Construction Accounting Challenges

When SC Contractors Pte Ltd approached us to assist with their first audit for the financial year ending 31 December 2024, they were understandably overwhelmed. Preparing for an audit is already a daunting task, but for a construction company, the complexities of accounting standards like FRS 115 (Revenue from Contracts with Customers) add an extra layer of challenge.

After reviewing their financial records for the past three years (2022 – 2024), we identified a range of issues that are common in the construction industry, including:

• Fluctuating profits caused by improper revenue recognition.
• Misaligned cost allocation practices.
• Lack of project-specific reconciliation.
• Inadequate WIP tracking and cash flow management.
• Over-reliance on manual bookkeeping systems.
• Lack of regular financial reviews and monitoring.

In this blog, we’ll highlight the lessons learned from SC Contractors’ experience, explain the impact of these issues on their financial reporting, and provide practical solutions to overcome them. If you’re a construction company facing similar challenges, this guide is for you.

SC Contractors’ Financial Performance: A Closer Look

Here’s a summary of SC Contractors’ financial performance over the last three years, which sheds light on the challenges they faced:

Profit and Loss Summary [2022 – 2024]

Key Observations:

1. Revenue increased significantly in 2024 (by 71% compared to 2023), but the cost of sales and operating expenses also rose sharply.
2. The company turned around from a loss of SGD 1.47 million in 2023 to a profit of SGD 1.1 million in 2024, indicating operational improvements or better cost control.
3. Dormitory expenses, foreign worker salaries, and levies are the largest components of operating expenses, accounting for a significant portion of total costs, with dormitory expenses alone increasing by 31% in 2024.

Balance Sheet Summary – [2022 – 2024]:

1. Accounts Payable decreased significantly in 2024 (from SGD 1.1 million to SGD 316,760), indicating better payment management or reduced procurement.
2. The company experienced a drastic improvement in its net assets from a negative position in 2023 to SGD 827,334 in 2024.
3. Accounts Receivable dropped by 19% in 2024, which could indicate better collection efforts or reduced billing or retention amount balance.

Key Challenges and Lessons Learned

1. Fluctuating Profits Due to Improper Revenue Recognition

One of the most common mistakes in construction accounting is failing to recognize revenue progressively. In SC Contractors’ case, revenue was being recorded [based on invoices raised] only when projects were completed or milestones were billed, rather than proportionally as work was completed.

For example:

• In 2023, the company incurred significant costs for ongoing projects, but revenue was not recognized until 2024 when the projects were completed. This led to artificial losses of SGD 1.47 million in 2023.
• In 2024, profits rebounded to SGD 1.1 million, but this was due to revenue from work performed in 2023, creating an inaccurate picture of financial recovery. Meanwhile, certain revenue related to work completed in 2024 might recognised in 2025, resulted understated of 2024 profit.

Impact on Financial Reporting

• 2023 Results: The company reported a loss of SGD 1.47 million despite significant ongoing projects. This loss likely includes costs incurred in 2023 for projects where revenue was only recognized in 2024.
• 2024 Results: Profit rebounded to SGD 1.1 million, largely due to revenue from projects completed in 2024. However, this profit includes work performed in 2023 and this profit might exclude works performed in 2024, creating an illusion of financial recovery.

Why This Is Wrong

Under FRS 115, construction companies must:

• Identify performance obligations within each contract.
• Recognize revenue over time as performance obligations are met, not just when invoices are issued.
• Disclose contract assets (e.g., unbilled revenue) and contract liabilities (e.g., advances from customers).

Contract Asset: If revenue exceeds the amount invoiced, record the difference as a contract asset (unbilled revenue).

Contract Liability: If the customer pays in advance, record the excess as a contract liability.

2. The Domino Effect on Income Tax

Fluctuating profits caused by improper revenue recognition can significantly affect income tax calculations:

• In 2023, the company reported a loss of SGD 1.47 million, which would likely result in no tax payable.
• In 2024, profits jumped to SGD 1.1 million, leading to a taxable amount that could have been smoothed out if revenue had been recognized progressively.

Consequences

• Overpayment in High-Profit Years: Tax is calculated on inflated profits in years like 2024.
• Missed Tax Relief in Loss Years: Losses in 2023 could have been reduced if revenue was allocated to the correct periods, limiting the company’s ability to carry forward tax losses.
• Improper Cost Allocation: Dormitory and Worker Expenses

Bookkeepers at SC Contractors Pte Ltd record dormitory expenses, foreign worker salaries, and levies as general operating expenses, instead of allocating them to specific projects. For instance:

• Dormitory-worker expenses in 2024 were SGD 2.45 million, a 31% increase from 2023.
• These costs are directly tied to labour for ongoing projects and should be allocated to job costs, not treated as general expenses.
• Did not maintain detailed WIP records to track the percentage of project completion thus made it difficult to measure progress accurately and allocate revenue and costs appropriately.

Why This Is Problematic

When costs are not allocated to specific projects:

• Project profitability cannot be accurately assessed.
• Directors may make decisions about pricing, resource allocation, or project viability based on incorrect data.

The Solution

• Implement job costing to allocate direct costs (e.g., labour, materials) and indirect costs (e.g., dormitory expenses) to each project.

4. Lack of Awareness: Directors and Bookkeepers

Both the directors and bookkeeper of SC Construction appear unaware of the requirements under FRS 115. This lack of knowledge is evident in:

• Revenue being recognized only upon project completion.
• No disclosure of contract assets or contract liabilities.
• No provisions for loss-making contracts, as required under FRS 115.

Without proper understanding:

• Directors cannot make informed decisions about the company’s financial health or compliance with tax laws.
• Bookkeepers may unintentionally misstate financial results, leading to tax audits, penalties, or reputational damage.

5. Not Keeping Projects Separate for Reconciliation and Contract Modifications

A critical mistake in construction accounting is failing to maintain separate accounts for each project. When all project costs and revenues are lumped together, it becomes nearly impossible to:

• Reconcile project-specific income and expenses.
• Assess the profitability or losses of individual projects.
• Identify cost overruns or underbillings on a project-by-project basis.
• Did not account for changes to contracts, such as variations or additional work

Why This is Problematic:

• Without separate project accounts, bookkeepers cannot accurately track the financial performance of each project.
• Directors may struggle to make informed decisions about resource allocation, pricing, or project viability.
• Errors in project-level accounting can lead to disputes with clients, delays in invoicing, and potential audit findings.

Solution:

• Set up separate cost centres or accounts for each project in the accounting system.
• Track all project-specific income, expenses, and WIP separately to enable accurate reconciliation.
• Adjustments were made to revenue recognition and job costing to reflect contract modifications.
• Use construction-specific accounting software (e.g., QuickBooks for Contractors, Xero Projects, Sage 300 Construction) to automate project tracking and generate project-level financial reports.

6. Cash Flow Management and Payment Delays

Cash flow management is a critical issue for construction companies like SC Contractors due to the nature of the industry, where upfront costs are high, and payments are often delayed. Despite a significant improvement in accounts payable in 2024 (from SGD 1.1 million to SGD 316,760), the 19% drop in accounts receivable.

This could be attributed to retention clauses, where a portion of payments (usually 5% – 10%) is withheld until project completion or defect rectification, tying up cash for long periods.

Additionally, delayed payments often stem from lengthy invoice approvals, disputes over milestones, or dependency on other contractors’ progress.

Such misaligned cash inflows and outflows result in operational strain, limiting the company’s ability to finance ongoing projects or pay suppliers and workers on time. Poor cash flow also disrupts project timelines, increases reliance on credit, and affects financial stability.

For SC Contractors, these issues highlight the importance of aligning cash inflows with outflows, tracking receivables more effectively, and negotiating better payment terms to mitigate the impact of retention clauses and payment delays.

Call to Action

At S C Mohan PAC, we specialize in audit assurance services for SMEs, contracts, and group companies. For our contract clients, we go the extra mile by assisting with:

• Bookkeeping services tailored to the construction industry.
• Year-end adjustments for contracts in compliance with FRS 115.
• Preparation of schedules and financial statements for audit.

Let us help you navigate these complexities with confidence!

📞 Call: +65 9144 1840
📧 Email: accounts_1@scmohan.com.sg or office@scmohan.com.sg

Our dedicated team is ready to assist you every step of the way.

Next Blog: How to Account for Contracts

In our next blog, we’ll explore how to account for contracts in compliance with FRS 115. Topics include:

• Progressive revenue recognition.
• Managing performance obligations for long-term contracts.

Stay tuned for actionable insights that will transform your construction accounting practices!

Disclaimer

The information in this blog is provided for general informational purposes only and does not constitute professional advice. While every effort has been made to ensure the accuracy of the information, it is not a substitute for professional judgment or consultation. Readers are advised to seek guidance from qualified accounting professionals or consultants before making any financial or business decisions.

The opinions expressed in this blog are those of the author, and specific circumstances may vary. The examples provided are for illustrative purposes only and do not represent any specific company’s financial data or situation.