While we all make mistakes, some are more costly than others. No matter the industry, accounting requires diligence and attention to detail to avoid major pitfalls. For construction companies, common errors may be hiding behind the numbers unless great care is taken. To avoid costly mistakes, it is important to know the five common accounting errors made in construction accounting. 

1. Misestimation of job costs 

The most important factor to consider in construction accounting is the estimated costs of jobs since most contractors use the percentage-of-completion method for revenue recognition. Poor estimating, inaccurate actual cost accumulation, or improperly excluding revisions from change orders often create complications. To avoid these errors, it is imperative to compare actual costs to estimated costs every month and ensure that estimated costs include the same elements as actual costs. Additionally, consideration must be given to increasing prices and wages in the future while revising estimates monthly. 

2. Inaccurate joint venture 

Though a joint venture is common in construction, the proper accounting for it is often misunderstood. To avoid mistakes, it is vital to determine the correct accounting from the beginning. For example, consolidation is needed with direct or indirect “control” of the entity and is generally used when there is a 50 percent ownership interest. However, when there is significant influence over the entity, the equity method is used and is typically applied with a 20 percent ownership interest. Generally, the cost method is used when the ownership interest is below 20 percent.  

3. Incorrect overhead rate 

To allocate indirect costs such as rent, utilities, and depreciation, most contractors use an overhead rate where a percentage is multiplied by direct labor costs or material costs. However, there are some variations of this. If the rate is left unchecked and is not an accurate depiction of the company’s current overhead costs, this can lead to an over-or-under-allocation of costs. To prevent this error from occurring, it is imperative to revisit the rate annually to determine that correct costs are included, and the most appropriate method is applied. Determining the best method for a contractor to use should be based on the most critical components of the construction activity, labor, and materials. 

4. Failure to record losses 

For revenue recognition, most contractors commonly use the percentage-of-completion method. Unfortunately, errors often occur when the completion percentage is multiplied by the contract amount without consideration given to whether the job is estimated to be a loss. General accounting principles require that a loss contract be fully recognized at the time the loss is determined. To do this, monitoring is needed. A detailed job schedule including the estimated total job revenue, estimated costs, and the related estimated gross profit will assist with monitoring. When an estimated loss is determined, an accrual for the loss must be recorded. 

5. Improper costs cutoff 

The accrual basis of accounting is the standard method used by most contractors. With this accounts receivable and accounts payable method, revenues and costs are recorded in the time earned or incurred. However, a cutoff error occurs when incurred costs are omitted from the period reported. This is usually the result of receiving invoices after the period, therefore, closing the process in accounts payable before acknowledging the costs. A voucher system is needed to avoid this error where costs incurred are recorded as liabilities in the period incurred. Then the accrued costs can be matched with invoices and set up for payment as recorded in accounts payable. 

How can Accounting for Construction help? 

Accounting for construction requires a keen eye for detail, whether accurately tracking expenses or categorizing costs, and we know that there are unique challenges associated with the construction industry. With knowledge from decades of experience, our financial professionals at Accounting for Construction are ready to help your business with the complexity of construction accounting. Ensure that your company avoids these construction accounting pitfalls by contacting us online or calling (918) 984-9262 today.