Updated: Oct 27, 2022
The construction industry presents its own set of challenges for accurate and timely financial reporting. In the construction world, revenue comes from building contracts with custom terms, specifications, and deliverables, which complicates revenue and expense recognition. To make things more difficult, construction projects are often delayed or experience changes that can impact the financial reporting on a periodic basis.
The most important tool in construction accounting is the job cost report and sometimes referred to as the work-in-progress schedule. In order to generate a job cost report, your company will need to track actual costs incurred for each job as well as budgeted costs. This data should be captured in your accounting software so that you can generate reports on an ongoing basis. Job costs would typically include direct costs such as material and labor which would then be housed in a specific project code. Since there are many performance obligations due to the customer, it is important to allocate the transaction price over time.
Imagine a 100k contract with an estimated cost of 75k, the billing terms the first 50k is due in Feb, after the start of the project, and another 50k in May. If revenue is recognized at the time of billing and costs are accumulating as the months go by, it will put the company in a negative profit position. This is where the construction accountant needs to have a firm understanding of cost accounting so they can make accurate job cost reports to management showing the real financial picture of the project.
5 Principles of ASC 606
To address these difficulties and others, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 606. There are 5 steps that guide the principles of this standard.
In order to comply with the new standard, you will need to make some changes to your construction accounting process. Here are a few things you should keep in mind:
You will need to track progress billings and lien releases separately from other revenue and expenses.
Revenue should be recognized as work is completed, rather than when the invoice is created.
You will need to maintain detailed documentation of the contract, including any change orders that are made.
If you're not sure where to start, check out our blog post ASC 606: Comprehensive Guide to Revenue Recognition. The FASB website offers several helpful publications, and your accounting software provider may also have information and resources to help you get started.
Whatever route you choose, make sure you give yourself plenty of time to implement the new standards and adhere to the principles that haste makes waste. And if you have any questions, don't hesitate to reach out to your software provider or accountant for guidance.