PCM is more complicated, but can provide more current insight into financial performance on long-term contracts, if estimates are reliable.
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December 4, 2018 

Percentage of Completion Accounting: TCJA Provides Exception for Some Companies

Hi There!,

How do you report revenue and expenses from long-term contracts? Some companies that were required to use the percentage of completion method (PCM) under prior tax law may qualify for an exception that was expanded by the Tax Cuts and Jobs Act (TCJA). This could, in turn, have spillover effects on some companies’ financial statements.

Applying the PCM

Certain businesses — such as homebuilders, real estate developers, engineering firms and creative agencies — routinely enter into contracts that last for more than one calendar year. In general, under accrual-basis accounting, long-term contracts can be reported using either 1) the completed contract method, which records revenues and expenses upon completion of the contract terms, or 2) the PCM, which ties revenue recognition to the incurrence of job costs.

The latter method is generally prescribed by U.S. Generally Accepted Accounting Principles (GAAP), as long as you can make estimates that are “sufficiently dependable.” Under the PCM, the actual costs incurred are compared to expected total costs to estimate percentage complete. Alternatively, the percentage complete may be estimated using an annual completion factor. The application of the PCM is further complicated by job cost allocation policies, change orders and changes in estimates.

In addition to reporting income earlier under the PCM than under the completed contract method, the PCM can affect your balance sheet. If you underbill customers based on the percentage of costs incurred, you’ll report an asset for costs in excess of billings. Conversely, if you overbill based on the costs incurred, you’ll report a liability for billings in excess of costs.

Syncing financial statements and tax records

Starting in 2018, the TCJA modifies Section 451 of the Internal Revenue Code so that a business recognizes revenue for tax purposes no later than when it’s recognized for financial reporting purposes. Under Sec. 451(b), taxpayers that use the accrual method of accounting will meet the “all events test” no later than the taxable year in which the item is taken into account as revenue in a taxpayer’s “applicable financial statement.”

So, if your business uses the PCM for financial reporting purposes, you’ll generally need to follow suit for tax purposes (and vice versa).

In general, for federal income tax purposes, taxable income from long-term contracts is determined under the PCM. However, there’s an exception for smaller companies that enter into contracts to construct or improve real property.

Under the TCJA, for tax years beginning in 2017 and beyond, construction firms with average annual gross receipts of $25 million or less won’t be required to use the PCM for contracts expected to be completed within two years. Before the TCJA, the gross receipts test limit for the small construction contract exception was $10 million.

Got contracts?

Compared to the completed contract method, the PCM is significantly more complicated. But it can provide more current insight into financial performance on long-term contracts, if your estimates are reliable. We can help determine the appropriate method for reporting revenue and expenses, based on the nature of your operations and your company’s size.







Anne Taros, CPA
Twitter: @MooreStephensDM

Anne Taros assists a variety of clients with business and tax-related issues domestically and abroad. She works with small and mid-sized clients in the manufacturingservice, retail and wholesale industries, offering business advisory services, general ledger management, and tax planning and compliance. Contact Anne at taros@moorestephensdm.com or (248) 244-3160.

Two New Accounting Reporting Requirements: Are You Ready?

Ebook cover Two New Financial Reporting Requirements Are You ReadyTwo updates to U.S. Generally Accepted Accounting Principles (GAAP) released by the Financial Accounting Standards Board (FASB) will go into effect in the next few years, ASU No. 2016-02, Leases and ASU No. 2014-09, Revenue from Contracts with Customers. These updates — combined with the Tax Cuts and Jobs Act — have created a precarious atmosphere for CFOs and controllers.

Download our complimentary ebook, Two New Accounting Reporting Requirements: Are You Ready?, to prepare.

Moore Stephens Doeren Mayhew is ready and able to help you navigate this sea change in financial reporting. Contact us today.


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