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Construction Accounting: The Ultimate Guide

If you are in the construction business, it’s important to know that there are accounting differences that are specific to your type of work. While there are some general accounting principles involved, there are several notable differences. 

We’re going to take a look at what these differences are as well as some key topics you need to know about when it comes to construction accounting.

What Makes Construction Accounting Different?

Construction has several key differences if you were to compare this type of business with other industries.

There is No Central Location

Unlike a manufacturing plant where work is done on one site, construction projects differ with unique sites for each one. Equipment and labor are mobile which need to be factored into a company’s expenses. These costs have to be looked at with each job site so that the correct figures are used.

Also, construction companies may not be able to maintain large amounts of inventory due to the changing circumstances of each project. This can influence production costs and must also be tracked.

It is Project-Based

Unlike other businesses, construction concentrates on one project at a time. That means the billing, labor, and other facets of the job are unique and short-term. When one job finishes, another will begin and bring with it a new set of finances.

Even when projects are similar in the work provided, each will have its own budget, materials, and local requirements. Construction companies need to track accurate costs for each project on an individual basis.

Long-Term Contracts

Unlike some other businesses, construction companies often allow customers a longer period to pay an invoice. This can result in not getting paid for a project for 30 or 60 days after it’s completed. Money management has to be taken care of differently because wages and material costs will need to be paid although the complete contract may not be paid in full.

Things to Know About Construction Accounting

Despite the key differences, it’s also vital to know about some important concepts involved with construction accounting.

Revenue Recognition

Revenue recognition refers to when a contractor determines that they’ve officially made money on a project. It can also help them determine when to officially record an expense. There are several ways this can be done:

The Cash Method

This type of method works in real-time. Revenue is only recorded when payment is received. Contractors only report expenses when they actually pay. With this method, there are no accounts payable or receivable. Only construction businesses with less than a set average annual revenue can use this method for tax purposes. According to the IRS, if sales exceed that amount, they’ll have to use another method for tax purposes. These other methods are referred to as an accrual method. This recognizes expenses when they are incurred and revenue when it’s earned even if it hasn’t physically come in yet.

The Complete Project Method

With this method, income nor expenses are not reported until the project is done. This can mean that contractors are not able to defer taxable revenue when the contract won’t be done until the following tax year. To be eligible for this method, contractors can’t exceed a certain average annual revenue. The contract must also be complete within a certain period.

The Percentage of Completion Method

There is another method that can also be used with construction accounting. With the percentage of completion method (PCM), contractors can recognize revenue as they earn it over time. Every time an invoice is issued, they can record the revenue earned. This process continues until the contract is done.

Understanding the ASC 606 Revenue Recognition Standards

The ASC 606 Revenue from Contracts with Customers provides a new set of standards for recognizing revenue. The Financial Accounting Standards Board which oversees generally accepted accounting principles issued this rule. As of December 2018, all companies that report under generally accepted accounting principles must follow ASC 606.

These standards help contractors to know whether they should recognize revenue at a single point or over time. This decision is based on transferring control. Control is transferred when the asset being built becomes the customer’s. This can mean that one part of the project becomes the customer’s at a single point while others do not. This is why both parties need to decide ahead of time when control will be transferred. This will help to account for income. 

The ASC 606 rule also covers things like:

  • When a project should count as one contract or multiple contracts
  • How to determine the contract price
  • Changes to accounting for contract losses
  • Stored materials

Contractors need to check in with their accountants regularly so that they can be sure everyone is on the same page.

Job Costing

Job costing is the process of tracking and reporting transactions that are specific to each job. It is the process of tracking costs to each project and its production activities. Job costing works hand-in-hand with the general ledger that tracks each transaction and how it impacts the company as a whole.

The General Ledger looks at the company as a whole while job costing looks at the specific project, cost activities, and cost types. When a construction company has all of this information, it will know what is needed to break even on a project and what is needed to make a profit.

Job costing also contractors to keep tabs on the physical completion in units, the costs faced in dollars, and the labor used in hours. When this is done with each job, contractors can track progress and see profitability and overages as they’re happening. They can also look at costs shared between multiple jobs and determine fair ways to distribute the costs in what is referred to as overhead allocation.

With all of this information at their fingertips, companies can determine their true profitability and costs from contract to contract.

Contract Retainage

Retainage is the predetermined amount of money an owner may hold until they are happy with the contract completion. Typically, this can be 5-10% of the contract value. Retainage can protect the customer against problems with the project. Retainage laws can vary from state to state with some money being held for as long as a year. 

The retainage amount is not treated as a receivable amount. Instead, contractors record it in a separate account. Once the contract has become completed to the customer’s satisfaction, an invoice is issued for the amount and the money moves from the asset account to the accounts receivable account for collection.

Construction Payroll

Construction payroll can be complex due to things like certified payroll and prevailing wage, multiple pay rates, and other compliance reporting.

Contractors have to pay a rate of compensation that is deemed to be the standard for each worker on similar jobs in the area. This is like minimum wage but is more complicated. Prevailing wage may include and can require non-cash compensation like health care or continuing education, sometimes referred to as fringe benefits. The amount will vary by area and by specific worker classification. This can mean that there are different prevailing wage rates on one job depending on what each worker was doing every hour they were on the job.

Multiple Rates

If workers are doing jobs in different cities and states, they may have multiple tax withholdings within one payroll. This can result in double taxation which needs to be monitored. It can especially be a problem when an employee lives in one state and works in another. Construction companies must also watch that they don’t overpay on unemployment tax when an employee works in multiple states.

Compliance Reporting

Even if a certified payroll is not required, contractors can still face many payroll reporting requirements. This can include things like workers’ compensation, union reports, and equal employment opportunity minority compliance. Contractors need to be aware of all of these requirements when they bid and work in jobs in different areas.

Certified Payroll and Prevailing Wage

Contractors have to pay a rate of compensation that is deemed to be the standard for each worker on similar jobs in the area. This is like minimum wage but is more complicated. Prevailing wage may include and can require non-cash compensation like health care or continuing education, sometimes referred to as fringe benefits. The amount will vary by area and by specific worker classification. This can mean that there are different prevailing wage rates on one job depending on what each worker was doing every hour they were on the job.

Specialized Billing

Since construction is project-based, there are different contract types and billing options.

Fixed Price

This type of billing is based on a detailed estimate that will give the total cost of the project. It can be negotiated or a hard bid. A hard bid is just what it sounds like, there is no wiggle room. The price is what it is. A negotiated fixed price allows for some unforeseen events. 

Time & Material Billing

This bases the contract price on a per-hour labor rate plus the cost of materials. In both cases, the contractor may apply a standard markup. This takes overhead into account and builds the profit percentage into the amount.

Unit Price

This type of billing calls for the contractor to bill a customer at a fixed price-per-unit rate. This type of billing is common with utility construction companies. With this type of billing both the contractor and customer are taking a risk since production quantities can end up higher than originally estimated. If the unit pricing was estimated right, the contractor should not lose money.

AIA Progress Billing

This type of billing is named after the American Institute of Architects. It invoices the customer based on the percentage of work that was completed for that billing period. A signed summary sheet along with a schedule of values that shows what’s been completed and billed to date accompanies the invoice. 

The customer will have a chance to review the summary and either accept or dispute the amount billed. If there is a discrepancy, the contract can be revised and resubmitted.

Do You Need Help with Construction Accounting?

When it comes to construction accounting it’s important to know what distinguishes it among other types of accounting. Many intricacies can make it confusing which is why it’s important to have an experienced accountant on your side. With nearly 30 years of experience in the Raleigh area, Carson Thorn can assist with bookkeeping, financial statements, and year-end tax preparation. Call today at  919-420-0092 for more information.

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