Accounting processes are an essential part of every booming industry, including construction. But the construction industry is distinct in accounting terms. The sector is dynamic and is influenced by the global economic scenario, real estate investment, and various government policies impacting the real estate industry.
General accounting focuses on accounts receivable, accounts payable, balance sheet, and capital, while construction accounting deals with billings, allowances, construction in progress, etc.
Construction companies work on projects simultaneously with other contractors, labourers, and revenue. These aspects make this segment unique.
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In this guide, we will cover the following aspects related to construction accounting: –
- Introduction to Fundamental Accounting Principles-GAAP
- What are the differences between construction accounting and other type of accounting?
- Best practices to follow in construction Accounting
- Wrapping up
Introduction to Fundamental Accounting Principles- GAAP
All accounting processes must adhere to the standard rules and regulations of accounting, known as Generally Accepted Accounting Principles (GAAP).
Every company complies with this procedure while formulating financial statements. GAAP comprises of 10 principles which are as follows: –
What are the differences between construction accounting and other types of accounting?
Construction accounting is a broader concept as it is an ever-changing sector, spanning anything from essential maintenance to single-family home restorations to new and massive expansions.
While monitoring your money, you frequently need to utilise precise accounting techniques to adhere to government requirements and thus accurately submit your income tax return.
To do so, one must know the essential concepts to manage the company’s finances. Some of the critical differences between construction accounting and other accounting are as follows: –
1. Project-based work
The construction industry has many contractors responsible for managing multiple projects simultaneously and assisting the sub-contractors in their job.
The majority of the earnings from construction projects are realised at the end of the projects. At the same time, contractors need to pay wages and purchase construction materials.
Thus, they make advance payments to ensure a smooth flow of operations. Therefore, construction firms frequently make project-wise profit and loss (P&L) accounts.
2. Accounting for the sales
The scope of other businesses is narrow as they offer a smaller number of services, while construction enterprises provide diverse services. This includes labour, architectural design, consultation, development, sourcing of construction materials, and other activities. This might make it tough to keep spending and efficiently measure revenue from every service area.
3. Cost of goods sold
Organisations keep records of the total cost associated with every product or service. On the other hand, construction businesses must deal with all types of expenses, whether direct or indirect, which are further classified into various segments. For swift functioning, all the accounting applications of the enterprises must be robust to monitor income, record costs effectively, and gather transactions. Construction businesses can only comprehend their financial standing and profitability if they have accurate reports.
4. Expenses
Most businesses can immediately distinguish between the cost of goods sold and indirect expenses. Unfortunately, in the construction business, this gets more problematic. Numerous products that a conventional firm considers indirect expenses are classified as “cost of goods sold” in construction projects because they are specifically connected to the project.
While organising your finances, you should define all the expenses as indirect or overhead that incur specifically for the project work of a client against the project’s cost. This method ensures clarity while estimating your business’s net profits and gross income.
Best practices to follow in construction Accounting
Construction accounting is a complicated subject. It entails the capacity to monitor and record expenses, payroll functions, and other accounting duties. As a result, you should precisely split all the expenses. We have listed some of the best cost accounting procedures for your business.
1. Cash-based accounting
There are two primary accounting methodologies to choose from i,e, cash and accrual. Smaller construction enterprises frequently prefer the simple approach of cash-basis accounting. The business logs income as soon as it is obtained and expenses it when disbursed to the vendors. This accounting streamlines daily financial administration and demands minimal financial knowledge.
2. Accrual-based accounting
Cash-based accounting is quite complex in comparison with accrual basis accounting. Irrespective of the complexity, bigger businesses must use the accrual basis of accounting.
Under the accrual method of accounting, income is recognised when earned, and expenses are recorded when incurred.
3. Job Costing
A construction business may handle multiple at the same time. Assigning expenditures precisely to each work is crucial for controlling the cost and attaining profitability in the project. Job costing guarantees allocation of expenses to an appropriate position which helps a firm assess its financial situation.
Job costing necessities everyone engaged in logging expenditures throughout the job instead of at the end and thus required to report these charges regularly.
On-site staff costs are trackable with time-tracking applications or entry logs. Further, the expenses are classified per the estimated costs to determine if the project is progressing as anticipated.
4. Completed Contract Method
Under this approach, all the earnings, profit, and expenses are listed together after completing the project. This technique is helpful for projects having a short duration of less than a year, and the method is highly efficient if there is a delay in revenue subject to conditions.
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Wrapping up
Construction accounting may sound difficult to you, and thus you may avoid keeping a record of all the transactions. But you should know that a solid foundation is essential for attaining any goal, and these cornerstones are vital for any strategic and prolonged success of the organisation.
Take your time to learn it and put effort into organising your accounts. Learn appropriate methods to help you save time on invoicing, tax filing, auditing, and bookkeeping. Hire a professional accounting firm if you find the job too difficult.
