Construction businesses use accounting to measure and analyze their financial information. Business industries often have special accounting principles to follow when recording financial information. Construction accounting uses a mix of management and financial accounting. Each type of accounting helps business owners and managers understand operational effectiveness and the profitability for each construction project. This information also helps managers make business decisions regarding new projects.
Construction accounting relies extensively on the completion of percentage accounting method. This method measures each construction project individually. It also uses a qualitative analysis for determining each project’s stage of completion. Qualitative analysis usually relies on the business owner's or general construction manager’s analysis of each project. These individuals are responsible for providing the accounting department with information relating to the project’s completion process. Companies can also use a quantitative completion of percentage accounting method. Quantitative methods use mathematical formulas to calculate the completion percentage of each project. Qualitative methods often require business technology such as an accounting module to gather financial information from operational modules. This offers construction companies one source of information related to construction projects.
Construction accounting uses the project cost allocation technique from management accounting. Project cost allocation involves a company attributing a specific dollar amount of construction resources to each project. Management accountants usually separate construction resources based on each job’s written bid or proposal. Construction resources include direct material, labor, subcontractor costs, overhead, insurance, support and other construction-related costs. Each project is managed separately on the general ledger to ensure an accurate total cost is maintained for each accounting project. Cost allocation is an important construction accounting procedure. Companies want to avoid construction costs overrunning a project’s expected profit. Many times, companies are unable to bill clients for additional resources used on construction projects. Using high cost construction resources can also affect the expected profits from construction projects.
Completion percentage accounting and project cost allocation provide a foundation for the construction accounting’s revenue recognition process. Revenue recognition rules allow construction companies to report revenue using a completion estimate. This method usually requires construction companies to estimate the percentage of completion based on the number of items completed in the business contract. Costs are also recognized based on the same completion percentage method.