In the construction industry, accurate accounting practices are crucial to maintaining financial control and achieving project success.
However, navigating construction accounting, especially without construction accounting software, can be daunting because it involves a unique set of terms and concepts.
In this article, we will explain the essential construction accounting terms you need to know in alphabetical order, empowering professionals in the industry to better understand and use them effectively.
Aged Accounts Payable (A/P)
Aged accounts payable periods, such as current (not yet due), 30 days past due, 60 days past due, 90 days past due, and so on. The purpose of the report is to track the company's outstanding liabilities and manage its cash flow effectively.
Aged Accounts Receivable (A/R)
Aged accounts receivable is a report that provides a breakdown of outstanding, unpaid invoices owed to the construction company by its clients or customers. The report aims to track the company's outstanding receivables, assess the timeliness of client payments, and help with cash flow management. It categorizes unpaid invoices by how long they have been outstanding, typically in predefined time periods (e.g., 0-30 days, 31-60 days, 61-90 days, and over 90 days).
Accrual Method
Under the accrual method, revenue is recognized when the service is performed, and expenses are recognized when incurred (but not necessarily paid). This means that if a construction project is completed in December but the customer doesn't pay until January, the revenue from that job would be reported in December, when the customer is billed.
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AIA Billing
AIA Billing, also known as AIA (American Institute of Architects) Document G702 and G703 billing, is a standardized billing and invoicing process commonly used in the construction industry for progress billing on construction projects.
The AIA billing process is designed to provide a clear, transparent method for construction contractors to submit payment applications in accordance with the project's payment schedule, and for project owners or clients to review and process them.
ASC 606
ASC 606, also known as Accounting Standards Codification (ASC) Topic 606, is a set of accounting principles issued by the Financial Accounting Standards Board (FASB) that outlines the guidelines for recognizing revenue from contracts with customers.
This standard was introduced to establish a comprehensive and consistent framework for revenue recognition across various industries and replace the previous guidance, including industry-specific guidelines, with a single principle-based standard.
The core principle of ASC 606 is to recognize revenue in a manner that reflects the transfer of goods or services to customers in an amount that reflects the consideration the company expects to receive in exchange for those goods or services.
The revenue recognition standard applies to all types of revenue-generating activities, including the sale of goods, the rendering of services, and the licensing of intellectual property.
Assets
Assets represent the resources owned or controlled by construction businesses, which have economic value and are expected to provide future benefits.
In the construction industry, assets can include items such as cash, accounts receivable (outstanding payments from customers), inventory (construction materials, supplies, and in some cases raw materials), property and equipment (e.g., machinery, vehicles), and work in progress (the value of ongoing construction projects).
Backlog
In the construction industry, backlog refers to the value of work that a construction company has been awarded but has not yet completed. It represents the total amount of contracted work that is still in progress and has not yet been recognized as revenue upon completion.
Balance Sheet
In the construction industry, a "balance sheet" refers to a financial statement that provides a snapshot of a construction business's financial position at a specific point in time. It is one of the three main financial statements used to assess a company's financial health, along with the income statement and the cash flow statement.
Cash Flow
Cash flow in construction refers to the movement of money into and out of a construction company over a specific accounting period. It represents the cash inflows and outflows related to the company's construction projects and other business activities.
Cash Accounting Method
Under the cash accounting method of revenue recognition, revenue is recognized when cash is received, and expenses are recognized when they are paid.
This means that if a construction project is completed in December, but the customer doesn't pay until January, the revenue from that job would be reported in January. Expenses would be reported when they are paid for. If they are purchased with cash before the job is completed, this could cause a mismatch between revenue reporting and expenses.
Using the cash method can be a very good tax strategy, but it does not give as clear a picture of how the company is doing as the accrual method does. Many companies run their businesses on the accrual basis and switch to the cash method at tax time if they are allowed to do so.
Certified Payroll
Certified payroll in construction is a specific payroll report that construction contractors or subcontractors are required to submit to the government agency overseeing a public construction project. The purpose of certified payroll is to provide transparency and ensure compliance with prevailing wage laws and other labor regulations.
Change Order
A change order is a document that modifies a construction project's scope, cost, or schedule after the original contract has been signed. It outlines the changes requested by the owner, architect, or contractor and specifies any cost and time adjustments.
Chart of Accounts
In construction, a chart of accounts is a structured list of financial accounts used to record and categorize transactions specific to the industry. It serves as a standardized framework for organizing and classifying financial data for construction projects, enabling accurate financial reporting and analysis.
Committed Costs
Committed costs occur when a company agrees to buy something via a purchase order or contract.
For example, if a general contractor has agreed to hire an electrician for a project and has signed a contract specifying the scope of work and the amount to be billed, this is a committed cost.
Other examples include unposted payroll, purchase orders in which you are waiting for delivery, or the bill for the materials has not been paid yet, and open contract or subcontractor agreements.
Cost Code
A cost code is a unique identifier used to track and categorize specific construction costs associated with a project. It helps organize and analyze expenses.
Cost codes play a crucial role in construction project management, cost control, and financial reporting.
They are typically alphanumeric and follow a standardized format established by the construction company or project management team. The structure of cost codes may vary from one organization to another, but they generally consist of numbers and letters that convey specific information about the cost's nature.
Davis-Bacon
Davis-Bacon refers to the Davis-Bacon Act of 1931, a federal law in the United States that requires contractors and subcontractors to pay prevailing wages and fringe benefits to laborers and mechanics working on federally funded or assisted construction projects.
The act was enacted to ensure fair wages and working conditions for construction workers employed on government projects and to prevent contractors from significantly lowering wages to win contracts.
Direct Costs
Direct costs are those that can be traced directly to a specific project, such as materials, labor, and subcontract costs, as well as equipment costs for both equipment rentals and the use of a company's own equipment.
Enterprise Resource Planning (ERP)
Construction Enterprise Resource Planning (ERP) is a comprehensive, integrated software system that manages and streamlines business processes and operations across a construction business.
ERP systems provide a centralized platform that connects different departments and functions, enabling real-time data sharing, collaboration, and efficient resource utilization.
Estimates vs Actuals Report
An estimates vs. actuals report in construction is a financial document that compares the estimated costs or revenues for a construction project with the actual costs or revenues incurred during the project's execution.
This report is a valuable tool for project managers, construction companies, and stakeholders to monitor and analyze the financial performance of a project and to identify any discrepancies between the initial budget projections and the actual financial outcomes.
Fixed Assets
Fixed assets are long-term, tangible assets essential to a construction business's operations and not intended for immediate resale. These assets are expected to provide benefits to the construction company over an extended period, typically exceeding one year.
Fixed assets play a vital role in supporting construction projects and overall business operations. Some examples include land, buildings, construction equipment, vehicles, tools, and construction accounting software.
General Ledger
The general ledger is a foundational and central component of the accounting system. It is a complete and systematic record of all financial transactions and accounts for a construction company over a specific period of time.
The general ledger serves as a repository for financial data, capturing the details of each transaction and providing a comprehensive overview of the company's financial health.
Indirect Costs
Indirect costs are overhead costs allocated to a specific project, such as staff salaries and administrative costs.
A common indirect cost in the construction industry is equipment usage, where the cost of using a contractor's owned equipment must be allocated to each job on which it is used.
This cost should be allocated to jobs based on standard rates, such as a daily internal rental rate or an hourly usage rate. To calculate this rate, you can divide the number of equipment hours used on a project by the equipment hours incurred by the company for the period in which the indirect costs are being allocated.
Job Costing
Job costing is the process of tracking and allocating costs to individual construction projects. It involves monitoring direct and indirect expenses, such as labor, materials, equipment, and overheads, to determine the total cost of each job.
Job Cost Report
A job cost report in construction is a detailed financial document that provides an overview of the costs associated with a specific construction project. It is a critical tool used by construction business executives and project managers to monitor and control project expenses, analyze profitability, and make informed decisions throughout the project's lifecycle.
Job Profitability Report
A job profitability report in construction is a financial document that analyzes the profitability of a specific construction project. It provides a comprehensive view of the project's revenues, costs, and overall profitability, enabling construction companies to assess its financial performance and make informed decisions.
Liabilities
Liabilities are the obligations or debts that the construction company owes to external parties.
Current liabilities, such as accounts payable (outstanding payments to suppliers and subcontractors) and loans, represent debts or obligations that the construction company needs to fulfill in the near future.
Long-term liabilities, such as long-term debt, deferred tax liabilities, and pension obligations, represent debts or obligations that the business expects to settle over an extended period, usually more than one year.
Overbilling
Overbilling in construction occurs when a contractor or subcontractor submits an invoice or payment application to the client or project owner for an amount higher than the actual work completed or costs incurred. It occurs when the billing or payment request includes charges that exceed the contractual agreement or the work progress on the construction project.
Overhead Costs
Overhead costs are actual costs related to the indirect costs incurred by a construction company that are not directly attributable to a specific project but are necessary for the overall operation of the company, such as office rent, utilities, administrative salaries, and insurance.
Overhead Cost Allocation
Overhead cost allocation is the process of assigning a portion of the overhead expenses to each project or job. This helps construction companies accurately track and measure expenses, enabling them to make sound business decisions and maximize profits by setting reasonable service prices and avoiding costly errors.
Percentage-of-Completion Method
The percentage-of-completion method is an accounting and revenue recognition technique commonly used in construction and other long-term projects to recognize revenue and expenses as work progresses. Instead of waiting until the project is completed to recognize revenue, the percentage-of-completion method allows companies to recognize revenue and related expenses based on the progress of the project.
Performance Obligation
A performance obligation is a distinct promise or commitment made by a contractor to a customer under a contract for the delivery of goods or services. It is a key concept in accounting for revenue recognition under the principles outlined in Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers.
Prevailing Wage
Prevailing wage in construction is the minimum wage rate that must be paid to workers employed on government-funded construction projects. It is determined by federal or state laws and regulations and is intended to ensure that workers receive fair compensation for their labor on public projects.
Progress Billing
Progress billing in construction is a billing method used by contractors to invoice clients or customers for work completed on a construction project.
Instead of invoicing for the entire project's value at the end, progress billing allows contractors to submit invoices periodically as specific project stages or milestones are achieved.
Profit and Loss Statement
A profit and loss statement (P&L), also known as an income statement or statement of earnings, is a financial report that summarizes a construction company's revenues, expenses, and profitability over a specific period, typically a quarter or a fiscal year.
The P&L statement is one of the key financial statements used by construction companies to assess their financial performance and profitability.
Retainage
Retainage is a portion of the contract price that is withheld by the owner or client until the project is completed satisfactorily. It serves as a form of security for the owner against potential defects or non-compliance.
Revenue Recognition
Construction revenue recognition refers to the accounting process of recognizing and recording revenue from construction contracts in the financial statements. It is a critical aspect of construction accounting, as it determines when and how revenue should be reported based on the project's progress.
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Schedule of Values
The schedule of values is a detailed breakdown of the contract price or total value of a construction project. It is an essential document used by contractors to itemize and allocate the total contract amount to specific components or tasks within the project.
The schedule of values serves as a reference point for progress billing and payment applications, allowing the contractor to request payments based on the completion of various project milestones.
Surety Bonds
Surety bonds are financial instruments that provide a guarantee to project owners (also known as obligees) that a construction project will be completed in accordance with the terms and conditions of the contract.
These bonds serve as a form of risk management and assurance, ensuring that the contractor fulfills its obligations and, if not, that the surety company steps in to remedy the situation.
Time and Material Billing (T&M)
Time and material (T&M) billing is a billing method that charges clients for the actual time spent and materials used to complete a construction project.
Unlike fixed-price contracts, where the total project cost is predetermined, T&M billing offers greater pricing flexibility, making it suitable for projects with uncertain scope or those that involve ongoing changes.
Trial Balance
A trial balance is a financial report that lists all the account balances from a construction company's general ledger at a specific point in time. It is an essential tool for accountants and financial professionals to verify the accuracy of the company's accounting records and ensure that debits and credits balance.
Underbilling
Underbilling occurs when a contractor submits an invoice or payment application to the client for an amount lower than the actual work completed or the costs incurred.
It occurs when the billing or payment request does not fully account for the construction project's progress or the expenses that should be billed to the client.
Union Payroll
Union payroll in construction refers to the system of compensating construction workers who are members of labor unions.
In many regions, construction unions play a significant role in the industry, representing the interests of workers and negotiating collective bargaining agreements with construction companies. These agreements outline the terms and conditions of employment, including wages, benefits, working hours, and other labor-related matters.
Unit Billing
Unit billing in construction is a billing method in which payment for construction services is based on specific units of work completed or materials supplied, rather than a lump-sum or fixed-price arrangement.
In this billing approach, the total cost is calculated by multiplying the quantity of work completed or the quantity of materials provided by a pre-agreed unit rate.
It offers transparency to both the contractor and the client, as they can easily track progress and understand the cost breakdown. Unit billing might not be suitable for all construction projects, especially when the scope of work is uncertain or when there are potential changes in the project's requirements.
Work in Progress (WIP)
Work in Progress is the value of unfinished construction projects at a specific point in time. It represents the costs incurred on a project that are yet to be completed and is used to determine the financial position of ongoing projects.
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Work in Progress (WIP) Report
A Work in Progress (WIP) report is a financial document that provides an overview of the ongoing construction projects and their current status in terms of costs, progress, and overall financial performance.
The WIP report is crucial for construction companies to monitor the status of active projects, assess their profitability, and make informed decisions to ensure projects are completed successfully.
Increase Profitability with Construction Accounting Software
Understanding construction accounting methods and terms is vital for the success and financial well-being of any construction business.
This comprehensive guide has provided valuable insights into essential terms, from the percentage of completion method to revenue recognition, job cost reports, and beyond. By mastering these concepts, construction professionals can navigate the complexities of their financial landscape, make informed decisions, and ensure accurate financial reporting through construction accounting software.
Whether managing project costs, tracking cash flow, or evaluating profitability, a solid grasp of construction accounting terms empowers companies to stay competitive, build stronger financial foundations, and thrive in an ever-evolving industry.
With this newfound knowledge, construction professionals are well-equipped to tackle accounting challenges and elevate their construction endeavors to new heights of success.
