Accounting maybe similar for a lot of trading & service companies but accounting for a construction company differs in a lot of ways as accountant or the accounting companies needs to keep in mind a lot of different concepts usually associated with construction companies such as advance payments & retentions.
In this article we will try to explore the accounting for construction companies briefly:
So what is construction accounting?
Construction accounting refers to a form of accounting where in all the costs related to a specific contract or a project are assigned to a discrete job in the accounting software or system. Such costs are linked to the discrete jobs created in the accounting software as & when they are incurred. Included within the costs in construction accounting are mostly materials, labour & other direct costs such as insurance, architectural fees, equipment rental costs, support costs etc.
What are the different kinds of construction contracts?
In terms of accounting for an entity involved in a construction business the company has to consider the kind of contract that is being entered into, a few types are as follows:
1) Fixed fee contract
A fixed fee contract is a type of contract for which the contractor agrees to receive a fixed amount for the entire project. So any variance in costs of the contractor will not affect the amount to be paid by the client. Therefore this contract is beneficial for the client.
2) Cost plus contract
As the name suggests the price that a contractor will charge is dependent on the costs that will be incurred in a construction project such as direct materials, direct labour & overheads. The contractor upon assessing the costs then adds up a markup on the costs to arrive at the price to be charged from the client.
3) Time & Materials contract
This contract is an amendment of the cost plus contract for which the client is charged a standard hourly rate for the labour employed plus the actual material costs.
How to recognize revenue?
There are several ways to record revenues in construction accounting & they are as under –
1) Percentage of completion
This method of recognizing revenue includes booking the revenue, expenses & profit for the project on an ongoing basis or corresponding to each accounting period. For example if a project is complete to the extent of 40% then the company can book revenue, expenses & profit for the 40% completion of project. Percentage of completion can be measured in several ways such as:
- Cost to Cost method – It is a method in which the costs incurred to date are compared with the total expected project costs.
- Work performed units method – Work performed units method is the amount of physical units of production finished to date in proportion to the estimated materials to be used in the contract.
2) Completed contract method
Under this method the company only recognizes revenue after the completion of contract or the project. Therefore accounting under this method would mean booking all bills issued & costs incurred on the Statement Of Financial Position in all the periods prior to the completion of the project & upon completion of the project transfer all the bills & costs in the Statement of Profit or Loss & Other Comprehensive Income.
Therefore accounting for construction contracts involves a great deal of expertise & knowledge of various international standards namely –
IFRS 15 (Revenue from contracts with customers) which provides a 5 step model to recognize revenue:
- Identify a contract.
- Identify the performance obligations.
- Identify the transaction price.
- Allocate the transaction price to the performance obligations.
- Recognize revenue.
We at Oxford auditing & accounts thrive to provide our clients with the best accounting services that show a true & fair view of the business’s financial performance & position.