Construction accounting

When selecting a qualified CPA,
industry experience always plays a
crucial aspect of the determination process. Never is this need more pronounced than in the construction industry,
where there are a number of accounting
nuances.

“Since the public accountant is often the
primary outside adviser to his or her
clients, particularly in the case of smaller
organizations, the industry experience factor is of considerable importance in the
selection process,” says Michael Reiff,
executive vice president of Gumbiner
Savett Inc
.

Smart Business spoke with Reiff about
construction accounting, how construction
progress and payment schedules should be
monitored, and the importance of hiring a
CPA firm with experience in the industry.

What is construction accounting?

Construction is the process of organizing
materials, labor and capital resources in
such a manner as to build roads, dams,
buildings, bridges and the like. It is an
industry different from all others as well as
being diverse within itself. The types of
work performed will range from the general contractor who oversees every phase of
the project to the specialty subcontractors
who perform a specific part of the project,
such as the electrical, concrete or plumbing
contractor. The size of a project can range
from rehabilitating a house to the construction of a superhighway or an office building
and shopping complex. Construction
accounting is the financial method
employed to track the revenue and costs of
the project from inception to completion.

What are some accounting requirements
specific to the construction industry?

Generally accepted financial reporting in
the construction industry requires revenues to be recognized using the percentage-of-completion method, which attempts
to match revenues earned in a particular
accounting period with costs incurred in
the same period. The completed-contract
method of accounting, on the other hand,
recognizes all the revenue at the completion of the project, which obviously could
result in wild distortions in comparing
income statements from period to period.
The percentage-of-completion method
requires the accountant to measure and
make judgments concerning the reasonableness of estimates provided by the
owner/contractor. Because of the reliance
on estimates, the dependability of the estimates needs to be measurable with some
precision. Throughout the duration of a
project, modifications of the original contract are extremely common — these modifications are known as ‘change orders’ and
each change order requires a recalculation
of the percentage of completion.

How should construction progress and payment schedules be monitored?

Management of a construction project is
key to completing it successfully and profitably. The goal in the industry is to get
work by submitting a reasonable and profitable bid and then to complete the project
within the parameters set by the original
estimate. Each event that occurs during
the course of a construction project affects
the result of that project, and results affect
profits. Each construction project is a
separate profit center with its own cash
cycle based upon the costs of the activities
involved in that project and on payments
from the owner, which are determined by
contract terms. Typically, the subcontractors will bill the general contractor according to the percentage of completion calculated by costs incurred to the total contract, less a negotiated retainage percentage to be paid at a later date when the
entire project is completed.

Why is it important for construction companies to hire auditors and accountants with
experience in their industry?

In light of the requirements of the construction industry and its unique accounting principles, auditing requirements and
tax regulations governing contractors, the
selection of a CPA firm bears significant
importance. Investors, credit grantors and
surety companies frequently require annual independent audits for construction contractors. Even if they don’t require certified
audits, there can be no question that such
financial statements can enhance borrowing and bonding capacity. In many industries, the background and experience that
an accounting firm has in a particular
industry is a key factor in the selection
process. With the financial reporting and
tax regulations particular to the construction industry, this could not be more true.

How should one go about finding a qualified
CPA firm?

Referrals from one’s peers is always the
best place to start. Also, the contractor
should ask the following questions:

 

  • Does the CPA firm have experience in
    the industry and with other contractor
    clients?

     

     

  • Are the partners and staff of the firm
    knowledgeable about contracting?

     

     

  • Does the firm have a good reputation
    in the community and is it known by and
    acceptable to lenders and surety companies?

     

     

  • Is the CPA firm a good fit in terms of
    size, geographical location, etc.?

 

MICHAEL REIFF is executive vice president of Gumbiner Savett Inc. Reach him at (310) 828-9798 or [email protected].

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