Intro to Construction Accounting
Construction accounting is a different form of accounting than that of many regular companies. It is usually project-based instead of bookkeeping on the whole company level.
This becomes even more crucial when you are a contractor company with multiple clients. You probably want to know the P/L (profit/loss) on a project level or, ideally, even on a job level.
This means that the project management teams (project managers, quantity managers, and site staff) need to work hard to determine the current state and profitability of each project's job. Either way, this is where job costing comes into play.
Job Costing = Construction Accounting
Most companies are fine with using a normal company-wide general ledger (G/L) to keep track of all transactions the company has been involved in—money in, money out, etc.
It is not an option for construction companies because construction accounting is project-based. Job costing in construction is tracking the costs of a particular project or a stage (job) in a project.
Job costing provides this insight by attaching additional info to each expense and income. You can achieve this by securing a project or cost-level code for each accounting entry. You can even have codes with a combination of both. With this additional cost code information, you can see your balance for each.
Often, companies use a standard budget structure so that jobs between projects become more comparable and easier to estimate. The budget estimate is structured data with the price and quantity we expect to have our required jobs done.
Find our example template for construction budget categories here.
Construction Bidding
When we have an initial estimate, we ideally want to get some verification that the prices are realistic. We can do this by looking at price lists or asking for offers/bids from subcontractors.
When we ask for prices from subcontractors, we will then get feedback to set actual forecasts for the project so that we know the most up-to-date project outcome.
When we finally find a bid that we are happy with, we can either sign the subcontract with the subcontractor or send out a purchase order to receive the materials when needed.
Subcontracts and Purchase Orders
It is already a good state if you know each project's or job's profitability after it has ended. However, when your subcontractors or suppliers send you invoices for work they did or the materials you ordered, you need to see if you haven’t already received the materials. Or that you haven’t paid the subcontractor in the total amount already.
Purchase orders are tools you use for jobs involving materials you need to buy. You send an order to the supplier to determine the amount of the materials you need, and the supplier will provide them to you. The purchase order is a good comparison document to see how much you receive.
In jobs where subcontractors will do all the work and provide their materials, you must sign a contract or at least have a verbal agreement. When you fix the quantities of work that need to be done, you can more easily track the progress of these jobs against the contracted amounts. The work done by a subcontractor is periodically (bi-weekly or monthly) presented to the project management teams using progress reports.
Progress Reports (or pay applications or claims or valuations)
Subcontractors submit progress reports periodically by the subcontractor to confirm the work done. The project manager compares the progress report against the contract, actually doing work and the previously reported work.
Based on the combination of all these three factors, the project manager or quantity surveyor can decide whether the progress report is valid. If it is confirmed, then the project manager confirms that the done jobs are accepted, and the subcontractor can send the invoice to be paid.
But what about unexpected additional work that you missed in the design phase or was added due to client wishes? For this case, the thing to use is change orders.
Change Orders (or variations)
Autodesk says a change order is “a bilateral agreement between parties to the contract.” Change orders usually appear in a subcontract or purchase order scope when something extra needs to be done or ordered. Often, either party—the contractor or the subcontractor—provides the need for change orders.
So that the initial estimate (and the budget) do not surprisingly exceed expectations, there has to be a way to keep track of these as well. It is good to do this in a similar way to the contracts. You can fix the quantities and prices you agreed on, and in progress reports, you can see if the agreed-upon amount has been reached.
Cost and Invoice Management
You will also receive the bill from the supplier when you receive your materials. The same goes when you agree with the subcontractor and his proposed progress report—he will want you to pay him for the work.
The main challenge is ensuring you have a systemic way to receive your invoices and check them with the people who know about the project and job. When the invoices come in, part of the checking happens again. First, you need to find the contract or purchase order the invoice. Second, you must see how much you have already paid in this contract. This job is not trivial and can take up much of your time. And it is not even providing any added value to your employer.
Finally, after all that, you can tell the accountant what account the item is connected to to make the payment. Additionally, you have to find your spreadsheet and update the state there to make the checking a bit easier. The same happens again next month and probably takes even longer.
What if there was an automatic solution that does most of the work for you?
Construction Accounting Software
The scenario we describe in this article is based on using regular Microsoft programs such as Excel and Outlook. The problem with these tools is that most of the data entry and validation are still relatively manual.
Standard workflow tools, like Procore and Planyard, do most of the data-heavy work for you and let the subcontractors do the data entry for you. This means you can focus on checking the subcontractor’s values and see the previously approved ones. This can save your monthly data-crunching days, and you can love your job again! As a bonus, both platforms integrate with your accounting software and forward the pre-approved documents automatically. For example, there are two industry-standard accounting platforms: Xero and QuickBooks.
Check out our blog post on comparing accounting software and construction financial platforms.
Conclusion
Because the accounting is done on a different level, it is slightly more complicated to understand whether what you do is profitable or not. You need to manually add a reference to the documents in analog or digital form so that you can keep track of everything.
You can likely get by using email, Excel, and your accounting software if you’re smaller. You can keep the contract documents in a local folder or cloud storage. You can refer back to them when you approve costs. This works fine for smaller projects and keeps the process very simple.
As soon as you start to have projects in the multimillions or have tens of subcontractors working on your projects, the whole system starts to shake. Against this, there are various temporary solutions. You can start by hiring quantity surveyors to do the data entry. Or you can sleep less on the weekdays and give up parts of your weekends as some of our friends and customers have done.
Or, you can use a quantity surveying platform that does all the calculations for you and makes your life manageable again.
Do you think you are already having difficulties with cost tracking?