Residential Construction Accounting: Basics and Best Practices
Differences Between Regular Accounting and Accounting for Construction Companies
Residential construction accounting is more complex than standard business accounting, which is designed for companies that sell a set number of standardized products — or provide a limited selection of defined services — from a fixed location, with a relatively stable workforce. Residential builders face a very different set of business circumstances, including:
- A broad range of potential service categories — consulting, engineering, design, labor, physical materials, service work and more.
- Costs and revenues tied to projects that are one-of-a-kind, with unique and prolific requirements.
- A different job site for every project, rather than a fixed production location like a factory.
- A workforce that changes from job to job, in response to project requirements and location.
- A longer sales cycle than most businesses; months or years can pass between signing a contract and completing a project.
These factors add unique requirements to residential construction accounting.
Job costing is the practice of tracking expenses to particular projects. This is an essential part of residential construction accounting because it is what enables companies to properly manage costs in ongoing projects, as well as bid successfully and profitably on new projects.
However, it can be very complicated to manually track the direct and indirect costs for every job. There are hundreds of potential categories that differ from project to project. Different job sites mean different site conditions or local variables, such as labor availability and material costs. Mobilization costs, travel time, delivery to the site and more need to be included. Timecards must be accurate and change orders acknowledged. Given all the variables, even the break-even cost for a job can become hard to understand. In a tight-margin market, any inaccuracies around break-even and profitability numbers make bidding risky and can threaten a company’s financial stability and growth.
Specialized Construction Billing
Multiple unique pricing and billing methods are used in residential construction. Methods can vary from firm to firm but also from project to project, in response to client/builder requirements.
Fixed Price — A total cost is bid for the entire project. This type of pricing may be set in stone or may allow for some contingencies. Unit pricing is similar to fixed pricing, but the price is set per unit for a multi-unit project.
Time and Materials — This type of estimate and contract price is based on a per-hour labor rate plus material costs. Both categories contain standard mark-ups to cover overhead and profit.
Whichever pricing method is used, residential construction projects are generally invoiced on a progress basis because of their long time frame. Progress billing is one of the most important and complex processes for a residential builder’s or subcontractor’s accounting team. It requires an accurate estimate of the percentage of progress towards completion on each of a firm’s multiple, simultaneous jobs. It must tie the timing and amounts of accounts payable (AP) to the timing and amounts of accounts receivable (AR) in a way that supports healthy cash flow. Out of sync AP and AR is one of the most common and troubling financial problems for residential construction firms, causing problems in both keeping the bills paid and suppliers happy. This can, in turn, generate a need for costly financing to keep projects moving.
Changing job sites and workforce makeup, plus unique compliance requirements, make payroll processing more complex in this industry than in most others. Builders often deal with multiple pay rates across multiple locations; union and multi-union reporting and deduction requirements; payroll compliance on public projects; federal and state compliance reporting (EEO, workers’ comp, etc.); and all of the headaches of employee tax withholdings and business tax filings. Dealing with payroll alone can put pressure on a traditional accounting department with manual processes.
Common Construction Accounting Methods
Residential construction contractors have more accounting method options than other business taxpayers due to the unique nature of construction activities and the inherent challenges of measuring profit at different points along a project pathway. Three basic methods of income reporting can be used, depending on a firm’s annual revenue and preferred cash management practices.
Cash basis accounting is a very simple method. Revenue is counted when it is received and expenses are recorded when they are paid. It gives an accurate picture of how much cash is on hand. However, it can paint a very fuzzy picture of a business's financial health and growth, especially given the long lag time between signing a contract and getting paid in the residential construction industry. For example, a firm that receives payment on several projects in one month will look healthy, even if they aren’t signing any new contracts and are headed for trouble.
The IRS only allows businesses under a certain annual revenue level to use cash basis accounting in filing their taxes.
Completed Contract Method (CCM)
Under the completed contract method, all contract revenue and expenses are reported when the project finishes. Payments and billing still occur throughout the contract, but they don’t go onto the income statement until the end.
The IRS prescribes rules for when a contract is considered to be complete and also restricts this method for tax purposes to contractors who don’t exceed a specified annual revenue.
Percentage of Completion Method (PCM)
The percentage of completion method measures and records revenue through an estimate of the percentage of completion of a contract. It is more closely related than CCM to how most contractors bill and is required by the IRS for large companies.
Accounting Technologies for Construction Companies
The complexities in residential construction accounting and the variety of options firms have for preparing their books can seem overwhelming, especially if your company still depends on manual accounting processes. Accounting software designed specifically for this industry can reduce stress, simplify the process, increase accuracy and offer an actionable analysis that can lead to better decision-making in the future.
Using fully integrated residential construction accounting software can make job costing much more effective. It enables workers to complete and submit daily time cards, progress reports, cost reports and change orders right from the site. When this information is automatically processed through your accounting software, tracking past and present expenses for each and every project becomes easy, no matter how many service and expense categories there are. Having a thorough understanding of project expenses leads, in turn, to better pricing estimates and a better grasp of the kinds of jobs that are most profitable for your firm and that you should be pursuing.
In addition, you can use accounting software solutions to:
- Generate and view orders and contracts and view job-specific pricing
- Consolidate your ledgers and produce standard and custom financial statements
- Automate tax calculation
- Enter payroll data to apply wages at multiple levels, create custom deductions for union and non-union payees and produce W2s
- Automate supplier payments
- Produce 1099’s
- Generate reports on general liability and worker's compensation
- And more
Hyphen Solutions offers Builder Solutions including BuildPro, a scheduling software, BRIX ERP software with integrated accounting, SupplyPro GM for general and specialty contractors, and Hyphen Wallet, simplifying the payment process between builders and trades, and much more. Our solutions are built with the home builder and trades in mind to help you manage your complex business tasks more easily and profitably. Visit Hyphen Solutions to learn more about the entire product suite.