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You are forming a business with a couple of construction friends who want to build custom homes. They are good at construction, but do not know anything about accounting. Using the example of the construction in the PBS TV show “This Old House”: explain to your new business associates how you would do the accounting for this type of business. Using proper terminology and accounting concepts, provide a general explanation of the different types of costs involved and create some sample transactions to record what you see on the TV show. Assume the costs amounts and identify any other assumptions necessary to record the transactions. Also, discuss other transactions and costs that need to be recorded but are not directly visible on the TV show.

Sample Paper For Above instruction

Introduction

Starting a custom homebuilding business with friends who possess construction expertise requires a solid understanding of accounting principles. Effective accounting practices are vital for managing costs, ensuring profitability, and complying with legal and tax obligations. Since construction involves numerous types of costs and transactions, clarity in recording and interpreting these financial activities is essential. This paper provides a comprehensive overview of the relevant accounting concepts, illustrative sample transactions, and additional costs that are often overlooked but critical for accurate financial management.

Understanding Construction Business Costs

Construction businesses incur various costs categorized broadly into direct and indirect costs. Recognizing these distinctions is fundamental for proper accounting and project management.

Direct Costs

• Materials: The raw building materials such as lumber, concrete, fixtures, and finishes. For example, purchasing $50,000 worth of lumber for a project.
• Labor: Wages paid to construction workers and subcontractors directly involved in building the home. For instance, paying $20,000 in wages over a month for carpenters and masons.
• Equipment: Costs related to the purchase or rental of tools and machinery specifically used for the project, such as renting scaffolding for $3,000.

Indirect Costs

• Overhead: Expenses not directly linked to a specific project but necessary for business operations—office rent, utilities, insurance, and salaries of administrative staff.
• Marketing and Advertising: Costs involved in promotion, such as website development or advertising campaigns for $2,000.
• Permits and Licensing: Fees paid to local authorities, say $1,000 per project.

Sample Transactions and Recording

To illustrate, assume the following transactions based on a typical homebuilding project:

1. Purchase of materials: Bought $50,000 worth of lumber and supplies on credit.
2. Labor expenses: Paid $20,000 in wages to workers on a weekly payroll.
3. Equipment rental: Rented scaffolding for $3,000, payable upfront.
4. Overhead allocation: Allocated $5,000 monthly for office rent and utilities to the project.
5. Permits and licenses: Paid $1,000 for necessary permits.

These transactions would be recorded using appropriate accounting entries:

Additional Transactions and Costs

Beyond the visible transactions on the TV show, certain financial activities are crucial:

• Progress billings: Billing clients periodically based on completed work; recording accounts receivable and revenue.
• Change orders: Changes in scope that result in additional costs or revenue; these must be documented and integrated into the accounting records.
• Loan and financing costs: If loans are taken to fund projects, interest expenses and loan repayments need to be recorded.
• Depreciation: Allocation of equipment and assets over their useful lives.
• Warranty reserves and contingencies: Setting aside funds for warranties or unforeseen expenses post-completion.

Accounting Methodologies for Construction Business

Construction companies typically employ either the percentage-of-completion method or the completed-contract method. The percentage-of-completion method recognizes revenue and expenses proportionally as work progresses, offering a real-time view of profitability. Conversely, the completed-contract method defers revenue recognition until the project’s completion, which might be suitable for small or uncertain projects.

Conclusion

Effective accounting management is essential for a successful construction business. Understanding the different cost types, accurately recording transactions, and accounting for additional costs ensure financial clarity and operational efficiency. As construction projects are complex and multifaceted, diligent record-keeping and adherence to accounting standards promote profitability, transparency, and compliance with tax laws.

References

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• Hansen, D. R., & Mowen, M. M. (2021). Cost Management: A Strategic Emphasis. Cengage Learning.
• Hilton, R. W., & Platt, D. (2022). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Higher Education.
• Kelly, J. (2018). The Construction Business Management Tool. Construction Industry Institute.
• Larson, W., & Sharma, S. (2019). Construction Financial Management. Routledge.
• Scagliarini, J. A., & Munson, R. (2022). Accounting for Small Businesses in Construction. Journal of Small Business Management, 60(1).
• United States. Securities and Exchange Commission. (2014). Financial Reporting Manual.
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• Young, D. (2019). Cost Accounting for Construction. Pearson Education.