Construction Site with a hard hat and building.

A Comprehensive Guide to Construction Accounting

If your construction company is only working on small, residential projects, you might be able to skate by with a bare-bones approach to accounting. But if you have ambitions to work on much larger commercial and government projects, a more thoughtful approach is vital.

Without reliable accounting, it’s impossible for construction company owners to understand the profitability and progress of their projects. And if you want to obtain the bonding capacity required to work on lucrative government and public works projects, a robust accounting system complete with precise financial reports is non-negotiable.

Construction accounting, as we’ll explain throughout this guide, is markedly different from the way most companies manage their accounting processes. From the use of percent complete accounting to the increased granularity of your financial statements, construction accounting is a unique field of accounting that demands a tailored approach.

In this guide, we’ll explore all the basic accounting principles that owners of both established and growing construction companies need to understand. We’ll cover:

  • Construction Accounting vs. Regular Accounting: Key Differences
  • The Key Financial Statements in Construction Accounting
  • How to Manage Accounting in Your Construction Company
  • Whether You Need Construction Accounting Software
  • The Benefits of Taking a Specialized Approach to Construction Accounting
  • And more

We hope that by the time you’re through reading, you’ll be well informed to make decisions about the accounting processes in your construction company. As we’ll explore, a reliable accounting and finance system is central to your continued growth and success.

James Moore: Experienced Construction Accounting Professionals

At James Moore, our highly specialized construction CPAs and advisors have decades of experience serving leading construction companies across Florida and the Southeast.

Our group of accounting, assurance, and tax professionals provides a wide range of services that help construction companies manage their finances, secure bonding capacity, and build tax-efficient growth strategies.

To learn more about James Moore’s construction accounting services, contact an advisor today.

Why is Strong Accounting Important to Construction Companies?

Strong accounting is important to every company, But for construction companies, it’s especially vital.

Successful construction companies work on significant projects with budgets of millions of dollars. To even qualify to work on these projects, your construction business must have a strong accounting infrastructure. Beyond this, there are several other reasons that it’s crucial that construction companies embrace precise accounting and bookkeeping:

  • Reviews & Audits: Your construction company may be required to obtain a review or an audit to work on particular projects, especially government projects. For example, in Florida, contractors that wish to work on Florida Department of Transportation (FDOT) road and bridge projects must have a review for contracts up to $2 million and an audit for any contracts above that amount. Without robust accounting, it’s unlikely your reviewed or audited financial statements will pass muster.
  • Obtaining Construction Bonds: Many government and public works projects require your construction company to obtain bonding from a surety company. Without high-quality financial statements, no surety company will offer your company bonding capacity. And that precludes you from working on these types of projects.
  • Managing Project Costs: Every construction project has a lot of costs: labor, materials, sub-contractors, equipment, and so on. Closely managing these costs is crucial to bringing your project in on budget and ensuring your work remains profitable.
  • Maintaining Positive Cash Flow: Every contractor knows that construction is a cash-intensive business. One of your biggest responsibilities as a construction company owner is to ensure that you don’t run out of cash mid-project. If all you do is monitor your bank balance, you won’t discover any issues until it’s too late. By investing in robust accounting workflows and cash flow projections, you’ll always be able to plan for what’s next.
  • Proactive Tax Planning: Construction companies enjoy access to a wide range of tax planning opportunities. But without reliable accounting, it’s impossible to know where you stand. That makes planning and decision-making next to impossible since you and your tax advisor are essentially operating in the dark.

A reliable approach to managing your accounting workflows isn’t just something that’s nice to have – it’s an indispensable asset. Without reliable accounting, you’re effectively guessing every time you have to make a decision. Accounting shines a light on your financial position both today and in the future, helping illuminate the path toward sustainable growth.

Construction Accounting vs. Regular Accounting

It’s clear that accounting is a function of vital importance to every construction company. But an often-overlooked element of construction accounting is just how different accounting for a construction company is compared to accounting for other types of businesses.

These differences are so stark, in fact, that once your construction company reaches a certain level of maturity, it’s vital you seek out a specialized construction CPA with the domain expertise to support all your company’s needs. A traditional, non-specialized CPA, whether that’s your friend from college or the local CPA firm in your town, will lack the specialized knowledge required to take your construction business to the next level.

What are some of the key differences between construction accounting and regular accounting? The list below is a great place to start.

Percent Complete Accounting

Project-based construction accounting uses percent complete accounting, which means that construction companies recognize revenue as they record expenses. If a construction company has incurred 80% of the costs on a $10 million project, it may recognize (and bill for) $8 million. This is tracked using the WIP schedule, a vital construction accounting document that we’ll explain further below.

Job Costing

Many construction companies work on multiple projects simultaneously. Accurately assigning costs to these projects is vital to understanding their progress and profitability. Labor and materials costs are assigned to particular projects. Companies are also required to assign their overhead costs toward specific projects using a consistent methodology, such as a cost pool.

Unlike traditional accounting, in which all expenses are recorded on a general ledger, construction accounting uses both a general ledger and job costing. Tracking costs in such a granular way adds additional complexity but also provides leaders with increased clarity on the costs of different projects.

Construction Financial Statements

Construction companies that follow GAAP must produce similar financial statements to any other GAAP-compliant company. These include an Income Statement, Balance Sheet, and Cash Flow Statement. However, for construction companies, these statements often look a little different.

In construction accounting, it’s important to disaggregate revenue and expenses, categorizing income and expenses both at the project level and the category level (materials, labor, SG&A expenses). This increased level of detail is key to understanding the progress and profitability of different projects.

Tax Planning Opportunities Available to Construction Companies

As business owners in a capital-intensive industry, construction company owners have access to a wide range of tax planning opportunities. There are many provisions in the Internal Revenue Code that allow construction companies increased flexibility in their tax planning, such as the ability to defer gross profits on contracts that are less than 10% complete.

There are also federal tax credit opportunities like the Section 179D Energy Efficient Construction Deduction, as well as a range of incentives available at state and local levels. Working with a CPA firm and tax advisors that understand these nuances, and help you manage your financial strategy to best take advantage of them, enables your company to grow faster.

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In short, working with a construction CPA does more than ensure your business does things the right way. It also exposes you to a wealth of new opportunities that can help you grow your business in the most efficient manner possible.

Key Financial Statements in Construction Accounting

Financial statements play an important role in construction accounting, serving as a scorecard that helps you understand how your company is performing.

While many construction companies only produce financial statements once a year, it’s best practice to produce them on a monthly or at least quarterly basis. Many sureties require this and showing that you assess your financial position on a monthly basis will likely improve the rate you’ll pay to be bonded.

There are four key financial statements in construction accounting:

  • Income Statement (or Profit & Loss Statement)
  • Balance Sheet
  • Cash Flow Statement
  • Work-In-Progress (WIP) Schedule

Here's what business owners need to understand about each of these key statements, including how each statement is used and what they can tell you about the performance of your business.

Income Statement

An income statement, also known as a Profit and Loss Statement (or just a P&L), captures your business’s revenues and expenses over a certain time period. In construction accounting, it’s best practice to maintain income statements for every project your firm is actively working on and to have these roll up to a company-wide income statement.

By keeping a monthly income statement, you can better understand how your construction firm’s financial performance is evolving. Look for anomalies or trends that might indicate an increase in material costs or improved profitability in certain types of projects. Then use these to refine your business strategy.

Balance Sheet

A balance sheet documents a company’s assets, liabilities, and equity. Your assets are what you own, such as cash, materials, equipment, accounts receivable, contract assets, and so on. Your liabilities are your company’s debts: any lines of credit, accounts payable, or contract liabilities will be listed here.

By subtracting the liabilities from the assets, you can calculate the owner’s equity in the firm. (This is the value of the company if everything were to be liquidated.) Over time, your aim should be to grow your assets and equity while keeping your liabilities in check.

Cash Flow Statement

In construction, cash is king. Construction firms primarily go out of business because they run out of money, and that makes proactively managing cash flow critical. That’s the purpose of the cash flow statement, a financial document that tracks the flows of cash into and out of your construction company.

To make sure your business retains sufficient liquidity to fulfill all its contractual commitments, you need to closely manage your cash flow. By monitoring your cash flow statements over time, and creating cash flow statements for every project you work on, you’ll be able to pinpoint inefficient cash management practices and better understand your ability to fund future projects.

A cash flow statement is a backward-looking document. It tells you what happened, but it doesn’t tell you what’s going to happen next. For that, you should invest in creating cash flow projections that help forecast your future needs. Compare your projections to your actual cash flow statement on a regular basis to understand the accuracy of your forecasts.

Work in Progress (WIP) Schedule

A work in progress schedule, commonly referred to as a WIP schedule, is a supplemental schedule that is unique to the construction industry. WIP schedules track the progress of individual projects and serve as the basis for the percent complete accrual accounting approach that construction companies use to manage revenue recognition and billing.

Some companies maintain a real-time WIP schedule, but it’s best practice to produce this report every month. Of all your financial statements, this is perhaps the one of most interest to your bonding agent and surety, since it documents the progress of the projects they have bonded.

How to Manage Accounting in Your Construction Company

When it comes to determining how to best manage your construction company’s accounting environment, you have a couple of different options. Let's explore the different routes construction company owners might take, highlighting some of the operational considerations (as well as the pros and cons) for each model.

Internal Accounting Department

Most construction companies start out with just one accounting and finance professional: a construction bookkeeper. This is typically an entry-level position focused on tasks such as managing accounts receivable and payable, categorizing transactions, and running payroll. If you run a small construction firm focused on residential projects, this may well be enough. But once you scale to larger projects, it’s time to build out a more comprehensive team.

If you decide to build out an internal construction accounting team, it’s important to hire a chief financial officer (CFO) — or at the very least a controller — with significant experience in construction accounting. As we’ve noted throughout this guide, accounting for construction companies is unique, so it’s important to have the right level of expertise on staff.

Pros of Building an Internal Accounting Department

  • Increased Control: Your accounting team will work for you full-time, giving you full visibility over their work.
  • Fixed Costs: Once you hire your staff, you know exactly how much it’ll cost to manage your accounting each month and can plan accordingly.
  • More Access: Your CFO or controller will sit across the office from you, making it easy to get a quick answer to any questions you might have.

Cons of Building an Internal Accounting Department

  • Cost: Talented accounting and finance professionals, particularly those with proven construction accounting experience, are in short supply. You should expect to pay a sizable salary to attract the right talent.
  • Lack of Expertise: Generalized accounting knowledge doesn’t necessarily translate well into construction accounting. This is a wide-ranging subsector of accounting full of complexity and nuance. A small internal team may lack the expertise to advise on every issue.
  • Scalability: Sometimes you may need to quickly ramp up your accounting and finance function in preparation for a huge project. At other, quieter times, you might not have the work to keep them busy.

Construction Accounting Software: Yes or No?

Many large, well-developed construction firms use highly specialized construction accounting software programs to more effectively manage their finances. There’s no question these tools are impressive: they enable firms to much more effectively manage job costing and even support the creation of real-time WIP schedules. However, they are extremely expensive – sometimes over $100,000 per year.

In our view, most construction firms do not need this specialized software until they reach tens of millions of dollars in revenue each year. The costs are prohibitive, and learning how to use these systems can be a steep learning curve for your existing accounting team. Instead, using a flexible platform like QuickBooks Online, paired with experienced construction accounting professionals, is likely the best approach for many small and growing construction companies.

Outsourcing to a Construction Accounting Firm

Instead of managing all your company’s accounting processes internally, many construction firms take an alternative approach: outsourcing some or all of their accounting to a specialized construction CPA.

This relationship can take many forms. You might partially outsource accounting to a construction CPA, relying on them to train your staff, inspect your books on a quarterly basis, and provide you with tax planning, assurance, and other advisory services. Your internal team will still manage the day-to-day, but you’ll have the benefit of an experienced CPA regularly checking on your work to ensure everything is accurate.

Alternatively, many companies choose to fully outsource their accounting to a construction CPA. In this scenario, the outsourced accounting team handles the majority or all of your accounting tasks, from managing payroll to preparing monthly financial statements. As part of this process, you can expect to have a monthly meeting with your CPA to evaluate your financial statements and analyze future projections.

Pros of Working with an Outsourced Construction CPA

  • Cost Savings: Outsourcing solutions typically work on a fractional basis, meaning you’ll only pay for the services you need. Plus, you won’t have to pay for hiring, training, employment taxes, health insurance, and all the other costs associated with full-time employees.
  • Domain Expertise: Construction accounting CPAs are highly specialized. They have an in-depth knowledge of the construction accounting field and will use this expertise to ensure your financial statements are prepared in line with industry standards and best practices.
  • All-In-One Solution: Outsourcing your accounting needs to a construction accounting firm gives way to new efficiencies when it comes to tax planning since your accountant will already have an intimate understanding of your business. Many construction CPAs also offer additional services, such as HR and technology consulting, that can further advance your business.

Cons of Working with an Outsourced Construction CPA

  • Potential Scope Creep: Many outsourcing relationships start with relatively clearly defined boundaries, which are often stretched over time. This can introduce scope creep, with your outsourcing firm gradually taking on more and more work — which can lead to increased costs. Make sure you proactively manage deliverables to avoid this.
  • Communication Challenges: Unlike an in-house accounting team, you can’t just walk down the hall and ask your outsourced accounting team a quick question. You’ll have to pick up the phone or send an email. So it’s important to partner with a firm that’s committed to high standards of client communication.

James Moore: Dedicated Construction CPAs

At James Moore, our dedicated construction accounting CPAs provide a wide range of services to construction companies across Florida and the Southeast. With decades of experience advising construction firms, our team takes a long-term approach to continually improving our clients’ businesses and supporting their growth through robust accounting.

Our support allows construction companies to focus on what they do best: building the infrastructure that brings our communities together. It’s our goal to help you increase profitability, streamline your operations and enhance the value of your business.

That’s why we provide a full suite of services specifically tailored to the needs of construction companies, including:

ASSURANCE

Audits, Reviews, and Compilations

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TAX PLANNING

Business, Individual, and State and Local Tax Planning

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BUSINESS ADVISORY

Advisory Support for Due Diligence

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BONDING & SURETY SUPPORT

Support in Securing Bonding for Your Next Project

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HR CONSULTING

Consulting and Outsourced HR Solutions

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TRANSITION PLANNING

Plan For What’s Next

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TECHNOLOGY SOLUTIONS

Managed IT Solutions
and Support

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WEALTH MANAGEMENT

Plan Your Financial Future with our Wealth Management Professionals

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OUTSOURCED ACCOUNTING

A Range of Outsourced Accounting Services & Solutions

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Ready to learn more about working with James Moore’s construction CPAs? Contact an advisor today to set up your free consultation.

Frequently Asked Questions (FAQs)

We’ve summarized our answers to some of the most common questions that prospective construction accounting clients ask us.

What is Construction Accounting?

Construction accounting is a specialized branch of accounting that focuses on the unique financial demands of large-scale construction projects. A variety of factors set construction accounting apart from traditional accounting, including job costing, percent complete accounting, and project-based accounting.

How is Revenue Recognized in Construction Accounting?

Revenue recognition in construction accounting is typically based on the percent complete method. This method recognizes revenue and expenses as a project progresses. If a project has incurred 60% of its expenses (labor, materials, and so on), the construction company may recognize 60% of the project’s revenue.

What Is Retainage and How Is It Accounted For?

Retainage is a portion of a contract value that is withheld until the construction project is completed (usually no more than 10%). In construction accounting, it's important to track and manage retainage, as it can significantly affect cash flow and financial reporting.

How are Costs Classified in Construction Accounting?

Construction costs are typically classified as direct costs or indirect costs. Direct costs are directly attributable to a specific project (e.g., materials, labor), while indirect costs are shared costs that support multiple projects (e.g., overhead). Indirect costs must be allocated toward a specific project using a consistent methodology.

What is the Role of the WIP Schedule in Construction Accounting?

The work in progress (WIP) schedule tracks the progress of each construction project a company is currently working on. As the company incurs expenses related to the project, it records an equivalent amount of revenue. The WIP schedule is where these expenses are tracked, making it a vital report in enabling companies to understand the progress of their projects and bill their clients accordingly.

Should Construction Companies Use Cash or Accrual Accounting?

Construction companies often benefit from using accrual accounting, particularly once they start working on larger projects. Accrual accounting provides a more accurate reflection of a project's financial health by recognizing revenue and expenses when incurred.

What is the Role of Change Orders in Construction Accounting?

Change orders involve modifications to the original construction contract and occur often. In construction accounting, it's important to track and account for the impact of change orders on project costs, revenues and completion timelines, and to ensure that these changes are reflected in all financial statements.

What Are Some of the Key Tax Considerations for Construction Companies?

Construction companies enjoy access to a wide variety of tax planning opportunities, including deductions for equipment depreciation and tax credits for energy-efficient construction. Working with an experienced construction CPA with tax planning expertise enables construction company owners to take advantage of these opportunities and build an efficient tax strategy that accelerates their growth trajectory.