Construction accounting is different from regular business accounting. In addition to the standard accounts payable, accounts receivable, and payroll transactions, construction companies deal with retention, job costing, change orders, progress billings, customer deposits, and other anomalies. These added facets make construction accounting different and require special processes.
The approved method of recording a construction company’s financial transactions is called the double-entry method, as it requires two entries to be made to a ledger to record each transaction. Smaller companies may be able to track and record these transactions in a spreadsheet or another simple format. As companies grow and have more transactions, accounting software is often required to keep up and make reporting easier.
Read on to discover the ins and outs of construction accounting, its principles, and useful tools for accounting in a construction business of any size.
Table of Contents
Intro to construction accounting
Generally accepted accounting principles (GAAP)
Construction accounting, like all accounting, has to follow the processes and procedures accepted by the accounting and business industries. These processes are called GAAP (Generally Accepted Accounting Principles), and are the basis for the “rules” of accounting.
Any business that releases financial statements to the public or is publicly traded has to use these principles in its accounting practices.
GAAP is based on 10 principles that inform the procedures used to record financial transactions, and those principles help ensure that financial reports are accurate and truthful.
Chart of accounts and general ledger
The chart of accounts is a listing of the general ledger accounts that are used to categorize transactions.
The list includes the names and brief descriptions of each account, as well as an account number that is used to ease entry into accounting software and financial statement organization.
The general ledger is the series of accounts that are used to record transactions. Account types include:
- Current assets
- Non-current assets
- Current liabilities
- Long-term liabilities
- Cost of goods sold
- Indirect expenses
- Administrative expenses
Common cost types in construction accounting
Job costing is the practice of assigning project costs to a specific job and tracking those costs throughout the project’s life.
Often, job costs are compared to the estimate established at the beginning of the project to see how accurate the estimate was and to track progress on the job. Job costing also affects income recognition for companies that are using percentage of completion as the basis for their income.
Work in progress
Work in progress refers to jobs that are currently under contract or active.
Companies need to track this so they can project their income and cash flow into the future. This term also sometimes refers to a specific report that shows the progress of jobs by looking at how much costs have come in and how much revenue has been recognized.
Cost of good sold
The cost of goods sold refers to costs that have been incurred that are specific to projects in progress. These costs include material, labor, labor burden, equipment rental, and other expenses that are directly related to the project and its administration and management.
Unlike product sales, where companies recognize revenue when a widget is sold, construction has several different ways to recognize revenue.
Which one a company uses is based on the size of the company and the duration and type of projects the company works on.
Cash vs accrual accounting
Cash basis accounting means that costs and income are recognized when the cash changes hands. This means payables aren’t recognized until a check is written to pay the bill, and revenue isn’t recorded until payment is received and deposited into the company’s account.
This type of reporting provides an accurate representation of cash flow. However, it doesn’t recognize costs and revenues in a timely fashion. Only companies with gross receipts under $5 million are able to use this type of accounting.
Accrual accounting recognizes costs and income when a bill is received from a vendor and when a client is billed. Because both are recognized in the time period they were incurred, accrual accounting provides a more accurate picture of a company’s financial standing. That’s why accrual accounting is recognized under GAAP, while cash accounting is not.
Percent complete vs completed contract income recognition
Income can be recognized in two ways in construction — percent complete and completed contract. The first method, percent complete, recognizes the revenue on a project based on the percentage of costs that have come in.
For example: If a project is supposed to cost $100,000 and $50,000 in costs have been incurred, the project is considered to be 50% complete. Based on this calculation, 50% of the project’s income can be recognized at this time. If the contractor has billed its customer for more or less than 50% of the project, the net income will be adjusted accordingly, so only 50% is recognized.
Completed contract revenue recognition only counts revenue once a project is complete. This often is used by home builders who build on spec and only recognize their income on a house once the house has sold.
Note: Because revenue is recognized after costs have been incurred, this method of income recognition is not GAAP-approved.
Common reports in construction accounting
Every construction business needs reports that help them understand their financial health.
Accounts receivable aging
Your accounts receivable (AR) is an asset that includes all of the outstanding payments that you have already billed for, but have yet to receive. An accounts receivable aging report lists the amounts due from customers and shows how long it’s been since the invoices were created.
This report shows a snapshot of the monies owed to your company and lets you prioritize who to follow up with for collections. Aging is usually split into categories for 30, 60, and 90-plus days since the invoice was sent.
The shorter the time between billing and collecting, the healthier your AR. Managing accounts receivable can be a particular challenge for construction companies, given that the building industry suffers from some of the longest payment delays of any sector.
Accounts payable aging
The flip-side of AR, accounts payable (AP) is a record of the money you owe. An accounts payable aging report lists the amounts due to vendors and subcontractors and shows how long it’s been since those invoices were created. Aging is usually split into categories for 30, 60, and 90-plus days since the invoice was created.
Profit and loss/income statement
A profit and loss report, or income statement, shows the amount of income and expenses accrued during a period, and the net profit or loss for that period.
A balance sheet shows the assets, liabilities, and equity holdings of a company. It’s often used to determine the financial position of a company for lending and credit purposes.
Cash balance or cash flow report
A cash balance report or cash flow report shows the cash received and expensed during the period the report covers. It’s used for predicting cash needs in the future and to inform business decisions like financing equipment purchases.
Job cost report
A job cost report provides a breakdown of the costs incurred for specific projects during the period of the report. It’s often used to inform customer billing amounts and to show project progress.
Job profitability report
A job profitability report analyzes the difference between the estimated costs and actual costs. It shows how profitable a project is by taking the difference between the actual costs and the projected revenue.
Earned value report
An earned value report analyzes the difference between the estimated costs and actual costs over the schedule of a project. It can show both budget and schedule savings and overruns over the life of a project.
Work in progress report
A work in progress report analyzes the progress on active projects by recognizing revenue as a percentage of the costs that have been accrued to date. The schedule determines if income needs to be adjusted for the period to account for over billings and under billings.
Estimates vs actuals report
An estimates vs actuals report breaks down a project into parts and analyzes whether costs are above or below the estimate for that scope of work. It shows the overall budget position of a project, as well as a detailed report showing specific phases or trades.
A payment application is a form used to apply for a payment from a client. The general contractor or project owner may provide a specific form that needs to be used to request payment.
Construction accounting software for contractors
Taking advantage of accounting software can help save a lot of time.
When using accounting software for construction, you’ll have to personalize the account organization system to fit your company’s needs and how you want to present your financial statements. And contractors: It’s a good idea to meet with your accountant before implementing new software, process, or account structure.
Construction accounting is customized to the industry
While construction accounting is similar to regular business accounting, there are some differences that have been adapted to the industry.
Work in progress reporting, job costing, and estimate comparisons make construction accounting specialized, requiring new skills and learning for anyone new to the construction business.