Construction accounting is a unique form of bookkeeping and financial management with many distinctive features. This can leave many subcontractors and construction companies struggling to find the right accounting methods to keep up with their various different projects, decentralized work, and irregular costs.
In this article, we’re sharing the difference between accounting for construction companies and regular accounting, diving into three construction accounting methods, and sharing several construction bookkeeping tips. This article will help you decide which method is best suited for your construction projects and simplify your construction accounting processes.
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Construction Accounting vs. Regular Accounting
First things first, construction accounting and regular accounting are not the same. While most industries, such as retail or manufacturing, can use typical accounting principles, construction accounting is an entirely different ball game. Most other businesses offer fixed products or services from a fixed location at a fixed price. For example, a restaurant might sell a piece of cake for $10. But, unlike other industries, construction businesses offer customized work in variable locations. Every job is different, which makes construction accounting… not a piece of cake.
We’ll expand on the differences between construction accounting and regular accounting in the sections below.
Construction companies primarily operate around projects, whereas other businesses have more stable and predictable profit centers. Each branch or division of the company makes an identifiable contribution to the company’s bottom line. For example, a restaurant might have multiple franchise locations. Each location is treated as a separate, standalone entity that is responsible for contributing to the company’s bottom line.
Most construction projects are custom jobs with unique requirements and a variety of associated costs. Although two projects may have similar requirements, a number of factors including labor and equipment availability, working conditions, and more could result in entirely different costs.
It can be helpful to view construction projects as individual profit centers. Although projects are constantly opening and closing and have unique requirements that change based on a number of factors, keeping project profits and losses separate will help you ensure that each of your jobs is profitable.
The project-centered nature of the construction business means that construction companies need a different way to keep track of costs and expenses for each job. That’s where job costing comes into play! Job costing is a construction accounting practice that allows construction companies to track costs to particular projects.
Field and Mobile Work
Unlike other industries where work is done at a fixed location, businesses in the construction industry have to manage the accounting of operations that are constantly on-the-go. Equipment and labor is constantly moving from site to site to complete a variety of different jobs. This means that you have to consider mobilization costs such as travel time, insurance, and other related expenses for each job. It also means that you need to manage your inventory, equipment, and labor effectively so you ensure that you have the right tools to complete each job.
The next accounting challenge construction companies face is ever-changing costs. Most businesses have fairly stable overhead costs. Fixed costs are pre-determined and variable costs are relatively easy to control. Construction businesses play more of a guessing game. You have to estimate your project timelines which will affect the costs of a project.
It can also be difficult for construction companies to differentiate overhead costs from project costs. To solve this problem, it can be helpful to ask yourself, “would I still have these expenses if I didn’t have these contracts?” This will help you decide whether you need to allocate certain indirect costs to jobs so they are appropriately billed. Indirect costs may still be necessary to a project’s completion but are often overlooked when attributing costs to certain jobs.
Accounting Methods for Construction Companies
Now that we’ve covered the differences between regular accounting and construction accounting, it’s time to dive in and discuss the different construction accounting methods. Certain revenue recognition methods may be more suitable for your business depending on your company size, annual revenue, and project lengths.
The cash method is the easiest and simplest accounting method that construction companies can use. However, it’s important to recognize that it can also provide the least accurate depiction of your financial health! This method involves recording revenue only once money is in the bank. Cost of goods sold and overhead costs are also only recorded when expenses are actually paid. This could leave you relatively in the dark in regards to the financial health of your business. You might not realize your business is in a financial hole until it’s too late.
Although many small businesses prefer the cash method for its simplicity, only some contractors qualify. Those who do qualify generally yield lower taxes making it a desirable accounting option for tax purposes. Those with average annual revenues over the threshold for the cash method must choose one of the following accrual methods.
Percentage of Completion
Next up is the percentage of completion approach which is often considered the best accounting method for construction companies. This method provides a more accurate way for accountants to keep track of the expected gross profits and losses of each project. Contractors record income and expenses regularly throughout each project and revenue is only calculated for the portion of a project that has already been completed.
This method gives contractors a better understanding of whether or not their projects will be profitable before a project is completed. Although this method is based on estimations, it generally provides relatively accurate financial data that can be used to better manage profit margins.
In this method, it is critical to first implement cost-accounting methods to ensure that expenses are accurately recorded so the profits and losses of a given project can be accurately estimated.
The percentage of completion method is often ideal for long-term contracts because tax calculations are made each year. This reduces your tax burden at the end of the project and protects you from the risk of tax fluctuations. On the other hand, if you prefer to defer your taxes, the next method may be a better option for you.
Completed Contract Method
The completed contract method involves reporting income only once a contract is completed in full, although payments may be received throughout the duration of a project. While this approach is often the most preferred method in the construction industry, it’s really best suited for short-term contracts under two years.
Contractors will also use the completed contract method if it’s not possible to calculate the percentage of completion for a project or if they prefer deferring their taxes. By using this method, contractors can defer taxes until a project is completed. Keep in mind that using this method could increase your tax burden in the long run if tax laws are amended. Proceed with caution when using this method!
Construction Bookkeeping Tips
In order for accountants to provide the necessary financial insights regarding your construction business, you need to be diligent with the day-to-day recording of your financial transactions. That is – your bookkeeping! Here are a few quick tips to help you simplify and improve your construction bookkeeping process:
- Record all the information from your receipts and invoices with the help of an accounting software solution. This will save you time and eliminate manual errors.
- Keep a digital copy of your receipts and invoices on a cloud-based technology that will allow you to access these files anytime, anywhere.
- Use construction job costing software to manage project costs and general business ledgers. The use of software will simplify your job costing process, especially when your projects are complex.
Use Construction Software to Simplify Your Accounting Processes
Let’s face it: construction accounting can be complicated! There are specific elements of the construction industry that can make accounting a real challenge. However, you don’t have to do it alone.
Ease the stresses of construction accounting and simplify your construction bookkeeping processes by implementing a reliable construction accounting software solution. Jonas Construction Software includes accounting features that save you time and ensures that your financials are always up-to-date. Every function in Jonas Construction Software is fully integrated with accounting to allow you to accurately track profitability in real-time and make key financial decisions. Request a demo of Jonas Construction Software today!