A chart of accounts is a window into your business’s financial standing. It’s a comprehensive list of all account numbers and names relevant to your operation.
From this list (or chart) of accounts, you can generate financial statements (e.g., income statements and balance sheets). Financial statements are a wealth of information about your business performance and financial position.
This knowledge is invaluable to management, investors, and stakeholders interested in your business. However, you shouldn’t think of financial statements–or construction accounting–as a retrospective practice. As much as they can tell you where you’ve been, they can tell you where you’re going and what to do next. Giving you the power to predict the financial future and growth of your business.
As Warren Buffet said, “Accounting is the language of business.” From this language, your financial statements tell a story about your business. As a business owner, it’s imperative that you understand this story.
For this reason, a chart of accounts is a foundational accounting tool for providing the accuracy and structure needed to understand every transaction in your business.
In this article, we’ll explore what a construction chart of accounts is, why it’s vital for your business, and how you can interpret one to have a complete picture of your finances.
What is a chart of accounts?
A chart of accounts is an index of financial data used to both categorize and organize all business transactions. In other words, a chart of accounts is simply a list of all accounts within your business. It mainly works by separating and organizing income from expenses; putting all financial information into distinct categories (i.e. accounts).
Therefore, list accounts in the order that they appear in your financial statements. Balance sheet accounts appear first with the usual order:
- Assets
- Liabilities
- Owner’s equity
The above is what’s known as the accounting equation:
- Assets = Liabilities + Equity
Following the balance sheet is the Income statement. Listed in the order of expenses and revenues.
- Income = Revenues – Expenses
To simplify this, the balance sheet is your high-level view of finances from year to year. Underneath the balance sheet falls the income statement which depicts a specific period of time–the month of May, for example.
With this structure, the chart of accounts will help you organize every transaction by type or category, such as assets, liabilities, income, and expenditures. This lets you quickly and easily see where every transaction falls.
In the construction or specialty trades, some commonly used categories will include:
- Cost of labor
- Material expenses
- Overhead costs
- Operating expenses
- Office/administrative overhead
An example of asset and liability accounts are as follows:
Asset Accounts:
- Cash accounts receivable
- Inventory
- Equipment
- Prepaid expenses
Liability accounts:
- Accounts payable
- Notes payable
- Accrued expenses
- Line of credit
- Long term debt
Why is a chart of accounts needed?
The chart of accounts is critical to a contracting business because it creates a link (codified structure) between your financial statements, the line items within your financial statements, and general ledger accounts.
As a reminder, your general ledger is where you’ll find all accounting and financial entries. This information is then used (with the help of a chart of accounts) to create financial statements. While bookkeeping tools like QuickBooks will sort this out for you, it’s important to know how everything fits together.
With that said, the chart of accounts then lists all accounts so you can record and organize all activity happening in your general ledger. This forms the basis for creating general ledger accounts before posting transactions.
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In simpler terms, the chart of accounts determines where you’ll record every transaction. This is important because, as mentioned, investors, shareholders, or interested parties will use a chart of accounts to obtain a clear view of your company’s financial health.
Since transactions display as individual line items, third parties can quickly view and assess your business’s core components (assets, liabilities, revenue, expenses).
How to create a chart of accounts for construction businesses
To recap, a chart of accounts is a list of all relevant account names and numbers in your business; however, there is a high degree of freedom in terms of what you call your “accounts,” where you list transactions, and how you organize everything. But still, they’ll all fall under one of the core categories (e.g., income or expenses).
For example, you might list printer ink under “office expenses” or “office supplies.” However, it still falls under the expense category at the end of the day, regardless of the specific label you place on it.
From this reason, a company can tailor its chart of accounts to suit its specific purposes and add accounts as needed. A chart of accounts could be as large and complex as the company itself. Smaller companies may have a single-page chart of accounts, while larger construction companies may have a ten or 20-page chart of accounts.
Each account in a chart of accounts is typically assigned a name and unique number for identification. Some companies may structure their chart of accounts so that it includes unique codes used for the various divisions within the company.
For example, you may code your sales department as “08” so that when you see a transaction labeled with “08,” you can immediately know this is coming from the sales department.
It’s important to keep in mind that once you establish a structure for your chart of accounts, it should remain consistent and shouldn’t change very often. You can add accounts as needed throughout the year, but you and your accountant should hold off on any major changes until the start of a new fiscal year. If you feel the need to revitalize your chart of accounts, always consult with your accountant first.
Sample chart of accounts for a construction company
You can work with your accountant to create your chart of accounts through the following steps:
- Assign a number to each element of your financial statements. For example:
- Assets – 1
- Liabilities – 2
- Equity – 3
- Determine the number of digits you wish for each general ledger
- Identify the code ranges for each element
- Identify groups within each element of your financial statements
- Associate unique codes to each group identified in step 4
- Create code ranges within each group
- Associate each group to either SFP (assets, liabilities, and equity) or income statement
Below is an example of a chart of accounts using unique number identifiers:
| Number | Description | Account types | Financial statement |
|---|---|---|---|
| 1-001 | Cash | Asset | Balance sheet |
| 1-010 | Accounts receivable | Asset | Balance sheet |
| 1-020 | Prepaid expenses | Asset | Balance sheet |
| 1-030 | Inventory | Asset | Balance sheet |
| 2-001 | Accumulated depreciation | Liability | Balance sheet |
| 2-010 | Accrued liabilities | Liability | Balance sheet |
| 2-020 | Taxes payable | Liability | Balance sheet |
| 2-030 | Notes payable | Liability | Balance sheet |
| 3-001 | Common stock | Equity | Balance sheet |
| 3-010 | Retained earnings | Equity | Balance sheet |
| 3-020 | Additional paid capital | Equity | Balance sheet |
| 4-001 | Revenue | Revenue | Income statement |
| 4-010 | Sales returns and allowances | Revenue | Income statement |
| 4-020 | Cost of goods sold | Expenses | Income statement |
| 4-030 | Advertising expenses | Expenses | Income statement |
Account types and expenses
There are six main accounts in a chart of accounts:
- Assets
- Liabilities
- Equity
- Revenue
- Expenses
- COGS
You’ll notice that this encompasses the balance sheet (Assets=liabilities+equity) and the income statement (Income=revenues-expenses).
Assets
Assets include all cash, accounts receivable, equipment, and materials purchased or leased for a project. On a high level, an asset is any resource with economic value owned or controlled by you.
They can be tangible (physical things like equipment, or intangible (non-physical like brand value). In the construction industry, assets are often tangible such as equipment, tools, and any materials needed to complete jobs. They’re the resources needed to do your job.
Liabilities
Liabilities include accounts payable, contracts parable, bonds, mortgages, notes payable, and any other debts. Liabilities are any legal responsibility you hold to pay debts or fulfill contractual obligations; loans, deferred revenues, or other accrued expenses.
In the construction industry, liabilities will often include accrued labor costs, accounts payable owed for materials, and customer deposits.
Equity
The formula for equity is as follows:
- Equity = Assets – Liabilities
This formula will reveal your “book value” or the value returned to all shareholders after paying debts and liquidating assets. In other words, it’s a measure of ownership in a company or asset after considering all outstanding debts. However, equity isn’t a surefire way to determine your specific value or ownership in a company. Determining individual ownership can be quite complicated for a multitude of factors.
Revenues
Revenue reflects the amount of money brought in before taking out expenses. Revenue only indicates how effective you are at generating sales or winning bids. It won’t tell you anything about operating efficiencies or cash drains. Revenues will include customer charges, fees, and any rental income associated with projects.
Expenses
Expenses are the costs incurred in the process of running and managing your business. This includes operating costs, payroll, overhead, supplies, materials, fuel, taxes, repairs, advertising, insurance, depreciation, and rent.
All project or job costs will also fall under expenses such as labor, material, equipment, and permits. Together, these expenses are essential for a successful construction project and enable the company to work competitively and productively.
COGS
For contractors, cost of goods sold (COGS) provides a vital glimpse into the profitability of a project over a specific period of time. Often referred to as “job costs”, COGS is best tracked through construction management software like Knowify.
Subtracting COGS from total revenue is the surest way to determine your gross profit margin. Gross profit and gross profit margin is a tremendously useful tool that will allow you to measure the efficiency of your jobs, operations, and sales/bidding process.
Example of direct project costs:
- Equipment
- Materials
- Permits
- Subcontractor costs
- Direct labor costs
- Permits
- Management fee
How does accrual accounting work with a chart of accounts?
As a reminder, accrual accounting recognizes transactions when they are earned or promised, regardless of when money actually switches hands.
Using the principles of accrual accounting, percentage of completion and the completed contract method are both heavily utilized within the construction industry. Below we’ll take a look at what to keep in mind for both when structuring your chart of accounts.
Percentage completion method
Percentage of completion requires:
- Under billings: Costs and profits that are in excess of billings
- Over billings: Billing totals are ahead of actual work completed (profits and costs)
Completed contract method
The completed contract method is best used for small jobs that are relatively short-term or when a project brings an inherent risk in completion. Under the completed contract method, you’ll recognize revenue after the contract’s completion (or substantial completion).
In practice, this means you won’t record any expenses or revenues as the project progresses, even if you buy materials or receive compensation from the project owner.
If using the completed contract method, you’ll need the following in your chart of accounts:
Short-term assets
- Work-in-progress reports (WIP)
- Finished units
- Funds due on construction and development loans
Long-term assets
- Land (including lots or buildings)
- Finished units
- Assets not expected to be sold within a year
Use Knowify and QuickBooks Online for better bookkeeping
Knowify and its integration with QuickBooks Online helps construction contractors create and use a chart of accounts by automatically synchronizing data between Knowify and QuickBooks Online. This helps streamline the process of setting up and managing the chart of accounts in both systems.
This automation helps contractors easily keep both systems up-to-date and accurate. Since QuickBooks Online helps create financial reports, contractors can use the integrated accounts from Knowify to help create reliable and accurate financial reports for their business.
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