Accounting in Construction Industry

Accounting in Construction Industry

Understanding the Basics of Accounting in the Construction Industry

Accounting is an important aspect of running a company, ensuring profitability and transparency. However, for the construction industry, the concept of accounting is a little different and complex. In this blog, we will understand how accounting in the construction industry is different from regular practices, what the challenges are, and why it is crucial to seek professional help to improve your accounting system.

How Accounting in Construction is Different?

Accounting for the construction industry is more intricate and challenging. Therefore, firms should have a different approach to accounts management. Here is how construction accounting is unique from that of regular businesses:

  • Sales: Most companies have a product or service line of 1-5 categories. Thus, accounting for sales is less complicated. However, for construction companies, it is not so simple. They have a wide range of service categories – consulting, design, engineering, service work, materials, labor, etc. With such manifold business, accounting can be difficult.
  • Expenses/Overhead: In general accounting, there is a transparency between overhead and cost of goods sold. In the construction industry, items that usually fall under the category of overhead would be considered as the cost of goods sold because it is related to a client’s project directly.
  • Cost of Goods Sold: In regular accounting practice, the cost of the product sold is recorded simply. However, for the construction industry, maintaining the cost of goods sold is difficult. Every job has both direct and indirect costs, falling under the purview of various categories. Recordkeeping can be elaborate and problematical.
  • Break Even: For general businesses, the break-even point is calculated on the basis of where income cuts over expenses. For construction firms and contractors, calculating breakeven is easier said than done. There are so many categories of items that it becomes harder to achieve break even on a project. Moreover, there are hundreds of custom jobs, each having unique requirements and varied associated costs.

Common Accounting Mistakes 

When construction companies adopt general accounting principles, the following errors can show up in their financial statements. It is important to avoid such accounting mistakes and use advanced software solutions designed particularly for the construction industry.

1. Not Accounting for Estimated Job Costs Properly

 Estimated job cost is vital for any construction project because contractors mostly use the percentage-of-completion approach to calculate revenues. However, mistakes occur in accounting estimated job costs due to poor forecasting/estimating, inappropriate accumulation of actual costs, or excluding revisions inaccurately in case of change orders.

To avoid this, it is vital to compare actual project costs to estimated costs on a monthly basis and make sure both include the same elements. Future increases in wages and prices should also be taken into consideration, and likewise, monthly revisions should be made to the estimated cost.

2. Inaccurate Assignment of Overhead to Jobs

 Most construction firms and subcontractors use overhead rates for the allocation of indirect costs such as depreciation, utilities, etc. to individual jobs. This is generally calculated by using a fixed percentage that is multiplied by either material costs or direct labor costs. However, most often, the overhead rate is not tracked to determine whether it accurately represents the firm’s current overhead costs. This results in under-or-over allocation of costs.

 Prevent this mistake by monitoring the overhead rate on an annual basis to ensure that the costs are input accurately and an appropriate method is used that considers important elements of construction labor, materials, and activities.

3. Inappropriate Job Cost Cut-off

 Most construction firms adopt the accrual accounting method in which costs and revenues incurred and earned are recorded in the period. However, cut-off mistakes arise as a result of excluding the costs incurred during the period being accounted for. This often happens when certain invoices are received after the period and are not recorded in the accounts payable closing process.

You can avoid this error by implementing a voucher system that records the costs as liabilities incurred in the period. You can then match the accrued costs with the received invoices, and make payments as shown in accounts payable.

4. Not Recording 100% of Loss Contracts in the Period

 In the construction industry, the percentage-of-completion method is popularly used for revenue calculation. This can lead to an accounting error when it is not considered whether the job that is estimated is a loss. A loss contract should be accounted for fully when determining a loss. Prevent this by monitoring the job schedule in detail which comprises estimated cost, estimated job revenue, and estimated gross profit or loss. When you record estimated loss, an accrual of loss should also be accounted for.

 Widely Used Construction Accounting Methods

 Here is a quick glimpse of the most commonly used accounting methods for the construction industry:

  • Percentage of Completion: Construction businesses widely use the percentage-to-completion method to calculate their gross profits in each period instead of doing it after job completion. It helps calculate the profit or loss of a construction project in progress.
  • Job Costing: This is another standard practice of construction accounting wherein you have to allocate all direct and indirect revenues and costs to each contract or job. This simplifies the process of tax preparation and also provides contract profitability.
  • Completed Contract: In this method, all job expenses are capitalized. This means recording the expenses as an asset to the balance sheet. Revenues received are moved as liabilities in the balance sheet. After completion of the contract, the expenses are revenues are moved from the balance sheet to the right income and expense accounts.
  • Cash Basis: The simple accounting method is frequently used in the construction industry wherein revenues and expenses are recorded as and when received and paid.

Get Expert Advice for Accounting in Construction Business

Accounting for the construction business can be most challenging and daunting. Additionally, it is a time-consuming process and creates backlogs.

Get expert help from chartered certified accountants who have vast knowledge and experience in accounting for the construction industry. They use cutting-edge technology and keen expertise to save time on paperwork and accurate tracking and recordkeeping to ensure profitability. Arrange a consultation today. Call us at 0208 090 2604, or email us at info@gnsassociates.co.uk. or reach out to us on our Facebook.

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