Construction Accounting

a collection of free online resources

An electronic handbook
compiled and edited by
Asian Contractor Association
©April 2018

Asian Contractor Association

4201 Ed Bluestein Blvd.
Austin, TX 78729
www.acta-austin.com
[email protected]
Tel: 512-926-5400
 Table of Contents
Accounting Overview ...................................................................................................1
All Accounting Uses the Same Accounting Equation (Assets = Liabilities +
Equity). .....................................................................................................................1
Regular Accounting..................................................................................................1
Regular Accounting Is Used In Fixed Environments. ............................................1
Regular Accounting Has These Things In Common: .............................................1
Construction Accounting .............................................................................................2
Construction Accounting Is Used In Mobile Environments. .................................2
Construction Accounting Has These Things In Common: .....................................2
What’s Unique About Accounting in Construction? ...................................................3
Key Differences between Regular and Construction Accounting ..............................4
Sales. .........................................................................................................................4
Cost of Goods Sold. ..................................................................................................4
Expenses/Overhead. ................................................................................................4
Break Even. ..............................................................................................................4
Percentage of Completion Method ..............................................................................4
Example of the Percentage of Completion Method ................................................6
How to Use Percentage-of-Completion Accounting ...................................................7
Mechanics of Percentage-of-Completion Accounting ............................................8
Project Accounting Technologies for Construction Companies .................................9
Conclusion ....................................................................................................................10
About Asian Contractor Association (ACA) ................................................................11
Maps and Directions --- ACA and SMBR ....................................................................11
ACA Member Services ..................................................................................................13
 1

Accounting Overview
Accounting is one of the most important aspects of management and
administration in business. In firms with several moving parts, an accounting
team that accurately tracks the movement of assets into and out of the company
is necessary to ensure both transparency and profitability. In the construction
industry, firms and contractors face unique challenges when it comes to
accounting. In this resource article, we’ll look at what those challenges are,
identify the key differences between construction accounting and regular
accounting practices, and emphasize the importance of adopting a software
solution to improve your accounting and help you earn more money as a
construction company or subcontractor.

All Accounting Uses the Same Accounting Equation. (Assets = Liabilities +

Equity)

Business owners need three basic reports: Cash, Profit, and Equity.

1. Cash On Hand .................... (Bank Balance - Un-cleared Checks) = Cash

2. Profit And Loss Report ....................................(Sales - Expenses) = Profit
3. Balance Sheet Report ................................... (Assets - Liabilities) = Equity

Regular Accounting. Roughly 80% of all businesses in the world use regular
accounting. Its main purpose is to provide basic financial reports for annual tax
returns and some very rudimentary management decisions:

1. Accounts Receivable
2. Accounts Payable
3. Profit & Loss
4. Balance Sheet

Regular Accounting Is Used In Fixed Environments. It is a kind of business

environment where customers will visit physically or an environment where
products are shipped or delivered. In essence, products or services are delivered
or provided from a fixed location.

Regular Accounting Has Four Things In Common:

1. Sales - With 1-4 categories
2. Cost of Goods Sold - If they sell products with 1-4 categories
3. Expenses - Overhead required to maintain business operations
4. Breakeven - Is fairly easy to calculate because there is a direct
relationship between income and expenses on every item. It is easy to
run reports to determine which items are profitable and unprofitable
and make adjustments quickly as needed.
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Construction Accounting
Construction Accounting Is Roughly 15% Of All Accounting and Accounting with
manufacturing making up roughly 5%. So it is given very little attention in
schools, colleges and universities.

Construction Accounting Is Used In Mobile Environments. Which means having

a system that can track the costs that contractors incur related to doing custom
work in a strictly mobilization environment. Some of the costs include travel time,
mobilization (packing the tools, equipment, labor and material at their
warehouse, delivering everything to the job and unpacking it) before starting the
work and then demobilization (reversing the entire process when the job is
finished).

Construction Accounting is built upon regular accounting and shares the same
basic financial reports for operating and growing a business and preparing
annual tax returns and some very rudimentary management
decisions. Construction accounting adds many complex layers of reporting
mechanisms to show the contractor where their best customer are within
psychographic and geographic market segmentation boundaries.

Construction Accounting Has These Things In Common:

1. Sales - With 1-10 categories

2. Cost of Goods Sold - Has Direct and Indirect Job Costs with 25 - 200
categories with 1,000s of sub categories
3. Expenses - Overhead is extremely complex because some expenses in
regular Accounting are actually Cost of Goods Sold in construction
accounting
4. Breakeven - Very difficult to calculate because most projects are one-of-
a-kind custom jobs. Proactive contractors have systems and cost
libraries with pre-priced assemblies for bidding which works in
conjunction with Strategic Construction Accounting to provide
management with progress invoicing, job costing and job profitability.
5. Job Costing and Job Profitability Reporting - Is similar to the Company
Profit and Loss report except that it is specific to each particular job and
has different expense codes. These reports in combination with the Five
Key Performance Indicators are what help the contractor understand
which projects to pursue and which ones to ignore. They form the
foundation of a Business Process Improvement Plan and Construction
Business Strategy.
 3

What’s Unique About Accounting in Construction?

Whether you’re laying the bricks or keeping the books, it’s important to
understand that construction accounting is different from regular accounting. A
typical business like a restaurant or grocery store uses typical accounting
principles. This model works perfectly for that type of business – selling products
from a fixed location. The business understands the cost of each item it sells and
overhead is kept relatively constant.

In contrast, construction businesses are mobile and complete customized work

in novel locations on a regular basis. Thus, construction companies must monitor
totally different categories of costs: travel time, mobilization costs such as
packing tools and equipment, delivery of materials to the jobsite, and even
clearing the jobsite of excess materials once a job is completed. In a sense, the
business has no fixed location and it is moved to wherever the customer needs it,
along with the materials necessary for the job.

A short list of titles commonly used for construction accounting and regular
accounting. The list is intentionally short in order to make the point without
being completely overwhelming.

1. Construction Accounting Titles = 233

2. Regular Accounting Titles = 115

Example #1 - The contractor asks the bookkeeper "How much money did we
make on the John and Mary Doe house remodel?" The bookkeeper generates a
report showing $5,000 profit when in reality it was a ($15,000)
loss! QuickBooks setup was done like every other Accounting business and
$20,000 worth of transactions was put in the wrong category. In this case some
direct costs and some indirect costs were misallocated and not assigned to the
job.

Example #2 - The contractor asks the bookkeeper "How much money did we
make on the Bob and Sally house remodel?" The bookkeeper generates a report
showing ($5,000) loss when in reality it earned $5,000 profit! QuickBooks was
setup wrong and $10,000 worth of transactions was put into the wrong category.
In this case some overhead costs were classified as direct costs and assigned to
the job.

The Inevitable Result Is - The contractor makes bad decisions on what to bid and
not to bid on and eventually runs out of time and money.
 4

Key Differences between Regular and Construction Accounting

Sales. Regular businesses account for sales and usually offer 1-5 categories of
products and services. Construction businesses offer a greater range of service
categories – service work, consulting, engineering, labor, design, physical
products and materials, and more.

Cost of Goods Sold. Regular businesses simply record the cost of the product sold.
In construction accounting, it is never so simple. Each job incurs both direct and
indirect job costs that fall into hundreds of categories.

Expenses/Overhead. In regular businesses, the distinction between Cost of

Goods Sold and Overhead is very clear, but this is not the case in construction.
Many of the items that grocery stores would call “Overhead” fall into the “Cost of
Goods Sold” category in construction because they are directly connected to the
customer’s project.

Break Even. In regular businesses, the direct relationship between income and
expenses makes breakeven points very easy to calculate. In construction, however,
there are far too many categories of items to easily understand how to break even
on a project. Additionally, most projects are one-of-a-kind custom jobs, with
intricate requirements and a variety of associated costs.

Percentage of Completion Method

Construction companies also use the Percentage of Completion Method, where
revenue is accounted for based on the estimated profit of a contract and what
percentage of that project has been completed. This makes it even more critical
that construction firms implement cost-accounting methods that enable accurate
tracking of their expenses to accurately project profit and loss.

The percentage of completion method involves, as the name implies, the ongoing
recognition of revenue and income related to longer-term projects. By doing so,
the seller can recognize some gain or loss related to a project in every accounting
period in which the project continues to be active. The method works best when it
is reasonably possible to estimate the stages of project completion on an ongoing
basis, or at least to estimate the remaining costs to complete a project. Conversely,
this method should not be used when there are significant uncertainties about the
percentage of completion or the remaining costs to be incurred. The estimating
abilities of a contractor should be considered sufficient to use the percentage of
completion method if it can estimate the minimum total revenue and maximum
total cost with sufficient confidence to justify a contract bid.

The ability to create dependable contract estimates may be impaired when there
are conditions present that are not normally encountered in the estimating
 5

process. Examples of these conditions are when a contract does not appear to be
enforceable, there is litigation, or when related properties may be condemned or
expropriated. In these situations, use the completed contract method instead.

In essence, the percentage of completion method allows you to recognize as

income that percentage of total income that matches the percentage of
completion of a project. The percentage of completion may be measured in any of
the following ways:

1. Cost-to-cost method. This is a comparison of the contract cost incurred

to date to the total expected contract cost. The cost of items already
purchased for a contract but which have not yet been installed should
not be included in the determination of the percentage of completion of
a project, unless they were specifically produced for the contract. Also,
allocate the cost of equipment over the contract period, rather than up-
front, unless title to the equipment is being transferred to the customer.
2. Efforts-expended method. This is the proportion of effort expended to
date in comparison to the total effort expected to be expended for the
contract. For example, the percentage of completion might be based on
direct labor hours, or machine hours, or material quantities.
3. Units-of-delivery method. This is the percentage of units delivered to
the buyer to the total number of units to be delivered under the terms of
a contract. It should only be used when the contractor produces a
number of units to the specifications of a buyer. The recognition is based
on:
4. For revenue, the contract price of units delivered
5. For expenses, the costs reasonably allocable to the units delivered

Use the same measurement method for similar types of contracts. Doing so
improves the consistency of the percentage of completion results over time.

When the contractor has difficulty deriving the estimated cost to complete a
contract, base the recognition of profit on the lowest probable profit, until the
profit can be estimated with more accuracy. In cases where it is impractical to
estimate any profit, other than to be assured that a loss will not be incurred,
assume a zero profit for revenue recognition purposes; this means that revenues
and expenses should be recognized in equal amounts until such time as more
accurate estimates can be made. This approach is better than the completed
contract method, since there is at least some indication of economic activity that
spills over into the income statement prior to project completion.

The steps needed for the percentage of completion method are as follows:

1. Subtract total estimated contract costs from total estimated contract

revenues to arrive at the total estimated gross margin.
 6

2. Measure the extent of progress toward completion, using one of the

methods described above.
3. Multiply total estimated contract revenue by the estimated completion
percentage to arrive at the total amount of revenue that can be
recognized.
4. Subtract the contract revenue recognized to date through the preceding
period from the total amount of revenue that can be recognized.
Recognize the result in the current accounting period.
5. Calculate the cost of earned revenue in the same manner. This means
multiplying the same percentage of completion by the total estimated
contract cost, and subtracting the amount of cost already recognized to
arrive at the cost of earned revenue to be recognized in the current
accounting period.

This method is subject to fraudulent activity, usually to over-estimate the amount

of revenue and profit that should be recognized. Detailed documentation of
project milestones and completion status can mitigate the possibility of fraud, but
cannot eliminate it.

Example of the Percentage of Completion Method

Logger Construction Company is building a maintenance facility on a military
base. Logger has thus far accumulated $4,000,000 of costs related to the project,
and billed the customer $4,500,000. The estimated gross margin on the project
is 20%. Therefore, the total of expenses and estimated gross profit for the project
is:

$4,000,000 Expenses ÷ (1 – 0.20 Gross margin) = $5,000,000

Since this figure is higher than the to-date billings of $4,500,000, Logger can
recognize additional revenue of $500,000, using the following journal entry:

Debit Credit

Unbilled contract receivables 500,000

Contract revenue earned 500,000

Logger should also recognize a proportional amount of expense to offset the

amount of revenue recognized, for which the calculation is:

$500,000 Additional contract revenue × (1 – 0.20 Gross margin) = $400,000

 7

How to Use Percentage-of-Completion Accounting

In the simplest sense, a ratio of the percentage of completion is determined and
applied to the expected gross profit on the contract to determine the gross profit
and revenue to be recognized in the financial statements.

Jones Builders just obtained a contract for $500,000 to build a home for Mr. &
Mrs. Smith. Jones estimates his total cost on the job to be $400,000. During the
first month of the job, the following transactions occur:

1. Cash of $10,000 is paid for permits, fees and other startup costs.
2. An invoice is received from the excavation subcontractor for $10,000.
3. The first progress billing is prepared for $60,000.
4. If the above transactions were the only ones Jones Builders had for the
month, its income statements under each accounting method would
look like this:

Completed % of
Cash Accrual
Contract Completion

Revenue $0 $60,000 $0 $25,000

Costs 10,000 20,000 0 20,000

Gross
$(10,000) $40,000 $0 $5,000
Profit

Under the accrual method, revenue earned equals the amount invoiced on the
first progress billing ($60,000). Revenue under the percentage-of-completion
method was computed as follows:

1. Calculate what percentage of the job is complete.

2. Calculate the amount of revenue to be earned.

Costs to date / total estimated costs = % complete

$20,000 / $400,000 = 5% complete

Contract amount x % complete = revenue earned

$500,000 x 5% = $25,000
 8

By examining the four income statements, you see that the percentage-of-
completion method best reflects the company's revenue, costs and gross profit for
the period. If the president of Jones Builders received an accrual-basis statement,
he might think the company is really prospering (the job is only 5% complete, and
the company already made $40,000).

However, this statement does not give a true picture of the company's
profitability as of the end of the month. Because the job was only 5% complete,
only 5% ($5,000) of the total projected gross profit ($100,000) has been earned.

However, the costs and revenues calculated in this method are at best still
estimates of the job's true outcome. For this reason, care should be taken when
determining job progress.

Mechanics of Percentage-of-Completion Accounting

In the simplest sense, a ratio of the percentage of completion is determined and
applied to the expected gross profit on the contract to determine the gross profit
and revenue to be recognized in the financial statements.

Two typical methods of measuring the percentage of completion are:

 The cost-ratio method, which uses the ratio of actual contract costs
incurred during the reporting period to total estimated contract costs.
 The effort-expended method, which uses the ratio of some measure of
the work input during the reporting period, such as labor hours,
machine hours or material quantities, to the total units of that measure
of work required to complete the contract. This method assumes that
profits on the contract are derived from the contractor's efforts rather
than from the acquisition of materials or other tangible items.
 Many other techniques will be found in practice, including combinations
of the above, or the application of these methods to different phases and
cost codes of the same contract.
 For a remodeler, the most important subsidiary ledger is job cost, which
accumulates the costs for each job. The sum of the costs entered in this
ledger must agree with the general ledger for a variety of reasons:
 When jobs cross year-ends, the job-cost subsidiary ledger survives the
closing of the books for the year and is the only record covering the
entire life of the job.
 It is the only reliable way of actually keeping track of cost on a job
because it is controlled by the general ledger's balancing system (part of
internal control).
 Under the percentage-of-completion method, all cost and progress
billing against a contract are accumulated in revenue and cost accounts
of the general ledger and the job-cost ledger until the period in which
 9

the contract is completed, at which time the costs and billings are
transferred to income and expense accounts and the job's subsidiary
record is closed out.

At the end of the accounting period, an adjusting journal entry must be prepared
to adjust the revenue recognized on jobs that are in progress based upon the
estimated percentage of job completion as of that date. That journal entry is
reversed on the first day of the next reporting period.

In computing percentage of completion, only four items need to be pulled from

your job-cost accounting records.

 Cost to date = total costs incurred on the job from inception through the
end of the accounting period.
 Billings to date = total billings (draws) taken on the job from inception
through the end of the accounting period.
 Current contract = original contract plus change orders executed
through the end of the accounting period.
 Total estimated costs = current estimate of total anticipated costs on the
job. This estimate should be updated to account for any projected
budget overruns or underruns as well as include estimated costs on all
change orders included within the current contract amount.
 The mechanics of making the adjusting entry consist of the following:
 The amount of revenue to be recognized for the period is computed by
multiplying the completion percentage (determined by whatever
method is appropriate for the contract) by the current contract amount.
Using the cost-ratio method (the simplest to use), completion
percentage is computed by dividing total estimated costs by costs to date.
 The revenue to be recognized for the period is subtracted from the
revenue posted to the job-revenue account (billings to date). This
difference is posted to either Account 248, Billings in Excess of Costs, or
Account 126, Costs in Excess of Billings.

Project Accounting Technologies for Construction Companies

Construction accounting is significantly more complex than it is for most
businesses. Being able to track, report and categorize costs and other expenses in
your construction business is important for understanding how to bid on projects,
which projects are profitable for your business, how to bill clients accurately and
fairly, and how to make the most of your firm’s resources.

Accurate job costing currently requires daily reports to be generated in the field
and submitted to the accounting department on a regular basis. Accountants
 10

must manually enter the reports into the accounting system regularly, a process
that is time-consuming and generates backlogs on paperwork.

An integrated software platform that allows frontline workers to complete and

submit daily cost and progress reports, time cards, and change orders is an
effective way to keep track of what costs are being incurred during a project.
Better yet, the reports are instantly digitized and accessible to both workers in the
field and the accounting office, which enables rapid resolution of any costing
issues and accurate tracking to ensure profitability.

Conclusion
Improving your construction company accounting procedures starts with an
understanding of the different types of costs you can incur working on a project.
The next step is to categorize those costs effectively, understanding the nuances
between expenses/overhead and cost of goods sold, and appreciating the
complexity of the projects that your firm is capable of. The best way to ensure
accurate accounting is to implement a software solution that allows workers at
your firm to easily submit data on costing through a platform that is integrated
with your accounting software. This practice saves time on paperwork and
ensures that important data is never lost, making your firm more profitable as a
result.
 11

About Asian Contractor Association (ACA)

Founded in 2001, ACA has been a service provider for the City of Austin to help
increase Asian participation of the city’s MBE program. Our services include:

 Individual consultation
 Bid and project opportunities notifications
 Networking with prime contractors
 Referral services
 Plan room services
 Plan reading and estimating
 City procurement process
 MBE/WBE program advocacy
 … much more

Maps and Directions --- ACA and SMBR

Heading south on Highway 183 – continue on S. Hwy 183. You will pass MLK,
and 51st St. Make a left on Techni Center Dr. and another left at the light. Keep
going straight to enter the parking lot located at the back of the office building.
Go down a flight of stairs to enter the lobby to sign in. SMBR and ACA are on the
second floor. ACA is located inside SMBR in room #2105.
12
 13

ACA Member Services

1. Business and Technical Consultation

2. Minority Business Enterprise Certification Application, Renewal and
Profile Change Process
3. Asian Subcontractor/Sub-consultant Referral Services
4. Upcoming Bid/Event Notifications
5. How to Use COA Vendor Connection
6. Plans Room Services
7. Plan Reading, Cost Estimating Consultation (RSMeans)
8. Proposal Writing and Bid Submission
9. Assist Vendors in Navigating City Procurement Processes
10. Contract Compliance and Contract Review
11. M/WBE Program Ordinance and Compliance Plan Orientation
12. Translations
13. Liaison Services Between Vendors and City Departments
14. Research Assistance of Current and Past City Solicitations and Winning
Proposals
15. Collective Representation to Improve Asian Vendor Utilization
Asian Contractor Association
A non-profit organization serving Asian businesses
in the Greater Austin Metro Area since 2001

We Build Diversity and Inclusion

Board of Directors

Chairman
LiLi

Executive Vice Chairman

Sung E. Cho

Treasurer
George Chang

Member
Mahesh Naik

Member
Thong Vo

4201 Ed Bluestein Blvd., #2105, Austin, TX 78721

Tel: 512-926-5400
www.acta-austin.com Executive Director
[email protected] Aletta Sung