Construction Accounting: Cash Vs Accrual Accounting

Construction bookkeeping is uniquely complex, requiring special methods that track revenues and expenses across long project timelines. While large firms must often choose between the Completed Contract Method (CCM) and the Percentage of Completion Method (PCM) for tax reporting, every contractor must first decide on the fundamental basis for recording transactions: Cash Basis or Accrual Basis.

This choice is critical, as it dictates when your business officially records income and costs. Choosing the wrong method can severely distort your financial picture, leading to poor operational decisions and unexpected tax bills.

In this guide, we break down the two core methods and provide clear criteria for choosing the right one for your construction firm.

In this Article:

• Cash Basis Accounting: Simplicity Over Accuracy

• Accrual Basis Accounting: The True Business Picture

• Side-by-Side Comparison

• How to Choose The Right Construction Accounting Method

• Conclusion & Action Steps

Cash Basis Accounting: Simplicity Over Accuracy

The Cash Basis method is the simplest approach. It recognizes revenues and expenses only when cash is physically received or paid.

• How it Works: The transaction is recorded only when money actually changes hands when a check clears, or a payment lands in your bank account.

• Example: Your construction company completes the framing phase and sends an invoice for $10,000 (due in 30 days). Under the Cash Method, you record $0 income today. You only record the $10,000 as revenue next month, when the customer's payment clears. Similarly, an expense is recorded when you pay the bill, not when you receive the supplier's invoice.

• Pros: It’s easy to understand and manage, often requiring less specialized accounting software or training. It also aligns your reported income directly with the cash in your bank account, which is beneficial for smaller firms focused purely on immediate cash flow.

• Cons: It provides a misleading picture of profitability. A large bill sent but not yet paid means your P&L doesn't reflect the work you've completed, making management decisions difficult.

Accrual Basis Accounting: The True Business Picture

The Accrual Basis method records revenues and expenses when they are earned or incurred, regardless of when the cash is exchanged.

• How it Works: Transactions are recorded at the time of the economic event. You record revenue when you issue an invoice, and you record an expense when you receive a bill.

• Example: Using the same case, when you complete the framing phase and send the $10,000 invoice, you immediately record $10,000 in revenue and $10,000 in Accounts Receivable (A/R). When the payment arrives next month, you simply move the $10,000 from A/R to your Cash account.

• Pros: It provides a full, more accurate picture of financial results because it matches revenue to the costs incurred to generate that revenue (matching principle). This is vital for analyzing true profit margins and assessing long-term solvency.

• Requirement: The Accrual method is the only method that complies with GAAP and is required by banks, surety companies, and most larger construction firms.

Side-by-Side Comparison

Feature	Cash Basis	Accrual Basis
When Revenue is Recorded	When cash is received.	When the revenue is earned (invoice sent).
When Expenses are Recorded	When cash is paid.	When the expense is incurred (bill received).
Financial Accuracy	Lower (Can be manipulated by timing payments).	Higher (Provides a clear match of revenue and expense).
Compliance (GAAP)	No.	Yes.
Best For	Very small businesses, simple operations.	Most construction firms, firms with inventory, growth-focused businesses.

How to Choose The Right Construction Accounting Method

For a construction business, the choice is usually not "optional" due to industry standards and regulatory requirements.

1. GAAP and External Reporting Requirements

• If your firm intends to secure bank loans, lines of credit, or performance bonds (surety), you will be required to produce financial statements prepared using the Accrual Method and potentially GAAP.

• IRS Exception: The IRS generally allows small contractors (those with average annual gross receipts not exceeding $25 million) to use the Cash Method for tax purposes, but this often conflicts with GAAP reporting needed for the bank/surety.

2. Job Duration and Complexity

• Short-term Projects (completed within one fiscal year): The Cash Method might suffice for internal tracking in very small firms, as the revenue and expenses align quickly.

• Long-term Contracts & Retainage: If your business handles complex AIA billing processes, retainage, scheduled payments, or long-term projects, the Accrual Method is essential. It is the only way to accurately track income earned versus work completed over multiple reporting periods.

3. Inventory and Capital Machinery

• If your construction company holds inventory (materials for resale) or capitalizes equipment costs, the IRS and GAAP generally require the Accrual Method.

• Depreciation: Accrual allows you to capitalize and depreciate the cost of machinery over its useful life, providing a much clearer picture of annual profitability than recording the entire expense in the year you paid for the equipment (Cash Basis).

Read more: AIA Billing vs. Progress Billing: Which One Works Best?

Conclusion & Action Steps

While the Cash Method is simple, the Accrual Method is superior for managing, financing, and growing your construction business. It is the only method that shows the actual cause and effect of your business activities, revealing your true profitability and financial obligations.

Need help understanding and transitioning to the right accounting method? We are Construction Cost Accounting (CCA). We specialize in providing the expert bookkeeping that contractors need to build a stronger financial foundation.

Schedule your Free 30-minute consultation today to discuss your accounting needs and set up a system that fuels your growth.