Construction accounting is a specialized type of accounting tailored to accurately reflect the unique nature of the construction business. Construction accounting is a subset of project accounting, and Generally Accepted Accounting Principles (GAAP) still apply to those who must comply with those standards. However, just as the industry is unique, so are some aspects of construction accounting. In fact, construction accountants follow some very specific rules when reporting the financial health of a firm.
Construction Accounting vs. General Accounting: What’s the Difference?
There are some key variations between construction accounting and accounting for other types of businesses. These arise from industry characteristics like these: Construction work is project-based, production is often decentralized to one or more job sites and projects may have long-term production cycles. Project-based business can cause each sale to be different and customized. Decentralized production adds management and control complexities and can distort profitability. Lastly, long-term production cycles complicate fiscal revenue recognition and industry practices like retainage that make accounting even more complex.
General accounting:
It’s important to note that standard cash or accrual accounting practices are still applicable to construction companies when it comes to properly accounting for the entire business, rather than work related to specific construction projects. These businesses still must have employees with knowledge of standard accounting and in some cases need to abide by GAAP.
Construction accounting:
Most of the revenue generated by construction firms falls under Standards Codification 606 (ASC 606), which sets standards around how revenue from contracts and project-related expenses are recognized. ASC 606 is one of many accounting standards under GAAP, not a wholly different accounting system, and many construction businesses will choose to follow those principles for things like revenue from investments or non-project-related expenses. Key characteristics include:
Job costing for expenses
Most construction projects are defined in individual customer contracts with specific
deliverables. Project-based accounting methods are used to create separate profit centers to
capture project-specific revenue and expenses for each job. Central to construction
accounting is job costing for both direct and indirect costs. It’s especially
challenging because construction job sites are decentralized, and the projects can take a
long time to complete.
To help illustrate the effects of this difference, consider the hypothetical Acme Construction Co., a full-service builder of office complexes. Acme is hired by the equally hypothetical SKSN Enterprises to build two office buildings in two years, for a total contracted price of $8 million. Even though it’s one contract, Acme sets up two distinct profit centers to account for SKSN’s project — one for each building. In this way Acme can account for SKSN’s project separately from its other clients while capturing job costs related to each building separately.
Specialized revenue recognition methods
The project-based and sometimes long-term nature of construction contracts causes challenges
for revenue recognition, especially when there are interim performance obligations. Prior to
ASC 606, companies used industry-specific methods for revenue recognition, such as completed
contract method (CCM) or percentage of completion method (PCM) guidelines. While the new
standard is similar — revenue is recognized whenever a performance obligation is met
— these older standards are not as important.
Like many construction companies, Acme follows ASC 606 when recognizing revenue for financial reporting and tax purposes. Because Acme will turn over control of the first building to SKSN prior to commencing construction on the second, it is considered a performance obligation to which Acme must apportion some amount of the contracted $8 million. Since building one will be twice as large as building two, Acme ascribes $5 million to building one and $3 million to building two. In accordance with ASC 606, Acme breaks up that $5 million into smaller payments as different obligations related to building one are completed.
Accounting for industry characteristics
Particularities found in the construction industry give rise to their own accounting
challenges, including retainage, change orders, customer disputes and billing cycles that
can be out of sync with project progress.
Since this is the first time SKSN is working with Acme, they included a 10% retainage clause in the project contract, allowing it to hold back $800,000 until satisfactory completion of both buildings. To reflect the retainage, Acme’s progressive invoices over the course of the project are based on a $7.2 million total instead of $8 million, with a final invoice for the $800,000 retainage when SKSN agrees everything is satisfactory. Acme adjusts its cash flow forecasts to reflect this timing. Acme also adjusts the amount of revenue to be recognized for each building to exclude retainage: Building one is $4.5 million (90% of $5 million) and building two is $2.7 million (90% of $3 million). The $800,000 retainage is not considered an account receivable, but instead is set up as a separate asset account on Acme’s books.
Acme bills SKSN in equal $900,000 quarterly installments over the two years. Acme monitors building progress for revenue recognition and reconciles the amount billed each quarter with the project’s actual progress to determine whether it has overbilled or underbilled SKSN. During the project’s first quarter, backordered materials caused building delays, so Acme’s quarterly invoice turned out to be higher than the amount of revenue it recognized under ASC 606 (10% of $7.2 million). As a result, Acme’s accountant books an adjusting journal entry to move the excess billed amount into a liability account.
4 Key Differences
Construction accounting and financial accounting are more alike than different, since the former is simply a branch off the financial accounting tree. However, an experienced construction accountant would note these four key differences:
- More sales categories
Construction companies often offer several types of services and account for them separately. Examples include consulting, engineering, design, physical products, hired labor and materials. While other businesses may also have a wide range of offerings, it’s especially common in the construction industry. - Granularity of cost of goods sold (COGS)
During job costing, all direct and indirect expenses specifically identified for each building project are captured as COGS. Examples include materials, labor, subcontractors and project-specific equipment rentals. Most other businesses record COGS based on a standard cost for each item sold, derived from their inventory costing method: first-in, first-out (FIFO); last-in, first-out (LIFO); or average cost method. Further, some indirect costs are added to construction COGS (see item 3). - How overhead is treated
The line between COGS and overhead expenses can get blurry in the construction business, which impacts expense classification in construction accounting. For example, the cost of gas used to transport materials to a job site can be job-costed as COGS in construction accounting, although the truck and its related depreciation expense would be considered overhead. Temporary utilities including office rental, sanitary facilities or drinking water at a job site are another example of overhead expenses that can be included in COGS for the construction industry. Yet, seemingly similar overhead expenses, such as office rent for the company’s marketing and accounting staff, would not be included. - Difficulty understanding profitability
Like most other forms of project accounting, construction accounting requires close attention to detail. The custom nature of each project reduces the usefulness of broad trend analysis, an important tool used in other industries where direct costs are more predictable. Careful planning and set up of processes to capture costs, together with frequent reporting updates, can help construction managers better understand project breakeven and ultimately its profitability. In other industries the direct relationship between product revenue and expenses is typically easy to identify through regular financial accounting.
Manage Finances With Construction Accounting Software
Construction accounting is a meticulous and labor-intensive effort. Job costing requires careful setup so all costs can be tracked accurately and reported quickly since any plan deviations can directly affect the profitability of a project. Additionally, industry-standard billing schedules and complex GAAP and tax rules require system flexibility. When considered alongside a timesheet, payroll and materials inventory tracking, it's easy to see how a robust, integrated system, like NetSuite’s accounting software, can reduce administrative burden, provide valuable reporting and improve profitability. Beyond just the historical project reporting, NetSuite’s integrated set of business applications provides essential management tools for budgeting, forecasting and tracking key performance indicators. And because it is cloud-based, it’s easily accessed when at job sites.
Conclusion
Construction accounting shares many similarities with standard financial accounting, but it
also has some important differences, owing to the nature of the construction business. With
more sales categories, job costing for COGS and unique allocations of overhead, construction
accounting is a complex endeavor. Errors can make understanding profitability and managing
the business exceedingly difficult. The right software can help ease that burden.
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Construction Accounting FAQs
How is construction accounting different?
Construction accounting is a subset of financial accounting that shares the same principles
but is more specifically aligned with the unique characteristics of the construction
industry. Construction accounting deals with specialized revenue and expense recognition
challenges arising from long-term contracts, individual projects, job costing and
decentralized production.
How do you become a construction accountant?
Construction accountants typically hold a bachelor’s degree in accounting; however,
most college accounting programs spend only a few weeks discussing construction accounting.
Construction accountants learn their specialty through on-the-job training and experience
and from industry-specific training courses given by construction industry associations or
accounting societies.
What is accounting for construction contracts?
In the construction business, most projects are outlined in contracts, since no two projects
are the same. The contract documents the details of the project and establishes all
parties’ obligations. Accounting for these contracts is done using specialized methods
that reflect the nature of the project and the performance obligations. Accounting standards
codification 606 (ASC 606) is the most current guidance for accounting for construction
contracts.
How do you do bookkeeping for a construction company?
Bookkeeping for construction companies is extremely detailed to ensure accurate job costing.
Typically, distinct profit centers are set up to handle each project and all expenses are
coded to that project. Billings are also accumulated by project and revenue adjustments are
made according to the appropriate revenue recognition standard.
