How to Create a Construction Chart of Accounts

Listen or watch now:

https://www.youtube.com/watch?v=P-tMvomBVPo

The foundation of any robust construction accounting system lies in a well structured chart of accounts. But building one can be tricky. Let’s walk through it.

Topics we cover in this episode include:

  • Walking through the Chart of Accounts
  • How to treat retaineage properly in your Chart of Accounts
  • Cost of revenue categories

LINKS
Join the conversation on our LinkedIn page: https://www.linkedin.com/company/CarpenterCPAs

FIND US ONLINE
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

TRANSCRIPT

[00:00:00] Wade Carpenter: Is your construction business’s financial tracking as effective as it could be? The foundation of any robust construction accounting system lies in a well structured chart of accounts.

But building one with the unique needs of the construction industry can be a tricky task.

Come on in, let’s talk about it. This is the Contractor Success Forum. If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs. With me is my co host Stephen Brown with McDaniel Whitley Bonding and Insurance.

Stephen, setting up a chart of accounts is more than just a bookkeeping exercise, it’s about creating a financial roadmap that guides decision making and growth. Any initial thoughts with this to start us off?

[00:00:42] Stephen Brown: A financial roadmap. Robust. Tricky. You’ve thrown some really good adjectives out here in this introduction. love it because if it doesn’t work for you and if it doesn’t accomplish your goals, it doesn’t do any good. I want to know, Wade, exactly what is a chart of accounts in the construction industry.

[00:01:01] Wade Carpenter: So the chart of accounts is one of the main building blocks of building your accounting system. And it’s one of the things that contractors will start up their company and never really get advice on. And then years later, they’re going back and come to somebody like me to get their chart of accounts set up, the cost code structure set up, and they are two very different systems.

 The main building block of your accounting system needs to be built on a chart of accounts. That is the financial structure of building a balance sheet and a profit and loss. And in my world it’s basics, but there are some nuances to construction that we just don’t find in a chart of accounts in other industries.

 The receivables, the payables, and certain things like retainage. are unique to construction. If you’ve got construction deposits that come in, if you’ve got over and under billings on percentage of completion.

So, if we can, I just wanted to talk through that and maybe hit some of these highlights as we go.

[00:01:57] Stephen Brown: All right, I’m all ears.

Walking through the Chart of Accounts

[00:01:58] Wade Carpenter: We’re going to share the screen here and, just walk you through.

A chart of accounts are the building blocks of an accounting system. And you can see on the screen, we typically will do it in the order of a balance sheet and then the income statement. I would recommend you start off in the order of assets versus liabilities and then equity.

This is a balance sheet. The assets, just high level, those are the things you own. The liabilities, those are the things you owe to other people, and then the equity is what’s left over.

[00:02:31] Stephen Brown: Wait. Wait a second. Tell me about those numbers to the left and what they mean and what they’re used for. For example, current assets is 1000. Cash is 1010. There’s a number to the left hand column. What’s the purpose of that?

[00:02:44] Wade Carpenter: We’ll come back to these numbers. Basically, building a balance sheet means that the total assets are going to equal the total liabilities and equities. So that’s what makes it balance.

Just from the top level, we understand the income statement. That’s the sales minus the expenses is the profit. And in a contractor’s world, one of the main pieces that you need to get right is the cost of revenues.

You may see this as cost of goods sold, but in construction, it is cost of revenues because we’re not really selling goods. This is one of the biggest pieces that we can get right in knowing how our jobs are really coming out.

 Then we have the section below that is the expenses or I refer to them as selling general administrative expenses or SG& A. And properly done, this should be what you consider your overhead.

I do have these numbers out to the side, and these are the building blocks of the chart of accounts. This is the way our firm standard is, but depending on, if you’re a general contractor and you’ve got multiple divisions, you could have multiple numbers beyond this, or letters, but typically it goes in an order similar to this.

The 1000s are typically the assets, and then at some point we go into the current assets, and then other assets that are more long term.

We’ll hit some of the nuances of this in a minute. Then we have the current liabilities, and that starts with the 2000s in my chart of accounts, and it goes to say 22, 23, 2400. Where we’re trying to figure out the things that are due within the next 12 months, which would be the accounts payable, things like your payroll tax liabilities. the principal payments on your long term debt that are due within the next 12 months. The higher 2000s are the liabilities.

We know by looking at our account number, this is the class it goes in, and then the 3000s are equities, which means things like common stock, retained earnings, paid in capital.

4000s are the revenues, 5 000s are cost of revenues, 6 7 000s the expenses. And then we leave the 8 9 000s for things like other income and other expense, such as interest income, interest expense is really related to the financing. A lot of people will put that up here, but we like to put it down here because it has more to do with financing part of your operation.

[00:04:56] Stephen Brown: Absolutely.

If you’re working with a client and they don’t have this in place, can you and your team help them set this up and explain to them when some certain invoice or bill comes in of what code to put it under so you produce pretty accurate in house information?

[00:05:14] Wade Carpenter: Absolutely, and we’re trying to put some order to it. I just recently took on one that the guy’s been in business over 25 years, and doing about 5 million a year. Never really got any of this stuff down, didn’t get the cost code structure down. And sometimes people just survive by sheer luck.

And he wanted to put some order to it and start running it right. Because he realized, hey, these numbers have gotten bigger, my overhead’s gotten bigger. I’m not really taking home as much as I really wanted to. So this is something that’s a lot more common than just a startup business.

Typically businesses will go many years and never really get this set up right, but maybe you get to that next level and you need to start adding a higher end accounting software than QuickBooks Online. You need to put the structure in place.

I’m going off topic here, but one of the things I see all the time is where somebody will try to bring in one of these third party softwares, whether they’re tying it into QuickBooks Online or even if you got something like it’s not Timberline anymore, like Sage Construction Real Estate, but all of them have a canned chart of accounts, canned cost code structure.

If you set up a contractor in QuickBooks, they have a canned chart of accounts. And I do not agree with the way they set that up. A lot of it is not set up so that some of the things that should be going to a job are stuck in the cost of revenue side. So that’s why it’s very confusing to a lot of people.

Same with the cost codes, and I’m trying to stick to the chart of accounts right now, but the cost code structure that’s canned in your software a lot of times does not reflect what you’re doing.

So these are the basic building blocks of building the entire accounting structure and getting some help in your industry specialization, getting some help beyond what the software rep can tell you the software can do, that can go a long way. And it’s something we pretty much do with every client we take on.

[00:07:08] Stephen Brown: I can definitely see why not getting it set up the right way in the first place, it will absolutely defeat the purpose of what you’re trying to accomplish. Build an accounting system that gives you the right information so you can make the right decisions in order to make the profits you want to make.

How to treat retainage properly in your Chart of Accounts

[00:07:23] Wade Carpenter: Let’s spend a little bit of time walking through this. We talked about before things like having accounts receivable, and that’s standard for any business, but if you got retainage, a lot of people treat retainage improperly. And when they bill it out, they will not put it on their books.

And so that 10 percent retainage, say a hundred dollar invoice, and the only book 90 percent in your accounts receivable, you’re not capturing both the retainage as a receivable and the income that goes with it. That’s one of the things that we see, we’re trying to put a financial statement together and they’ve never really had books. And a lot of times they’ll look like they’re way under billed because they don’t have this in place.

Other things like inventory, I don’t even usually like to even bring up inventory because most contractors don’t really have it. But what you will see on the standard QuickBooks chart of accounts is they will come up with something called WIP, or Work In Process. And nobody knows what that means.

The people that set up the QuickBooks just have a generic account that gets thrown in there. And, this type thing where we’re talking about costs in excess of billings and billings in excess of costs are measures that you would see if you’re trying to do percentage of completion basis accounting, and it’s an adjustment to revenue, and we’re also going to have an offset in our income statement section to as that gets adjusted, we’re going to have an offset in our income statement section to where, as that gets adjusted, it’s going to go here. I typically will break this out in the income section to where you have billings and you can tie back to that billings number. So that’s just another thought with this.

[00:08:51] Stephen Brown: You were talking about the retainage receivable and retainage payable, and showing it on your financial statement. I was just curious, in this situation where the amount is 5,000, would that be retainage that’s on the books that has not been earned yet or not been paid yet?

[00:09:08] Wade Carpenter: Not been paid. It doesn’t mean you’ve billed it. If you’ve got a retainage receivable that you’ve actually got the right to bill, you should remove it from retainage receivable and put it into regular accounts receivable.

[00:09:19] Stephen Brown: Okay.

[00:09:19] Wade Carpenter: Otherwise, if Stephen is looking at this and they want to look at your counter receivable and you put all that retainage in there, and it shows that, hey, this bill is 180 days old, you didn’t really have the right to collect it, but it’s going to make it look like this is some receivable that nobody’s going to collect.

[00:09:35] Stephen Brown: Okay. So retainage payable would be retainage that you owe maybe a subcontractor that’s working for you.

[00:09:42] Wade Carpenter: While we’re at it, I don’t know if you’ve noticed, but I’ve also got a retainage receivable down here in the bottom and very few people I’ve ever seen do this. And this typically has to do with contractors that have longer term contracts. But if you don’t expect to collect that retainage within 12 months of this balance sheet date, then that is actually a long term retainage receivable.

And so we like to tell the bonding company that, because they, technically should not be counting that as working capital, according to accounting rules.

[00:10:13] Stephen Brown: That’s a great way to do it, Wade.

[00:10:15] Wade Carpenter: Same token, we talked about the retainage payable, that’s another part where I think I told a couple of stories about one big contractor that we were working with that had never captured any of that, and they were not capturing the cost, so they were not billing all these costs. They only booked what was currently due on that job, and so they were leaving two to three million dollars worth of subpayable, plus the profit on top of that. And, it’s just simply because people have not been treating it properly.

And again, you may see other things in here I don’t have job deposits as a liability, or the over under billings. There’s a few different things that you might see. But the biggest part of the differences lie in the income statement. So any thoughts on the balance sheet before we leave that?

[00:11:01] Stephen Brown: No, I think this is rock solid. I like and agree with everything that you have in this.

[00:11:07] Wade Carpenter: Okay. It’s just an example, and while I’m at it too, the way this ties in, the retained earnings is simply the retained earnings from your profit that you leave in the business.

In this case, we started the year with 23,000, we ended up with a 36,000 net profit, and the owner took out distributions of 10,000 and leaves 49,000 in this example. This is how all of this balances. We tie all of this into our retained earnings.

 Typically what we see In the income statement, in structuring this properly, the revenue section, like QuickBooks Online, we see all this time, they have these canned things that says product revenue, and you’re a construction contractor, you’re not selling product. And setting those items up properly and getting the captions properly, but we do have a section where we do tie out the billings, and if it’s a percentage of completion, we’re going to make an adjustment for that.

Cost of revenue categories

[00:12:01] Wade Carpenter: I want to spend some time talking about the cost of revenue, and I realize this is a high level type discussion for this, but, I still think of them through five main categories of job costs are your labor, materials, subcontract, equipment, and then your other job costs.

 There’s a lot of debate about what should be going into this. GAAP does have rules about that. Typically when we set it up, I will do like the 5100s or the labor 5200s or the materials 5300 subcontract. 5, 400 equipment and the ones under like the 54 to 5499 would be equipment related like depreciation or repairs and maintenance on your equipment or some kind of equipment burden or leasing and then other job costs. I would probably break down some subcategories of this, but things like your bonds, other things, shop supplies or whatever.

[00:12:53] Stephen Brown: Mobilization and utilization cost.

[00:12:55] Wade Carpenter: Yep. Typically we want to do things like under the labor, obviously things like the payroll taxes that go with the direct job labor.

[00:13:04] Stephen Brown: All the costs of the labor for your project.

[00:13:06] Wade Carpenter: Yeah, so that would include your payroll taxes, but it would also include things like workers comp up here because we can tie it directly to the labor that it goes with.

You’ll notice like things like labor. I’ve got administrative labor, so if somebody is working, doing your accounting, your, office workers, we carve that out because we know that those people are not working on a job.

Sometimes there’s things that are not cut and dried between the two. You could have also depreciation down here. And if it’s depreciation on your computers and your desk and stuff like that, that’s one thing. That would go down here.

But if it is depreciation on your equipment, if you’ve got heavy yellow iron, that can be a huge cost that you’re missing by not allocating those things to the job.

So just talking in general, a lot of these expenses, there’s a few different ways to do it. When we have good records, we could tie in labor directly. A lot of times the better systems will be able to pull in workers comp rates and payroll taxes automatically. But some of these things , perhaps you’re trying to allocate things like your retirement plan allocation that has to do with your job labor versus your administrative labor.

 Say, we’ve got fuel. Typically fuel for a job, I would try to get up here. But things related to, say, equipment, repairs and maintenance on heavy yellow iron can be very expensive. It’s hard to sometimes tie that to a job.

[00:14:29] Wade Carpenter: Sometimes we’ll take a, accumulate it down here in our SG& A, but we will make an allocation to the different jobs depending on how we set it up.

[00:14:38] Stephen Brown: Okay.

Six to seven thousand, your overhead as a percentage of your revenue is a number you need to tie into your estimates, right?

[00:14:47] Wade Carpenter: It is. And, there are several times I’ll have a contractor and they’re very inconsistent. They may have sub up here, but contract labor down here. And, being consistent is, one of the key things I would tell you to do internally. But externally, if you’re trying to compare this with other grading contractor industry statistics, and you’re not following industry standards, you’re going to say, why is my overhead so much more or less than industry standards? As well as the bonding company and the bankers may be questioning, what’s going into that?

[00:15:18] Stephen Brown: A humongous general contractor of ours once told a younger customer of mine that the key to their success is they account for everything. If you use a shovel, on a job, it’s accounted for. Why? It’s just a shovel. Because eventually that shovel has to be replaced, and if you don’t account for it, then it comes out of your profit.

It sounds so simple, but it’s everything. So the detail that you can put into getting this right really pays off financially for you.

[00:15:49] Wade Carpenter: Absolutely. This usually is going in hand with the conversation about a cost code structure. I’ve said this many times, a contractor that has no job costing, as long as we can at least get them in the main categories and get it actually costed to a job, that’s a huge leap forward.

But having the cost code structure means hey, if you’re demo or concrete or electrical, plumbing, whatever the things are, you could be subbing out parts of those things, or you could have materials for plumbing or electrical. And so there’s a cost code where we’re slicing and dicing our costs different ways so we can see, on a line by line basis how we’re doing, how we’re billing it.

If you’re using AIA billing, you probably got to do the schedule of values and put a lot of that detail. And all this marries up to this structure that we’re trying to build.

The topic today is figuring that chart of accounts out. But you would be surprised at how many people that I see have been doing this for years and never really gotten their structure down.

 I know I’ve hit a lot of different things just off the cuff. But, final thoughts on this or any questions you have that I didn’t address?

[00:16:57] Stephen Brown: No, I think you did a great job. The information that you present is basic. There’s so many added categories that change and evolve based on your needs, but a good foundation gives you clear and quick picture of how things look and also to your bond agent and underwriter and your banker. It’s a picture of how you look.

So getting it right, my closing advice would be, call Wade or someone with Wade’s experience, to help, to help you get it set up the right way. And again, I say, as always, find a construction oriented accountant. that is specific to your industry, because they really know how to set this up the right way and they know, based on their experience, the kind of things that are going to come up, the questions that you’re going to have.

Wade, what is your closing advice?

[00:17:44] Wade Carpenter: I recently had one that actually reached out last week, before they started and they wanted to get the accounting structure before even opened the doors, and I’m like that is so unusual for me.

[00:17:56] Stephen Brown: Did you tell them you loved them right then and there? Because I imagine that made your day.

[00:18:01] Wade Carpenter: It did. And honestly, the guy actually signed up on the spot. It was amazing to me after I talked to him a little bit. It’s hey, I really need to do this, but so many times it’s the exact reverse of that. It’s, we’ve been running for years, and we’ve never really got the structure down and we really like to get some advice on how to get really good job numbers.

So that’s my advice is reach out to somebody. I’d love to talk to you about your structure if want to give me a call, but I hope if nothing else, this gave you some kind of overview of the process.

[00:18:31] Stephen Brown: I think it did Wade. Thank you.

[00:18:33] Wade Carpenter: All right, thank you all for listening to Contractor Success Forum.

 Check out the show notes at contractorsuccessforum.com or on the Carpenter CPA’s YouTube channel for more information. We would appreciate it if you consider subscribing and follow us every week as we post a new episode and we will look forward to seeing you on the next show.

Posted in

contractorsuccessforum

Leave a Comment





Listen or watch now:

GET notified of future episodes!