job cost accounting for construction

job cost accounting for construction

The Importance of Job Cost Accounting in the Construction Industry

1. Introduction to Job Cost Accounting

A job cost accounting system that is designed to provide management with the broader view, as well as the immediate and necessary specifications and operations of any element of construction accounting. It must be flexible to accommodate unexpected conditions as well as established procedures. It must have value as a tool, not as an end in itself, and should help management to achieve corporate goals. Special needs of diverse types, size, activity, and management-information requirements of firms engaged in the actual performance of construction work.

Good job! Cost accounting is essential to the successful management of a construction contracting firm. Construction is a business that has become increasingly complex and competitive in the last 10 to 15 years. Management improvements must be made on a very timely basis. A job cost accounting system that is an outgrowth of construction realities is the most useful tool for the immediate and accurate information needs of an active construction business.

2. Key Concepts and Terminology in Job Cost Accounting

Several key concepts and terms are helpful in understanding job cost accounting. Job cost accounting is concerned with two types of construction jobs. The first type is a fixed-price job, in which the contractor has a contract to complete the work and is paid a contract price by the owner. The contractor negotiates a price for performing the job based on cost estimates for material, labor, and overheads to complete the project. The second type is a service job or contract. In this case, the contractor works on a cost plus basis. The owner pays for the cost of the material, labor, and overheads, plus a specified amount of contractor’s fee. The contractor negotiates a fee based on cost estimates for material, labor, and overheads, to cover the job.

Construction companies operate by performing construction activities. Each activity is referred to as a construction job or contract. The result is a product or building and an accounting challenge. Companies in the construction industry prepare many accounting reports to measure job performance. Unlike general accounting that is concerned with an entire company, job cost accounting in the construction industry is concerned only with the receipts and disbursements for specific jobs. Revenues are derived primarily from the fees charged for contracts or construction service work. Operating expenses reflect the costs of labor, materials, and operating expenses. The purpose of job cost accounting is to determine the true cost of each job and the term or maturation of that cost.

3. Methods and Techniques for Job Costing in Construction

As the financing of construction projects range from large institutional or industrial endeavors to a small commercial or residential effort, the requirement that the construction company has a useful job costing system has to offer information that can be used by different decision-making levels within the organization. The criteria for job costing must be modified to fit the differences in projects. The more complex large project should require a system where the cost can be properly charged either to the final overhead only or to the total overhead of the construction company. Various billing points should be identified in the cost analysis to provide an information breakdown which can be used for profit control, as well as used in obtaining progress payments. In the smaller construction projects, a simplified system of recording the cost might be necessary to keep the cost of job accounting within bounds. The immediate benefit in cost control, meaning expense control, would be the system’s most beneficial feature. The profit control benefit is difficult to produce in the final analysis due to the very nature and size of this type of work. Small works would seldom provide useful cash flow information, as this is dictated by the contractor’s own financial position rather than by the work underway.

In this chapter, the progress billing method of job costing will be explained in detail. There are numerous methods and techniques that can be used to job cost in the construction industry. Many times, job costing previously involved a great amount of laborious detailed accounting work to distribute the cost properly. Technology has had a substantial impact on this situation. Today, job costing should be an everyday business management tool. The need for detailed cost control for both estimated expense and financial reporting in the construction industry has dictated that specific reference to some of these methods and techniques was necessary. The various complexities of each individual project lead to a different approach, both in the techniques used in recording the costs and expenses, as well as in the timing of the reports needed.

4. Benefits and Challenges of Implementing Job Cost Accounting in Construction Projects

In the construction industry, particularly in small firms with limited access to accounting professionals, one of the major difficulties in implementing job cost accounting is the lack of adequate accounting and bookkeeping. Workers may complete work orders and sign payroll sheets that show their work hours and the types of work performed, yet projects could still have unaccounted-for worker hours. Cost data may not be properly collected, recorded, and allocated in the accounting information system. Implementing job cost accounting in construction projects requires the full and accurate recording of costs and efficient collection of data. Subcontractors can be another significant challenge to the implementation of job cost accounting in a project. Subcontractor payments are one of the largest costs to a general contractor, and subcontractors’ inefficient accounting systems become major sources of profit loss and differences of opinion between the general contractor and the subs. In addition to the costs and complexity of recordkeeping, managers do not always get reliable performance from a subcontractor’s accounting or vital information from their daily activities will connect subcontractor costs to their job codes in the accounting system. Some general contractors believe that they cannot begin timely and effective cost accounting until they receive a tale of accounts from subs, but specialty subs are often the very last to close out their contracts. Finally, managerial attitudes towards change are another roadblock that prevents project managers from implementing essential job cost accounting systems.

4.2 Challenges Faced by Contractors when Implementing the Job Cost Accounting System

Timely and accurate cost control of project activities is critical if profitability is to be maintained over time. Project managers can use the cost accounting system to estimate costs for job completion, including materials and labor, and to establish realistic budgets for future work. Job cost accounting provides financial management with accurate and timely cost data for setting future norms and forecasting costs on various construction activities. Job cost accounting helps project managers recognize when their building will not be profitable. Managers can stop action on unprofitable projects or renegotiate with the customer or other parties for a change in the contract to account for additional costs. From a decision-making perspective, the job cost accounting system helps management personnel plan and coordinate production schedules.

4.1 Benefits of Implementing Job Cost Accounting in Construction Projects

5. Case Studies and Real-Life Applications of Job Cost Accounting in the Construction Industry

The area construction has improved significantly in the past 30 years from a labor-intensive, relatively technology-ignorant industry to a capital-intensive, high-tech industry. The changes perceived in the education process are the changes in the job requirements and advancement perception available to recent graduates. The necessities by government and industry for properly trained professionals with management ability, technical competence, and quantitative skills, predestined that the traditional construction forms and functions were at least conceptually intact. Graduates were viewed as honest people who give and receive contracts, who received and delivered finished jobs, and basically stayed out of the way except for emergencies. Society saw relatively little malfeasance among engineers who usually followed the unwritten code of practice established by peer professionals. Honesty, integrity, and propriety were much more easily established and esteemed. However, today, most professions including the construction business are heavily entrenched in the economics of the 1980s and many tenets of the business world that academicians have ignored are now evident to graduates and faculty every day. The light that was not perceived previously was the importance of job cost accounting and accounting systems for construction contractors.

On one hand, this lack of readily available information about cost accounting systems is influenced due to competitive considerations. On the other hand, the fast pace of technological improvements and the high costs differ from other job cost accounting systems, making it difficult to update texts and other educational material. This leads to a large theory-practice gap, in which students trailing in modern accounting courses lose an opportunity to put theory into a context and enable them to place accounting concepts within a framework. The purpose of this study is to analyze case studies and real applications in contractor job cost accounting. Hopefully, the reports in the various studies will provide accounting students with much-needed information regarding how real contractors actually prepare their cost accounting systems and perhaps what their problems are with the information they obtain. In this way, students will outpoint information agencies such as the SEC who in the past have discriminated against contractors when setting performance measurements and have found little if any information with respect to accounting by contractors in an increasingly important part of the industry.

Studies of actual contractor job cost accounting systems are not readily available. Although a great deal has been written in texts about how job cost accounting should be done, these writings are primarily prescriptive in nature and do not spend much time examining what contractors actually do. Little has been mentioned in the modern literature pertaining to how contractors account for job costs, how they design their job cost systems, and what particular difficulties are encountered when they take their costs to completion. Solely design criteria for a contractor’s accounting are the main concerns of accountants when they discuss this topic and not how the actual design is achieved. The main reason for the lack of information on contractor accounting procedures is that this type of information is confidential and internal in terms of a competitive advantage. There are good reasons for this. The ability to obtain various contracts from a pool of competing contractors may be enhanced by the information a contractor keeps about how to estimate costs, how costs affect the final outcome and the margins of profit. The more one knows about the financial performance, the better are the strategies for future performance. However, some information regarding cost accounting practices is available in accounting textbook solutions to exercises, but usually this is also uninsightful and deals with specific design criteria.