Construction Accounting and Bookkeeping

Construction accounting diverges from standard business accounting in ways that create real financial exposure for contractors who treat them as equivalent. A single misallocated job cost, an incorrect revenue recognition method, or an untracked retainage balance can distort profit margins across an entire project portfolio—and trigger tax liability that catches a contractor flat-footed at year-end. For businesses operating in the Northern Mariana Islands, where the contractor market intersects with federal compliance requirements, getting the accounting fundamentals right is not optional.

How Construction Accounting Differs from General Business Accounting

Standard retail or service businesses track revenue when a sale closes. Construction contracts span weeks, months, or years, with costs and income distributed unevenly across the project lifecycle. This creates three structural problems that general bookkeeping software and methods do not automatically solve:

Accounting Methods: Cash vs. Accrual vs. Percentage of Completion

The IRS Publication 538 defines the two primary accounting methods available to construction businesses: the cash method and the accrual method. Under the cash method, income is recorded when payment is received and expenses when paid. Under the accrual method, income is recorded when earned and expenses when incurred, regardless of cash movement.

For contractors with average annual gross receipts exceeding $29 million (adjusted for inflation under IRC §448), the accrual method is generally required (according to IRS). Most small-to-midsize contractors qualify to use cash accounting, but the choice has downstream consequences for tax timing, bonding capacity, and financial statement presentation.

A third method—the percentage-of-completion method (PCM)—applies to long-term contracts under IRC §460. PCM recognizes revenue and costs proportionally as work progresses, based on the ratio of costs incurred to total estimated costs. The FASB Accounting Standards Codification under ASC 606 and ASC 910 governs revenue recognition for construction contracts in financial reporting, requiring that revenue reflect the transfer of control to the customer over time—a standard that aligns closely with PCM for most construction work.

Job Costing: The Core of Construction Bookkeeping

Job costing assigns every cost to a specific contract. A proper job cost system tracks at minimum:

  1. Direct labor — Hours and wages tied to each project by worker
  2. Direct materials — Lumber, concrete, conduit, fixtures, and all installed materials
  3. Subcontractor costs — Payments to licensed trade subs, including amounts subject to 1099 reporting
  4. Equipment costs — Rental fees or allocated depreciation for owned equipment
  5. Job-specific overhead — Permits, inspections, temporary utilities, and site-specific insurance

The SBA Business Guide on managing finances recommends maintaining separate ledger accounts for each project rather than pooling costs into a general expense account. For federal work, FAR Subpart 31.2 sets binding cost principles that govern which costs are allowable, allocable, and reasonable on government contracts—including requirements that indirect costs be distributed on a consistent basis.

Subcontractor Payments and 1099 Reporting

Any subcontractor or independent contractor paid $600 or more in a calendar year must receive a Form 1099-NEC (according to IRS). Failure to file required 1099s exposes a contractor to penalties ranging from $60 to $310 per form, scaling with how late the filing occurs. The IRS Small Business and Self-Employed Tax Center provides recordkeeping guidance that applies directly to contractor payment documentation—W-9 collection before first payment, payment ledgers by vendor, and year-end reconciliation against accounts payable totals.

Overhead Allocation and the Burden Rate

Unallocated overhead is the most common source of understated job costs. Overhead includes general liability insurance, vehicle costs, shop rent, tools not assigned to a single job, and administrative payroll. A burden rate—expressed as a percentage applied to direct labor—distributes these costs across projects. If a crew costs $80,000 in direct wages annually and overhead attributable to that crew totals $32,000, the burden rate is 40%. Every hour of labor billed to a job carries that 40% overhead load in the cost calculation.

OSHA construction standards impose compliance costs that belong in overhead: safety training, PPE procurement, fall protection equipment, and required recordkeeping all carry real dollar costs that must appear somewhere in the cost structure—not absorbed invisibly into margin.

Retainage: Tracking What Has Not Been Paid

Retainage withheld by the owner is a receivable, not a write-off. A contractor completing $500,000 of work with 10% retainage carries $50,000 in receivables that will not collect until final acceptance. That figure must appear on the balance sheet separately from standard accounts receivable, and its release schedule must be tracked against contract milestones. Failure to track retainage inflates perceived cash flow and masks the true working capital requirement of ongoing work.

Recordkeeping Minimums

The IRS requires that business records supporting tax returns be retained for a minimum of 3 years from the filing date, and up to 7 years if underreported income is suspected (according to IRS). For construction businesses, this means maintaining:

The SBA financial management guidance recommends monthly financial statement review at minimum—income statement, balance sheet, and job cost report reviewed together to catch cost overruns before they become unrecoverable.

References

The law belongs to the people. Georgia v. Public.Resource.Org, 590 U.S. (2020)

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