Accounting for Construction Contracts: Be Brilliant at the Basics

Here’s a story we’ve heard one too many times: A construction firm wins a major contract, completes the job on time and within budget, but ends the year with a surprisingly thin bottom line. What happened? The work in progress (WIP) schedule wasn’t updated, over/under billings were missed and job costs were lumped together instead of categorized.

In other words, the basics weren’t covered.

In construction accounting, the fundamentals are more than paperwork; they’re performance drivers. Unlike many industries where revenue recognition is straightforward, construction businesses operate in a world of job schedules, retainage, change orders and complex cost structures. Getting the accounting basics right is the difference between hitting your goal profit margin and missing it by a mile.

Let’s look at what it means to be brilliant at the basics when it comes to accounting for construction contracts. Doing so can protect your cash flow, strengthen your reporting and improve your bids.

Understanding Percent Complete Accounting and its Critical Role

Revenue recognition in construction is about when you’ve earned that revenue based on the work you’ve actually performed. That’s where the percent complete accounting method comes into play.

Under ASC 606, revenue should be recognized as performance obligations are satisfied. In construction, that typically means measuring progress toward completion. The most common approach is cost-to-cost: comparing the actual costs incurred to date to the total estimated costs of the project. This method is the standard under IRC § 460 and is recommended by the IRS for most long-term construction contracts.

Why does this matter? Because billing doesn’t always align with earned revenue, you may bill ahead (creating overbillings) or behind (leading to underbillings), and both situations require proper journal entries to reflect your financial position accurately. Improper revenue recognition can inflate income one period and cause an unexpected dip the next, misleading your stakeholders and potentially affecting bonding capacity.

Here’s a quick example. Say you’ve billed $400,000 on a job that’s only 50% complete but projected to cost $1 million. Your percent complete is 50%, meaning you’ve earned $500,000 in revenue. But you’ve only billed $400,000, which is a $100,000 underbilling. Failing to reflect this on your WIP schedule and income statement can distort everything from profitability reports to tax estimates.

Contractors who truly understand the mechanics of percent complete accounting make smarter decisions not only in estimating and bidding, but also in managing cash flow and reporting accuracy. It’s a basic, yes. But it’s the kind of basic that sets top-tier contractors apart from the rest.

Laying the Foundation With Accurate Job Cost Codes and Cost Tracking

Job costing is the foundation of financial visibility in construction. Without precise cost tracking, you can’t know how a job is performing until it’s too late to fix the issues. That’s why setting up meaningful job cost codes and maintaining consistent, detailed tracking of labor, materials, equipment and subcontractor costs is essential.

Start by building a standardized job cost code structure that reflects your unique operations. While it’s tempting to create a new code for every project nuance, the real value lies in consistency. Codes should mirror the way your team estimates jobs and manage budgets. This could be by phase, CSI division or project milestone. The key is making sure your project managers, field supervisors and back office are speaking the same language.

Tracking actual costs against these codes gives you the real-time feedback you need to detect overruns, update estimates and make informed billing decisions. It also feeds directly into the WIP schedule, providing accurate percent complete data. Skimping on cost tracking is like flying blind. You might be on budget today, but without visibility, tomorrow’s overrun can hit fast.

Proper job cost tracking also enables powerful insights. When your codes are well-structured, you can compare performance across jobs, evaluate subcontractor efficiency and improve future estimates. In fact, we often see contractors improve bid accuracy noticeably within a year of implementing tighter cost code discipline.

Here’s where technology also plays a role. Cloud-based construction accounting platforms like Viewpoint, Sage 300 Construction or Procore make it easier to track costs in real time and synchronize them with your accounting system. But technology alone doesn’t create clarity. It’s the processes and discipline behind it that make your job costing system a true decision-making tool.

Allocating Overhead the Right Way

Direct job costs are only part of the story. To understand your true profit margins, you need to properly allocate overhead. These are indirect costs like insurance, rent, office salaries and equipment depreciation that keep your business running. Done right, overhead allocation helps you price bids accurately and track profitability job by job. Done wrong, and you could be overpricing yourself out of work or underbidding jobs that drain your margins.

And accuracy matters. If overhead is under-allocated, your job looks more profitable than it actually is. Over time, this leads to bidding errors, poor financial forecasts and operational strain. On the flip side, over-allocating inflates job costs and makes your bids less competitive (especially in tight markets).

Many construction firms review their overhead allocation annually. But we recommend reviewing quarterly, especially if your cost structure is changing due to expansion, new equipment purchases or shifting job volumes. If you qualify for specific contractor tax elections, your allocation methods may even impact your taxable income. This is why accurate tracking and reporting matter to both your books and your bottom line.

Keeping the WIP Schedule Current and Actionable

If job costing is the heart of construction accounting, your work in progress (WIP) schedule is the lifeblood. It connects billing, revenue recognition, cost tracking and profitability into a single, vital report.

Yet too often, we see WIP schedules treated as a year-end requirement instead of a dynamic management tool. That’s a missed opportunity. An up-to-date WIP schedule allows you to monitor job performance, spot trouble early and course-correct before things spiral. It includes essential columns like:

• Contract value
• Costs incurred to date
• Revenue recognized (based on percent complete)
• Amount billed to date
• Over- or under-billings

These over- and under-billings provide important insight into your project cash flow. Overbilling, while good for short-term cash, can hide job issues if not reconciled against earned revenue. Underbilling can choke cash flow and may suggest issues with billing practices or change order delays.

To keep your WIP accurate, it must be updated monthly and tied directly to your job cost reports and percent complete calculations. Journal entries should reflect over- and under-billings as adjustments to revenue and balance sheet accounts.

But numbers alone don’t tell the full story. You also need to analyze your WIP. Are certain PMs consistently underbilling? Are specific project types prone to cost overruns? These patterns reveal the real health of your operations.

A WIP schedule isn’t just for internal use. It’s also essential for bonding agents and banks evaluating your financial strength. Inaccurate or delayed WIP schedules can damage credibility and limit growth opportunities.

For practical guidance on managing WIP and project profitability, explore our construction accounting services built specifically for contractors like you.

Review Reports Like a Pro: Key Financials to Watch Monthly

Even the most sophisticated job costing system can’t replace the need for regular, rigorous financial report reviews. At a minimum, every construction company should be reviewing these critical reports monthly:

• Bank reconciliations: Ensures your cash balances are accurate and identifies any timing issues with deposits or disbursements.
• Accounts receivable aging: Helps you monitor slow-paying clients, enforce payment terms and improve cash flow forecasting.
• Accounts payable aging: Keeps you aware of upcoming obligations and maintains good vendor relationships.
• Trial balance: Acts as a snapshot of your entire chart of accounts, which is crucial for catching data entry errors or misclassified expenses.

Why monthly? Because construction is fluid. Delays, change orders, weather and staffing shifts mean your numbers can turn quickly. Waiting until year-end can leave you reacting to problems you could’ve seen coming.

Use these reports to hold monthly internal finance meetings, even if it’s just you and your outsourced controller. Review project-by-project profitability, question unusual balances, and compare actuals to budget. These bookkeeping steps serve as essential business strategy sessions.

Also consider benchmarking. Are your receivables aging beyond 60 days? Are overhead costs creeping up? Are your margins slipping by phase or project type? Asking these questions routinely gives you the edge over competitors who operate on gut feel.

For deeper insight into professional standards and audit-quality reporting, consult the GAO’s Yellow Book, which outlines principles used in governmental and contractor audits alike. While it’s not required reading, it reinforces the idea that accuracy, independence and regular review matter—no matter the size of your firm.

Simple Systems, Powerful Profits: Mastering Construction Contract Accounting

Strong construction businesses build financial systems that support growth, cash flow and long-term success. And it starts with getting the basics right.

From timely WIP updates to accurate job costing and smart overhead allocation, the fundamentals of accounting for construction contracts drive better decisions and sharper bidding. Reviewing your reports regularly and basing your financial strategies on reliable data allows you to plan, control and succeed.

If you’re ready to strengthen your accounting foundation, contact a James Moore professional. Our construction accounting specialists help firms across the industry turn basic practices into bold results.

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