Construction accounting

Construction accounting involves collecting, organizing, recording and reporting the financial data of a construction firm. It helps in identifying the problems encountered in effective management of financial resources of the firm and taking the corrective measures in time. The accounting system allows for the systematic recording and reporting the financial information form one period to another in accordance with the accounting principles. Financial data relates to assets, liabilities, net worth, cost incurred, revenue earned etc. and is required for preparing the financial statements of the construction firm. The most important financial statements which are used to represent the financial status and evaluate the performance of the firm are balance sheet and income statement. The financial statements are also used to communicate the financial status of the firm to the shareholders and financial institutions. The shareholders and financial institutions can get the useful information about the utilization of financial resources in the business activities, costs incurred, revenues earned and other financial information of the firm from period to period. In addition the financial information is also required for calculating the income tax to be paid by the firm.

Construction firms use different types of accounting methods for recognition of the revenues, costs and profit while preparing the financial statements. These accounting methods are cash method, accrual method, percentage-of-completion method and completed contract method. For obtaining the most accurate picture of financial status, the construction firm has to use the best suitable accounting practice for recognition of the revenue and expenses.

In cash method, revenue is recognized when construction firm actually receives the payments from the owner of the project for the services provided. Similarly the cost (expenses) is recognized when the construction firm actually pays the bills (to subcontractors, material suppliers etc.). Normally the cash method is not used for preparing the financial statements of the construction firm as the revenues or costs are recognized when these are actually received or paid rather than the revenues billed to date or the costs incurred to date. Due to this delay in the recognition of revenues and costs, this method does not provide accurate financial status of the firm.

In accrual method, revenue is recognized when construction firm bills the owner of the project i.e. before the actual receipt of payments from the owner and expenses are recognized as the construction firm receives the bills from subcontractors, material suppliers etc. i.e. before the bills are actually paid. This method of accounting is used for preparing the financial statements of the firm as it provides more accurate information about the financial status of the firm.

In percentage-of-completion method, the revenue and expenses are recognized as percentage of work that is complete during the course of the project. This method of accounting normally used for long-term construction projects. The revenue is recognized as the construction firm bills the owner of the project and expenses are recognized as the construction firm receives the bills from subcontractors, material suppliers etc. The percentage complete till date can be calculated by dividing the cost incurred to date by the total estimated cost at completion. Corresponding to this percentage completion, the revenue and profit to date are calculated. The percentage-of-completion method is used for preparing the financial statements and it provides the most accurate picture of the firm's financial status.