Construction and contracting involves some specific bookkeeping concepts and requirements not often encountered by firms in other industries. For example, construction firms and contractors have to account for revenues and expenses associated with specific jobs – at a variety of different locations. While a retailer may be able to recognize revenues and expenses all in a steady stream, the rules are different for contractors.
Not every bookkeeper is up on the latest tax and accounting rules, requirements and best practices for construction firms in Canada. It’s important that your bookkeeper, accountant and CFO are all on the same sheet of music so you can minimize your overall tax burden and maximize your company’s cash flow, net of taxes.
Accounting Methods for Canadian Contracting Firms
Most Canadian businesses must use the accrual accounting method. But for contractors with multiple projects at any given time, it’s usually better to use the percentage completion method. Under this method, contractors don’t recognize revenue and expenses as soon as they link the contract, as is done under the accrual method. Instead, under the percentage completion method, contractors recognize the revenue and expenses on their books in stages as the project is completed.
For contracting companies, this usually provides a much more accurate picture of the financial health of the company than using the accrual method.
If it is not possible to estimate the percentage of completion of a project, you can consider using the completed contract method: all revenues and expenses are recognized on the books only when the construction project is done.
Who can use the completed contract method?
The completed contract method of accounting is best suited for smaller contractors and those whose projects are normally completed within less than one year. This defers all income tax due to the completion of the contract.
For most applications, the percentage completion method is preferable, though it requires more ongoing bookkeeping work. The percentage completion method is best when firms are growing and taking on – or expect to take on – larger and more complex projects over time.
Accounting for Credit and Debt
Contractors frequently rely on loans and access to lines of credit in order to buy supplies and pay workers until the client pays. Contractors and their bookkeepers need to know specifically how to record credit transactions.
Under Generally Accepted Accounting Principles (GAAP), any debt taken out is booked as a liability on the balance sheet.
It’s a current liability if the balance is due within a year, or within the business’s normal accounting/operating cycle (if longer than one year).
The liability is booked as long-term debt if the terms stretch longer than one year.
You must disclose all short-term/current debt and long-term debt on your income statement.
Any principal payments due over the next five years must be notated as such on your income statement as well.
If anything on your balance sheet is serving as collateral for the loan, you must disclose that on your company balance sheet.
It’s important to account for holdbacks correctly. You need to create a separate accounts receivable account for holdbacks – one that allows for project allocations. When you issue new project invoices, your need to create two line items:
- Amounts owed
- The amount of the holdback
The 2nd line item needs to be a negative number on your books. So the two numbers net out against each other.
Your bookkeeping or accounting professional should know how to do this.
All business owners and managers should carefully monitor their cash flow statements and balance sheets. But there are three more reports that construction industry businesses and contractors should monitor on a daily basis:
- Progress invoicing
- Job costing
- Job profitability
As you can tell, each of these reports reflect the profitability (or lack thereof) down to the contract/job level. This way, managers can tell which projects are approaching or entering unprofitability – and can take action before too much damage is done.
Schedule a call with LedgersOnline and let us show you how we can help you grow your construction company or contracting business and achieve better bookkeeping results.