Providing a clear picture of the Profitability of Manufacturing Assemblies and Construction Contracting: Project Management
- Priscilla Wolfe
- Dec 2, 2023
- 11 min read
Updated: Aug 14
(part 2) of 2
*The following instructions are proprietary information, created by bookkeepingbusinessonline.com, and are subject to copyright laws.
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The recording of raw materials in accounting is crucial for accurate financial reporting, cost analysis, and inventory and project management.
Profitability in Manufacturing and Construction Contracting
Key Benefits of Proper Raw Material Inventory Recording:
Accurate Financial Reporting: Reflects the true cost of production and profitability.
Enhanced Planning and Analysis Management: Supports project managers in tracking project-specific costs.
Regulatory Compliance: Ensures adherence to GAAP accounting standards using either inventory valuation methods (FIFO, LIFO, or Weighted Average).
Improved Decision-Making: Facilitates data-driven decisions through clear visibility into material usage and costs.
Follow Consistent Accounting Procedures:
Accounting in QuickBooks follows a specific and structured process. As an accrual-based system that complies with GAAP standards, following consistent accounting procedures is imperative. Proper setup of products and services, including standard sales and purchase prices, is essential for calculating COGS when no bill is linked to an invoice. The primary goal of GAAP accounting is to align expenses and bills with the revenue generated from the invoices, creating a clear audit trail to connect all transactions seamlessly and produce accurate financial statements.
The accounting process is:
Estimate (optional) to PO (optional) to Bill Item or Expense Item (marked billable, attach receipt from your QBO to your custom email) to bank feed (transaction) matched to bill or expense, adding Inventory (quantity) and COGS (amount) to your financial statements. When invoiced (add billable items to the invoice from the suggested transaction pop out drawer). This process Bill + Invoice is critical for correct accounting of Sales, COGS and Inventory, is GAAP Compliant and produces accurate financial statements.
My accounting preference is to GAAP accounting (matching purchase with revenue to calculate accurate Gross Profit) following correct workflows.
Send bills from vendors or store receipts to custom QBO email, then wait for match in the bank feed (bank transactions). Follow the prompts from the Receipts menu. These bills will remain on A/P until paid, from a bank feed transaction or otherwise.
Pre-entered bills will dictate whether the expense/purchase is for:
Item dropdown lines for products and services purchased for resale, typically billable items sold and matched to an invoice. OR
Category dropdown lines for indirect overhead expenses, asset purchases, liability payments, and are typically non-billable. You can enter a bill or expense for COGS directly to the Income Statement, using the category field, for cash accounting transactions only <not recommended where inventory valuations are concerned
Always add, customer or job, class and location to each document
The rule of COGS calculations:
An invoice (income) + billable attachment (Item: COGS) with markup = gross profit.
An invoice (income) + billable attachment (Item: COGS) and no markup is a reimbursement = zero gross profit.
An invoice with no billable item or expense attachment will not calculate COGS at all (if not stated in your products and services), Increasing your stated gross profit-income, and your tax liability.
An Invoice with only a receipt attachment may not calculate the true COGS, or COGS at all, to your income statement (from the receipt) if the price and cost are pulling from the products and services and the receipt is not attached to a billable expense item, attached to the invoice. Increasing gross profit income and your tax liability.
Sales, Inventory and COGS should be reconciled EOM.
Create a (BOM) monthly and save to My Accountant > Shared Documents, maintaining a historical record of Inventory, COGS and Sales.
Here are some basic tips:
Profitability in Manufacturing and Construction Contracting
Enable Markup in Accounts and Settings.
Set up products and services Inventory with purchase cost and sales price for raw materials. Inventory and COGS requires cost and purchase price info if no bill is received at invoicing to calculate Gross Profit correctly. (Average Costing)
Match most recent bill + invoice (specific identification) for current cost and sales price (GAAP accounting) on the Income Statement, regardless of FIFO Inventory Build.
Select sales tax for items from products and services.
Use Manufacturing or Construction Sales for Chart of Accounts Income and COGS.
Be cautious with Excel spreadsheet sync. Avoid overwriting quantities on hand and maintain a BOM production report regularly.
Test the project workflow before starting.
QuickBooks Online Advanced with Excel Spreadsheet Sync is recommended for large projects.
Here is an example of Basic Production Workflow for material inventories recorded in progress:
1. Purchase of Raw Materials Inventory (typically tax exempt requires certificate)
Job Purchase Order:
When raw materials are purchased, an accounting entry is made using a Purchase Order (from the Pending Estimate).
When materials are received, a Bill or Customer: Bill Bundle is created.
Bill #1:
Date of movement (+) QTY and AMT Raw Materials Received from the Purchase Order to (A/P).
Debits: Raw Materials Inventory.
Credits: Accounts Payable or Cash/Check Bill Payment.
2. Issuance of Raw Materials Inventory for Production (Job Production Order)
As raw materials are issued for production, an accounting entry is made.
Bill #2:
Date of movement (-) QTY and AMT Raw Materials (+) QTY and AMT WIP Issuance Inventory (from copy Bill #1, change fields (-) and (+) line items, date).
Debits: Work-in-Process Inventory Issuance.
Credits: Raw Materials Inventory.
3. Conversion of Raw Materials Inventory into WIP Conversion (Installation)
As work begins, the cost of raw materials is transferred to the Work-in-Process Inventory.
Bill #3:
Date of movement (-) QTY and AMT WIP Issuance Inventory (+) QTY and AMT WIP Conversion Inventory (from copy Bill #2, change fields (-) and (+) line items, date).
Debits: Work-in-Process Inventory Conversion.
Credits: WIP Inventory Issuance.
4. Completion of Production and Transfer to Finished Goods (Job Phase Completion)
When production is completed, the cost of raw materials and WIP inventories are transferred to finished goods.
Bill #4:
Date of movement (-) QTY and AMT WIP Conversion Inventory (+) QTY and AMT Finished Goods (from copy Bill #3, change fields (-) and (+) line items, date).
Debits: Finished Goods Inventory.
Credits: WIP Inventory Conversion.
5. Sale of Finished Goods (Ready to Invoice)
When finished goods are sold, the cost associated with production is transferred from Inventory to the Cost of Goods Sold (COGM), and revenue is recognized on the Income Statement.
Invoice + Bill + sales tax (dated):
Debits: Cost of Goods Sold Manufacturing or COGS Construction.
Credits: Finished Goods Inventory.
These accounting entries ensure that the materials are accurately accounted for at various stages of the process. The goal is to match the cost of producing goods with the revenue generated from their sale, providing a clear picture of the profitability of the business operations at each interval or job phase, ensuring GAAP compliant accounting. Effective Inventory and Project Management is the key to accurate reporting.
Tracking Inventory Assembly or Job Phase Production:
To check the stage of the inventory in production, run a Balance Sheet, double click the inventory asset account (with any subcategories) to view the Bills or customer: Bill Bundles and the date of job progression, along with inventory quantity and/or value. This enables you to determine when the finished goods are ready to be sold on invoice (earned revenue). **One broken in progress (Create an inventory quantity adjustment, from the products and services list for that item) Details of the inventory in stock and movement are also available on other reports such as the Product and Services List Report. The example transaction report below demonstrates the quantity and value movement of inventory as of the report date. (Customize by vendor, customer, product, and more) Note *Customer: Bill Bundles track inventory quantity and date only.
Manufacturing
The Invoice formula for calculating COGS in manufacturing and assemblies:
COGM = Direct Materials Used + Direct Labor + Manufacturing Overhead
*Don't forget to add sales tax on the Finished Goods Sale (setup by product and service item). The final invoice will contain the costs (bills) linked to the revenue (invoices), aligning with the GAAP matching principle and is consistent with the ASC 606. guidelines
Construction
The Invoice, formula for calculating COGS in construction is similar:
COGS = Materials Inventory + Billable Labor + Billable Subcontractor Costs + Billable Equipment Costs + Billable Overhead Costs (*Costs that are not directly associated with a specific project should be excluded) The sales invoice(s) will contain the costs (PO + Bill) linked to the revenue, aligning with the GAAP matching principle and is consistent with ASC 606 guidelines.
Progress tracking of construction inventory is a necessary activity and can be accomplished using bundles and the zero balance Customer: Bundle Bill process described below.
From inventory stock order to job order and job completion, through each job phase of construction (Preparing the Homesite, Laying the Foundation, Framing the Home, Installing HVAC, Plumbing, and Electrical, adding the Insulation, affixing the drywall, Inserting the Interior and Exterior Finishes to Completing the Final Inspection and Walkthrough) Inventory progress tracking serves as a valuable tool for measuring compliance with AIA, ASC 606, and IFRS 15 Revenue Recognition Standards: For a performance obligation satisfied over time, an entity would select an appropriate measure of progress to determine how much revenue should be recognized as the performance obligation is satisfied.
Construction inventory tracking also provides a good control measure to identify and reduce inventory shrinkage and assist in identifying overspending, ultimately a measure to job cost containment and is compatible with inventory and project management (and associated accounting collaboration), planning and analysis. Conduct a physical inventory count before construction starts and after final walkthrough, or as necessary. Make any adjustments (inventory quantity adjustments to an item) accounting for inventory shrinkage, if required, or to identify inventory that can be returned for vendor credit/refund.
You can also utilized standard project progress invoicing against an estimate based on the AIA model of % of project complete. In this case, only the amounts actually retained (deferred revenue deposit) + invoice paid (earned revenue) along with any cost plus or change order invoices, would be recognized on your financial statements. The balance of the estimate remains (non-posting-off the balance sheet and is invoiced in progression) Due to sales tax obligations, job progress reporting purposes, A/R and A/P planning and analysis, I do not recommend the (off balance sheet) % completion method of progress invoicing. With the revenue recognition method, reports are available to demonstrate % completion and can be invoiced accordingly.
Some notes about bundles:
Bundle Item (Multi-Inventory Items)
(Income = Sales for Invoices, and the Purchase/Expense = COGS for Bills/Expenses)
Bundles can have up to 50 items (last I checked with QBO and requested an increase).
(The National Association of Home Builders estimates that over 3,000 components are used in constructing a house, in 6-10 Phases. Therefore, a Job Phase may include as many as 6-10 bundles.)
There is no additional markup or change in price for bundles. (Bundles aren’t assemblies) Rather the price of a bundle = The total price of all its finished goods inventory items. (Inventory Lot for instance, a complete kitchen)
Bundles can be used for estimating projects and job phases (e.g.: kitchens, bathrooms, et...) by using Job Phase Bundles when estimating. This process is GAAP compliant and conducive to efficient and accurate Inventory and Project Management (and associated accounting collaboration) as well as planning and analysis.
(*Optional Production Workflow for Bundling Multi-Products Estimates and
Customer: Bill Bundles
First complete the steps to Revenue Deferral (Review Details of (Part 1): Revenue Deferral)
Begin Inventories in production:
Once all inventory items are verified as received and the deferral revenue deposit invoice paid, a Bill is created for inventory tracking. This is the zero balance Customer: Bundle Bill includes all product items that were bundled on the estimate (by Job Phase, consistent with the received items from the unbilled charges report. the Customer: Bill Bundles are NOT connected to the Job PO's). For the zero balance Customer: Bundle Bill leave the line item amounts as a zero balance but leave item quantity and check mark as billable. This net zero bill does not increase A/P but will create an open transaction on the Unbilled Charges Report and is used for job progress workflow tracking of inventory quantities, for the particular Job Phase. You can use Spreadsheet Sync to create the Customer: Bundle Bill, in comparison to the bill(s) for the job phase on the Bill(s) detail report.
Use this zero balance Customer: Bundle Bill to begin the workflow production process from Raw Materials through to Job Phase Completion. This will allow you to monitor the bundle inventory movement from start to finish. Track the job progress workflow according to the Project Managers report of progress (along with any inventory debits/credits (Inventory Adjustments) reported during production.
When all Customer: Bill bundles of a job phase have reached completion, and the finished goods items are ready to be invoiced, the original PO sales invoice (earned revenue) can be voided and replaced with a new sales invoice (earned revenue), for the same or actual(s) by job phase end date. Select > Create Invoice from the approved estimate, adding the actual inventory items received and open on the unbilled charges report to the new invoice. (if the job is a cost-plus billing, the mark-up line amount(s) will be separate line items on the Income Statement. This is assuming the quantities and amounts of the approved estimated materials are identical to the billed amounts and are consistent with the deferred items revenue deposit invoice. If not, a change order would be necessary or otherwise expect that the profit margin at the end of the project will be reduced by higher actual costs than were estimated and invoiced. The new sales invoice (earned income) will clear the unbilled charges report, track amounts and quantities invoiced against the approved estimate and any remaining unbilled amounts (evidenced from the Estimates & Progress Invoicing Summary by Customer or Project report or Estimates vs Actuals Report) It will also reduce inventory quantities on hand, while not affecting A/P (plan payments to A/P after the deferral revenue deposit is received, to avoid late fees and take advantage of vendor discounts). Your Income Statement will now reflect the earned revenue and COGS, at the appropriate time. Job Phase-GAAP compliant accounting complete!
The zero balance Customer: Bundle Bills can be DELETED at the end of production for each Job Phase. Before job sign off of each Job Phase, use the zero balance Customer: Bundle Bill(s) and a transaction detail by account report, filtered to the customer, or sales of inventory report, or in spreadsheet sync the bill details report
1.) to make comparisons of PO's, bill(s), and invoice(s) comparing Inventory from the approved estimate by Job Phase, and 2.) to reconcile job inventory received, and invoiced with quantity on hand or, negative quantities on hand from the products and services list (BOM). This process will maintain inventory asset integrity on your balance sheet and substantiate PO + Bill + Invoice amounts (verifying your Income Statement). Any final billings to adjust for inventory discrepancies can be presented as a Change Orders and issued prior to Sign off. The same comparisons apply to Project Substantial Completion, if appropriate.
The Sales Price quoted on an Estimate should be consistent with the products and services of the invoiced job phase bundle(s) and include markup. (best to try and maintain bundle pricing for all customers or create customer specific bundles as is described by the above process) Change orders would be used for any deviations as a result of an increase in material costs, or unbilled costs, et...
Run a bill of materials (BOM) production report, generated from the products and services list reports. Produce these reports periodically throughout the job and file to My Accountant > Shared Documents. This will maintain a complete historical record of the project through each job phase.
Approved Estimates used for invoicing purposes will have a line or field representing the item and amounts invoiced, remaining to be invoiced, or marked fully converted. The Estimates & Progress Invoicing Summary by Customer will track the open balance (filtered by class, location and customer job) Use this information to determine if there are unbilled items. When the project is concluded there should be no balance left on the approved estimate.
See Also: APPS Integrate with QuickBooks Online
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