Managing an accounting department is critical to the success of any construction company. But proper financial management for your company doesn’t always come easily, especially if you’re not good with figures.
In addition, there are certain difficulties in accounting for construction companies compared to other kinds of business.
This guide explores the fundamentals of construction accounting. Follow this guide step-by-step to create a productive accounting procedure, avoid costly errors, and increase revenue.
Table of Content
Key takeaways
What is construction accounting?
A specialist area of accounting known as “construction accounting” is dedicated to meeting the construction sector’s particular operational and financial requirements. It addresses the difficulties of building projects, like extended schedules, intricate costing schemes, and contractual duties.
Unlike standard accounting, construction accounting concentrates on specific projects, guaranteeing their financial feasibility and closely monitoring them from beginning to end.
Fundamentals of construction accounting
Below are a few of the key methods of construction accounting:
1. Job Costing
Job costing is a crucial accounting principle used in the construction industry to manage and track the financial components of each project separately. This approach is essential in the sector, where each job frequently has unique specs, costs, and obstacles.
In the construction industry, companies use a general ledger to handle overall finances, but they also use a job cost ledger to manage finances specifically for individual projects. This dual strategy ensures that the unique financial details of every project are correctly documented while maintaining the overall financial health of the construction company.
Here’s an overview of how the whole job site costing cycle operates in construction:
- During a Project
Construction accountants allocate distinct cost codes to every expense category incurred during the project. This categorisation helps provide specificity to each expense, guaranteeing that all project expenditures are precisely and completely recorded.
- After a Project
When a project is finished, the task cost ledger is stored away. This stored data acts as a financial history of the entire project itself, offering a useful resource for research and analysis.
- Before the Next Project
The management team examines previous job cost ledgers before starting a new project. This assessment helps create more exact project bids and cost estimates. Through historical data analysis, the business can spot patterns, find areas for cost savings, increase the accuracy of its budgets, and improve its overall financial planning.
- Continuous Improvement
The company’s recording, evaluating, and refining cycle is repeated with each project. Incorporating real-world information from completed projects allows the organisation to improve its competitiveness.
Enhanced data accuracy leads to stronger offers, stable prices, higher profit margins, and more informed financial decisions for future projects.
2. Sales and cost of sales categories
Construction accounting covers various sales and spending groups that do not appear in a normal financial chart of accounts. This is due to the level of information required when monitoring construction projects.
Cost categories are divided into three types: direct costs, indirect costs, and committed costs.
- Direct costs
Direct costs, such as labour, materials, equipment rentals, and subcontractors, can be linked directly to a particular project.
- Indirect costs
Indirect costs are overhead expenses related to a project, such as employee pay and administrative costs. Equipment utilisation is a frequent indirect cost in the construction business, with the expense of using a contractor’s owned equipment allotted to each work.
This expense must be divided among the occupations according to uniform rates, either an internal daily rental charge or an hourly use rate. To determine the rate for indirect costs related to equipment, you can divide the total equipment hours used by the company during a period by the total equipment hours used on a particular task.
- Committed costs
Committed costs arise when a business purchases a contract or purchase order. For instance, if a general contractor engages an electrician for a project and signs a contract specifying the amount of work and the amount to be invoiced, this is a committed cost.
Other instances include open contracts or subcontractor agreements, unposted paychecks, purchase orders awaiting delivery or payment, and purchase orders that still need to be paid for.
3. Revenue recognition methods
The right revenue recognition technique is essential for accurately reporting income and expenses in construction accounting. There are various alternatives available to contractors, including:
1. Cash method: Records revenue when payment is received and expenses when paid. It determines income or profit based on the company’s current cash position.
2. Accrual accounting: Recognises income and expenses when incurred, regardless of when payment is received or made.
3. Percentage of completion method: Recognises revenue and cost depending on the portion of work completed on a project.
4. Completed contract method: Recognises income and costs upon project completion.
Selecting the approach that best fits your financial and company objectives is important because each has pros and cons.
4. Construction payroll and compliance
Construction payroll and compliance are complicated due to prevailing wage specifications and multi-state laws. Because of these intricacies, construction businesses must maintain rigorous compliance with all relevant rules through precise tracking and reporting.
Contractors must speak with their local union business manager to find any unique reporting requirements that may apply to union payroll, such as local or nationwide.
5. Financial reporting
Financial reporting in construction accounting involves creating and presenting financial statements that provide insights into a company’s financial performance and position; they include the following:
1. Income Statement: Measures profitability over a period, including revenue from projects, cost of goods sold, gross profit, operating expenses, and net profit.
2. Balance Sheet: Demonstrates financial position at a specific point, including assets (current and long-term), liabilities (short-term and long-term), and equity.
3. Cash Flow Statement: This statement tracks cash inflows and outflows from investing, operating, and financing activities, which is crucial for understanding liquidity.
4. Work in Progress (WIP) Reporting: Details the status and financial performance of ongoing projects, showing costs incurred, billings, and estimated costs to complete.
Final thoughts
Construction accounting plays a vital role in the ecosystem supporting the construction sector. It calls for specific expertise and methods designed to meet the particular difficulties of various construction projects.
If you have a solid understanding of construction accounting, you can manage your money and find growth prospects. Additionally, hiring a construction accountant in Uk, will provide you with an extensive understanding of your cash flow and profitability that will help you make better decisions and set longer-term goals for your company.
