Introduction to construction accounting (for busy contractors)

According to a recent Intuit QuickBooks survey, nine in ten business owners say their accounting professional contributes to their business’s success. Moreover, businesses that don’t use an accounting professional are less likely to report strong financial health or believe they could pass a financial audit. 

Many construction company owners struggle to master the unique complexities of their industry, from tracking project-based expenses to managing long-term contracts.

Understanding construction accounting is necessary to avoid pitfalls, better monitor the financial health of projects, identify cost overruns, make strategic decisions, and control costs.

This article introduces construction accounting’s key principles and techniques to help you take control of your finances and build a stable, thriving business.

Jump to:

• What is construction accounting?
• How construction accounting differs from regular accounting
• Construction accounting methods
• Job costing in construction accounting
• Billing methods for construction accounting

• Construction payroll and invoicing
• Essential documents for construction accounting

• Simplify your construction accounting

What is construction accounting?

Construction accounting is a specialized type of accounting tailored to the unique needs of construction projects. It focuses on managing the financial aspects of construction businesses, ensuring accurate tracking, reporting, and decision-making. 

Key elements include:

• Project-based accounting: Tracks financial transactions, such as costs, revenues, and expenses—for each construction project individually rather than grouping all projects together.
• Expense tracking: Monitors materials, labor, equipment, and overhead costs to ensure accurate budgeting and profitability.
• Accounts receivable and payable: Manages incoming payments from clients and outgoing payments to suppliers, subcontractors, and employees.
• Cash flow management: Ensures your business maintains sufficient liquidity to handle ongoing project costs and operational expenses.
• Financial reporting: Prepares detailed reports that provide insights into the business’s financial health and individual projects.

This approach helps construction companies control their finances and make informed decisions. The following sections explore key principles and techniques to manage your construction business effectively.

Construction accounting methods

Each construction accounting method offers insights into a project’s financial impact, helping ensure projects stay on track, on budget, and successful. Choosing the right method depends on your business’s unique needs and goals.

Percentage of completion method (PCM)

The percentage of completion method (PCM) records revenue as it’s earned, even if not yet received, aligning revenue and expenses within the same accounting period for improved financial reporting.

Ideal for ongoing projects, PCM tracks progress by stages, providing real-time insights into performance and enabling proactive decisions like reallocating resources or adjusting timelines. It also enhances collaboration by keeping stakeholders informed of milestones and risks.

For long-term contracts, PCM ties revenue to completed stages, reducing discrepancies, ensuring compliance, and offering a clear cash flow picture. PCM works well for larger projects involving installations, repairs, or replacements.

Why it works for large, ongoing projects:

• Aligns revenue and expenses to project milestones
• Provides real-time financial insights for better resource allocation
• Keeps stakeholders informed with consistent progress updates

Completed contract method (CCM)

The completed contract method (CCM) records revenue and costs only after project completion, simplifying financial reporting and offering a clear snapshot of earnings and expenses.

Best for short-term projects, CCM minimizes administrative overhead and focuses on the final outcome rather than incremental tracking.

Why it works for short-term projects:

• Simplifies accounting by delaying revenue recognition
• Reduces administrative tasks for quick turnarounds
• Provides clarity after project completion

Cash basis accounting

Cash basis accounting records transactions only when cash changes hands, making it straightforward and ideal for smaller contractors. Income is recorded upon receipt, and expenses are recorded when paid, aligning with the day-to-day realities of small businesses.

Why it works for smaller contractors:

• Simple and easy to manage
• Offers clear cash flow insights
• Complies with IRS requirements for small businesses

For smaller construction businesses, cash basis accounting delivers an accessible and effective way to manage financial records without unnecessary complexity.

Accrual basis accounting

Accrual accounting records transactions when they are incurred, regardless of payment timing, providing a more accurate financial snapshot. It’s particularly useful for small construction companies managing long-term contracts.

Why it works for contractors with long-term projects:

• Tracks revenue and expenses as incurred
• Ensures accurate reporting across multiple periods
• Supports better budgeting and cash flow planning

Job costing in construction accounting

In construction accounting, job costing can be a powerful tool when combined with a general ledger. While the general ledger (G/L) gives a company a full overview of its overall financial picture, job costing allows a company to track the costs associated with each job. 

This allows accurate construction job costing, helping businesses to determine profitability. Together, these two systems give a construction company a holistic view of its finances.

By tracking the direct costs associated with each project (materials, labor, equipment), contractors can:

• Control costs: It helps identify areas where costs are exceeding estimates, allowing contractors to take corrective actions before it’s too late.
• Improve resource allocation: With detailed cost data, businesses can allocate resources more effectively across multiple projects, ensuring that the budget meets or stays under forecasted amounts.
• Monitor progress: Contractors can track the progress of projects in real time, ensuring that costs are in line with the work completed.
• Measure profitability: By comparing estimated versus actual costs, job costing reveals which projects are more profitable and which may require cost adjustments.

Key job costing metrics

The following metrics are critical in job costing, especially when it comes to managing billing and ensuring the financial health of your business:

• Overbilling: Occurs when billings exceed the actual costs incurred. It may lead to cash flow benefits in the short term but can cause problems if not managed correctly.
• Underbilling: This happens when costs incurred exceed the billed amounts, leading to potential cash flow issues for the contractor. 

By regularly tracking these metrics, contractors can ensure that their cash flow remains healthy and that each job is within its financial scope.

Example of job costing

Imagine a contractor is working on a commercial building project with the following estimated costs:

• Material: $50,000
• Labor: $30,000
• Equipment: $10,000
• Total estimated costs: $90,000

As the project progresses, the contractor tracks actual costs and billing:

• Material spent: $45,000
• Labor spent: $28,000
• Equipment costs: $9,000
• Total actual costs: $82,000

Billing methods for construction accounting

Choosing the right billing method can simplify your path to profitability. It also ensures you stay compliant with industry standards and aware of any regulatory changes affecting your bottom line or your customers' invoices.

There are four main billing methods for construction accounting: 

1. Time and materials (T&M) billing: Best for projects with an uncertain scope or evolving work requirements, T&M billing charges clients for the time spent and materials used. Costs are based on estimated hours worked and materials purchased. 
2. Lump sum billing: Ideal for fixed-budget projects with well-defined scopes, lump sum billing charges a predetermined amount for the entire project. This covers materials, labor, and overhead. 
3. Unit price billing: Perfect for contractors who need transparency and accuracy, unit price billing assigns fees to specific units of work (e.g., per square foot or hour). It ensures fair compensation, helps control costs, and offers clients clear expense tracking.
4. AIA billing: Designed for large, complex projects, AIA billing follows a detailed invoicing format by the American Institute of Architects. It provides maximum transparency by documenting services, materials, labor, and costs.

Construction payroll and obstacles to overcome

Construction payroll helps ensure accurate, timely payments to construction workers and subcontractors. There are three key challenges construction companies face when running payroll:

1. Varying rates

Construction payroll wages can vary greatly depending on the location of the job, the size of the job, and the individual skill level of the employee. Common construction payroll wages range from minimum wage in some areas to more than $50 per hour for experienced workers such as carpenters or electricians. 

Payroll also often includes a variety of bonuses, benefits, and other incentives, such as overtime pay or extra pay for hazardous working conditions.

2. Davis-Bacon Act

The Davis-Bacon Act (DBA) is a United States law that requires employers to pay prevailing wages—the regional minimum pay requirement—on public works projects for laborers and mechanics.

The purpose of the Act is to protect local wages from being undercut by out-of-area contractors and construction workers. The Davis-Bacon Act applies to all construction projects under government contracts, including road construction, building construction, renovations, new construction, and painting.

3. Union payroll

Union payroll for construction businesses involves wage calculation and management and other benefits for employees who work on union-affiliated projects. It requires a comprehensive understanding of labor contracts and collective bargaining agreements, along with implementing appropriate payroll and taxes based on those contracts. 

To simplify the process, follow these steps:

• Stay up to date with labor and union regulations
• Understand union benefits
• Communicate with unions
• Invest in payroll software
• Hire a union payroll expert

Essential documents for construction accounting

Before you begin accounting for a construction company, ensure that you have each of these financial statements handy:

• Job estimates vs. actuals report: Tracking job estimates against actual costs is crucial for understanding project performance. This report compares original project estimates, including change orders, to expenses incurred. Regularly updating this document helps you identify cost overruns early, allowing you to adjust budgets or renegotiate contracts. 
• Accounts receivable aging report: Tracking unpaid invoices is critical for maintaining steady cash flow. The accounts receivable aging report organizes outstanding invoices by the length of time they’ve been overdue. 
• Accounts payable aging: Just like you need to track what you’re owed, you also need to manage what you owe. This report lists unpaid bills and their due dates, ensuring you don’t miss payments to suppliers or subcontractors.
• Job cost statement: This job costing document is your detailed record of all costs related to a specific job. It breaks down expenses like labor, materials, equipment, and overhead. 
• Work in progress report: Your WIP report is a section of the balance sheet that shows whether your projects are underbilling or overbilling. It provides a detailed account of ongoing project performance and the financial implications.

By organizing these essential documents, you’ll build a strong financial foundation for your construction business. 

Simplify complex construction accounting

Managing construction accounting doesn’t have to be overwhelming. With software like Intuit Enterprise Suite, you can streamline invoicing, track job costs, and gain deeper insights into your project’s profitability—all from one place. Learn more about how QuickBooks can help our construction business thrive.