Accounting For Construction Contracts Explained

As a small business owner, you spend a lot of time ensuring your financial records are up to date and accurate. But what if you're not sure how to structure your construction accounting?

As you know, or may not know, depending on your experience in the industry, that as an owner/operator of a small business involved in the construction sector, it is critical to your success that you file the proper tax returns at the end of each fiscal year.

It is equally vital that these returns be adequately prepared, requiring qualified professional assistance from one knowledgeable and experienced in the nuances of accounting for construction contracts.

While the accounting for construction contracts terminology may sound intimidating, it's pretty simple once you know what types of accounting are in play. This article focuses primarily on the most comprehensive definition of construction accounting and its use.

What are the basics of accounting for construction contracts?
What should the accounting for construction contracts entail?
Tips to streamline the accounting for construction contracts process
What things to consider while beginning accounting for construction contracts?
What are the troubleshooting tips for facilitating the accounting for construction contracts?
What are the tricky parts of accounting for construction contracts?
What are basic accounting principles that every contractor should know?
Why do people prefer accounting software for accounting for construction contracts?

What are the basics of Accounting for Construction Contracts?

Accounting for construction contracts is tricky, and it can be frustrating when you end up making mistakes. But you can make the process easier by being aware of what you're doing and why you're doing it. Here's a rundown on the basics of accounting for construction contracts:

When it comes to building or remodeling on your property, you'll have to pay the general contractor and the subcontractor a fair price for their work. This means that all costs have to be accounted for and documented. You should have an itemized contract with each contractor detailing their responsibilities, as well as their compensation. The general contractor should be responsible for managing the project's budget and ensuring that your project stays within it. At the same time, the subcontractors should get paid based on the amount of work they perform.

You'll need three pieces of paperwork for every project: a signed general agreement, a signed subcontract agreement, and a completed cost estimate verification form.

If you want to record your subcontractor payments accurately, you'll also need to keep track of their invoices and receipts. When you receive remuneration from the general contractor or owner of your home, bring these documents along with all other related paperwork to verify them at the end of each job.

What should the Accounting for Construction Contracts entail?

The contractor or project manager is responsible for accounting for all funds received from the owner. The contractor should maintain an accurate, detailed invoice for all funds received and pay the various subcontractors and suppliers promptly.

The records should include the following information:

Copies of contract - original and amendments if any
List of Subcontractors/Suppliers - name, address, contact person, and telephone number
Detailed Invoice -for each Subcontractor/Supplier showing

Cost incurred to date
Any hold back amount due the Subcontractor/Supplier

Funds Disbursed to Each Subcontractor/Supplier;
Timely Payment to Each Subcontractor /Supplier-It is the project manager's responsibility to ensure that each subcontractor is paid on time

A good practice would be to request that each subcontractor furnishes a copy of their pay stub or check stub when they submit invoices for payment. This will confirm that payment has been made. All expenses should be itemized with check number, date, and amount paid to each subcontractor or supplier.

Tips to streamline the Accounting for Construction Contracts process

Contractors often have to do a lot of accounting. Because individual jobs pay them, they must record more detailed information about each project rather than by the hour. A contractor's accounting records are also subject to scrutiny because they're not just used for tax purposes but vital records for the construction industry.

Complete and accurate invoices are crucial for any contractor's accounting system, so it's essential to get the details right to avoid any disputes. Here are some tips:

Use a time-and-material estimate that accounts for all extra costs and finishes (for example, paying overtime or a bonus)
Budget for your materials. You won't always be able to replace them at cost, but you'll need to cover their cost at least once — probably when you buy them in bulk
Also, don't forget about having enough cash on hand to pay for materials that you can't replace with your own money — such as electrical wiring or a specific type of flooring
Set up a spreadsheet to organize the various costs of construction
Create a list of all vendors that are essential for the job
Use your software program or create an Excel document to keep track of all payments made to each vendor
Keep track of all check numbers used on job sites and make sure they correspond with the checks issued with the information shown in your accounting software

What things to consider while beginning Accounting for Construction Contracts?

Specific to contractors, here are some things you need to know about this side of the business:

You'll only be able to control the bottom line. While each department has its own set of accounting standards, none of them will collect revenue until you've entered it into the books
So if you're in charge of sales tax or payroll for your construction company, start by entering those figures into the books so that you have a complete view of how much money is coming in and going out
Your profit will be calculated differently from how a small business might calculate it. When you're just starting, there's no reason why you can't keep all revenue out of your books in whole dollar amounts
Once you have a few more clients and start having expenses, though, you must begin breaking down revenue into smaller groups so that you can assign revenue amounts to each expense category

What are the troubleshooting tips for facilitating the Accounting for Construction Contracts?

Accounting for construction contracts is the real challenge for most businesses. It needs to manage the accounting transactions' day-to-day accounting information and prepare the financial statements.

The accounting for construction contracts process can be broken down into two major parts:

The financial management of a construction contract. This includes; entering into an agreement, defining the costs and revenues for each proportionate part, receiving payments from your client, managing payables, preparing interim reports and finally closing out the contract at completion.

Troubleshooting tips include:

How to reconcile your cash flow and balance sheet?
How to account for change orders and extras?
How to handle non-construction revenue on a project?
How to manage subcontractor payments?
How to account for undocumented expenses and revenues?
How to understand profits on a project?

What are the tricky parts of Accounting for Construction Contracts?

The general rule is that you must report it to your accountant whenever you sign a contract. In many cases, including construction contracts, it's okay just to input the contract into your accounting software. The accountant isn't required to do anything other than reporting it — they don't have to be involved in doing the work or keeping records.

When you're a contractor, you may have to account for construction contracts that you've been awarded. This type of accounting involves having a written agreement and understanding how the project will progress. You'll also need to track your progress on the project, which means keeping careful records on everything from the money spent to the hours worked.

The trickiest part of accounting for construction contracts is deciding when to break out those funds and start reporting them separately. As long as they're part of the overall budget, they usually don't need their line items in your books. Still, if they become too large, it might make sense to move them out of general operating expenses and into another category like "capital improvements."

What are basic accounting principles that every contractor should know?

Every construction company has unique needs and requirements for accounting, though there are many similarities in the way jobs are completed. For example, all construction companies need to generate invoices, track time spent on jobs, and much more. No matter what your situation, knowing accounting principles will help you be more prepared for any situation that may arise. Here are some basic accounting principles every contractor should know:

Job costing – Job costing is a process used to estimate each project's costs. This process requires you to track how much you spend on each job throughout your entire career and how much profit you make from each one
Accounts payable – Accounts payable is a list of all the bills or expenses that your company owes at a given time. You must balance this list with accounts receivable at the end of every month. This will tell you whether or not your business has taken in more money than it has paid out
Inventory control - Construction companies usually deal with large amounts of inventory. The cost of this inventory must be tracked and managed accurately to ensure that it does not become lost or damaged by theft
Keep Good Records – A good bookkeeper has to be organized and has excellent attention to detail. Good record-keeping is essential to getting paid by your customers and avoiding unnecessary legal problems down the line
Separate Personal and Business Accounts – Every business has to pay taxes. It's essential to keep your own money separate from your company's money so that it's clear what is going where when tax time arrives
Account for Every Dollar – This is an important part of good management. You don't want any money disappearing without explanation. Even if it's just a small amount here or there, you can't afford to let things slip through the cracks. Every penny counts when you're running a business

Why do people prefer accounting software for accounting for construction contracts?

Every construction business owner knows that accounting for construction contracts is vital for running a successful business. It's important to manage your progress payments and your change orders as much as possible to stay on top of where you're at with your project. However, managing these documents can often be tedious and time-consuming.

Trying to find a way around this problem is the best thing you can do to ensure the success of your business. If you manage your accounting for construction contracts correctly, then you can always keep track of how much money is still owed to you by clients, as well as how much money you still owe subcontractors and suppliers.

If you make sure that everything is correctly accounted for promptly, then this means that cash flow problems will be kept at bay. You'll be able to keep track of your finances and make sure that all of it adds up correctly.

Wrapping Up

Before getting into the specific accounting and tax requirements for construction contracts, it is necessary to understand the characteristics of a construction contract.

The best way to be successful with accounting for construction contracts is to plan and know what you will do before you start. So make sure you check out this guide to be better prepared!

Key Takeaways

Accounting is the process of identifying, measuring, recording, and communicating financial information to prepare financial statements that are useful to decision-makers.

Using software like the one at Deskera will simplify the process and automate the essential accounting aspects.

The following tips will help you streamline the accounting for construction contracts process:

Create an invoicing template for submitting to your clients
Use a contractor bank account to assist in the process
Set up recurring monthly bills with vendors
Create a Jobsite calendar that tracks essential dates and deadlines
Begin tracking all relevant data from the beginning of your contract, not just when you need it to close out the month or year
Keep tabs on your business's cash flow using a cash-flow statement spreadsheet
Stay organized by keeping all documents related to a single project in one folder on your desktop
Document your business processes by developing standard operating procedures