Construction accounting can be complex, especially due to the many schemes and regulations introduced by the UK Government. Taking control of your finances is essential for the stability and long-term growth of a construction business.
This article explains how to do construction accounting, how it differs from accounting in other sectors, and important considerations.
What is construction accounting?
Whether you’re installing drywall or settling the books, it’s important to recognise that construction accounting differs from standard accounting. In other sectors, standard accounting principles work well because these businesses have a fixed pricing method and their overhead costs do not vary significantly.
However, in construction, there are many more variables at stake. The location, materials, and work involved will change from project to project. Therefore, construction accounting involves monitoring standard operational costs, but also project costs.
As an example, calculating the cost of goods sold (COGS) for a construction company is not as straightforward as other businesses. Regular businesses can simply record the cost of the item sold. In construction, businesses incur both direct and indirect costs which can fall under a variety of categories. Keeping track of these costs is much more difficult.
Accounting regulations for construction
In the UK, there are several schemes and regulations in place to ensure construction businesses are correctly reporting their taxes. These invoicing and accounting requirements have been modified throughout the years to reduce the possibility of tax evasion in the construction sector.
Construction Industry Scheme (CIS)
The Construction Industry Scheme is an HMRC scheme outlining rules for how subscontractors should be paid. Under the CIS, a percentage of the subcontractor's pay is deducted and transferred to HMRC for tax purposes. The amount is used towards income tax and National Insurance contributions.
Most subcontractors and businesses that hire subcontractors will need to register for the scheme. The contractor is responsible for deducting the amount from the subcontractor’s pay and reporting it to HMRC.
Domestic VAT reverse charge
The domestic reverse charge was implemented in March 2021 as a new way of reporting VAT in the construction industry.
Previously, the supplier accounted for and reported VAT on their sales. Now, the contractor (buyer) has to report the VAT rather than the subcontractor.
Most businesses registered for the Construction Industry Scheme will need to follow the domestic reverse charge procedure. There are specific invoicing and accounting requirements if your business is affected by this change.
Invoices will need to state “Domestic reverse charge” and include the amount of VAT the customer needs to account for. It will also need to include the subcontractor’s CIS deduction if applicable.
Your VAT Returns will also be affected by this change. For the seller, the reverse charge sale should only be included in box 6 of the VAT Return (VAT exclusive value). The buyer will input the output tax in box 1 and the input tax in box 4.
You can read more about the specifics of this rule in our article: “Domestic VAT reverse charge for construction services.
Making Tax Digital (MTD)
Making Tax Digital is a government initiative of reporting taxes online, to reduce manual entry and tax mistakes. It is currently only required for reporting VAT, however, it will include other taxes in the future.
Preparing your construction business
If you’re just starting your construction business, there are a few steps you can take to set yourself up for success.
To start, you should decide on a business structure and register with HMRC. Most small construction businesses decide to incorporate as a limited company which provides legal protection. If you decide to work as a sole trader, bear in mind that you are personally liable for any financial losses incurred by the business.
You should also consider purchasing insurance. Construction can be dangerous, but insurance can protect you, and also provide coverage for any accidental damage incurred.
Since construction accounting can be tedious and time consuming, we also recommend hiring an accountant who specialises in construction. Although this can be pricey, accountants can help you prepare your year-end reports and make sure that everything is accounted for and compliant. If anything is incorrect, you may incur fines from HMRC. So it’s best to hire a knowledgeable professional, at least for your first couple of years.
Keep an eye on your cash flow
One of the most important aspects of construction accounting is keeping track of your cash flow.
Construction projects often require large purchases of materials upfront, before you receive any payment from the customer. That’s why you should always keep your cash flow balanced - large purchases should be matched with an equivalent income.
Invoicing & accounting software for construction businesses
Invoicing & accounting software, like Debitoor, can help make complex construction accounting simple.
Every time you record income or an expense, your accounting reports are automatically updated. Each invoice you issue will be compliant under UK law, and you can enable CIS and reverse charge in a few clicks.
As a Making Tax Digital approved software, your VAT Reports are automatically created for you and you can submit them directly to HMRC from your Debitoor account.