Construction Accounting

Construction Accounting
➢Construction accounting is a specialized branch of
accounting that caters specifically to the unique
financial and operational needs of the construction
industry. It addresses the distinct challenges
presented by construction projects, such as long-term
timelines, complex costing structures, and contractual
obligations.
 What makes construction accounting different
Construction business
Typical manufacturer
Process-based. Production involves Project-based. Production requires
Production method repeated processes with easily different processes, materials, and
identifiable costs. equipment with varying costs.
Decentralized. Each project takes
Fixed location. Manufacturing or
place in a new location with varying
Location production happens in a single (or
site conditions and unique
several) controlled locations.
challenges.
Inconsistent. Frequent use of
Consistent. Long-lasting
different specialty contractors and
Vendors relationships with vendors ease
suppliers affects efficiency and cash
negotiations and improve efficiency.
flow.
Retainage. Some portion of
No retainage. Payment arrives in
payment may be withheld until
Contracts full or with regular payments for the
project completion even when the
full contract amount.
contractor’s work is finished.
Irregular. Retainage, slow
Predictable. Regular production and
payments, and high upfront costs
Cash flow short-term contracts lead to
lead to long, irregular cash flow
manageable cash flow cycles.
cycles.
Concepts in Construction Cost Accounting
• Job Costing: This method assigns costs to specific construction projects,
allowing for detailed tracking of expenses related to each job.
• Direct Costs: These are expenses directly related to the construction
project, such as labor, materials, and equipment.
• Indirect Costs: These are expenses that support the overall construction
operation but are not directly tied to specific projects, such as
administrative costs, insurance, and utilities.
• Overhead: This represents the indirect costs incurred by the construction
company.
• Profit: This is the difference between the revenue earned from a project
and the total costs incurred.
 Example
• Project: Construction of a small
residential house in Quezon City.
Profit Calculation:
• Contract Price: ₱2,000,000
• Total Costs: (Direct Costs) + (Indirect Costs)
Cost Breakdown:
• ₱1,700,000 + ₱200,000 = ₱1,900,000
• Direct Costs:
• Labor: ₱800,000 • Profit: (Contract Price) - (Total Costs)
• Materials: ₱600,000 • ₱2,000,000 - ₱1,900,000 = ₱100,000
• Equipment Rental: ₱100,000
• Subcontractor Costs: ₱200,000 • Profit Margin: (Profit) / (Contract Price)
• Total Direct Costs: ₱1,700,000 ₱100,000 / ₱2,000,000 = 5%
• Indirect Costs (Overhead):
• Office Rent: ₱50,000
• Salaries: ₱100,000
• Utilities: ₱20,000
• Insurance: ₱30,000
• Total Indirect Costs: ₱200,000
Importance of Accurate Cost Accounting
• Accurate cost accounting is essential for construction companies for several
reasons:
• Profitability: Tracking costs helps companies determine the profitability of
individual projects and overall business operations.
• Pricing: Understanding costs allows for accurate pricing of projects,
ensuring competitive bids and healthy profit margins.
• Financial Reporting: Accurate cost accounting is required for financial
statements and tax reporting.
• Decision-Making: Detailed cost information enables informed decision-
making regarding project management, resource allocation, and
operational efficiency.
Preparing Income Statement
• The income statement, also
known as a profit and loss (P&L)
statement, shows a company's
revenue, expenses, and net
income or loss over a specific
period
(e.g., monthly, quarterly, annually). It
highlights the company's profitability.
Components of a Construction Income Statement:
1. Revenue: Total income generated 4. Operating Expenses: Indirect costs of
from construction activities during running the business, such as:
• Selling Expenses
the reporting period. • General and Administrative (G&A) Expenses
2. Cost of Goods Sold (COGS): Direct • Depreciation and Amortization
costs associated with producing 5. Operating Income (EBIT): Gross profit
the goods or services sold, minus operating expenses.
including: 6. Interest Expense: Cost of borrowing
• Direct Labor money.
• Materials 7. Income Tax Expense: Taxes owed on
• Equipment Rental taxable income.
• Subcontractor Costs 8. Net Income (or Net Loss): Final figure,
calculated by subtracting interest and
3. Gross Profit: Revenue minus income tax expense from operating
COGS. income.
Preparing an Income Statement:
❑Gather Data: Collect revenue and expense information from invoices, purchase
orders, payroll records, etc.
❑Categorize Expenses: Classify expenses into appropriate categories (COGS,
operating expenses, etc.).
❑Calculate Subtotals: Determine gross profit, operating income, and net income.
❑Format the Statement: Present the information in a clear and concise format
using a table or spreadsheet.
Example
Consider a hypothetical construction company in the Philippines:
Company: GHC Construction
Reporting Period: January 2024
Item Amount (₱)
Revenue 10,000,000

Cost of Goods Sold (COGS) 7,000,000

Gross Profit 3,000,000

Operating Expenses 1,500,000

Operating Income (EBIT) 1,500,000

Interest Expense 100,000

Income Tax Expense 300,000

Net Income 1,100,000

Balance Sheet - The balance sheet provides a snapshot of a company's financial position at a
specific point in time. It shows what the company owns (assets), what it owes (liabilities), and
the owner's equity.
Components of a Construction Balance
Sheet:
• Assets: Resources owned by the company,
including:
• Current Assets (cash, accounts receivable,
inventory)
• Long-Term Assets (property, plant, equipment)
• Liabilities: Amounts owed to others,
including:
• Current Liabilities (accounts payable, short-term
loans)
• Long-Term Liabilities (long-term loans,
mortgages)
• Equity: Owner's stake in the company,
calculated as total assets minus total
liabilities.
Preparing a Balance Sheet:
✓List Assets: Identify and value all assets owned by the
company.
✓List Liabilities: Identify and value all liabilities owed by
the company.
✓Calculate Equity: Subtract total liabilities from total
assets to determine equity.
✓Format the Statement: Present the information in a
clear and concise format using a table or spreadsheet,
ensuring assets equal liabilities plus equity.
Example:
Item Amount (₱)
Item Amount (₱)
Liabilities
Assets
Current Liabilities
Current Assets
Accounts Payable 1,500,000
Cash 1,000,000
Short-Term Loans 500,000
Accounts
2,000,000 Total Current Liabilities 2,000,000
Receivable
Inventory 500,000 Long-Term Liabilities
Total Current Long-Term Loans 5,000,000
3,500,000
Assets Total Long-Term Liabilities 5,000,000
Total Liabilities 7,000,000
Equity
Owner's Equity 6,500,000
Total Equity 6,500,000
Total Liabilities and Equity 13,500,000
Importance of Income Statements and
Balance Sheets
• Financial Performance: Provide insights into
profitability and financial health.
• Decision-Making: Inform decisions
regarding pricing, resource allocation, and
operational efficiency.
• Investor Relations: Communicate financial
performance to investors and lenders.
• Tax Reporting: Required for tax purposes.
General Financial Control Over the Business
 Importance of Financial Control in Construction
• Project-Based Nature: Construction projects are often complex, involve multiple
stakeholders, and have long timelines. This requires meticulous cost tracking,
budget management, and revenue recognition to ensure profitability.
• Fluctuating Costs: Material prices, labor costs, and equipment rentals can
fluctuate significantly, impacting project budgets and profitability. Effective
financial control helps mitigate these risks.
• Cash Flow Management: Construction projects often have delayed payments,
creating challenges in managing cash flow. Strong financial control is essential
for maintaining liquidity and covering operating expenses.
• Compliance with Regulations: The construction industry is subject to numerous
regulations, including tax laws, labor laws, and environmental regulations.
Financial control helps ensure compliance and minimize legal risks.
Key Elements of Financial Control in Construction Accounting
➢Job Costing: Accurate job costing provides insights into project profitability,
identifies cost overruns, and helps make informed decisions about bidding
and pricing.
➢Revenue Recognition: Construction projects often span multiple accounting
periods, requiring careful revenue recognition methods. The percentage of
completion method is commonly used, where revenue is recognized
proportionally as work progresses. This ensures accurate reporting of
income and expenses over the project's lifecycle.
➢Budget Management: Developing and adhering to detailed budgets is
crucial for controlling costs and ensuring project profitability. Regular budget
reviews, variance analysis, and corrective actions are essential for staying on
track.
➢Cash Flow Forecasting: Predicting cash inflows and outflows is vital
for managing liquidity and avoiding financial distress. Cash flow
forecasting helps identify potential shortfalls, plan for financing
needs, and optimize working capital.
➢Internal Controls: Establishing strong internal controls helps
prevent errors, fraud, and unauthorized transactions. This includes
segregation of duties, authorization procedures, and regular
reconciliations of bank statements and accounting records.
➢Financial Reporting: Regular and accurate financial reports are
crucial for making informed decisions, monitoring performance, and
communicating with stakeholders. These reports should include
income statements, balance sheets, cash flow statements, and key
performance indicators (KPIs).