Construction Accounting 101: Choose the Right Method

In the case of wholesale and retail businesses, the cost of goods sold is the amount that was paid for the inventory items to be sold, plus any shipping costs or labor for delivery. For example, a restaurant record food costs, labor costs and consumables as COGS. In this industry where margins are often tight, it is important to track COGS by location as well to understand which locations might be the most or least profitable, diagnose and fix issues. Cost of Goods Sold are expenditures in the course of business directly related to the production of revenue. COGS are also referred to as the “Cost of Revenue” or “Cost of Sales.” In a nutshell, COGS tracks how much a business is spending to generate their top line sales.

They include materials, subcontractors, wages for labor, and other expenses. The COGs are an important metric on the financial statement as it is deducted from revenue to determine gross profit. You use the gross profit to measure your profitability and evaluate how efficient your company is in managing labor and supplies in the production process. Careful attention must also be paid to subcontractors’ costs and how they are estimated and tracked. It is customary for a contract to be signed, fixing the cost of a specific part of the contract. You must ensure both parties are on the same page regarding the scope of services, or you could find yourself spending unanticipated dollars to finish a job.

How to calculate COGS in construction

Once you’ve found and tested the “sweet spot,” you can calculate your profit markup (i.e., the percentage you add to your project costs to create this profit). It’s also essential to remember that your overhead cost isn’t a one-time calculation. Business expenses can increase as well as decrease, so it’s crucial to re-calculate at least twice a year. Since you have more crew members doing more work, you can afford to spread out your overhead costs across more projects.

Construction businesses cannot use cash basis accounting on their tax returns if job materials constitute more than 15 percent of the total cost to the customer. The Internal Revenue Service provides an exception to this rule allowing constructions businesses with less than $1 million in annual revenue to not adhere. Construction contracts vary in length and size making it difficult to match expenses to their respective source of revenue. Because of the nature of transactions incurred by construction businesses, job costing is a standard practice in all methods of construction business accounting. Job costing requires the allocation of all direct and assignable indirect expenses and revenues to each respective job or contract. Job costing simplifies tax preparation and provides profitability by contract.

Unnecessary costs

But because it’s part of a contract obligation, the parties must settleahead of time when control is transferred — at a point in time or over time — in order to account for income appropriately. On top of distinct construction bookkeeping project requirements, construction also features long and often seasonal production cycles. Because production can be less predictable, contractors often aren’t able to retain large amounts of inventory.

According to the IRS, small companies can use the cash method of accounting for tax purposes, but large companies cannot. Plus, small companies can use CCM, avoiding PCM, for contracts up to two years, whereas large companies must use PCM for long-term contracts. And small companies can avoid the IRS look back for contracts up to two years. Here’s how to choose the right accounting method for a construction business or for individual projects within a construction business. Progress Billings is a separate account that the entity should create to keep track of Revenue that is collected for each individual project. The entity will submit bills for work completed throughout the project.