Construction contractors typically work on different type, size and length contracts. Depending on these variables, recommended contractor accounting methods may differ. Before filing a Federal tax return, construction contractors of any business structure (sole proprietor, partnership or corporation) must choose a method of accounting.
So, why not start with your business tax planning and preparation now?
3 Types of Contractor Accounting Methods
The IRS has several steps construction contractors must follow to determine which accounting method is right for them. The method selected by contractors depends on the type of construction contract, the stage of completion at year’s end and a contractor’s yearly average gross receipts. Since construction jobs are completed in stages, contractor accounting methods must take into consideration the periodic inflows of income as well as properly recognize expenses.
Whether you hire a construction accountant or not, contractors should be aware of these methods.
The cash method of accounting
For construction contractors, the cash method matches income with expenses on a rolling basis. Contractors record income as it is received and expenses when they are paid. IRS reporting of these items are registered in the tax year they occur. Contractors are eligible for the cash method of accounting, if the construction firm has $10 million or less in gross receipts annually for each of the past three years.
The accrual method of accounting
With the accrual method of accounting, contractors must wait to recognize income and expenses until after the contract is essentially completed. Construction contractors may choose the accrual method if annual gross receipts exceed $10 million for each of the past three years.
Which accrual method should I choose?
- Percentage-of-completion method
The percentage-of-completion method to account for long-term contracts could be a good fit for both large and small construction firms. This construction accounting method matches revenues against expenses for a specific period of time. The amount of income recognized in this accrual method depends on how much of the construction work is finished.
- Completed-contract method
The completed-contract method is only available to small construction firms. It can be used in addition to the percentage of completion method to monitor long-term contracts. In this method, revenue is not recognized until after the completion of the contract.
The hybrid method
When selecting contractor accounting methods, the IRS permits mixing the best of both worlds. A construction contractor may use the cash method for receipts and disbursements, while at the same time the accrual for inventory and payables related to inventory.