Accounting is one of the most important aspects of management and operations in business. In companies with many operating divisions, accurate accounting tracking of the movement of assets into and out of the company is essential to ensure both transparency and profitability. In the construction industry, companies and contractors face unique challenges when it comes to accounting.
In this article, we'll examine what those challenges are, identify the key differences between construction accounting and traditional accounting practices, and highlight the importance of adopting software solutions to improve your accounting and help you earn more money as a construction company or contractor.
1. What is unique about accounting in the construction industry?
It's important to understand that construction accounting differs from conventional accounting. A typical business, such as a restaurant or a trading establishment, uses typical accounting principles. This model works perfectly for that type of business – selling products from a fixed location. The business understands the cost of each item sold, and operating expenses are kept relatively stable.
In contrast, construction businesses are mobile and complete customized work at new locations (construction sites) on a regular basis. Therefore, construction companies must manage entirely different types of costs: travel time, transportation costs such as packing tools and equipment, delivering materials to the job site, and even cleaning up excess materials after the work is completed. In a sense, the business has no fixed location and it moves wherever the client needs it, along with the necessary materials for the job.
Construction companies also use the Percentage of Completion method, where revenue is calculated based on an estimate of what percentage of the project has been completed. This further complicates the implementation of cost accounting methods that allow for accurate tracking of their costs in order to accurately predict profits and losses.
2. Key Differences Between Conventional Accounting and Construction Accounting
2.1. Business operating revenue
Businesses often generate sales by offering "complete packages" of products and services, making revenue easily identifiable.
Conversely, construction businesses have very specific revenue streams, which typically include:
- Initial revenue is stated in the contract;
- Increases and decreases in revenue resulting from contract performance, bonuses, and other payments if these are likely to change revenue and can be reliably determined.
Detailed instructions on recognizing revenue from construction activities can be found in the following article: Principles for recognizing revenue from construction contracts
2.2. Cost of Goods Sold
Traditional businesses only need to track the cost of goods sold. In construction accounting, it's never that simple. Each job involves both direct and indirect labor costs for hundreds of items. The sum of these costs is what forms the cost of goods sold.
2.3. Costs / Overhead Costs
In typical businesses, the distinction between Cost of Goods Sold and Expenses is clear; this is not the case in construction. Many items that are normally overhead expenses are actually cost of goods sold in construction because these costs are directly linked to the client project.
2.4. Break-Even Point
In typical businesses, the direct relationship between revenue and costs makes the break-even point easy to calculate. However, in construction, there is a vast list of items, making it difficult to calculate the break-even point for a project. Furthermore, most projects are one-of-a-kind, custom-built jobs with varying levels of complexity, resulting in a wide range of associated costs.
2.5. Project accounting technology for construction companies
Construction accounting is significantly more complex than most businesses. Being able to track, report, and categorize expenses and other costs within your construction business is crucial to understanding how to bid on projects, which projects are profitable for your business, how to accurately and fairly invoice clients, and how to make the most of your company's resources.
Accurate cost management requires daily reports to be generated within departments and submitted to the accounting department on a regular basis. Accountants must frequently enter these reports into the accounting system, a time-consuming process that creates a backlog of paper records.
An integrated software platform that allows frontline staff to complete and submit daily expense and progress reports, time cards, and order changes is an effective way to track ongoing costs within a project. Even better, reports are digitized instantly and accessible to both field workers and the accounting department, enabling quick resolution of any cost issues and accurate tracking to ensure profitability.
3. Advice for construction accounting
Improving your construction company's accounting procedures begins with understanding the different types of costs that can arise when working on a project. The next step is to effectively categorize those costs, understand the different natures of project costs, general administrative costs, and cost of goods sold, and properly assess the complexity of the projects your company is likely to undertake.
The best way to ensure accounting is organized, appropriate, and accurate is to implement a solution that builds a separate accounting management process for the construction company. This approach saves time and costs, manages the construction company effectively, and ensures that necessary data is fully tracked.