Construction accounting methods differ from general business accounting because of things like the project-based nature of the industry, long-term contracts, fluctuating costs, progress billing, retainage, and complex revenue recognition.
What’s more, choosing the right accounting method can make a huge impact in your financial reporting, tax compliance, and decision-making.
So which method is right for your business?
In this article, we discuss the pros and cons of four of the most common construction accounting methods and then give you five factors to consider when making your choice.
Key Takeaways
- The main construction accounting methods are cash basis, accrual basis, completed contract method (CCM), and percentage of completion method (PCM). Each has its own pros and cons
- Construction accounting methods differ from general business accounting methods for a variety of reasons, including the project-based nature of the industry, long-term contracts that can last for years, fluctuating costs, and complex revenue recognition.
- Choosing the right accounting method for your business is crucial for accurate financial reporting, tax compliance, and effective decision-making.
- When choosing a construction accounting method, take into account your business size and revenue, the project’s duration and complexity, your financial reporting needs, the tax implications, and the administrative and accounting expertise you have.
Construction Accounting Methods And Their Pros & Cons
Cash Basis Accounting Method
In cash basis accounting, income and expenses affect your ledger as they happen. So, when money comes in or goes out, you add it or subtract it from the money in your bank account.
Pros
Cash basis accounting is easy to understand and maintain, and provides an immediate, real-time picture of the cash flowing into and out of the business.
You can also defer your tax obligations because you only have to pay taxes on income when you actually receive the money.
Cons
Cash basis accounting doesn’t reflect outstanding invoices or unpaid bills, especially for long-term projects. Because of that, you may not get as accurate a report about the business’s financial health as you could with other construction accounting methods on this list.
In addition, cash basis accounting does not comply with Generally Accepted Accounting Principles (GAAP), often conflicts with retainage practices, and the IRS limits its use to contractors whose gross receipts are typically under $30 million (per 2024 guidelines).
Accrual Basis Accounting
In accrual basis accounting, income and expenses are recognized when services are performed or goods are delivered, regardless of when the cash moves into or out of your bank account.
Pros
Accrual basis accounting is GAAP compliant (which makes it easier to get external financing), gives you an accurate view of financial performance, and enables more effective financial planning.
Cons
Accrual basis accounting is more complex than cash basis accounting, and, so, requires a much more robust accounting system and careful attention to detail.
With accrual basis accounting, your business may owe taxes on revenue before you actually get paid.
Completed Contract Method (CCM)
In the completed contract method (CCM), all revenue, expenses, and gross profits for a project are recognized on the general ledger when the contract is complete and accepted by the client.
Pros
The completed contract method is often easier to implement than the percentage of completion method (see next section) and allows you to defer income tax until the project is complete.
CCM is better for short-term and uncertain projects in which reliable estimates and progress can be difficult to obtain.
Cons
The completed contract method can distort financial statements and the ongoing performance of your business.
CCM is not GAAP preferred for long-term contracts and is not recognized under the International Financial Reporting Standards (IFRS).
In addition, CCM provides limited financial insights, making it harder to manage costs, identify issues, and make timely decisions.
Percentage Of Completion Method (PCM)
With the percentage of completion method (PCM), revenue and expenses are recognized proportionally as the work progresses on a long-term project.
Pros
The percentage of completion method is GAAP preferred for long-term contracts, results in more consistent financial statements, and provides an accurate reflection of progress and financial health.
Cons
CCM is very complex and requires precise tracking, comes with a high risk of estimation errors, and often needs specialized knowledge and accounting software to maintain.
How To Choose A Construction Accounting Method
To help you choose a construction accounting method, find the characteristics and needs of your business in the table below.
Business Size And Revenue
For smaller businesses and those with revenue below the IRS threshold, cash basis accounting might be simpler for day-to-day operations and tax deferral, but it comes with limitations for growth and financing.
For larger businesses, accrual basis is preferred, if not required, provides a more accurate financial picture, and doesn’t limit growth and financing.
Project Duration And Complexity
For short-term projects completed within a single fiscal year, cash basis accounting or CCM is often sufficient.
For long-term projects that span multiple fiscal years, PCCM is preferred for its accurate reflection of ongoing financial performance.
Financial Reporting Needs
If your business needs detailed financial analyses such as KPIs and ratios (e.g., liquidity, profitability, efficiency, and leverage), income statements, cash flow statements, job costing, or work-in-progress (WIP) reports, accrual basis coupled with PCCM is the way to go.
Tax Implications
Regardless of which construction accounting method you think works best for your business, always consult with a tax professional regarding how federal, state, and local laws impact your tax liability.
Administrative And Accounting Expertise
When choosing a construction accounting method, be sure to consider the administrative and accounting expertise you have or will need to keep everything running smoothly.
Keep in mind that cash basis and CCM require less intensive bookkeeping and can be managed with basic accounting knowledge.
Accrual basis and PCM, on the other hand, require more intensive bookkeeping, advanced expertise, and even specialized software.
Consult with an accountant to get their input on which construction accounting method is right for your business.
Simplify Construction Accounting With Coast
Simplify your bookkeeping with Coast, regardless of which construction accounting method you choose. Coast is an all-in-one expense management platform and fleet card built for construction businesses. With Coast, you can:
- Code transactions to the right project or cost code as they happen
- Restrict spending by category, merchant, or amount to prevent overruns
- Capture receipts and job codes instantly from the job site via text or mobile app
- Sync expenses effortlessly to your accounting software or construction ERP to reduce reconciliation time
Whether you use the percentage-of-completion method, completed-contract method, or a hybrid approach, Coast gives you the visibility, control, and accuracy you need to keep your books clean and your projects profitable.
For more details about how Coast can help your business, visit CoastPay.com.
Frequently Asked Questions [FAQs]
Why are construction accounting methods different from regular accounting methods?
Construction accounting methods differ from regular accounting methods because the construction industry is project-based rather than company-based and has to deal with long projects, changing costs, and complex contracts.
Most regular businesses use their accounting to get a financial picture of the whole company. While construction businesses need to do that too, they also need to track budgets, costs, and timelines for each project that they take on. Construction accounting makes that possible.
Unlike the relatively quick buying and selling that regular businesses execute, construction projects can take months or even years to complete.
Because of that, construction companies deal with money earned and spent over a long period of time. That calls for special accounting methods to keep track of everything.
To make things even more complicated, the construction industry has to deal with the rapid change in cost of materials and labor, as well as complex contracts, retainage, and change orders.
Regular accounting isn’t designed to deal with those variables. That’s where construction accounting comes in.
What is job costing in construction accounting?
Construction job costing is a detailed accounting method used in the construction industry to track and manage all expenses associated with a specific project.
With the use of job codes, spending categories, and other organizational methods, all expenses are tracked and added to a special construction-in-progress (CIP) account that is separate from the general business accounting ledger.
Job costing makes it easier for construction managers and owners to monitor budgets, address cost overruns before they get out of control, protect profit margins, analyze performance, and improve future bidding and estimating.
How does retainage work in construction accounting?
Retainage (sometimes called retention) is a common practice in the construction business whereby clients withhold a percentage of the payment (typically 5-10%) until the project is completed satisfactorily or for a specified period of time after completion.
In the construction industry, retainage can go both ways, so that you have retainage receivable (what clients owe you but are holding back) as well as retainage payable (what you are holding back from subcontractors).
Track both variables carefully in order to get as accurate a picture as possible of the profitability of each project and the business as a whole.
