How does construction accounting differ?
In Week 1, we took a broad view of business accounting, but let’s delve deeper into what this really means for construction projects.
Accounting is a vital discipline that is required in the management and administration of any business. In any organisation with numerous moving parts, the accounting team within the organisation accurately tracks the movement of assets into and out of the organisation for the purpose of transparency and profitability.
In the construction industry, firms and contractors face unique challenges when it comes to accounting.
Nuances of construction accounting
Whether you’re constructing a foundation for a residential building or keeping the books, it is vital to be aware that construction accounting is different from regular accounting.
For example, a typical business, such as grocery shop, adopts regular accounting principles. This model works perfectly for that type of business as they are selling products from a fixed location. The business understands the cost of each item it sells and overheads are kept relatively constant.
Construction accounting is a type of project accounting in which costs are allotted to particular contracts. A separate activity is set up in the accounting system for every construction undertaking and costs are allotted to the project as they are incurred. These costs could be materials and labour, with additional charges for such items as consulting and architectural fees.
A number of indirect costs are also charged to construction projects, including the cost of supervision, equipment rentals, support costs and insurance. It’s worth noting that administrative costs are not charged to a construction project unless this is allowed by the client.
The key differences between regular accounting and construction accounting are as follows:
Sales: Construction accounting offers a greater range of service categories such as consulting, engineering, labour, design, physical products and materials, and more.
Cost of goods: Regular accounting records the cost of the product sold. In construction accounting, it’s not so simple. Each job incurs both direct and indirect job costs that fall into a variety of categories.
Expenses/overheads: In regular accounting, the distinction between cost of goods sold and overheads is very clear, but this is not the case in construction. Many of the items that a grocery shop would call ‘overheads’ fall into the ‘cost of goods sold’ category in construction because they are directly connected to the client’s project.
Break-even point: In regular businesses, the direct relationship between income and expenses makes break-even points very easy to calculate. In construction, however, there are far too many categories of items to easily understand how to break even on a project. Additionally, most projects are one-of-a-kind custom jobs with intricate requirements and a variety of associated costs.
A project manager in a contracting firm was asked how much money the firm made on executing a two-bedroom bungalow. The project manager generated a report showing £10,000 profit – in reality, it was a £25,000 loss.
An investigation revealed that £35,000 worth of transactions were assigned to the wrong category. In this case, some direct costs and some indirect costs were misallocated and not assigned to the job.
List a few examples of direct and indirect job costs that may be incurred in construction projects.
Share your ideas with your fellow learners.
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