How to Record Construction Accounting?

Accounting in the construction sector is crucial for understanding a company's finances and operations. Maintaining precise and current accounting records is therefore key to a construction company's success.

To achieve this, it's important to acknowledge that how construction companies handle income and expenses differs from other industries, simply due to the nature of construction projects. It demands a specific strategy and the appropriate tools to produce reliable, timely financial and accounting records.

This blog post on recording construction accounting will cover:

• Why Construction Accounting is Distinct?

• The Importance of Accurate Construction Accounting?

• How to Handle Bookkeeping and Accounting for a Construction Company.

Why Construction Accounting is Distinct?

Accounting in construction can be considered quite unique, for various reasons. As mentioned earlier, this stems from the nature of service and construction projects. Construction companies face different challenges compared to industries like manufacturing, retail, or service-based businesses.

Below are some of the key reasons why construction businesses require a special approach to their accounting and how construction accounting varies from standard accounting.

It's Project-Based

Construction accounting is project-based, meaning each project has its own specific accounting needs and requirements. It's almost as if each project operates as its own entity, with distinct client expectations, vendors, designs, and materials. In essence, nearly everything on the project is variable, requiring companies to assign values to these variables for accurate accounting.

Contracts Are Long-Term

The duration from contract signing to project completion and handover to the client is another consideration. This timeframe is much longer than the shorter contracts common in other industries.

Many construction project contracts span multiple years. During the contract's lifespan, contractors and subcontractors are compensated based on their progress and contributions. Additionally, change orders, redesigns, and other variables can influence the original contract, potentially altering the timeline and initial estimates, increasing the likelihood of cost overruns in construction projects.

Locations Vary

Most businesses have fixed locations for their operations. They can control equipment allocation, handle bulk material orders, and predict productivity. Construction projects occur wherever the client requires them, which impacts how the contractor budgets time and resources, and ultimately affects accounting methods.

Furthermore, the time and resources required to move equipment between locations must be factored into the contract price. This mobilisation element is not a typical cost that other industries have to account for, as centralised production enables them to keep their machinery and materials in one place.

Subcontractors and Vendors Vary

Not only do project types and locations differ, but so do the subcontractors and vendors companies use for construction. Even if a contractor has a team of preferred subcontractors, they might not be available or possess the necessary licenses for particular projects. Moreover, unique designs may require materials that contractors can only obtain from specific suppliers.

Each new vendor might have their own payment or billing terms. Contractors need flexible accounting solutions to accommodate them all, which further contributes to the uniqueness of construction accounting.

The Significance of Precise Construction Accounting

Though the methods and tools used for recording accounting in construction and service projects may differ from those in other industries and businesses, construction companies still must produce dependable and precise accounting data for their business to prosper.

Having accurate accounting data available allows businesses to utilise this data to reliably generate other crucial reports and documentation for the business, such as construction cost and WIP (work in progress) reports, correct financial records, better estimations, and proof of adherence to tax laws and regulatory standards. Read on to discover more about how precise accounting backs up these vital reports and documentation.

Effective Job Costing & WIP Reports

Whether a company employs job costing, construction WIP reporting, or a combination of both methods (which they should), accuracy is key.

With job costing, it’s vital to have the most precise data possible to compare against estimates and contract totals. It’s also important to ascertain how much future projects might cost, considering the data gathered from these real-world projects.

Construction WIP reporting necessitates accuracy to reflect the value of completed and incomplete work on the company’s financial statements and accounts. It also permits companies to account for the proper revenue and expense amounts within the correct accounting periods.

Combined, these methods let a company get a clear picture of its financial position when making decisions—but only if the data is accurate.

Precise Financial Records

Financial records function as more than just a record of a company's history. If utilised correctly and compiled with accurate data, they are tools that companies can use to make better decisions and prevent repeating past errors.

For instance, accurate financial records allow companies to compare projects and pinpoint which contracts, crews, methods, and other variables are most profitable. Any mistakes will usually appear strikingly on these reports (if they're accurate, with the proper cost codes and documentation), allowing companies to prevent repeating them moving forward.

Compliance with Tax Laws and Regulatory Standards

Keeping accurate construction accounting data allows a company to remain compliant with tax laws and regulations. Detailed records simplify preparing and filing taxes and lessen the risk of an audit or dispute. And, if an audit does occur, the company can be confident that it has the necessary paperwork to avoid penalties and tax liabilities.

Better Estimates

The longer a company concentrates on compiling accurate accounting data, the more potent its estimating process becomes. Estimators will have a collection of reports and data to rely on and reference, enabling them to compile better estimations with greater accuracy going forward.

How to do Bookkeeping and Accounting for a Construction Company?

The following are some helpful steps for approaching bookkeeping and accounting in a service and construction company. Every business will have its own unique needs, but this overall guide should offer a straightforward roadmap for how to record construction accounting. To learn about the various methods an accounting professional can use to record construction accounting, visit this page.

1. Set Up a Chart of Accounts

Before any accounting methods can be productive, a company needs to evaluate its current accounts. Setting up a Chart of Accounts enables a construction company to identify its assets, liabilities, and expenses, among other accounts, to better assess its current status, improve reporting accuracy, reinforce its tax law compliance, and simplify reconciliations.

2. Record Project Costs

One of the most significant aspects a construction company has to recognise is the cost of the projects in progress and the pipeline. Without this data, there is no way to assess profitability or long-term viability.

Project costs involve both direct and indirect costs. Direct costs are the materials costs, supplies, labour costs, rental, and subcontractors’ costs associated with the projects. Indirect costs are overhead costs that can be spread out over multiple projects, such as marketing, administrative salaries, office rent, utilities, insurance, depreciation of equipment, software fees, and other associated costs.

3. Use Job Costing

Job costing permits a service and construction company to better understand the actual costs associated with each contract. But you cannot just do this based on invoices and accounts payable.

When back-office staff are job costing, construction accounting personnel need to assign a cost code to each project and then to each cost linked with the project. For instance, a specific project might receive a project code, and then the cost of excavating the foundation will receive a specific code, as will the pouring of the foundation and the installation and so on. When each step has a code associated, contractors are able to drill down into the individual costs incurred for better job costing reports.

4. Record Project Revenues

There are many layers to revenue recognition in construction, but it's a requirement to accurately record and report income data from projects. The process involves identifying contracts, the contract obligations, transaction prices, and reporting income in financial statements.

Project revenue should be recognised based on individual contracts. There are several methods for doing so, but the Over Time method is the most common for long-term construction contracts.

5. Record All Transactions

Every transaction that occurs throughout the lifecycle of a project should be recorded accurately. This includes payments made to subcontractors, materials suppliers, permitting offices, designers, and other instances where money changes hands in exchange for goods or services.

Recording transactions not only enhances financial accuracy, it also offers an audit trail to track the flow of money throughout the business. Any discrepancies or errors can easily be traced to the contract and person who authorised them. This also makes budgeting and forecasting easier, as repeated transactions become more predictable and easier to account for.

6. Reconcile Accounts

With so many accounts (multiple for each project, in most cases), account reconciliation becomes critical. Comparing projects or estimated costs against the actual value of these accounts in terms of both revenue and progress can help companies identify issues early and make the necessary adjustments to keep projects on track.

Many construction companies perform reconciliations once a month. At that point, it might be too late to fix the problem. Theft, misappropriation of funds, and honest mistakes can compound over the course of a month, so reconciling accounts regularly with effective reporting can help identify issues earlier.

7. Prepare Financial Statements

A major part of construction accounting is preparing the financial statements needed for decision-making and compliance. These reports are vital for helping executives and other decision-makers not deeply involved in construction accounting to understand the company’s financial position. Financial statements can be crucial in helping these folks make financial decisions that determine the future of the company.

Additionally, financial statement preparation is part of complying with the Generally Accepted Accounting Principles (GAAP) regulations as well as the International Financial Reporting Standards. Financial statements are also the foundation for tax preparation—keys to better-navigating tax season and avoiding penalties.

8. Implement Accounting Software

Construction companies should think about implementing accounting software if they are having difficulty accessing accurate cost and accounting data. Construction accounting software is designed specifically for the unique landscape of the industry, making account reconciliation, change order management, accounts receivable and accounts payable, and payments easier and more precise. With some construction accounting solutions offering multi-company accounting functionality, construction businesses with multiple companies can be more operationally efficient, saving immensely on time and resources.

Automating as much of the accounting process as possible lowers the risk of error, whether it’s reducing double data entry or simply forgetting to update line items and budget changes. Similarly, these programs can alert users to issues like overpayments, unpaid invoices, and other situations that accounting staff need to stay aware of.

Recording Construction Accounting Needs a Unique Approach

Construction accounting demands a unique approach to produce precise and timely data due to the nature of the business. While there are many options for a business to record their construction accounting data, gathering precise accounting data starts with unifying the field operations with the back office in real-time. Only when cost and revenue data flows directly from the field to the back office can contractors stay informed of their most recent financial updates and generate precise, timely reporting to make cost-effective decisions.