Contractors and even accountants are sometimes confused by the proper accounting for construction contracts. There are two generally accepted accounting methods used to account for construction contracts; the percentage of completion method (PC) and the completed contract method (CC). It is important to note that these two methods do not represent alternatives for which the contractor or accountant can choose their preferred method. The appropriate method must be determined based on the accounting circumstances of each specific contract. Following is description of each accounting method and the factors that should be used to determine which method is most appropriate.
The PC method is the most common and allows the contractor to recognize income throughout a contract’s life. Under the PC method, revenue is recognized based on the extent of progress toward completion of the contract at a given point in time. For example, if a contract is 50% complete through a particular date, the contractor would recognize 50% of the contract’s revenues, estimated costs, and gross income through that date. The CC method, differs by deferring revenues and costs until a contract is substantially complete. This method is far less common and should only be used when the PC method cannot be used.
The key to determining the appropriate method of accounting is based primarily on the contractor’s ability to make reasonably dependable estimates regarding the extent of progress toward completion of the contract. Because estimating is an essential part of a contractor’s business, there is a general presumption that most contractors can make sufficiently dependable estimates, thus requiring the use of the PC method. The only time the CC method is acceptable is if either of the following circumstances exist:
- The results do not vary materially from those achieved under the PC method, or
- The contractor is able to prove with persuasive evidence that they do not have the ability to make reasonably dependable estimates regarding the extent of progress toward completion.
Now that the contractor has determined that PC is most appropriate method of accounting, the next step is to correctly determine the extent of progress toward completion of the contract. In the second part of this blog I will discuss the methods most commonly used to determine the extent of completion on a particular contract.
About the Author:
Matt Low is an Audit Manager at PDR CPAs + Advisors. He has extensive experience in accounting, assurance and tax. He specializes in audits, reviews, compilations, employee benefit plans and agreed upon procedures for a variety of industries including construction & real estate, engineering & consulting, healthcare, manufacturing & distribution, professional services and not-for-profits.
Matt has a Bachelor of Arts in Accounting from Stetson University and a Masters in Accounting from the University of Florida. Matt is a member of the American Institute of Certified Public Accountants (AICPA), the Florida Institute of Certified Public Accountants (FICPA), the Association for Builders and Contractors (ABC) – FL Gulf Coast Chapter and the Clearwater Regional Chamber.