Construction Accounting Basics: A Simple Guide

Solid accounting and bookkeeping is the foundation of any successful construction company. Without reliable financial data, it’s impossible for business owners to understand how their projects are progressing, keep up with billing and secure the bonding capacity required to take their business to the next level.

But while construction accounting is certainly important, it’s an area that many construction companies struggle with as they grow. In their early days, construction companies typically follow cash-basis accounting, a relatively simple form of accounting that records transactions when cash is received or paid.

As companies grow, however, they’re required to embrace accrual accounting, become GAAP compliant and take a more sophisticated approach to managing their projects. This is true for businesses in every industry, but construction accounting is somewhat unique. That’s why, in this introductory guide, we cover several fundamental construction accounting basics you need to understand.

Construction Accounting: What’s Different?

Unlike a traditional business with straightforward revenue streams, construction companies have to manage multiple projects, long timelines and highly variable costs. Construction accounting demands precision; every single cost has to be accounted for and mapped to a specific job, and there are all kinds of accounting nuances to consider.

Even setting these complexities aside, growing construction companies face all kinds of challenges when it comes to accounting. It’s likely that as a small growing company, you can’t afford to bring in a full-time construction accountant or CFO. Equally, you as the owner likely don’t have the time (or expertise) to take a more hands-on approach to accounting. You’re too busy overseeing job sites, managing crews and building relationships with your clients.

Regardless, getting the construction accounting basics right is non-negotiable if you want to grow your business. Whether you need bonding to work on a large-scale project or just a better approach to financially managing several construction projects at once, understanding the basics of construction accounting is key to your success.

5 Fundamental Construction Accounting Basics

Understanding the fundamentals of construction accounting is essential for keeping projects on track. From maintaining a work in progress (WIP) schedule to recognizing revenue in accordance with Generally Accepted Accounting Principles (GAAP), here are five construction accounting basics it’s vital you understand.

1. Construction Accounting Methods

Construction companies have a choice of accounting method. While other accounting methods are available, the most common choice for construction companies is the percentage of completion method.

Under this accounting method, revenue and expenses are recognized proportionally as work on a project progresses. For example, if your company has completed 40% of a project, it may recognize 40% of the revenue and costs on its financial statements. This accounting method is advantageous since it presents companies (and sureties) with a clear view of the profitability of projects. However, it requires accurate job costing and regular updates to project estimates.

It’s a sharp contrast to the cash method used by smaller, early-stage construction companies. While this method is more simple, it can lead to misleading financial statements, cash flow issues and trouble estimating progress on long-term projects.

2. A WIP Schedule

Key to successfully adopting the percentage of completion accounting method is the WIP Schedule. This key financial document tracks the progress of the projects your construction company is working on.

Every unique project a construction company works on should have a standalone WIP schedule. The WIP schedule provides a detailed overview of how much work has been completed, how much revenue has been recognized and whether a project is overbilled or underbilled. Think of it as a report card for your projects, showing whether you’re on track financially.

WIP schedules should be updated every month with data including the costs incurred to date, estimated costs to complete and the amounts billed to the customer. This helps companies understand the ongoing progress and profitability of their projects, identify issues early and be better informed to make decisions about their financial position.

3. Job Costing

Construction companies incur a lot of costs: labor, materials, subcontractors, overhead and more. Job costing is the process of assigning all of these costs to individual projects that the company is working on. This ensures all costs associated with a project are accurately tracked so companies can track progress effectively, recognize revenue and maintain accurate financial statements.

The key to effective job costing lies in detailed tracking. For example, labor costs should be broken down by project and workers’ time, while material costs should account for the quantities of each material used on each specific job site. Job costing also involves regular updates to ensure that any changes — such as unanticipated expenses or project scope adjustments — are reflected in real time.

This approach not only improves financial management but also aids in future estimating and bidding. By analyzing the costs from previous projects, contractors can submit more accurate bids, ensuring better pricing and profitability.

4. Revenue Recognition

Revenue recognition in construction is based on accrual accounting, in which revenue is recorded as work is completed, not when payment is received. For long-term projects, this means recognizing revenue at key milestones, such as foundation or mechanical work. Since payment may lag behind recognized revenue, managing cash flow is crucial for construction companies.

Under ASC 606, the revenue recognition process involves five steps: identifying the contract, determining performance obligations, calculating the transaction price, allocating it to milestones, and recognizing revenue as each obligation is fulfilled. Special considerations like contract assets, liabilities, and retainage must also be managed to prevent cash flow issues and ensure accurate financial reporting.

5. Monthly Close Processes

The monthly close process is important to all kinds of businesses but especially so for construction companies working across multiple projects. By closing their books each month, construction companies can ensure they stay on top of their accounting and don’t have a disorganized mess to untangle come year-end.

Key elements of the monthly close process for construction companies include:

• Reconciling Accounts: All general ledger accounts, including cash, accounts payable, accounts receivable and job costing accounts, should be reviewed and reconciled.
• Revenue Recognition: Review completed work and make sure revenue is recognized appropriately in financial statements.
• Job Costing: Ensure all costs are allocated to the correct project and that there are no unallocated costs.
• Monitoring Cash Flow: Monitor accounts payable and receivable and track aging schedules to ensure all income and payments are accounted for and that there are no emerging issues.
• Financial Reporting: Monthly construction financial statements should be prepared, including a balance sheet, profit and loss statement and cash flow statement.

A More Efficient Approach: Outsourced Accounting for Construction Companies

While it’s important to understand all of the basics, there’s still a big difference between that and managing your construction accounting by yourself. If you lack the bandwidth to manage your company’s accounting but can’t afford to hire a full-time professional, there’s another solution: outsourcing your accounting.

At James Moore, our dedicated outsourced construction accountants serve as an external accounting department for a wide range of construction companies. Our professionals will manage your accounting and bookkeeping, build the infrastructure required to manage the financial demands of complex construction projects, and ensure your financial records are always GAAP-compliant.

It’s an affordable solution that ensures your construction business is ready to capitalize on new opportunities — whether that’s securing bonding capacity to bid on new projects or investing in new equipment to drive your growth. Ready to learn more? Contact a James Moore construction CPA today.

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