QuickBooks Tip 10 Plus Methods of Accounting for Construction Contracts

Published June 1, 2010 | By Nancy Smyth

Every contractor, regardless of their business structure (sole proprietor, partnership, corporation) has to choose an overall method of accounting; before the first federal tax return is filed. Accounting methods include:

the cash method
the accrual method
the accrual method which excludes retentions, and (possibly)
a hybrid method(s)

Depending on the type, size, and length of the construction contract, there are various methods of accounting for long-term construction projects that are allowed – each method has its own advantages and disadvantages.

A contractor will need to select a specific long-term contract accounting methods – possibly with different methods for it’s exempt and non-exempt contracts – and also selects sub-treatments for the classification of contracts and the allocation of indirect costs.

In a nutshell, accounting for long-term contracts relates to the treatment method that is chosen; or that is required by the rules and regulations of the tax code, in order to account for income and cost recognition for long-term contracts.

10+ Methods of Accounting for Construction Contracts

Method	Revenue Recognition	Cost Recognition
Cash	As payment is received	As expenses are paid, except for depreciation and capitalization rules.
Hybrid – (Part Cash/Part Accrual	Cash or accrual – depending upon the method selected	Could be cash or accrual. For example, the contractor could use the cash method for receipts and disbursements AND accrual for inventory and payables related to inventory.
Accrual	As billing invoices are issued	Based on economic performance regulations of §461(h)
Accrual Excluding Retention	Based on when billing invoices are issued OR billings minus retainage deferred under the contract. Recognition of retainages, once entitled to receive	Based on economic performance regulations of §461(h)
Completed-Contract (CCM)	Billings or total contract price once contract is finished and accepted. See 1.460-4(d) for revenue recognition for disputed contracts	Costs are deferred as incurred. Specific costs are outlined in 1.460-5(d). Once completed, costs are closed out to expense.SG&A costs are expensed as incurred. See 1.460-4(d) for expense recognition for disputed contracts.
Exempt Percentage-of-Completion (EPCM)	Contract price (including change orders) multiplied by percent complete.Percent complete determined by various alternative methods, such as: Cost-to-cost Labor hours to total labor hours Various other permitted input and/or output measurements	Based on economic performance regulations of §461(h).Costs determined by 1.460-5(d). All costs are expensed as incurred.
IRC §460(b)Percentage-of-Completion Method (PCM)	Revenues determined by only the cost-to-cost formula	Based on economic performance regulations of §461(h).Costs determined by 1.460-5(b). All costs are expensed as incurred.
IRC §460(b)(3) Simplified Cost-to-Cost Method	Same formula as §460(b), except costs determined as outlined by §460(b)(4) or 1.460-5(c)	Based on economic performance regulations of §461(h).Job costs are direct material, direct labor and depreciation, amortization, and cost recovery on equipment directly used. All costs are expensed as incurred.
Reg. 1.460-4(e), §460(a) Percentage-of-Completion/Capitalized-Cost Method (PCCM)	Use PCM formula as §460(b) with same type of costs for 70%, and use exempt contract method for the remaining 30%.	For 70%, same as the §460 PCM method, the balance of the contract is accounted for by the exempt-contract method.
IRC §460 10% Deferral Method	Same as §460(b) above, except that revenues and billings on all contracts with less than 10% complete, determined by the cost-to-cost formula, are deferred until greater than 10% complete.	Based on economic performance regulations of §461(h).All costs are expensed as incurred. All costs on contracts less the 10% complete are not expensed as incurred, but rather are deferred in an account similar to an inventory account