Best Practices in Developing a Chart of Accounts for a Construction Company

A well-structured Chart of Accounts (COA) is the backbone of any accounting system, serving as a financial roadmap for organizations. The necessity for a customized COA becomes even more crucial in the construction industry, where projects can greatly differ in size, scope, and complexity. It not only supports accurate financial reporting but also enhances project management, budgeting, and compliance efforts.

This post highlights the optimal strategies for creating a construction chart of accounts, tailored to the specific requirements of construction firms. It emphasizes the efficient categorization of expenses, along with the incorporation of crucial accounts such as cost in excess, billing in excess, and an over/under account in the income statement.

Understanding the Basics of a Chart of Accounts for Construction Accounting

A Chart of Accounts (COA) is an organized listing of all accounts within the general ledger of an organization. It provides a framework for classifying and recording all financial transactions, ensuring that financial statements are accurate and comprehensive. The COA typically includes the following components:

Assets: Resources owned by the company (e.g., cash, equipment, accounts receivable). ‍

Liabilities: Obligations owed to creditors (e.g., loans, accounts payable). ‍

Equity: The owner’s interest in the company (e.g., retained earnings). ‍

Revenue: Income generated from business activities. ‍

Expenses: Costs incurred to generate revenue.

Unique Considerations for Construction Companies

In the construction industry, the Chart of Accounts (COA) must be tailored to meet the unique requirements of the industry, like monitoring expenses by project, stage, and type. Unlike many other industries, construction requires a more granular approach to account management to capture the various elements of each project. This often involves using subaccounts and segmentation to reflect the different stages and types of work involved in construction projects. However, it is important to use subaccounts in moderation, if not avoid them entirely, to maintain clarity and simplicity in the COA.

Tailoring the Chart of Accounts for Construction Industry Needs

Job costing is a critical component in customizing a chart of accounts for construction. It enables detailed tracking of all project costs, including direct costs like labor and materials, and indirect costs such as equipment rentals. A well-structured construction COA should integrate seamlessly with job costing systems to provide detailed tracking and reporting on a per-project basis.

Construction-Specific Chart of Accounts (COA) Best Practices

1. Categorization: Breaking Down Costs into Direct, Indirect, and G&A

The income statement for a construction company must be carefully structured to differentiate between direct costs, indirect costs, and general and administrative (G&A) expenses:

• Direct Costs: These are costs directly attributable to a specific project, such as labor, materials, and subcontractor fees. They should be the first section on the income statement, as they represent the core expenses of the construction business. ‍
• Indirect Costs: These are costs that support construction activities but are not directly tied to a specific project, such as equipment depreciation, utilities, and supervisor salaries. They should be listed separately to give a clear picture of the overhead costs associated with running the business. ‍
• G&A Expenses: General and administrative expenses are costs associated with running the overall business, such as office rent, executive salaries, and marketing expenses. These should be distinguished from construction-related costs to ensure accurate financial analysis.

2. Job Costing Integration: Aligning COA with Job Costing Reports

To ensure accurate project costing, the COA should be fully aligned with job costing reports. This involves creating accounts that correspond directly with the categories used in job costing, allowing for seamless integration and reporting. For example, if a job costing system tracks costs by labor, materials, and equipment, the COA should have corresponding accounts that mirror these categories.

3. Segmentation: Leveraging Reporting Dimensions in Software

Instead of using the COA to segment departments, divisions, or locations, construction companies should leverage the reporting dimensions available in their accounting software. Many modern software solutions, like QuickBooks, use classes or similar features to divide the business based on units, allowing companies to track costs and revenue separately for each department, division, or location without complicating the COA. This approach keeps the COA clean and focused on financial accounts while still providing the detailed insights needed to manage and analyze business performance across different segments of the company.

4. Consistency: Maintaining Uniformity Across Projects

To facilitate meaningful comparisons and reporting, it’s important to maintain consistency in the COA across all projects. This means using the same account structure and coding system for every project, regardless of size or scope. Consistency helps ensure that financial reports are accurate and comparable, making it easier to analyze performance and identify trends.

5. Compliance: Adhering to Industry Standards and Regulations

The COA should be designed to comply with industry standards and regulations, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). Additionally, construction companies must be mindful of specific regulations related to contract accounting, revenue recognition, and cost allocation. Ensuring that the COA is compliant with these standards is critical to avoiding financial discrepancies and potential legal issues.

6. Retention: Create AR and AP Retainage Accounts

Retainage, or the portion of a contract payment withheld until the completion of a project, is a common practice in construction. It’s crucial for construction companies to have separate accounts for Accounts Receivable (AR) and Accounts Payable (AP) retainage within their COA. These accounts ensure that retainage is accurately tracked and managed, preventing discrepancies between the amounts withheld and the final payments. The use of distinct retainage accounts helps maintain transparency in financial reporting and ensures that all parties are aware of the outstanding amounts.

7. WIP: Create Work In Progress (WIP) Accounts

Work-In-Progress (WIP) accounts are essential for accurately reflecting the financial status of ongoing projects. WIP accounts should be included in both the balance sheet and the income statement:

• Balance Sheet WIP Accounts: These accounts track the costs incurred on projects that are still in progress, including labor, materials, and overhead costs. Specifically, they should reference Cost in Excess of Billing under Assets and Billing in Excess of Cost under Liabilities. These accounts need to be regularly adjusted to reflect the actual costs incurred and the percentage of project completion, ensuring an accurate financial snapshot of ongoing work. ‍
• Income Statement WIP Accounts: WIP accounts on the income statement should reflect the Over/Under WIP Account, which helps in recognizing revenue and expenses based on the percentage of completion method. This approach aligns revenues with the costs incurred, providing a more accurate and detailed picture of a company’s profitability during the construction period.

8. Complication: Avoiding Too Many Accounts & Use Cost Codes

To maintain an efficient and manageable Chart of Accounts (COA), it's crucial to avoid overcomplicating it with too many accounts. An overly detailed COA can become difficult to navigate, increasing the risk of errors and inefficiencies. Focus on creating only the most essential and meaningful accounts, using subaccounts sparingly to capture necessary details without overcrowding the main COA. Streamlining the COA ensures it remains functional and easy to manage.

A best practice in construction accounting is to strategically use cost codes instead of creating excessive accounts. Cost codes allow for the precise categorization of expenses such as Material, Labor, Equipment, and Subcontractor costs, enabling detailed tracking and analysis without overwhelming the COA. By leveraging cost codes, construction companies can accurately allocate costs, improve budgeting, enhance cost control, and make informed decisions. This method simplifies financial reporting, increases transparency, and provides a clear overview of expenses across different project components.

9. Don't Under-Segment: Avoid Under-segmenting Critical Accounts

Conversely, under-segmentation can lead to a paucity of details, complicating the process of cost tracking and analysis. Make sure the Chart of Accounts is adequately segmented to gather the necessary data for precise reporting and informed decision-making. For instance, consolidating indirect costs into one account could make it hard to pinpoint areas for potential cost reductions.

Sample Chart of Accounts

In a construction company, it's crucial to implement a uniform Chart of Accounts (COA) across all projects for the sake of consistent financial reporting and easy comparison of project performance. Having a consistent account structure ensures that financial data is recorded and presented in a uniform way, regardless of the project's size or scope. This not only improves the precision of financial evaluations, but also aids in better decision-making and project management by offering a transparent and comparable financial overview. Furthermore, a uniform COA simplifies the training of new employees, decreases the chance of mistakes, and guarantees adherence to industry standards, thereby enhancing the overall financial stability and operational effectiveness of the company.  Hereis a sample Construction Chart of Accounts.

Assets (1000-1999)

• 1000 Cash: Represents cash balances in bank accounts, on hand, or equivalents readily available for company operations.
• 1200 Accounts Receivable: Amounts due from customers for completed work that have been invoiced but not yet collected.
• 1220 Retainage Receivable: Portion of payments withheld by clients until project completion as a guarantee of work quality.
• 1230 Construction in Progress (CIP): Costs associated with ongoing construction projects not yet completed or billed.
• 1240 Cost in Excess of Billings: Costs incurred on jobs that have not been billed to clients, creating a future billing opportunity.
• 1300 Other Current Assets: Assets expected to be used or converted to cash within a year, such as inventory, short-term investments, or deposits.
• 1400 Prepaids: Expenses paid in advance, like insurance premiums or rent, which are allocated to future periods.
• 1500 Fixed Assets: Long-term physical assets such as machinery, vehicles, or buildings used in operations.
• 1600 Accumulated Depreciation: The total depreciation charged against fixed assets over their useful life to account for wear and tear.

Liabilities (2000-2999)

• 2000 Accounts Payable: Outstanding amounts owed to suppliers and subcontractors for goods and services received.
• 2100 Retainage Payable: The portion of payments withheld from subcontractors or vendors until project completion.
• 2200 Billing in Excess of Costs: Progress billings to clients that exceed the actual costs incurred, creating a liability to finish the work.
• 2300 Credit Card Payables: Balances due on credit cards used for business expenses.
• 2400 Loans: Short-term and long-term debt obligations from loans or lines of credit.
• 2500 Accrued Liabilities: Expenses incurred but not yet paid or invoiced, such as wages, taxes, or utilities.
• 2600 Long-Term Liabilities: Debts and obligations due beyond one year, such as long-term loans, leases, or bonds.

Equity (3000-3999)

• 3000 Owner’s Equity: The owner’s initial and additional investment in the business, reflecting their residual interest.
• 3100 Retained Earnings: Accumulated profits or losses retained in the business and not distributed to owners.
• 3200 Distributions: Withdrawals made by the owner or shareholders as a return on investment.

Income (4000-4999)

• 4000 Revenue: Total revenue generated from construction projects and related services, typically broken down by type of work.

Direct Costs (5000-5999)

• 5000 Direct Labor: Costs associated with labor directly attributable to specific construction projects.
• 5100 Direct Materials: Costs for materials used in construction projects, such as lumber, concrete, or electrical components.
• 5200 Direct Subcontractor Costs: Payments made to subcontractors for work performed on specific projects.
• 5300 Direct Equipment Rental: Rental costs for equipment used on specific construction projects.
• 5400 Direct Other Costs: Other direct costs not covered by labor, materials, or subcontractors, such as permits or specific project fees.
• 5900 Direct Indirect Allocation: Allocation of indirect costs to projects where they directly support the work.

Indirect Costs (6000-6999)

• 6000 Indirect Labor: Labor costs for employees not directly working on a specific project but supporting construction activities.
• 6100 Indirect Materials: Materials that support construction but are not directly used in any one project, such as maintenance supplies.
• 6200 Small Tools and Supplies: Tools and minor equipment used on multiple projects and not tied to a single job.
• 6300 Equipment Depreciation (related to projects): Depreciation on equipment used in projects, allocated over time.
• 6400 Safety and Compliance Costs: Costs associated with safety equipment, training, and regulatory compliance.
• 6500 Vehicle and Equipment Fuel: Fuel expenses for vehicles and heavy equipment used across multiple projects.
• 6600 Temporary Facilities: Costs of setting up temporary jobsite facilities like trailers or portable restrooms.
• 6900 Indirect Allocation: Allocating indirect costs across projects to accurately reflect their contribution to project expenses.

General & Administrative Expenses (7000-7999)

• 7000 Salaries and Wages - Office Staff: Salaries for office employees such as administrative staff, accountants, and executives.
• 7100 Office Rent: Rent expenses for office space used for general operations.
• 7200 Office Supplies: General supplies required for office operations, like paper, pens, and printer ink.
• 7300 Professional Fees (Legal, Accounting): Costs for professional services, including legal counsel, auditors, or consultants.
• 7400 IT and Software Expenses: Costs of technology, software licenses, and IT support.
• 7500 Insurance - General Liability: Premiums for business insurance, protecting against general liability risks.
• 7600 Marketing and Advertising: Costs for advertising services, campaigns, or promotional materials.
• 7700 Travel and Entertainment: Business-related travel expenses and client entertainment costs.

Other Income (8000-8099)

• 8000 Interest Income: Interest earned on business savings or investments.
• 8010 Gain on Sale of Assets: Profits from selling business assets like equipment or property.
• 8020 Miscellaneous Income: Any other income streams outside core construction activities, such as rebates or one-time payments.

Other Expense (8100-8999)

• 8100 Interest Expense: Interest paid on loans, credit lines, or other borrowing.
• 8200 Depreciation and Amortization: The reduction in value of fixed assets and amortization of intangible assets over time.
• 8300 Loss on Sale of Assets: Losses incurred from selling assets below their book value.
• 8400 Other Miscellaneous Expenses: Any other costs not directly tied to construction activities, such as fines or penalties.

Key Takeaways

• Standardization with Tailoring: Standardizing the Chart of Accounts is essential, but it should be tailored to your business’s specific needs and operations for optimal effectiveness. ‍
• Efficient Categorization and Sequencing: Categorize accounts into Direct Costs, Indirect Costs, and G&A Expenses with clear sequencing and numbering to enhance organization and clarity. ‍
• Integration with Job Costing: Align the COA with job costing reports to provide a detailed and accurate financial picture of each project. ‍
• Use of Retainage and WIP Accounts: Incorporate specialized accounts for Retainage and Work-In-Progress (WIP) to manage construction-specific financial aspects effectively. ‍
• Avoid Overcomplication: Maintain simplicity in the COA by avoiding excessive accounts and leveraging cost codes for detailed tracking without cluttering the COA. ‍
• Adherence to Industry Standards: Ensure the COA is compliant with GAAP or IFRS and specific regulations related to contract accounting and revenue recognition.

How RedHammer Can Help You

At RedHammer, we understand the complexities of construction accounting and the importance of a well-structured Chart of Accounts. Our expert team is here to support your business with the following services:

• Design and Implement a New Chart of Accounts: We will help you create a COA tailored to your company’s specific needs, ensuring it supports accurate financial reporting and effective project management. ‍
• Assist with Software Selection and Implementation: Choosing the right software is crucial for your financial success. We’ll guide you through the selection process and ensure seamless implementation that aligns with your COA and overall business goals. ‍
• Software Remediation and Accounting Cleanup: If your current accounting system is not meeting your needs, we can assist with remediating your software setup and cleaning up your accounts to ensure data integrity and compliance. ‍
• Outsourced Accounting Services: Let us take the burden off your shoulders with our comprehensive outsourced accounting services. We’ll handle everything from day-to-day bookkeeping to high-level financial management, allowing you to focus on growing your business.

Conclusion

A well-structured Chart of Accounts is critical for the financial health of any construction company. Customizing your COA to align with your business needs ensures better financial management and compliance with industry standards.

By focusing on simplicity and consistency, your COA will remain functional and effective as your business grows. Implementing these best practices will enable you to maintain an organized and accurate financial system, making informed decisions that drive business success.

Remember, a tailored COA is not just a tool for financial reporting; it’s a strategic asset that can help you achieve your business goals.