JUDY ANN F.

GAZZINGAN

What are the reasons why we need the accounting for construction contract? Discuss.
Contracts are an important part of the process of any construction project. Primarily the contract
safeguards against payments and guaranteeing adequate work, but if a dispute arises, construction
contracts can also dictate how the parties move forward to resolve the issue.

Many business owners view accounting as nothing more than an administrative headache. But
good construction accounting systems and practices are powerful tools for managing your
business. Accurate and timely construction financial reports can help you monitor your
performance, control costs, improve profitability and manage cash flow. This is important for any
business, but it’s particularly critical in the construction industry, which, by its nature, is subject
to a great deal of uncertainty. Good accounting practices provide a snapshot of where each project
stands at any given time, allowing management to detect problems and make necessary
adjustments before it is too late.

Construction accounting is distinct from other types of accounting because of the long-term nature
of many construction contracts. Revenue recognition is one of the main principles of generally
accepted accounting principles (GAAP), which strives to match revenues with the expenses that
generate them. However, this matching of revenues with expenses can be a challenge over the
earnings process spans a long period of time. Typically, revenues and costs are recognized when
the earnings process is complete or virtually complete and an exchange has taken place. Consider
the typical retail transaction in which a buyer exchanges money for a product. Both recognition
criteria are satisfied and the seller’s profits can be calculated immediately by subtracting the
product’s cost from the sale price. With a long-term construction project, on the other hand, a
contractor performs work over several months or even years. A project’s scope, costs and
revenues may fluctuate over the contract’s term, so the precise profit or loss associated with a
job will not be known with certainty until project completion. GAAP recognizes that the usual
rules of revenue realization don’t necessarily apply to long-term construction contracts. If
revenue isn’t recognized until the earnings process is complete and an “exchange” has taken
place, then the contractor’s financial results will be distorted during the life of the contract.