Construction projects are complex endeavors that require meticulous planning, organization, and precise execution. To successfully manage a construction project, project managers must comprehensively understand various aspects, including construction accounting. Having a solid grasp of construction accounting principles is crucial for project managers to effectively monitor project costs, track financial performance, and make informed decisions.
In this blog, we will explore the basics of construction accounting and discuss what project managers should know.
What Is Construction Accounting?
Construction accounting is a specific branch of accounting that focuses on recording, analyzing, and reporting financial transactions in the construction industry. It involves tracking the costs of construction projects, managing budgets, and assessing the profitability of projects. Construction accounting goes beyond conventional accounting practices, as it involves dealing with unique aspects specific to the industry, such as job costing, work in progress (WIP), and retention.
Key Terms and Concepts in Construction Accounting
Job Costing
Job costing is a method used to track and allocate costs to specific construction projects. It helps project managers understand the direct and indirect costs associated with each project, enabling effective cost control and budget management.
Work in Progress (WIP)
WIP refers to the value of construction projects that are currently in progress but not yet completed. As a project manager, it is vital to track the WIP in order to assess the financial status of ongoing projects accurately. WIP is calculated by considering the costs incurred to date and the estimated costs to complete the project.
Retention
Retention is a typical practice in the construction industry where the owner or client withholds a portion of the contract price as security against any potential defects or non-compliance issues. As a project manager, you need to be aware of retention requirements and account for them correctly in your financial reporting.
Construction Accounting Methods and Systems
Percentage of Completion Method
This accounting method recognizes revenue and costs based on the percentage of completion of a project. It allows project managers to report accurate financial information over the duration of the project rather than waiting until its completion. This method is suitable for long-term projects and allows for more accurate revenue recognition and financial reporting.
Completed Contract Method
In this method, revenue and costs are recognized only when a project is completed. It involves deferring revenue until the project is finished. This method is more suitable for short-term projects where it is challenging to measure the progress accurately.
The Importance of Construction Accounting for Project Managers
Cost Control and Budget Management
Construction accounting helps project managers track project costs in real time, enabling effective cost control and budget management. By comparing actual costs against budgeted costs, project managers can identify any cost overruns or deviations from the plan promptly. This allows them to take corrective actions and make informed decisions to mitigate financial risks.
Accurate Financial Reporting
Construction accounting plays a crucial role in providing accurate financial statements and reports for various stakeholders, including clients, lenders, and investors. Project managers need to ensure that financial reports accurately reflect the project's financial performance, including revenues, costs, and profitability. Accurate financial reporting builds trust and transparency, strengthening relationships with stakeholders.
Cash Flow Management
Construction projects often involve multiple contractors, suppliers, and subcontractors who must be paid promptly. Effective construction accounting helps project managers manage cash flow by monitoring project invoicing, payments, and collections. By staying on top of cash flow, project managers can ensure that there are no cash shortages, thereby preventing project delays or disruptions.
Contract Compliance
Construction projects are governed by various contracts and regulations. Project managers must ensure that their financial practices comply with the terms and conditions outlined in the contracts. Construction accounting allows project managers to monitor contract compliance and avoid any potential legal or financial consequences.
Tips for Effective Construction Accounting for Project Managers
- Implement Construction-Specific Accounting Software: Utilizing construction-specific accounting software can greatly simplify the accounting process for project managers. Such software often includes features like job costing, WIP tracking, contract management, and financial reporting tailored to the construction industry's unique needs.
- Engage with the Project Accountant: Collaboration with a project accountant or a financial expert specializing in construction accounting can be immensely valuable. Their expertise can help project managers navigate complex accounting procedures, interpret financial data, and provide guidance on financial decision-making.
- Regularly Review Financial Reports: Project managers should review financial reports, such as income statements, balance sheets, and cash flow statements, on a regular basis. Analyzing these reports enables project managers to identify any financial issues promptly and take appropriate actions to mitigate risks.
- Use a Chart of Accounts: Develop a comprehensive chart of accounts specific to the construction industry. This will allow you to categorize expenses and revenue properly, providing a clear and accurate picture of financial transactions.
- Accurate Job Costing: Ensure that job costing is done accurately and consistently. This involves tracking all direct and indirect costs associated with each project, including materials, labor, equipment, and overhead. Accurate job costing will help you understand the profitability of individual projects and make informed decisions.
- Monitor Change Orders: Construction projects often involve change orders, which can impact project costs and financial performance. Project managers should closely monitor and document all change orders and their associated costs. Incorporate these changes into your budget and ensure that they are properly accounted for in your financial reports.
- Document and Review Subcontractor Agreements: Subcontractors play a significant role in construction projects. Ensure that you have detailed subcontractor agreements in place, clearly defining the scope of work, payment terms, and any other financial obligations. Regularly review these agreements to track subcontractor costs and ensure compliance.
- Cash Flow Forecasting: Develop a cash flow forecast to anticipate and manage cash requirements throughout the project duration. This will help you in planning for upcoming expenses, ensuring that sufficient funds are available to cover costs and avoid cash flow issues.
- Stay on Top of Invoicing and Payments: Timely and accurate invoicing is crucial for maintaining cash flow. Ensure that you promptly issue invoices to clients and follow up on payments. Similarly, monitor payments to subcontractors and suppliers to prevent any payment delays or disputes.
- Engage in Continuous Learning: The construction industry and accounting practices are constantly evolving. Project managers should stay updated with the latest accounting trends, regulations, and industry-specific changes. Attend workshops, seminars, and industry conferences to enhance your construction accounting knowledge and skills.
By implementing these tips, project managers can enhance their ability to effectively manage the financial aspects of construction projects. Accurate and proactive construction accounting practices will contribute to the overall success of projects, ensuring financial stability and profitability.
In conclusion, understanding construction accounting is essential for project managers to successfully navigate the financial aspects of construction projects. By familiarizing themselves with construction accounting principles, methods, and systems, project managers can effectively control costs, manage budgets, and ensure the financial success of their projects. Embracing construction-specific accounting software and seeking the expertise of a project accountant can streamline the accounting process, facilitating efficient financial reporting and decision-making. With a solid foundation in construction accounting, project managers will be better equipped to handle the financial complexities of the construction industry.
| Features | Lumber | Sage | QuickBooks |
|---|---|---|---|
| Purpose-built | Construction-specific platform with tailored features. | A generic platform for small businesses of all industries. | A generic accounting application for all industries. |
| Ease of Use | Intuitive interface across devices. | A complex interface that requires extensive training. | Aging interface, stagnant innovation, clunky project management. |
| Payroll Experience | Streamlined with tax filing and integrated money flow. | Complex workflows demand extensive training. | Non Existent |
| Payroll Processing | Mobile-friendly, auto-stubs, and tax adjustments. | Complicated processes and workflows. | Complex workflows that demand extensive training. |
| Payroll Speed | Quick integration with time tracking and AI-powered payroll process. | Slower integration hampers the overall process. | Quickbooks integrates only with its own time-tracking app. |
| Payroll Calculation | Supports certified payroll, prevailing wages, union rates, multi-rate and multi-state wages. | Not construction-focused and requires extensive tweaks. | Needs extensive tweaks to make it work for construction. |
| Flexible Payroll Service | Lumber offers flexible payroll- options Payroll Services: Outsource your payroll needs to Lumber experts and bookkeepers Payroll App: Process payroll in-house | Not available | Not available |
