Construction Accounting 101: Ultimate Guide for Contractors

As someone who works in construction, you know that construction projects require not only proper planning but also tight cost control. You also understand that managing finances is often a big challenge because when construction costs are not recorded properly, it can cause chaos in budgeting and scheduling. This is where construction accounting comes in. 

Construction accounting is a method of financial management that focuses on recording and reporting on construction projects. It works by allocating costs and revenues based on the stages of project completion, ensuring finances remain under control throughout the entire building process.

However, why should construction projects implement construction accounting? How is it different from the general type of accounting that is also widely used by various businesses? Read on as we discuss in detail construction project accounting and why you should apply it to your projects. 

What is Construction Accounting?

Construction accounting is a specialized method of financial management designed to meet the unique needs of the construction industry. Unlike traditional accounting it focuses on tracking project costs, managing budgets, and ensuring accurate reporting throughout the lifecycle of a construction project.

This approach helps construction companies monitor expenses, assess profitability, and stay compliant with industry regulations. By managing financial data specific to each project, accounting for construction company ensures that costs are controlled, profits are maximized, and financial risks are minimized.

Why Construction Accounting is Important?

Effective construction accounting is crucial for the success of any construction business. It goes beyond basic bookkeeping, providing specialized insights tailored to the industry’s unique challenges. Here are the key reasons why construction accounting is essential:

• Improved Financial Accuracy: Construction project accounting software helps record and track project costs in detail, thus minimizing recording errors. When this is integrated with effective business budgeting software, it ensures more accurate and transparent financial reports.
• Real-Time Monitoring of Project Costs: With accounting software, companies can monitor project expenses in real time, making it easier to control the budget. This helps avoid uncontrollable cost overruns.
• More Efficient Management of Multiple Projects: The accounting system enables the management of financial reports from multiple projects in a separate and organized manner. This makes it easier for companies to keep an eye on the financial performance of each project without confusion.
• Easier Compliance with Tax Regulations: Construction accounting systems make it easier for companies to comply with tax and audit regulations through more organized and complete reports. This reduces the risk of being penalized for tax or reporting errors.

Construction Accounting vs Regular Accounting: What’s the Difference? 

Construction accounting and regular accounting share the same fundamental principles, but they differ significantly in their application due to the unique needs of the construction industry. The following table highlights the key differences between the two:

Construction Accounting Concept

To better understand the financial aspects of the construction industry, it’s essential to grasp the core principles of construction project accounting, which play a crucial role in managing project costs, budgeting, and financial reporting.

• Job costing: Job costing is the cornerstone of construction accounting. It involves tracking all costs related to a specific project, such as materials, labor, and equipment. This method ensures that businesses understand the profitability of each project and can make informed decisions about budgeting and resource allocation.
• Progress billing: Unlike many industries where payments are made after a product is delivered, construction projects often use progress billing. This means clients are invoiced at various stages of project completion. This concept helps contractors maintain a steady cash flow and ensures that payments align with the work completed.
• Retention accounting: Retention refers to a percentage of the payment that is withheld by the client until the project is fully completed and meets agreed-upon standards. Construction accounting carefully tracks these amounts to ensure they are correctly recorded and eventually released when due.
• Revenue recognition: Revenue recognition in accounting for construction company can be complex due to the long-term nature of many projects. Common methods include the percentage-of-completion method, where revenue is recognized as the project progresses, and the completed-contract method, where revenue is only recognized upon project completion.
• Change orders management: Construction projects often evolve with change orders, which alter the scope, timeline, or cost of the original agreement. Accurate accounting tracks these changes to ensure budgets remain realistic and clients are billed accordingly.
• Equipment and asset management: In construction, equipment like machinery and tools represent significant investments. Construction accounting involves tracking depreciation, maintenance costs, and usage to ensure these assets are efficiently utilized and accurately accounted for in financial statements.
• Overhead allocation: Overhead costs, such as office rent, insurance, and administrative salaries, must be distributed appropriately across different projects. Proper overhead allocation helps businesses understand the true cost and profitability of each job.
• Compliance and tax considerations: The construction industry is subject to specific regulations, including payroll taxes for subcontractors and compliance with local labor laws. Construction accounting ensures businesses stay compliant while optimizing tax strategies.

Types of Accounting Used in Construction

Understanding the types of accounting used in construction is essential for ensuring accurate financial management and maintaining control over complex projects. Each approach serves a specific purpose tailored to the unique demands of the industry:

• Job cost accounting: This type of accounting focuses on tracking all costs related to individual construction projects. It helps contractors manage project budgets, monitor spending, and ensure profitability for each job.
• Cash basis accounting: Cash basis accounting records revenue when cash is received and expenses when they are paid. This simple method is often used by smaller construction companies for its straightforward approach.
• Accrual basis accounting: Accrual accounting recognizes revenue and expenses when they are earned or incurred, regardless of when cash is exchanged. This method provides a more accurate financial picture for larger construction companies.
• Percentage-of-completion accounting: Common in long-term construction projects, this method recognizes revenue and expenses proportionally as the project progresses. It ensures that income is recorded throughout the project, providing a more consistent financial overview.
• Cost allocation accounting: This type focuses on distributing indirect costs, such as overhead and administrative expenses, across multiple projects. It ensures accurate job costing and profitability analysis.

Key Aspects of Accounting Software for Construction

One of the unique things that distinguishes construction accounting from regular accounting is the way revenue is recognized. In accounting for construction, revenue is recognized based on the percentage of project completion, so the company can record revenue along with the project. This is in contrast to ordinary accounting which tends to recognize revenue once the transaction is fully completed.

Accounting for construction company also focuses more on individual project management. Because each project has a budget that must be tracked separately. Accounting for construction company must ensure that every expense and revenue is recorded appropriately, so that financial management is more detailed and focused. 

Another uniqueness is in terms of financial reporting. Accounting for construction company  often involves specialized reports that show financial progress per project, such as project cost reports that help project managers monitor the financial health of each project in real-time. 

Difficulties and Tips for Making Accurate Construction Accounting 

Although accounting for construction companies can indeed make it easier for management to manage finances, implementing construction project accounting cannot be said to be easy. What are the difficulties that will be faced to make accounting for construction companies difficult to do? 

Here are the difficulties of implementing accounting for construction and tips on how to overcome them: 

1. Fluctuating income

You must be aware that the construction industry often faces volatile revenues as projects can run for a long time, with payments made in stages. These fluctuations make financial recording and cash flow difficult to predict, which can affect the company’s ability to manage its day-to-day finances.

How can we overcome this?

To overcome this challenge, it is important for companies to carefully plan their cash flow. One tip is to make monthly cash flow estimates based on project payment milestones. That way, companies can anticipate when revenue will come in and prepare emergency funds in case of payment delays.

2. Changes in project demand and specifications

Construction projects often experience mid-course specification changes, such as redesign or material changes. This affects the project budget and schedule, making it difficult for the accounting team to maintain accurate and up-to-date financial reports.

How can we overcome this?

To overcome this, construction companies need to be more flexible in budgeting. Make sure every project change is recorded in detail in the financial system. By using a accounting for construction company application that has an automatic update feature, any changes can be immediately reflected in the financial statements without having to repeat the calculation from the beginning.

3. Difficulty recording projects by stages

On construction projects, it is often the case that work is carried out in stages. Financial records must reflect the progress of the work, including the revenue received and costs incurred for each stage of the project. This difficulty is further increased when the project is protracted or split into many phases.

How can we overcome this?

One solution is to apply the percentage of completion method in the financial statements. This method allows companies to record revenue and costs based on the percentage of work completed, which makes the financial statements more accurate and in line with the actual progress of the project.

4. Constraints in managing construction tax

Construction projects have more complex tax requirements compared to other businesses. Apart from income tax, there are also material and subcontractor taxes that need to be managed. Mistakes in tax management can expose the company to fines or penalties.

How can we overcome this?

The solution is to ensure the finance team has a deep understanding of the tax regulations that apply in the construction sector. In addition, it is important to consult regularly with a tax consultant to ensure the company always complies with the latest regulations. By doing so, the risk of mistakes and potential fines can be avoided.

5. Complex project cost management

In accounting for construction companies, managing project costs can be challenging as it involves many aspects, such as materials, labor, equipment, and overhead costs. Differences in project duration and scale can also lead to costs that are difficult to predict, complicating real-time monitoring of project budgets.

How can we overcome this?

To overcome this, construction companies need to have a structured and detailed cost recording system. One example of a high-quality system that you can use is HashMicro’s accounting system. HashMicro’s system is one of the best accounting software Philippines and is designed to meet various accounting needs, one of which is accounting construction.

Furthermore, the HashMicro system also comes with a comprehensive range of features and extensive flexibility. One of the features offered is Multi Level Analytical. 

This feature provides insight into all financial transactions in real-time and can be filtered based on various categories. This helps management know the construction financial activities that involve various aspects, such as building materials, operational money, employee salaries, and others. 

Not only does HashMicro provide comprehensive features, it also provides a free demo that gives enthusiasts the opportunity to try and understand how the system works without being charged. 

Common Mistakes in Construction Accounting

Errors in construction accounting can lead to financial losses, project delays, and damaged relationships with clients and stakeholders. Below are common mistakes that construction businesses should avoid, along with explanations of their impact:

1. Disorganization

Lack of proper organization in accounting records can result in misplaced invoices, untracked expenses, and incomplete financial data. This can cause errors in budgeting, compliance issues, and difficulties in tracking project profitability.

Implementing a systematic record-keeping process and using accounting software can help maintain order and ensure accurate reporting.

2. Poor Job Cost Estimates

Inaccurate cost estimates during the planning phase can lead to unexpected expenses and diminished profits. Estimating errors often arise from inadequate data, overlooked variables, or failure to account for potential risks.

Detailed analysis, historical data, and contingency planning are critical to creating reliable job cost estimates.

3. Inaccurate Recognition of Joint Ventures

In construction projects involving joint ventures, improperly accounting for shared costs, revenues, and responsibilities can cause financial disputes and compliance issues. Businesses must ensure clear agreements and accurate financial tracking for all parties involved. Adopting consistent methods for allocating costs and revenue is essential.

4. Incorrect Overhead Calculations

Overhead costs, such as administrative expenses and equipment depreciation, are often miscalculated or overlooked. Incorrect calculations can distort project profitability and affect pricing strategies.

Regularly reviewing and updating overhead cost allocations ensures accurate financial reporting and fair project pricing.

5. Mismanaged Change Orders

Change orders, which alter the scope of a project, are common in construction but often poorly tracked. Failing to document and account for change orders can lead to unbilled work and disputes with clients.

Establishing a clear process for approving, tracking, and billing change orders is crucial for avoiding financial discrepancies.

6. Accepting Unreasonable Contract Terms

Agreeing to contract terms that are unfavorable or unclear can expose businesses to significant financial and legal risks. For instance, payment delays, unexpected liabilities, or unrealistic deadlines can harm cash flow and operations.

Thoroughly reviewing contracts and negotiating fair terms protect the company’s interests and sustainability.

Financial Statements Specific to Construction Accounting

In construction project accounting, certain financial statements are tailored to address the industry’s unique complexities. These specialized reports are designed to provide accurate, actionable data that reflects the dynamic nature of construction projects.

Below are key financial statements that are essential for construction businesses to track progress and make informed decisions:

1. Work-in-Progress (WIP) schedule

The WIP Schedule is crucial in tracking the financial status of ongoing construction projects. It provides a detailed snapshot of costs incurred and revenue earned and helps identify project overruns or underruns, aiding financial decision-making for active projects.

2. Construction-in-Progress (CIP) report

The CIP Report tracks the financial data of projects still in progress, including costs and revenues. It offers a clear picture of ongoing expenses and cumulative revenues, enabling construction companies to assess project profitability and detect potential financial risks early.

3. Job cost sheets

Job Cost Sheets are essential for tracking the costs associated with individual construction jobs. By providing a detailed breakdown of expenses and comparing actual costs to budgeted amounts, they allow construction companies to monitor budget adherence and make real-time adjustments.

4. Profit and Loss (P&L) statement

The P&L Statement consolidates a project’s revenues and expenses, offering insight into its profitability. For accounting for construction company operations, this statement provides stakeholders with a clear understanding of financial performance.

5. Balance sheet

The Balance Sheet in construction accounting reflects assets, liabilities, and unique items like retentions, advances, and construction equipment. This statement is crucial for understanding the financial position of a construction company, including project-specific financing.

These financial statements in construction project accounting are not only vital for tracking financial health but also crucial for informed strategic decisions, enabling construction companies to stay on top of their financial performance and achieve sustainable growth.

Achieve Error-Free Construction Accounting with HashMicro System 

As we mentioned earlier, HashMicro accounting system is one of the best construction accounting software Philippines that you can use to be able to overcome the difficulties of working on accounting for construction companies. Yes, it has extensive customization options and integration with construction project management software, so it can meet all your construction-specific needs. 

The following are the features of the HashMicro accounting system that can help with accounting for construction: 

• Cash Flow Reports: Monitor the company’s cash inflows and outflows to ensure sufficient liquidity, make proper financial planning, and identify and address potential financial issues.

• Budget S Curve: This feature helps visualize the progress of project or budget expenditure in the form of an S curve.

• Financial Statement with Budget Comparison: Provides a clear picture of how the company’s actual financial performance matches the plan to identify deviations and make necessary adjustments to achieve financial goals.
• Forecast Budget: Predict future budgets based on historical data to help plan finances, allocate resources efficiently, and make better strategic decisions.

Also, the system has no limit on the number of users. What can you benefit from that? With no limit on the number of users, the accounting process in construction can be supervised by several people at once, ensuring compliance with accounting principles. This will increase the transparency of the construction accounting process.

Conclusion

Construction accounting is a specialized field that focuses on the unique financial aspects of construction projects. Unlike general accounting, construction accounting involves specific variables and processes tailored to the industry.

Because of these differences, accounting for construction also has its own difficulties. One way to overcome these difficulties is to use an accounting system, such as HashMicro’s Accounting System.

HashMicro’s system is crafted to meet the diverse needs of construction businesses, offering scalable solutions that adapt to industry growth. It integrates seamlessly with other systems, like asset management, facility management, and construction management software.

Schedule a free demo to discover how this system can streamline your construction project and enhance efficiency!

FAQ About Construction Accounting

• What type of accounting is used in construction?

  Construction companies often use job costing, percentage-of-completion, and completed-contract methods. These approaches are designed to suit the distinct characteristics of construction projects, enabling businesses to track project expenses, recognize revenue over time or at project completion, and handle long-term contracts efficiently.

• How do you account for construction?

  Accounting for construction involves several specialized practices. These include tracking project-specific costs (job costing), managing revenue recognition based on the stage of completion or contract terms, and preparing detailed financial reports such as work-in-progress (WIP) schedules. Proper accounting ensures accurate budgeting, cash flow management, and compliance with industry regulations.

• What is the formula for construction accounting?

  A key formula in construction accounting, particularly for the percentage-of-completion method, is:
  Revenue Recognized = (Costs Incurred to Date ÷ Total Estimated Costs) × Total Contract Revenue
  This formula calculates the proportion of revenue that should be recognized based on the progress of the project, ensuring financial statements accurately reflect the current status of the work.