Accounting Methods: Cash vs Accrual

Some are even customized for the construction industry—however, there is still room for error when using these programs. That’s because, at the end of the day, it’s on you to conduct your own accounting. Transactions are recorded when you pay for an expense and when you receive a payment for the service you have provided. With a proper dispute resolution clause in place, contractors, subs, and suppliers can avoid taking their disputes into litigation.

Contractor “A” has one contract which requires two custom-ordered, high-value, airborne cameras. The contractor’s established policy is to order such special items specifically identified to a contract as the need arises and to charge them directly to the contract. Another contract is received which requires three more of these cameras, which the contractor purchases at a unit cost which differs from the unit cost of the first two cameras ordered. When the purchase orders were placed, the contractor identified the specific contracts on which the cameras being purchased were to be used. Although these cameras are identical, the actual cost of each camera is charged to the contract for which it was acquired without establishing a material inventory record.

Estimated Cost to Complete Jobs/Projects

Construction companies can use onsite consultants to help monitor your accounting needs. Together with your team, a consultant can work to develop an action plan to meet your specific pain points and goals based on the type of contracts you’re working on. As the largest expense on your books, labor costs should be diligently tracked and reconciled. Labor costs have the ability to impact schedules, project timelines, budgets and, ultimately, the total profitability of your contract. You recognize revenue when cash is in hand and record expenses as you spend it.

In this case, the latter corporation serves as a “home office,” and the corporation with which the contract is made is a “segment” as those terms are defined and used in this Standard. For purposes of contracts subject to this Standard, the contracting corporation may only accept allocations from the other corporation to the extent that such allocations meet the requirements set forth in this Standard for allocation of home office expenses to segments. In estimating the cost of direct material requirements for a contract, it is a common practice to first estimate the cost of the actual quantities to be incorporated in end items.

Choosing the Right Accounting Method

Final cost objective means a cost objective which has allocated to it both direct and indirect costs, and, in the contractor’s accumulation systems, is one of the final accumulation points. Company Z estimates service life for tangible capital assets by grouping assets according to use without regard to service lives. The average replacement life for machinery and equipment in Company Z is 10 years. In accordance with the provisions of the Standard, Company Z shall use an estimated service life of ten years for the acquisition unless it can support a different estimate for the entire group. Depreciation cost may be charged directly to cost objectives only if such charges are made on the basis of usage and only if depreciation costs of all like assets used for similar purposes are charged in the same manner. Its vacation plan provides that on January 1, each employee who has been employed for at least 1 year shall become entitled to 2 weeks of vacation.

The purpose of retainage is to ensure that owners have some assurance that contractors complete the entire job rather than abandoning work after progress payments are made. However, retainage can lead to significant cash flow challenges for contractors, who may lack the working capital necessary to take on new jobs if earned income is withheld. Understanding each contract type and knowing which projects call for a certain type of contract will help construction businesses keep track of their costs and revenue more accurately. Most importantly, a company can deal with large swings in income as contracts are completed, leading to potential difficulties managing cash flow — especially compared to the more regular cadence that comes with a percentage of completion. One potential downside of the accrual method is that businesses can pay income tax on unrealized profit since the accounting system can record revenues that have not yet been received.

Specialized Construction Billing

The cost accounting practices used by the contractor, however, must be followed consistently and the method used to reallocate such costs, of course, must provide an equitable distribution to all final cost objectives. The purpose of this standard is to require that each type of cost is allocated only once and on only one basis to any contract or other cost objective. The criteria for determining the allocation of costs to a product, contract, or other cost objective should be the same for all similar objectives.

General contractors need to subtract subcontractor payments from revenues to calculate working capital turnover, as this money simply passes through the GC from the owner. Costs including materials, labor, equipment, and subcontracts are listed on the income statement. Many construction contracts include retainage — also called retention — which is a percentage of the payment withheld for a specific period of time, often until the entire construction bookkeeping project is completed. While the percentage varies among contracts, retainage is often 5 to 10 percent of the total payment owed to contractors. Job costing is a form of project-based accounting that helps construction companies keep track of the expenses for a specific job or project. On the other hand, using the completed contract method means that you will only record revenue and expenses related to a project when it is complete.

Use construction accounting software

In many industries, these functions can be easily recorded and closed over short-term periods. The type of accounting work completed can also look very similar month to month, as the types of goods or services being provided are similar, if not carbon copies of work completed in previous fiscal periods. Construction accounting is a specialized practice, subject to unique financial reporting methods and tax rules. The nature of the construction business — with long contract terms, unique deliverables and “asynchronous” billing that can be disconnected from the pace of job progress, fiscal reporting periods or both — creates complicated issues for accounting and tax treatment.