There are three accounting-related imperatives for construction company owners:
1. Deciding that accounting is a priority
2. Choosing the right accounting method
3. Meticulous, exact, unfailingly accurate record keeping
Many construction company owners, as expert as they may be in the process of building a structure, are not nearly as well-versed in the nuances of the uniqueness of construction accounting.
Accounting as a priority:
On many workdays as various construction phases are underway - particularly on major, long-term projects - there are company employees, subcontractors, subcontractors to the subcontractors, and others swarming over the construction site performing a massive number of tasks.
People, equipment, time, deliveries, materials - and every other aspect of construction activity - costs money. Everyone expects to be paid, the client expects the building to be constructed on time and within budget, and the construction company has to make a profit or it may collapse like a badly built wall.
An example that having work doesn’t automatically mean having a healthy company is the bankruptcy of Peyronnin Construction Company:
“Peyronnin Construction Co., Inc. from Evansville has filed for Chapter 7 bankruptcy, throwing several projects into limbo, including the International Blue Grass Museum in Kentucky, as well as the McLean County Regional Water Treatment Plant, the International Blue Grass Museum, Owensboro Community and Technical College, and a gravity-fed sewer line in Mt. Vernon.”
The values of the four named projects totaled about $31 million. Somewhere, somehow, in some fashion, the numbers didn’t work. Proper accounting has to be a priority. Without it, everything including the future of the company, is in constant jeopardy.
Choosing the right accounting method for revenue recognition:
The project’s nature means deciding what form of revenue recognition to employ. Revenue recognition is the proper accounting for money received on a job under Generally Accepted Accounting Principles (GAAP). For example, revenue is recognized in a typical retail transaction when money passes from the buyer to the seller. If you buy a computer for $1,000 the revenue is recognized (accounted for) when it’s received from you by the store. The product (or service) is provided, the exchange made, and the transaction is complete.
However, construction accounting, with all its parts, sub-parts and project length, is more complex. The contractor and owner may agree on a $10 million contract, but the owner doesn’t hand over $10 million at the project’s start. The transaction isn’t complete until the work is finished, and in-between are schedules, negotiations; change orders; contractors and subs who perform, or don’t perform; and a thousand other steps until the ribbon-cutting.
The two methods of revenue recognition are:
Percentage of-completion method:
This method is the most often-used, given the length and complexity of most construction projects. Revenues are calculated based on the costs incurred throughout the project.
There are conditions for the use of the percentage of completion method, and among them are: there must be an enforceable contract in place the specifics on how funds will be paid and received; the contractor must be able to measure – account – for the percentage of completion as the job progresses; and there must be a reasonable assurance that the contractor can collect what’s owed. This method is GAAP for all but a limited number of contracts.
Completed contract method:
Revenue is recognized when the project is either nearly or completely finished. This method mostly applies to spec built residential construction.
This process is not uncomplicated. For example, the Financial Accounting Standards Board (FASB) guidance on Accounting for Performance of Construction-Type and Production-Type Contracts is 95 single-spaced pages long. But even that doesn’t cover every procedural nuance. Furthermore, new guidance has been issued on various aspects of revenue recognition in light of the Bipartisan Budget Bill of 2018 passed earlier this year.:
Meticulous, exact, unfailingly accurate record keeping:
Seemingly obvious on its face, this condition goes unmet with surprising frequency. One reason is the number of project-related moving parts. Another is that some contractors put their full trust on others to ensure proper accounting is made of all those moving parts. A third is that contractors want to build buildings, not pore over logs, ledgers, and accounting figures.
But failing to do so invites one or all of three potential problems: the profitability of the job; a disgruntled or litigious owner; difficulties with local, state or federal tax authorities.
The basics of construction accounting are just that, basics. Contractors are well-advised to seek out and work with accounting professionals experienced in construction accounting. Not every accountant is alike, and not every accountant knows what another one knows. Just as with construction contractors.