9 construction accounting best practices you should know
Construction accounting can be more complex than other industries for many reasons – major long-running projects, fluctuating costs, and a workforce with a high proportion of contractors.
This guide lays out nine practices for construction accounting, from job costing to expense reporting.
1. Job/Project costing
Accurate job or project costing is one of the most important elements of construction accounting. Get it wrong, and you could face major cost overruns. At its most basic, job/project costing means looking at an upcoming project in detail, breaking down the labour and materials needed, calculating the total cost, and then adding a percentage for your overhead costs and profit. It also means tracking the actual costs and the budgeted costs to ensure that the project is on target at any point in the project timeline.
Of course, it's not as simple as it sounds. Accurate costing needs to account for fluctuations in the cost of materials and labour, as well as indirect costs, subcontractor costs and project duration.
2. Selecting the correct accounting method
The correct accounting method depends on the size and complexity of your business:
Cash-basis accounting
Cash-basis accounting, sometimes called cash accounting, is the most basic accounting method, which makes it appealing to new business owners. With this method, you record revenue when you receive payment and record expenses when you pay your bills. Profit is calculated as payments received minus payments made.
While it's simple, this method makes it hard to plan for future costs and manage finances effectively. Because you're not actively planning for future income and expenses, cash flow problems can pop up unexpectedly. This is why most construction companies use more complex accounting strategies.
Accrual accounting
The accrual accounting method looks at your future finances by accounting for costs and payments as soon as they're incurred. For example, if your business sends an invoice out for payment, it's recorded as revenue at that stage rather than when it's paid. On the other side, when a supplier sends you an invoice for materials, it's recorded as an expense as soon as it comes in.
The upside of the accrual method is that it projects future cash flow, helping you understand what your accounts should look like in the next months. If upcoming expenses outweigh income, you can take out loans or look for new work to keep cash flow moving. On the downside, the accrual method doesn't necessarily reflect the reality of costs and expenses – if an invoice isn't paid, your statement could show a healthy balance while your actual accounts are empty.
There are also various project accounting methods:
Completed contract method (CCM)
The completed contract method (CCM) - a project accounting method - delays recording income or expenses until a project is finished.
The upside: waiting until a project is complete means that you get a full, accurate look at the costs and revenue involved. However, the CCM method can also lead to major swings in income if projects drag on, making it difficult to manage cash flow and ongoing overheads.
Because it records income after the fact, accrual accounting doesn't work for companies that manage months or years-long projects – it's better suited to businesses focused on smaller short-term contracts.
Percentage of completion method (PCM)
Percentage of completion (PCM) - also a project accounting method - is an effective method if you're running a large construction company with lengthy, ongoing projects. This method records revenue, expenses and profit based on the percentage of work completed on a project.
The calculation looks like this:
Costs to date ÷ Total project cost (estimated) = Percentage of completion
For example, if your project is estimated to cost $500,000 and you've spent $60,000 to date, the percentage completed would be 12% (60,000 ÷ 500,000 = 0.12)
When you know that 12% of the project has been completed, you can record 12% of the expected revenue, profit and expense on your balance sheet. Because it lets you record income over time, the percentage of completion method can help you manage cash flow fluctuations. It's also a useful way to plan ahead, as it gives you insight into the progress of each project and future income.
Of course, percentage of completion accounting isn't perfect. The method relies on cost estimates, which aren't always accurate. If you claim tax credits based on estimated costs, you can over or underpay taxes for the period.
3. Incorporate accounting into your workflow
Incorporating accounting into your workflow can help you track expenses more efficiently, keep a closer eye on project costs and change orders, and minimise end-of-day paperwork. Making accounting part of everyday work can also improve visibility of costs and project progress for you and your team.
Many business management platforms and ERP systems (particularly those designed for construction) make it easy, with remote access, project tracking dashboards, time tracking, change order management, expense receipt recording and other tools to make accounting part of your everyday work.
4. Use construction-specific software
Because construction accounting tends to be complicated, it's smart to use business management software designed for the industry. This type of software can help you streamline accounting and change order processes, track expenses and income accurately, generate estimates or job costings, and ensure tax and payment compliance. The type of software depends on the size of your business, the contracts you take on and the specific tools or features you need.
Many large-scale construction companies rely on construction-specific ERP systems, while more basic small business accounting software works for smaller construction firms that only manage a few short-term projects at once.
5. Use a robust payroll system
A robust payroll system is essential in every business – and construction is no different. In fact, payroll management can be more complicated in construction, thanks to the high proportion of contractors, subcontractors, casual workers and part-time employees.
Whether you use integrated payroll software or a third-party payroll provider, it's crucial that your payroll management is compliant and set up for time-tracking, varied employment types and tax brackets, superannuation and KiwiSaver (NZ).
Payroll software helps you track payroll costs and calculate wages, ensures staff are paid accurately and on time, and generally saves you time that would otherwise be spent calculating payroll and tax payments.
6. Plan your tax strategies
The right tax strategy depends on your income, how you manage your costs, and the turnaround time for projects. However, most construction companies benefit from using the right accounting method, understanding tax credits, and reducing the amount of taxable income on your tax return.
Use the right accounting method
There's no single accounting method that works for every business – although the percentage of completion method is common in construction. If you're just starting, it's a good idea to talk to your accountant about the best method for your business. As you grow, your accounting and tax strategy may change.
Research construction tax credits
Do your research into construction-specific tax credits, or talk to your accountant to make sure you take advantage of all the potential tax benefits on offer.
In Australia, if your business builds residential projects for sale, it is liable for GST and you can claim tax credits on some of the costs involved.
Reduce your taxable income
You can reduce your taxable income, sometimes called tax liability, by claiming valid business expenses. These can include day-to-day operational expenses, products or services for your business, and the cost of depreciation on equipment and machinery.
Generally, you'll need to keep a record of all business expenses throughout the tax year and enter the total on your tax return.
Receipts and invoices above $82.50 (incl GST) are required with your tax return.
7. Track your business expenses
Tracking business expenses is a key accounting practice in every type of business, as it helps you minimise your tax liability and reduce your tax bill.
Here’s how to track expenses:
Keep a copy of every receipt or invoice – you can do this manually or use an app to save and store digital copies.
Use a separate business account or business credit card to pay for claimable expenses so it's easier to check records at the end of the year.
Australian businesses must retain a record of all business expenses in a secure location (digital or paper) for at least five years from the date of lodgement of that year’s tax return.
8. Implement effective change order variations
Effective change order management can be the difference between a profitable business and one that struggles to turn a profit on some projects. Change orders are documents that lay out changes to the original construction contract. They can alter the scope, schedule, timeline, costs or details of a project, and ensure that everyone involved understands the changes.
Done well, a change order ensures that your business won’t pay for a change requested by a client. Managed badly, it can delay a project and create extra costs without bringing in more income. For example, if you accept a change without amending the original contract or having extra costs signed off, your business could be liable if the project timeline blows out – even if it was a result of a client request.
Implementing effective change order management means setting up a strict process.
For example:
Client requests a change.
You scope out the estimated cost and time involved with the change.
You create a change order that includes the new details, adjusted costs and new end-date.
You update the contract and send it to the client for approval.
The client signs off, and the amended contract is sent out to all stakeholders.
9. Reconcile bank and supplier statements
Reconciling your bank, credit card, loans and supplier statements is a key accounting process in almost every business. In construction, it can involve huge invoices and complex costs, so it's even more important to identify invoice discrepancies, underpayments and overpayments. The earlier you spot an issue with an invoice, the faster you can sort it out, which means fewer issues down the road.
It’s also important to reconcile the project WIP and ensure it is being invoiced and reconciled to the agreed project scope of work.
Bank reconciliation is about matching up your bank transactions with your unpaid invoices or bills. While it can be a tedious manual task involving hours of work every week or month, setting up bank feeds helps to automate the process.
When your bank feed is connected, your transactions will start flowing into your MYOB software ready for allocation. You can also create bank rules to automate the allocation of transactions based on specific criteria that you set. For example, you can create a rule that says all transactions from Paper Palace will be allocated to the stationery expense account.
Construction accounting FAQs
What makes construction accounting different?
Construction accounting is different from general business accounting because companies need to cost and account for multiple projects that they run concurrently. This can be a complex process as the cost of labour and materials fluctuate, each job is unique so pricing is not necessarily predictable, and project scope is subject to change. Further, the industry operates with extremely slim profit margins, which means there is no room for error.
What type of project accounting method is best for construction?
While there's no single method that works for every business, PCM is probably the most common project accounting method in the construction industry. This method involves recording costs and income in line with the percentage of the project that has been completed, allowing businesses to manage long-term projects without major swings in revenue.
How do you account for construction expenses?
Construction expense categories include the cost of labour, materials, equipment, insurances, overheads (for example, office space and marketing), and other operating expenses. Many of these expenses can help to reduce your overall tax liability.
How do you account for construction in progress on a balance sheet?
Accounting for construction in progress on your balance sheet helps you understand how your ongoing projects are progressing, which makes it easier to manage cash flow. The costs of materials, labour and overheads should be recorded as assets on your balance sheet because they reflect an upcoming payment when the project is complete.
How do you calculate construction in progress in accounting?
Calculating the percentage of work completed is key if you're using PCM accounting. The formula looks like this:
Percentage of work completed = Actual costs to date ÷ Total estimated costs
You can use the PCM calculation to claim project costs and income on your tax return if it needs to be filed before the project is complete.
Streamlined construction accounting with MYOB
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If you’re a larger business looking for construction-specific software to help you cut paperwork, minimise cost overruns, and manage the complex accounting needs of the sector, MYOB Advanced Construction may be the solution for you.
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