Blog updated August 2022
Identifying the best accounting method to report your income and expenses is not always an easy task. Many rules and regulations apply and making the incorrect choice can negatively impact your business. It’s important to understand how each method differs, paying special attention to the impact on your taxes and your long-term business goals. The two primary accounting methods for financial and tax reporting are the Completed Contract method and the Percentage of Completion method.
Selection of accounting methods depend on:
- The type of contracts you have
- Your contracts’ completion status at the end of your tax year
- Your average annual gross receipts
- Other factors specific to your Company
Completed Contract Method
This method is often used by contractors averaging less than $27 million in annual revenues. With this method revenue, expenses and gross profit are deferred until the completion of the contract. The advantage of using this method is that it allows for the maximum deferral of income taxes as revenue is not taxable until the job is completed. Under the completed contract method revenue from contracts are not matched with their respective costs. As a result this method of accounting can pose some risks, one of which is a volatile bottom line. It may be great to defer revenue from a tax standpoint, but this can pose a challenge for a company seeking financing, bonding or a potential investor. Under Generally Accepted Accounting Principles (GAAP), the Completed Contract method is only allowable under certain circumstances for financial reporting.
Percentage of Completion Method
This method is generally the required method for financial reporting purposes for larger construction companies for long-term contracts, as it is the primary method used under GAAP. The percentage of completion method matches revenue from long-term contracts with their respective costs, calculating estimated revenue and gross profit at various stages of construction. Calculating gross profit on a regular basis allows contractors to track their progress and provide profitability benchmarks, which can provide timely feedback to allow management to proactively control costs or pursue the most profitable jobs.
Choosing what method is right for your company can be complex and can play an integral role in your company’s success. It is critical to know the distinction between the various accounting methods for both accurate financial reporting and tax compliance. Often time the best answer is a not a simple yes or no, but a strategy developed just for you. Don’t feel like you need to do it alone, let one of Corrigan Krause’s construction experts help you build success and a great future.
Corrigan Krause Specializes in Construction Accounting
If you’re unsure which accounting method is right for your business, the Construction Services group at Corrigan Krause can help. Email firstname.lastname@example.org for more information and sign up for our Construction Services newsletter here.