Construction Accounting Definition
Construction accounting, a type of project accounting, is the method for financially tracking the progress of a construction job. This is essential for bidding, request-for-proposals, project management, invoicing, construction retention payments, and more.
The process of construction accounting management involves monitoring both costs and revenues. Costs fall into 3 main categories: Direct (Direct Labor, Direct Materials, etc.); Indirect (Indirect Labor, Indirect Materials, etc.); and selling, general, and administrative.
To account for revenue, compare the expected project value to the approximate percentage of completion of the project. Over time, you will receive cash with completion invoices. A final payment made upon satisfactory completion of the job. The construction retainer is the final payment because it retains the contractor until that the project is completed.
Construction accounting and financial management involves monitoring draw, progress billing, work-in-progress, and a slew of construction accounting methods which range from GAAP compliant to industry-specific. Generally, the industry has accepted a series of unique methods of financial reporting that are not present anywhere else. These aid in construction accounting and taxation.
Construction Retention Definition
Construction retainage is the final amount of payment kept, by the customer, to ensure satisfactory completion of a project. In both residential and commercial construction, construction retainage is also referred to retention money. Although it is extremely common to the construction world, you can use this method of quality control in other places.
In the world of construction, retention accounting occurs in a similar method as above. Projects are paid with increasing completion until finished. Then, the customer will examine the project, with the project manager, to ensure that it meets their needs. The customer makes the final payment once this is agree upon. To contractors and other workers in construction, this is when retention release has occurred.
Laws exist to protect the investment of the customer as well as the contractor. Laws vary from state to state. An attorney that is experienced with construction retention laws should deal with any discrepancies. In the event of unacceptable or negligent construction, recovery of the retainage is a possibility. Maintain every document and record for each client and each project so that in the event of a disagreement, you will have support to your case.
Construction Accounting Example
The founder of Cabinetco, a custom cabinetry builder, is Maggie. Her projects, pieces of art in their own right, have continuously pleased customers. Maggie, over time, has become well versed in the process of accounting for her projects.
Maggie begins her projects with a Request-for-proposal, or RFP. Her records of past projects allow her to closely estimate the total cost of each new project. Upon this foundation Maggie makes a bid for the estimated cost of each project. In her experience, customers are always pleased when they pay less than the estimate. Therefore, Maggie makes sure to present customers an estimated cost which will be less than her billed price. She does this with a keen eye so as to ensure consistent profitability on each project.
Maggie knows that her bid price does not drive her business: customers do. She has made great efforts to present excellent work and has created happy customers. Word-of-mouth is her most effective marketing message. This leverage allows her to negotiate the lowest retainage payment possible. Maggie knows the importance of cash flow in the survival of her business.
How To Account on Long Projects
Once Maggie has confirmed her bid with a customer she begins building. She then orders the perfect materials and has a trusted team to subcontract her building. Her role in this process is as a project manager. Her ability to control quality drives word-of-mouth recommendations to Cabinetco.
On long projects Maggie sends regular invoices. These state the percentage of completion on the project, the payment due for that level of completion, expected date to the next invoice or benchmark, and other details.
Maggie, finally, presents the project to the customer. She knows that every time she sees a happy face she is retaining customers as well as defining her brand. She then sets a date for final completion and invoices for her project retainage.
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