Standard accounting has rules and regulations for businesses in every industry. Some industries, like construction, need a more tailored system to understand their business’s financial picture. In addition to accounts receivable, accounts payable, and payroll, contractors must consider job costing, change orders, progress billings, and customer deposits. Construction accounting offers more in-depth options for tracking, managing, and reporting financial data, but it can be challenging to implement.  

These best practices can help contractors better manage their cash flow, maximize job profitability, and make better business decisions.  

Master Job Costing 

Allocating direct and indirect expenses to respective jobs allows construction firms to track expenses and measure a job’s profitability. When done correctly, it also simplifies tax preparation, creates efficiencies that lower overhead costs, helps bookkeepers create accurate change orders, and gives project managers the data they need to track performance.  

Construction firms should track expenses like labor, materials, equipment, administrative expenses, and other related expenses for each project they’re working on and balance those expenses with the general ledger.  

Recognize Revenue Correctly 

Construction accountants have a few options for recognizing revenue: cash basis, percentage of completion, and the accrual method. Each option offers a different reason a construction firm may want to use it.  

1. Cash basis allows accountants to record revenue as it’s received and expenses as they are paid. You cannot use this method on tax returns if average gross receipts for the past three years exceed $25 million. If you are using this method, and any of your contracts cross over a tax year, be sure to properly allocate expenses, so they are evenly distributed over the entire period of benefit. 
2. The accrual method of accounting involves recognizing expenses and revenue as they happen. That means revenue is recognized as the service is performed, and expenses are recognized when incurred. If the expense is on an account with terms, the expense is still recognized on the date the materials, services, or supplies were purchased. 
3. Percentage of completion allows contractors to understand the financial picture of any job as it’s being completed. It is typically calculated by dividing the total expenses incurred by the total estimated job expenses to determine the profit or loss of the project at that moment in time. It’s an excellent method for ensuring costs stay on track and safeguarding against financial surprises at the end of the project.
4. The completed contract method of accounting reports the income from the job only after the job has been completed. This method is typically preferred by contractors deferring expenses. It works best for projects of less than two years or firms with an average gross profit under $25 million for the previous three years. Keep in mind that materials are regarded as assets until utilized with this method, and the cost cannot be included without a contract expense ledger account.  

Identify the Chart of Accounts 

The standard chart of accounts can’t keep up with most construction firms. Contractors need something more robust to match the more in-depth bookkeeping they’ll be doing. Including categories like new construction, remodel/renovation, service, and rental income will allow managers and owners to see where the firm makes the most profit and could affect decisions on which contracts to pursue.  

Track Employee Resources 

Rather than working in a single location, most of your employees work at different job sites – often traveling from one to the other on the same day. To fully understand the cost of each job and have the data needed to provide more accurate quotes in the future, it’s important to track the cost of their work as it relates to each job.  

Another variable to be mindful of is when employees are paid a different rate for different jobs. It is important to tax withholding and Form W-2 and Form 1099 reporting at the end of the tax year.   

Accounting for construction firms is daunting. Having a quality system and knowledgeable professionals in place will make a notable difference in how you see your business. Reach out to our team of professionals to schedule a time to review your accounting methods.