How to Account for Construction Costs

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Construction costs are accounted for through a project accounting system where costs are charged to a particular contract that has been set up as a project in the system. The project accounting system allows for several construction projects to be ongoing at one time with the costs accounted for separately for each project. Costs usually fall into three categories: direct costs, such as labor, materials and subcontracting; indirect costs, such as indirect labor, supervision, tools, equipment costs, supplies, insurance and support; and selling, general and administrative costs, which are excluded from contract costs because they apply to the overall administration of the company and cannot be readily identified with a particular project. There are generally two accounting methods that can be used for reporting purposes: the completed contract method and the percentage of completion method.

Record the day to day transactions in journals, initially. Periodically, summarize and post the transaction information to ledger accounts where each transaction is recorded as both a debit and a credit to particular accounts in the ledger. For example, payment for building materials represents a debit or increase to a project cost account and a credit or reduction to the company's cash account.

Make financial reports under the completed contract method. Using the completed contract method income is only reported for completed projects. Work in process (Costs) is only reported on the balance sheet, resulting in an asset if contract billings exceed costs or a liability if costs exceed contract billings. The total net profit or loss is reported in the final period, when the project is completed and directly impacts income for that period only. The completed contract method of accounting is entirely retrospective (the company will not know if there is going to be a loss on the project until the very end) and provides no guidance for management during the project period.

Decide which of the two methods you will use and be consistent. Under the percentage-of-completion method, costs are reported on the income statement along with a prorated share of all project revenues (or billings) equal to the proportion of work completed during the period. The proportion of work completed is determined by dividing the costs for the period by total estimated costs of the project. The percentage-of-completion method estimates the actual earnings in each period but is susceptible to possible manipulation of results which can distort the actual position of the company.

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