Construction Bookkeeping: Job Costing, AIA Billing and Retainage

How do I do bookkeeping for a construction company so each job shows its profit?

Treat each contract as its own set of books: a budget, every cost coded to the job, every billing tied to the contract, and a monthly comparison of cost, billing and earned revenue. A job's profit is its contract price, including approved change orders (written changes to price or scope), minus the costs charged to it. Overhead stays outside the job, so this is profit before overhead: each month, total the jobs' profit and subtract overhead to see whether the business made money.

The monthly routine:

1. Open a job for each signed contract, with its price and a budget by cost code.
2. Code every cost to a job and cost code when it is entered: bills, payroll hours, card charges, equipment.
3. Bill from a schedule of values, not a lump sum.
4. At month-end, estimate the cost to finish each open job and work out percent complete.
5. Compare earned revenue to billings and adjust the books to the difference.
6. Compare each job's profit to the original budget.

A case is not simple when:

• you cannot say which jobs made or lost money, or why;
• your first large pay application is due and no schedule of values exists;
• retainage is held on both sides, the owner holding yours and you holding your subcontractors', and year-end shows balances with no job detail;
• the job is public, federally funded or prevailing-wage;
• jobs cross year-end, so the books and the tax method can show different income;
• subcontractors are paid before their paperwork is complete;
• the books are cash basis and built from the bank feed.

Gather the contract and change orders, the schedule of values, pay applications, subcontract agreements and invoices, lien waivers, and payroll by job. The IRS says business books must show gross income, deductions and credits, backed by supporting documents (Publication 583).

How do I create a project budget, and which costs go on the job?

Build the budget from the estimate, line by line, using the same cost codes the books will use for actual costs. A cost code is a short number for a kind of work or cost, such as framing or electrical. A cost belongs to a job when it exists because of that job; a cost that would exist anyway is overhead.

A project manager or yard crew who serves several jobs is either charged out by a fixed rule, such as hours or job size, or left in overhead. Pick one rule and apply it to every job.

Charge an owner who works on site to jobs at a set hourly rate, or jobs look more profitable than they are. If the owner is not on payroll, keep that rate on the job report only.

Never overwrite the original budget. Add each approved change order as its own line, so the original and revised margin both show. Direct job costs usually sit above gross profit; see cost of goods sold for a service business. Whether sales tax applies to materials is covered in contractors' sales tax on materials.

How do I record progress billing with a schedule of values (AIA billing)?

A schedule of values splits the contract price into line items, such as demolition, framing and electrical. An AIA-style pay application (modeled on the American Institute of Architects' form, often called a pay app) then reports, for each line, the work done this period, the total done to date, stored materials, retainage held and the amount now due. The pay application is the billing document; the books follow it.

Federal fixed-price construction contracts ask for similar detail. The contractor's request must itemize the amounts by element of work, list the amount for each subcontractor's work, and carry a certification that earlier payments to subcontractors were made (FAR 52.232-5). On private work, the contract decides what is billable and when.

Book each pay application as one invoice per job, numbered to match:

The month-end adjustment in the over and under billing section below brings revenue to what was earned.

What is retainage, and how do I book it?

Retainage (also called retention) is the part of each progress payment that an owner holds back until the work is finished or accepted. It appears on both sides of the books: retainage receivable from the owner, and retainage payable to subcontractors whose bills you hold back.

Retainage receivable is earned work the owner has not yet paid for, so it belongs in billings. Leave it out and the job looks under-billed. Track both balances by job, because each releases on its own date. A year-end retainage balance with no job detail usually means nobody tracked it. Release approval is not payment: book the cash when the money moves.

When do I collect retainage, and what do state and federal rules say about release?

The contract sets the percentage and the release date, inside whatever limits the law puts on that kind of job. Public jobs have the clearest statutes. Private-job limits vary by state, so read your state's law before you sign.

Public work also limits what you hold from subcontractors and when you pay them. A federal subcontract may hold back a specified percentage (FAR 52.232-27), but the contractor certifies that its payment request leaves out amounts it intends to withhold from a subcontractor (FAR 52.232-5). A federal prime contract also requires every subcontract to commit the contractor to pay the subcontractor within 7 days after the government pays the contractor, with interest on late payments, and to pass those clauses down to lower tiers. Agreed retainage and withholding after proper notice are the exceptions (FAR 52.232-27). In Florida, when a public entity pays retainage that belongs to subcontractors, the contractor must timely pass it on (Fla. Stat. 255.078). In Washington, a contractor on a public project may withhold no more than 5% from a subcontractor and owes it interest at the rate the contractor earns on the reserved funds (RCW 60.28.011).

Release often depends on more than the calendar: completion, the punch list (the owner's last-fix list before acceptance), closeout documents and lien waivers. Record each release condition per job.

What are over-billing and under-billing, and where do they show on my balance sheet?

On accrual books, over-billing means you billed more than you earned, and it shows as a liability. Under-billing means you earned more than you billed, and it shows as an asset. These are accounting terms, not tax terms, and no official source defines them; account names vary. Cash-basis books show neither balance; keep the comparison on the work-in-progress schedule, outside the ledger.

To measure them:

1. Percent complete = cost to date divided by estimated total cost. Some companies use units installed or an engineer's estimate instead. Materials bought but not yet installed can push cost to date ahead of the real work, so many contractors leave them out until installed.
2. Earned revenue = contract price times percent complete.
3. Compare earned revenue to billings to date.

A schedule of values loaded toward early work creates over-billing, which looks like profit but is cash you hold for work not yet done. A growing over-billed balance on a job whose costs lag is a warning. Under-billing means work is done but not billed; bill what the contract lets you bill on the next application, and track what it does not yet allow.

On accrual management books, set each job's over-billing liability or under-billing asset to the cumulative difference between billings and earned revenue, and post only the change from last month's balance. A bigger under-billing debits the asset and credits contract revenue; a bigger over-billing debits contract revenue and credits the liability.

How do I track work in progress and the estimated cost to finish?

Keep a work-in-progress schedule: one row per open job, updated every month. Each row shows contract price with approved change orders, estimated total cost, cost to date, percent complete, earned revenue, billed to date, over or under billing, and expected profit.

Estimated total cost is cost to date plus a fresh estimate of the cost to finish from the person running the job. Do not use budget minus spent. A job can be mostly spent and only partly built, and a budget-minus-spent figure hides it.

Expected profit is contract price minus estimated total cost. A losing job shows the month that estimated total cost passes the contract price. In accrual practice a job expected to lose money is written down for the whole expected loss once that is known, so flag it then, not at close-out. Comparing expected profit to the bid margin shows which kinds of bids lose.

Accrue subcontractor work done but not yet invoiced. Otherwise cost to date and percent complete are too low and the job looks more profitable than it is.

How do I handle change orders, deposits and subcontractor bills on a job?

Tie each one to its job: a change order raises the price only once approved in writing, a deposit is a liability until earned, and a subcontractor bill is a job cost.

• Change orders: add them to the contract price and budget only when approved in writing. Until then, track the pending amount separately. Costs of the extra work are job costs from day one, approved or not.
• Deposits: on accrual books, a deposit received before the work is done is a liability tied to the job, not revenue. Apply it against pay applications as the contract says, and recognize revenue as the work is earned. When a deposit is taxed depends on the tax method; see long-term contracts.
• Subcontractor bills: code each bill to a job and cost code, hold retainage as the subcontract says, and compare the percent the subcontractor bills to your own field check before paying.

What paperwork do I need from each subcontractor?

Collect these before the first payment.

Whether a worker is a subcontractor at all turns on the whole relationship: behavioral control, financial control and the type of relationship (IRS). See contractors who may be employees. Paying a subcontractor in cash is covered in paying subcontractors in cash.

Does tracking jobs this way change my tax method?

Not by itself, but the two are linked. Taxable income is computed under the method the taxpayer regularly uses in keeping the books, and a change in that method generally needs IRS consent, requested on Form 3115 (26 U.S.C. 446; IRS instructions). A job schedule that measures percent complete does not pick the return's method, but a difference between the books and the return should be a deliberate choice.

Federal law requires percentage of completion for some long-term contracts and exempts others, including certain residential construction contracts and, for a business within the gross receipts limit of section 448(c) that is not a barred tax shelter, construction contracts it expects to finish within two years (26 U.S.C. 460(e); Public Law 119-21, section 70430). Each exemption is a defined test, so whether a contract qualifies depends on its length, its type and your size.

The method rules, retainage and deposits for tax are in long-term contracts. Cash versus accrual books are in switching from cash to accrual accounting.

Example

These examples use US dollars and round, illustrative numbers.

An under-billed remodel

A remodeler signs a $250,000 job and has billed $125,000. Costs to date are $90,000 against a $150,000 estimated total cost, so the job is 60% complete and earned revenue is $150,000. The $25,000 gap is under-billing, an asset on the balance sheet. If this is the job's first adjustment, the month-end entry debits costs and estimated earnings in excess of billings and credits contract revenue for $25,000. Expected profit is $100,000. If the contract allows it, the next pay application should bill that work; if not, track what holds it back.

Retainage on both sides

A $300,000 commercial contract withholds 10%. After $200,000 of work is billed, $180,000 is receivable now and $20,000 sits in retainage receivable. A framing subcontractor bills $90,000, and the contractor holds back 10%: $81,000 is payable now and $9,000 is retainage payable. Both retainage balances clear when the released money is paid, not at the invoice.

A job that loses money while cash looks fine

A $200,000 job was bid at a $170,000 cost. Five months in, costs to date are $110,000 and the project manager estimates $110,000 more to finish, so estimated total cost is $220,000 and the job is 50% complete. Earned revenue is $100,000. A schedule of values loaded toward early work has billed $120,000, and the owner has paid it, so the job is over-billed by $20,000 and the bank balance looks healthy. Expected profit is a $20,000 loss, visible this month instead of at close-out. Earned revenue less cost to date shows only a $10,000 loss so far; under the full-loss practice above, record the other $10,000 as a provision for the loss still to come. That is a books entry; tax follows the return's method.

Different for you?

• You bid jobs that lose money and cannot say why, your first large pay application is due, or year-end shows retainage no one tracked: the cost codes and work-in-progress schedule are set up once, and the books can be built to feed whichever tax method applies. Start with bookkeeping help.
• Your books are months behind: see catching up on overdue books and bookkeeping help.
• Your books are cash basis and jobs cross year-end: see switching from cash to accrual accounting.
• A bank or bonding company wants statements or a work-in-progress schedule: see financial statements for a bank loan and bookkeeping help.
• Contracts run past year-end, or you must choose or change a tax method: use long-term contracts.
• Your 1099 shows the full job amount but crews were paid from it: see subcontractor pass-through on Schedule C.
• Subcontractors may really be employees: see contractors who may be employees.
• The job is federally funded or prevailing-wage: covered contractors submit payroll weekly, so track payroll by job and worker from the first pay application. See bookkeeping help.