Updated: Jul 5
How Is Construction Accounting Different?
It can be said that accounting is a necessary part of every business to ensure the financial matters of the company. However, we need to know that construction accounting and regular accounting are two different types of accounting, even though both are based on Accounting Standards such as financial statements, balance sheets, ...
For typical businesses, today such as selling stores will apply regular accounting. This is because the business operations of these firms are fixed, and the costs of goods sold are relatively stable.
On the other hand, construction accounting is a type of project accounting in which costs are allocated to a specific contract. Construction accounting is designed specifically to help contractors keep track of each job and how it affects the company's business. Although construction accounting is based on the same basic principles as regular accounting, construction accounting also has important points and differences.
In this article, we will take a look at some of the most obvious differences between construction accounting and regular accounting.
1. Project-based accounting
Business activities of construction businesses are based on the projects they have. Issues of payment, production, or labor are only viewed based on each project. The finances of a business are built on the performance of each project.
For conventional businesses like retailers, the stores they have are their main profits and they can control or forecast profits and costs.
For a construction company, the projects that the contractor has are their main profits/costs but all are short-term and unique. Even when projects have similar production requirements, they’re often subject to different site conditions or local variables like labor availability, cost of materials, and legislation. Plus, projects are continually opening and closing during the year with each contract.
For regular accounting, the cost of goods sold and expenses are both relatively clear numbers, but there is no similarity with construction accounting. In construction accounting, there are a lot of "overheads" that will be counted in the "cost of goods sold" section because they are directly linked to the client's project.
3. Decentralized Production
Activities of construction companies take place mainly based on different locations according to each project. That is why equipment and labor also move regularly from place to place. Because of that, construction accounting needs to focus on carefully managing each job.
In addition, construction is a less predictable business process and often does not have a large inventory because projects often have long and seasonal cycles. As a result, the cost and availability of production inputs can fluctuate and require special, careful tracking and planning.
4. Long-Term Contracts
The long-term production cycle is an influencing issue in construction accounting.
If you are a clothing reseller, your contract is completed as soon as you hand over your product to the buyer.
But in construction, the contracts can last for many years, and payments can also last during that time. Typically, terms in a construction contract will allow 30 to 90 days for payment. Therefore, revenue and cash-in the construction both need different accounting than regular accounting. Contractors need precise tracking and reporting, as well as collection and cash-flow strategies.
Key Differences Between Construction Accounting and Regular Accounting
Accounting is one of the most important elements of management and administration in the business. In common, 80% of all accounting is regular accounting with the basic financial reports. In the meanwhile, 15% is construction accounting and the 5% left is manufacturing accounting. Whether a construction company owner or a bookkeeper, it is necessary to be aware that construction accounting is different from regular accounting.
For example, a typical business, such as a wedding dress shop, uses regular accounting principles. The result is that they are selling products from a fixed location. Besides, the business could understand and separate the cost of each item it sells and relative overhead. A construction company, on the other hand, has to set up construction accounting to allocate costs per particular contract. These costs primarily include materials, labor with additional changes such as consulting, architectural fees. In addition, a number of indirect costs such as supervision, equipment rentals, or insurance are charged. Sometimes, administrative costs could be charged if they are allowed by the customer.
In summary, Key Differences between Regular and Construction Accounting could be listed as below:
Sales: Regular business accounts for sales and often has 1-5 categories of products and services they provided. Construction accounting offers up to 10 categories of products and services.
Cost of Goods Sold: Regular accounting simply records the cost of the product sold. A wedding dress shop owner could recognize the fabric, costs for tailors as the cost of goods sold. In construction accounting, because the contractor needs to concern about both direct and indirect costs relating to the project, it is more complex to set up the cost of goods sold.
Expenses: whereas overheads in the regular business are expenses used to maintain the business operations, overhead in construction accounting requires more analysis because some expenses in regular accounting are recognized as Cost of Goods Sold in construction accounting.
Breakeven time: In regular business, it is easy to calculate breakeven because revenue and expenses are clearly shown on the report. By analyzing reports you can determine which items are profitable and unprofitable, then make adjustments when needed. In the construction industry, it is very difficult to calculate because projects are unique custom jobs with intricate requirements and a variety of associated costs.
According to some key differences between regular accounting and construction accounting, it is necessary to understand the different types of costs you could incur working on a project. Then, a business should categorize those costs, understand the cost of goods sold and expenses as well as the complexity of the project that the company performs. Understanding the industry the business works in could help you to choose the correct accounting principles and keep your accounting data correctly.
To improve the accounting procedures of a construction company, you must first understand the different types of costs you may incur on the project. The next step is to effectively classify these costs, understand the nuances between expenses/overheads and the cost of goods sold, and understand the complexity of the projects your company can undertake. The best way to ensure accurate accounting is getting advice from outsourced accounting firms or you can use their accounting services, because of their expertise and experience in the construction industry. Irvine Bookkeeping is a worthy choice for you. With over 15 years of experience, we understand complex issues in construction accounting.
Are you ready to get help, or are you still not sure if you need help to run your construction business? Contact Construction Cost Accounting to have a free 15-minute consultation!