What Is Construction in Progress in Accounting?

Construction in Progress (CIP) represents a temporary asset account on a company’s balance sheet, designed to accumulate the costs associated with building or developing a long-term asset. This asset category captures the value of ongoing construction projects that are not yet ready for their intended use. CIP is temporary, as the accumulated costs are eventually transferred to a permanent fixed asset account upon project completion.

Defining Construction in Progress

Construction in Progress (CIP) is an asset account that holds all direct and indirect costs incurred during the construction or development of a long-term asset. These projects typically include new buildings, significant renovations to existing structures, custom-designed machinery, or even internally developed software intended for a company’s own use. The purpose of this account is to ensure that all expenditures related to creating an asset are properly tracked and capitalized rather than expensed immediately.

Costs accumulated within the CIP account are specific to the construction phase. These include direct materials, such as lumber, steel, or specialized components, which are physically incorporated into the asset. Direct labor costs, representing the wages and benefits paid to workers directly involved in the construction, are also capitalized. Additionally, allocable overhead costs are included, encompassing expenses like indirect labor, utility costs for the construction site, and depreciation of construction equipment used on the project. Furthermore, design and engineering fees, permits, and other regulatory costs directly tied to the project’s development are added to the CIP balance. For qualifying assets, interest costs incurred on borrowings specifically for the construction period can also be capitalized. All these costs are aggregated in the CIP account until the asset is complete and ready for its intended operational use.

Accounting for Costs During Construction

During the construction phase, as a company incurs costs related to the project, these expenditures are not immediately recognized as expenses on the income statement. Instead, they are accumulated in the Construction in Progress (CIP) asset account, which resides on the balance sheet, typically within the Property, Plant, and Equipment section. This accounting treatment aligns with the matching principle, capitalizing costs that provide future economic benefits.

For instance, when construction materials are purchased, the company would debit the CIP account and credit Cash or Accounts Payable. Similarly, as direct labor wages are paid or accrued for workers on the project, the CIP account is debited, and Cash or Wages Payable is credited. Overhead costs, such as allocated utilities or indirect labor, are also debited to CIP, with corresponding credits to various expense or liability accounts.

This continuous process of debiting the CIP account causes its balance to grow progressively throughout the construction period. The accumulated balance represents the total investment made in the asset up to a given point in time. This systematic capitalization ensures that the full cost of acquiring and preparing an asset for its intended use is properly reflected on the balance sheet.

Capitalizing Completed Projects

Once a construction project is complete and the asset is ready for its intended use, the accumulated costs in the Construction in Progress (CIP) account are transferred to the appropriate fixed asset account. This transfer signals the asset is operational and provides economic benefits. The trigger for this transfer is the point at which the asset is substantially complete and available for its designed purpose, regardless of when it is actually put into service.

The transfer is executed through a specific journal entry. The specific fixed asset account, such as “Building,” “Machinery,” or “Software,” is debited for the total accumulated cost, and the “Construction in Progress” account is credited by the same amount. Upon this transfer, the balance of the CIP account for that specific project becomes zero.

After the transfer, the asset is then subject to depreciation over its estimated useful life. Depreciation is the systematic allocation of the asset’s cost over the periods in which it is expected to generate revenue. This transition from CIP to a depreciable asset shifts the asset from a non-depreciating, accumulating account to an operational asset that will impact the income statement through depreciation expense.