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Accounting for Contractors

Construction accounting is a bit different from other accounting methods. Costs get assigned to specific contracts in simple terms. It is a form of project accounting where costs get assigned to specific contracts. In the accounting system, a separate job is set up for each construction project. Then the costs get assigned to the project. The costs get coded to the unique job number as they get incurred.

These costs mainly include labor and material charges. Additionally, they may also include charges for construction projects, including the cost of supervision, equipment rentals, and insurance. Administrative costs are only charged on the project if allowed by the customer.

Choose BDE Accountants

Get a wide range of project-based accounting services for constructors. The contractors work from project to project and can manage multiple projects at a time. Get an account for contractors to get paid for the services. Additionally, projects do not get paid for as soon as it is completed. It might need an upfront deposit. Or the project could be paid in full or it can take months to get the final invoice settled.

Due to the following reasons, construction companies have to publish two separate statements- i.e. for profit and loss (P&L) for each project.

Overhead Costs

Construction companies also experience fluctuating overhead costs. Take into consideration the cost of insurance, travel, workers' compensation, materials, subcontractors, equipment, and more. Consider adding this factor into your construction accounting.

Best Methods for Construction Accounting With BDE Accountants

Cash-Based Accounting System

The cash-basis accounting simplifies day-to-day financial management. It does not require a lot of financial expertise. Therefore, smaller construction firms tend to opt for a more straightforward cash-basis accounting system. The goal of the company is to record the revenue they receive and the expenses that go into paying the vendors.

Accrual Based Accounting System

Accrual-basis accounting is an alternative method. However, it is more complex. It is required by large companies like public companies. For instance, ones that have to comply with the Accepted Accounting Principles (GAAP) issued by the Financial Accounting Standards Board (FASB).

Additionally, it underpins specialized revenue recognition accounting approaches. For instance, the percentage of completion methods.

Percentage Of Completion Method (PCM)

This is a widely used accounting approach. It enables contractors to recognize revenue for each project as they earn it over time. During each of the projects, the contractor pays the bills in stages. The workers get paid for the work they performed to date. They record the earned revenue and expenses at each stage. This is considered the most accurate way of recording the revenue. This makes sure that the revenue matches the work that is being performed. Therefore, banks and lenders often prefer it.

The PCM works well if you can generate accurate estimates. The PCM can also help you ensure that the contractors are paid for their work. Make sure that the workers get paid even if there is a case where the construction project did not get completed.

Contractors can measure the percentage of completion with the help of the following ways:

Cost-To-Cost Method:

With the help of this method, the contract costs incurred get divided by the total estimated cost of the contract. This ratio reflects the percentage of total contract revenue that the company has earned. If most of the needed materials are bought at the start of the project, then this method can help the contractors recognize the largest portion of project revenue in its early stages.

Method Of Effort-Expending:

This method draws a comparison between the proportion of effort expended to date along with the estimated total effort. The direct labor hours, the number of materials used, or machine hours sometimes may affect and are taken into consideration in this calculation.

Units-Of-Delivery Method:

This calculates revenue and cost depending on the number of units delivered to the customer when it is compared with the total number of units that the terms of the contract specify.

Completed Contract Method:

With CCM(Completed Contract Method),  the contractor acknowledges all project revenue, expenses, and profit only when the project is finally completed. This approach is ideal only for projects that last for only a few months. The CCM proves to be an advantage for contractors especially when it comes to deferring their revenue to a future period.

Plan strategies to reduce and manage their tax liability.

Construction firms have to plan their tax strategies all year-round. In this way, they can get the most benefit. Additionally, they have to ensure that they comply with IRS requirements.

Contractors can manage their tax liability with these reporting strategies.

  • Contractors that are owners of or investors in pass-through entities, including sole proprietorships, partnerships, and most LLCs and corporations, get to deduct their allocated share of losses to the extent of their debt and equity. Contractors can also minimize their tax liability when they maximize their retirement plan contributions. In conclusion, this reduces pretax income.
  • Construction projects are bound to change from the original plan. If the contractors do not handle them carefully, change orders can cut into project profits or it can even cause disputes with customers. Ideally, the original contract should have clear instructions on how to handle the change orders. Therefore, contractors should establish a standard change order process along with full documentation of the work and cost required for each change requested.
  • It’s a best practice for contractors to hold off on starting work until they receive a signed agreement from the customer. However, in reality, job site leaders often accept change orders without going through a formal approval process.
  • Change orders that do not get approved and are unlikely to get any approval at all. For instance, let’s say a contractor is incurring costs to implement certain changes. However, they do not know whether the customer will approve payment for them, a conservative approach is to add the costs associated with the change order to the project’s direct costs.
  • Get the approval for change in orders. Add all costs associated with the change order to the project costs. The total contract value may see an increase in the amount charged for the change order.

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