Accounting for construction projects according to the HGB: Minimise risks, accurately record values
Are you facing the challenge of accurately accounting for a multi-year construction project? Accounting for construction projects under HGB involves strict rules, particularly the realization principle, which pose significant financial risks. This article shows you how to avoid pitfalls and ensure a sound, legally compliant assessment.
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The topic briefly and concisely
According to HGB, profits from construction projects are generally realized only upon overall completion and acceptance (Completed Contract Method).
All costs incurred in the project that can be capitalised must be accounted for as 'unfinished services' until acceptance.
If a loss is imminent because costs exceed revenue, a provision for anticipated loss must be made immediately in accordance with the principle of prudence.
The correct balance sheet treatment of long-term construction projects presents many property owners and investors with a complex task. Unlike international standards, the German Commercial Code (HGB) requires a very conservative approach due to its strict principle of caution. Errors in the capitalization of production costs or premature realization of profits can distort the balance sheet and lead to significant economic disadvantages. Therefore, a precise understanding of HGB regulations is not merely an accounting issue, but a crucial factor for the financial stability and transparency of your project. We guide you through the central aspects of accounting for construction projects according to HGB and show you how to record values correctly and proactively manage risks.
Foundation of the Valuation: The Realisation Principle according to the German Commercial Code (HGB)
The core of accounting for construction projects according to the HGB is the realisation principle as per § 252 Abs. 1 Nr. 4 HGB. This states that profits may only be reported once they have actually been realised in the market. For construction projects, this generally means that the profit may only be recorded once the finished work has been accepted by the client. Until this point, all incurred costs are capitalised in the balance sheet as "unfinished services" or "unfinished products". This strict regulation, known as the Completed Contract Method, serves to protect creditors and prevents the reporting of uncertain profits. The consistent application of this method ensures a cautious and risk-aware representation of your company's financial position. Accurately defining the costs eligible for capitalisation is a crucial step in this process.
Correctly activate and distinguish manufacturing costs
The determination of manufacturing costs is a critical process strictly regulated by § 255 of the German Commercial Code (HGB). Incorrectly assigned costs can distort the financial statement result by up to 15%. Therefore, precise allocation is essential to accurately assess the value of your construction work in progress. Knowledge of the correct valuation of real estate is highly beneficial in this context.
What counts as manufacturing costs
There is a clear hierarchy for capitalization, which costs must and can be included. This prevents arbitrary valuations and ensures comparability.
The following costs must be capitalized:
Direct material costs: All directly attributable material consumption such as concrete, steel, or bricks.
Direct production costs: Wages for construction workers directly involved in the project.
Special direct production costs: Costs for special models, licenses, or external appraisals incurred solely for this project.
Appropriate material and production overhead costs: Depreciation on construction machinery or salaries of the construction management.
A common mistake is the capitalization of pure distribution costs, which is impermissible under HGB and leads to an inflated valuation. Therefore, the careful documentation and allocation of all cost blocks forms the basis for HGB-compliant accounting.
The exception proves the rule: partial profit realization
While the Completed Contract Method is the standard, under very strict conditions there exists the possibility of partial profit recognition (Percentage of Completion Method). However, the hurdles for this are intentionally set high in the HGB. Application is only conceivable if contractually agreed and legally enforceable partial acceptances for completed trades take place. For example, the acceptance of 50 completed units in a large residential complex could justify partial profit recognition. Without such binding partial acceptance, early profit booking poses a significant attestation risk for the auditor. Less than 5% of HGB accountants use this method due to the strict requirements. The complexity of assessing real estate projects increases significantly as a result. This strict interpretation underscores the conservative nature of the HGB compared to international standards like IFRS, where the PoC method is the norm.
Anticipating Provisions: The Provision for Imminent Losses
The principle of prudence in the German Commercial Code (HGB) requires not only that profits be reported late, but losses as early as possible. If it becomes apparent in a construction project that total costs will exceed the agreed fixed price, a provision for anticipated losses must be made immediately according to § 249 Para. 1 HGB. Suppose a project with a contract volume of 2 million euros has already incurred costs of 1.5 million euros, and a further 0.6 million euros are needed for completion. In this case, a provision of 100,000 euros must be made immediately. This obligation to anticipate losses protects creditors and ensures a realistic picture of the financial situation. The early identification of such risks is a core task of project controlling. A professional and data-driven assessment, such as that offered by Auctoa with ImmoGPT, can help to validate cost forecasts and identify impending losses in good time.
Distinction from IFRS: Two Worlds of Accounting
The differences in accounting for construction projects under HGB and International Financial Reporting Standards (IFRS) are significant. They lead to fundamentally different representations of earnings. The comparison between HGB and IFRS highlights the divergent philosophies.
Core Differences at a Glance
The choice of standard has far-reaching consequences for a company's financial ratios.
Profit Realisation: HGB mandates the Completed Contract Method (realisation upon acceptance), while IFRS 15 prescribes the Percentage of Completion Method (realisation based on the completion stage) as a norm.
Presentation of Results: Under HGB, there are highly fluctuating profits with a significant profit surge in the year of completion. IFRS smooths profits over the entire project duration.
Focus: HGB focuses on creditor protection through the principle of prudence. IFRS aims at the most accurate representation of financial conditions for investors ("true and fair view").
Production Costs: While the definition of cost boundaries is similar, HGB prohibits the capitalisation of research and development costs, which IFRS allows under certain conditions.
A project can show a profit of 1 million euros annually over three years under IFRS, while under HGB, a profit of 3 million euros arises in the third year with none before. These differences are crucial for internationally operating investors and in company valuation.
Conclusion: Caution and control as the key to success
Accounting for construction projects under the HGB is deliberately conservative and designed to protect creditors. The strict application of the Completed Contract Method and the obligation to immediately create provisions for onerous contracts require meticulous project management and comprehensive documentation. An accurate understanding of the capitalizable production costs according to § 255 HGB is fundamental for the correct valuation of work in progress. For you as an owner or investor, this means: Do not rely on your intuition, but on data-driven analyses and precise bookkeeping. This is the only way to ensure that your balance sheet presents an accurate picture of your financial position and performance, safeguarding you from unpleasant surprises at your next audit. An external, impartial evaluation can assist you in identifying risks early and placing your accounting decisions on a solid foundation. Get in touch now, without obligation, to have your projects assessed.
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Additional useful links
KPMG offers a brochure on the audit of real estate according to IFRS and HGB.
The IDW provides an announcement on the accounting of real estate.
Haufe offers an article on tangible assets, particularly assets under construction.
On gesetze-im-internet.de you can find the official statutory text of § 266 HGB regarding the structure of the balance sheet.
The Federal Statistical Office provides information on construction prices and real estate price indices.
The Federal Statistical Office publishes press releases on construction price indices.
The Federal Ministry for Economic Affairs and Climate Action (BMWK) provides a study on the significance of the regulation on public procurement prices.
The German Construction Industry Federation offers an article on valuation and accounting.
FAQ
How are advance payments received for construction projects accounted for according to the German Commercial Code (HGB)?
Advance payments received from customers are reported on the liabilities side of the balance sheet under liabilities as 'advance payments received on orders' as long as the service has not yet been rendered. They are only offset against the receivable and recognised in profit or loss upon acceptance and invoicing.
What happens if it turns out after the accounting that the manufacturing costs have been calculated incorrectly?
If an error in cost calculation becomes apparent, it must be corrected in the period of detection. If it is a material error, this may require an adjustment of prior year figures and disclosure in the notes. The principles of proper accounting require careful and verifiable cost determination.
What role does the usage duration play in the accounting of construction projects?
During the construction phase, the duration of use does not yet influence depreciation. The capitalized production costs are recorded as work in progress in current assets. Only after completion and transfer of the building to fixed assets (e.g., for own use) does the scheduled depreciation begin over the expected useful life of the building.
Do interest on borrowed capital have to be included in the production costs?
According to § 255 (3) of the German Commercial Code (HGB), there is an option to capitalize interest on borrowed capital used for the production of an asset. If the interest is capitalized, it increases the value of the construction project on the balance sheet. If it is not capitalized, it is recorded directly as interest expense in the profit and loss account.
How does inflation affect the provision for anticipated losses?
When assessing the provision for anticipated losses, future price and cost increases must be taken into account (§ 253 (1) sentence 2 HGB). This means you need to include foreseeable cost increases, such as those resulting from inflation in materials and wages, in your calculation of future project costs, and adjust the provision accordingly to a higher amount.
What exactly are special direct costs of production in a construction project?
Special direct costs of manufacturing are costs that cannot be attributed to a single product but can be clearly assigned to a specific order. In a construction project, these could be costs for site setup, specific construction plans, models, licenses for a particular construction method, or the costs for a site investigation.
