Efficient and accurate accounting is as vital to success in construction as in any other industry. But despite being built on standard accounting principles, construction accounting is a specialized discipline because of the unique way construction companies operate.
Construction accountants focus on managing the cost and profitability of large, individual projects versus product lines, for example, while helping their firms manage industry practices such as retainage, specialized billing and revenue recognition methods and tracking frequent change orders.
Because construction accounting involves specialized concepts, it typically requires specialized accounting skills.
What is Construction Accounting?
Construction accounting is a specialized branch of accounting that caters specifically to the unique financial and operational needs of the construction industry. It addresses the distinct challenges presented by construction projects, such as long-term timelines, complex costing structures, and contractual obligations. Unlike traditional accounting which focuses on routine business transactions, construction accounting revolves around individual projects, ensuring that each is financially viable and monitored closely from initiation to completion.
Key Takeaways
- Construction accounting is a specialized domain, distinct from general business accounting, focusing on the unique dynamics of construction projects.
- Techniques like the Percentage-of-Completion Method and Completed Contract Method determine when revenues and expenses are recognized in construction accounting.
- Specialized financial statements, such as the Work-in-Progress Schedule and Construction-in-Progress Report, are essential for tracking ongoing project finances.
- Implementing and utilizing modern accounting software, along with consistent professional training, are paramount for maintaining accuracy and efficiency in construction accounting.
How to Account for Construction
As in other industries, construction accountants perform critical activities to manage the company’s finances, such as recording transactions, managing cash flow and analyzing profitability. Much of the work of construction accountants is involved with tracking the individual projects that make up most contractors’ workloads. The practice of job costing helps businesses estimate and analyze costs and revenue for each project, keeping projects on track and profitable.
Construction Accounting vs. Regular Accounting: What’s the Difference?
Though construction accounting shares the same basic principles as accounting in most other industries, it involves a number of industry-specific challenges. For example, construction firms typically aim to ensure that each project is profitable, which makes accurate job costing vital. And, projects are often large and one-off, so leaders must get the numbers right the first time. This is particularly challenging because a company’s projects are typically distributed across multiple sites, use a mobile workforce and are subject to fluctuating costs.
In addition, construction accountants often need to manage revenue recognition and billing for multiyear projects that may undergo many changes over their lifetimes.
Project-based
Unlike companies in other industries, such as retail or manufacturing, construction accounting typically focuses on custom projects, each of which must be managed for profitability.
Estimating quotes to be competitive while profitable and keeping them on track can be difficult because of the unique intricacies of each project. For example, labor, material costs and local taxes can vary widely depending on the type of building and where it is based. Furthermore, contractors are often juggling resources among many projects at the same time, each with its own schedule.
Production is decentralized and mobile
With construction companies, production generally occurs on project sites rather than in a single fixed location. Workers and equipment move from site to site, so firms must be able to account for the costs of travel and moving and installing equipment.
The company must also ensure it complies with local wage scales and regulations in effect at each site, and it may need to purchase materials or rent machinery from outlets near each site. Many contractors choose to lease rather than purchase vehicles, and lease accounting brings its own challenges.
Mobile technology that enables workers to access and enter information in the field can help companies stay up to date on project progress and cost.
Long-term, irregular and flexible contracts
Large construction projects tend to be lengthy, spanning multiple accounting periods or even years. Even smaller projects can stretch out due to problems such as raw material shortages or bad weather. To ensure adequate income and document cash flow, contractors typically need to manage a schedule of multiple payments during the contract based on work completed to date.
In addition, work tends to be seasonal, and it’s often difficult to predict when jobs will come in.
Fluctuating direct and indirect costs
Continuously fluctuating direct and indirect costs make it difficult to estimate project expenses. The price of labor and materials can change considerably over the life of a long-term project, and those changes are often not easy to predict. Contractors are particularly vulnerable to changing costs for materials because it’s difficult to stockpile building supplies in advance. Even indirect costs, such as administrative overhead and insurance, can change during a multiyear contract.
Limited sales
Construction firms — especially those undertaking large-scale projects like commercial or municipal buildings — may win only a few contracts per year. Thus, a typical chart of accounts for a contractor will look different from a manufacturer or high-volume retail or hospitality business. Sales staff will also be remunerated differently, and accounting needs to pay significant attention to the financial health of customers.
Change orders
For most contactors, change orders are the norm rather than the exception — especially on longer projects. If they’re not handled efficiently, they can cut into project profits. It’s important to accurately document the financial impact of each change to the overall project, which isn’t always easy because contractors often start work on changes before they’re formally approved and priced. Ideally, contractors should document a change order process in the original project contract.
Predicting profitability is difficult
Determining whether construction projects will be profitable is more difficult than in industries such as retailing or manufacturing, due to all of the factors above. Each project brings its own unique challenges, while change orders and fluctuating expenses during projects further complicate the picture.
This emphasizes the fact that accurately accounting for all costs is key to determining whether projects make a profit, break even or lose money.