Revenue Recognition in Construction: What Contractors Need to Know
- Cost Construction Accounting
- Mar 27
- 6 min read
Understanding revenue recognition is one of the most important aspects of running a profitable and legally compliant construction company. Whether you're a small contractor or a huge construction company, how you account for and report income has a direct impact on your financial statements, tax planning, and long-term success. However, with several methods of revenue recognition available, many contractors may find it difficult to understand. In this post, we'll go over the basic ideas of revenue recognition, answer common issues, and investigate the best ways for construction organizations.
What is Revenue Recognition?
The method by which a business records the money it makes from work that has been finished is called revenue recognition. Because construction jobs often last for months or even years, it can be harder for contractors to figure out how to record their income. It is important to understand the different ways that revenue is recognized in order to follow the rules for construction financial reporting and stay out of trouble with the tax officials.
A construction business has to decide when and how to show revenue in their financial statements when work is finished. The general rules for recognizing revenue are meant to match how money is actually earned. This means that revenue should only be recognized after the service or product has been given.
Why Revenue Recognition in Construction is Different
In retail or service-based companies, sales are recorded when the goods are sold. But construction projects have their own problems, like:
Long lead times for projects
Several payment dates
Orders for changes and changes to the scope
Retainage (payments not sent)
Because of these difficulties, contractors need to follow certain rules and building accounting standards, like ASC 606 construction, which tells them how to record revenue in long-term contracts.
What is ASC 606 and Why Does It Matter?
ASC 606 is the accounting standard that governs how businesses recognize revenue. For contractors, this means revenue should be recorded based on when work is completed, rather than when cash is received.
ASC 606 outlines five key steps:
Identify the contract with the customer.
Determine performance obligations (specific tasks or deliverables).
Set the transaction price (how much you’ll be paid).
Allocate the price to each performance obligation.
Recognize revenue when the performance obligations are satisfied.
Now, let's look at the two most common construction contract revenue recognition methods.
Common Revenue Recognition Methods
In construction, there are two main ways to figure out how much money you've made: the finished contract method and the percentage of completion method. Each of these ways has its own benefits and times when it works better than the other.
1. Percentage of Completion Method
For long-term building projects, the percentage of completion method is often used. With this method, contractors can record income as the job moves forward. Basically, you record a part of the project's total income based on how much of the work was finished at the end of each reporting period.
For instance, if you've finished half of a $1 million job by the end of the third quarter and can count that as revenue for that time period, you can write off $500,000. For building projects, the percentage of completion method is the best way to figure out how much money has been made because it matches up with the work that has been done.
How Do You Calculate the Percentage of Completion?
The percentage of completion is calculated by dividing the costs incurred to date by the total estimated costs.
For example, if your project has incurred $500,000 in costs and the total estimated cost is $1,000,000, the percentage of completion would be 50%. You can then recognize 50% of the total revenue.
2. Completed Contract Method
The completed contract method, on the other hand, doesn't count revenue until the job is finished. This method is often used for projects that won't last long or when it's hard to guess how much they will cost or how far along they are.
It's easier to use the completed contract way because you don't have to keep track of costs over time. But it can cause big changes in profit and revenue from one time to the next, which can make it hard to predict how profitable a construction business will be. It's usually used when the contract result isn't clear or when the project deadline is short.
3. What About the Hybrid Method?
Based on the type of contract or job, some contractors may use a mix of the percentage of completion and completed contract ways. Contractors might use the percentage of completion method for some parts of a project and the completed contract method for other parts if the project has more than one step.
Key Challenges in Construction Revenue Recognition
It can be hard for workers to figure out how to track their income and use the right methods. Let's look at some important things to think about and problems that workers might have in this area:
1. A Correct Estimate of The Costs
One of the hardest things about percentage of completion is getting a good idea of how much the whole job will cost. It's possible for big differences in recognized revenue to happen if the original estimates are wrong. This could have an effect on both the financial statements and the taxes. To stay on track, it's important to keep track of how much construction jobs cost and make sure that estimates are updated often.
2. Complexity of Billing Schedules
A lot of construction jobs have complicated billing plans. An example of this would be a contractor billing clients on a regular basis while a job is going on. Each of these billings needs to match up with the right way to record income. Contractors need to make sure that their building accounting systems can handle all of these details and give them correct information.
3. Impact on Taxes
When a building company recognizes revenue, it has a direct effect on the taxes it has to pay. As an example, contractors may have to pay taxes on money they haven't even received in cash yet if they use the percentage of completion way. It is very important to know how each way changes your construction tax planning and your overall tax plan.
Revenue Recognition and Your Financial Statements
The way financial statements are made is also affected by how income is recognized correctly. For instance, construction financial statements made with the percentage of completion method will show how income and costs change over the course of a project, which is a more true reflection of how the business is currently running. This is a great way for workers to show that they have stable cash flow and are making money.
The completed contract method, on the other hand, won't show much or any income until the job is finished, which can make financial statements look wild. If you are looking for loans or financing, possible lenders may be worried about how your income changes when you use this way.
How Can You Improve Revenue Recognition on Your Own?
You can improve the way you record your income as a worker by doing the following:
Spend money on the right software: For construction accounting software that can handle recognizing revenue and other complicated accounting needs, use it. This will help you save time and avoid making mistakes.
Update your estimates often: To make sure that your revenue recognition is based on the most correct information, you should always keep your cost estimates up to date as the project goes on.
Get Professional Help When You Need It: You can handle some parts of income recognition on your own, but it's not a bad idea to get help from a professional when you need it. For your business to be successful in the long run, you need to properly recognize income. Professional bookkeepers can help you make sure you're doing it right.
CCA: Handling the Complexity of Revenue Recognition
One big reason why many contractors choose to get professional help with their contractor bookkeeping is that recognizing revenue in the building industry is hard to keep track of. Many construction business owners find it hard to keep accurate records of their income, prices, and compliance with construction accounting standards.
We at Construction Cost Accounting are experts in project-based accounting for the building business. We can help you figure out the complicated rules of income recognition so that your projects are properly accounted for and your finances are in great shape. Our skilled staff will take care of the details, leaving you to do what you do best: building great things.
Conclusion
Recognizing revenue is an important part of managing finances and making sure compliance for building contractors. You can choose between the finished contract method and the percentage of completion method based on the type of projects you have, how complicated your contracts are, and your financial goals. You can speed up the process of recognizing income and set your business up for success by carefully considering your options and getting professional help when you need it.
Construction Cost Accounting can help you if you're having trouble with your financial reporting for construction projects or just want to save time and get better results. Our team of experts is ready to help with everything, from helping workers keep track of their income to planning their taxes and more. You can focus on growing your business and finishing jobs on time and on budget while we take care of the complicated parts of your accounting.
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