Construction Accounting vs. Traditional Accounting: Key Distinctions

When it comes to accounting, every industry has its own intricacies and nuances. Construction is no different. Accounting for construction companies can be significantly different from accounting in more traditional businesses.

Several factors make accounting for construction businesses unique – especially large, well-developed construction companies that work on major long-term projects. U.S. Generally Accepted Accounting Principles (GAAP) specify that construction businesses must follow certain accounting methods. But beyond this, taking a specialized approach to construction accounting often unlocks major opportunities.

Up to a certain point, construction companies can (and do) take a relatively generic approach to accounting. But as your company grows, it’s almost always worth investing to upgrade the sophistication of your accounting to take a more tailored approach better suited to the demands of the construction industry.

In this overview, we share the unique accounting considerations that growing construction companies must keep in mind. We also highlight why business leaders should engage a specialized construction accounting firm like James Moore to guide their growth.

Unique Accounting Considerations for Growing Construction Companies

Building a comprehensive accounting and finance infrastructure might not feel like a top priority for a growing construction company. But without it, you’re effectively operating in the dark. Robust accounting helps business owners better understand their financial position, anticipate future developments and make better decisions.

As your company begins to grow, adopting the specialized construction accounting practices outlined below will stand you in good stead to continue your journey.

Increased Granularity of Financial Statements

In most industries, a company’s income statement typically contains just a few categories of revenue. But in construction companies, revenue is disaggregated further. Construction companies typically categorize income and expenses both by project and by service line (engineering, labor, materials and so on).

Taking this approach enables construction companies to ensure more accurate job costing for expenses. This allows leaders to better understand the financial position of each standalone project and service line. As your company expands and works on multiple projects concurrently, this accounting can become very granular.

An additional complexity here is that GAAP requires construction companies to allocate overhead expenses into jobs via costs of goods sold (COGS). In regular accounting, there is a clear distinction between COGS and indirect overhead costs. In construction, however, that’s not the case.

Instead, construction companies must allocate selling, general, and administrative expenses (SG&A) toward specific projects. This is best done by creating a cost pool, but companies are permitted to apply any reasonable methodology that’s in line with industry standards.

The Work In Progress Schedule (WIP) and Percent Complete Accounting

Three core financial statements apply in all accounting: the income statement (also known as a profit & loss statement, or P&L), the balance sheet and the cash flow statement. Construction companies engaged in large, long-term projects have a fourth important financial document: the schedule of contract activity, commonly known as the WIP (for work in progress).

These reports are used for all long-term projects which overlap financial reporting periods or tax years. They track the total costs of a project, from which construction companies can infer the current rate of completion of the project. If a construction company has incurred 80% of the costs associated with a project, the project is considered 80% complete.

In construction accounting, costs drive revenues. And GAAP requires the construction company to recognize 80% of the contract’s revenue, regardless of whether they’ve sent invoices to their customer.

Percent complete accounting also impacts the balance sheet as it can often lead to the creation of contract assets and liabilities. Consider the example of a construction project with a $2 million budget. After recording costs of $1.6 million, the project is considered 80% complete. If the company has only billed $1.5 million to date, there is revenue recognized in excess of billings (better known as underbillings) of $100,000. This will be recorded on the balance sheet as a contract asset.

Cash Flow Projections

Cash flow is the lifeblood of any business, but it’s crucially important in the capital-intensive construction industry. Construction companies don’t go out of business because of a lack of backlog; they go out of business because they run out of cash in the middle of a project. Issues like retainage, supply chain disruptions and irregular billing cycles can all contribute to cash flow challenges without sufficient oversight.

Developing and maintaining rigorous cash flow projections on at least a monthly basis is critical to a growing construction business’s success. As part of this process, businesses should make sure their cash flow projections and their WIP are in sync. Working with an experienced construction accounting firm helps growing businesses proactively manage their cash flow before any problems arise.

Specialized Construction Accounting Software

Given the many nuances of accounting for large construction projects, many larger companies use specialized construction accounting software. These tools can produce on-demand WIP schedules and automate large elements of the accounting and bookkeeping process. However, they tend to be relatively expensive.

Construction companies should undertake a cost-benefit analysis to determine whether adopting construction accounting software is the best approach for their business. Many smaller companies can’t justify the investment and continue to use tools like Quickbooks Online. But once your company starts to approach $50 million in annual revenue, it’s time to seriously evaluate the efficiency gains that switching to a specialized construction accounting platform could unlock.

James Moore: Specialized Construction CPAs and Advisors

Many construction companies work with a highly specialized construction accounting firm – particularly companies that engage in bonded work. Access to surety bonds is crucial for companies looking to compete for major commercial or government construction contracts. Moving upmarket into this kind of work is a major transition point for the accounting infrastructure in many construction companies.

Partnering with a specialized construction accounting firm offers your business access to all kinds of new opportunities – from significant tax savings to increased financial insight that enables leaders to make important decisions with a higher degree of confidence.

At James Moore, our construction accounting professionals have decades of experience providing accounting, assurance, and tax services to a wide range of construction companies. With significant domain expertise in construction accounting, James Moore is a trusted name in the construction accounting industry that sureties and bonding companies are familiar with.

Together, our team thrives on unlocking incremental value and helping our clients build for the long term. To learn more about how James Moore can help your construction business, contact an advisor today.

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