Construction accounting is complex. Its project-based, production is decentralized (it happens at job sites), and contracts are long-term with extended payments. Our industry-focused support will help you navigate the challenges you face. From razor-thin margins, to seasonality and the need to manage cash flow, we will help you address your challenges in a efficient and effective manner. Below we have provided an overview of several of the key concepts that are unique to this industry, and with which we have specific experience addressing.
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For many businesses the general ledger (G/L) will be sufficient to track transactions and produce financial statements. Construction accounting is project-centered and just use job costing to track costs on each project. The G/L and job costing must work together. The G/L is made up of accounts (such as accounts receivable or accounts payable) whereas job costing is made up of individual projects, cost activities and cost types (labor and materials). Construction Specifications Institute.
A well-designed job costing structure will not only track each job, but also, within each group of job activities, and each type of cost. By identifying every transaction with information from the job cost structure, you can see how much each aspect of operations costs on a particular job and across the company as a whole. You can also determine a fair way to distribute costs shared between multiple jobs (overhead allocation). Construction Specifications Institute
Cost codes should be assigned to every transaction to separate costs into specific categories. What the G/L Chart of Accounts is to company-wide financial reporting, the Job Cost Structure is to project reporting. Think of it as activity-based costing. The cost code structure will typically Construction Specifications Institute (CSI) standards. You can use the CSI MasterFormat, the National Association of Home Builders (NAHB) cost codes or go with a custom coding system. One of the common mistakes is creating and trying to maintain too many cost codes which makes accounting and managing costs more complicated than it needs to be. One rule of thumb is that one or only a few cost codes are needed if you don't self-perform and subcontract out the work.
Having established a good job cost structure is only the first half of the equation. The second part is ensuring people are documenting the work and assigning the cost codes correctly. It is very valuable to have your accounting policies well-documented and your system of internal controls should include proper reporting that fosters accountability in a way that can detect miscoding errors timely.
Work In Progress (WIP)
The Work in Progress (WIP) report is a key report. It makes sure you know where each job stands and the billings progress. It helps monitor profit fade, cash flow and loss-job issues. As will be discussed below, it is the foundation report used to determine revenue recognition and job profitability. The four main components of a well-designed WIP analysis will include the contract amount, cost estimate, costs to date and billings to date. If these numbers are accurate, the revenue and job costs (and job profitability) will be reported accurately in the income statement, while the over and under billings will be accurately reported on the balance sheet.
The WIP report gives operations and accounting a common goal; to accurately report the status of each project that form the basis for accurate financial reporting. In order to successfully complete monthly WIP reports, it is helpful to hold weekly meetings to make a thorough review of each job and monitor the costs to complete. These meetings should be documented.
Revenue recognition for the construction industry is unique. Historically in contraction accounting the main options have been cash-basis, completed contract and percentage of completion accounting. However, since 2018, contractors have been required to consider the guidance of ASC 606 Revenue from Contracts with Customers. Under ASC 606, in name, the percentage of completion and completed contract methods no longer exist. Billings in Excess of Costs and Costs in Excess of Billings are note called Contract Liabilities and Contract Assets. Albeit that the actual math used is different the cost "input method" as described in ASC 606 used when calculating the contract liability/asset will be nearly identical to the calculation used for percentage of completion.
ASC is based on the delivery of promised goods or services to a customer ("Performance Obligation"). Under this guidance you will need to identify each performance obligation and the most appropriate way to account for its revenue as it is delivered. This is accomplished using the Five-Step Model:
Identify the contract with a customer
Identify the performance obligations
Determine the transaction price
Allocate the price to the performance obligations
Recognize revenue with the satisficed performance obligation
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