Surety Corner: Construction accounting, a class of its own

Every year, or perhaps quarter, a construction company will call their accountant and ask for an audit, review engagement, or notice to reader.

Some time later, they will receive a polished financial document ready for their perusal and to forward to their creditors. This document represents both the past (income statement) and the present (balance sheet). In concert with a work-on-hand statement (the future), financial statements that are prepared by a CPA that is well-versed in construction accounting tells the story of a construction operation.

So, what is the story of your business?

The stories of business owners in the construction industry may vary significantly, but the common themes are captured perfectly in every set of financial documents. Over the next several weeks we will break down each of these themes in further detail. For now, let’s identify them:

Your work: job costing

Job costing involves the recognition of expenses for items such as labour, materials, equipment and overhead related to individual contracts. Proper job cost tracking allows contractors to recognize their profitability on specific work to identify whether business objectives are being met. For example, if a profitability target is not being achieved, it is important to understand whether this is being driven by:

• a lack of top-line revenue to cover bloated in office overhead;
• a challenge specific to a particular contract; or
• sizeable financing costs that current margins are not covering.

This is the foundation of understanding what drives success as it pertains to profitability and what needs to be done to build your business’ balance sheet.

Your livelihood: revenue recognition

Another key piece in understanding your business’ financial success is through sound revenue recognition methods. This process is actually slightly more complex than other areas of business.

In construction, the generally accepted gold standard for accuracy as it pertains to revenue recognition is the “Percentage Complete” method, based on costs. This method ensures over-payments and under-payments by the construction owner are recognized and profitability is strictly shown based on the amount of work completed to date.

In future, we will discuss how a strong construction accountant goes about these calculations and how you can ensure your records are kept to make this process smooth.

Your family and future: corporate structure

Corporate structure is not a line item on a balance sheet or a method for recognizing revenue, but it is something your accountant should absolutely be able to guide you on. Depending on your willingness to provide creditors access to your holding companies or family trusts, decisions made with regards to where your assets are held can create interesting situations when looking to borrow money, access surety bonding or bid to owners with pre-qualified bidders lists.

Of course, corporate structure decisions can be impacted by many things. Aside from creditor proofing and ensuring assets are working hard for you, a sound corporate structure can also be a strong tool for succession planning.

There are many considerations when deciding how to structure your operations:

1. How does tax planning factor into the equation?
2. What decisions must be made when it comes to creditor proofing or sheltering assets for your future?
3. Who will purchase or take over the business when you retire and how will the structure affect a potential buyout?

How you organize your financial picture is impactful to your business and the balancing act of planning for your future, satisfying creditors and remaining liquid are all things that should be discussed with your accountant. Having a construction accountant specialist prepare your financials and provide you advice is critical.

Sunny Nagra from I&A Chartered Professional Accountants talks about the importance of having a construction specialist accountant.

“Contractors need an accountant that can speak the same language as them, which is why it is crucial that their accountant understands their industry. The construction industry is unique. There are many moving pieces and these pieces need to be captured in the financial records of the company. It is important that the person responsible for capturing the financial activities of an organization actually understands the day-to-day activities of that organization.

“Having an accountant with the proper skillset for your industry will help to present a true picture of your performance. In addition to the financial reporting of past performance, the right accountant can also provide guidance on how to approach future jobs and future transactions.”

By specializing in construction, it has allowed us to stay ahead of general accountants and remain ahead of the curve to provide our clients with creative solutions.

Your money, your pocket: tax planning

Tax planning can be a confusing and complex discussion. There are many considerations, including the impact these efforts will have on your balance sheet and on future years’ profits. You will also want to ensure your accountant can guide you with the most up to date and applicable tax laws to maximize tax planning tools available to your business.

As mentioned previously, it is also important to advise your accountant on your business goals so that they can take these into consideration when making decisions at tax time. If you are planning to sell the business to your now adult children, you may be eligible for an intergenerational transfer and could use your life time capital gains exemption which in 2022 is $913,630.

If you are about to go seek financing or surety credit, perhaps retaining that profitability and acknowledging that you may have to pay more taxes this year is necessary in order to show a stronger position on your balance sheet.

In future posts, we will dive into each of these topics in partnership with I&A – Chartered Professional Accountants – Tax & Consulting.

Andrew Cartwright is the vice-president of surety for FCA Insurance. With over 10 years of experience as an RVP of a large national surety company, Cartwright uses his expertise to help FCAs clients manage and build their surety capacity. Send comments and column ideas to editor@dailycommercialnews.com.