Elizabeth Friswold, CPA CFE is a manager at Corrigan Krause.
Construction accounting has its own unique set of accounting complexities not faced by other industries. Whether you are the bookkeeper or owner of a construction company, you are affected by the accounting practices your company elects. This article provides different best practices that your accounting team should consider when determining the best accounting approach for your company:
Percentage of Completion
Percentage of completion is a methodology to recognize revenues for multi-year contracts – it aids a construction company to better match its revenues and expenses. Many construction companies determine their percent complete by dividing their actual costs to date by their total estimated contract costs. Your percent complete multiplied by your total contract’s gross profit is what will be the gross profit recognized to date. This method to calculate the percent completed may only be used if you can rely on your estimates. Poor estimates of total estimated contracts costs will either cause your company to recognize gross profit too soon or too late – both can be costly!
Completed Contract Method
Contrary to the percentage of completion method previously mentioned, the completed contract method allows construction companies to defer all revenue of a project until its completion. This is a perk for construction companies who prefer to defer taxes into a future period. Note, that similar to revenues, all costs related to a project are not reflected in the determination of current income unless there is a loss projected on the contract. Instead costs are capitalized on the balance sheet until project completion. This accounting method may only be used on projects that are less than two years from inception to completion.
Job costing is defined as allocating all direct and indirect costs to any given contract. Tracking these expenses by contract is critical in determining your contracts profitability. This task may be easier said than done depending on the volume and size of contracts your team is managing. We can assist your team with developing a process for coding direct expenses and allocating overhead expenses to your projects.
As mentioned above, job costing is critical to determining if your contract was a win or a bust – finding the correct software will ease the burden and stresses of job costing. Additionally, construction accounting software will provide your team with real-time, active reports to calculate your percentage of completion and financial position on demand. We have built relationships with construction accounting software companies and will be able to assist you in determining which software will meet your team’s needs.
Tax Reporting Strategies
Tax laws are never constant and the rules are always changing. When determining the best method your tax reporting, you must consider your company size and the nature of your contracts. Depending on if your company uses percentage of completion or completed contract method, you may have significant differences between your books and tax return. Additionally, determining cash or accrual basis must be carefully considered when evaluating your short and long-term tax strategies.
At Corrigan Krause, we are here to help you better understand how to apply the these best practices into your business. We look forward to discussing your business with you and your team.