Introduction to Construction Accounting

When accounting people talk about the General Ledger, they use words like “debits” and “credits” and other fancy accounting words that frustrate non-accounting people, like project managers. Project Managers don’t care about “debits and credits.”  They care about dollar amounts. First, the General Ledger is something that accountants really care about. Anytime an accounting transaction is recorded in the system, it hits the General Ledger. This could be a payroll check, or an accounts payable invoice, or a credit card receipt.

1. Job costing can be flexible, be open to trying a variety of cost structures until you find your most successful version, effective construction job costing is different for each company.
2. The reality is that job costing takes place across your entire organization, from the field to your back office.
3. As a result, tracking and recording individual job costs can be difficult because you are looking at your business’s overall revenue and expenditure, rather than that project alone.
4. The most effective construction companies are proactive rather than reactive.
5. For a cost coding system to be successful, everyone needs to use it consistently.

As a contractor, you’ll want to have your chart of accounts set up to include direct job cost accounts for labor, materials, subcontractors, equipment, and other. These accounts represent the costs construction job cost accounting typically required to complete a project. You’ll decide how to breakdown your jobs, you’ll identify a consistent set of cost codes, you’ll train your team, you’ll learn to analyze your reports.

What is Job Costing?

People don’t start out in construction knowing everything about construction accounting, even if they are “good with numbers” or have a background related to general accounting. To become successful, they need to learn about construction-specific accounting and how to apply best practices in a construction business. In the following chapters, we break down and explain each of the three components and walk you through how to create each one along the way. By the end of this series, you’ll know how to create a job costing system, which tools to use, and how to optimize it to maximize the profits of your business. These are individual classifications for costs within a cost category. Similar to their parent, cost codes are defined by both a name and numerical value.

Common misconceptions about job costing

To effectively track each dollar, you have to have a place to put each dollar. You need to know which expense goes to what project and how that expense fits into the budget. The cost structure gives you an outline to work with — it gives you ways to break down your company’s finances so that you know exactly where each cost goes and why. Tracking your dollars gets easier as you grow accustomed to using the job cost structure. The more committed you are to recording your expenses, the better you’ll know your actual costs and the progress of your jobs. Effective job costing practices allow for better cash flow management in construction.

Contract terms commonly allow 30, 60, or even 90 days or more to pay invoices. As a result, revenue recognition and cash management in construction both carry special considerations. Contractors need precise tracking and reporting, as well as collection and cash-flow strategies. Contractors, however, need to treat each and every construction project as a unique, short-term profit center. What really makes this special is that each construction job tends to have unique inputs and requirements. Even when projects have similar production requirements, they’re often subject to different site conditions or local variables like labor availability, cost of materials and legislation.

And a construction company using a strong job cost system enjoys easier, more accurate budgeting, better progress tracking and a thorough zeroing-in on profit margins. Job costing is an effective accounting method for any construction company wanting to maximize their profits. Tracking every dollar helps contractors monitor their budget — letting them make spending adjustments in real time before major financial discrepancies occur.

However, retainage can lead to significant cash flow challenges for contractors, who may lack the working capital necessary to take on new jobs if earned income is withheld. One potential downside of the percentage of completion method is that businesses may incidentally underpay or overpay for taxes depending on how accurately they estimate costs. One potential downside of the accrual method is that businesses can pay income tax on unrealized profit since the accounting system can record revenues that have not yet been received. One way to mitigate this problem is to structure contracts with the profit evenly distributed rather than front-loaded.

Job costing is especially helpful when there is a wide range of items to track because job costing is built for detail. The more moving parts a company has, the more useful a job cost structure will be. Job costing provides a granular view of where every dollar is spent in a construction project. This detailed tracking helps identify areas where costs are higher than anticipated, allowing for timely interventions to control spending. With our streamlined approach, you can not only reduce the risk of error, but gain powerful insights and forecasting capabilities, so you can make more informed project management decisions.

For example, an HVAC technician paid at $20 an hour might be billed at a fixed $50 per hour. Additionally, the equipment they install might follow a standard markup table by item or price, such as “2x” for a disposable air filter. If the technician spent two hours on the dispatch and additionally replaced a $20 air filter, the contractor would bill the customer $100 for labor plus $40 for materials. Another peculiarity to be accounted for in construction is the practice of withholding retainage, or, retention.

How to Use Construction Cost Coding

After all, there’s not much point in accepting the project without one. This can differ wildly from client to client, so it’s important to reassess this each time you create a new job cost to ensure a good deal for both you and the customer. For that reason, it’s usually advisable to track and calculate each individual labour expense separately and add them together in the job costing outline. It might seem like job costing is simply about producing an accurate estimate at the start of the project. While it’s easy to calculate the cost of bought or loaned equipment, pre-owned tools are more difficult because there are no direct costs. Best practice for equipment costing involves charging a standard rate you would expect to pay for renting the equipment, then calculating your total cost based on your rate.

Organizing cost codes within cost categories provides the ability to separate and track common costs, such as labor, at a more granular level in financial reporting. Of course, the ASC 606 rule provides many other important standards for contractors to follow. That includes identifying whether they need to count a project as one contract or multiple contracts, how to determine the contract price, and how to allocate the sales. It also entails changes to accounting for contract losses, stored materials and cost-to-cost calculations. As with using cash accounting or methods like PCM and CCM, contractors need to consult with their construction CPA to make sure they’re on track. Under the completed contract method (CCM), contract income isn’t reported until the project finishes.

Cash Flow Optimization

And then you have a historical record of projects that you’ve bid and the data you used to bid it and whether you got the job and whether you could have gotten the job and made the profit that you wanted. The other example of the indirect job costing, that’s where I’m saying it depends on what type of indirect job costs you have to allocate. But I think again about these heavy equipment guys, the ones that have the heavy yellow iron. If you own that equipment, you may not be thinking about the maintenance on that equipment, the depreciation on that equipment.

Of course, that doesn’t mean there aren’t expenses during construction or that contractors can’t bill in the meantime. This sometimes means contractors are able to defer taxable revenue if the contract won’t be completed until the following tax year. When all of that job data is recorded and organized, the result is actionable reporting that project managers and foremen can really use. Contractors are able to coach their project managers and superintendents on how to supervise costs and production successfully. Estimators are able to know the true break-even cost even in tight bids.