Construction companies have unique accounting needs. Production contracts often span multiple fiscal periods, and varying payment terms like retainage withholding add to the challenge of revenue recognition.
The solution to these challenges is a powerful construction accounting method called job costing. This enables contractors to use real-world cost data to optimize bids, estimates and profit margins.
One of the biggest challenges construction companies face involves project management. Each new project brings unique costs and requirements, even with repeatable processes and standardized materials. Managing these variables can only be easy with robust accounting systems.
For example, revenue recognition is more complicated because most construction work is long-term contracts. Adhering to an accrual accounting method can lead to revenues being recorded before they’re received, and the impact on cash flow is substantial.
Additionally, construction expenses like equipment use and labor are often tracked project-by-project. This helps manage costs and enables informed bidding decisions, but it requires precise record-keeping and monitoring to be successful. Getting it wrong can result in underbilling, inaccurate estimating and missing important financial projections. It can also lead to missed opportunities, like securing short-term financing or re-evaluating upcoming projects. This is why top-performing construction businesses rely on a professional advisor and outsource bookkeeping for construction companies. This way, their accountants can ensure accurate records and proper reporting.
Accounts receivable track the pending payments owed to a business by customers. This is an asset that companies track so they know if they have the resources to pay their bills without risking financial hardship.
Construction accounting differs from other industries because it’s based on each project and deals with long-term contracts paid over time. This means contractors need a job cost accounting system to help them manage the unique aspects of their business.
One difference is that a contractor may choose to use the completed contract method of accounting (CCM) instead of cash-basis accounting for tax purposes. CCM requires the company to recognize a complete project’s profit at the end of the project, which can be advantageous for some contractors.
However, the IRS only allows CCM for contractors that meet specific average annual revenue requirements and that can prove they’ll be able to finish projects within a set timeframe. This makes the process more complicated for most contractors.
Construction accounting requires more precise tracking and recording of expenses and incoming payments. Production contracts can last years and require multiple charges based on project completion and progress. In addition, contract terms typically allow 30, 60 or 90 days or more for a customer to pay invoices, and retainage withholding and disputes can further delay payments.
In addition, production in the construction industry is decentralized – it takes a lot of money to move workers and equipment around. This leads to a separate category of costs called mobilization costs.
A separate business bank account should be opened to track incoming revenue and outgoing expenses. Using a credit card with a business-specific perks program is also beneficial to help track and control expenses. Finally, a job costing system should be implemented to record only true project-level costs (i.e., materials, labor and equipment). It’s common to see other expenses such as payroll, insurance, taxes and travel expenses included in the overall overhead cost for a company. Still, these should be tracked by the project as well.
Construction production is project-based and decentralized, so contractors use a variety of billing styles and methods. This can make calculating profitability tricky.
To understand their true profit margins, contractors must track costs like materials and equipment project-by-project. In addition, labor tends to be the largest expense, and contractors must deal with the complexities of pay rates, workers’ compensation, taxes and other payroll expenses that vary by state.
Additionally, construction contracts often include retainage, a portion of the payment that is withheld until all work is completed on the contract. This means it can be years before a contractor gets paid for their work, impacting revenue recognition and income tax liability reporting. To address these issues, companies often employ job costing or a similar accounting method, where all project-specific costs are recorded in a database with unique codes called work elements. This allows managers to analyze past job ledgers and use the information in future estimating and budgeting.