What is Construction-in-Progress?

Construction-in-progress (CIP) is an account in which the costs incurred to build a fixed asset are stored. This account is only used while an asset is being constructed, after which the total cost is shifted to another fixed asset account. This account typically contains the costs of labor, materials, and overhead incurred during a construction project. It has a natural debit balance.

Accounting for Construction-in-Progress Charges

You should pre-screen CIP-related invoices when they are first entered into the system, so that items to be expensed are charged off at once. They should NOT be stored in the CIP account; otherwise, there is a considerable risk that expensable items will not actually be charged off for some time. As an alternative, if you want to use CIP as a tracking mechanism for an entire project, create a pair of sub-accounts for it, one of which stores items to be charged to expense, and the other for items to be capitalized. This approach makes it easier to charge off expenses in a timely manner.

Types of Construction in Progress Journal Entries

The main journal entries related to the construction in progress account are as follows:

Recording construction costs. When construction costs are incurred, such as labor, materials, or subcontractor fees, they are debited to the Construction in Progress account. This entry accumulates the cost of the asset under construction as a capital project.
Capitalizing overhead or indirect costs. Allocated overhead related to the construction project is added to CIP through a debit entry. This ensures that indirect costs, like supervision or equipment depreciation, are included in the total asset cost.
Billing the customer. When a contractor bills the customer for work completed, the Accounts Receivable account is debited and a billing account (e.g., Billings on CIP) is credited. This entry tracks amounts invoiced separately from actual construction costs.
Recognizing revenue. Under the percentage-of-completion method, revenue is recognized based on the project’s progress, debiting Construction Expenses and crediting Revenue. This entry aligns income recognition with the project's stage of completion.
Transferring completed construction to fixed assets. Once the project is finished, the total accumulated CIP is transferred to a fixed asset account, such as Buildings or Equipment. This is done by debiting the asset account and crediting CIP, removing it from construction-in-progress.
Recognizing losses on contracts. If a construction contract is expected to result in a loss, an entry is made to recognize the loss immediately. This typically involves debiting a loss account and crediting a liability or CIP adjustment.

Why is Construction-in-Progress Accounting Necessary?

You need to operate a construction-in-progress accounting system when you are constructing assets that will not be completed for an extended period of time. If you do not have a system for tracking construction-in-progress, then some expenditures may be charged to expense instead of being capitalized, while other expenditures may be capitalized without any depreciation for an extended period of time - which misrepresents the profits being reported.