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Owning your own medical practice is an exciting prospect, but it comes with additional accounting responsibilities. While you’d probably prefer to focus on providing healthcare services to your patients, you can’t afford to ignore the business side of your operation. 

Here’s what you should know about medical practice accounting to keep your financial systems running smoothly, including the unique challenges involved, some best practices to implement, and the most common mistakes to avoid.

How Is Accounting For Medical Practices Different?

The many years you spent in medical school were highly effective at preparing you to assist your patients. Unfortunately, they probably didn’t do as good a job of teaching you how to be a business owner.

As a result, healthcare professionals are often unprepared to manage their company’s accounting and tax responsibilities. To make matters worse, the unique nature of the healthcare industry creates financial issues beyond what most business owners face.

Generally, the most significant medical practice accounting challenges stem from the healthcare billing process. Most businesses provide a product or service to a customer, then receive a predictable payment from them in exchange.

Unfortunately, medical practices provide services to their patients but have to coordinate payment between them and their insurance companies. There are many more moving parts than usual, and it’s much easier for things to go wrong.

For example, medical coders make mistakes, patients fail to pay their bills, and insurance companies reject claims. As a result, medical practices must establish even more efficient systems for tracking and organizing data.

Best Accounting Practices For Medical Practices

As a healthcare provider, you probably want to focus on serving your patients and spend as little time as possible worrying about the financial health of your business. An efficient accounting system is essential for doing so without harming your practice. 

Here are some best practices you can implement to optimize your accounting function and minimize the time you have to spend managing it.

Leverage Cloud-Based Software

The sheer complexity of medical practice accounting makes software essential for healthcare providers. It’s prohibitively difficult and time-consuming to keep track of everything by hand.

Fortunately, modern cloud-based software solutions can automate many of the most time-consuming aspects. That noticeably reduces the strain on your administrative staff with bookkeeping and accounting responsibilities.

Businesses often need to invest in multiple tools, but healthcare providers can meet most of their needs with practice management solutions (PMS). For example, they can usually facilitate processes like the following:

• Scheduling appointments
• Capturing patient details
• Storing treatment plans
• Billing patients and insurers
• Insurance claim scrubbing

You may still need to acquire a few tools for whatever your PMS can’t help you with, such as accounting and payroll services. Before committing to any products, make sure you’ve chosen ones that can interface with each other seamlessly.

Use The Accrual Accounting Basis

Businesses generally have to choose between the cash and accrual accounting methods. Neither is inherently superior, but the accrual basis is generally better suited to medical practices.

The cash basis of accounting involves recognizing revenues when you receive them and expenses when you pay them. Meanwhile, the accrual basis recognizes revenues when you earn them and expenses when you incur them.

The cash basis is easier to implement, but it generates financial statements that poorly represent a medical practice’s profitability. Doctors often provide services and go without the corresponding revenues for months, if they ever receive them at all.

As a result, the accrual basis is much better at matching revenues with expenses and accurately representing your business's financial situation. However, it makes cash flow monitoring harder, so remember to track that separately.

Invest In Financial Education

One of the reasons healthcare providers often struggle to run their practices' accounting effectively is that business management is well outside their expertise. Fortunately, you can remedy that by investing in your own financial education.

Finance, accounting, and tax strategies aren’t the most exciting topics for most medical practitioners, but you don’t have to become a master. You usually only need to know enough to hire and manage people who run those functions.

Once you have an administrative staff in place, it’s a good idea to invest in their financial education as well. The more knowledgeable and reliable they are, the less that business will interfere with your day-to-day routine.

Delegate As Much As Possible

Providing medical services to your patients is more than enough work to occupy all of your working hours. It’s also the aspect of your business where your time generates the highest return, not to mention the one you probably enjoy the most.

As a result, delegating will benefit you even more than most business owners. Embrace the fact that you’re going to need help managing your medical practice accounting responsibilities, and don’t be afraid to pay for assistance.

Of course, labor is expensive, and you shouldn’t waste money unnecessarily. Fortunately, you don’t need to hire full-time workers for all your accounting functions.

For example, an in-house bookkeeper might make sense, but you’re probably better off using an outsourced accounting service for your more sophisticated financial needs.

A Certified Public Accountant (CPA) firm can provide all of the medical practice accounting services you need for a fraction of the cost, including proactive tax planning strategy, new business advisory, and business tax preparation services.

Common Mistakes

Healthcare providers rarely study business management during higher education. As a result, it’s easy for new practice owners to make mistakes as they transition into business ownership.

Here are some of the most common errors physicians make that you should know to avoid.

Lack Of Organization

Accounting for medical practices involves many more moving parts than accounting for most other businesses. As a result, it’s more important than usual that you set up systems to keep everything organized and running smoothly as soon as possible.

Here are some of the most effective steps you can take:

• Separate personal and business accounts: Using the same bank accounts for your business and personal activities forces you to go back and split the two later. Separate them from the beginning to save yourself the trouble.
• Customize your chart of accounts: Medical practices have nuanced revenues, expenses, assets, and liabilities. Creating particular accounts in your accounting software helps keep your bookkeeping accurate and actionable.
• Keep track of your asset purchases: Medical practices need expensive equipment to run. Unfortunately, you need to capitalize and depreciate these costs instead of deducting them immediately, so keep separate records for them. 

Whatever you can do to optimize your accounting from the start will pay dividends indefinitely, so be as diligent as much as possible from day one. Preventing accounting problems from occurring is much more effective than fixing them later.

Neglecting Financial Analysis

Healthcare providers can benefit significantly from automating and delegating significant portions of their accounting. However, that doesn’t mean you can ignore your medical practice’s finances.

Patient care can be your main priority, but your medical practice is also a business. As a result, you need to take the time to review your financial statements and reports to draw conclusions that can inform your business decisions.

For example, variable analysis is one great way to identify extraneous expenses and improve your overall profitability. It involves creating budgets for your expected costs, comparing them to your actual numbers, and investigating the differences.

While you can pay an accounting firm for help with a lot of this, you can't give up the financial controls altogether. You need to know enough to understand and assess any management solutions they suggest.

Choosing A Generic Accounting Advisor

While the same fundamental accounting principles apply to every business in the United States, the nature of the healthcare industry presents some unique issues. As a result, it’s usually a mistake to settle for a generic CPA’s medical practice accounting services.

The average CPA firm can handle basic small business accounting and tax services. However, if they’ve never worked with a busy medical practice before, they may not be able to develop effective medical practice accounting solutions.

When you’re looking through accountant websites, make sure you select providers who demonstrate a clear understanding of healthcare accounting challenges. Use the free consultation and ask each one how they deal with insurance and medical billing issues.

Here For Your Funding Needs

As you're growing and expanding your medical practice, you'll likely need access to additional capital. Lendio can help match you with the right lender for your medical practice loan.

All businesses in the United States follow the same fundamental accounting principles, but their application varies between industries. Because the hospitality industry has some unique financial quirks, hotel accounting can be particularly intensive.

If you're a hotel owner, here’s what you should know about accounting for your business, including what separates it from accounting in other industries, the most significant obstacles you’ll face, and some best practices that can minimize your issues.

How Is Hotel Accounting Different?

The fundamental challenge of accounting for hotel operations is relatively straightforward. In simple terms, there’s much more financial data to document, organize, and analyze in the lodging industry than in most others.

The rules aren’t any more sophisticated than usual, but running a profitable hotel business often requires managing many different income streams and a diverse set of expenses.

While room rentals are a hotel’s primary offering, their supplemental revenue streams can still be significant. They often have their own unique costs, and running them may require accounting for them separately.

In addition, hotel activities are virtually endless and generate transactions every day of the year. Unlike other businesses that close at the end of the day and shut down entirely for a couple of days a week, hotels do business at all hours and every day of the year.

As a result, everything from maintaining organized, accurate financial records to analyzing operational data for decision-making purposes becomes significantly more difficult.

Accounting Challenges Faced By Hotels

Ultimately, the primary challenge of hotel accounting is establishing systems that can effectively organize and analyze the overwhelming amount of data involved. To help you tackle the problem, here’s a more in-depth explanation of the factors contributing to it.

Ceaseless Operations

One of the most significant contributors to the challenge of hotel accounting is that hotels rarely close. In most cases, hotels are open for business 24 hours a day, 365 days a year.

After all, their primary offering is a place for people to stay, and there’s always demand for it. Demand is often even higher on holidays when many other businesses are closed since people tend to travel away from home around those days.

As a result, hotels have new transactions to deal with daily, which creates a constant strain on the staff members responsible for maintaining financial records. For example, this typically necessitates a “night audit.”

Now a standard in the hotel industry, the night audit is an after-hours process that involves confirming room statuses, documenting no-shows, reconciling guest transactions, and everything else necessary to close the books for the day.

Multiple, Unrelated Activities

Hotels generate the vast majority of their revenues by renting out their rooms. However, many of them have multiple additional income streams that range from tangentially related to completely separate from their primary offering.

For example, hotel revenues can come from room rentals, room service, meeting space rentals, on-site restaurant and bar sales, valet and parking charges, vending machines, spa and massage services, gift shops, in-room minibars, movie rentals, and more.

It might not make sense to account for all of these activities separately. However, if a few are significant enough to impact profitability, it’s often worth breaking out the related transactions to help managers handle them effectively.

For example, a hotel with a popular on-site bar would need to keep track of its revenues and expenses separately to maintain the supplies necessary to maximize profitability and operational efficiency.

Varying Room Rates 

Setting room rates is one of the most unique and complex aspects of hotel accounting. Though software exists that can organize the necessary data and help with the challenge, it’s not perfect, and human input is still often needed.

Once again, the sheer scope of the data to consider is what makes this so challenging. For example, all of the following have some impact on the ideal price of your hotel rooms:

• Seasonality
• Days of the week
• Competitor prices
• Customer expectations
• Current occupancy rate
• Minimum price to cover costs

Accounting for all these variables while setting prices is a delicate process, even for experienced hoteliers using hotel management software. Setting prices too high can scare off customers, but setting them too low means leaving money on the table.

Complex Payroll Costs

Few businesses have a staff as diverse as the army of workers that hotels need to employ to function effectively. For example, even a small hotel with simple amenities and offerings would need to hire all of the following:

• Front desk staff
• Housekeepers
• Security
• Management
• Valets
• Culinary staff

In addition to the many different functions they need to fulfill, these workers often have vastly different compensation formats. Hotels usually have both full-time and part-time workers, with some receiving tips and others not.

Unfortunately, hotels need to account for these labor costs accurately and timely so their managers can staff effectively. Otherwise, they risk wasting money by overstaffing for slow periods or overwhelming employees by understaffing in busy times.

Increased Managerial Accounting Requirements

Another reason accounting can be more challenging for hotels than other businesses is that there’s a greater need for managerial accounting processes in the hospitality industry.

Managerial accounting involves organizing your financial reporting in a way that helps managers make intelligent business decisions, and it’s essential for hotels. They need financial information to set room rates, hire staff, and determine budgets.

For them to do so effectively, you can’t lump your hotel’s activities together. It obscures the numbers relevant to individual income streams, and hotel managers need more specific accounting data than revenue and expense totals.

As a result, a significant portion of hotel accounting involves matching transactions to the correct activities so managers can generate the financial reports they need to make intelligent choices.

Best Practices For Hotel Accounting

Hotel accounting can be challenging, but you can mitigate many of the most troublesome issues with preparation, organization, and automation. Here are some best practices you should follow to ensure your accounting system is as efficient as possible.

Choose An Accounting Basis Carefully

Hotels can choose between using the cash or accrual methods of accounting. Both have pros and cons, but the best option depends primarily on the size of your operation. If you choose incorrectly, you could cause yourself significant accounting issues later.

The cash method involves recognizing revenues when you receive payments and deducting expenses when you pay them. It’s generally easier to implement, but it’s also the less accurate of the two.

It generally does a better job of measuring your company’s cash flows than its actual profitability. As a result, it’s usually only suitable for small hotel businesses like bed and breakfasts.

Meanwhile, the accrual method involves recognizing revenues when you earn them and deducting expenses when you incur them. It also requires that you keep track of your accounts payable and receivable.

These additional complexities make it harder to execute, but accrual financial statements paint a more accurate picture of your business’s profitability and financial position. Managers, investors, and lenders all prefer them for that reason.

As a result, accrual accounting is often better for larger, more sophisticated hotel businesses. Keep that in mind if you plan to scale your hotel operation up over time.

You might want to use the cash method at first, then change to accrual as you grow, but switching can be difficult. If you plan to use accrual eventually, it may be better to do so from the start.

Take Advantage Of Software

Bookkeeping can be one of the most intensive aspects of hotel accounting. Theoretically, it involves the least amount of critical thinking, but the volume, diversity, and unending flow of transactions make it difficult to handle the function manually.

As a result, accounting software is essential for tracking your hotel’s activities efficiently. However, while generic tools are effective for many small businesses, they may not meet the complex requirements of many hotels.

The more your business grows, the more likely you'll need advanced industry solutions. For example, if you’re running a group of hotels, you’ll need a property management system that can handle all of your locations from a single dashboard.

Fortunately, many hotel accounting software options exist with a broad range of capabilities. The right accounting solution will depend on your tech stack, level of sophistication, and growth expectations, so explore your choices thoroughly.

If you choose a less comprehensive option to keep the cost down, you may need to supplement it with additional tools, such as payroll, booking, or point-of-sale software. Keep those extra potential expenses in mind as you shop.

Optimize Your Night Audit

Hotels usually need to perform nightly audits to ensure the accuracy of their complex financial records. These involve taking steps like confirming room statuses, posting room charges, and preparing financial management reports.

Because these audits are a daily occurrence and critical to the success of your accounting function, it’s worth taking the time to optimize them. Otherwise, they can become one of the most tedious and time-consuming aspects of your business.

To make the process as efficient as possible, consider doing the following:

• Systematizing your night audit training
• Documenting step-by-step instructions for the process
• Training multiple employees to complete night audits
• Investing in software to automate the audits as much as possible

Because these reconciliations need to happen nightly, you don’t want to rely on one accounting team member to complete them. They won't be available every day of the year, but your hotel has to be.

In addition, you want it to be relatively easy to train someone new to complete the process. Otherwise, losing one or two key team members could cripple your accounting department.

Get Expert Help 

Almost every business can benefit from expert accounting services, and hotels are no exception. Running a hotel is more than a full-time job, so you’ll probably need to pay others to handle your business’s more sophisticated accounting needs.

In addition to the accounting manager responsible for recording daily transactions and other bookkeeping activities, it’s best to get assistance from a Certified Public Accountant (CPA) knowledgeable in hotel accounting services.

In addition to verifying the accuracy of your balance sheet and income statement, they can provide personalized tax planning, cash flow and financial analysis, budgeting, and forecasting services.

One of the best ways to get these kinds of accounting services without paying for another full-time hotel accountant is to hire an outsourced CPA firm. Just make sure you choose one with experience in the unique challenges of hospitality accounting.

*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.

Opening your own law firm is an exciting point in your legal career, but you can’t get so caught up that you neglect the financial aspects of owning a business. To keep your company running smoothly, you must stay on top of your accounting responsibilities.

Here’s what you need to know to establish and maintain an effective accounting system for your law firm. We’ll cover the unique accounting challenges lawyers face, some general best practices to follow, and the most common pitfalls you need to avoid.

How is accounting for law firms different?

Fortunately, most accounting concepts for law firms are relatively straightforward. The finances of service providers tend to have far fewer moving parts than those of businesses with an inventory on the books.

However, there are a couple of unique aspects to law firm accounting, and managing them can be challenging. Most notably, lawyers often hold onto funds that don’t belong to them, and specific rules govern how you need to handle that cash.

For example, lawyers may collect settlement funds on behalf of their clients. Not only do you have to keep these funds separate from yours and your firm’s, but even mingling them with other clients’ funds can be problematic.

In addition, you may need to use clients’ funds on their behalf, in which case you must provide detailed reports about your activities to remain in compliance.

That’s known as trust accounting, and you should understand the guidelines thoroughly before opening your own law office. If you make a mistake and violate the rules, it could cost you your law practice or your license.

In addition, law firms sometimes pay for expenses on behalf of their clients using the company’s funds. These aren’t tax-deductible expenses and can muddy your financial records if you’re not careful.

Bookkeeping vs. accounting for law firms

Before proceeding further, let’s clarify the difference between bookkeeping and accounting. The two functions are closely related, and there’s often some significant overlap between them. Accountants may provide bookkeeping services, and bookkeepers frequently need to know accounting fundamentals.

However, they’re still distinct, at least theoretically. Bookkeeping for a law office involves recording your day-to-day transactions and maintaining clean financial records. It’s an almost administrative task that involves relatively low levels of critical reasoning.

As a result, lawyers can automate a significant portion of their bookkeeping using accounting software. Subsequently, they can often handle the aspects that require a human touch personally without much training.

Conversely, accounting for law firms is more complex. It involves verifying bookkeeping data and using it to generate financial statements and facilitate processes like tax planning and cash flow analysis.

Much like practicing law, accounting requires extensive training and in-depth knowledge of intricate rules. Making mistakes can lead to penalties and interest or audits from the Internal Revenue Service (IRS).

As a result, it’s unwise for lawyers to attempt to handle their law firm’s accounting without assistance from an expert. It’s usually best to pay for a Certified Public Accountant’s (CPA) tax services.

Best practices for lawyer accounting

Staying on top of your law firm’s accounting responsibilities while providing legal services to clients can be a significant challenge. Here are some practices you should follow to minimize the burden and set yourself up for success.

Open Separate Accounts Before Going Into Business

Every small business owner should have a separate bank account for their personal and business activities. Splitting your funds makes it much easier to determine which of your transactions belong in each camp.

Many new small business owners make the mistake of diving head first into growing their operations without taking this step. Unfortunately, that often makes filing their first tax return a headache since they must go back and sort out what belongs where.

That’s challenging in any industry, but it can be especially difficult for a small law firm. Not only do you have to keep track of which transactions are personal and which are business, but you also need to know which costs you incur on behalf of your clients.

If you need to go back at the end of the year and sort your financial data into all three categories, it’ll be a nightmare. As a result, you should open a separate checking account and credit card for your legal practice before you start taking on clients.

Implement Job Costing

Preventing messes before they occur instead of cleaning them up afterward is a common theme in many lawyer accounting best practices. One of the most important ways of doing this is to develop an organized bookkeeping system as soon as possible.

For example, job costing is a strategy lawyers can use to ensure their financial records are easy to interpret and analyze. It’s a form of cost accounting that involves assigning every expense you incur to a specific project.

For businesses like law firms whose operations revolve around clearly distinct jobs, it’s one of the best ways to organize expenses. It’s especially beneficial when you employ other lawyers, as it can help you set a profitable hourly rate when billing your clients.

Take Advantage Of Software

Continuing with the theme of setting yourself up for success from day one, make sure that you take advantage of software’s ability to streamline your accounting processes as soon as possible.

At the very least, you should leverage accounting software to track your transactions. There’s no reason to manually enter transactions anymore with so many affordable options available.

However, most lawyers shouldn’t settle for generic software. Attorney-specific accounting software exists, and it can facilitate many more aspects of running your business, including:

• Time tracking software that integrates with your invoices
• Client intake, scheduling, and relationship management
• Automatic trust account updates and reconciliations

Many different solutions are available, and each can offer you a unique combination of benefits. Make sure you review them carefully and determine which tool makes the most sense for your business in its current stage of development.

Consider The Cash Accounting Basis

One of the most significant decisions small business owners have to make in the early days of their company is which accounting basis to follow for tax purposes. Generally, the two allowable options are the cash basis and the accrual basis.

The cash basis of accounting involves recognizing revenues when you receive cash and deducting expenses when you pay them. Because it’s the easiest to implement, lawyers often prefer this method. The American Bar Association also recommends it.

Meanwhile, the accrual basis of accounting involves recognizing revenues when you earn them and expenses when you incur them. That requires significantly more expertise and forces you to keep track of accounts receivable and payable.

You’ll often hear that the accrual basis is worth the extra work because it’s more accurate, but that’s primarily true for businesses that carry inventories. The IRS requires companies with inventories and revenues above $26 million to use it.

Meanwhile, a legal business can use the cash basis no matter their revenues, and it often represents their activities more accurately. As a result, many lawyers can avoid a lot of trouble by electing the cash basis.

Stay On Top Of Your Tax Obligations

One of the most significant changes you face when transitioning from full-time employment to business ownership is the loss of tax withholding benefits. As a result, you must make estimated tax payments each quarter.

These payments are to cover your federal and state income taxes as well as your self-employment taxes. If you don’t make them on time or pay much less than you should’ve, you may incur penalties and interest.

If you expand your operation and hire employees or structure your business in a way that involves paying yourself a salary, you’ll also have to worry about payroll taxes. These are also due throughout the year, usually bi-weekly or monthly.

Ultimately, it’s unwise to try and navigate your tax obligations alone. The last thing a new law firm needs is to get on the wrong side of the IRS. Consider consulting with an accounting firm to clarify your responsibilities and ensure you’re meeting them.

Get Expert Help

Finally, one of the best ways to lessen the burden of accounting for your business is to pay someone to help you with it. Not only is accounting complex, but it’s also time-consuming, and you have other responsibilities.

Fortunately, you usually don’t have to hire a full-time accountant for your law firm. That’s often expensive and unnecessary. Instead, consider paying for outsourced accounting services from a CPA firm.

It’s a lot like businesses that engage a law firm for their needs instead of hiring an in-house lawyer. You’ll pay far less and get only what you need. Just be sure to choose a CPA experienced in providing law firm accounting services.

Common mistakes

As a lawyer, you can appreciate the time and effort that goes into becoming an expert in a complex field. Unfortunately, accounting and tax rules can be every bit as convoluted as any area of study in the legal industry.

Since law school doesn’t cover these subjects, it’s easy for new law firm owners to make financial mistakes. Here are some of the most common pitfalls you should know to avoid.

Underestimating Accounting Duties

When lawyers decide to open their firm, accounting is rarely at the top of their minds. After all, you have many more exciting things to pull your attention, such as winning clients and providing services.

As a result, it’s easy to make accounting a secondary priority thinking you can always deal with it later. Unfortunately, that attitude leads to some of the most frustrating accounting situations.

For example, you could discover once it’s time to file your return that you owe penalties and interest for missing your estimated tax payments or that your accounting records are in such disarray that you have no idea how to untangle them.

Remember, it’s always better to prevent problems than to try and solve them after the fact. If you’re planning to open your own law firm, make sure you give your accounting the attention it’s due sooner rather than later.

Misattributing Transactions

Whether it’s mixing up your business and personal transactions or deducting an expense from the wrong client trust account, it’s easy for law firm owners to record transactions incorrectly.

As a result, you must develop a habit of performing regular reconciliations to ensure that your financial records are in order. It’s typically best to perform bank reconciliations for your business checking accounts each month.

In addition, all state bar associations require law firms to perform three-way reconciliations monthly or quarterly. That involves confirming that your trust ledger, client ledgers, and trust account statement balances agree with each other.

A trust ledger records all the transactions impacting your trust account. Client ledgers record those same activities but assign each one to a specific client.

Mismanaging Trust Accounts

Managing trust accounts is one of the unique aspects of legal accounting, and the consequences of mishandling them can be significant. Not only will you incur fines, but you could also lose your license or face legal repercussions.

You might think that keeping your clients’ funds separate from your own sounds simple enough, but it’s surprisingly easy to violate trust accounting requirements.

For example, many banks are unfamiliar with lawyer trust accounts. As a result, you could accidentally use a regular business checking account to store your clients’ funds, which violates trust accounting rules.

As a result, you need to understand your trust account responsibilities thoroughly. Take the time to master what constitutes professional conduct. For example, you should understand all of the following:

• Taking funds out of trust accounts: While you must pay taxes on advance fees in the year you collect them under the cash method, you can’t take them out of your trust account until you earn them. Unfortunately, it can be hard to determine when lawyers can say they’ve earned their advance funds and retainers.
• Pooling client funds in one trust account: Generally, lawyers that hold relatively small amounts of money for a short time from multiple clients place them all in a single trust account. However, a significant sum from a single client should have its own.
• Interest on Lawyer Trust Accounts (IOLTAs): Traditional trust accounts may or may not earn interest, but IOLTAs do. However, lawyers can’t keep the interest their clients’ funds generate. Instead, IOLTAs automatically go toward charitable purposes.

Once again, it’s best to master the trust accounting rules well before you go into business for yourself. It’s one area you can’t afford to make mistakes because there’s rarely a chance to fix them later.

Looking for financing for your law firm? Learn more about law firm financing options.

Running a manufacturing company while managing its books is a challenging prospect. Manufacturing involves a significant amount of cost accounting, which is a notoriously complex subject.

Here’s what you need to know to navigate manufacturing accounting successfully, including the best practices for the industry, the most complicated processes involved, and some fundamental terms.

Manufacturing accounting tips.

Manufacturing accounting follows the same fundamental principles as accounting in other industries, but there are many more moving parts than usual. Let’s look at some general best practices you should follow to optimize your accounting system.

Leverage manufacturing software.

Bookkeeping is one of the most time-consuming aspects of manufacturing accounting. Maintaining accurate and organized records of all the transactions and costs involved in production can be incredibly laborious if you do it manually.

However, manufacturing accounting software can automate a significant portion of this responsibility. You or an accountant should still perform reconciliations to confirm the accuracy of your financial records, but it’s much easier than doing everything by hand.

Invest in your financial education.

While you probably won’t handle all your business’s accounting personally, you still need to understand it. A lot of manufacturing accounting revolves around creating records that managers can use to inform business decisions.

As a result, it’s worth investing in developing a deeper understanding of the related accounting and tax rules. If nothing else, it’ll help you analyze your financial statements and reports to improve the efficiency of your business.

Choose your accounting basis carefully.

Because manufacturing businesses carry an inventory, the Internal Revenue Service (IRS) requires them to use the accrual basis of accounting. However, there’s an exception for small businesses with less than $26 million in average annual revenues.

As a result, your manufacturing company may get to choose between using cash or accrual accounting. While the cash method is often easier to implement, it’s not always the best way to organize your financial records.

Because you must get special permission from the IRS to change your accounting basis later, it’s best to get it right the first time. Consider consulting an expert before choosing one or the other.

Get expert assistance.

Getting expert tax and accounting advice is worthwhile for virtually every business. A Certified Public Accountant (CPA) with experience in your industry can provide valuable financial insight and ensure you meet your tax obligations.

Fortunately, you don’t necessarily have to hire an accountant full-time for your manufacturing business at first. Outsourced accounting from a CPA firm is less expensive and may be enough to meet your needs.

What type of accounting is used in manufacturing?

The primary type of accounting used in manufacturing is known as cost accounting. It’s a form of accounting that tracks production costs in a way that managers can use to inform business decisions.

As a result, cost accounting is less about creating financial statements for third parties and more about facilitating various forms of internal analysis. For example, manufacturing businesses use cost accounting to complete processes like the following:

• Budgeting: Manufacturers must create budgets for each stage of the production process to ensure they stay on track and set appropriate sales prices. Cost accounting tracks historical production costs, which helps create more accurate estimates for future activities.
• Constraint analysis: This involves isolating potential bottlenecks in your manufacturing and improving them to increase overall efficiency. Organizing your production costs helps managers determine which resources limit their output most and plan accordingly.
• Margin analysis: This involves calculating all the costs associated with an aspect of production, then subtracting them from the revenue it generates. That gives you each aspect’s marginal profitability, which managers can use to find the most lucrative products, customers, or channels and inform business decisions.

In addition, manufacturing involves inventory management accounting. Because manufacturers carry significant inventories, they need to know how to track their costs to create accurate financial statements and comply with accounting standards.

Cost-flow assumption methods.

Your cost of goods sold and ending inventory values play a significant role in your manufacturing business’s profitability. Because that directly affects your tax liability, the IRS requires that you use specific methods to calculate both numbers.

These are the inventory tracking methods they accept for manufacturing businesses. 

Specific identification

The specific identification method is the most straightforward option. It involves keeping track of each item in your inventory. If that’s feasible for your business, the Internal Revenue Service (IRS) requires you to use this method.

However, specific identification is usually only possible for manufacturing businesses that produce a low volume of differentiated products. For example, car manufacturers may use this approach, but a stapler manufacturer probably wouldn’t.

FIFO

If you can’t keep track of every item in your inventory because the units are interchangeable, you must assume which ones you sell first. While you can’t know for sure which you sell first, this keeps your books organized.

The first-in-first-out (FIFO) inventory valuation method assumes that the first unit you manufacture is the first one you sell. FIFO is generally the most popular approach, especially for manufacturers of products with limited shelf lives.

LIFO

The last-in-first-out (LIFO) inventory valuation method is the opposite of the FIFO approach. It assumes that the last unit you produce is the first one you sell.

Because prices tend to rise over time, the LIFO method generally maximizes your cost of goods sold and minimizes your closing inventory values. As a result, it also leads to the lowest possible net income, which is beneficial for tax purposes.

However, LIFO is controversial among regulators. The International Financial Reporting Standards (IFRS) prohibits it, and businesses in the United States may not be able to use it forever.

Weighted average

The weighted average cost flow assumption is between FIFO and LIFO. It involves calculating the weighted average cost of all units available for sale during a given period. You then assign that cost to your goods sold and ending inventory.

The weighted average is generally the least common cost flow assumption for manufacturers. In fact, the IRS previously dismissed this method as inaccurate, only allowing businesses to use it for tax purposes in 2008.

Production costing methods.

Production costing methods organize your cost accounting records to help management make decisions. Depending on your business model, you may prefer to structure your accounting around individual units, product lines, or processes.

Here are the most popular production costing methods for manufacturers. Keep in mind that the terminology for these approaches can vary between sources.

Standard costing

Standard costing is one of the most common production costing methods among manufacturers. It involves calculating a standard rate for groups of costs that go into each unit, including direct materials, direct labor, and manufacturing overhead.

This approach to production costing helps with creating and refining budgets. When you can estimate how much it’ll cost to produce each unit, you can gauge your progress during each accounting period.

Variance analysis, which involves comparing your standard costs to your actual expenses, is a great way to reveal areas of overspending, improve production efficiency, and increase cash flow.

Job costing

Job costing organizes your accounting around each unit. It involves tracking the costs for every item you produce, including direct materials, direct labor, and manufacturing overhead. It’s also popular in construction accounting.

This approach is primarily beneficial for manufacturers who produce a relatively low number of unique products. For example, a manufacturer of made-to-order furniture would likely employ job costing.

Manufacturers of highly differentiated products need to track costs for each unit so they can set prices appropriately and monitor the profitability of their products.

Process costing

If job costing is ideal for manufacturing businesses that produce lower numbers of unique products, process costing is for those that create a high volume of homogenous units. For example, a cement manufacturer might use this method.

Process costing involves tracking the cost of each stage of production. It helps facilitate analysis and efficiency refinement for businesses that revolve less around each unit and more around repetitive procedures.

Activity-based costing

Activity-based costing (ABC) is a way to assign indirect manufacturing costs like overhead to products or processes. Though it takes more work than applying a standard overhead rate, it generates more accurate cost estimates.

ABC systems involve sorting your business’s indirect costs into groups, calculating a per-unit rate based on their primary cost drivers, then using that rate to allocate costs to products or activities. It helps businesses factor indirect costs into pricing.

Basic manufacturing cost terms.

Deciphering jargon can be a frustrating challenge when you’re learning to navigate the complexities of manufacturing accounting. Here are brief explanations of some fundamental terms you’ll need to know to succeed.

Direct materials

Direct materials refer to the raw materials that manufacturers transform into finished products. That includes everything you can readily identify as going into a unit. For example, wood and screws are direct materials for table manufacturers.

Direct labor

Direct labor includes the cost of workers who transform raw materials into finished goods. For example, say you’re a table manufacturer. The wages of the worker who assembles the tables are direct labor, but not the salary of the janitor who keeps your factory clean.

Direct costs

A direct cost is an expense that you can easily trace to product manufacturing processes. Direct expenses primarily include direct labor and direct materials.

Manufacturing overhead

Also known as factory overhead, manufacturing overhead refers to the cost of maintaining and operating your production facilities. Overhead costs include expenses like factory rent, utilities, and administrative costs.

Indirect costs

Indirect costs are those that you can’t tie directly to the production process. Instead, you must allocate each indirect cost to your products using various methods to determine the value of each unit. It primarily refers to manufacturing overhead.

Fixed costs

In manufacturing, fixed costs remain consistent no matter how many units you produce. For example, that might include rent for your factory or interest payments on a business loan.

Variable costs 

Variable costs change depending on the number of units your manufacturing firm produces. For example, direct materials and direct labor are both variable costs.

Cost of goods sold

The cost of goods sold includes all direct and indirect costs associated with the products you sell during a given period. It typically refers to direct materials, direct labor, and manufacturing overhead. Its value depends on your cost-flow assumption.

Cost of goods manufactured

Your cost of goods manufactured includes all direct and indirect costs that go into the products you finish producing during an accounting period. Like the cost of goods sold, it generally refers to direct materials, direct labor, and manufacturing overhead.

WIP inventory

Work-in-process (WIP) or work-in-progress inventory refers to products that have made it through part of the manufacturing process but remain unfinished. Though they’re not ready for sale, these goods are still an asset on your balance sheet.

Finished goods inventory

Finished goods inventory refers to the units that have made it through the production process and are ready for sale. You must use cost-flow assumptions and inventory valuation methods to calculate the balance.

Staying on top of your business’s accounting while running the operation is often challenging, but it can be particularly complex in the retail industry. Retail stores face at least one significant challenge that many others don’t.

Here’s what you need to know about retail accounting to navigate it successfully, including what makes it different, how to approach its most complicated aspects, and some best practices to keep in mind.

The primary reason retail accounting is different from accounting in other industries is that retail stores must keep track of their inventories. In contrast, a service business’s financial system usually has fewer moving parts.

Meanwhile, retail businesses can have extensive, diverse inventories that change constantly. Stores may hold large quantities of many different products and sell a high volume of units each business day.

Unfortunately, inventory accounting is essential for creating accurate financial statements and reports. In most cases, it’s simultaneously your business’s most significant asset and expense.

Not only is having inventory numbers necessary when creating financial statements to inform your tax strategies, but it’s also vital for performing cash flow analysis and making financial projections.

For every period, retail stores need to know their beginning inventory, units sold, and the amount left on hand. Otherwise, they may struggle to meet expected demand without buying too many units and impacting their cash flow management.

Cost-flow assumptions in retail accounting.

Because your inventory cost significantly impacts your business’s profit and tax liability, the Internal Revenue Service (IRS) requires that you use specific methods to calculate its value on your balance sheet and income statement. Here are the allowable options.

Specific identification

The specific identification cost method is the most straightforward approach to tracking your inventory. It requires keeping track of each item individually. As a result, there’s no need to assume which ones you sell first.

Typically, this method is only possible for retail stores with fewer products, higher prices, and lower transaction volume. For example, a car dealership or jewelry shop could keep track of each item in its inventory, but a grocery store generally couldn’t.

If it’s feasible for your retail business to use the specific identification method, the IRS requires that you do so.

FIFO

If you can’t keep track of every item on hand, you must make an assumption about which ones you sell first to calculate the cost of your inventory. Whichever you sell first is unknowable, but the assumption keeps your books consistent.

These “cost-flow assumptions” are necessary when stores have many interchangeable units. In such cases, it’s unlikely that it costs the same amount to acquire or produce each item since materials, labor, and overhead prices shift over time.

As a result, the order in which you sell your inventory has a significant impact on its value at any given point.

The first-in-first-out (FIFO) method is a common cost-flow assumption among retailers with perishable goods. As the name implies, it assumes the units you purchase or produce first are the ones you sell first.

LIFO

The last-in-first-out (LIFO) cost flow assumption is the opposite of the FIFO method. It assumes that the last units you purchase or produce are the first ones you sell.

LIFO is a controversial cost-flow assumption because it can artificially lower your business’s tax burden. Prices tend to rise over time, causing LIFO to maximize your cost of goods sold (COGS) and minimize your net income.

In addition, few businesses legitimately sell their most recently acquired units first. As a result, the LIFO method isn’t acceptable in countries that follow International Financial Reporting Standards (IFRS) and may eventually become forbidden in the United States.

Weighted average

The weighted average cost flow assumption is the least common approach to tracking inventory. In fact, the IRS considered it inaccurate and prohibited businesses from using it for tax purposes until 2008.

The weighted average method is somewhere between FIFO and LIFO. It assumes that the cost of each unit sold in a given period and left in ending inventory afterward is the weighted average cost of those you had available for sale during that time.

For example, say you buy three hundred units at $100, four hundred units at $115, and three hundred more at $110. These are the only units you had on hand during the year. The first group is 30% of your inventory, the second is 40%, and the third is 30%.

To find the weighted average cost of your inventory, you’d multiply 30% by $100, 40% by $115, and 30% by $110, then add them together. That equals $109, which you’d assume to be the cost of all your units.

Inventory valuation method.

In addition to following a consistent cost flow assumption, retail businesses must use an inventory valuation method to determine their cost of goods sold and the cost of ending inventory.

Retail method

The retail inventory method is popular among retail stores because you can calculate both numbers without knowing the precise number of units you have on hand, which reduces the need to take physical counts.

However, your store must use a consistent markup rate for determining sales prices to save time with the retail method. If you don’t have a standard markup rate, the IRS requires that you track the actual markup percentage for each product.

For example, say your retail store’s inventory on January 1 cost $10,000. During the first quarter of the year, you buy more units for $2,500 and have $5,000 in sales. Every product you sell is similar enough that your retail price is always 30% above cost.

To calculate ending inventory on March 31 using the retail value method, add the cost of your beginning inventory and purchases during the period to get the total available for sale. In this case, that would be $10,000 plus $2,500, which equals $12,500.

Next, calculate your cost of goods sold. Since you mark up all of your products by 30%, you know that it always equals 70% of your sales in a given period. As a result, when you multiply $5,000 in sales by 70%, you get $3,750 for your cost of goods sold.

Finally, you have what you need to calculate the cost of your ending inventory without taking a physical count. It equals the cost of your beginning inventory plus the cost of your purchases minus your cost of goods sold.

In this case, that’s $10,000 plus $2,500 minus $3,750, which equals $8,750.

Pros and cons of the retail accounting method

The retail method of accounting is a popular valuation strategy for retail stores primarily because of its simplicity. If you use a flat markup rate across all products, then you can calculate your ending inventory cost without counting it.

While that’s not necessarily significant for retail businesses that use the specific identification method, it’s helpful for stores with diverse inventories in multiple warehouses. Taking a physical count in these situations is highly labor-intensive. 

Of course, using the retail method, for this reason, has a problematic implication. Namely, using a flat markup rate for all your company’s products usually isn’t a good idea.

It limits your ability to price your products dynamically and strategically to compete in the marketplace. You could miss out on raising the price of one item because you don’t want to increase the prices of others.

Even offering discounts on certain products would throw off your calculations. Many retail stores use these as effective marketing tactics and to incentivize customer behaviors like buying in bulk or paying on time.

Best practices for retail accounting.

Accounting for a retail business can be a significant challenge, especially for stores with complex inventories and high transaction volume. Here are some best practices you should follow to make your accounting system more efficient and effective.

Take advantage of software

Software has made many aspects of running a retail business more manageable. Some of the most beneficial tools include inventory and retail accounting software. These can automate a significant portion of your bookkeeping.

Choose accounting methods carefully

Businesses must get special permission from the IRS to change accounting methods, including cost-flow assumptions and inventory valuation approaches. They don’t want taxpayers trying to game the system by switching constantly.

Because there’s no guarantee you’ll be able to change your accounting methods later, you must choose them carefully the first time. Consider asking an accounting firm for recommendations.

Use retail accounting services

It’s a good idea for most small businesses to consult a knowledgeable accountant, but it’s especially beneficial for retail stores. Accrual accounting and tax rules for companies with inventories are complex, and you shouldn’t try to navigate them alone.

Even if you don’t have the funds to hire a full-time accountant, consider paying for outsourced accounting and tax services with a Certified Public Accountant (CPA) firm. It’s often much more economical for a small business.

In addition, a highly experienced CPA firm can be a surprisingly comprehensive business advisor. Not only can they confirm that you’re taking appropriate deductions, but they can create a personalized tax strategy and give targeted financial advice.

Before selecting a CPA, confirm that they specialize in retail accounting services. If they’ve never had retail clients or have a brand new business advisory practice, they may not be able to help you with your biggest financial difficulties.

Even though dentistry is your focus, running a dental practice comes with extra responsibilities that take time away from patient care. One of the biggest and most important of those responsibilities is bookkeeping. It’s an essential part of running a successful dental practice. 

It gives you a clear view of the financial state of the business and can be used to make your business run more efficiently. Whether you’re doing it yourself or delegating it to your office manager there are a few helpful tactics you can use to simplify the process. 

7 Tips For Dental Bookkeeping

Don’t Mix Business And Personal Finances

Combining business and personal transactions might not seem like a big deal until you have to sort through them. Mixing the two types of transactions makes the bookkeeping process much more difficult. 

It’s confusing and time-consuming to try and remember which purchases or deposits belong to the business. That makes it a hassle to get a clear view of the company’s financial status. And when it comes to your taxes, it complicates matters even further. 

Taxes and financial statements aren’t the only areas that could be affected. It might also impact your ability to get approved for financing or find investors. Potential lenders want to see clean and precise financial data when they’re deciding to approve your business for credit. 

The best solution is to have two separate accounts. One strictly for the business, and one that’s for personal transactions. 

Use A Chart Of Accounts For The Dental Industry

A common misstep that happens in dentist bookkeeping is attempting to use a standard chart of accounts to track income and expenses. A standard COA doesn’t provide the same level of usefulness that a dental industry COA would have for your practice. 

You run the risk of omitting important information without the use of a dentistry-specific chart of accounts. This might affect you further down the line when you transfer those figures to other financial reports. 

You can arrange your chart of accounts to track the areas that pertain to your business model. For example, the payroll for your receptionist would be considered an overhead expense. In contrast, the dentists' and hygienists' payroll would be considered to be part of the Cost of Sales. 

These are important distinctions that might be overlooked when using a standard COA as opposed to a dental industry COA.

Use A Cloud-Based Accounting Software

One of the best things you can do for your dental practice is to take your bookkeeping digital. It minimizes the clutter that comes with paper and makes it easier to maintain reliable financial records. 

When tackling bookkeeping for your small business, it’s difficult to keep up with all the tax guidelines you’ll have to follow which is why many business owners choose to hire a dental CPA or accounting firm. However, outsourcing can be costly for a small dental office. 

Small business accounting software offers an affordable alternative. Most accounting software comes pre-loaded with a chart of accounts and tax guidelines so you don’t have to be a bookkeeping expert. 

You’ll still need a base knowledge of bookkeeping or accounting to get started, but most accounting software offers basic educational walkthroughs of what to do. 

Lendio’s cloud-based accounting software is a great tool for dental bookkeeping. With their affordable Sunrise Plus version, you can

• Keep receipts and expenses organized
• Easily generate profit and loss statements
• View up-to-date cash flow monitoring
• Send and track invoices

If you decide that bookkeeping isn’t your strong suit, they also have a paid bookkeeping service to make the process even easier. It allows you to work with a professional bookkeeper for an additional cost. 

See how Lendio can improve your bookkeeping process and sign up for your free 14-day trial!

Review Your Finances Regularly

Reviewing your finances is an important part of ensuring your bookkeeping process is working well. It also helps you make the best decisions for your business. Not reviewing your financial situation regularly can leave you with unanswered questions about your business.

For example, If your expenses are running high and you’re not aware, approving the purchase of new equipment could put your finances over the edge. Take time each week or each month to review the finances for your business. There are several benefits to doing this:

• Makes you aware of the company’s financial situation
• Gives you solid information to base decisions off of
• Allows you to target unnecessary expenses
• Helps you identify any financial gaps
• Pinpoints where profits are stemming from

Close Your Books The Right Way

At the end of a financial period, you’ll need to close your books. Meaning that the financial information in the reports is finalized. 

Once the books are closed, that’s it. No more changes can be made. This is to ensure that data from other accounting periods doesn’t bleed into the current period . 

Without closing your books properly, it could result in mistakes and inaccurate depictions of how much profit or loss was experienced within one accounting period. To close your books properly, you’ll need to transfer journal entries to a general ledger account. 

Most small businesses choose to close their books monthly. Depending on what works for your business you could also choose to close books annually. 

Reconcile Your Financial Details

When making a dental accounting entry, it’s easy for all of the numbers to start running together. Before you know it, there are transposed numbers or expenses recorded in the wrong place. That’s why it’s important to reconcile the financial details as you go.

A simple way to do this is to confirm the dental accounting entry amount with a copy of the receipt, invoice, point of sale ticket or other pertinent information that can confirm the amount that should be recorded. 

So while the earlier suggestion of adopting cloud-based dental accounting software is effective at cutting down on paper, it doesn’t eliminate the need to keep certain documents. Without the following documents stored safely in your records, you could face big problems. 

• Company bank account statements
• Medical billing for insurance
• Cash flow statements
• Accounts receivable documents
• Accounts payable documents

You can also use the data in these documents to create monthly financial reporting for your company. 

Consider Outsourcing Your Bookkeeping

There are several reasons why dentists and oral surgeons decide to outsource their bookkeeping to a dental accountant instead of keeping it in-house. You might be running a larger dental practice, or the job is just too much to hand off to an office manager. 

Either way, finding dental bookkeeping services that take the task off your hands can be exactly what you need to focus more energy on your patients. By outsourcing your bookkeeping, you’re giving yourself the ability to do what you do best– improving peoples’ smiles. 

Meanwhile, the accountant does what they do best, which is taking care of your financials. Hiring accounting services comes at a cost but it also comes with plenty of benefits: 

• Increased accuracy
• More time to dedicate to patient care
• Some accounting services may help you run payroll
• Trained professionals who are well-versed in bookkeeping
• May assist in developing tax strategies or tax preparation

Overall, dental bookkeeping requires attention to detail and base knowledge of bookkeeping guidelines. You’ll need to use an industry-specific chart of accounts, reconcile financial data and make sure that the books are properly closed each month. The full process takes time. 

Even if you decide to outsource your bookkeeping, you’ll still need to review the financial reports regularly and avoid mixing personal and business transactions. This will help you stay on top of the company’s financial status and limit mix-ups in the accounting process. 

Running a company and maintaining its books is challenging for every small business owner, but the construction industry presents additional accounting challenges.

Contractors usually have multiple projects running simultaneously in separate locations, each with unique costs, goals, and time horizons.

If you run a construction company, here’s what you should know about construction accounting to navigate the industry's complexities.

How To Do Construction Accounting

Construction accounting has so many moving parts that it can seem intimidating, but the process doesn’t need to be stressful. If you have a system in place before you begin taking on projects, you can save yourself a lot of headaches.

Here’s a step-by-step guide you can follow to create an effective construction accounting system for your business.

1. Separate Personal And Business Transactions

The first thing every general contractor should do to minimize their accounting issues is to separate their business transactions from their personal ones. Open a checking account and credit card for your company and use it exclusively for your business activities.

If you mingle your personal and business funds in the same bank account, determining which transactions belong in each category can be incredibly time-consuming. You’ll waste hours going back and trying to sort everything out.

It’s also likely that you won’t do a perfect job since it becomes increasingly difficult to figure out past transactions as time passes. That could cause you to miss out on deductions, misattribute expenses, and create even more problems for yourself.

2. Choose A Primary Accounting Basis

One of the primary complications of construction accounting is that projects have extremely variable completion times. You may be able to finish some within a few months, but others will span multiple tax years.

Contractors must account for projects they complete within a single tax year differently than those that take place in more than one. First, let’s explore the accounting methods allowable for jobs that last less than a year.

Generally, you can use either the cash or accrual basis of accounting for these contracts. Here’s how those methods work:

• Cash basis: Recognize revenues when you receive cash and deduct expenses when you make payments.
• Accrual basis: Recognize revenues when you earn income and take deductions when you incur expenses.

The cash method is typically easier to implement, but it's better at tracking your cash flow than your actual business profits. Meanwhile, the accrual method takes more work, but it more accurately captures the strength of your financial position.

Construction companies can choose either one as long as their average gross receipts are less than $25 million over the last three years or their total time in business, whichever is less. If you exceed that threshold, you must use the accrual method.

3. Choose A Long-Term Revenue Recognition Method

Unfortunately, you can’t use the typical cash or accrual accounting methods for construction contracts that span more than one tax year.

Instead, you generally must use either the completed contract or the percentage of completion (POC) method to record your transactions. Here’s how they work:

• Completed contract method: Recognize your revenues and expenses for a contract all at once after you finish the project.
• Percentage-of-completion method: Recognize your revenues according to the percentage of the contract expenses that you’ve paid.

As a simple example, say you have a construction project that you estimate will take you 18 months and $200,000 in materials, labor, and overhead to complete.

The client agrees to pay you $300,000 for the job, and you begin work on March 1st, 2022. By the end of 2022, you’ve incurred $137,500 in costs, and the client has paid you $200,000.

Using the percentage of completion method, you’d deduct $137,500 in expenses. To calculate your revenues, divide $137,500 by $200,000 to get 68.75% and multiply it by $300,000.

That equals $206,250 of revenue, which you’d recognize even though the client only paid you $200,000 so far.

Using the completed contract method, you’d record neither the expenses incurred nor the revenue received in 2022. You’d wait until you finished the project in 2023 to recognize both.

Once again, each option has its merits. The POC method is more accurate, but the completed contract method is easier to use and lets you defer earnings to later tax years.

Unfortunately, construction businesses don’t get to choose freely between the two options. If your average gross receipts exceed $25 million or your contract lasts more than two years, you must use the POC method.

The only exception to those rules is if your project qualifies as a home construction contract. That means 80% of the total project costs are for work on a residence with four units or fewer.

The POC method has become even more involved since Accounting Standards Codification (ASC) 606 took effect. You must apply the method to every individual “performance obligation” within each construction contract.

The complexities of ASC 606 are beyond the scope of this article, but you should consult a construction accountant for assistance in staying in compliance with it.

4. Implement Job Cost Accounting

Job cost accounting or job costing involves allocating all business expenses to individual projects. Typically, that includes materials, labor, and overhead.

Due to the project-based nature of contracting, job costing is at the core of construction accounting. It’s necessary for projects that last more than one year since you need to know each project’s costs for the completed contract and POC methods.

For example, say you agree to complete a landscaping project. When you first meet with your client, you estimate that it’ll cost you $25,000 in materials and 500 labor hours at $45 per hour to complete, which equals $22,500.

In addition, you estimate that your total overhead costs for the year will be $300,000, including office rent and utilities, administrative expenses, insurance, and equipment depreciation.

After consulting with an accountant, you plan to allocate overhead to each job based on its labor hours. In other words, you'll apply a portion of your annual overhead to each project for every labor hour required. 

To find your applied overhead rate, you estimate that you’ll incur 10,000 total labor hours during the year. Your $300,0000 overhead divided by 10,000 labor hours gives you an applied rate of $30 per labor hour.

Since you estimated that you’d have 500 labor hours for this project, you allocate 500 hours multiplied by $30 per hour to the job, which equals $15,000 of applied overhead.

As a result, your total estimated job costs would be $25,000 in materials plus $22,500 of direct labor plus $15,000 of applied overhead, which equals $62,500.

5. Perform Regular Reconciliations

Working in the construction industry involves managing multiple contracts simultaneously, many of which will likely change their scope at least once before completion.

As a result, staying on top of your construction accounting requires consistently checking in with your company’s books. Here are some steps you should consider taking each month:

• Confirm that you've allocated all costs to the proper projects
• Reconcile your books to your bank and credit card statements
• Verify that your cost estimates for each project are still accurate

Performing regular reconciliations is beneficial in any industry, but it’s essential for construction accounting. If you fall behind on your bookkeeping, it will be difficult to catch back up.

How Is Construction Accounting Different From Regular Accounting

Construction accounting follows the same general accounting principles as regular accounting. However, the nature of the construction industry creates challenges that force construction accountants to take additional measures.

These are the primary traits of the construction industry that require you to use irregular accounting strategies.

Decentralized and Project-Based

The most significant difference between construction and regular accounting is that contractors must track their finances separately for each project. Few other industries need to resort to job costing to stay organized.

For example, a manufacturing company with a single product could easily keep separate financial records for every factory. Its materials, labor, and overhead would be consistent and predictable for each one.

Similarly, a lawyer might have multiple projects simultaneously, but they can easily account for them together. The hourly rate might vary slightly between services, but the labor, materials, and overhead cost inputs would be similar for each job.

However, contractors can have any number of projects going on at once, and each one has cost inputs that vary drastically. For example:

• Materials: Construction contracts are all unique and require widely varying materials. Even when there's overlap, the costs are still usually very different since they occur at separate times and places.
• Labor: Contractors often use separate subcontractors with different rates for each job. Even if they were to use the same people for multiple projects, the work varies so much that the actual cost per labor hour would still be different.

Though job costing takes more work, it’s the only way to accurately measure a contractor’s profitability by matching cost inputs with the related revenues.

Long-Term Contracts

Another reason construction accounting differs significantly from regular accounting is contractors often have projects that last for many months, even spanning more than one tax year.

Unfortunately, those long contracts are unavoidable. It takes much longer to construct or improve a building than to complete most other products or services.

That necessitates accounting methods such as the completed contract or the POC method. It also means that the accounting and tax rules in place at the start of a contract may change by the time it ends.

In addition, contractors often offer their clients extended payment options, such as net 30 or net 60 terms, which makes properly timing revenue recognition even harder.

Unpredictable Job Scopes

The final issue with construction accounting that doesn’t affect regular accounting is that contractor job requirements change more often than not. In fact, there could be multiple change orders during a project that affect the scope drastically each time.

Even if a client doesn’t submit any change orders, there’s no guarantee that the initial job cost estimates will be accurate. It’s difficult to predict the material and labor costs over long-term projects, even for experienced contractors.

Unfortunately, inaccurate estimates due to changing scopes or poor predictions will disrupt your revenue recognition for long-term contracts. That’s another reason why construction accounting is often more demanding than accounting for other industries.

Construction Accounting Best Practices

Our step-by-step guide to the fundamentals of construction accounting should help you get started, but we can’t cover all of the details involved in a single article. However, we can discuss some best practices.

Here are several high-level tips to make your construction accounting system more efficient.

Leverage Construction Software

Nowadays, there’s little reason to keep track of anything by hand. It’s too easy and affordable to find software that can handle administrative tasks without requiring much of your time or effort.

For example, construction accounting software is a must. Contractors have too many transactions across too many projects to keep track of everything manually.

Time tracking software is another tool that can make your construction accounting easier. Labor is one of the primary cost inputs for construction projects, but manually tracking the hours of multiple workers across several jobs is difficult.

Software like Justworks Hours can automate a significant portion of the process. Not only does it let each worker report their hours digitally and aggregate the data for you, but it can integrate directly with accounting software.

Plan For Change Orders

As discussed above, construction firm projects rarely stick to the initial scope of work. Clients often change their minds about certain aspects of projects or try to cut costs, causing them to alter the original plans.

Alternatively, construction contractors may change the scope or price of a project after learning something they weren’t aware of at the onset of the job.

As a result, it’s best to have systems in place ahead of time to account for these pivots. Make sure you have procedures for both approved and unapproved change orders.

It’s best to include your methods for handling change orders in your initial contract with your clients. That can minimize the amount of back-and-forth necessary when changes occur and help prevent any disputes.

Maintain Digital Records

In regular accounting, you might be able to get by keeping paper copies of your supporting documents like receipts, bank statements, and invoices. It’s never optimal, but it’s doable for many small businesses.

However, keeping physical records is unreasonable in the construction industry. You need to keep track of too many documents for too many projects.

While many businesses can get the supporting detail they need for most of their deductions from a bank statement, that’s usually not the case for contractors. They need more information for almost all of their expenses.

For example, imagine you buy several different materials from a supplier in bulk. You'd need to define each of those materials to perform accurate job costing, especially if you’re using them for multiple projects.

As a result, it’s essential that you keep detailed supporting records on hand. Digital copies are infinitely easier to store and review and less susceptible to getting damaged or lost.

Get Help From An Accounting Expert

Doing a company’s accounting and project management is always hard, but it’s even more difficult in the construction business. Not only is construction accounting more time-consuming overall, but there are many more potential complications.

As a result, it’s best to get construction accounting and tax services from an expert. Fortunately, that doesn’t mean you have to hire an accountant full-time. Many small businesses, including contractors, can benefit from outsourced accounting services.

Instead of hiring an employee, that involves paying an accounting firm for help from a Certified Public Accountant (CPA) specializing in construction accounting services and tax planning for contractors.

Accounting is one of the least exciting aspects of small business ownership for many owner-operators. However, you can’t afford to neglect it since your responsibilities can quickly become overwhelming if you fall behind.

Here’s what you need to know about trucking accounting, including how to set up an effective system and some common mistakes to avoid.

Bookkeeping Vs. Accounting for Trucking

Bookkeeping and accounting are closely related business functions. While they’re theoretically distinct, the line between them is somewhat blurred. Accountants sometimes perform bookkeeping services and vice versa.

In broad terms, bookkeeping involves maintaining financial records of your trucking business’s day-to-day transactions in a general ledger. It’s a routine, administrative process that requires relatively little critical thinking.

As a result, many truck drivers handle a significant portion of their bookkeeping without much assistance. For example, it’s usually best for a driver to keep track of their miles, fuel purchases, and meal expenses while on the road. 

Meanwhile, accounting refers to refining and using the financial records created through bookkeeping for various purposes; including the development of financial statements, cash flow analysis, and tax planning.

Accounting is more sophisticated and analytical than bookkeeping, and there’s often more at stake. For example, accounting errors could cause you to miss out on valuable financing or get you in trouble with the Internal Revenue Service (IRS).

As a result, you probably shouldn’t try to manage your trucking business’s accounting function without help. It may be worth handling some lower-level aspects, but you’re better off outsourcing the more complex and time-consuming parts.

How To Do Accounting For Trucking

Even if you rely heavily on the transportation accounting services of a Certified Public Accountant (CPA), you still need to know the fundamentals of trucking accounting, as you’ll always be somewhat involved.

Here’s a general framework you can use to establish a trucking accounting system as a self-employed truck driver.

Open Separate Business Accounts

The first thing every business owner should do to simplify their accounting is to separate their business activities from their personal ones. The easiest way is to open up a new checking account and credit card and reserve them for business use only.

Many business owners learn too late that mingling your personal and business funds makes it hard to identify which transactions belong in which category.

It's often even more difficult for truck drivers, whose gas and food expenses could easily be personal costs if they occurred outside of a trucking trip.

Choose A Legal Entity Structure

Another decision every small business owner has to make is what type of legal entity they want to use. Sole proprietors are the default structure, so owner-operators who start doing business without filing any paperwork will fall into that category.

The simplicity is convenient, but it comes with unlimited liability. As a sole proprietor, you and your trucking business are a single entity. If someone sues your company, your personal assets are vulnerable.

Because working in the trucking industry involves taking on significant risk, you’re often better off taking the time to form a limited liability company (LLC) or a corporation. However, that’s a decision you should get a CPA firm’s advice on first.

Choose An Accounting Basis

Truckers must choose between the two fundamental methods of accounting, the cash and accrual bases. They impact your tax return significantly, so consider consulting an accountant before choosing one.

The cash basis involves recognizing revenues when you receive payments and deducting expenses when you pay them. Because it’s easy to implement, many small businesses favor this method.

The accrual basis of accounting requires that you recognize revenues when you earn them and expenses when you incur them, regardless of when funds enter or leave your accounts. It takes more work, but it also documents your profitability more accurately.

Track Your Expenses And Retain Supporting Documents

All businesses need to keep track of their expenses, but it’s more challenging in some industries than others. Unfortunately, trucking is a business that requires you to be particularly diligent in your record keeping.

Truck drivers can incur many different expenses while on the road, and most of them are potentially tax-deductible. For example, you need to keep careful records of all of the following costs while you’re on long hauls away from home:

• Fuel 
• Meals
• Lodging
• Auto washing
• Tolls and parking
• Vehicle maintenance

Because the IRS sees semi-trucks as qualified nonpersonal use vehicles, you must deduct your actual auto costs instead of using the standard mileage method. Keep records of each purchase's amount, date, location, and business purpose.

In addition to keeping records of your expenses, you should have documents that prove their validity, such as receipts, trip logs, and account statements. Keep these on hand for at least three years. That’s how much time the IRS typically has to audit you.

Stay On Top Of Your Tax Obligations

All business owners must make quarterly estimated tax payments to cover their income and self-employment taxes, and truck drivers are no exception. You'll incur penalties and interest if you don't meet your federal and state liabilities.

Unfortunately, truck drivers often have additional tax obligations, depending on the lengths of their trips and the size of their vehicles. These include the International Fuel Tax Agreement (IFTA) and the Heavy Vehicle Use Tax (HVUT).

The IFTA is a way to redistribute the fuel taxes truck drivers pay in the lower 48 states and the 10 Canadian provinces. It ensures your funds go to the areas where you used your fuel instead of the ones where you purchased it.

IFTA applies to you if you drive a vehicle across multiple states or provinces that weighs more than 26,000 pounds or has at least three axles.

To comply with IFTA, you must report your trips and fuel purchases quarterly. The IFTA office in your home state will allocate your payments to the proper jurisdictions and determine whether you owe more or deserve a refund.

Meanwhile, the HVUT is an annual fee that truckers must pay if they drive a vehicle that’s at least 55,000 pounds for more than 5,000 miles on public highways. It equals $100 plus $22 for every 1,000 pounds over 55,000 pounds up to $550 and 75,000 pounds.

To stay in compliance, file Form 2290 with the IRS and pay any applicable taxes by the last day of the month after the month you first used the vehicle on public highways. For example, if you place your truck into service in July, the due date is August 31.

If you owed taxes in the previous year but not the current one, you must file Form 2290 to report the change and suspend your responsibilities.

Best Practices For Trucking Accounting

One of the primary problems with managing your small business accounting is the sheer amount of time and energy it takes. Running a trucking company alone is enough work to keep you busy, and trying to do both is a lot to handle at once.

Here are some best practices you can follow that will help juggle all of your various responsibilities.

Leverage Software

The ever-expanding capabilities of modern software have made many aspects of business ownership significantly easier. You must be strategic about which tools you invest in to avoid wasting resources, but it’s worth utilizing in many areas.

For example, transportation management software, also known simply as trucking software, is a must-have for owner-operators. It serves as a digital hub and tax center from which you can manage all of your paperwork and filing responsibilities.

For example, you can use it to accomplish all of the following:

• Generate custom invoices and collect payments
• Store copies of records and supporting documents
• Generate and file your quarterly IFTA reports
• Dispatch other drivers and plan their trucking routes
• Extract driving data from an electronic logging device (ELD)

An accounting solution is also essential for most small businesses, including trucking companies. If you link your trucking accounting software to your business bank account and credit card, it should track your every invoice and expense automatically.

Use A Fuel Card

IFTA compliance is one of the additional accounting responsibilities unique to trucking companies. Fortunately, it doesn’t have to take up too much time or energy if you plan ahead.

One of the best ways to streamline your IFTA reporting is by using a dedicated fuel card. These work much like any other credit card, except they’re tied to a unique driver number and provide fuel discounts.

Fuel cards can automatically track, organize, and display the information you need to fill out your IFTA expense reports. If you’re also using truck management software, you can usually link the two and automate your IFTA responsibilities completely.

Get Expert Help

Last but certainly not least, it’s always a good idea to hire a CPA for help with tax preparation and trucking accounting services. Trucking and accounting are full-time jobs, so don't try to do both.

Fortunately, you don't need to hire an accountant for your business full-time. Outsourced accounting lets you select only the specialized accounting services you need, keeping your costs down.

Make sure you choose a service provider carefully. The transportation industry has unique quirks and challenges, and it’s much better to work with a CPA who’s an expert in the applicable tax regulations than a generalist, even if it costs a little more.

Common Mistakes

Executing proper transportation accounting procedures requires as much training and expertise as the transporting itself. While there’s no substitute for experience, here are some common pitfalls you should know to avoid.

Procrastination

One of the most common mistakes small business owners make is putting their accounting responsibilities on the backburner for too long. That’s always problematic, especially for truck drivers.

Remember, it can be surprisingly hard to catch up on trucking records once you’ve fallen behind. It becomes even worse if you also neglect to separate your business and personal transactions.

In addition, ignoring your accounting for more than a couple of months means you’ll likely miss one or more tax due dates. If you fail to make estimated tax payments, submit your IFTA reports, or file Form 2290 on time, you’ll face penalties and interest.

Misunderstanding Tax Deductions

Tax strategies for truck drivers can be surprisingly complicated. Even some CPAs are unaware of the specifics of the industry, where unique rules and changing regulations can cause you to misreport your tax-deductible expenses.

For example, most small business owners can only take 50% of meal expenses, but truckers are allowed to take 80% of either their actual costs or per diem allowances.

That's another reason paying for tax services is essential for the transportation business. You don't want to leave money on the table or risk triggering an audit.

Are you looking for ways to expand your business or cover operating expenses? Learn more about trucking business loans.