Last Updated on April 23, 2024
Construction accounting plays an integral role in providing visibility and insight into a business’ financial health and operations. Therefore, maintaining up-to-date and accurate accounting records is essential to the success of any construction company.
To do this, it’s important to recognize that the ways that construction companies account for their income and expenses differ from other industries simply due to the nature of how construction projects work. It requires a unique approach and the right tools to produce accurate, timely financial and accounting records.
In this blog on how to record construction accounting we’ll discuss:
Why Construction Accounting is Unique
Accounting in construction can be considered fairly unique for several reasons. As mentioned above, this is due to the nature of how service and construction projects operate. There are different challenges for construction companies to deal with compared to other industries like manufacturing, retail, or service-based industries.
The following are some of the most significant reasons why construction businesses require a unique approach to their accounting and how construction accounting differs from regular accounting.
It’s Project-Based
Construction accounting is project-based, meaning each project has its own accounting requirements and needs. It’s almost as if each project is its own business, with unique customer expectations, vendors, designs, and materials. In short, almost everything on the project is a variable, so companies need to assign values to each of the variables for proper accounting.
Contracts are Long-Term
The length of time from recording the signatures on a contract to finishing the building and handing it over to the customer is another factor. This time frame is much longer than the shorter contracts that other industries work with.
Many construction project contracts span several years. Throughout the contract, contractors and subcontractors are being paid for their progress and contributions. Also, change orders, re-designs, and other variables can impact the original contract, potentially changing the timeline and original estimate, which make construction projects susceptible to cost overruns.
Locations Vary
Most businesses have set locations to perform their work. They’re able to control the allocation of equipment, handle bulk materials orders, and predict productivity. Construction projects occur wherever the customer needs them to, which impacts how the contractor budgets time and resources, ultimately impacting accounting methods.
Furthermore, the time and resources it takes to move equipment from one location to another needs to be factored into the contract price. This mobilization factor is not a typical cost that other industries have to account for, as centralized production allows them to keep their machines and materials in one place.
Subcontractors and Vendors Change
Not only do the project types and locations vary, but so do the subcontractors and vendors that companies use to construct them. Even if the contractor has a team of preferred subcontractors, they might not have the availability or the proper licenses to work on specific projects. Also, unique designs might call for materials that contractors can only get from certain suppliers.
Each of those new vendors may have their own payment or billing terms. Contractors need flexible accounting solutions to accommodate them all, which is another reason why construction accounting is so unique.
The Importance of Recording Accurate Construction Accounting
Though the tools and methods used for recording accounting on service and construction jobs may vary from other industries and businesses, construction companies still need to produce reliable and accurate accounting data in order for their business to succeed.
Having accurate accounting data available means that businesses can use this data to reliably produce other critical reporting and documentation for the business like construction cost and WIP (work in progress) reports, accurate financial records, better estimates, and proof of compliance to tax law and regulatory standards. Read on to learn more about how accurate accounting supports these important reports and documentation.
Effective Job Costing & WIP Reports
Whether a company is using job costing, construction WIP reporting, or a combination of both methods (which they should), accuracy is key.
With job costing, it’s essential to have the most accurate data as possible to compare against estimates and contract totals. It’s also important to determine how much future projects might cost, given the data gathered from these real-world projects.
Construction WIP reporting requires accuracy in order to reflect the value of finished and unfinished work on the company’s financial statements and accounts. It also allows companies to account for the correct revenue and expense amounts within the appropriate accounting periods.
Combined, these methods allow a company to get a clear picture of where it stands when making decisions—but only if the data is accurate.
Accurate Financial Records
Financial records serve as more than just a paper trail of where a company has been. If utilized properly and compiled using accurate data, they are tools that companies can use to make better decisions and avoid repeating past mistakes.
For example, accurate financial records allow companies to compare projects and identify which contracts, crews, methods, and other variables are most profitable. Any mistakes will typically show glaringly on these reports (if they’re accurate, with appropriate cost codes and documentation), allowing companies to avoid repeating them moving forward.
Compliance with Tax Law and Regulatory Standards
Keeping accurate construction accounting data allows a company to stay in compliance with tax laws and regulations. Detailed records make preparing and filing taxes easier and reduce the risk of an audit or dispute. And, if an audit does occur, the company can rest assured that it has the paperwork necessary to avoid penalties and tax liabilities.
Better Estimates
The longer a company focuses on compiling accurate accounting data, the more powerful its estimating process becomes. Estimators will have a stack of reports and data to rely on and reference, allowing them to compile better estimates with more accuracy moving forward.
How to do Bookkeeping and Accounting for a Construction Company
The following are some helpful steps for approaching bookkeeping and accounting in a service and construction company. Each business will have its own unique needs, but this overall guide should provide a simple roadmap for how to record construction accounting. To learn about the different methods an accounting professional can use to record construction accounting, visit this blog.
1. Set Up a Chart of Accounts
Before any accounting methods can be productive, a company needs to take inventory of its current accounts. Setting up a Chart of Accounts allows a construction company to identify its assets, liabilities, and expenses, among other accounts, to better assess its current status, improve reporting accuracy, shore up its tax law compliance, and make reconciliations simpler.
2. Record Project Costs
One of the most significant values a construction company has to recognize is the cost of the projects in progress and the pipeline. Without this data, there is no way to judge profitability or long-term viability.
Project costs involve both direct and indirect costs. Direct costs are the materials costs, supplies, labor costs, rental, and subcontractors costs associated with the projects. Indirect costs are overhead costs that can be spread out over multiple projects, such as marketing, administrative salaries, office rent, utilities, insurance, depreciation of equipment, software fees, and other associated costs.
3. Use Job Costing
Job costing allows a service and construction company to better understand the actual costs associated with each contract. But you can’t just do this based on invoices and accounts payable.
When back office staff are job costing, construction accounting personnel need to assign a cost code to each project and then to each cost associated with the project. For instance, a specific project might receive a project code, and then the cost of excavating the foundation will receive a specific code, as will the pouring of the foundation and the installation and so on. When each step has a code associated, contractors are able to drill down into the individual costs incurred for better job costing reports.
4. Record Project Revenues
There are a lot of layers to revenue recognition in construction, but it’s a requirement to accurately record and report income data from projects. The process involves identifying contracts, the contract obligations, transaction prices, and reporting income in financial statements.
Project revenue should be recognized based on individual contracts. There are several methods for doing so, but the Over Time method is the most common for long-term construction contracts.
5. Record All Transactions
Every transaction that occurs throughout the life cycle of a project should be recorded accurately. This includes payments made to subcontractors, materials suppliers, permitting offices, designers, and other instances where money changes hands in exchange for goods or services.
Recording transactions not only improves financial accuracy, it also provides an audit trail to track the flow of money throughout the business. Any discrepancies or errors can easily be tracked to the contract and person who authorized them. This also makes budgeting and forecasting easier, as repeated transactions become more predictable and easier to account for.
6. Reconcile Accounts
With so many accounts (multiple for each project, in most cases), account reconciliation becomes critical. Comparing projects or estimated costs against the actual value of these accounts in terms of both revenue and progress can help companies identify issues early and make the necessary adjustments to keep projects on track.
Many construction companies perform reconciliations once a month. At that point, it could be too late to fix the problem. Theft, misappropriation of funds, and honest mistakes can compound over the course of a month, so reconciling accounts regularly with effective reporting can help identify issues earlier.
7. Prepare Financial Statements
A major part of construction accounting is preparing the financial statements required for decision-making and compliance. These reports are critical for helping executives and other decision-makers not entrenched in construction accounting to understand the company’s financial standing. Financial statements can be crucial to helping these folks make financial decisions that determine the future of the company.
Also, financial statement preparation is part of complying with the Generally Accepted Accounting Principles (GAAP) regulations as well as the International Financial Reporting Standards. Financial statements are also the foundation for tax preparation—keys to better-navigating tax season and avoiding penalties.
8. Implement Accounting Software
Construction companies should consider implementing accounting software if they are having trouble accessing accurate cost and accounting data. Construction accounting software is designed specifically for the unique landscape of the industry, making account reconciliation, change order management, accounts receivable and accounts payable, and payments easier and more accurate. With some construction accounting solutions offering multi-company accounting functionality, construction businesses with multiple companies can be more operationally efficient, saving immensely on time and resources.
Automating as much of the accounting process as possible reduces the risk of error, whether it’s reducing double data entry or simply forgetting to update line items and budget changes. Similarly, these programs can alert users to issues like overpayments, unpaid invoices, and other situations that accounting staff need to stay aware of.
Recording Construction Accounting Requires a Unique Approach
Construction accounting requires a unique approach to produce accurate and timely data due to the nature of the business. While there are many options for a business to record their construction accounting data, gathering accurate accounting data begins unifying the field operations with the back office real-time. Only when cost and revenue data flow directly from the field to the back office can contractors stay apprised of their most recent financial updates and produce accurate, timely reporting to make cost-effective decisions from.
If you’re interested in learning more about how Jonas’ integrated construction accounting software can support your business needs and concerns, let’s chat!
Accurate Construction Accounting as the Foundation of Building Business Success
Accounting in construction management transcends mere number crunching. It’s the keystone in building a successful, financially stable construction enterprise. By diligently tracking costs, ensuring regulatory compliance, and providing clear financial insights, accounting steers construction projects through the complexities of budgeting, planning, and execution.
Businesses that wish to maintain their financial data accuracy and integrity should consider integrated construction accounting software – software that can unify their field and back office operations together in real-time. Only when cost and revenue data flow directly from the field to the back office can contractors truly stay apprised of their most recent cost and financial updates and produce accurate, timely reporting to make cost-effective decisions from.
If you’re interested in learning more about how Jonas’ integrated construction accounting software can support your business needs and concerns, let’s chat!
