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6 Min. Read

How to Do Construction Accounting: The Ultimate Guide

How to Do Construction Accounting? The Ultimate Guide

Do you take care of all your accounting processes? Or do you have a dedicated finance team that does everything? There’s a lot that goes into accounting to make sure it’s accurate.

And construction accounting is a bit different compared to regular business accounting. With normal accounting practices, you have accounts payable, accounts receivable and payroll transactions. In construction, there's also a need to handle job costing, retention and change orders.

Plus, considering customer deposits and processing billings is just as important. This means that construction accounting will vary and requires different processes.

Here’s your ultimate guide to accounting for your construction business.

Here’s What We’ll Cover:

What Are the Generally Accepted Accounting Principles (GAAP)?

Change Order Management

Key Takeaways

What Are the Generally Accepted Accounting Principles (GAAP)?

It’s worth understanding the Generally Accepted Accounting Principles (GAAP) first. These are the rules and processes to follow when it comes to accounting.

Any business that’s publicly traded or releases financial statements use these principles. There are ten principles that make up the foundation of the GAAP. They’re used to help make sure that your financial reports are truthful and accurate.

These are the ten Generally Accepted Accounting Principles:

  1. Principle of regularity
  2. Principle of consistency
  3. Principle of sincerity
  4. Principle of permanence of methods
  5. Principle of non-compensation
  6. Principle of prudence
  7. Principle of continuity
  8. Principle of periodicity
  9. Principle of materiality
  10. Principle of the utmost good faith

Even though construction accounting varies, it still follows the Generally Accepted Accounting Principles.

Construction Accounting Best Practices

There are a lot of moving parts that go into construction accounting. You want to accurately divide indirect and direct project costs. Here are some of the best practices you can use for construction accounting.

Cash-Basis Accounting

There are two main accounting methods: cash-basis accounting and accrual-basis accounting. Cash-basis accounting works well for small businesses and contractors. This is since it's a little more straightforward compared to accrual-basis accounting.

With cash-basis, you record your revenues when they’re received and any expenses when they’re paid. This helps simplify your accounting and doesn’t require a ton of financial expertise.

Accrual-Basis Accounting

Opposite of cash-basis accounting, accrual basis accounting can be a little more complex. But, larger companies must use accrual-basis accounting depending on their revenue. It recognizes revenue as any work that’s been completed and your expenses when they happen.

This means that it doesn’t necessarily account for when money actually changes hands. Accrual-basis accounting can provide an accurate look into your business financials. But, it’s worth noting that it might obscure any short-term cash flow problems.

Job Costing

How many jobs do you have on the go at the same time? Accurately dividing expenses is critical to control costs and measure profitability. Efficient job costing helps allocate the proper direct or indirect expenses. This helps you keep your finances on the right track.

Anyone involved in the project must record and submit expenses as they happen. Not after the project gets completed. Try and categorize expenses to help ensure the project is going according to plan. It can also be helpful to allocate indirect expenses, such as administrative overhead.

Completed Contract Method

With this method, you recognize all project revenue, profits and expenses once the project gets completed. Typically, this is a good approach for projects that don’t last longer than a year. It can also be helpful if you wanted to defer revenue to a period in the future.

Percentage of Completion Method

This method allows you to recognize the revenue for a project as you earn it. Throughout each project, you would bill the customer in stages for work that’s been performed to date. You are also going to record the earned revenue and any expenses during each stage.

This method can be a great option if you can generate accurate estimates. Plus, it helps to make sure you get paid for work that’s been performed so you don’t have to wait until it gets completed.

You’re able to measure the percentage of completion in a few different ways.

  • The units-of-delivery method. It calculates your revenue and costs based on the number of units you deliver to the customer. It gets compared to the total number of units that got specified in the terms of the contract.
  • The cost-to-cost method. This method takes any contract costs incurred to date and divides them by the estimated cost. The ratio represents the percentage of the total contract revenue that’s been earned.
  • The efforts-expanded method. This method compares how much effort actually gets used to date. The calculations get based on materials used, machine hours or direct labour hours.

Change Order Management

Sometimes things change, and it’s no different with construction projects. When this happens, change orders can make a dent in your project profits or cause disputes. To help avoid this, include a section in the contract that outlines how to handle change orders.

You should establish an efficient change order process. This can include full documentation of work and the cost of the changes. Here are some of the most common accounting approaches to manage change orders.

  • Change orders that are unlikely to get approved. If you aren’t sure if the customer will approve a payment, you can add costs associated with the order to the direct costs.
  • Change orders that are likely to get approved. If you expect a change order to get approved, you can add costs to an asset account until approval gets made. You can add expenses as well to increase the anticipated revenue by the exact same amount.
  • Approved change orders. When change orders get approved, you can add all costs associated with the project costs. You then increase the total contract value by the same amount that gets charged in the change order.

Key Takeaways

Construction accounting has a few differences that are worth knowing. And depending on your industry, some of the processes can get further adapted.

Allocating project costs accurately can ensure a project becomes successful. And when it comes to construction accounting, there can be a few different approaches. You can use cash-basis accounting or accrual-basis accounting. It all depends on the size of your business.

There's also a percentage of completion method, a completed contract method and change order management. Plus, job costing is one of the most important elements to estimate for a project. It’s worth noting again that construction accounting still follows the GAAP.

As a construction company, you need to worry about normal accounting processes. Plus, you need to factor in things like labor costs, tax preparation and overhead costs. There are also going to be various other construction costs.

Did you enjoy reading this guide? Head over to our resource hub for a ton more great content!