Owner Paid Materials

On the average construction project, a construction contractor purchases material and bills the project owner for it. With every purchase, the contractor is charged sales tax, which is of course passed on to the project owner. However, some project owners, primarily Native American tribes in my area, are exempt from paying sales taxes. In order to take advantage of the sales tax exemption, these project owners will pay for the materials directly. If they don't pay for the materials directly, they will lose the sales tax exemption. So, instead of you billing them for pipes purchased, you or the vendor will send them the invoice and they will pay for the pipe themselves. Those of you that have experienced this know that the record keeping can be a nightmare. How do you track costs that you won't pay for? Those costs are incorporated into the contract price as well, so how do you track the revenue side too?

One thing to note is that there are multiple ways to account for and track activity for a project with owner paid materials. Usually, the contract price and the estimated total cost includes the owner paid materials. But if you're not going to pay for the material for the project, how do you track it? If the project owner is not going to pay you for the material purchased, how do you account for that as well?

Let's get into some of the details!

You have a $100,000 contract with estimated costs of $80,000, which includes $25,000 in owner paid materials.

$25,000 in PVC pipe was purchased for the project but the owner is going to pay for it, not you. Do you record a payable? If you record a payable, that payable will stay on the books forever since it will never be paid. So what do you do?! Also, remember that the contract price includes that $25,000 in material so do you record a receivable you'll never collect?

The best way to approach this is to keep in the mind the overall theory behind it. You are tracking costs and billings that will not result in cash outflows/inflows. You want to affect the income statement (Costs/Revenue), but not the balance sheet (AP/AR). There are a few different ways to do this, some may be easier than others depending on your accounting software.

I would consider recording each invoice separately with some additional designation like "OPM" at the end of the invoice to know that it's for owner paid materials. If your accounting software gives you the option, create a new liability account you can post invoices to called "Owner Paid Materials Clearing". Instead of crediting accounts payable when you post the invoice, credit the Owner Paid Materials Clearing account. After posting the invoice, you have a cost on the books tied to that project but you have an amount hanging out in the clearing account as well. Remember we said the owner paid materials are included in the contract price as well? That means we have to invoice the project owner for $25,000 as well, even though we won't be paid for it. To do so, you would credit revenue and debit the Owner Paid Materials Clearing account. The $25,000 credit and debit will zero each other out and we're left with cost and revenue on the books. When we run inception to completion numbers for the project we should end up at $100,000 in revenue and $80,000 because we are accounting for that $25,000.

Another way to track owner paid materials is to record a payable with the same OPM designation. However, when it comes time to pay the invoice, instead of using your operating account, you would use a "dummy" OPM clearing cash account. For the invoice to the project owner, you would credit revenue and debit accounts receivable. To get rid of the receivable, you would record the "receipt" against the OPM clearing cash account so that in the end, the OPM clearing cash account is zero.

I recommend recording these transactions for better record keeping, especially when they correspond to progress pay applications. It's easier to find mistakes or issues when you've been tracking everything as opposed to everything but material.

Hope that was as clear as mud!

Ara

info@thewipreport.com