Construction accounting is a field that often uses specialized terminology and acronyms. These terms are important for every professional in the industry to know.
Understanding common construction accounting terms is crucial for effective financial management and project success. This guide provides an overview of the terms you’ll encounter in construction accounting.
Whether you’re a contractor, project manager, or accountant, understanding these industry-specific concepts and terms and familiarizing yourself with these terms can help you navigate the financial aspects of construction projects more effectively. Here’s a comprehensive overview of common construction accounting terms, providing clarity and insight into each concept.
The accounting equation is the backbone of the double-entry bookkeeping system. It represents the relationship between a company’s assets, liabilities, and equity. The equation is fundamental because it must always balance after each transaction. It is expressed as: Assets = liabilities + equity. It underpins the balance sheet and double-entry bookkeeping.
Accounts payable (A/P) refers to the amounts owed for future payment in construction under accrual accounting, recorded in a general ledger account.
Accounts receivable (A/R) refers to the amounts earned and expected to be collected under the accrual accounting method in construction.
Accrual accounting is the field of accounting that States revenue is recorded when earned, not when collected. Expenses are recognized when owed, not when paid.
AIA billing is a specialized progress billing format using AIA Document G702 and G703, commonly used in construction.
The latest accounting standards for revenue recognition, ASC 606 introduces a five-step model for recognizing income.
Assets are resources of value owned by a construction business, including current and long-term assets.
Backlog refers to revenue expected from an ongoing construction contract.
The balance sheet is a financial statement showing a snapshot of assets, liabilities, and equity at a point in time.
Billings in excess of costs happens when billings exceed actual revenue earned, and is recorded as a liability on the balance sheet.
Recording a purchase as an asset, recognizing its expense over its useful life.
Cash accounting happens when income and expenses are recorded when payments are received or made.
Cash flows statement shows how a contractor’s operations, financing, and investments affect cash accounts.
This is payroll reporting submitted for government contracts, ensuring laborers are paid prevailing wages.
Chart of accounts is a list of general ledger accounts used to track financial transactions in accounting.
Completed contract is the term when both revenue and expenses are recorded only when a project is finished, subject to IRS restrictions.
Costs in excess of billings happen when revenue earned exceeds billings, recorded as an asset until billed.
Increases liability, equity, and revenue accounts; decreases expense and asset accounts in double-entry bookkeeping.
Easily convertible to cash within 12 months, like checking accounts and receivables.
Obligations to be paid within 12 months, like accounts payable and accrued liabilities.
Measures a contractor’s ability to pay current liabilities with current assets (current assets / current liabilities).
This refers to the federal act and related prevailing wage requirements.
Debit increases asset and expense accounts; decreases liability, equity, and revenue accounts in double-entry bookkeeping.
Deduction refers to amounts taken from an employee’s earnings for obligations like taxes or benefits.
Depreciation refers to the gradual loss of value of an asset over time and its cost spread over its useful life.
Direct costs are project-specific expenses like labor and materials.
In double-entry accounting, each transaction is recorded in two accounts, ensuring debits and credits balance.
Enterprise resource planning (ERP) is software integrating multiple business processes like accounting and HR.
Equity refers to what owners have invested in a business. Equity is shown on the balance sheet.
Financial statements are records of a company’s financial activities, including the income statement and balance sheet.
Fixed assets are tangible assets with a fixed lifespan, like equipment and buildings.
General and administrative costs (G&A) are business operation costs not tied to specific projects, like office rent and salaries.
Generally Accepted Accounting Principles (GAAP) are standards and practices for recording transactions and preparing financial statements.
The primary record of financial transactions, made up of various accounts.
The income statement (P&L) shows total revenue and expenses, resulting in profit or loss over a period.
Indirect costs are job costs related to construction activities but not directly tied to one job.
Organization of construction activities and costs for consistent job costing.
Tracking project-specific costs to ensure they match the general ledger.
The ratio of debt to equity in a construction company.
Liabilities pertain to what a construction business owes, used to finance assets.
A Lien waiver is a document waiving a claim on property value after payment.
Long-term assets are resources not available as cash within 12 months, like investments or trademarks.
Long-term liabilities are obligations not due within 12 months, like loan principals.
Expenses are reported in the same period as the revenues they relate to.
Mechanic’s lien is a claim on a property by an unpaid contractor or supplier.
Net D refers to payment terms specifying the number of days to pay the full invoice amount.
Overbillings are made when billing is done ahead of work completed. It is recorded as a liability.
This pertains to spreading costs across multiple jobs proportionally.
Overhead costs ate costs not directly tied to a single project.
Revenue recognition based on project completion percentage.
A promise in a contract to deliver distinct goods or services.
The standard compensation rate for construction labor in a given area.
Gradual loss of expected gross profit on a project.
Billing based on the percentage of project completion.
Measures the ability to pay current liabilities without converting non-cash assets (cash + receivables / current liabilities).
Measures how effectively a contractor collects credit sales.
A request to modify the scope, schedule, or value of a contract.
A document seeking clarification on design or specifications.
A document soliciting bids from contractors.
Retainage refers to money withheld from payment until contract completion.
Revenue recognition refers to rules for when a contractor records income from a project.
Schedule of values (SOV) refers to a line-item list of tasks and costs in a project.
Section 179 is an IRS rule allowing deduction of equipment and software costs from taxable income.
Single-entry accounting is a bookkeeping method recording transactions as single items.
Software as a service (SaaS) refers to software accessed online rather than installed on local computers.
Submittals are documents provided for approval to verify materials and specifications.
A surety is a party assuming risk for a contractor’s performance, often through bonds.
Time-and-material billing is pricing based on hourly labor rates plus material costs.
Formal communication of project documents that don’t require a response.
Underbillings are made when a blling is less than the work completed, recorded as an asset.
These are materials procured but not yet installed, significant in cost relative to total project costs.
Unit price billing is invoicing based on a fixed price-per-unit rate.
This is a federal form for reporting certified payroll compliance.
A WIP tracks job progress and financial performance, used with percentage-of-completion revenue recognition.
Working capital pertains to free cash available for construction operations (current assets – current liabilities).
Measures how effectively working capital is used to produce sales.
Understanding common construction accounting terms is important for effective financial management and project success in the construction industry. These terms, such as the accounting equation, accounts payable, accrual accounting, and AIA billing, are essential for contractors, project managers, and accountants to navigate the financial aspects of construction projects.
RedHammer is able to handle construction accounting challenges firms face.
RedHammer offers tailored accounting services to help you improve your operations and cash flow. Among its services are operational guidance, system implementations, bookkeeping, job cost reporting, and advanced accounting solutions such as capital advisory and fractional CFO services.
