Construction companies can not operate without regularly making high-ticket purchases.
One of those costs is construction insurance.
You don’t have a choice about purchasing insurance and other expensive costs (i.e., machinery, land acquisition, and other fees).
But, you have a choice — within the bounds of some rules and regulations — if the costs should be counted as an expense or capitalization.
If you are confused about the rules of capitalizing insurance costs, read this blog post to learn when to capitalize insurance costs during construction.
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Can You Capitalize Insurance Costs During Construction?
Although there is not a direct cost associated with it, the value of insurance costs in construction is capitalized as a long-term asset for the policy — also known as amortized costs.
This value is passed on when the construction on the property is completed and sold.
When capitalizing costs, companies do not account for the entire amount on their balance sheet in the first year but spread the cost over time. This helps businesses to avoid having to pay large expenses at all once to save on costs.
However, there are certain rules and regulations, as noted by the IRS, that define which costs can be categorized as amortization.
The Basics of Capitalized Costs
In the construction industry, capitalization is a process by which a purchase is recorded as an asset, not an expense.
How does that work?
The value of the purchase is:
- Amortized as capitalized costs
- Allocated as an expense over time; and
- Not charged as an expense when incurred
A common example is when businesses capitalize insurance costs during construction to protect against losses during work on the project.
For example, if the building you're currently constructing burns down before it's finished, those premiums were money well spent because they weren't written off as an expense right away.
To ensure these kinds of expenses are recorded correctly and don't negatively impact future earnings statements, they must be capitalized instead.
Capitalization vs. Expensing in Construction
Construction is a unique industry in that it often involves large, one-time projects that are paid for overtime. This can create a challenge when deciding whether to capitalize or expense certain costs.
In general, the differences can be explained as:
- Capitalization represents the costs of long-term assets; and
- Expensing represents the costs of short-term assets
However, there are no hard and fast rules for construction companies.
Which Construction Costs Should Be Capitalized?
There are several types of construction costs that should be capitalized for financial reporting purposes.
These include costs associated with:
- Land acquisition
- Building construction
- Architectural and engineering services
- Installation of mechanical and electrical systems
- Property taxes, survey costs, architect fees, and permits; and
- Installing or repairing equipment or machinery used in construction
Simply put, capitalizing these costs will make them more visible and easier to track over time.
Which Construction Costs Should Not Be Capitalized?
Indirect costs are costs associated with procuring materials or labor, and overhead costs should not be capitalized. Some non-recurring construction costs also should not be capitalized.
Indirect construction costs can include the cost of:
- Labor; and
Overhead costs can include expenses such as:
- Staff training; and
- Contingency planning
Then, some construction costs may not recur and should not be capitalized, such as:
- Advertising; and
- Site preparation
4 Important Factors in Creating a Construction Capitalization Policy
Before a company can begin to generate revenue from its construction projects, it must first establish a capitalization policy.
This document will outline the important factors that go into creating such a policy.
By taking these factors into account, a company can create a sound financial foundation on which to build its future success.
#1: Be Aware of Agency Standards and Requirements
Construction companies have an abundance of useful advice on how to implement capitalization policies correctly.
Among the resources, you have access to include standards set up by:
- Internal Revenue Service (IRS)
- FASB (Financial Accounting Standards Board); and
- Generally Accepted Accounting Principles (GAAP)
To capitalize construction-related costs, you must comply with the agency standards and requirements set forth by these governing bodies.
Failure to do so may lead to penalties or other negative consequences.
#2: Be Consistent
A construction company should have a standard capitalization policy it follows to decide whether to capitalize inventory expenses.
For example, companies who wish to capitalize materials under $1000 should include such expenses on their reports for internal bookkeeping and taxation purposes alike.
Some general consistent procedures for companies to adopt may include:
- Capitalize all expenses that have a potential impact on the company's long-term financial health, such as new equipment purchases and employee training.
- Do not capitalize expenses that are purely cosmetic or have no real impact on the bottom line, such as office supplies and software licenses.
- Refer to a documented capitalization policy to avoid any confusion or controversy among employees or creditors.
However, construction companies may change this policy from year to year.
#3: Talk to Your Construction CPA
A CPA (Certified Public Accountant), who specializes in construction will know the best accounting methods for you to use when engaged in capital construction projects.
They can advise on the required tax reporting needs, as well as help your company:
- Define the types of projects you will undertake
- Determine the amount of capital you need to fund your ventures; and
- Draft a construction capitalization policy that will allow for increased liquidity and predictability in your business
With a CPA-approved construction capitalization policy in place, you will be able to:
- Comply with regulations
- Streamline financial reporting; and
- Make more confident business decisions
#4: Make the Most of Your Construction Capital With the Flexbase Card
Construction costs can be high and unpredictable, which can make it difficult to budget for them. One way to minimize the cost of construction is to utilize a business credit card.
There are a variety of options available when it comes to business credit for construction projects, and it is important to choose the right one for your specific needs.
Consider making the most of your construction capital with the Flexbase card. It offers flexible terms and options that can help you get the most out of your construction budget.
For instance, you can use it to:
- Pay for materials and supplies in advance
- Cover unexpected costs; or
- Consolidate debt
If you're looking to boost your business's liquidity and flexibility during construction, consider using Flexbase.
Construction can be expensive, and oftentimes there are unexpected costs that pop up.
One way to help cover these costs is to use business credit.
There are a variety of business credit options available for construction companies, but it is important to choose the right one for your specific needs.
Consider making the most of your construction capital with the Flexbase card.
Flexbase offers flexible terms and options that can help you get the most out of your construction budget.
For example, with credit approval, your company can utilize our app to take advantage of 0% interest for 60 days*, as well as ...
- Receipt tracking; and
- Expense management
... built into the Flexbase app.
If you're looking to boost your business's liquidity and flexibility during construction, consider Flexbase.
Contact us today to learn more about how the Flexbase Card could benefit your business.