing expenses, including the cost of subcontractors, machinery, equipment, insurance, office staff, office supplies, vehicles, and other costs. Since many such expenses in construction are attributed to specific construction projects, other businesses would consider overhead often fall into the COGs category for construction companies.
Project-base work
Contractors often work on and manage multiple projects at once - all of which are in different stages of progress. The payment process for each project is also different. There may be an upfront deposit required, the project could be paid in full, or take months before getting full payment. For these reasons, construction companies may need to generate separate profit and loss statements for each project. Therefore, the accuracy of bookkeeping and accounting plays a crucial role in giving a full insight into their financial health and support to making informed business decisions.
Revenue recognition
Unlike product sales, where companies recognize revenue when a widget is sold, bookkeeping and accounting in construction have different ways when it comes to revenue recognition. However, to reduce confusion and inaccuracies, you need to decide on and stick to one set way of recording your income and expenses.
Cash vs accrual accounting
Cash basic accounting means that revenue and expenses are recognized on the income statement only when cash is received. In other words, payables aren’t recorded until a check is written to pay bills, and the revenue isn’t recorded until payment is received and deposited into the company’s account.
The cash method is mostly used by small businesses because the financial statements closely reflect their cash position and the bookkeeping process is much easier and cheaper. In addition, under cash-basis accounting, a business doesn’t have to pay taxes on cash it hasn’t been collected. Despite its simplicity, cash accounting isn’t accepted by GAAP, and the resulting financial statements are considered distorted and insufficient about the company’s financial overview health.
Cash accrual accounting recognizes expenses and revenue in the time they are incurred before any money changes hands. The advantage of the accrual method is that it includes accounts receivables and account payables, as a result, provides a more accurate picture of the profitability of a company. The accrual is the most common method used and also a standard method under GAAP acceptance.
Percent Complete vs Completed Contract Income Recognition
The percentage completion vs completed contract is often used by construction companies because they typically work on long-term large projects in which income and expenses are often deferred. Accordingly, both percentages of completion and completed contract methods allow for such tax deferral.
The Percentage of Completion Method (PCM) that are used to recognize revenues, expenses, and taxes over the life of the construction contract based on its completion percentage. For example, if the contract is 50% complete then the contractor will recognize half of the revenues, costs, and income.
The Completed Contract Method (CCM) allows for the recognition of revenues, expenses, and taxes once a project is complete. Because revenue is recognized after expenses and revenue have occurred, this method of income recognition is not GAAP-approved.
Construction Accounting Software for Contractors
The flow of money in construction companies is tremendously fast and involves a lot of money, not to mention projects are involve hundreds of types of costs. Fortunately, accounting software can help your business eliminate human errors, improve financial management, and save you countless hours.
Construction accounting software can perform complex functions that help you with tax compliance, and keep track of revenues and expenses on each job site. Itemized receipts automatically, perform payroll duties, and much more.
The most reputable accounting software that is popularly chosen by contractors include:
Sage 100 Contractor (Best overall accounting software for construction)
FreshBooks
CoConstruct
QuickBooks Desktop
To choose wisely, you need to do some research to assess which one can meet your business's meets and demands before paying for accounting software. It would not cost you too much but it’s essential to keep your business organized and you can spend more time on revenue-yielding activities.
Common Reports in Construction Accounting
As an owner of a construction business, reports are one of the primary ways you gain visibility into your financial health and operation. Reports turn large amounts of data into summaries to help you make day-to-day decisions while keeping your eye on the big picture.
Balance sheets summarize all of your business’s assets, liability, and owner’s equity. It gives you an overview of the financial health of your construction company and a straightforward way to see when you need to cut costs. Also, it’s often used to determine the financial position of your company for lending and credit purposes.
Income statements, also known as profit and loss statements, summarize revenue and expenses accrued and the net profit or loss during a period.
Cash flow statements help with forecasting and ensure that you have money to cover your expenses. Cash flow statements break down how much cash entered the business and how much you spent during a given period.
>> Read More: Common Risks in Construction Project Accounting
Tips to Simplify Your Construction Bookkeeping - 7 Strategies to Consider
As you’re no doubt aware, bookkeeping for contractors is complex and challenging. Here are some bookkeeping tips that can help you stay organized and set up your construction business for success in the coming year.
Separate Business and Personal Finances
When it comes to construction bookkeeping and accounting, it’s important to have a business bank account or credit card and keep it separate from your personal finances. That makes reconciling your transactions much easier and faster because you don’t have to sift through income and expenses unrelated to your construction business.
Open Multiple Bank Accounts
It’s recommended to open multiple bank accounts for separate business uses. Reserve one account for receiving payments from customers, use another account exclusively for payroll, and yet another to build a cash reserve. It’s also worthwhile to have an account designated for taxes. Separate accounts help you better determine how much money is coming into and out of your construction business. Additionally, you waste countless hours when tax seasons come around.
Create a Series of Journals to Record the Daily Transaction of the Company
Keeping a record of accounts payable, such as invoices from your suppliers is an essential bookkeeping practice. And doing the same for accounts receivable, and invoices you sent to your customers. Another tip is that you should avoid paying for anything in cash because those transactions are harder to track and easily forgotten. As you record information, whether expenses you’ve paid or revenues you’ve received, including key details as follows:
Transaction dates
Transaction amounts
Description of transactions
The precise names of other parties
Account number
And so forth.
Ideally, accounting software and apps will make it simple to keep separate bookkeeping journals for:
Accounts payable (including rent, utilities, equipment, and insurance)
Accounts receivable (direct payments from customers)
Project-specific expenses (such as on-site worker payroll and material purchases)
Keeping thorough records and categorizing business transactions properly in this way provides insight into where money is going and serves as proof of expense in case you get audited by the IRS or another tax authority. Also, it gives you sufficient information to make smart financial decisions.
Use Job Costing
Job costing is one of the core parts that support you to run a successful construction business. Put simply, job costing is a process that assists contractors estimate and determining the budget and bidding for any new construction project. Under job costing practice, you can estimate the costs for labor, material, and additional overhead costs allocated for a project. This way, you can accurately decide how much to charge. Job costing also helps you determine which types of projects are profitable and which ones to avoid.
Keep Digital Backups of Records
All invoices, receipts, and other documents should be organized and filed so that they’re easy to find later. Whether storing hard copies in filing cabinets or keeping digital files on a hard drive, it’s necessary to have a backup in case the original documents are lost or damaged. It is important to make three digital copies of each document, including:
Save one copy on a secure hard drive
Save another copy on an external storage device
Save a third copy on a cloud-based platform
Backing up your data regularly to keep it up-to-date.
>> Read More: How To Improve Your Construction Company’s Profitability
Implement Regular Financial Review
This helps you catch discrepancies early, understand your financial health, and make informed decisions about your business’s future. Regular reviews also prepare you for unexpected audits and help you see overall your financial trajectory, so you can strategize and plan for upcoming projects more effectively.
Ask For Help
Handling your own accounting and bookkeeping is doable but it’s time-consuming and requires a deep understanding of bookkeeping rules in the construction industry. We’re here to review your ledger, and get your book done and up-to-date. We advise on better financial recordkeeping, suggest ways to improve payroll management, and even help you identify opportunities for growth. Please contact us for personalized assistance. Click here.
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