Cost accounting allows contractors to identify costs associated with each project and contract they take on. What are the different methods? And what are the benefits of cost accounting?
Key takeaways
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What is cost accounting?
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What is revenue recognition?
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Types of cost accounting
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Benefits of cost accounting
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Why work with an accounting professional
Contractors have a unique place in the market, as their bottom line stems from client projects. As such, different accounting systems are necessary so they can keep tabs on how much time, money, and energy is going to each contract. It also shows how those costs are balanced with revenue.
There are several methods used in cost accounting, and a few important terms you need to know to set up the right system for your business. We’ll walk through what cost accounting is, the primary cost accounting methods, the benefits of using this approach, and why working with an accounting professional is a must.
What is cost accounting?
Cost accounting helps general contractors, subcontractors, and businesses break down their production costs. It assesses all fixed and variable costs, which are terms that are helpful to define:
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Variable costs: Labor, taxes, equipment, commissions, operational expenses
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Fixed costs: Rent, utilities, salaries, loan payments, insurance
Direct and indirect costs are also part of the process. Direct costs are those that are directly associated with a product or service. Indirect costs are not directly linked to a specific product but are necessary for operations.
Cost accounting differs from standard financial accounting because it is less focused on financial reports and balance sheets distributed to external audiences. It focuses on internal reporting for better business management.
Cost accounting is used by contractors who often operate on a project-by-project basis. It helps contractors keep tabs on each job’s cost and how it impacts the bottom line. Job costing is another term for cost accounting commonly used by construction contractors and helps them cost out projects, production materials, and individual contracts.
What is revenue recognition?
Revenue recognition is another important component of job costing. This is how contractors identify the revenue they make on a project versus what is considered a project expense. Sometimes contractor payments are delayed and may skew cash flow analysis for a short time. There are three methods for revenue recognition used by many contractors:
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Cash method: Revenue is recorded when payment is received, and expenses recorded when paid.
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Completed contract method: Income and expenses aren’t reported until the project is completed (even if they’re paid or received during the project term).
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Percentage of completion method: Revenue is recognized as it is earned, so a contractor could send an invoice for the work they’ve done so far, and they would record that as earned revenue.
The method used for recognizing revenue will impact the cost accounting approach as a whole and will vary from contractor to contractor.
Next, we’ll look at the different types of cost accounting.
Types of cost accounting
Within the cost accounting sphere, there are several approaches. These are standard costing, activity-based costing, lean accounting, and marginal costing.
Standard costing
This method means using standardized costs instead of actual costs for goods and services. Variance analysis is then used to evaluate the cost between the standard and actual costs. It helps the business understand how effective it is in keeping that variance low.
Activity-based costing
Another method is activity-based costing, where goods and services are costed based on the overhead expenses for each part of the business. The system uses business activities (tasks, units, events) to measure and allocate overhead costs and identify cost drivers for the business.
Marginal cost accounting
Marginal cost accounting assigns only the variable costs to the deliverables, while the fixed costs are allocated as part of the period and are included on the income statement. This method can help contractors determine how volume and cost levels impact profits. It is sometimes referred to as cost-volume-profit analysis.
Lean accounting
Lean accounting is used by organizations that need to improve their financial systems. This method is based on the idea that there should be minimal waste and optimal productivity. For example, there shouldn’t be a lot of unnecessary inventory sitting around because of the associated holding costs.
Benefits of cost accounting
There are many advantages of using a cost accounting strategy if you’re a contractor or subcontractor. Benefits include:
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Better understanding of financial trends
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Identify causes of major cash flow issues
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Effectively value inventory
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More visibility into cost-per-project
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Determine where tasks can be outsourced
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Visibility to budget alignment
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And others
Because contractors often run project-based businesses, other accounting methods may not give them the visibility they need to improve their bottom line.
Why work with an accounting professional
It’s nearly impossible to put a successful cost accounting system in place without the right tools and assistance. It’s important that each factor of the business is considered and that the right method is adopted for your specific needs and goals. New technologies also make it easier to incorporate automation tools to streamline the process.
If you’re looking for a job cost accounting system for your business, work with an accounting professional who can help you get set up for success. The experts at Franco Blueprint offer job costing assistance, in addition to cash-flow analysis, time and materials management, work-in-progress (WIP) reporting, and much more.
When you’re ready to set up an efficient accounting system for your business, utilizing the latest technologies to streamline workflows, contact Franco Blueprint to set up a free consultation.