Keeping track of finances and making financial decisions can feel overwhelming in the busy world of construction. Though it’s frequently seen as a specialization within the larger accounting field, it helps in the proper management of constructions. Specialized knowledge and customized activities make it possible to achieve the maximum result in work and guarantee business sustainability for contractors.
We will guide you through the details of construction accounting in this blog post: its differences from regular accounting, the components of construction accounting, recommendations, and pitfalls. By the end of this article, you’ll have a solid understanding of construction accounting and how this can be used to improve the operational strategies of your construction business specifically in the area of managing the finances.
Content Outline
What Is Accounting for Construction Companies?
Construction accounting is a kindred field that focuses on financial management within construction utilizing distinct features of the construction industry. It focuses on project-oriented activities, distributed production, and a complex of managing long-term contractual relations. Through proper identification of the job costs, conspicuous recognition of the contract revenue, and practical billing procedures, construction accounting helps the contractors to have proper control over the financial aspects which are highly crucial to establishing a strong and successful construction business.
But what particularly sets construction accounting aside from traditional accounting practices, and how can construction businesses avoid mistakes? We will explore more details in the next section.
The Unique Nature Of Construction Accounting
Construction accounting differs greatly from general accounting because construction companies operate on a project basis. This entails accurate identification of cost and revenue and general bills related to every construction project. Thus, cost control enables construction businesses to keep projects on time and profitable, which is so vital for business success. Furthermore, the correct recognition of revenues plays a vital role, by accurately indicating all sources of income originating from projects of construction.
In addition, construction accounting has a close focus on proper consecutive billing to track and document costs effectively, which constitute essential elements in construction contracts. Finally, due to the specificity of construction accounting, construction firms should effectively monitor and control project-based accounting and fiscal procedures.
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Talk to us The key elements of construction accounting
Construction accounting can be made up of the following; job costing, revenue recognition, billing, payroll, and financial reporting. Subcontractors, machinery, equipment, insurance, office staff, supplies, and vehicles which come under the overhead expenses are the driving forces of any job costing.
Another way of costing impacts is accurate cost estimation for controlling the deficits on the projects, preventing renegotiation problems with clients, and for proper revenue recognition. Any wrong calculations that involve the overhead costs may result in wrong estimations and low profitability thus the need to have accounting software specific to the construction trade.
By learning these basic building blocks of construction accounting, these construction companies prepare themselves to handle the special issues in the construction business with great accuracy.
It is time to take a closer look at the structure of job costing and how it affects the success of the construction business.
Direct Costs
Direct costs in construction account for immediate expenses in a project, such as labor, material, and equipment. These costs must be well monitored and charged back to the knowledge that every project has its ability to fund. For example, the time and materials form of legal billing is a contract pricing system in which the contract price for the work is based on an hourly rate plus the cost of materials used. To account for overhead costs, contractors can calculate their profit percentage by adding a standard markup for both labor and material components.
Time and material billing example includes an HVAC technician who earns $20 per hour although might be charged $50 per hour. Furthermore, they may add their standard markup table to the cost of equipment that they have installed, based on item or price. Therefore, the application of accurate direct cost tracking and distribution enables contractors to keep a clear financial vision and achieve the goal of overall project profitability.
Indirect Costs
They are expenses that are not directly attributable to the functions, products, or operations of construction projects. These costs include:
- Administrative procedures or operations
- Employee wages or payroll
- Coverage or insurance policies
- Asset depreciation or amortization
- Overhead costs
Thus, it is important for construction companies to trace and allocate indirect costs to their projects properly to manage their resources and be profitable.
For instance, spreading overhead costs, including office rent and electricity bills across project-specific costs facilitate the understanding of the project’s cost by the contractors. Such control in cost accounting of direct and indirect costs helps construction companies in decision-making processes for the profitability of projects, distribution of resources, and overall detailed control of a company.
Revenue Recognition Methods
Revenue recognition is a crucial step in construction accounting for accurate reporting of income and expenses. There are several options such as :
- Cash Accounting Method: Recognizes income or profit as a function of current cash balance, and records revenue when received and expenses when paid.
- Accrual Accounting Method: Regardless of the timing of payment, accrual accounting records income and expenses while they are incurred or generated.
- Percentage of Completion Method: Sses the percent complete of a project to recognize revenue and expenses.
- Completed Contract Method: This uses the completed project method which recognizes revenue and expenses when they are complete.
They all have their strengths and weaknesses; therefore, the method suitable for specific business and financial goals should be chosen.
On the other hand, the percentage of completion method enables contractors to record sums of revenue relating to their contracts in progress. The completed contract method recognizes both the revenue and expenses only when the contract is completed. Proper choice of the appropriate method of recognition of revenues gives the contractors the capacity to maintain accurate records of their financial position and ensures that their construction business complies with the universally accepted accounting practices.
Managing Construction Billing
Construction billing involves various methods, including construction contracts such as:
- There are also contracts with a fixed price that could be billed on a percentage-of-completion method. Also, retainage is normally deducted until the work is finished.
- Contracts for time and materials, in which contractors charge for both the actual amount of time they spend on a project and the cost of the materials they use.
- The unit price contracts where the contractor charges a fixed amount of money per unit for instance, where the two parties have agreed on the meaning of the word “unit” being used for that specific project.
Every technique has its own risks and benefits. The billing method is an essential aspect of any contracting business, and a contractor should know what billing method suits for the projects.
Risks of unit price contracts include the fact that the actual quantity of production might be different from the estimated figure, a factor that influences the contractor’s profit levels. Understanding and effectively handling construction billing methods involves helping a contractor to minimize risks, maintain accurate accounting books, and most importantly, ensure that contractors’ projects turn a profit.
Construction Industry Payroll and Compliance
Payroll processing as well as compliance is complex because of issues such as prevailing wage, union payroll, and many state requirements. Such complexities make it crucial to monitor and report these construction firms to the letter so that they do not defy any of the existing laws or regulations.
For instance, unionized projects may have reporting requirements not only on the national level but also at the local level, and contractors may have to deal with the local unions in order to meet these requirements.
Certified payroll reports are legal documents that attest to adherence to prevailing wage laws for every project and the details of their preparation depend on the state or the institution. Awareness and adherence to these details on construction payroll and legalities help the contractors avoid legal pitfalls and be in good standing within the construction domain.
Financial Reporting For Construction Companies
In construction accountability, financial reporting involves statements that are as follows; Work-in-Progress (WIP) schedules, Construction-in-Progress (CIP) reports as well and the Job Cost Sheets which play crucial roles in the decision-making process. WIP schedules give an estimate of several financial aspects such as project total costs, accumulated costs, billed amounts, and recognized amounts. Using WIP data is useful to foresee the possibility of excess or insufficient of the budget since it is critical in assessing the progression of a project about the relevant finances, and directing choices for the continuing projects.
Applying various specialized financial reports like the financial statements, CIP reports, and job cost sheets, gives the contractor a single consolidated picture of the construction projects’ financial health. This critical information assists in making a proper decision hence improving on project delivery as well as financial improvement.
Effective Accounting Advice For Construction Companies
To maximize the efficiency in constructing a successful accounting system, contractors should consider the following:
- Understanding Job Costing: This makes it possible for contractors to identify opportunities for profitability or loss so that necessary actions are taken fairly and promptly to considerably reduce any adverse effects on profitability.
- Adopting Cash Basis Accounting: This accounting method gives a more realistic picture of a contractor’s financial situation by recording income and costs as soon as cash is received or paid.
- Emphasizing Job Costing for All Employees: Ensuring employees are compliant in the area of job costing and making sure all the employees are fully trained to follow the right procedures while costing a particular job.
- Implementing Effective Tax Strategies: Consulting a tax specialist on the correct strategies that can be implemented in the construction business to ensure that the right taxes that will favor its operation are paid.
Adopting such practices assists contractors in enhancing the efficiency of finance and decision-making in their businesses.
Construction accounting implies the contractor’s income tax law that depends on the revenue recognition, the type of business the contractor is involved with, and the project delivered. Thus, these aspects should be measured more thoroughly to obtain an accurate estimation of the discussed liability. Compliance with best practice models and the proper application of construction accounting concepts can assist contractors in optimizing matters relating to their fiscal aspects of construction business, specifically minimizing taxes and maximizing profits on projects.
Accounting Mistakes in Construction Companies And How You Can Avoid Them
Some common mistakes in construction accounting processes include:
- Disorganization that might result in a lack of understanding of project expenses and possible tax issues.
- Improper estimation of a job cost can often lead to either loss-making, delayed delivery, or both.
- Improper joint venture recognition may lead to the use of inaccurate accounting methods.
Construction accounting software that focuses on construction, proper record keeping, and updating can assist construction businesses in avoiding these pitfalls. As a result, contractors can improve their ability to correctly manage their finances in the construction industry as well as their level of profitability.
Summary
Construction accounting is a specialized field that addresses the unique challenges of the construction industry. Key issues include accurately determining job costs, revenue recognition, financial management, and ensuring the profitability of a contractor’s business. To thrive in this competitive environment, construction companies must focus on critical factors and work to eliminate significant pitfalls.
No construction company can thrive without proper accounting, which serves as the foundation of your business. The principles and practices discussed in this blog post can help you establish an effective financial base for your construction company.
For more information about accounting services for the construction industry, get a free consultation with FastLane Group. Contact us now!
Frequently Answered Questions
What are the accounting principles for construction companies?
Construction companies can employ four accounting methods: cash, accrual, percentage of completion, and completed contract which have their strength and weaknesses.
Is accounting for construction different from other industries?
Yes, construction accounting is different from other types of general accounting and bookkeeping because of its characteristics and unique ideas used. It has to keep the correct supplies for the distinct tasks in the factory to make sure the projects are profitable.
What is the difference between construction accounting and financial accounting?
Construction accounting is different from financial accounting because the former enables tracking of financing and expenses in multi-year projects while financial accounting systems are usually short-term based.
How does the feature of job costing work towards the prosperity of construction businesses?
Job costing helps construction businesses form effective tools to control resources, increase project outcomes, and boost the profitability of its delivery, which is crucial for its success.
Can I change my company secretary?
Yes, you can. If you choose to change your company services to FastLane, we will facilitate an easy transfer of responsibilities. We will take over all documents and registers from your current vendor and handle all necessary paperwork on your behalf. We guarantee a seamless transition.