When it comes to the construction industry, nailing a multi-year, long-term contract is the holy grail, but it can be a bit challenging when it comes to the accounting process.
In the case of a long-term contract, the percentage of completion method is the standard construction accounting method. It involves reporting revenues and expenses on a period-by-period basis, depending on the timeline detailed in the agreement.
Why? Because as a project grows by, say, a percentage each year, its revenue also increases incrementally. Your company’s current income and expenses are then compared to the project’s estimated costs to help determine tax liability in the coming year.
Rather than having a sudden spike of taxable income at the end of the project—which is often a substantial figure—the earnings are reported evenly over the term of the contract.
The key to the percentage of completion method is the probability of revenue collection. Without estimated revenue, the procedure falls apart.
Advantages of the Percentage of Completion Method
There are two primary accounting methods: percentage of completion (POC) and completed contract method (CCM). Both are ideal methods for long-term projects, specifically within the construction industry. Why choose the former over the latter?
- Estimating cost and revenue per project focused on a specific period and extent of completion allows an accountant to immediately recognize the construction project’s value and income to date.
- Simultaneously, by ignoring incurred costs that have yet to be used on the project, an accountant may provide accurate estimates of all associated costs and revenues.
- As a business, spreading your tax liabilities across multiple years ensures the project does not go belly-up before completion. By reporting expenses annually, you lower your taxable income and write off qualifying expenses.
Why Choose POC Over CCM?
You will see the percentage of completion method more frequently in construction accounting, as it directly ties revenue and expenses to the project’s completion. It offers construction companies a more accurate view of their financial status over the long-term and more manageable tax liability. POC recognizes income and profit as the project progresses. The closer to completion, the more profitable it becomes.
Conversely, the CCM method only recognizes income and project expenses once the work is complete.
Construction accounting can be complex—let an expert handle implementing the percentage of completion method for your project. Contact MKS&H for a consultation today!