The most significant and unique topics for construction contractors from an accounting point of view are those dealing with contracts and revenue recognition. The timing of contract costs being charged through and the ability to measure revenue earned on long term contracts are areas which need special attention.
Long Term Construction Projects in ASC 910
The construction industry is different than many other types of industries by the long term nature of a typical construction contract. Large, multi-million dollar skyscrapers, stadiums, and many of the other structures they are so famous for erecting span several years to construct, which means they also span several accounting periods. As it is the purpose of the accrual basis of accounting to match revenues and expenses in the same periods, the construction industry has the ability to utilize percentage of completion accounting.
Percentage of Completion Accounting
This methodology allows the construction company to recognize a portion of the revenues which have been completed as a result of their efforts at the end of the reporting period, despite the entire project not having been completed. The specific guidance on this revenue recognition approach is detailed in FASB ASC 605. It should be noted that this method is more complex than if you were to wait until the project was completed, as it relies on several estimates which are inherently something that are risky when they enter accounting.
Completed Contract Method
The completed contract method is also detailed in FASB ASC 605 and is the other way in which a construction company may recognize revenue related to construction contracts. It differs from the percentage of completion method in the fact that the revenue is only recognized once the work is finished rather than incrementally. This methodology is one that would be better used if a company were working on several smaller projects, perhaps building residential houses one by one, for example. However, it is not necessarily applied in this manner, as either methodology can be used in the construction industry.
It is important to note that the FASB prefers the application of the percentage of completion method, despite the inherent complexities surrounding the estimates included. This is because it smooths the earnings of companies across the years rather than showing the volatility which is involved with finishing a project only after so many years.
Accounting made easy, for FREE!
Access the contact form and send us your feedback, questions, etc. We are always welcome to help someone out. You can also contact us if you wish to submit your writing, cartoons, jokes, etc. and we will consider posting them to share with the world! The Facebook and LinkedIn groups are also good areas to find people interested in accounting like yourself, don’t hesitate to join as everyone of all levels are welcome to become part of the community.