Construction accounting is a specialized branch of accounting that differs from traditional methods used in other industries. It involves analyzing contracts, managing costs, and recognizing revenues in a way that reflects the complexities of the construction environment. In this blog post, we will explore the unique elements of construction accounting, the importance of job costing, and the methods used to track and report financials in a construction company.

Construction accounting goes beyond the typical analysis found in manufacturing or retail businesses. Instead of straightforward sales, construction companies deal with various contracts that must be accounted for in their financial statements. Rather than focusing on sales alone, construction accounting emphasizes the management of contracts, including the unique costs associated with them.

In a typical business, the "cost of goods sold" is a primary focus, but in construction, this is replaced by "costs of construction." Despite the different terminology, the components remain similar: labor, materials, subcontracting (comparable to outside services), and overhead. These components contribute to determining the gross profit of a construction project, and they must be carefully tracked and analyzed to ensure accuracy.

One of the most crucial elements in construction accounting is the work-in-process (WIP) schedule. Any construction company’s financial statement should include this schedule, which outlines the various projects the company is currently working on. The WIP schedule helps stakeholders understand the company’s progress on its ongoing projects and the financial position of each.

A key question to ask when reviewing a construction company’s financials is whether they are using the completed contract method or the percentage of completion method . These two approaches significantly impact how revenues and profits are recorded.

For companies using the percentage of completion method, it is vital to estimate the total profit on a project early on. This involves analyzing the contract value and forecasting potential profits based on initial bids and ongoing costs. As the project progresses, the company determines the percentage of completion, which directly affects the recognition of revenue and profit for each reporting period.

The percentage completion calculation compares the work completed to date with the estimated total cost of the project. This comparison allows companies to determine how much revenue has been earned at each stage of the project. However, it’s important to note that these earned revenues might differ from what has been billed or collected.

A key challenge in construction accounting is managing the differences between earned revenue, billed amounts, and incurred costs. These discrepancies often result in either underbilling or overbilling .

These variations also affect whether a company reports work-in-process (WIP) or no WIP. In either case, accurate tracking and reporting of these differences are essential for maintaining financial clarity.

The calculation of earned revenues in construction accounting is based on the percentage completion method. The process involves the following steps:

Simultaneously, the company monitors incurred costs, comparing them to the estimated costs needed to complete the project. This analysis is critical for determining the profit earned in a given period, as it requires a thorough comparison of earned revenues and costs incurred to date.

Construction accounting involves a distinct set of practices and challenges that differ from traditional accounting. By focusing on contracts, cost management, and percentage of completion calculations, construction companies can accurately reflect their financial position throughout the lifecycle of a project. Understanding these nuances is vital for anyone involved in the financial analysis of construction companies, as it provides insight into the specialized nature of this industry.

Future discussions in cost accounting will dive deeper into job costing and the specific calculations involved in managing the financial health of construction projects, offering further insights into this specialized field.