Construction Accounting 101: The Importance of Job Costing

In the world of construction, jobs and accounting for them work differently than the average business. That’s why construction accounting relies on several key practices, including job costing. 

This vital process allows you to track costs specific to each project and should be part of your everyday tasks as it provides crucial insights, can help you boost your revenue, and fosters stronger client relationships by mitigating surprises. But if you’re not doing job costing yet, don’t stress it! We’re diving into what it is and how it works below.

What is Job Costing?

Job costing is a method used when products or services are produced to customer specifications or in distinct batches, often in a customized or unique manner. It involves tracking and accumulating costs associated with a specific job, project, or contract. While job costing is prominent in construction accounting, it’s also used in industries like custom manufacturing and professional services. 

The job costing process generally includes: 

• Customization: Each job or project typically has unique requirements, specifications, and costs. 

• Direct Allocation of Costs: Costs are assigned to specific jobs based on the resources consumed or activities performed. This includes direct materials, direct labor, and any direct overhead costs that can be clearly attributed to the job.

• Indirect Costs Allocation: Indirect costs, such as overhead expenses, are allocated to jobs based on a predetermined allocation method (e.g., labor hours or machine hours). This is often referred to as an overhead allocation rate.

• Cost Tracking: Job costing allows for detailed cost tracking throughout the production process, enabling managers to monitor the profitability of individual jobs and make informed decisions.

Job Costing vs. Process Costing

Unlike job costing, process costing is primarily based on previous work. You would look at historical data to determine the labor, materials, and overhead costs. You’d then determine the cost of each task in your current job based on these averages, add them up, and use this number as your total budget.

Process costing is ideal in industries like food processing and manufacturing because every job is usually the same. However, when it comes to construction, projects vary from one to the next, so process costing can result in excessive spending. 

Why is Job Costing Essential for Construction Companies?

Job costing is an essential practice in construction accounting because it ensures accuracy and doesn’t leave you guessing, which means your client pays a reasonable price and you are paid fairly. Although the process entails more time and work, it tells you precisely how many people/how much labor, how much time, and all necessary materials. 

Accounting for all of these areas in detail results in more revenue and prevents the project from going over budget. Plus, it can give you pivotal insights about the profitability of each job so you can plan accordingly and continue to improve on future projects (i.e., negotiations, team members, material sourcing, etc.).

How Should Costs Be Categorized?

When conducting construction job costing, costs should be categorized into several key categories to accurately track and allocate expenses related to each project. Let’s break them down below.

Materials

In every construction project, you’ll have direct and indirect materials. Direct materials include lumber, steel, concrete, pipes, and electrical components. These costs are directly traceable to specific projects and are usually obtained from purchase invoices or materials requisition forms.

Indirect materials include tools like nails, screws, caulking, fasteners, and cleaning supplies. While you’ll use many of these items for the project at hand, they can also be used in any of your other jobs. 

Dividing your direct and indirect materials makes it easier to create the most accurate budget possible.

Labor

Your labor costs should be subcategorized into two buckets: W-2 employees and 1099 contractors. This includes carpenters, plumbers, electricians, and other workers engaged in construction activities. Labor costs should be tracked by hours worked. With your employees, you’ll need to account for wages, benefits, taxes, insurance, and overtime.

Subcontractor costs are expenses incurred by hiring external firms or individuals to perform specific tasks or portions of the project. These may include services such as excavation, roofing, painting, or specialized installations. Your independent contractor costs simply include the agreed upon rate and should be tracked separately from your employee labor costs.

Equipment Usage

This includes the cost of using equipment and machinery on the construction site, such as excavators, bulldozers, cranes, and trucks. Costs may include depreciation, fuel, maintenance, and rental fees. Equipment costs should be allocated to projects based on usage hours or other relevant metrics.

Indirect Costs (Overhead)

Indirect costs, or overhead costs, are expenses incurred to support overall business operations rather than directly tied to specific projects. These costs include items such as supervision, project management, administrative salaries, utilities, insurance, and facility rent. Indirect costs should be allocated to projects using an appropriate overhead allocation method, such as labor hours, labor costs, or square footage.

Other Direct Costs

This category encompasses other direct costs associated with the construction project, such as permits, inspections, travel expenses, and temporary facilities. These costs should be tracked separately and allocated to specific projects as applicable.

Contingency Reserves

Construction projects often encounter unforeseen events or changes requiring additional resources or expenses, in which case you would need to create a change order and have the property owner sign and approve it. 

For example, the local permitting authority may require adjustments or additions to your project scope. Or you might have to substitute materials due to shipping and/or supply chain delays. These are the types of unexpected costs that your contingency reserves cover. This budget should be tracked separately and used only when necessary to mitigate project risks.

Implement Job Costing in Your Construction Business

Job costing allows construction businesses to effectively track and allocate expenses related to each project, enabling accurate budgeting and financial reporting. This level of detail provides valuable insights into project profitability, cost control, and resource management, ultimately contributing to the success of your construction projects. 
However, if you would rather outsource your accounting to ensure accurate job costing, JLS Accounting would be happy to help! We understand the level of work and detail involved and our team is highly experienced in the construction field, which means we can manage your books efficiently while you focus on growing your business. Book an intro call today to get started.