UK Construction Accounting: A Guide to Regulatory Compliance
Accounting plays a fundamental role in the success of any business, and this holds for the construction industry as well. However, the construction business is distinctive in its operations, and so is construction accounting. Unlike many other industries, the construction industry does not operate on a straightforward buy-and-sell model. Instead, it involves numerous intricate aspects, and projects often span several years.
In this industry, it is challenging to determine who should get paid and when, how much they should receive, and when tax obligations are due. Payment arrangements are more complex, and projects may take several months or even years to reach completion. To navigate these complexities, construction contractors must adhere to technical regulations such as the Construction Industry Scheme (CIS) and the VAT domestic reverse charge.
Fortunately, the solution to these challenges lies in construction accounting. Construction businesses can ensure accurate and timely employee payments by adopting specific accounting practices tailored to the industry. These accounting practices differ from other companies, considering the construction sector’s unique characteristics and requirements.
Construction Accounting vs Regular Accounting: The Difference!
Simple rules form the basis of traditional accounting. Generally, goods and services are sold from set places and provided quickly, usually no more than a few months. Therefore, a typical accounting system comprises assets and liabilities. The construction sector is more complex than that. With different stakeholders involved and no set deadline for a project, outsourced human resources and subcontractors for projects who may juggle many assignments at once create payroll and payment complexities.
Additionally, general expenditures like insurance and project management must also be considered, as might the possibility of equipment relocation and other overhead expenses.
These are all factors that accountants in the construction industry take into consideration. Typically, you’ll create a new activity for each project and assign expenses there.
The way you divide up those expenses depends on the following strategy:
Income and costs are allotted on an accrual basis rather than a cash one. This method is for long-term projects, and reviews occur according to how far the project has come.
Allotments of income and expenditures are done at the time of payment. This option is more practical for smaller construction companies.
Understanding Generally Accepted Accounting Principles (GAAP)
To fully understand construction business accounting challenges, it is essential to grasp the fundamentals of Generally Accepted Accounting Principles (GAAP), which serve as the set of rules applied in the United Kingdom.
GAAP forms the bedrock of accounting practices, encompassing various industries, including the construction sector.
Ten core standards guide these principles:
- Regularity: Companies must avoid practices deviating from GAAP and consistently adhere to its principles.
- Consistency: Utilising the same accounting rules allows for easy comparison of financial figures from year to year, enabling investors and other stakeholders to make informed decisions.
- Sincerity: Accounting should be done honestly and ethically, without bias or trickery.
- Methods’ long-term viability: Similar to regularity, businesses should maintain consistent bookkeeping procedures year after year to ensure continuity and reliable financial reporting.
- Non-Compensation: All relevant financial information must be disclosed accurately, without embellishment or concealment.
- Prudence: Reporting should be based on factual information rather than assumptions. It is crucial to avoid overstating asset values or underestimating expenses.
- Beliefs: It should be grounded in everyday business operations, assuming continuity similarly.
- Periodicity: The norm is to provide monthly, quarterly, or yearly reports, focusing on information relevant to the specific accounting period.
- Complete/Material Disclosure: Financial aspects such as profits, loans, costs, and other relevant details should be meticulously documented and presented appropriately to ensure transparency.
- Absolute trust: The accounting process should strive for utmost transparency, with the understanding that other businesses will uphold the same standards.
Navigating Tax Obligations in the Construction Industry
Some aspects of the construction industry’s financial management are subject to strict statutory restrictions. To succeed, you must understand them and adjust your accounting procedures accordingly. Here are a few things to think about.
The Construction Industry Payment System (CIS)
The Construction Sector Scheme (CIS) is only one of several tax and regulatory guidelines unique to the construction sector that you’ll need to be familiar with before launching your own company.
The government established this program so that contractors would have a standardised way to manage payments to their subcontractors. If your firm will be engaged in any facet of the construction sector, limited, single trader, or partnership registration under the CIS system is mandatory. Speak to a contractor accountant if you are unsure about these issues’ intricacies.
Subcontractors’ wages will have taxes withheld and sent to HMRC under this program. The pay-as-you-earn (PAYE) system already covers payroll for direct employees; thus, this doesn’t apply to them.
But if you work with or are a subcontractor, you should sign up for the Construction Industry Scheme (CIS). Depending on the nature of your employment and your relationship with your employer, you may need to register as a contractor, subcontractor, or both.
Subcontractors might consider the CIS tax deductions as payments before their tax and NI obligations. If you’re a contractor, you must keep meticulous records of your expenses and submit tax returns regularly. If you’re a subcontractor registered, you’ll pay less in taxes.
Who Is Considered an Independent Contractor or Subcontractor?
- A person must sign up as a contractor if either.
Contractors get hired and paid to do construction work.
You have spent over £3,000,000 on construction in the last 12 months, even though your company does not specialise in such work.
- If you do construction services for an employer, you must register as a subcontractor.
- If you qualify for both, you must register for both.
The majority of building projects are included in the government’s CIS program because:
- A building, whether permanent or transitory
- Civil engineering projects like building roads and bridges are joint.
Construction tasks covered by CIS include:
- Laying of foundations and other site prep work
- Dismantling and demolition
- Developmental Efforts in Construction
- Renovations, mending, and embellishing
- Putting up infrastructure for environmental control, energy production, plumbing, and ventilation
- Post-construction cleaning of indoor spaces
Submitting Taxes via Making Tax Digital
It is crucial to have a comprehensive understanding of the system to ensure proper tax filing and to minimise the CIS fees.
In 2019, the government introduced Making Tax Digital (MTD) to streamline the tax process and enhance financial management. If you intend to file your taxes with HMRC, you need accounting software compatible with MTD.
HMRC has provided a list of approved software programs that can assist in keeping track of financial records and filing tax returns.
Transitioning to digital methods can save time and money, as it helps automate many tasks. Familiarising yourself with your responsibilities in ensuring MTD compliance and understanding the benefits of this effort will help you avoid potential fines in the future.
There are several advantages to going paperless with taxes, as supported by the Making Tax Digital initiative:
- Simplified tax filing process for individuals and businesses.
- Integration of tax administration with other aspects of operations through software usage.
- Promotion of digitalisation, leading to improved corporate efficiency.
- Reduction in tax revenue loss caused by avoidable errors, thanks to increased accuracy in digital documentation and integrated instructions within various software programs.
- Direct digital data transmission to tax authorities eliminates the need for manual submission.
VAT Domestic Reverse Charge
Value-added tax (VAT) applies to almost all businesses that sell goods or services, including those in the construction sector. However, CIS-registered contractors have an additional responsibility known as the VAT domestic reverse charge. Our Guide to VAT returns explains the vat return process in detail.
In the UK, most purchases, particularly in the construction industry, are subject to VAT. If your business is VAT registered, you can charge VAT to your customers on the goods or services you sell and reclaim VAT paid on your company’s purchases.
While there are different VAT rates (standard, reduced, and zero), it is essential to note that the standard rate is the most commonly applied for building work.
Registering for VAT if your annual revenue is expected to exceed £85,000 is mandatory to ensure compliance and avoid penalties. VAT registration is optional if your business’s annual revenue is below this threshold.
The VAT domestic reverse charge shifts the responsibility of VAT payment to HMRC from the supplier to the end user. This measure helps prevent fraudulent activities where subcontractors collect VAT from clients but fail to submit their returns before disappearing with the managed funds.
Under the reverse charge, subcontractors are not required to charge VAT—instead, the contractor’s responsibility for accounting for and remitting VAT on the transaction to HMRC. Subcontractors need only indicate on their invoices that the reverse charge applies to the main contractor.
Whether you operate as the main contractor or a subcontractor, being familiar with the VAT domestic reverse charge rules is crucial. By maintaining accurate tax records and adhering to the regulations, you can ensure compliance and avoid incurring penalty fees.
Revenue Recognition in a Construction Company:
Regarding building projects, revenue is recognised based on the quantity of work done rather than the invoice amount. In contrast to traditional accounting, construction accounting allows for a greater variety of revenue recognition techniques.
To align with revenue recognition rules, contractors must keep meticulous records of each project’s development. This data calculates earnings and generates financial statements at the appropriate times.
The scope of work, the timing of the project, the method of payment, and the total cost are all present in the construction contract. The measurement of work in progress is key to accounting.
5 Steps to Determine Revenue in a Construction Company
In the construction business, revenue recognition entails the following five stages:
- Find the customer’s agreement: While written contracts are the norm, verbal or implicit agreements may serve the same purpose as long as they include important terms and circumstances, such as scope, fee, and terms and conditions.
- Determine the extent of the project: The services that a company and a client have agreed upon to carry out a task or set of projects are known as the “scope of work” or “performance obligation.”
- Finalise your cost breakdown and pricing markup: During take-off, you estimate how much of each item you’ll need to finish a project. The markup is the amount added to the cost of goods or services before they get sold.
- Divide the purchase price among performance obligations: The project cost gets broken up into its parts, which are also called performance responsibilities.
- Recognise earnings: Revenue recognition should occur only when all performance criteria have been satisfied.
Constructional Contracts in a Construction Company:
A construction contract is a legally enforceable agreement between parties engaged in constructing, refurbishing, or installing a building, infrastructure, or other construction project.
The parties’ responsibilities and rights on the project are available in the contracts.
The Joint Contracts Tribunal (JCT) and the New Engineering Contract (NEC) are two examples of industry organisations in the UK that have drafted standard forms of contract to manage building projects.
Typical construction contracts include the following:
Contracts with NEC:
The New Engineering Contract (NEC) is a different set of standard form contracts that is frequently used in the UK construction industry. In agreements with NEC, cooperation, openness, and adaptation are emphasised. They offer a variety of contract types, including engineering and construction contracts, professional services contracts, and term service contracts.
The FIDIC Agreements:
The International Federation of Consulting Engineers (FIDIC) contract is customary for international projects in the UK and overseas. These contracts set down a procedure for obtaining engineering and construction jobs of all descriptions, ranging from straightforward house renovations to intricate infrastructure projects.
Standard-form contracts are created by the Joint Contracts Tribunal (JCT) and are often used in the UK’s construction sector. Design-build, construction management, and traditional agreements are available to suit the requirements of varied projects. They offer a framework for choosing how expenses will be divided, identifying obligations, and resolving conflicts.
Custom contracts, also referred to as “bespoke contracts,” are designed from the ground up to satisfy the particular needs of each building project. Sometimes, a custom contract is required for bigger, more difficult projects or those where the parties would want more freedom.
The Complexity of Accounting for the Construction Sector
Construction businesses face particular, complex accounting issues that call for careful thought.
Cost Estimation Challenges
Accurate cost estimation can be time and effort-consuming due to the variety of building projects and differences in timeframes, resources, and personnel requirements.
Long-term Project Perspectives
Accurately assigning costs and recognising income becomes more difficult because construction projects might last for months or years.
Uncertainty and External Factors
Due to the multiple variables that might affect a project’s development, including supply chain concerns, weather conditions, and subcontractor availability, the construction sector is inherently unpredictable.
Adapting to Changing Objectives
The dynamic nature of construction projects often necessitates quick adjustments to scope and priorities. Adapting efficiently without incurring excessive debt is crucial.
Multiple Expenses to Manage
Managing several subcontractors with their terms and payment schedules across various projects and locations complicates construction accounting.
Accounting Software Simplifies Your Job!
Using reliable accounting software significantly improves the effectiveness of maintaining financial records. It automates financial tracking and generates detailed reports to maximise data use and conform to MTD regulations.
Purchasing accounting software tailored to the needs of the construction industry might be helpful. A cloud-based system is convenient. One can access the data stored on the cloud from any device, anywhere.
It allows quick updates to data or scope modifications, both in and out of the office. In contrast, while using a conventional, locally installed software system, your options for making adjustments are restricted to a predetermined time and place.
For example, Xero has features that allow construction companies to stay compliant with Domestic Reverse Charge, track costs on projects or use various apps to scale its abilities to track field service work, improve project workflows, etc. Speak to your Xero Accountant to learn more.
Construction Financing: Working Capital Options for the Construction Industry
There may be significant outlays for goods and labour before you begin to see a profit in the construction sector, so careful cash flow monitoring is essential. An invoice finance service may help you deal with this problem by allowing you to sell your unpaid customer bills to a financing firm and utilise the money you get to cover other expenses.
This practice, known as “invoice factoring,” is so widespread in the building sector that many financing institutions now provide specialised construction finance invoice services.
Accurate construction accounting is vital in expanding construction firms, making it crucial. Adopting accounting procedures specifically designed for the construction sector becomes necessary to ensure efficient financial management and compliance with relevant laws and standards.
Construction businesses can significantly enhance their prospects of long-term success by familiarising themselves with and adhering to fundamental principles and practices in construction accounting. This proactive approach enables them to streamline their accounting processes and make informed financial decisions, ultimately paving the way for growth and prosperity.
Frequently Asked Questions
What Are the Essential Accounting Requirements for Construction Businesses in the UK?
To maintain financial transparency and compliance, construction enterprises in the UK must adhere to several crucial accounting rules. These criteria include keeping accurate and current books of accounts, which entails methodically logging all financial activities, such as receipts and payments for goods and services. Additionally, construction companies should prepare financial statements such as balance sheets, income statements, and cash flow statements to understand their financial performance comprehensively. The accuracy and integrity of financial reporting can be increased by adhering to standard accounting procedures, such as double-entry bookkeeping.
What Regulatory Compliance Obligations Do Construction Businesses Need To Meet?
In the UK, construction companies must adhere to a number of distinct regulatory compliance requirements. These responsibilities include tax compliance, where businesses must accurately and on time satisfy their tax obligations for income tax, corporation tax, and Value Added Tax (VAT). Payroll compliance is also essential because enterprises engaged in the construction industry are subject to rules governing employee compensation, National Insurance contributions, and pension plans.
How Can Construction Businesses Streamline Their Financial Processes?
Implementing effective accounting software and automating activities like expenditure monitoring and invoicing are key to streamlining financial processes. Regular account reconciliation and the use of financial controls can assist in quickly spotting errors and maintaining correct financial data.
What Steps Should Construction Businesses Take To Stay Compliant With Regulations?
Businesses in the construction industry should conduct internal audits, evaluate and update their policies and procedures regularly, and stay abreast of any changes to the law.
Where Can Construction Businesses Find Further Guidance on Accounting and Regulatory Compliance?
Professional accountants, trade organisations, government agencies like HM Revenue and Customs (HMRC) and the Health and Safety Executive (HSE) are all excellent sources of advice for construction enterprises. They might also consider speaking with legal professionals focusing on construction laws.
Jibran Qureshi FCCA is the Managing Director of Clear House Accountants and has over 15 years of experience in practice across multiple industries. Jibran’s educational background includes a Master’s in Financial Strategy from Oxford University and an Executive MBA from Hult International Business School. His experience in Financial Strategy, Tax Planning, Operational Consultancy, and Performance Reporting guides his cognizant approach to leading Clear House and its clients to the future. This dexterity led him to be one of Enterprise Nation’s Top 50 Advisors. Jibran recognised the need to manage the innovative disruptions sustainably early on and shaped Clear House Accountants not just to be compliance specialists but advisors who help build complex ecosystems around cloud accounting software, provide advice on funding support, help manage innovative tax schemes, set up and implement complex strategic plans, and much more. So, his clients can thrive, not just survive.
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