Construction Accounting Archives

2018 Tax Filing Considerations for Contractors

February 18, 2019 By JAK + CO.

Andrew F. Knutson - Tax Advisor St. Paul — Andy Knutson, CPA

For most contractors and construction-related businesses—particularly for those structured as pass-through entities—the 2018 tax season is anything but business as usual. With the Tax Cuts and Jobs Act (TCJA) on the books, there are several tax law changes that could impact your tax filing this year. Here are a few things to consider as you prepare your return.

Do you qualify for the qualified business income deduction?

One of the changes brought about by the TCJA was the qualified business income (QBI) deduction for pass-through entities, such as partnerships and S corporations. Only certain types of businesses qualify for the deduction; thankfully, most general contractors and subcontractors meet the requirements.

There are many phases to the calculation, but in general it is equal to 20 percent of the lesser of your flow-through business income or your taxable income. If a business owner’s taxable income exceeds $207,500 (or $415,000 if married filing jointly) you must also factor in wages paid by the company and the original cost of equipment and property owned by the business. Please talk to your tax advisor about this deduction, as it is highly complicated and the rules surrounding it were only recently finalized.

If you do qualify for the 20 percent deduction, consider this: The TCJA also limited the state income tax deduction and eliminated the production deduction, both of which were approximately 9 percent deductions (for high-income Minnesota taxpayers). So, although 20 percent sounds really great, in reality it’s only a 2 percent sway.

Should you change your accounting method?

Thanks to the TCJA, businesses with less than an average of $25 million in annual revenue over the last three years can now file tax returns on a cash basis. Previously, the threshold was $10 million ($5 million for C corporations). So, if you are a $10-million-a-year contractor who has been “stuck” on the accrual method of accounting, you now have an option to switch to cash.

Will you make the switch? A decision about whether or not to change your accounting method should never be made in haste. There are pros and cons to both methods, so it’s important to talk to your tax advisor to determine which is best for your business.

One more thing: The new $25 million threshold also applies to the use of percentage of completion for long-term contracts. This means you could have additional options for how you account for these, too.

Are you required to do a lookback interest calculation?

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Previously, businesses that had more than $10 million in average annual revenue over the prior three years were required to do a lookback interest calculation. Now, this threshold has increased to an average annual revenue of $25 million or more over the last three years. For many contractors, this provides even more of an incentive to be conservative in estimates, which is not only good practice but also desired by third-party users of financial statements.

Will you expense incidental inventory?

One of the new rules ushered in by the TCJA is the ability to elect to expense up to $2,500 of incidental inventory. If you make this election, it must be reflected on your internal books and records. The election may not be appropriate if you’re using GAAP financial statements.

Partner with an expert to file your 2018 return.

When it comes to tax filings, much has changed since last year. It’s important to not only be aware of the new deductions, rules, and thresholds but also how they could impact your tax burden in 2018 and beyond. If you haven’t already, ask your tax advisor to help you understand your options, so you can make the right filing for your business.

Why Maintaining Your Job Schedule Is Good Business

December 12, 2018 By JAK + CO.

Jason J. Loven - CPA Firm Minneapolis — By Jason J. Loven

A job schedule—also known as work-in-progress or WIP schedule—is a subsidiary ledger that tracks actual costs and billings per project. Ideally, your job schedule should be updated and reconciled with the general ledger at least once a month. But in the fast-paced contracting world, it can be tempting to fall behind on these tasks.

Unfortunately, not maintaining your job schedule can have consequences that stretch beyond a single project. Here are three reasons why maintaining your job schedule on a monthly basis is simply good business.

1. Errors and instances of over/under billing on your job schedule can affect your gross profit.

Reconciling your job schedules with your general ledger each month is a smart way to identify errors on your job schedule or general ledger. Common mistakes include posting direct job costs to an indirect or overhead account, posting costs to the wrong job, or forgetting to include costs associated with small miscellaneous jobs, such as callback, carryover, and warranty work in the cost of sales. It also allows you to review over/under billings and their causes. For instance, is an under billing an indication the job isn’t going well, or is it that your billings aren’t being sent out in a timely manner? Regularly maintaining your job schedule can help you get to the bottom of it and make billing adjustments if needed. Without the proper adjustments, your gross profit and bottom line are likely to be inaccurate.

2. Project managers rely on job schedules to deliver on-time, on-budget work.

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Your job schedule is a critical project management tool. An updated, accurate job schedule allows a project manager to consistently monitor and track a job’s profitability—key to a successful delivery. Job schedules also provide a way to continually compare a job’s actual costs to estimated costs, which is, of course, valuable information to have when bidding out future jobs.

3. Outside users expect to see accurate job schedules.

Job schedules are typically laid out in an Excel spreadsheet and should include columns for year-to-date (YTD) billings and costs and prior-year (PY) billings and costs. If you’re not updating your job schedule and reconciling it with your revenue and costs of sales in your general ledger, it’s nearly impossible to verify that you’ve accounted for everything. This could lead to inaccurate billings adjustments and misleading information. Whether your outside users are internal executives or external stakeholders or sureties, handing over an inaccurate job schedule won’t put you in the best light.

Job schedule maintenance: A good business practice to start today.

Updating your job schedule and reconciling it with your general ledger each month can help you get an accurate picture of your gross profits and better manage your cash flow. And that’s good business! We understand, however, that worrying about your job schedule can be overwhelming, especially if you’ve already fallen behind. If you’re unsure of how to best maintain your job schedule or would like recommendations for going forward, please know the Twin Cities CPA firm of JAK is here to help.

Capital Lease or Operating Lease? 4 Questions to Ask

November 12, 2018 By JAK + CO.

By Stephanie Loiland, CPA

Many companies choose to lease assets for a period of time instead of buying them outright. If you’re in this situation, it’s important to know whether you’re dealing with a capital lease or an operating lease. That’s because the type of lease will affect how you record it—and the payments you make to it—in your books.

A few additional differences between capital and operating leases to consider: Capital leases affect your balance sheet, which means they can also impact your covenants and ratio calculations. Also, capital leases allow the leased asset to be capitalized. If an asset is capitalized, it could possibly qualify for an accelerated depreciation option such as bonus depreciation or Section 179, providing you with a larger deduction in the year you sign the lease. Operating leases, on the other hand, require less administrative time to account for them and do not affect the balance sheet.

Not sure if a lease is capital or operating? Here are four questions that can help you determine its classification. If you answer “yes” to any of the questions, the lease is a capital lease. If you answer “no,” it’s an operating lease.

#1 – Is there a transfer of ownership?

If the lease states that your company retains ownership of the leased asset at the end of the lease, it’s a capital lease. In this case, the lease acts as a loan for you to purchase the leased asset.

#2 – Is there a bargain purchase option?

Many leases contain an option to buy out the leased asset at the end of the lease. If this option is less than the expected fair market value of the asset at the end of the lease, it represents a bargain purchase option. Leases that include a bargain purchase option are capital leases. The most common example of this type of lease is a $1 ending purchase option.

#3 – Does the lease period equal or exceed 75 percent of the asset’s useful life?

If the lease in question does not contain #1 and #2 above, the length of the lease is compared to the economic life of the leased asset. If the lease period is equal to or exceeds 75 percent of the leased asset’s useful life, it’s a capital lease. Your company’s capitalization policy should provide guidance on the length of life used for the type of asset being leased.

#4 – Does the present value of the minimum lease payments exceed 90 percent of the asset’s fair market value?

If the lease does not contain any of the above features, the present value of the minimum lease payments should be compared to the fair market value of the leased asset. The present value of the lease payments can be calculated by inputting the total amount of lease payments to be paid over the life of the lease into a present value calculator. The fair market value of the leased asset is equal to its cash price. If the calculated present value of the lease payments is equal to or exceeds 90 percent of the asset’s fair market value, the lease is a capital lease.

What to know about recording the lease and lease payments

Operating leases are simple to record. The payments are recorded each month as an expense in a lease expense account; no asset or liability is recognized on the balance sheet.

Capital leases, however, require the value of the leased asset to be capitalized and recorded as a fixed asset on the balance sheet. This fixed asset is depreciated over time like any other fixed asset purchase. The related lease obligation is also recorded as a liability on the balance sheet and payments are applied to the obligation with a portion segregated for interest expense.

Lease classifications will change in the coming year—stay tuned!

A new lease standard effective for years beginning after December 15, 2019, will change the classification of leases. As this effective date approaches, the small business CPA firm of JAK, will provide more information on what you can expect. In the meantime, if you have questions about lease classifications or the new standard mentioned here, please don’t hesitate to call.

Top 5 Ways the New Revenue Recognition Standard Will Impact the Construction Industry

October 3, 2018 By JAK + CO.

By Kyla Hansen, CPA

There’s been a lot of talk about the new revenue recognition standard and the effect it could have on the construction industry. Although the standard, known as Accounting Standards Update (ASU) 2014-09, was first issued by the Financial Accounting Standards Board (FASB) in 2014, it goes into effect for privately held companies—for periods beginning after December 15, 2018, to be exact.

This means that if you are a privately held company with a December 31 year-end, this change will impact your 2019 financial statements. The good news is percentage of completion isn’t going away! However, there are several nuances that will need to be considered.

Here are five changes you should be aware of:

1 – Combination and segregation of jobs will be based upon performance obligations

Contracts will now be defined and tracked by performance obligations—i.e., the underlying deliverables. This concept may cause certain contracts that have one shared performance obligation to be combined, even if they were previously considered separate. Additionally, this concept may also cause a contract to be segregated into separate pieces based on the number of performance obligations it includes. Going forward, each contract will need to be closely evaluated to identify performance obligations.
Change orders will also be impacted by this concept. Some change orders may create a new performance obligation, resulting in an additional job that would have to be tracked separately on the contract schedule, while others may not.

2 – Front-loaded costs will no longer recognize early profit

Significant costs incurred after a contract is obtained but before goods or services are transferred will need to be capitalized and amortized over the life of the contract. These costs include items such as mobilization and bond costs, and do not include bid, proposal, and selling or marketing expenses. This treatment applies only if all of the following criteria are met:
The cost directly relates to a specific contract
The cost generates or enhances resources that will be used in satisfying the performance obligation(s) in the future
The cost is expected to be recovered (directly or indirectly)

3 – The transaction price might not be the stated value on the contract

When determining a transaction price, the new standards leave room for more judgment regarding the circumstances surrounding a contract and also allow for greater reliance on historical experiences. For example, if the contract is for time and material, the transaction price will represent the amount you anticipate the job to require. In addition, contracts will need to be evaluated if there are variable items such as contingent income or damage provisions. The new standards allow for several methods to evaluate the contract value. We expect the most commonly used methods to be the following:

Most likely value method: Used when there are only two possible values. You select the value that is most likely to occur.
Expected value method: Used when there is a range of possible amounts; each scenario is weighted based upon probability of occurrence. This determines the transaction price that you will use on your job schedule as the contract amount.

4 – Anticipate changes to your financial statements

Your balance sheets will include new items and names.
Contract assets: This will include costs in excess of billings, unbilled receivables, contract adjustments for variable consideration, and capitalization of costs to fulfill a contract such as mobilization and bonds. As I mentioned previously, these costs will be amortized over the life of the contract.
Contract liabilities: This will include billings in excess of costs, accrued warranty, refundable consideration, and customer deposits.
Retained earnings adjustment: If you adopt the new standard ahead of time, you will need to adjust your retained earnings to account for open contracts at the end of 2018 or restate your 2017 amounts in order to comply.
Additional footnote disclosures: There is a considerable amount of additional footnote disclosures that explain your policies and methods for determining contract prices and related revenue recognition.

5 – Understand the impact on your ratios

In light of the new standard, you may need to discuss modifying metrics used to determine items such as loan covenants or bonding capacity. For example, a lending agent might not give credit for a variable consideration contract asset.

Don’t get caught off guard.

The new revenue recognition standard will go into effect in less than two months, which means now is the time to get ready for the changes I’ve listed here—and the others I haven’t. Don’t forget: Team at JAK can help you pinpoint the ways your business will be affected, so you can prepare with efficiency. If you have questions, please please contact our St. Paul office today.

How Indirect Construction Costs Can Impact Your Profitability

September 6, 2018 By JAK + CO.

By Joy McAdoo, CPA

Keeping tabs on direct construction costs for a project is pretty straightforward. Take your materials costs, for instance: X number of beams used on the project multiplied by cost of each beam = total cost. Easy! Dealing with indirect construction costs, however, can be another story.

Indirect costs relate to the performance of the job, but they’re hard to track to a specific project. In other words, indirect costs might benefit multiple projects.

Here’s the thing: If you don’t have the full picture of your cost to complete a project, you’ll get a false sense of your profitability. That’s why it’s so important to track and allocate your indirect costs as accurately as possible. Here are a few tips for getting started.

Identify your indirect costs.

Indirect costs can generally be divided into two buckets: labor and equipment. Some contractors may use only one bucket, while others may use both. Examples of costs that may be included in the indirect labor cost bucket include payroll taxes, workers compensation costs, and employee benefits. Examples of costs that may be included in the indirect equipment cost bucket include fuel, maintenance, insurance, and storage cost related to your owned equipment. The key is to decide what makes sense for your business to accurately determine your project-related costs.

So, we’ve covered labor and equipment, but what about the costs associated with running your business, such as general liability insurance, advertising, and office-related salaries? These costs are categorized as “overhead.” Although typically flat (i.e., they don’t fluctuate) and easier to predict, they’re often the hardest type of costs to allocate. That’s because it’s likely your overhead costs do support projects—just not 100 percent of the time. For this reason, it’s important to consider allocating some of your overhead costs to specific projects.

Keep separate ledger accounts for each indirect cost bucket.

Once you’ve determined the items included in your indirect costs, it’s time to track them. First, make sure your general ledger has a separate account group for each indirect cost bucket you’ve identified. This is where you will post these costs. Often times a contra account, which is an account with a balance that is opposite of the associated account (e.g., a credit instead of a debit), will be used for each bucket to easily show the total amount allocated to the jobs. From a reporting perspective, this ledger setup will allow you to see a whole bucket of costs and compare the actual amounts incurred to the amount that has been allocated.

Allocate indirect costs using a systematic and rational method.

Once you have your buckets set, you’re ready to allocate. While there are numerous ways to allocate costs, the method you choose should be systematic and rational. For instance, you could allocate labor costs based on direct labor hours incurred, or on a percentage of total cost per labor hour. Equipment costs could be treated in a similar manner—allocated by total equipment hours incurred.

Most often, contractors will estimate their total annual indirect costs for each bucket and set a predetermined rate to allocate those costs throughout the year. Others will use the actual cost incurred each month and allocate the full amount based on activity during that time period. The decisions surrounding how to allocate indirect costs will vary depending on the nature of your business.

Let your accounting software share the load.

Many robust accounting systems have built-in functionalities for indirect cost tracking and allocation. This begs the question: Do you know what your accounting software is capable of? If yours has this functionality, you could automatically track and allocate indirect costs with little effort after the initial setup.

Look forward to better insight into your business.

As I mentioned, keeping up with your indirect costs gives you a clearer picture of your profitability. Another benefit of tracking and allocating indirect costs is the ability to see your actual cost compared to what you expected. This is valuable information to have when bidding and estimating jobs. If you don’t know exactly what your indirect and overhead costs will be, how can you compile an accurate bid?

In order to successfully track and allocate indirect costs, you have to tailor the methods to your business. But don’t worry—at JAK we can help you figure out the right buckets and allocation approach, giving you the relevant financial information you need for increased profitability.