A Visual Deep Dive into Cost Coding

One of the biggest stumbling blocks with contractors getting their job costing system set up properly is the cost code structure. There are several moving parts and it can be overwhelming. Where do you start? We’re showing you on this week’s episode. Make sure to check it out on the Carpenter CPAs YouTube channel.

Topics we cover in this episode include:

  • Reasons contractors fail at creating cost code structures\
  • The Job Costing Hierarchy
  • Cost codes mapping to Chart of Accounts
  • How to start with cost coding

LINKS
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

TRANSCRIPT

[00:00:06] Wade Carpenter: One of the biggest stumbling blocks with contractors getting their job costing system set up properly is the cost code structure. There are several moving parts and it can be overwhelming. Where do you start?

Come on in. Let’s talk about it. This is the Contractor Success Forum. If you’re new here, I’m Wade Carpenter with Carpenter Company CPAs. With me, my co host, as always, Stephen Brown with McDaniel Whitley Bonding and Insurance. Stephen, initial thoughts on our topic today?

[00:00:32] Stephen Brown: Cost codes. This is sexy stuff, Wade. In a previous podcast, you talked of analogy of a jigsaw puzzle being turned upside down where the colored pieces are facing down on the table and you got to try to put things together. And so let’s talk about flipping that jigsaw puzzle over and seeing the color pieces.

And instead of maybe starting with a thousand piece puzzle, let’s start with a 50 piece puzzle with the bigger pieces and put it together and talk a little bit about how to make your vision a reality of what you want your accounting system to do. It all hinges on your cost codes. So we talk about cash flow and a lot of that depends on your costs.

Wade, I love it. You’ve got visuals today.

[00:01:19] Wade Carpenter: Yeah, I do, and I know this is a podcast, so for those of you that are listening on some podcast engine, you may want to check this one out on the CarpenterCPA’s YouTube channel. or the Contractor Success Forum YouTube channel.

[00:01:32] Stephen Brown: As an insurance agent, I would tell you, do not drive and read these visuals please.

[00:01:37] Wade Carpenter: You’re trying to avoid some claims there, aren’t you?

But going back to that analogy we used. And if you remember that analogy, we had it all turned upside down and we see the cardboard pieces, but we also didn’t see the picture on the box to go by. And that’s what I’m hoping to do today is give the picture on the box. Where we’re going with this.

For a lot of people, when I explain it to them like this visually, they get it a lot better. And this really is one of the stumbling blocks that I see people buying these software products– not picking on anything. Just QuickBooks Online or whatever, and they may have some canned items in there or products and services, or again, not picking on any particular vendor, or BuilderTrend or Jobber or JobTread, all these will have some canned things in there that may have absolutely nothing to do with their–

[00:02:32] Stephen Brown: Right.

Reasons contractors fail at creating cost code structures

[00:02:33] Wade Carpenter: So today, what I was hoping to do was walk through some of the things that we– when I go through a contractor talking about and developing a system, we’re going to hopefully look at some of the reasons that they fail at this and how we get around that.

[00:02:48] Stephen Brown: Okay.

[00:02:49] Wade Carpenter: A couple of thoughts here, and I’m not going to go through all these, we’re talking about complexity over simplicity.

A lot of people try to make it perfect, but they get this analysis paralysis. They don’t know where that starting point is, and they try to develop a system that is too complex, has everything they possibly could do. And again, the complexity over simplicity. I would rather you have just the major chart of accounts level where we’re just, this is by job, labor materials, subcontract, equipment, other, as long as we’ve got that, we’ve got some kind of measure how we’re doing. Otherwise, it’s a very manual process to really figure out how you think you’re doing.

[00:03:29] Stephen Brown: Sure. And how are you going to explain that to others in your organization if you get too complex? You know, that acronym, KISS. Keep it simple, stupid.

[00:03:38] Wade Carpenter: A lot of my contractors, they will tell them, tell me they’ve got a gut feel. They know how they’re going, they’re doing their jobs are doing. And usually they do, but they know when the one’s going bad, but sometimes they are fooled by thinking that the ones that are, the big jobs or whatever, the things that they’re profitable.

And when we get a good cost code structure in there and we look at it a year later. They find out the things that they thought were making them money were actually costing them a lot of margin as well as costing extra overhead.

[00:04:11] Stephen Brown: Absolutely. And if you’re the owner of a construction company, for example, and you just have a material cost that’s important to your organization that goes up 20%, and you don’t realize it, you don’t know it, it doesn’t seem to stand out at the beginning, how are you going to see that in a timely manner and act accordingly so you just don’t keep bleeding money?

[00:04:31] Wade Carpenter: That’s a good analogy actually because, a lot of times, especially if you can get to the chart of accounts level and get it by job, if you had a particular type of job that had more costly materials than you normally do or you had something on that job that could be more of, we had to sub this particular piece out, so we’re giving away some of the margin.

And that can go a long way to getting you some better numbers, or at least numbers that you understand if you see a huge fluctuation in your gross margin overall.

But, again, these canned softwares, and even the expensive software, the Sage software, and some of the real expensive construction packages, they all have their chart of accounts, and they also have a canned cost coding structure in most cases.

And the problem is those canned cost code structures may have absolutely nothing to do with your industry.

[00:05:25] Stephen Brown: And then you have to figure out what they mean. In the drop down box, you gotta, what does this mean? And then you gotta research what it entails. That’s not working for your specific type of company. Are you a subcontractor? Are you a general contractor? If you’re a subcontractor, what specific trade, you can break it down a thousand ways.

[00:05:44] Wade Carpenter: That is another problem is these cost codes, most of them are very long in the canned good construction software products. And it again, causes this analysis paralysis versus say QuickBooks Online has something canned in there for a contractor is just overly simplistic and really has nothing to do, but people try to make it fit within that structure.

So again, why do people struggle? They spend two years playing around with the software that was supposed to revolutionize their job costing. And they never seem to get there. And they spend a bunch of money and time and they haven’t gotten anywhere. They try to achieve perfection.

[00:06:25] Stephen Brown: Preach it.

[00:06:26] Wade Carpenter: They attempt to achieve some level of perfection. They think it’s got to cover every possible option that we’ve got. And contractors are busy people, and they have time and budget constraints. This is sort of a project that we’ll work on it one day here, and then one day, two weeks down the road, and it never comes to fruition, just because it’s an afterthought, and they don’t know what that puzzle is supposed to look

[00:06:49] Stephen Brown: like.

Right. This sounds like a really good idea and something I should do. I just don’t have time right now. And you just put it on the back burner.

I was just going to lead into building up a base, of the most important things and then how to get more detailed later.

[00:07:04] Wade Carpenter: Let’s jump into that. This is one of the biggest things that I see.

The Job Costing Hierarchy

[00:07:08] Wade Carpenter: Every time we take on a new contractor, this is pretty much every time we’re redesigning that. And so this is where I wanted to explain a little more visually how this is supposed to look.

I created this for this particular presentation. The chart of accounts level is the basic building blocks of your accounting system. And, you’ve got a chart of accounts for any type of business, like retail store, or manufacturer, or eCommerce business, whatever it is. That’s the building block, and you’re not worried, typically, about trying to get job costing.

Then we have trying to figure it out by job, and as you, as we go up the chain, it is getting where we can get more detail, where we can get better information to run our jobs, better information to know how we’re coming out.

The next level is using this chart of accounts by the job. Another way to slice and dice that is by class, or you could call that division. From the chart of accounts level, that’s pretty much as far as you can go with that. I’ve got a couple of other ways you could slice and dice that by project manager or, construction team or by project type or a particular client.

But as we go up this hierarchy, it is more work to get that more detail. I say this all the time, but I’d rather you have basic level of understanding of how you’re doing on your jobs than trying to develop a system that you never put in place.

[00:08:36] Stephen Brown: Great point.

[00:08:37] Wade Carpenter: thousand times better. That’s, to use your analogy, that 50 piece puzzle is down here.

[00:08:42] Stephen Brown: Uh-huh.

[00:08:43] Wade Carpenter: Then, trying to put all the extra thousand piece puzzle.

Once we get in above here we’re slicing it and dicing it a little differently. So we’re talking about, and I call it phase codes. You can call it divisions, you can call it whatever, but I think about that from the the Construction Specifications Institute, or CSI, if I say that.

You have the main levels that could be the trades or whatever. Concrete, electrical, plumbing, HVAC, whatever it is, mechanical, and that’s the top level. And then we have the detailed cost codes below that.

Again, the Chart of Accounts level is the basic level for any building block of any accounting system.

[00:09:20] Stephen Brown: That’s the base of the pyramid. Number one.

[00:09:22] Wade Carpenter: Then splitting that out that way by job is a big step up, and it does require a little more work. Once we’ve done that, we can also split that job up into different classes where we’re trying to track, say, the example of, say, a residential contractor that does new construction versus, renovation type work versus restoration, insurance type work. You may be wanting to track it different ways.

 The next level is splitting it a little differently. That’s where we’re talking about the divisions, and then we jump into the detailed cost codes.

The traditional, profit and loss, getting it by job, gets you this level here. Profit and loss normally would just be one line item, or one column, and they’re all jumbled together. In this case we’re splitting it out by job, and we’re able to at least see, from a top level, construction income versus labor, all this stuff, and get some kind of profitability from that main level.

[00:10:19] Stephen Brown: Okay.

[00:10:20] Wade Carpenter: With, profit and loss by class, we could still do the same thing, but it’s adding another level of complexity. It could be concrete versus masonry. Whatever the class is, if you’re trying to see major lines of business, that’s another way to do it.

Here we’ve got a sample cost code list, and this was one that we built for a particular contractor, where you’ll see these try to follow the CSI specifications, but you may see 314 concrete in place, labor, and then materials, this is our hack for, we’ll say construction QuickBooks.

So that particular line item, sometimes you may be doing your own labor. You could also be using subcontractors, you could also have equipment that would fall under that major category. That’s where we try to build a cost code list like this.

Cost codes mapping to Chart of Accounts

[00:11:09] Wade Carpenter: And this is one of the biggest things that I think people should pay attention to, is — and this is in QuickBooks Desktop, they refer to them as items. In QuickBooks Online, they refer to them as products and services. In most other dedicated construction systems, they do refer to them as cost codes.

But when we’re setting them up, each one of these cost codes should translate to two different things. This is a big miss for a lot of people. Like this particular one for 03-350 M, slabs and walls. We’re going to point to construction income when we billed towards that. So if we use that particular line item in our bill, our customers, then we’re recognizing income on that. That’s with our markup.

If we recognize the cost side and we’ve got payables, we’re tying it to the same item, but that’s going to translate to, say, the materials. That’s going to show up in your profit and loss.

Now, this is one thing I wanted to throw out on here because this is one of the biggest misses I see, and it’s not intuitive, whether it’s, this is from QuickBooks or online. Or this one is from QuickBooks Desktop, but I see it all the time. It’s even harder to find in Online.

But the items that are set up are traditionally one-sided items. That’s by default. And so this particular concrete finishes, in this particular case, it would have been mapped to a subcontract. It’s mapped to an expense side of it. But when we actually check this little box, and there is a corresponding box on the QuickBooks Online used for subassemblies and all that stuff, that allows us to get what I refer to as these two sided item so we can also point it to the income.

I think I told you before about a contractor that was doing about 30 million that I took over down in Florida that had a very competent CPA firm, specialized in construction. But we were seeing 2 million on materials, negative 5 million on subcontract, expense, and the revenue was showing very little. And it was because they never figured out how to set all this stuff up right. They’ve never mapped this stuff right.

So that’s one of the key things that I want people to understand is the relationship between these cost codes and how they’re supposed to translate to the chart of accounts. That allows you to see that and slice and dice it many different ways.

Now, ultimately what we’re trying to do is take all these cost codes and, this is the sort of the upper level. If we can get our estimates in there and we can have estimated revenue and our estimated costs, when we start the job and we know that this particular line item that, temporary shoring, they have 1.1 million on that one, and they’ve already burned off 193, 000. They have a little over 900, 000 to go on that particular line item. That’s the cost side.

A lot of contractors actually bill by the line item. This particular one is not a good example of that. They roll it all up into one line item. But, when they do it that way, you can see hey, we billed, sometimes contractors do need to be set up that way. And we billed by 50 percent of this particular line item. We got part of it in place.

So ultimately, knowing where you are from this level means a lot more to a project manager, to an owner, trying to figure out where they are on the job than trying to do it from a chart of accounts level.

How to start with cost coding

[00:14:36] Stephen Brown: I can see maybe future podcasts, it might help our listeners if we take this where to start chart and do maybe some other kind of simple tutorials on how to get started.

[00:14:48] Wade Carpenter: We can, and I think we were also talking previously about things like tracking payroll. that is another big section that we could probably spend a whole podcast talking about. Because if you’ve got like an integrated system where, that particular one I was showing you, we have the integrated payroll where it will pull in the labor, as well as the payroll taxes and the worker’s comp, and allocate it to the jobs. I really do want to explain this part and we can probably do a little deeper dive on it, but if you got ADP or paychecks or not picking on anybody in particular, or even QuickBooks Online has their QuickBooks payroll. And you can do time tracking and all that stuff, and it will roll it up to the QuickBooks payroll section and you can see it there, but it does not translate to the books and records.

So we have a problem, even at the chart of accounts level, of, getting everything under the right category. But even the integrated QuickBooks Online payroll to the QuickBooks Online, it will not pull it over by job at all, and it’s a manual process. So that is one of the biggest headaches that I see, and another one that we address all the time when we’re setting somebody up.

[00:16:04] Stephen Brown: What might our listeners be able to download at your YouTube page?

[00:16:09] Wade Carpenter: The CSI master format, we can maybe put some links to that. That is, I think copyrighted. I do think we can give you the major phase codes, 40 or so major classifications from that.

[00:16:21] Stephen Brown: We could start with the chart of accounts.

[00:16:24] Wade Carpenter: The CSI master format is a great place to start. It’s an attempt to make it standardized across the industry, but people build their own all the time, and if you’re trying to figure out some kind of starting point, you may want to go to your industry trade organizations or talk to other people in your industry.

And if you’re struggling to find a place to start, look at these major categories first. Carve those down to the ones that you’re going to use.

[00:16:50] Stephen Brown: I like the analogy. Look at the picture on the box, the whole jigsaw puzzle analogy. You’re doing a jigsaw puzzle with your family and you’ve dumped it all out on the table and all the colored pictures are down, and you can’t flip them over and you don’t have the box, so you don’t know what the puzzle’s supposed to look like.

You flip it over color side and then you look at the picture, then you have some reference. I think that’s a great analogy here. 50 piece puzzle or a thousand piece puzzle. Start with the 50 piece puzzle until you get the fundamentals down and then work your way up to the bigger piece puzzle.

I think we ought to rename this podcast look at the picture on the box. Cost code structures for contractors. Thank you, Wade, for this.

[00:17:34] Wade Carpenter: If you’re struggling with that, again, getting that 50 piece puzzle is much better than nothing, but getting some help if you need it. If you’re struggling and you want to jump to that detail level, sometimes you need a third party to get you out of that analysis paralysis, I keep calling

[00:17:52] Stephen Brown: it.

Okay.

[00:17:53] Wade Carpenter: But I do think we’re running a little long on this one. Did want to thank our listeners for listening to the Contractor Success Forum. Want them to check out the show notes, ContractorSuccessForum.com or on the Carpenter CPA’s YouTube channel where we can put some more information and maybe a download of those 40 major categories.

And we would appreciate it if you consider subscribing and follow us every week as we post a new episode. And we will look forward to seeing you on the next show.