Key Differences between Construction Accounting and General Accounting
Construction accounting and general accounting are two distinct branches of accounting that serve different purposes. While both types of accounting involve the recording, analysing, and reporting financial transactions, they differ in many ways. This section will delve deeper into the key differences between construction accounting and general accounting.
Focus on Projects vs. Focus on Company Finances
One key difference between these two approaches is how they handle risk management. Focusing on projects allows for a more targeted approach to identifying potential risks within each project. However, this can also lead to overlooking broader financial risks that may affect the entire company. On the other hand, prioritising company finances considers all potential risks across various projects and allows for better risk mitigation strategies at a higher level.
Another important aspect that sets these two approaches apart is their impact on cash flow management. Focusing solely on individual projects means closely monitoring expenses related to each one separately but may not provide an accurate overview of overall cash flow needs. Prioritising company finances allows for better forecasting cash flow requirements based on all ongoing projects and other business expenses.
Percentage of Completion Method vs. Completed Contract Method
Percentage of Completion Method:
This method recognises revenue based on the percentage of work completed during a reporting period. If a project is estimated to be 50% complete at the end of a year, 50% of its total revenue will be recognised in that year’s financial statements.
Similarly, costs are also recognised in proportion to the percentage of completion. This allows for a more accurate matching of revenues and expenses, providing a clearer picture of a company’s profitability over time.
Completed Contract Method:
On the other hand, under the CCM method, revenue and costs are deferred until the project is substantially completed. This means that no profit or loss will be recognised until all work on the project has been finished.
While this may seem more straightforward than POC, it can paint an inaccurate picture as it does not reflect how much work has been done. However, this method provides certainty as no estimations are involved – revenue and costs are only recorded once they have been incurred.
Job Costing vs. Process Costing
Job or job order costing is a method of tracking expenses for a specific project or job. This can be useful for construction companies that work on multiple projects simultaneously, as it allows them to allocate costs accurately to each project. The critical feature of job costing is that it tracks costs by each unique job or contract rather than department or process.
On the other hand, process costing involves allocating costs based on the stages of production or manufacturing process. This method is more commonly used in food and beverage production industries, where large quantities of similar products are produced over time. This method may be applied in construction accounting when identical homes or buildings are being constructed.
Importance of Accurate Construction Accounting
One of the main reasons for the importance of accurate construction accounting is that it allows for effective cost management. Construction projects are known for their high costs and tight budgets, making having precise financial data at every project stage essential. Accurate construction accounting enables contractors to monitor costs and identify potential cost overruns early on in the project. This information can then be used to make informed decisions regarding budget adjustments or changes in project plans.
One of the critical reasons for the importance of construction accounting is its ability to provide accurate financial information about a specific project. This includes tracking costs, managing budgets, forecasting cash flow, and identifying potential risks. With this information, project managers can make informed decisions and take necessary actions to keep the project on track.
Furthermore, construction firms often have multiple ongoing projects with different scopes, timelines, and complexities. In such cases, having a robust construction accounting system becomes essential as it allows for efficient management of resources across all projects. This helps prevent cost overruns, delays, and other common challenges faced in the industry.
Another critical aspect of construction accounting is its focus on job costing. Unlike general accounting, where expenses are recorded high (such as utilities or office supplies), construction accounting breaks down costs by specific jobs or tasks. This enables businesses to accurately determine which projects are profitable and require improvement or adjustment.
Effective communication between various stakeholders involved in a construction project is crucial for its success. Construction accounting provides standardised reporting formats that allow contractors to communicate financial information clearly with their clients, suppliers, investors, and other parties involved in the project.