Construction accounting is the process by which an accountant records and tracks all of the financial data related to the construction of an approved project. Construction accounting is used to account for and create reports for residential and commercial projects.
In job costing, each area or item of the construction process is assigned a budgeted amount that is compared to actual expenses as construction progresses. Job-cost budgets are usually approved by the bank and investors prior to beginning construction, so it is very important to watch expenses closely. Overruns are often unavoidable, but every effort should be made to meet the budgeted amounts for each expense.
Rarely does a business have the cash available to fund its construction effort. Most businesses or investors apply for construction loans to facilitate cash flow. A proposal is prepared for the bank including items such as job-cost estimates for total construction, the estimated date of completion and an operating budget for two or more years after the construction is complete. A loan officer wants to know that the construction is reasonable in cost and the amount of time for completion, and that the proposed business will make enough money to cover the cost of the construction loan as well as its own operation costs.
Once the loan is approved, the project accountant submits invoices to the bank as they are received from vendors. The bank approves the invoices and provides enough money to cover them. In most cases, cost overruns beyond a certain amount must be discussed with and approved by the bank.
Release of Lien
Most construction work is subcontracted, meaning a lead contractor in charge of the project hires other teams or individuals to do specialized work. Bricklayers, carpenters, electricians and plumbers are all examples of subcontractors.
When subcontractors present invoices for payment, the project accountant also collects a release of lien. A release of lien states that the contractor will not place a lien against the project for the work he has completed, because he is being paid for his services. If the contractor purchased supplies from another vendor, the project accountant may also require a lien release from that vendor in order to ensure the supplies were paid for by the contractor.
Developers charge fees for managing construction projects, and the Internal Revenue Service (IRS) has provided two methods for which the developer can recognize those fees as revenue.
The first method is the percentage completion method. In the simplest of forms, the developer assigns a percentage completion to the construction project. For example, comparing the total budgeted amount of the project to the total amount of incurred expenses is one way to determine percentage completion. If the project is 50 percent complete, then the developer must recognize 50 percent of the total fees that will be earned on the project, even if the fees have not been paid.
The other method of recognition is contract completion. In this method the developer does not recognize any revenue until the project is complete. This method is only used in rare circumstances specifically outlined by the IRS (see References).
Construction Accounting Software
A construction project can produce hundreds or thousands of invoices each month. Because of the volume of paperwork and the need to constantly keep costs in line with budgets, using construction accounting software is the most efficient and accurate way to properly track and report on a project. Construction accounting software provides job-costing reports that compare budgeted to actual expenses, and it also provides reports that calculate percentage completion.
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