Construction and Real Estate Accounting
Construction and Real Estate Accounting: A Practical Guide to Costs, Billings, and WIP
Construction and Real Estate Accounting: A practical entry explaining the unique nature of contracting companies, how to manage project costs, progress billing, and control over Work in Progress (WIP) for accurate reporting and sustainable profit—Digital Salla.
- Fundamental definition: How Construction Accounting differs from trading.
- The 4 pillars of Project Costs: Materials, Labor, Equipment, and Overheads.
- Managing Work in Progress (WIP) and the “Inventory of Services.”
- Progress Billing (Invoices): Certification and Retention Payables.
- Revenue Recognition: The Percentage of Completion (PoC) method under IFRS 15.
- Advance Payments and the Guarantee Withholding logic.
1) The Concept of Construction Accounting
Unlike a retail store that sells finished goods, a Contracting Company sells a long-term service. Construction accounting is specialized because projects often span multiple financial years, requiring a methodology to allocate profit and loss over time.
2) The 4 Pillars of Project Costs
To calculate project profit, you must track these direct elements:
- Direct Materials: Cement, steel, and finishing materials delivered to the site.
- Direct Labor: Wages and benefits for site workers and engineers.
- Equipment & Plant: Depreciation or rental of cranes, excavators, and generators.
- Subcontractors: Payments to specialized firms (e.g., HVAC or Plumbing contractors).
3) Work in Progress (WIP) and Certification
In construction, “Inventory” is called Work in Progress (WIP).
- WIP: Accumulated costs that haven’t been “Cleared” by an invoice yet.
- Progress Billing (Invoice): Based on a Certificate of Completion signed by the client’s consultant.
4) The Construction Revenue Path (Visual Logic)
How a project turns from “Expenses” into “Audited Revenue”?
Projects Finance & WIP - Excel File
5) Revenue Recognition (Percentage of Completion)
According to IFRS 15, construction revenue is recognized “Over Time.” The most common way to measure progress is the Cost-to-Cost Method:
Revenue for the period = (% Completion × Total Contract Value) – Previous Revenue
6) Retention and Advance Payments
Two unique financial elements in contracting:
- Advance Payment: Cash received before work starts. It is a Liability, not revenue, and is deducted from future invoices.
- Retention (Guarantee Withholding): A percentage (usually 5-10%) the client keeps until the warranty period ends. This is a Retention Receivable for the contractor.
7) Operational Controls & Readiness Checklist
To ensure your Project Accounting is accurate:
Construction Quality Gate Checklist
- Are Variation Orders (Extra work) documented and approved in writing?
- Is the Estimated Cost to Complete updated monthly by engineers?
- Do we perform Site Visits to verify the existence of materials in WIP?
- Are Subcontractor Retentions being recorded in a separate ledger?
- Is the Percentage of Completion verified by the Technical Dept?
8) Common Errors and How to Prevent Them
- Front-loading: Inflating initial completion percentages to get cash faster. This leads to losses at the end of the project.
- Ignoring Variations: Doing extra work without an approved “Variation Order,” leading to uncollectible costs.
- Confusing Cash with Revenue: Recording the advance payment as sales. Sales = Effort, not Cash.
- Static Estimates: Using the same total project cost estimate for 2 years while material prices fluctuate.
9) Frequently Asked Questions
What is ‘Under-billing’ in construction?
It occurs when the revenue earned (based on work done) is greater than the amount invoiced to the client. This is a current asset (Accrued Revenue).
What is ‘Over-billing’?
It occurs when the amount invoiced to the client is greater than the revenue earned. This is a current liability (Deferred Revenue).
Is the cost of the site office part of direct costs?
Yes, if it is dedicated to one project, it is a direct overhead. If it serves many projects, it is an indirect cost.
10) Conclusion
Mastering Construction and Real Estate Accounting is the difference between a contractor who grows and one who disappears. By utilizing the Percentage of Completion method correctly and maintaining rigid control over WIP and Project Costs, you provide management with the “Real Story” of profitability. Accurate project costing ensures that your entity is not just “Busy” with work, but is actually generating cash flow and institutional value that survives the long project lifecycles characteristic of the industry.
Action Step Now (30 minutes)
- Pick your largest active project.
- Compare Total Invoiced vs. Total Costs Incurred.
- If costs > invoices, check: Do you have a Certificate of Completion pending for that WIP? If not, investigate the delay today.