Construction Accounting

Direct costs are expenses obtained and consumed for a specific identifiable project. Examples include the asphalt consumed in paving a road; the cost of the paint used to decorate a kitchen wall; the labor charges of a plumber installing bathroom fixtures.

The percentage of completion method of accounting measures the recording of revenue based on the costs incurred to date as a percentage of the projects total cost. This method of accounting ensures that the amount of revenue earned is measured in the same period as costs are incurred. If 20% of a projects costs have been expended, then 20% of the revenue is recognized as income.

Gross profit percentage is a measurement of profitability. The total cost of a sale divided by the sales income generates a percentage or margin. The higher the percentage or margin, the stronger indicator that a profit will be recognized by the contractor.

Companies can be profitable but have poor cash flow when a company has difficulty in collecting money or is required to pay principle on outstanding loan balances.

Labor can be a fixed or variable cost. For example, the accumulated hours of building a structure would be variable based on the total number of hours incurred. However, the costs of a salaried project supervisor would be fixed.

Construction often has a unique revenue recognition model. It utilizes accounting concepts that are in addition to the mechanics of traditional accrual accounting methods of recording revenue and expenses.

Direct Labor, Subcontractors, Material, Equipment Costs, Equipment Rentals, Inventory

General & Admin Salaries, Supplies, Auto & Truck expenses, Insurance, Employee benefits, Rent, Office Expenses, Utilities, Advertising expenses, Training expenses, Dues & Subscriptions

• Total Revenues X Percentage of Completion = Revenue Earned
• Percentage of Completion = Cost to Date/Total Contract Costs

• Gross Profit = Revenues – Costs of Revenues
• Net Revenue = Revenues – Costs of Revenues – Indirect Expenses – General & Admin Expenses

Viewpoint

• Create efficiencies in labor usage
• Reduce delays between project engagements

A draw is a method of providing payment to the contractor over the course of the work to be performed to compensate the contractor for direct costs, such as materials and labor, so that the contractor is not financing the entire project. A draw schedule is usually created identifying specific percentage of completion points in the project and the corresponding draw amounts for each of those respective points.

A contractor’s cost categories consist of (a) direct costs, (b) indirect costs and (c) selling, general and administrative costs. Direct cost and indirect costs comprise expenses related to the cost of goods sold. The direct and indirect costs are deducted from gross revenues to determine gross profit of the company. Conversely, the selling, general and administrative costs comprise all non-job specific expenses and are more related to company overhead.

Selling, general and administrative costs (“SG&A”) primarily consist of marketing and all overhead costs of the Company. Examples of selling costs are advertising, salaries for a salesman, and other marketing expenses. Examples of general and administrative costs are rent, utilities, office salaries, general liability insurance, and other non-job specific overhead expenses.

Generally Accepted Accounting Principles (“GAAP”) is a standardized and uniform method of preparing financial statements. GAAP is intended to be consistently applied so that the financial statements are comparative in form and content from year to year and between entities and specific industries.

There are numerous financial ratios that may be key for a construction company. There are liquidity ratios, such as the Current Ratio, which focuses on the companies’ ability to meet it short-term liabilities with its short-term assets. There are profitability ratios, such as Return on Assets, which measures the income earned on the assets placed in service. There are leverage ratios, such as Debt to Equity, which determines if the company is over or under leveraged based upon the amount of financing obtained and the owner’s capital investment in the company. Each construction company is different and each may find that the key financial ratios useful for their company will be unique to other companies.

Industry averages for marketing costs of construction contractors ranges between approximately 10% and 15% of gross revenues. However, individual marketing budgets will vary based upon the size of the entity, its location, the geographic area of client base, and various other factors.

For companies that have construction contracts that take more than one year to complete, a job costing system allows them to account for the direct and indirect costs incurred on a job-by-job basis. By accounting for individual job costs, the company can report revenues earned on a percentage of completion basis. The percentage complete of an individual job is calculated based upon the actual costs incurred to date divided by the total estimated costs for that specific job. The completion percentage is than multiplied by the adjusted contract price to determine the revenues earned to date. Any over or under billings are adjusted to balance sheet accounts entitled “Contract Billings in Excess of Costs and Estimated Profits” or “Costs and Estimated Profits in Excess of Contract Billings”, respectively.