Updated: Aug 6
Accounting and financial management is a challenging task in all industries. Especially in construction accounting, there are some unique challenges compared to regular accounting. Construction accountant must use sophisticated accounting solution to ensure a system is in place to match income and expense. In this article we recommend to contractors 5 best practices to do construction accounting.
Cash basic accounting is the easiest and simplest method in this list for construction. Accountants will record revenue when received and expense when paid. Nonetheless, certain precautions must be applied. Even though revenue is recognized and reported, expenses must be allocated evenly over the entire period of benefit when applied to multi-year contract.
If job materials cover up to more than 15% of customer’s total cost, construction company can not use cash basic method. You are also exempt from this rule is your business make less than 1 million dollars in annual revenue.
Job order costing is a system of expense monitoring in which a business only creates products to fill customer/client orders. Employees complete job order cost sheets for each order and usually separate expenses into three main categories: direct material, direct labor and manufacturing overhead. Companies in many industries can use job order costing, though a variety of product offerings/services complicates the tracking of expenses.
In construction industry, it is hard to balance variety of projects and jobs that vary in length and size. Therefore, job costing is one of the best practice for contractors. It is not only simplify tax preparation for contractors, but also provides efficient tracking on income and expenses across construction projects.
Percentage of Completion
Percentage of completion refers to the ability of construction company to balance between revenue and expenses . This is a challenging method due to the variety of length of projects and numbers of jobs.
However, it is helpful for contractors to determine whether or not a specific profit is bringing loss or gaining profit. Many construction companies determine their percentage of completion by dividing their actual costs to date by their total estimated contract costs. Then the percentage of completion multiplied by total contract’s gross profit is what will be the gross profit recognized to date.
Completed Contract Method
In contrast to percentage of completion method, completed contract method allow contractors to delay the report of all project revenue until its completion. But it’s possible to have the payment received before the end of the project. This approach is best applied for short term contracts which can be less than 2 years or have gross profit less than $1 million. This method also allow contractors to defer taxes into future period.
Tax Reporting Strategies
Tax law can be complicated and challenging for contractors because it always keep updating and changing. Effective tax preparation and planning can help you to minimize your future tax liability. You may have major differences between your books and tax returns depending on how company uses the percentage of completion or completed contract method. In addition, when evaluating your short and long term tax strategies, you must consider determining cash or accrual basis.
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