Construction accounting can be complex when applying generally accepted accounting principles properly. Bringing Internal Revenue Code Section 460 into the mix creates an even more complex aspect to the industry and the proper reporting of construction contracts.
Construction Accounting for Long Term Contract
Those in the construction industry are allowed to choose one of two methods for the proper financial accounting and reporting of long term construction contracts. The easier of the two is the Completed contract method. While the more complicated way to account for long term contracts is the Percentage of Completion method for long term contracts.
Completed Contract Method
The completed contract method is used by manufacturers and contractors. This method does not make an attempt to recognize revenue during the applicable periods of construction or while it is being manufactured. Both construction deposits and related expenses are accumulated on the balance sheet until the job is complete. This accounting policy then reports the income and expenses on the income statement once the job is completed.
Percentage of Completion method
The percentage of completion method for the reporting of long term contracts is a more complex construction accounting method. This method attempts to recognize revenue as the job is completed. Expenses are generally expensed on the percentage to which the job is complete. Revenue is recognized based on the contract amount and the percent of completion. Taking receipt of construction advances does not trigger the recognition of income under this method.
Construction Accounting and Tax Accounting
For federal income tax purposes the tax code generally allows for the use of either the percentage of completion or completed contract method. However contractors and manufacturers who’s average annual revenue of more than $10 million dollars are required to use the percentage of completion method for federal tax purposes. It is possible that a contractor could use one method for tax purposes and another for financial statement reporting purposes.