For many businesses, accounting is fairly straightforward. But in some industries, like construction, accounting is a little different – and it can get complicated as a result. If you're new to the construction business or learning to do your accounting yourself, here are the terms you need to know to be successful.
Small Contractor: Your business qualifies as a small contractor if your average annual gross receipts for the past three tax years total $10 million or less, according to the IRS.
Large Contractor: On the other hand, if your average annual gross receipts from the past three tax years are more than $10 million, your business is considered a large contractor.
Short-Term Contract: A short-term contract is a contract you start and finish within a single taxable year.
Long-Term Contract: A long-term contract is a contract that goes beyond the end of a taxable year. According to the IRS, this includes contracts that start in December and end in January, for example. Long-term contracts can be broken down into either home construction contracts, or general construction contracts.
Home Construction Contract: This is a long-term contract for work on buildings that have four or fewer dwelling units (like a house or a duplex, for example), according to the IRS.
General Construction Contract: General construction contracts are long-term contracts for work on anything that would not be considered a home construction contract.
Actual Receipt: Under the cash method of accounting, actual receipt is fairly straightforward – it refers to the time that you received payment for a job. According to the IRS, if you receive payment for a job in one year but don't deposit the check until the next year, it's still considered actual receipt – and therefore taxable income – in the year the check was cashed.
Constructive Receipt: Constructive receipt is more complicated – it means that you had access to payment for a job during a certain year, even if you didn't physically have it at the time. This includes if a customer were to call you and let you know a check was available before the end of the year but you didn't pick it up until January, or if you have someone else pick up the payment for you. If you had access to the payment – even if you didn't receive the payment or deposit the funds before the end of a tax year – it's considered taxable income for that year.
Merchandise: Also commonly referred to as "materials," merchandise means any item physically included (like lumber, for example) in a product that you transfer for your customers, according to the IRS.
Substantial: In construction accountingese, "substantial" refers to your merchandise or materials – and it usually means that said merchandise comprises at least 10 to 15 percent of your gross income for the year.
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Types of Costs
G & A Costs: G & A stands for "general and administrative" costs (also commonly referred to as "overhead"), which includes any of the costs associated with running a business that can't be traced back solely to specific jobs, according to the IRS. These are generally deductible.
Job Costs: Unlike G & A costs, job costs are expenses related to your actual construction jobs. These costs can either be direct or indirect.
Direct Job Costs: Direct job costs are expenses related to a specific construction project, including costs like labor, materials and subcontractor expenses.
Indirect Job Costs: These are the expenses – which can differ, depending on whether your business is a small or large contractor – necessary to completing a construction project outside of the direct labor and materials.
Cash Method: This is similar to what most other businesses use – you record income constructively received and expenses paid in the same year that they happen.
Accrual Method: With the accrual method, you count income when you've earned it (even if you haven't physically received it yet), and you deduct expenses either when you incur them or whenever they can be accurately calculated, whichever comes later. Under this method, if you use materials purchased in one year over multiple years, you need to spread out the costs over the years you used them.
Completed Contract Method: Like the cash method, with this method, you deduct expenses and report all income in the year that a project is completed. In this case, you would use the accrual method to account for G & A costs. Small contractors and home construction contracts can use this method.
Percentage of Completion Method: Mostly used by large contractors (though small contractors can use it too), you estimate the percentage you've completed on a project and count the income you have earned for that percentage even if you've yet to receive it. In the year you complete the project, you report the remainder of the income from the contract.
Exempt Percentage of Completion Method: This method is similar to the Percentage of Completion Method, and you use the accrual method to calculate G & A and job costs. There are two ways to use this method – the Cost Comparison and Work Comparison methods.
EPCM Cost Comparison Method: For this method, you divide deductible job costs for the year by the estimated total job costs, then you multiply that percentage by the price of the contract.
EPCM Work Comparison Method: This requires you to determine the percentage of work you've completed, then have it validated by an engineer or architect, or be supported by documentation, according to the IRS.
For more detailed information on the different accounting methods (each method has different requirements your business and contracts must meet), check out our Guide to Construction Accounting, as well as these tips from the IRS.