Tax and Accounting in The Nigerian Construction Industry

In Nigeria, construction companies can benefit from various allowable deductions and incentives for expenses incurred during the construction process. These typically include:

  • Cost of Construction Materials : The cost of materials used in construction, such as cement, steel, and bricks, can be deducted from the company's taxable income.
  • Labor Costs : Expenses related to labor, including wages, salaries, and benefits for construction workers, are usually deductible.
  • Depreciation of Assets : Construction companies can depreciate the cost of equipment and machinery used in construction over their useful life, reducing taxable income.
  • Interest on Loans : Interest payments on loans taken to finance construction projects are often deductible, reducing the company's taxable income.
  • Research and Development (R&D) Credits : Companies investing in R&D for innovative construction methods or materials may be eligible for tax credits. Companies can claim a 140% deduction for expenses incurred on R&D activities related to local raw materials used in construction
  • Investment Allowance : The Nigerian Investment Promotion Commission (NIPC) offers investment allowances for qualifying capital expenditures, which may include construction-related expenses.
  • Capital Allowances : Companies can claim capital allowances on qualifying capital expenditures, such as buildings and plant machinery, to reduce taxable profits.
  • Industrial Development (Pioneer) Status : Companies granted pioneer status enjoy tax holidays and other incentives for a specified period, which can significantly reduce tax liabilities during the construction phase.

These deductions and incentives can have a significant impact on a construction company's tax liability and financial statements:

  • Tax Liability : By reducing taxable income through deductions and incentives, construction companies can lower their tax liability, resulting in cash savings and improved cash flow.
  • Financial Statements : The impact on financial statements varies depending on the accounting treatment of deductions and incentives. For example, depreciation expense affects the income statement by reducing net income, while capital allowances impact the balance sheet by reducing the carrying amount of assets.
  • Cash Flow : Deductions and incentives can positively affect cash flow by reducing tax payments, allowing construction companies to allocate more resources to other areas of the business or reinvest in additional projects.
  • Competitive Advantage : Leveraging available deductions and incentives can enhance the competitiveness of construction companies by lowering costs and increasing profitability, thereby attracting more projects and investors.

In the construction industry in Nigeria, subcontractor costs are typically accounted for and treated in accordance with relevant accounting standards, such as the International Financial Reporting Standards (IFRS). Here's how subcontractor costs are usually handled, along with steps for recognizing liabilities and expenses and ensuring compliance with accounting standards:

  1. Recognition of Liabilities:
    • Subcontractor costs are recognized as liabilities in the financial statements when the construction company has received services from subcontractors but has not yet paid for them. This typically occurs when subcontractor services have been provided, but invoices are pending or payment terms extend beyond the reporting period.
    • The liability for subcontractor costs is recorded on the balance sheet as accounts payable or accruals, depending on whether invoices have been received.
  2. Recognition of Expenses:
    • Subcontractor costs are recognized as expenses in the income statement when the services provided by subcontractors contribute to the construction project's progress or completion.
    • Expenses related to subcontractor costs are matched with the revenue generated from the construction project to determine the project's profitability.
  3. Invoice Verification:
    • Construction companies must verify subcontractor invoices to ensure accuracy and completeness before recording liabilities and expenses. This verification process may involve comparing invoices with contracts, purchase orders, and delivery receipts to confirm the services provided and the amounts invoiced.
  4. Accrual Accounting:
    • Accrual accounting principles require construction companies to recognize subcontractor costs when the services are rendered, regardless of when payments are made. This ensures that expenses are matched with the revenues they help generate, providing a more accurate depiction of the company's financial performance.
  5. Compliance with Accounting Standards:
    • To ensure compliance with relevant accounting standards, such as IFRS and FRC Standards, construction companies should:
      • Stay updated on changes to accounting standards and regulations issued by regulatory authorities.
      • Implement internal controls and processes to accurately record subcontractor costs and other financial transactions.
      • Engage qualified accounting professionals or consultants with expertise in construction accounting and regulatory compliance.
      • Conduct periodic reviews and audits of financial statements to identify and rectify any errors or discrepancies.
      • Disclose relevant information related to subcontractor costs in the notes to the financial statements to provide transparency to stakeholders.

Construction companies typically treat overhead costs, such as administrative expenses, rent, and utilities, separately from direct construction costs. These overhead costs are necessary for the operation of the business but are not directly attributable to specific construction projects. Here's how construction companies commonly treat and allocate overhead costs:

  1. Treatment of Overhead Costs:
    • Overhead costs are usually recorded as expenses in the income statement as they are incurred, regardless of whether they are directly associated with a particular construction project.
    • Administrative expenses, rent, utilities, insurance, salaries of administrative staff, and other general operating expenses fall under overhead costs.
    • These costs are essential for the day-to-day operations of the construction company but do not directly contribute to the construction of individual projects.
  2. Allocation Methods:
    • To distribute overhead costs to construction projects, construction companies often use allocation methods that allocate these costs based on a reasonable and systematic basis. Common allocation methods include:

i.    Direct Allocation : Some overhead costs may be directly attributable to specific construction projects. For example, if a project requires dedicated office space or utilities, the costs associated with those facilities can be directly allocated to the project.

ii.   Indirect Allocation : For overhead costs that cannot be directly traced to specific projects, indirect allocation methods are used. Common methods include:

  • Percentage of Direct Costs : Overhead costs may be allocated to projects based on a percentage of direct construction costs. For example, overhead costs may be allocated based on the proportion of direct labor or material costs incurred by each project.
  • Labor Hours or Workdays : Overhead costs may be allocated based on the number of labor hours or workdays spent on each project. Projects that require more labor or longer durations would bear a larger share of overhead costs.
  • Square Footage or Area : For construction projects involving buildings or structures, overhead costs may be allocated based on the square footage or area of each project. Larger projects would bear a higher portion of overhead costs.
  • Machine Hours : If construction equipment usage varies across projects, overhead costs may be allocated based on the number of machine hours used on each project.
  • The chosen allocation method should be reasonable and reflect the underlying relationship between overhead costs and construction projects. It's essential for construction companies to document their allocation methods and ensure consistency in application to maintain accuracy and transparency in financial reporting.