In the previous post, I have talked about how to track revenues and expenses related to each project in progress at any time in Quickbooks.The reason is quite obvious as job costing enables you to have a clear picture which projects are profitable. Another reason is that, your accountant may have explained already, a good job costing bookkeeping will help them to easily determine whether there is a “work in progress” at the end of the year for tax purpose and do some tax planning to smooth income for tax purposes.
Let’s take a closer look at how it works from accounting perspective.
Generally, in accounting, revenue is recognized based on the fact that a seller has transferred to a buyer, the significant risk and rewards of ownership and when the consideration can be reasonably determined.And revenue from the sale of goods or provision of services should be recorded when ultimate collection is reasonably assured.
Those are too complicated, aren’t they? The options allowed in accounting treatment have more headaches.Here is what happened. Accounting principles allow contractors to use either the completed contract or the percentage of completion method of revenue recognition, depending on their situation.
Completed Contract Method
Under this method, revenue is recognized when the services is complete or substantially complete. For a lot of large builders/contractors, this method may not be appropriate as many construction contracts involve the execution of many acts and take a number of years. However, smaller builders/contractors feel this method is more straightforward as the contract completion is easily determined and costs components are known. Another view on this method is that, as contracts may vary over the years, the change may produce fluctuations in the bottom line. What doe your lender think if net income fluctuate from year to year? Furthermore, home builders/contractors’ bonding capacity may also be negatively impacted.
Percentage of Completed Method
The percentage of completion method is used when the contract involves the completion of more than one act. Under this method, revenue is recognized proportionately based on the extent of work accomplished by the home builders/contractors, by reference to the performance of each act.The recommended measure of the extent of work accomplished is the cost base. The idea is simple as the costs including materials, labor and overhead can be estimated based on the actual input as compared to the total estimate total costs of the contract. Well, nothing is easy, this requires a lot of effort from builder/contractors. As compared to completed contract method, this method helps builders/contractors to consistently assess the activities as well as external users of the financial statements.
Some home builders/contractors may use billing base to determine the extent of work accomplished.However, billing base may not be accurate as you expect.
Now, we know the accounting options. What does the CRA say about this then?
The CRA requires the home builders/contractors use the percentage of completion method if the contracts extends over 2 years. For those contracts are less than 2 years, home builders/contractors can choose completed contract method for tax purposes and the percentage of completion method for financial statement purposes.
In conclusion,
Job costing, percentage of completed accounting treatment and tax planning are all connected.The quality of your bookkeeping enables you to see the clear picture of your business. Furthermore, it helps your accountants easily do a better tax planning.
FranklyCA makes your business life simpler and more focused.We help our clients prepare beautifully organized accounting data (call books)/working paper.By leveraging the technology, we make it easy for you(business owners) to picture the competitive business world and be prepared for future growth. Bookkeeping should be wonderful. We love it as we believe,there is a gold mine in your books. Give us a call or email us. We surely can help.
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