Accounting for Construction Companies
Construction accounting has unique challenges compared to many other business bookkeeping and management types.
Construction businesses frequently travel, incur specialized job costs for each construction project, and use unique processes to keep track of financial transactions. Unfortunately, construction accounting errors can be costly, so contractors must hire professional, knowledgeable accountants to manage their finances.
Read ahead to learn a few construction accounting basics, then contact our CFO team to schedule your accounting consultation so we can help your construction company manage your expenses.
Construction Accounting vs. Traditional Accounting
The construction industry has unique challenges. Traditional businesses, such as restaurants, stores, or salons, sell their goods and services from a centralized job site. These businesses can use simple, straightforward accounting approaches and dedicated accounting software to track income and expenses, and they have an easier time monitoring gross profit and overhead costs.
However, the construction industry presents a unique set of challenges to the accounting world. Construction businesses move to new job sites frequently and accrue distinctive labor costs and overhead expenses for each project. They must also factor travel time, mobilization costs, delivery fees, and service work into their payments, all of which they must record accurately in their books and accounting software.
Because construction accounting includes a wide range of indirect costs and unique financial situations, contractors need to hire professional, experienced accountants who know how to manage their detailed accounts correctly.
Construction Industry Accounting Principles & Best Practices
Accountants use unique practices to manage construction accounts and ensure they record every financial transaction in the correct location. Construction bookkeepers use a few accounting principles, including job costing, contract revenue recognition, and retainage.
Job Costing vs. General Ledger
Traditional businesses utilize a general ledger to track overarching expenses and business transactions. However, contractors need to track income and expenses on a job-by-job basis and monitor their business’s overall revenue. As a result, contractor accountants implement “job costing” practices to track costs for each project.
Job costing includes all of the financial information about an individual project. These reports may contain, but are not limited to:
- Cost of goods sold
- Estimated production reports
- Actual production reports
- Work-in-process or work-in-progress reports
Keeping track of each job’s costs allows the contractor or project manager to understand how much to charge for specific projects and services, helping them create more accurate bids for future projects.
Contract Revenue Recognition
Revenue recognition is an accounting principle that determines when a company can recognize income: when they earn it, when they receive the cash in their bank account, or sometime in between.
Construction contracts often take months or years to complete, so contractors cannot always bill clients and collect revenue in the same month. As a result, contractors can determine whether they will recognize income on a cash basis, when they complete the entire job, or when they complete a percentage of the contract
The cash method is the simplest way for contractors to track revenue. In this method, contractors only record income and expenses when they receive a payment or pay a bill. In other words, when cash is moved.
While the cash method is attractive to many, the IRS specifies that only businesses that fall below a specified income level can use this method for tax purposes. A CFO consultant or a financial controller can help you determine whether you are eligible to track income on a cash basis.
Completed Contract Method
Instead of tracking income when they receive it, some contractors decide to report their expenses and payments at the end of the project. These businesses can still bill the customer before the end of the project, but any profit they earn will not be official until the contract is complete.
To use this method for tax purposes, a construction business cannot exceed a specified annual income level. In addition, if there are issues with a current job and adjustments need to be made, a business owner may not know a job is performing poorly until after the job is complete. This method may not be the best option for your construction company. You will want to advise a CFO or construction advisor.
Percentage of Completion Method
A construction business may also decide to bill its customers throughout the construction job. This is the most common method used for construction accounting. The percentage of completion method allows contractors to recognize income for the work they have performed during each stage of the project.
This method is beneficial for long-term contracts as it allows contractors to keep up with the accounting process throughout the project rather than saving all of their bookkeeping for the end. In addition, should issues arise on the project, if you have a CFO or financial controller, they can help let you know how your job is performing? Adjustments can be made in time if a project is not performing profitably.
Contract Retainage (Also known as Retention)
Another principle in construction accounting basics is retainage, also known as retention. It is common for clients or subcontractors to withhold a percentage of the payment, typically between 5% and 10% of the contract value, until they are satisfied with the completed project. Retainage gives customers and contractors some security against low-quality work and allows for change orders, but it often throws a wrench in a company’s accounting procedures. As a result, a contractor should record retainage in a separate asset account until the customer is satisfied with the project’s completion.
Retainage is trickier to manage than it sounds, and each state has different laws that specify how a company must record retainage in its balance sheet. Hiring a professional CFO team can ensure that your business manages and records every financial statement accurately and in the correct location.
Our Construction Company Accounting Services
At CFO Strategies, we offer all of the construction accounting services your business needs to maintain precise, accurate financial records. We can help you track expenses for individual construction projects, monitor your business’s annual revenue, and oversee accounting matters, including but not limited to:
- Financial Reporting
- Work in process (or work in progress) schedules
- Profitability by the job analysis
- Earnings forecasting
- Payroll management
- Budgeting income and expenses
- Preparing financial reports and schedules for tax preparation for your CPA
Working with an accounting service can help you understand whether you are bidding your jobs correctly, whether you’re paying your employees appropriately, and whether your expenses are too high based on industry standards. Better yet, hiring a team of CFOs or controllers takes the burden of accounting off your shoulders, allowing you to focus your time and attention on your contracts and building your business.
Contact CFO Strategies Today
In conclusion, construction accounting can be a complicated, overwhelming task for contractors to manage independently. CFO Strategies offers professional accounting services for construction businesses, and you can feel confident that we have the expertise necessary to handle your financial matters with care.
Contact CFO Strategies today to learn more about our construction accounting and construction financial reporting services. You can schedule a consultation at (855) 732-7861 or by visiting our website.