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
- 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 firstname.lastname@example.org.