What is construction accounting?
Construction accounting refers to the very specific and unique requirements of the construction industry in the UK and Ireland.
Construction accounting differs from regular accounting in a number of ways. For example, in construction accounting, specific costs are allocated to specific contracts. Each of these contracts requires its own individual set up in the chosen accounting software, allowing costs to be attributed from initial design right through to completion.
Construction projects can run for months or years, meaning costs will need to be allocated throughout the entirety of the project. Costs are broken down into materials and labour, to allow for full analysis and visibility of costs on a particular contract.
It’s common for contractors and construction companies to be juggling multiple projects or contracts at once, so it’s crucial that costs are allocated to the correct contracts.
How is construction accounting different?
The key points of difference between typical accounting and construction accounting can be summarised as follows:
Unlike regular accounting, within construction accounting, there is a much wider selection of categories when it comes to sales, including labour, materials, design, and more.
Cost of Goods
There are both direct and indirect costs across a range of different categories that need to be recorded in construction accounting, unlike regular accounting that typically just records the cost of a product sold.
Expenses & Overheads
Separating the cost of goods sold from overheads is easy in regular accounting, but not so much in construction accounting. That’s because many items that’d be classed as overheads in regular accounting are actually categorised as cost of goods sold within construction because they’re connected to a client project.
This is a straightforward metric to calculate in most businesses, but you guessed it, it’s not quite as easy for construction businesses. With a much larger selection of cost heads and categories to analyse, seeing the break-even point for construction projects is a little more difficult – but not impossible.
What is retention in construction accounting?
Retentions are another niche requirement of construction accounting.
A percentage of the amount certified (typically 5%) is deducted and held by the client for a period of time. This is to ensure that the contractor completes all the activities set out in the initial contract and gives the client some peace of mind.
Half of the amount retained is released on certification of practical completion and the remainder is released upon certification of making good defects.
It can be tricky to manage retentions without using construction-specific accounting software, and many retentions can be missed or forgotten about by contractors, effectively losing them money on works already completed.
In large construction projects retentions can be huge sums of money, that can cause significant cash flow issues, and there has been much discussion of abolishing them in the UK construction industry.
What is WIP in construction accounting?
A Work in Progress (WIP) report forms part of a construction company’s balance sheet. Contracts utilising the Percentage of Completion (POC) accounting methodology require this report, and it’s calculated for each accounting period.
WIP formats may vary slightly between companies, but generally it includes the current period along with financial metrics on the project to date. This gives a breakdown of each individual contract that a construction company is working on.
The objective of the WIP is to highlight whether you’re over or under billed, and cash positive or negative. The report not only gives this information for each individual project, but for the business as a whole, too, making it an incredibly powerful tool in construction accounting.
Perhaps one of the single most important elements within construction accounting, when WIPs are compiled correctly, they can give construction companies the foresight that they’re likely to go over budget in plenty of time to avoid this.
Not only does the WIP schedule give insight to the business internally, but it can also assist project stakeholders too in assessing risk exposure, including bankers and other lenders.
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