Construction accounting presents unique hurdles that, if you fail to navigate correctly, may lead to a decrease in profit margin or, worse, business failure. Most small construction business owners know their time is better spent elsewhere, whether bidding on jobs, overseeing current projects, etc. So, is it time to consider a change?

Even for the most experienced accountants, construction accounting can be challenging. Each project has unique terms covering the job's specifics, meaning account records cannot follow generic templates and must be customized for every project. The fluctuating cost of materials throws another wrench into the mix, especially when large projects take years to complete.

Eventually, subpar accounting methods will cost you, so do not risk your business's health. Consider the benefits outsourced accounting provides.

Construction Accounting Hurdles

More than in almost any other industry, accounting in construction comes with difficulties that you must navigate to maximize profit and minimize taxes owed. Two of the most common challenges are tracking costs and accurately reporting long-term contracts.

Tracking Costs by Job

There are two types of construction costs: direct and indirect costs. 

1. Direct Costs

The materials and labor are directly tied to the project. These are easy to record using material invoices and receipts and the number of labor hours required for the job.

2. Indirect Costs

Also known as overhead costs, are a little trickier to record than direct costs. These are costs incurred but not tied directly to a single project. An example of indirect costs includes equipment depreciation and maintenance. It is harder to track these costs, but it is crucial for accurate accounting.

The total cost of a project is the sum of the direct and indirect costs, which is then used to determine the profit margin.

Tracking Revenue for Long-Term Contracts

Frequently, construction projects do not fit nicely into a month, a quarter, or even a year. So, how do you accurately account for and track revenue from long-term contracts? There are two methods: the completed contract method and the percentage of completion method.

1. Completed Contract Method

The completed contract method means revenue and expenses are officially recorded in the accounting books once a project is more than 95% complete. Until then, all income and expenses are kept on a separate worksheet for projects in progress. This straightforward approach eliminates the need for job-progress estimation since you can access most if not all, actual costs associated with the job. For example, if a long-term project is completed during the second year, that is the year it will appear on your accounting records and the year it will be reported on your tax return.

2. Percentage of Completion Method

The percentage of completion method allows you to report revenue and costs in each accounting period the project is open. For example, if the project is 30% completed, you report 30% of the revenue. This method is ideal when you can reasonably estimate the stages of the project. It does not work well if progress estimating is difficult or impossible.

The percentage of completion method allows you to reconcile billing to job schedules to determine if contracts are over-billed or under-billed. A job that is overbilled is a good thing because it means customers are essentially financing other projects. On the other hand, an under-billed job means you must find other means to finance the job, such as debt or cash reserves.

In-House Accounting

Performing accounting duties in-house is feasible if your construction company is large enough to have a dedicated accounting team. However, most small and growing construction companies lack this capability. Even if another employee is delegated the role of bookkeeper, it can be challenging to gauge their level of competency in the construction industry unless you understand the complexities mentioned above.

Although in-house accounting provides a degree of privacy and confidentiality, it may lead to lower-quality accounting depending on your bookkeeper's knowledge and expertise. In most cases, it is less expensive for your internal team to provide general bookkeeping services and to outsource accounting needs.

Outsourced Accounting

Outsourcing your construction business's accounting needs ensures that all financial statements are created in a way that banks and bond agents prefer. This means more relevant information for decision-making. Also, by enlisting outside accounting services, you free yourself and your employees to focus on other, more relevant responsibilities.

Additionally, you have a trusted advisor when making financial decisions for your construction company. When outsourcing accounting, you will have peace of mind knowing that your team of experienced accountants stays up to date on the industry's latest rules and regulations.

Is Outsourced Accounting Right for Your Construction Business?

Analyze your internal bookkeeping team. Are they doing things correctly? Could their time be better spent elsewhere? Proper and thorough accounting methods are crucial to your construction company's growth. Outsourcing accounting to a team with in-depth knowledge of the nuances of the construction industry ensures your books stay in order and that you are maximizing profits.

Lutz’s certified team of experts offers a tailored approach combined with industry best practices to ensure your company's financial health is the best it can be. Contact us if you have any questions or would like to get started.

Contributors: Tom Docter, Steve Nebbia