21Apr
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How Construction Industry Accounting Differs from Traditional Accounting

Construction industry accounting versus traditional accounting – what’s the difference? It’s easy to assume that basic accounting will suffice for a construction company, but your industry has unique financial considerations and challenges that will shape your accounting processes.

Let’s take a closer look at some of the many unique aspects of construction accounting.

Job Costing

One unique aspect of construction accounting is job costing.

Job costing tracks all of a project’s costs, including materials, labor, and overhead. It provides a detailed breakdown of your projected costs, allowing you to track your expenses in real-time and calculate future profitability.

In construction accounting, job costing is important for several reasons. For example, it allows you to:

  • Quickly and easily identify expenses that are eating into your profit and take action to remedy the issue.
  • Predict most problems before they arise, such as when a project is reaching its maximum budget.
  • Better understand the profit and loss of each project, so you can optimize your pricing.

Software can help simplify and streamline the job costing process, saving businesses time and allowing them to generate more accurate estimates.

Work in Progress (WIP)

A work in progress (WIP) report helps construction companies understand whether a project is:

  • On-budget
  • Under-billed
  • Over-billed

WIP plays a crucial role in construction accounting because it helps businesses manage and understand their cash flow. It also helps businesses understand what’s been completed and what’s left to do, allowing them to manage their budgets more effectively.

Reports typically include:

  • Estimated costs
  • Remaining profit
  • The total amount as per the contract
  • Billed and paid revenue
  • Costs incurred
  • Percentage of the project completed
  • Over/under billings

WIP reporting allows construction businesses to create more accurate financial statements and take a proactive approach to project management.

For example, if your WIP report shows that a project is 35% complete but has already used 75% of the budget, it’s likely that the project will go over budget. Knowing this early on allows you to take action and address the issue before it escalates and you wind up under-billing the client.

Revenue Recognition 

Construction accounting also differs when it comes to revenue recognition. While there are many ways construction companies can handle revenue recognition, the percentage of completion method is one of the most common methods.

With the percentage of completion method, revenue and expenses are recognized based on the percentage of work that’s been completed during the period. Simply put, income and expenses are recognized as the project progresses. In most cases, this is on a monthly basis.

Here’s how it works:

  • The first step is to calculate how much of the project has been completed
  • Next, the percent is multiplied by the total expected revenue
  • The result is the amount of income recognized on the company’s income statement

Although the percentage of completion method is ideal for long-term construction projects, it’s not without complexities and challenges. When the recognized revenue and expenses differ from the actual amounts spent and received on a project, cash flow issues can arise.

Project Management Software Integration with Accounting Software

Construction companies often rely on project management software to ensure projects go smoothly and stay on budget. Integrating project management solutions into accounting software like QuickBooks improves accuracy and efficiency while providing real-time monitoring.

Although workflow integrations are common with traditional accounting, construction is unique in that each project will have individual costs and revenue that must be carefully tracked and managed.

Construction companies need to consider their software solutions carefully to ensure they work together seamlessly. Fortunately, QuickBooks integrates with many popular project management solutions. 

How They Get Paid By Clients 

Typically, businesses are paid when they deliver a product or service to a client. Construction companies differ in the way they are paid by clients, and sometimes, they don’t get paid. Cash flow issues are a very real concern for construction companies for this reason.

Construction companies may use a variety of payment models:

  • Progress payments
  • Deposit
  • On completion

Ideally, clients would pay a deposit and then make progress payments. Late fees would be imposed if payments aren’t made promptly. Taking this approach helps ensure steady cash flow throughout the project.

Without proper management of client payments, cash flow issues can quickly arise and make it difficult to stay afloat. Here’s where it pays to have an experienced accountant who understands the challenges construction companies face when it comes to getting paid. They can help you better manage your cash flow and ensure clients are paying promptly.

Pricing Options

Construction companies may use different pricing models, which will also impact their accounting. While there are many ways to price projects, two of the most common ones are:

  • Fixed pricing or stipulated sum. With this model, a definite price is set for the job and is only changed if there is a change in scope. 
  • Cost plus pricing, in which companies charge a cost plus a markup. The cost plus model is more complex and demanding, as every component of the work is tracked throughout the project.

Each type of pricing model will require careful management and tracking to keep the project on track and cash flow consistent.

Labor

Construction companies may work with subcontractors, have an in-house team, or a combination of both. This can complicate payroll and accounting.

Both types of labor have advantages and disadvantages.

  • Subcontractors can come with lower costs because you won’t incur payroll taxes or the cost of benefits. 
  • In-house employees may make it easier to predict labor costs. Crews that work together consistently are often more efficient, which can reduce costs and improve profitability.

It’s important for construction companies to understand how subcontractors and in-house employees will impact their accounting, payroll, and compliance needs. 

Conclusion

Construction accounting differs from traditional accounting in many ways, from job costing to labor, pricing, revenue recognition and more. With unique challenges and needs, it’s important to work with an accountant who specializes in the construction industry. 

To learn more about how Beyond Books Solutions can help you with construction accounting or to schedule a call, get in touch here

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