Construction accounting exists to provide two key financial points of information to contractors and the management team of a construction company. The first and most important financial point is field production profit. This particular profit measurement is commonly referred to as job profits. It is essential contract revenue less direct (hard) costs of construction. The secondary and almost as important as the primary key financial point is the company’s net profit after taxes. This particular key financial point is the customary financial profit of the company. The first financial point is tied to job costing and therefore, construction accounting is comprised of two different accounting systems. The two systems are job costing and traditional financial GAAP (Generally Accepted Accounting Principles) reporting.
The construction industry is a 800 billion dollar sector of the US economy. The construction industry is not only instrumental with growth but it is one of the largest employers too.
Charging a construction management fee is one of several different construction production styles. The most common is the traditional build and sell style. Here the contractor puts up the capital to build the house and sells the house while under construction. A common term used with this style is ‘Spec’ house. Another style involves shifting ownership of the project to the buyer upfront and the contractor merely runs the project, i.e. ensures it is built properly. This is referred to as a management fee style of construction. The typical contract is between an owner of a lot and a contractor. The owner is willing to fund the project through completion and pay a contractor a flat percentage of the cost of construction as a fee for managing the project. The contractor brings his license, experience and subcontractors to the job to build the home for the owner.
With the construction management fee style, the question for the contractor is: what is reasonable and fair rate to charge as a percentage of costs to build the home? This article explores how to determine a good rate and the various risk factors that affects this rate. Understanding how to determine the rate is essential to earn a fair and reasonable amount for your services. The reader must first grasp the risk factors involved and customary returns on each respective risk factor between the two most common styles – traditional and management. Once the contractor understands the underlying risk factors, the rate is easier to calculate. Finally, there are some nuances and adjustment factors requiring attention by the contractor in order to determine a good rate. The following sections explain the risk factors involved, proper rate determination and adjustments to determine a good contractor’s management fee.
In 2009, the Internal Revenue Service issued the Construction Industry Audit Technique Guide (ATG) for use by IRS agents and for contractors. The contractor’s audit guide explains the processes and methods the IRS uses to examine a contractor. The end goal is to verify actual taxable income over an assigned tax year for a contractor. The IRS recognizes that this industry is complex and utilizes multiple methods to establish revenue and net profits. It is so complex, the guide is 257 pages long.
This article introduces the guide and its major sections and how to understand what areas are applicable to your construction company.