Every construction company, regardless of whether they are a general contractor, subcontractor, or something in between, must be able to win and complete jobs efficiently. Business owners and project managers need information to accurately bid and estimate projects. It is imperative that the company generates accurate and timely reports. While some project managers rely solely on experience, the most successful project managers know how to best utilize the job schedule. The job schedule tells the story of construction projects at a point in time by providing a summary of all contracts the company has in process or has completed on a contract by contract basis. The job schedule relies on several factors, however, the most important is proper job costing. Proper project costing leads to better profitability, project estimating, management decisions, and timely financial reporting.
Job costing, profitability, and estimates
Proper job costing uses the costs recorded to a particular contract to reveal the profitability of each job, which can be compared to the original profit estimate. Diligent cost allocation also leads to more precise profitability numbers by project type. This in turn leads to more accurate feedback on current jobs and more precise estimating on future bids.
Knowing profitability by job helps management know where projects went right and where projects went wrong. A job cost system can track projects by phases and types, allowing relevant information at each stage of the contract. If a job has a loss, but all costs were coded properly, management can use that information to make decisions in the future. Profitability can vary from the estimate for a variety of reasons. It is possible the price of materials went up since the bid was submitted or a special skill was needed from a subcontractor that cost more than expected. If management can identify why a job did not go as planned, they can adjust their estimating on similar jobs in the future or find a more cost efficient way to handle issues that may arise again. This cannot be done without accurate cost allocation.
Job cost software and technology
A successful job schedule requires the proper processes and software. A strong job cost system will integrate with accounting software and processes such as tracking budgets and costs as they are incurred. Creating an effective system includes identifying jobs by numbers and type, and the ability to appropriately code costs. Many job cost software programs will use applications on mobile devices, allow subcontractors and vendors to send electronic documents, and integrate with the current accounting software to help achieve these goals.
The benefit of recording costs to jobs goes beyond accurate profitability, it also creates better accounting records. For accurate records both direct and indirect costs must be properly allocated to the correct job. Having good accounting practices, such as accurate and timely cost allocation, helps prepare precise reports and perform analytical review of contracts, which is crucial to making management decisions.
An analytical review is a comparison of financial information between the current and prior periods. When done accurately, a review will show the trends of the business, profitability on contracts, where cost saving opportunities may be available, and project financial results of the business in the future. Many contractors utilize management by exception reporting to identify a variance off the normal job costs which is another benefit of a comprehensive review. Management should predetermine a set percentage variance that would prompt a full investigation by the managing staff. As an example, the team may determine that a variance of 2% may not necessitate a review, but a variance of 10% does. This will be dependent on project, company, and industry standards. In short, the analytical review puts the numbers to work and helps them make sense. Take the following example of what one might ask based on the outcome of the review:
- If subcontracting costs have increased by 10%, were the cost overruns approved?
- Would the company have saved money if it used in house labor?
- Has the company reached maximum capacity of in house labor? Should additional employees be hired, instead of subcontracting work out?
Questions like these allow management to make better decisions for the company.
Along with accurately recording costs by contract, timely job costing is essential. When cost allocation is done in a timely manner, management is able to make decisions on jobs on an ongoing basis. Without timely job costing, management could miss an opportunity to identify unforeseen cost overruns that may require a change order to be applied. Likewise, completing financial statements on time satisfies the company’s investors and allows the company to meet bonding and financing requirements. As most bonding companies compare contractors’ work in process schedules from year to year, consistent record keeping is necessary.
Internal controls and detecting fraud
Timely cost allocation also improves the company’s ability to identify fraud. The construction process inherently creates situations where fraud can occur. A properly designed job cost system creates additional internal controls. Costs could be miscoded or unrecorded by mistake, giving the job a false sense of profitability, or a cost could be miscoded or unrecorded due to an employee trying to show false profits on a job to receive better commission or a bonus. Employees could also misdirect materials and other resources to personal projects. Having accurate and timely cost allocation provides the company with a real time accounting of costs, allowing unexpected or unreasonable costs to be detected earlier and prevent additional misallocation and lost profitability.
Overall, cost allocation provides important information for the job schedule, analytical review, and the company as a whole. Proper job costing leads to better profitability, management decisions, and timely financial reporting.
Ryan & Wetmore, P.C. is a Washington DC metro area firm with offices in Bethesda, Maryland, Frederick, Maryland, and Tysons’ Corner, Virginia specializing in construction contracting. We are members of the BDO Alliance’s Construction Accounting Network, Construction Financial Management Association, and Rainmaker Companies Real Estate & Construction CPAs. For assistance with industry comparison, establishing a job cost system, or software, please visit us online and contact our construction team Peter Ryan and Jason Dudas.
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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