In this article I am going to do my best to articulate the difference between accounting for Custom Homes and Remodels for clients and Flipping and Speculative building.
When I say custom homes and remodels, I mean your clients own their own property and handle their own financing for work that they hire you to do. House flipping and speculative building means that the contractor owns the property and handles the financing of a project and then later sells the property, or in some cases converts it to a rental property.
When it comes to client work customs and remodels for most contractors, the accounting is somewhat simple in that the money coming in from customers is accounted for as income and the job related costs are accounted for as cost of goods sold. I highly recommend regular % of completion/over and underbilling adjustments, which you can learn more about in this article, but in general money in=revenue, money out=cogs. Aside from over and underbilling adjustments, this is all Profit and Loss activity.
House flipping and speculative building are an entirely different accounting story. When an entity purchases property for the purposes of resale, the property becomes a current asset, like inventory. The costs during construction/rehab are also a current asset called either Construction in Progress (CIP) or Work in Progress (WIP). The funding of the projects may be through equity or loans, sometimes even customer deposits in the case of pre-sold projects, but there is no actual revenue until the project is sold.The accounting during construction is all Balance Sheet activity. Money out in the form of property purchase and job costs = Assets, money in=Liabilities (loans and customer deposits) or Equity/cash in the bank (self funded).
I will add that very often in speculative/flipping scenarios, there are multiple entities involved. One entity may act as the property owner, while another acts strictly as a contractor. In this case, the contracting entity accounting behaves as if the project is just like from any other client – revenue/cogs. It’s only the property owning entity that holds the costs and financing on its Balance Sheet.
There is a 3rd scenario here, and that is client contracting on a “completed contract” method. Completed contract accounting means that, even though the client owns the property and financing, the costs and revenue are held on the balance sheet as assets and liabilities until the project is complete . It is fairly rare that I run into this scenario, but it can be an advantage to clients who do both speculative and contract work for consistency in accounting processes. This is a great article from Investopedia with more information about completed contract method.
When it comes to complexity, speculative building and house flipping is far more complex than client contract or even completed contract scenarios. Part of this has to do with the fact that there is so much Balance Sheet activity that must be monitored, reported and accounted for in a very specific way in order to properly transfer the activity to the Profit and Loss at completion/sale. Additionally, there are complex transactions involved in the purchase and sale with seemingly infinite variances and scenarios, including things like: vendors paid out of escrow, closing costs to account for, interest to be accrued, loans to balance and pay off, and the recognition of everything in a way that will provide comprehensible reporting from the accounting system.
In many cases, a contractor may, in one entity, do both speculative building and client contract work, which often presents challenges in regard to accounting processes. For example, in QuickBooks Desktop, the job cost reports are item based. In a pure speculative environment, the items are mapped to the asset CIP or WIP so that all costs automatically hit the Balance Sheet when job related transactions are recorded.
When a client does both speculative and client contract work on a % of completion basis (revenue/cogs), additional methods must be employed – using 2 item lists, adjusting contract work to the P&L monthly or adjusting speculative projects to the Balance Sheet monthly. In QBO, I usually recommend running all projects through the P&L so that the Projects Center can be leveraged and adjusting the speculative projects to the Balance Sheet monthly. The integration of 3rd party apps can also influence the methods used.
If this all sounds like ALOT, you are not alone! I specialize in this work because it is complex and most contractors need help with it. I have untangled some crazy wild messes created not just by clients but by other accountants and CPAs who just didn’t have the experience to understand how convoluted this type of accounting can get if not set up and handled not just properly, but in very specific ways.
If you are in need of assistance – I can help! I cover all 3 types of accounting in both my Job Costing Intensive Desktop/Enterprise course and my Job Costing in QuickBooks Online Courses as well as offer one on one Training, Consulting, Coaching, Set up, Clean up and mentorship through my online Coaching.
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