Joseph Natarelli, National Construction Industry Group Leader & Barry Fischman, Tax & Business Services Partner, Article "Financial Vs. Income Tax Reporting" Featured in Construction Executive
By Joseph Natarelli, National Construction Industry Group Leader & Barry Fischman, Tax & Business Services Partner
Joseph Natarelli, National Construction Industry Group Leader & Barry Fischman, Tax & Business Services Partner, article “Financial Vs. Income Tax Reporting” featured in Construction Executive.
The following is an excerpt from the article:
Many contractors wonder why the amount of net income on their financial statements differs from the amount of taxable income on their tax returns. Simply stated, the Internal Revenue Service (IRS) allows different methods of accounting for construction contracts for income tax reporting purposes, as opposed to financial statements that usually are required to be based on generally accepted accounting principles (GAAP).
Following are several scenarios that may differentiate construction contractors’ financial reporting from their income tax reporting.
In accordance with GAAP, a contractor’s financial statement should be based on the percentage of completion method (PCM) of accounting for all long-term contracts. Disclosures should include:
- detailed notes on the financial statements;
- contracts receivable aging;
- a breakout of contracts and retention receivables by contracts in progress and jobs completed;
- an earnings from contracts schedule that ties the contracts in progress and completed during the year to the statement of income; and
- a contracts in progress and completed contracts schedule that illustrate the contract revenues, costs and gross profits by project for the accounting period.
Cost to Complete
Contractor financial statements rely heavily on estimates. One datum critical to the contractor is the estimated cost to complete on contracts in progress (ECCCP). Without accurately determining the ECCCP, a contractor’s financials can fluctuate wildly from one month to the next. Changing these estimates can impact financial statements significantly, so contractors should take this task very seriously.
Depreciation is another important estimate for contractors with equipment-intensive businesses. If the equipment’s useful life is not correct, the contractor could be charging an excessive amount of expense to a project, which would negatively impact profitability.
Contractors often incorrectly use the same depreciable lives and methods for financial statement and income tax reporting, which can result in significantly understating equity by using an accelerated tax method.