The construction industry is highly complex. When it comes to their operations there are multiple layers to it. With so many people involved, it can often get difficult for accountants to analyze how to balance the books of their construction clients effectively. From delayed timelines to complex structure designs, several contractual terms and obligations, and fluctuating costs – the limitations in the field of construction or contractor accounting are endless.
Because of the nature of the industry, it demands the accountants’ detailed attention. Besides an impeccable understanding of how everything works, and the rules and regulations involved, it becomes imperative for the accountants to provide thorough guidance to the contractors to ensure that they do not fall into the trap of legal issues.
In this article by Finsmart Accounting – trusted globally for outsourced accounting services, we will share everything major about contractors accounting and how to undertake it. Let’s start by understanding the common features of the contractor accounting industry!
Common features of the Contractor accounting industry:
If you are new in dealing with accounting for the construction industry, you will come across many complicated concepts and terms. Here are the top features of the industry to make it all easy for you to understand:
– It is mostly project-based and when balancing the books, you have to take into account individual projects as a separate profit center
– The contracts in contractors accounting are long-term and they last for years
– The locations of the projects are spread across different sites
– Multiple projects need to be tracked at the same time for expenses and revenue related to each of them
– The process of billing is dependent on the level or completion of the stages. A percentage of the total cost of the project is billed to the clients
– A part of the contract price is kept by the owner until a project is complete, which is known as retainage
– Contractors need to comply with several rules and regulations as per industry standards. It depends upon the jurisdiction of the site in question.
Contractor Accounting Basics
Being an accountant dealing in the construction industry can be gruesome. There are some of the common terms that you will come across more than you imagine. They include:
– Revenue Recognition:
Revenue recognition can be strenuous in contractor accounting due to long-term contracts. GAAP or Generally Accepted Accounting Principles are responsible for providing guidelines to recognize revenue based on the percentage of completion method or completed contract method.
– Cost tracking:
Accurate cost tracking is key to understanding the exact project profitability. For contractors, it is important to carefully monitor the direct costs, materials, and labor, for example, and indirect costs, overheads, for example. This allows the accountants and the client to get a clear picture.
– Job Costing:
In construction, each project has separately allocated costs, which allows the determination of total cost and profitability. Contractors also use job cost sheets and software to track expenses related to labor, materials, equipment, etc.
– Cash flow management:
It is an important aspect for the contractors to maintain and keep track of the cash flow. In construction, the chances of a surprise expenditure are quite high and hence, it is important to have sufficient funds that allow the covering of project expenses and operating costs. Failing to make payments in due time can lead to the project being halted indefinitely.
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– Financial reporting
Contractors need to prepare financial reports for internal management purposes and for external stakeholders, such as investors, lenders, and regulatory authorities. Some of the top things that need to be included in financial reporting are income statements, balance sheets, and cash flow statements.
Now that we have an idea of the basics and features of contractor accounting, let’s discover major challenges faced by bookkeepers, CPAs, and accounting firms active in contractor accounting.
Challenges in Contractor Accounting
Navigating through the challenges in the construction industry’s financial nuances can be tricky. Some of the top challenges that accountants face include:
– A Complex structure of projects:
The construction industry operates on projects that have complex structures involving multiple phases, subcontractors, and sources of funding. Accurately allocating costs and tracking them for several projects can be extremely challenging for accounting professionals. For accountants, it is important to navigate through the complexities to ensure accurate financial reporting and compliance with accounting standards.
– Job costing accuracy:
Costing estimate is a key factor in contractor accounting. Accountants need to track meticulously and allocate costs to specific projects. Accountants must reconcile different elements of cost, including labor, materials, equipment, and overhead expenses. All this, while ensuring accuracy and completeness. Inaccurate job costing can lead to distorted project profitability – both in the forecast and in actuals.
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– Contractual terms and conditions:
Construction contracts have jargon. They are filled with technical terms and conditions, which impact revenue recognition, cost allocation, and financial reporting. For accountants, it is imperative to understand these contractual obligations to correctly account for revenue, expenses, and liabilities. Overlooking of contract terms can lead to financial discrepancies and unnecessary legal implications. This is a major reason why contractor accounting is challenging.
– Varied revenue recognition:
Rarely, revenue recognition for contractors is straightforward. The contracts are usually long-term and complex. Accountants have to employ methods such as the percentage completion or completed contract method, which needs continuous assessment of project progress and completion. It is also essential for accountants to ensure compliance has been maintained, which accurately helps recognize revenue.
– Integration of technology:
The advent of technology has made the lives of accountants easy. But that is not exactly the case for accountants dealing in the construction industry. Integrating new software and systems can be challenging for contractor accountants. Adapting to new software, migrating data, and training staff on new platforms can be truly daunting, requiring an abundance of time and resources and the small accounting firms often lack both. No wonder, some accounting firms consider contractor accounting an uphill task!
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– Communication and collaboration:
Contractor accountants have to collaborate with project managers, subcontractors, and other stakeholders to obtain relevant financial information and ensure that everyone is aligned with the project goals. Effective communication and collaboration are important for accurate financial reporting, cost control, and decision-making. It is important to overcome communication barriers and foster collaboration across teams.
How can Outsourcing help accounting firms with contractor accounting?
Today, outsourcing has become an important business model that is beneficial to accountants across industries. Construction accounting is complex and needs extra attention. By outsourcing, small accounting firms can receive strategic advantages that can enhance efficiency, showcase expertise and ensure scalability. By outsourcing certain accounting functions like bookkeeping, payroll processing, and tax preparation, small firms can free up valuable time and resources needed to focus on core competencies and client-facing activities.
By outsourcing, construction accountants can also tap into the knowledge and expertise of the professionals which is extremely important. Outsourcing firms are often aware of the industry-based nuances and help make it easy for the accounting firms. Their agility is especially valuable in the dynamic and seasonal nature of the construction sector, where project volumes and contractor timelines vary significantly.
Make your contractor accounting successful with outsourcing. Write to us at connect@finsmartaccounting.com.
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Director Growth Strategy & Alliance
Maanoj Shah is a finance and outsourcing expert with strong Business Strategy and Scaling-up experience. Over the last 20 years, he has incubated multiple businesses and helped build global enterprises in verticals as diversified as hospitality, technology, and healthcare.
