Like most construction jobs,
Accounting and Taxes are NOT DIY
Mistakes are too costly to learn on the job
Accounting for construction companies is industry-specific and requires a high level of proficiency as it guides your business decisions. Mistakes can turn sure profits into unexpected losses and too often, the culprit is lack of accurate financial data to help in the decision-making process. That’s why SHELTER is here - to help you, the construction pro!
A proper bookkeeping system can help you stay on top of your debts, figure out where your profits and losses are coming from, how far behind you are on client draws, prepare you for tax season and brace your company for growth. We understand what you do everyday, and we’ve built a team around your specific needs.
Two of the most important factors in construction accounting include job costing and revenue recognition. When done incorrectly, these can give you an inaccurate read on a project’s profitability. Job costing ensures each project related expense is tied to that job financially. We’ll dive deeper into revenue recognition below.
How Should I Recognize Revenue?
One of the questions we get asked most often is “Which accounting method should I use for my Construction company?” Below is a quick overview of the 4 most common ones.
Percentage of Completion Method
The best way to track your projects’ costs and profitability (and arguably the most complicated method), the percentage of completion method recognizes revenue as the project gets closer to completion. Actual construction costs are compared to project estimates to get a project “percentage of completion”. This percentage is then applied to the expected project revenue to give you a more accurate picture of current job profitability instead of waiting until the job is complete.
Completed Contract Method
The completed contract method is the simplest way to track your projects. It’s also the most advantageous from a tax standpoint because it allows small-volume builders to recognize profit only after the project is complete and costs have been incurred.
Accrual Method
The most common accounting method for most businesses, accrual accounting recognizes revenue when billing is carried out. Expenses are recognized when invoices are received or costs are determined to exist for which invoices have yet to received.
Cash Method
Under the cash method, revenue and expenses are recognized based on receipt and disbursement of funds. While not the best method to measure profitability, it can be instrumental in understanding your home building business cash flow.
Not sure which method is right for your business. Give SHELTER a call - we can help.
4 Methods
4 Different Results
To highlight the differences between each method, we’ve put together an example. Let’s say you have a $1 million project where you expect to spend $800,000 and an expected profit of $200,000.
In month 1, you pay $50,000 for permits and other fees for this job and send a draw request to your client for $200,000. You also receive a $50,000 invoice from the lumber yard.
If you use the Percentage of Completion method, you recognize $100,000 in costs (50k + 50k above) and consider the project to be 12.5% complete ($100k costs / $800k expected total cost). You would recognize 12.5% of total revenue in month 1, $125k ($1 million total revenue * 12.5%).
Using the Completed Contract method, no costs or revenue would be recognized until the project is complete.
The Accrual method would recognized all costs incurred and invoices received ($100k) as well as all billing requests sent ($200k).
Lastly, the Cash method is only going to look at cash in and cash out. In this case, you’ve paid $50k for the permits and received no money yet from your client.
Construction Accounting Best Practices
While construction accounting can be challenging, you can make the process easier by keeping a few best practices in mind.
First, tax compliance can get tricky with construction companies. As a result, make sure you've decided on which strategies you'll be using with a reputable accountant for contractors. There are different approaches you can try, and which one you pick will come down to the size and structure of your business. The important thing is to choose a strategy and stick with it.
Next, make sure you are job costing. Job costing is one of the cornerstones of construction accounting, but it can be tedious. Explain the importance of job costing to your staff ato get everyone on-board.
Lastly, use accounting software that can handle the complexities and intricacies of construction accounting. We have found Quickbooks Online, integrated with a project management solution like Buildertrend or Coconstruct to be best combination for most contractors. Need help setting it all up? Give us a call.