Every business needs to choose a method of accounting report income and expenses. It is important to fully understand the chosen method, as each differs, especially in relation to taxes. After selecting the method cannot be changed without special permission from the internal revenue Service. The percentage-of-completion and completed contract methods often seen in construction companies, construction firms and other businesses that operate under long-term contracts for large projects. Since income and expenditures are often deferred during work on these long-term projects, companies seek to defer tax liabilities as well. Both the percentage of completion and completed contract methods allow such tax deferral.
Completed contract method Accounting takes into account all revenues and expenses directly related to long-term contract, as received, when the work is completed. Completion date in the contract is spelled out and often months or even years from the date the work begins. If the construction company can relax from income taxes during the operations phase, and may sometimes even qualify for certain tax benefits, at the same time – this method can be more risky method of accounting for transactions.
For example, if the contract is for completion in five years, the business may apply the tax on the income of the project during this time, but tax laws can and do change from year to year. If possible, tax rates were increased during this period of five years, the company faced paying higher taxes than if statements occurred early in the process.
In addition, if the business is looking for outside investors, it can be challenging to prove their value to the company while incoming revenues. The method of completed contract, but still the most conservative method of accounting for companies operating on long term contracts.
With some variations on the completed contract method, percentage of completion gives the same tax benefits, deferred with less risk for vibrations and more frequent reporting of income and expenses. Using this method, the company can provide milestones throughout the construction process or to estimate the percentage completed of the project.
While the specific amounts of income and expenses can be attributed to each completed part, whether it is by calculating the percentage or certain stages of work, types of reporting. For example, if a construction company builds a 10-storey office complex is under contract at the selling price in the amount of $4 million and the company estimates that the total construction cost of $3 million, at any time during the construction process it can report the completion percentage. Therefore, if the project is more than 40%, the business will report 40% of their income ($4 million) and 40% of its expenditures ($3 million) for the current gross profit of $400,000.