Buyer Beware...What You Need to Know about Construction Accounting

Posted on June 12, 2018

Buying design and construction services has never been an easy task. In today’s economic climate, the challenge has become exponentially harder as struggling builders are becoming increasingly “creative” in how they account, or represent, the various expenses associated with building a facility.  We will explore how contractor’s present their fees and how those fees can actually result in a much different outcome once all things are considered.
 
Prior to exploring the accounting side of a construction project, let’s define what the primary costs for the project are and how these costs can be represented, or even manipulated, to the financial gain of the builder, without you even knowing it. The primary cost items for a construction project are design and engineering, general condition costs, building construction costs which can include self-performed construction costs, reimbursable costs, fixture and furnishing costs, and builder overhead and profit.
 
Design and Engineering
Design and engineering expenses are related to but not limited to the architect, building and site engineer, mechanical and electrical engineers, and more, who are responsible for the plans from which the builder will construct the building.
 
General Conditions
General conditions is a very important area to focus on, as it is quickly becoming an area were “creative accounting” abounds.  General conditions are costs that the builder incurs to build the building but are not actually part of the building.  Examples of general conditions include:  the site trailer, temporary utilities, temporary restroom facilities, trash removal, site storage trailers, barricades, safety fencing, first aid kits and various safety equipment, quality control/material testing, traffic control, governmental compliance issues, and site/building cleaning.  The largest general conditions cost to any project is the site superintendent.  The superintendent is typically the only person who is “charged” to the job.  However, firms may often “lower” their stated overhead and profit by “moving up” various office staff costs to general conditions.  When comparing several builder’s bids, businesses should add the general conditions costs to the builder’s overhead and profit.  This figure will offer a true picture of each builder’s fees.
 
Construction
Construction costs are the basic bricks and sticks of your project along with the labor to put them in place.  Construction costs cover everything from the bulldozer pushing dirt to the carpenter installing studs, or the painter putting the finishing touches on your new facility.  Some builders may include self-performed work in their cost summary.  Self-performed work is labor and materials that are supplied by the builder’s own employees and is rarely competitively bid on the open market.

Reimbursables/Allowances
Reimbursable costs are those costs that the designer or the builder are not able to get a firm estimate or bid on.  Many of these costs are owner preference or weather related.  Businesses should eliminate as many of these unknown variables as possible.  Every unknown can and usually will, lead to cost overruns.
 
Fixtures and Furnishings
Fixtures and furnishings, also known as FFE, can become a large portion of a project. Typical items considered FFE are: office and classroom furnishings, café equipment, machinery and athletic equipment.  Prior to beginning any project, make sure that you have a point person that will work closely with the designer and builder to establish budgets and costing for your FFE accounts.
 
Builder Overhead and Profit
The builder overhead and profit, needless to say, is an important area to evaluate.  The overhead and profit allows the builder to pay their office support staff, maintain their home office, provide warranty on the finished project and supply a profit to the stakeholders for the risk taken and managed to build your building.  Choosing a builder, solely on their “low” overhead and profit percentage, has sometimes become a rude awakening for businesses around the country when they finally stumble upon the “hidden costs” of the project.
 
Faced with the daunting task of choosing the right builder for their project, business owners have resorted to shopping building firms based on their overhead and profit percentage and ignoring the monthly general conditions costs. The thought is that overhead and profit is the only variable between builders. The remaining project costs (Design & Engineering, Construction Costs and Fixtures & Furnishings) are somewhat fixed.  That assumption is far from accurate.  As a picture says a thousand words, numbers, especially dollars, speak even more.

Example Project Without Self-Performed Work

An example twelve-month project will be used to illustrate the accounting side of a typical construction project.  The primary cost items, for the Design/Builders are:

  • Design and Engineering                $  150,000

  • General Conditions                        Monthly Fee

  • Construction Costs                         $2,500,000

  • Builder Overhead & Profit              % of GC’s & Construction Costs

Design/Builder “A”

  • Design and Engineering                $   150,000

  • General Conditions                        $   300,000

    • $25,000/Mo x 12 Months

  • Construction Costs                         $2,500,000

  • Overhead & Profit @ 10%             $   295,000

  • Total Project Cost                           $3,245,000

Design/Builder “B”

  • Design and Engineering                $   150,000

  • General Conditions                        $   480,000

    • $40,000/Mo x 12 Months

  • Construction Costs                         $2,500,000

  • Overhead & Profit @ 7%               $   219,100

  • Total Project Cost                           $3,349,100

Design/Builder “C”

  • Design and Engineering                $   150,000

  • General Conditions                        $   660,000

    • $55,000/Mo x 12 Months

  • Construction Costs                         $2,500,000

  • Overhead & Profit @ 4%               $   132,400

  • Total Project Cost                           $3,442,400

 
At first glance, Design/Builder “A”, whose overhead and profit is at 10%, appears to be the higher cost solution, Design/Builder “B”, whose overhead and profit is at 7%, is in the middle of the pack while Design/Builder “C”, whose overhead and profit is at 4%, appears to be the low cost solution. The fact that Design/Builders “B” & “C” are moving much of their office overhead into general conditions, actually makes them the high cost providers by almost $100,000 and $200,000, respectively!
 
Many times, attention is gained with a low overhead & profit figure from a builder, only to find later, that “costs” the builder has moved into general conditions have created a higher actual project cost.  When evaluating your design and build team, make sure that the general conditions costs and the overhead & profit are identified and carefully compared.

Clearly, the “numbers” can be deceiving.  The “low cost provider” can quickly become the “high cost provider” if you are not aware of their accounting methods and practices.  Don’t rely just on the builder’s overhead and profit percentage when making such a large decision.  All costs should be accounted for when comparing the various approaches that builders take to present their fees.  An understanding of how your Design and Build Team accounts for the costs of your project goes a long way in making an accurate stewardship driven decision.