About Construction Contracts 10% or Less: Construction contracts are a tricky animal. There are so many ways to account for them for book and tax purposes and those methods are a bit more complicated than just cash and accrual. Understanding the methods and the reasons for each is important to properly prepare financial statements or tax returns for businesses with construction contracts.
The 10% or less method is for tax returns. You can elect to defer the income from contracts that are 10% or less complete. Basically you look at the contracts where less than 10% of the costs have been incurred, and then you defer the revenue and costs for those projects until the future year when the contracts will exceed 10% complete.
It doesn’t sound like much and in many cases it isn’t a huge deferral, but if you have the option to defer a little income, you might as well take it. For example:
A contract with $1M revenue projected and $850k costs projected would have a gross profit of $150k. If the project is 8% complete at the end of the year, then the profit realized using a percentage of completion would be 8% * $150k = $12k. Using the 10% or less election, you can defer that $12k of income until the next year when the contract inevitably exceeds 10% complete.
Not an enormous deferral, but deferring $12k of income is normally a good thing and every little bit helps.
Chris Wittich, CPA