Construction accounting is an important part of any construction business because it helps ensure that the company has solid financial reporting. By understanding these practices, owners can better monitor the financial health of their projects, identify cost overruns, make strategic decisions, and control costs.
This article will introduce construction accounting, including the key principles and techniques for managing your construction business.
Construction accounting is a specialized type of accounting that focuses on the unique aspects of construction projects. It involves tracking the financial transactions related to the construction process, such as costs, revenues, and expenses.
Construction accounting also includes the management of accounts receivable and accounts payable, cash flow, and the reporting of financial information. This article will introduce construction accounting, including the key principles and techniques for managing your construction business.
When it comes to financial reporting, subcontractors operate like the majority of small businesses. They need to track the construction accounting basics: overall profitability, cash flow, and liquidity. However, there are some major differences between construction and regular accounting.
Construction accounting
Regular accounting
Now that you know how company accounting is different, let’s get into the nitty-gritty of accounting for contractors.
Construction accounting is an essential part of managing a construction business. It involves tracking the cost of labor, materials, and other expenses to ensure that projects run as efficiently and cost-effectively as possible. Construction accounting also involves tracking revenues so that you can accurately measure the profitability of your projects.
Understanding construction accounting and bookkeeping allows you to take advantage of all available opportunities to increase revenue and profits—here are four lessons covering everything you need to know when tackling your business finances.
Each construction accounting method provides valuable insight into a project's financial impact that helps ensure projects stay on track, on budget, and succeed. When choosing the right accounting method, you should consider your business’s unique needs and objectives.
The percentage of completion method (PCM) is a method of accounting that records revenue when it has been earned but not yet received.
With the PCM, construction companies can more accurately match their revenue and expenses to the same accounting period, improving their overall financial reporting.
This method is beneficial for ongoing projects that require tracking individual stages of work. It’s helpful when you need to keep an accurate record of your progress and give stakeholders an idea of what to expect in the future.
PCM is common with long-term (and usually larger) construction projects that involve service-type activities, such as:
The complete contract method (CCM) is an accounting method contractors use to record revenue and costs associated with a construction project.
Under the complete contract method, all revenue associated with the project gets recorded after the contract is completed and accepted. All project costs get recorded as expenses only after the contractor has paid them.
This method assumes that a construction company records costs and revenue after they finish the job rather than incrementally throughout the project.
The cash method of accounting for contractors is a system that records all cash transactions when they occur. This method is often used in construction accounting because it allows contractors to accurately track their cash flow and the progress of their projects.
Under the cash method, you will record expenses as you pay them out, and income gets accounted for when payments are received.
This accounting method is great for small construction businesses that don’t have a high volume of sales or complex transactions.
Accrual basis accounting is a method contractors use to record financial transactions that involve revenue or expenses in the period they are incurred rather than when they are paid or received.
This method allows contractors to accurately report their financial position at any given point in time since all transactions are taken into account on an accrual basis.
Accrual accounting is beneficial for contractors because it allows them to track their expenses and earnings in real time, giving them a better understanding of their financial situation and cash flow. It’s especially useful for small construction companies that deal with longer-term contracts and transactions.
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 them to accurately estimate job cost and compare it to the actual cost, helping them determine profitability. Together, these two systems give a construction company a holistic view of its finances. Job costing helps maintain organization in the construction accounting process since the accounts related to individual projects are kept separate from the centralized accounts.
To ensure job costing is accurate, businesses must monitor and track their billing process closely. For this reason, we’ve outlined all the billing basics in contractor accounting.
Overbilling and underbilling can significantly affect job costing in a construction business. This core performance indicator helps track the progress of each job in relation to billing.
Construction accounting expert, Tonya Schulte, explains, "Essentially, [revenue recognition] boils down to keeping track of what we actually invoiced against the job versus what percentage of progress we’ve made on the job … and making sure, on an accrual basis, that we are really where we should be on the project in relation to revenue.
“[Thinking in terms of over- and underbilling] drives [contractors] to ask smart questions: Are they billing correctly? Are estimators providing accounting with good data? Is there good communication between those in the field and those working on admin items? All of this is important to track and understand.”
Using the correct billing method for your construction company can make your journey to profitability that much easier. Understanding the different billing methods keeps you aware of new regulations or changes to existing industry standards that may impact your bottom line or your customer’s invoice.
Time and materials billing in construction accounting is the process of billing clients for the materials used in a construction project and the time workers spent on the project. You will commonly use this type of billing when the project scope is uncertain or unpredictable, and the costs are determined by:
Great for: Construction projects with an undetermined scope
Lump sum billing in construction accounting is the practice of billing a customer one single amount for a project rather than billing for each phase or individual service. The lump sum is usually based on an established contract between the contractor and customer, including all projected costs of:
Great for: Contractors who encounter underbilling during construction projects
Unit price (or fixed-price) billing in construction accounting is a billing method that assigns a set fee to a unit of measure (for example, per square foot or per hour) for every unit of work you complete. This method allows contractors to accurately bill their clients for the work they have completed rather than charging them a lump sum fee.
Unit-price billing makes it easier to accurately track and keep all costs associated with a project organized and under control while allowing clients to better understand how you are spending their money.
Great for: Contractors who struggle with overbilling during construction projects
AIA billing is a type of bill format specified by the American Institute of Architects (AIA) that outlines how contractors should submit invoices to their clients. AIA billing is a complete record of services performed and materials supplied, including labor and associated costs for a specific project.
Great for: Customers who require maximum transparency and accountability in the billing process
Income recognition is an important part of the construction project cycle and a feature of accrual accounting. Also referred to as “revenue recognition”, it represents the point at which a construction project becomes profitable.
Contractors and real estate developers use GAAP construction accounting to increase their financial accountability and provide valuable peace of mind to customers. This specific branch of accounting adheres to Generally Accepted Accounting Principles (GAAP), as they apply to the construction industry, and has been helping companies better understand their construction-related finances for decades.
To maintain GAAP compliance, contractors must follow the Financial Accounting Standards Board (FASB) revenue recognition principle: You should only recognize revenue after the job is complete and the customer owns the project.
However, note that the FASB updated this principle to clarify how contractors should report information from their customer contracts. Topic 606 is an accounting standard update (ASU) that requires public companies to disclose information related to their revenue recognition practices.
Essentially, this ASU improves disclosure requirements, prompting more useful information out of financial statements. The FASB put it in place to ensure companies provide more transparency into how they recognize their revenues.
Construction payroll and invoicing help ensure accurate, timely payments to construction workers and subcontractors. Since this is the bread and butter of a contracting business, let’s go into more detail.
Invoices help ensure that both parties clearly understand what services the contractor has provided, when, and for how much. Contractor invoices provide a written record of any payment disagreements and you can use them in dispute resolution if necessary. Additionally, invoices provide necessary tax information for the client and contractor, allowing them to keep accurate records and file their taxes on time.
If you’re looking for a concrete example or template, try these free contractor invoice templates.
Contract retainage is a common practice where customers pay contractors less than the project's full cost. It ensures that the contractor meets all requirements and that the customer is satisfied with the performance before delivering the full payment. Generally, contract retainage is specified in the contract and is a percentage, typically five to 10 percent, of the total contract amount.
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.
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.
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:
Before you begin accounting for construction company, ensure that you have each of these financial staments handy:
You can also track and manage your construction projects with QuickBooks Online.
If you’re considering hiring an accountant, you want to be clear on their responsibilities.
An accountant in construction typically ensures that the organization's financial statements, taxes, and other documents are accurate and up-to-date. They might also work to develop budgets, provide cost analysis for current and future projects, and create and manage accounts payable and receivable.
Additionally, they will ensure that the construction company complies with all regulations.
Construction accounting can be complex, especially for nonaccountants. Many factors make it challenging for companies to accurately track and report their financial activity.
For one, there’s a large variety of financial transactions in the construction industry. Accounting for all of them can be overwhelming, especially for nonaccountants.
Another difficulty is that construction companies must track costs associated with each individual project, from labor to materials, and calculate portions of total project costs they should allocate to different accounts. We covered this earlier with job costing, but this step can cause a lot of obstacles for construction companies.
Finally, due to the complexity of construction projects, unforeseen issues often arise, leading to additional costs or time on the project. If you or your customer hasn’t planned and budgeted for these potential issues, they can cause the entire project to fail.
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