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Construction contractors and subcontractors must have a comprehensive understanding of what constitutes income and adopt appropriate accounting practices to pay taxes. Construction Accounting includes Cash Method and Accrual Methods (percentage of completion method (PCM) and the completed contract method (CCM) to recognize income).

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Cash Basis Method

Cash-based accounting is an approach that acknowledges revenue at the time of cash collection and expenses when cash is disbursed. The income or loss is determined by the disparity between cash received and cash expended

Accrual Basis Method

The accrual basis adheres to the accounting matching principle, acknowledging revenue in the period it is earned rather than when received, and expenses in the period they are incurred rather than when paid. This technique incorporates revenue accruals, like accounts receivable, and expense accruals, such as accounts payable, to capture transactions regardless of when money changes hands.

Construction Accounting Method

Percentage of Completion Method

The percentage of completion method (PCM) involves acknowledging income in alignment with the progress of the work completed. Contract progress can be assessed through the cost comparison method, where annual deductible job costs are determined as a percentage of the total estimated costs. Alternatively, the work comparison method can be applied by calculating the completed work divided by the total work to be performed.

Completed Contract Method

The completed contract method (CCM) is applicable for small contractors or projects where a minimum of 80 percent of costs is associated with home construction, involving buildings with no more than four dwelling units. With the completed contract method, you defer all income and deductions until the project is completed. General expenses not explicitly tied to the contract can be deducted as they are incurred under this method.

Percentage of Completion Method (PCM)

Many construction contractors typically employ one accounting method for projects initiated and completed within the same year and a different method for long-term contracts. Nevertheless, it is permissible to utilize the cash method of accounting for both short-term and long-term contracts, provided your average annual gross receipts do not exceed $5 million, and revenue from merchandise sales remains within the range of 10 percent to 15 percent of your gross income.

In cases where the average gross receipts for the preceding three tax years are $10 million or less, eligibility for the cash method is granted, irrespective of business structure or inventory presence.

Completed Contract Method (CCM)

The Internal Revenue Service designates a business as a "large company" if its average annual gross receipts surpass $26 million, mandating large contractors to employ the percentage of completion method (PCM) in accrual accounting.

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