The construction business is a complicated one due to which the accounting work is complicated too. The methods of accounting also differ from most other industries. Construction contractors usually run multiple projects simultaneously – for which accountants need to manage and compute expense, revenue, and profits.
Applying these routines and procedures when doing construction accounting is beneficial to the contractors and accountants.
4Things to Take Care of While Doing Construction Accounting
Leaving aside the on-site construction work, a lot of time and work goes into the process of construction. Bookkeepers need to allocate direct and indirect project costs to optimize tax reporting while the organization decides between cash-basis and accrual-basis accounting. These are the important things the contractor needs to take special care of while doing construction accounting:
1. Job costing
It’s very usual for construction companies to handle multiple projects simultaneously. Tracking the list of all expenses to each job is very important for controlling expenses and measuring profitability. Carefully administering all direct and indirect financial transactions ensures that the company’s economic condition isn’t at stake.
To efficiently perform job costing, one should take down records of expenses during the project is active and submit them daily. Actual expenses should be tallied with the estimate so that accountants and project managers can know if the job is going as it was planned. The construction company must have a tried and tested method of tracking indirect expenses like administrative overhead to each project.
2. Cash-basis accounting
Cash-basis and accrual basis are the two main accounting methods for projects like construction. The cash-basis accounting system is simpler due to which small firms utilize this method. All credit transactions are recorded when received and the expenses are recorded when dealers are paid. This method makes day-to-day financial management a lot easier and requires less financial expertise. But there’s a limit when it comes to cash-basis accounting. Firms with more than $25 million average revenue cannot use it due to tax reasons.
3. Accrual-basis accounting
Accrual-basis accounting is done by larger firms, including public companies. All firms must act in accordance with the Generally Accepted Accounting Principles (GAAP) issued by the Financial Accounting Standards Board. It also nurtures specialized revenue recognition methodologies like the percentage of completion method.
In this method of accounting, the revenue is registered when work is completed and expenses when they’re incurred. It lays out an accurate representation of the company’s fiscal matters. Using it, a company may look profitable on record even with payment delays from customers.
4. Change order management
Several factors from minor regulatory changes to changes in customer need cumulate for changes in the original plan. If not managed skillfully, change orders can result in disputes with customers and losses. Contractors must form a standard change order process with proper documentation of the work and find out the cost required for the plan deviations.
To avoid issues in the future, contractors should hold off on starting work until legal agreements corresponding to the customer are in order. Keeping track of the changes means easy calculation of project cost and profitability. There is more than one accounting approach to do this but the compatibility of the approach depends on the status of the change order. The 3 stages of a change order are discussed below:
- Pending change orders unlikely to be approved: As a contractor, if you’re calculating the costs to implement changes and are unsure about the approval of the customer, a safe thing to do is add them with the change order to the project’s direct costs.
- Pending change orders likely to be approved: When there’s a positive signal from the customer’s end, many things can be done. One can annex the costs to an asset account until the approval of the change order is sanctioned. Else, the expense can be added in the tab of project costs which affects the expected project revenue.
- 100% approved change orders: When there’s no dilemma, the total amount needed for the change order is simply added to the total project costs. And this also raises total contract value.