Construction project accounting is a hybrid method that combines both financial and management accounting. While not completely unique in its context, it does require a particular process. The two specific parts of construction project accounting are job order costing and percentage-of-completion reporting. Accountants must report this information accurately in order to present a reliable picture of profit and loss.
Job Order Costing
Job order costing is a cost allocation process for all items used in a construction project. Accountants will allocate the actual cost for materials used and labor hours spent directly on the project. A third cost to consider is overhead. This includes all costs for items not directly related to the construction project. These costs can include trucks or equipment used for the project, small items not purchased directly for the project and similar other items.
Percentage of Completion
The percentage of completion process allows a company to recognize income for a construction project at specific points. Each project must have a stated completion date. The number of months or years will then represent when the company can recognize income. For example, the company may recognize income at 20, 40, 60 80 and 100 percent completion. The factors that help decide when to recognize income include costs incurred, recent estimate of project cost and recent gross profit estimates.
To accurately pinpoint profit, construction companies will multiply the total project revenue by the current period’s percentage of completion. This figure less current construction costs for the year will determine the profit to recognize. For the subsequent year, the company will multiply the second year percentage of completion by the total project revenue. This figure less recognized revenue from the first year indicates the revenue to recognize for year two. Subtracting construction costs will then return the profit for year two.
Construction companies typically use the percentage of completion method as it gives a better presentation of financial data. If the company waited to recognize income only at projection completion, several months or years could pass without reporting profit. The only time when the contract method makes sense is when a company will only spend a few months on construction projects, such as three months or less. This time period may be harder to report information under the completion method.