Construction companies have different accounting needs than other businesses, because of the unique realities of their work. Construction businesses need to track the profitability of all their projects, but the details of each project differ. As a contractor, you need to juggle different timelines, locations and overhead costs. All of these factors will affect how much profit you earn from a job.
What’s the difference between construction and traditional accounting?
Construction companies have unique financial requirements. In more traditional industries, businesses sell specific products or services from a set location. They’re able to determine the cost of what they sell and their overhead expenses, such as rent, utilities and payroll.
Construction businesses, on the other hand, don’t operate from a fixed location. They work from multiple job sites and their costs vary based on the details of a job. Construction companies operate as mobile businesses, and their location changes depending on where the customer is located.
The length of construction contracts can vary wildly, from a number of days to more than a year. Overhead costs also change from contract to contract, depending on the number of employees working on a job site, the materials needed and the tools and equipment used.
Because contractors experience so many variables from project to project, they require specific accounting methods that differ from those used by more traditional businesses.
Here are the key areas in which construction accounting differs from regular accounting:
- Cost of goods sold: A traditional business that sells products simply records the cost of the products it sells. For contractors, the cost of goods sold changes with every new project, and includes both direct and indirect costs.
- Sales: Most businesses offer a limited selection of products or services for sale. Contractors, however, typically offer a wide range of services that fall into a number of different accounting categories.
- Overhead costs: In the construction business, overhead costs are less clearly defined than they are for traditional businesses. For contractors, many of the costs that would typically be defined as overhead actually fall under cost of goods sold since they’re directly related to a customer’s job.
What are the different accounting methods for contractors?
Contractors and construction companies can choose from a few different accounting methods to track their finances. Here are the most common accounting methods contractors can use:
The cash basis is the basic method of accounting for small businesses. The downside for contractors is that it can be the least accurate in terms of providing an overall view of the financial health of your business. In the cash basis method of accounting, any income is recorded on the date that the payment is received in your bank account. The cost of goods sold and overhead costs are also recorded as deductions on the day a payment is made.
In the accrual accounting method, businesses record their income when it is charged to a customer, so it would include all revenue received, as well as all outstanding invoices that have yet to be paid. Likewise, expenses are recognized when they’re charged, and so would include both paid and unpaid bills. The accrual basis provides a more accurate view of a business’s financial standing than the cash basis, but it still isn’t the best accounting choice for contractors.
Percentage of completion method
The percentage of completion method is often the best accounting method for contractors and other construction businesses. Under the percentage of completion method, the contractor can record income and expenses on a regular basis throughout the length of a project. The contractor recognizes revenue only on the portion of the job that has already been completed. This provides a more accurate overview of the profit margin for the project.
Completed contract method
As the name suggests, under the completed contract method of accounting, a contractor will only recognize income and expenses when a contract is completed in full. Typically, this method is only used for construction jobs when it isn’t possible to calculate the percentage of completion for a project.
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