The main goal of Accounting Standard Codification (ASC) 606 is to create a similar revenue recognition policy and calculation across all industries. The construction industry, which has historically had its own guidance and industry practices, is no exception. Below are the first four steps as required by ASC 606:
- Identifying the contracts
- Identifying the performance obligations
- Determining the transaction price
- Allocating the transaction price to the performance obligations
Once you have completed the above, please continued reading for items that may affect the construction industry when finally recognizing revenue in step five:
1. Timing of Recognition
ASC 606 has two basic options for recognizing revenue once control has been transferred:
- over time or
- at a point in time.
In order to recognize revenue over time, one of the following criteria needs to be met:
- The customer receives and consumes the benefits provided by the seller’s performance as they perform.
- The seller’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced. For example, you are constructing a building on the customer’s land, even if construction is stopped half way through the project, the customer’s asset (land) has received value.
- The seller’s performance does not create an asset with an alternative use to the seller, and the seller has an enforceable right to payment for performance completed to date. For example, pre-fabricated wall panels are customized for a specific project and the contract stipulates once production starts costs are the customer responsibilities.
Before determining if a contract meets one of the above requirements, construction companies will need to understand when transferring control of the asset, as defined within ASC 606, occurs. It is not until control is transferred that revenue can be recognized. ASC 606 defines “control of an asset” as the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from an asset.
Examples of indicators that transfer of control has occurred include:
- An entity has a present right to payment for an asset.
- Customer has legal title to the asset.
- Physical possession of the asset has transferred.
- Customer has accepted the asset.
These concepts are easier to conceptualize when the end product is a tangible item, but when considered in relation to the construction of a building, parking lot, house or any component within a larger construction project it becomes more difficult. Often in these projects, the customer will not accept the asset until all punch list items have been completed.
Percentage of completion and completed contract methods, in name, no longer exists. In essence, “billings in excess of costs” and “costs in excess of billings” will shift to the concepts of “contract liability” and “contract asset.” Instead of percentage of completion, contractors will use a cost “input method” as described in ASC 606 when calculating the contract liability/asset. Although the actual math using the new input method will be nearly identical to the calculation used for over and under billings, the path to this point will be different.
3. Change orders
Under ASC 606, the scope of a change order determines if it should be considered a separate contract or should be combined with the original contract. The determining factors in that decision is based on if the change order results in an addition of a distinct good or service and if that good or service reflects the standalone selling price.
4. Wasted materials
The accounting for wasted material was emphasized within ASC 606. If a construction company has wasted costs (purchased the wrong materials, had re-work due to error, poor job management, etc.) those costs are recognized immediately and not taken into account as a job cost. Therefore, this is not part of the cost input calculation when recognizing revenue over time.
5. High material costs
Based on the type of construction project, material costs can be the majority of the total job costs. ASC 606 requires construction companies to consider the realistic progress made on a job when determining if the material costs can be included in the cost input method calculation.
Example – If a $500,000 job includes a $300,000 generator and on day one of the job the generator is purchased, the calculation would exclude the $300,000 in costs and in contract value when completing the cost input calculation.
Even with nearly a decade of warnings, revenue recognition has arrived quickly, and is now requiring the attention of construction companies. Without careful planning and reviewing of contracts, revenue streams could unintentionally change.
Do you understand the impact of the new accounting standard on your construction company? Revenue recognition has been around since 2010, when the first draft of the new standard was released. Three exposure drafts and numerous accounting standards later, it will be required to recognize income under the five step approach beginning December 15, 2018.
Tariff – a tax on imports or exports, typically between two countries. It is a form of regulation of foreign trade and a policy that taxes foreign products to encourage or safeguard the domestic industry.
In recent years, governments have used tariffs as a form of protectionism. In 2018, the United States government began imposing tariffs on steel, aluminum and lumber from a number of countries. These tariffs were imposed in order to try to protect the United States manufacturing industry. However, these tariffs may lead to negative effects for industries, such as construction, because it relies heavily on these products. Construction businesses need to be:
• aware of these tariffs
• the challenges they could bring
• have strategies in place to address these challenges
Impact of Tariffs on Construction Businesses
• Increases in material costs.
As tariffs are an additional tax on the imported materials, the cost of these materials will increase, leading to increased job costs for your construction business. If they cannot be passed to the customer, they will go directly to the bottom line.
• Volatility in pricing.
As the government is in control of the tariff policies, at any time there may be changes to the rate or it may be removed completely. Being unable to accurately predict this pricing, may have a negative impact on contracts and budgets, which were completed under different scenarios.
• Delays in receipt of materials and project completion.
Tariffs often lead to delays in receipt of materials as processing times at ports of entry typically become longer. Large projects, which had their scheduling completed prior to the tariffs, may face difficulties in reaching completion.
• Changes in supply chain or lack of materials.
Tariffs may lead to your vendor’s prices increasing to where you cannot afford. You may need to shop around for the best price. This could lead to difficulties working with a new vendor, decreased reliability in receiving materials or having to settle for the increased costs. Tariffs may also affect the number or type of choices for material specifications for a project, as there may only be a few types of materials in the desired price range.
4 Strategies to Mitigate Challenges
- Escalation Clauses
An escalation clause is a provision in a contract calling for adjustments in fees, wages, or other payments to account for fluctuations in the costs of raw materials or labor. As it relates to tariffs, an escalation clause may be included in a contract to shift the burden of increased material costs from the contractor to the customer.
- Supply Bonds
Supply bonds are used to provide a guarantee that a supplier will deliver the promised materials on time. Securing supply bonds upfront, will mitigate the risk of materials not being delivered if a large tariff is imposed on the vendor in between the time of the signing of the contract and the time of delivery.
- Subcontractor Default Insurance
Subcontractor Default Insurance may be used to recoup costs incurred from a default in performance by a subcontractor. If tariffs affect a subcontractor to a point where they are unable to fulfil their performance requirements, this will help to protect the contractor.
- Stay Up-to-Date
Keep track of current and future proposed tariffs. This will help your construction businesses improve planning and allow you to get in front of the challenges discussed above.
Our Construction & Real Estate Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Contact us today to learn business strategies that will help you grow and save you money.
Success in the construction industry requires the ability to cost effectively create a building envelope, structure or support system and virtually every financial decision regarding your construction company, has a tax consequence. The summary outlined below covers the most common sales tax implications for construction contractors.
Materials & Supplies
Contractors must pay sales tax on the cost of all materials, supplies, and equipment to complete a construction contract.
Tax Tip: You may pass this tax onto your customers as part of the materials cost. Do not itemize it separately on customer invoices.
If you sell repair
parts or materials to your customers WITHOUT installation, you have made a
Tax Tip: Charge sales tax on the total selling price of retail sales and itemize on your customer’s invoice.
If you are a
contractor and also make retail sales, the rules for when and how you pay tax
on your purchases depend on:
- Whether you know how the items will be used when you buy them
- Whether they will be used in a construction contract or sold at retail
- In some cases, whether you are “primarily a retailer” or “primarily a contractor”
You are primarily a contractor if at least 50
percent of your business purchases are used for construction activity
- Pay sales tax on all purchases.
- If you sell any items at retail, deduct cost of materials you already paid sales tax on.
You are primarily a retailer if at least 50
percent of your business purchases are for retail sales.
- Do not pay sales tax on your purchase.
- Give supplier completed Certificate of Exemption.
Contracts with Exempt Organizations
You owe sales tax when you contract with exempt organizations such as churches, schools, and government agencies. In order to buy materials tax exempt, the exempt organization must designate you as its purchasing agent. The written contact must include all of the following:
- The appointment has been made.
- The exempt organization takes title to all materials and supplies at the point of delivery.
- The risk of loss for all materials and supplies is that of the exempt organization.
- The exempt organization has responsibility for all defective materials and supplies including those incorporated into realty.
You are responsible to keep documentation to show the purchasing agent relationship exists, such as a letter indicating the above information, copies of written contract including all four items noted above, and evidence of the organization’s exempt status. You must also keep records of all materials and supplies purchased for the exempt project.
An exempt organization
cannot appoint a contractor as its purchasing agent for the purchase or lease
of equipment used by the contractor in completing the construction contraction.
The exemption only applies to building materials, equipment, and supplies that
become part of the improvement to real property.
Aggregate & Concrete Sales
If an aggregate seller delivers and spreads aggregate material so no further leveling or movement is required by the purchaser, the sale is considered an improvement to real property and not taxable. The aggregate seller is required to pay sales or use tax on their cost of any taxable products or services used to complete the contract.
An aggregate seller
must charge sales tax on both the material and delivery charges when they dump
aggregate material in a pile and/or when the construction contract does not
require them to deposit the material so that no further leveling or movement is
Ready-mixed concrete sold from a ready-mixed concrete truck, without installation, is taxable, including transportation, delivery, or other service charges.
The U.S. Supreme Court struck down the physical present nexus standard established in the 1992 decision Quill Corp v. North Dakota in the landmark South Dakota v. Wayfair, Inc. case. States can now require certain retailers, with no physical presence, to collect and remit the applicable sales or use tax on sales delivered to locations within their state.
October 1, 2019, Minnesota’s Small Seller Exception does not require remote
sellers to collect sales tax until their sales during a period of 12
consecutive months total either:
or more retail sales shipped to Minnesota
or more in retail sales shipped to Minnesota
Note: When calculating this exception, do not include any sales where the purchaser is buying for resale. Purchaser should give you a completed Form ST3, Certificate of Exemption claiming an exemption for resale. August 2017 is the earliest month to include to calculate if the business qualifies for the Small Seller Exception.
What Does This Mean?
The biggest impact of the Wayfair case on the construction industry is the requirement of all Minnesota sellers, regardless of their location, to collect state and local sales taxes based on where your customer receives the taxable product or service. Construction businesses tend to operate in multiple locations and construction sites and it will be important to determine if/when local sales taxes are payable. See examples below detailing how to source the sale and determine which taxes are applicable:
A construction business is physically located in St. Paul, Minnesota. A customer from Rochester, Minnesota visits the store in St. Paul and purchases materials. In this example, the customer takes the materials with them when they leave, so the possession of the items were transferred at the physical location of the store. The tax assessed on the materials is the Minnesota general rate sales tax plus any applicable local taxes for St. Paul.
A construction business is physically located in St. Paul, Minnesota. A customer from Rochester, Minnesota purchases materials online and has them shipped to their home in Rochester. The tax assessed on this sale would be Minnesota General Rate sales tax and any applicable local taxes for Rochester, since possession of the items were transferred when the items were received by the customer at their home. Sourcing would also be Rochester if the customer went in to the physical location and asked for the materials to be shipped to their home. Keep in mind, the cost to ship the materials should be included in the sales price and the entire amount taxed.
You are responsible for researching or contacting each state to determine your sales tax registration and reporting requirements. If you are not up to speed on all the changing and new state tax laws, it may put your construction business at risk for penalties and interest charges on unpaid tax liabilities – potentially in multiple states.
of the most important relationships for any business is with their CPA. This is
especially true in the construction industry because of the many unique features
and complexities in construction accounting. Industry knowledge and close
collaboration are instrumental in providing construction businesses with the
insight and awareness to make the best decisions and seize growth
opportunities. Here are some things to look for when hiring a construction CPA
1. Knowledge of Construction Accounting
most important thing you should look for in a CPA is their knowledge of
construction accounting. There are many accounting issues affecting the
construction industry, including:
of recognizing revenue
of direct and indirect costs
of work in progress, over billing and under billing
of these items can be treated differently depending on the type of contractor,
the company’s gross annual revenue and the length of the projects. Working with
a CPA who is able to navigate these differences and provide you with accurate
and timely financial data is important to the success and growth of your
In addition, the Financial Accounting Standards Board (FASB) has issued a number of new accounting pronouncements that will go into effect in the near future. Two of the most important deal with the way in which companies recognize revenue, and the way companies record lease obligations. The CPA firm you choose should be knowledgeable about these two new standards and the potential impact they will have on your construction business.
2. Recognized in Industry
right CPA firm will work closely with your other professional service providers
such as bankers, lawyers and sureties. This is especially important in the
construction industry where these providers use your financial data to extend
credit, provide bonding and help ensure you are able to operate your business
successfully. Having a reputable CPA in the construction industry provides
comfort to your other service providers and allows them to make better
decisions regarding your finances.
Tip – When considering a construction CPA, ask for industry references!
“Excellent service matched with quality work and great people.” Tom Getzke | Minnesota Builders Exchange
3. Familiar with Construction Software
businesses use a fairly basic accounting software like Quickbooks or Sage.
However, some of these programs do not have the capability to handle accounting
issues specific to the construction industry. This is especially true for large
and growing construction companies. You should work with a construction CPA
firm that is knowledgeable about a wide variety of software packages. Your CPA
should make a recommendation if a change in your system is needed, and this
will help make implementation and maintenance easier.
4. Help Save you Money with Construction Industry Tax Advantages
Construction industry tax is a complex area and should be done by a CPA who understands these intricacies. There are a number of tax accounting methods and advantages available to construction companies, and each method has its own set of rules and exceptions. Your CPA firm should understand how these complexities affect your business and how you can benefit from the various tax methods available to the construction industry.
5. Other Experience
Knowledge and experience is an important factor in hiring a CPA firm. You should find a firm who works on a large number of construction clients of all sizes and types. This will ensure they understand the industry as a whole. The variety of experience will help them provide you with other value-added services, not just assurance and tax compliance. This will ultimately help your business grow and prosper.
“We have a great team working on our account! They are professional, proactive, and responsive.” Alan Matthys | Engineered Products Co.
Smith Schafer is a recognized leader in providing accounting, auditing and consulting services to the industry. Our Construction & Real Estate Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. From large construction companies to specialty contractors, we have the experience to bring you innovative solutions.
your construction company have an annual budget? Owning and operating a
construction business is not easy and requires expertise in your craft, as well
as in-depth knowledge of your company’s finances. According to data from
IBISWorld reports, one of the top success factors for a construction company is
effective cost controls and budgeting.
- Supports planning and financial goals
- Assists with managing your money
- Helps keep costs under control
- Aids with the decision-making process
Here are six tips to help you create and maintain a budget for your construction business:
1. Develop or refine your business plan.
Your budget is a financial representation
of your business plan. Creating a budget should not be attempted until you have
a developed and refined business plan.
2. Look at the market.
You should regularly monitor
construction industry trends and your business market(s). You should also study
local economic projections and census data. A rise in population and a thriving
economy may lead to increased residential and commercial building spending.
After studying your market trends, connect this with your business plan to
develop a realistic idea of potential revenue.
3. Evaluate your expenses.
The next step is to evaluate your
with your direct costs, which are expenses related to a specific project and
include materials, labor and subcontractor services.
assess your monthly fixed costs like rent and salaries.
review how your remaining costs vary month to month.
This will help determine cash flow needs
at various times throughout the year.
4. Determine if your rates are reasonable.
Once you have evaluated your revenue
potential and your actual expenses, you will need to determine the amount of
revenue needed to pay your expenses while also leaving enough to show a profit
at year end. Your project rates may need to be adjusted accordingly.
5. Create a spreadsheet.
Organize this information in a
spreadsheet or online budgeting software. Choose a tool that is convenient and
easy for you to continue to use going forward.
6. Track your progress.
Compare actual results against your
budget and adjust your budgeted numbers as needed. You should review your
income statement and cash flow statement monthly. These reports can be created by your internal
accountant or CPA firm, and should be shared with other
members of your management team.
Maintaining a realistic budget will allow you to make informed business decisions that will lead to continued success. Use these tips to create a budget and keep your financial progress on-track as your year unfolds. Need help? Our Construction & Real Estate Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Contact us today to learn business strategies that will help you grow and save you money.
construction company accounting software may be a time-consuming and costly
process, but an ineffective accounting software is burdensome and impedes growth.
Are you a construction company owner? Have you considered changing accounting
Before committing to a new software package, you should asses the following:
- What are your construction company’s NEEDS from its accounting software?
The first step, before changing an accounting software, is to discuss with all employees. From shop personnel, who will be receiving inventory, to the CFO, who will be running reports. Ask these individuals, what tasks should the software ideally perform? What tasks in the current software are not operated in an efficient way?
- What are the potential time and cost BENEFITS a new accounting software could provide?
Discuss the time and cost benefits your construction company may experience from making a change in accounting software. Potential benefits include:
- Removing the need to double track jobs in an excel spreadsheet or other outside application.
- Reducing time related to chasing down paper documents. Many softwares are able to host all documents electronically.
- Improving office to job site integration through add-on applications to the accounting software.
- Increasing understanding of individual jobs, which can lead to improved estimating, budgeting, forecasting and predicting of costs for current and future jobs.
- Does your CURRENT accounting software meet the above needs?
Changing accounting software is a commitment from every level of your construction company. Once you have accumulated your list of needs, take the time to determine if your current software has the ability to meet those. Consider the addition of modules, training and support offered by the vendor. Also consider your level of satisfaction with your current vendor. If you determine your current software cannot meet both your current and future needs, you can then consider making a change
If, after the above assessment, changing accounting software is the best option, below are four items to consider:
- Fully Integrated vs. Basic Accounting Software
A fully integrated construction accounting software helps to ensure your job costing and the accounting general ledger should reconcile to the penny between each other. A fully integrated system includes things such as, construction payroll, billings, purchasing and subcontract controls, general ledger reports by job, and job reports. Basic accounting software will not include modules specific to job costing. However, there may be a separate job costing system to meet your needs and may be used alongside your accounting software.
Note: In most cases, it is beneficial to switch to a fully integrated software once your construction company regularly has $3 million in annual revenues or have five or more major jobs occurring at one time.
- Access & Portability
Things to consider include multiple user access, security preferences, multiple business support, cloud based versus server based, and mobile access. Determining what your construction company needs, will help eliminate software options that do not meet the minimal requirements.
- Knowledge Required
Take into account the knowledge and willingness of your employees. Some software requires high-level accounting knowledge to use, while others are geared towards individuals with limited accounting education or experience.
Be aware of all aspects of the cost of the software. This includes fees for upgrades, annual licensing, support fees, training and hardware costs. Often, the premium features are not part of the basic software package and have additional add-on costs.
construction company goes smoother and profits stay higher with the right accounting
software. Smith Schafer can help you choose the right
financial management tools for your construction company and guide you through
Smith Schafer is a recognized leader in providing accounting, auditing and consulting services to the construction industry. Our Construction Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. From large construction companies to specialty contractors, we have the experience to bring you innovative solutions. Click here to schedule a free 30 minute consultation.
We look forward to speaking with you!