Running a construction company means dealing with accounting issues that most other industries don’t face. In construction, projects can span many months or even years, costs aren’t fixed, and each job is like its own mini-business.
This article is for new construction of entire buildings (commercial and residential). Other construction industries, such as plumbers, framers, finish work, remodels, etc. don’t have to follow this accounting method for tax purposes. In this blog, we’ll explain why construction accounting is different from regular accounting, focusing on long project timelines and fluctuating costs.
Construction accounting is inherently project-centric, meaning each project (or new construction job) is treated as a separate entity for accounting purposes. This is a big shift from regular businesses that simply track overall income and expenses. Here are a few key factors that make construction accounting unique:
One major reason construction accounting is unique is how revenue is recognized for long-term projects. The Percentage of Completion Method (PCM) is a specialized accounting approach designed for projects that take place over multiple periods. Under PCM, you recognize revenue and related expenses gradually over the life of a project, rather than all at once at the end.
In PCM, the portion of revenue you recognize in a given period is tied to the percentage of the project completed during that period. Typically, this is calculated using a cost-to-cost approach – you compare costs incurred to date with the project’s total expected costs to determine progress.
For example, if a new construction project has an expected total cost of $100,000 and you’ve incurred $50,000 in costs so far, the project is 50% complete. You would then recognize 50% of the project’s revenue in your books. If the contract value is $120,000, you record $60,000 of revenue to date. This revenue is matched with the costs incurred, so you’re recognizing roughly 50% of the costs against the 50% revenue, giving a realistic profit to date.
In contrast, using the Completed Contract Method (CCM), you’d wait until the project is 100% finished to recognize all the revenue and costs at once. The problem with the completed contract approach is that it can make one period look extremely profitable and the earlier periods look artificially unprofitable (or vice versa). It also slows revenue recognition, which can be an issue for tax purposes if the IRS or GAAP says you should be reporting income as you earn it.
Importantly, GAAP (Generally Accepted Accounting Principles) require that revenue be recognized in the period it is earned. This means for most long-term contracts, using PCM is the proper way to abide by accounting standards. Additionally, many new construction contracts (especially in commercial work) require contractors to provide work-in-progress reports that effectively use PCM to show percent complete and earned revenue.
Because each new construction project is unique and spans a long time, tracking income and expenses for each project separately is critical. This is often called job costing, meaning you assign all revenues and costs to the specific job they belong to. For construction company owners, this means you should be tracking by property or by project in your accounting system.
In practice, you’ll want to set up your books so that you can see the profit and loss for each project individually. For example, if you’re a homebuilder working on three houses at the same time, you should be able to tally the income and costs per house. You would record every expense – lumber, concrete, permits, labor hours, subcontractor invoices, etc. – with a label or tag for either “House A” or “House B” accordingly. Likewise, any customer billing or loan draw for House A is tagged to that project’s income.
Examples of Per-Project Costs: To illustrate, here are typical cost categories you’d track for each new construction project (property):
By tracking these costs, you can produce a job cost report that shows total expenses vs. budget for each job. This not only tells you if you’re on track to profit but is also necessary for calculating PCM. PCM uses the costs incurred on a project to figure out percent complete, you must have accurate cost totals per project to do it right.
Similarly, any income associated with a project should be tied to that project’s account. In our example, if you bill the client $50,000 as a milestone payment on House A, that revenue should be recorded under Project A’s name. This way, when the project is done, you can see total revenue vs. total cost and know your exact profit on that job.
The good news is modern accounting software like QuickBooks Online (QBO) has features to facilitate project-based accounting (job costing). To get accurate job profitability reports from QBO, you need to set it up correctly – typically using Projects or Classes.
QuickBooks Online Plus and Advanced editions include a Projects feature that is specifically made for job costing. You can create a project under a customer and assign all related income and expenses to that project. You can also use Class tracking as an alternative. Both approaches let you separate transactions by job.
Setting Up Projects in QBO: To enable project tracking, go to Account & Settings in QBO. Under the Advanced tab, make sure Projects is turned on (QBO may call it “Organize all job-related activity in one place” – enable that). Also, in the Expenses settings, it’s a good idea to turn on the option “Track expenses and items by customer”. This allows you to tag each expense to a customer or project. If you use Classes, enable class tracking in the Advanced settings.
Once that’s set up, here’s how you organize your new construction costs:
Using projects/classes in QBO brings organization to your new construction costs. Instead of one blob of “Construction Expenses,” you have a breakdown by job, which is exactly what you need for both managing your business and doing PCM calculations.
We’ve talked about PCM from a management perspective, but there’s another critical reason to follow it: tax compliance. The IRS has specific rules for accounting on long-term new construction contracts. If your company reaches certain size thresholds or project lengths, you may be required by law to use PCM for tax reporting.
Generally, the IRS requires contractors to use PCM for long-term contracts (contracts not completed within the same tax year) unless they qualify for an exception. The two main exceptions are:
If you do not meet these exceptions the IRS mandates you use PCM for that contract’s income reporting. Each year, you must report the portion of income earned per PCM calculations on your corporate tax return. If a contractor is required to use PCM but ignores it , several issues arise:
Construction accounting may be more complex than standard bookkeeping, but getting it right keeps your business healthy. By using PCM to recognize revenue appropriately and tracking each project’s costs properly (with the help of tools like QBO Projects), you set your company up for clarity and compliance. You’ll have a clear view of each job’s profitability and won’t be caught off guard by tax obligations.
Is your construction accounting set up correctly? LedgerFi can help you find out. We specialize in bookkeeping for new construction businesses, and our experts can audit your QuickBooks setup to be sure all methods are configured for success.
Don’t wait until an IRS audit or a profitless project surprises you! Contact LedgerFi today for a setup audit or project-based support. We’ll help you implement PCM where needed, organize your job costing in QBO, and keep your books compliant with industry standards. This way you can focus on building structures while we help build your financial foundation.