09 Jul 2023

What is the accounting method for contractors?

Accounting for contractors needs a clear method to track finances. Contractors in fields like construction or consulting must choose the right approach to manage their finances. The method used impacts taxes, reports, and decisions. This article explains the common accounting methods, their benefits, and how to pick the best one for your business.

Construction companies have some unique characteristics due to the different nature of their work. In this guide, you will get to know a few aspects of contractor accounting and bring efficiency to accounting.

How is the accounting for contractors different?

Contractor accounting is different due to job costs, project prices, and work fees. It needs special methods to track bids, manage wages, and handle costs.

Project-Based Revenue Recognition

Contractors work on many projects at once.
Revenue is recorded when a project milestone is met, not when money is paid.
The accounting method should match the project schedule.

Tracking Job Costs

Contractors track costs like labor, materials, and equipment.
By tracking job costs, you can estimate the potential earnings of a project.
It keeps track of all expenses for accuracy.

Fluctuating Operating Costs

Costs change from project to project.
Material prices or worker fees can go up or down.
The accounting method should help handle these changes.

Complex Payroll Management

Contractors hire workers or subcontractors for each job.
Payroll depends on work hours or project stages, making it change often.
Payroll needs to be tracked for taxes and planning.

Cash Flow Gaps

Payment terms vary, so contractors may wait for payment.
Good accounting for contractors helps plan for these gaps.

Tax Reporting and Deductions

Contractors can deduct business costs from taxes.
Track tools, materials, and mileage for tax purposes.
The accounting method must track these deductions.

Complex Contract Management

Contractors manage many contracts at once.
Each contract may have its own rules and costs.
A strong accounting system tracks every project’s money.

What are the different accounting methods for contractors?

Picking the right way to track money is key in accounting for contractors. The right method helps with tracking income, handling costs, and filing taxes on time. Here are the main options:

1. Cash Method

This method records money when it is received or paid. It’s simple to use and fits small contractors well. It provides a clear view of the available cash.

2. Completed Contract Method

Money is only recorded when the full project is done. This method lets you pay taxes after the project ends. It is good for long jobs that take months or years to finish.

3. Percentage of Completion Method

Money is tracked as each part of the project is completed. This gives a more steady record of income and cost. It helps plan for long projects with many stages.

4. Contract Retainage Method

A small part of the payment is held until the job is done. This ensures the work meets all terms. It is often used in large contracts where quality checks are key.

5. Fixed Price Method

The project price is fixed before the work starts. Even if costs change, the payment stays the same. This method works best when the job scope is clear.

Each accounting method for contractors has its pros and fits different types of work. Choosing the best one helps contractors keep clear records, control costs, and follow tax rules with ease.

Hire A Dedicated Team

That Grows With You, Flexible, Scalable and
Always On Your Side

Quick Start Within 48 Hours →

Which Accounting Method Should Contractors Use?

The best accounting method depends on your project size and how your business works. Below are simple tips to help you choose the right one.

For Small Contractors or Sole Proprietors

If your work is simple and you get paid quickly, the cash method works well. It is simple to monitor and shows your current cash balance.

For Larger Contractors or Long-Term Projects

If you take on big jobs or long contracts, use the accrual method.It records revenue when it is earned, not when it is received. This gives a full view of your money and costs.

Hybrid Approach

Some use both types. For daily work, they use cash. For long jobs, they use accrual. This combined accounting method benefits many contractors.

How to bring efficiency in accounting for contractors?

Some tips will be effective in bringing accounting efficiency to the contractors.
Here are a few vital tips for bringing an efficient contractor accounting system:

Breaking down the cost as per the project

Since the project is central to a contractor's business, costs are categorized based on each project's specifics. The revenue and expenses can be easily tracked using the project-based costs. This will allow you to assess the business's performance based on individual projects.

Separating business and personal accounting expenses

When the business and personal expenses are separated, tracking the expenses and profits becomes simpler. Even if you are a single person working as a contractor without any employees, separating business and personal expenses is advisable. Here, you will need Personal identification, employer identification number, business license copy, etc.

Financial transactions are recorded on a day-to-day basis

Recording of the financial transactions on a daily basis, at proper places in the accounting books. The record must mainly include the transaction date, description of transactions, and revenue received. A few accounting software also provides invoices as per the contractor's business.

Select the method of revenue recognition

General business would have revenue recognition simpler, as simply products or services is sold, while contractors would have a different business method. While doing accounting for contractors, methods like the Percentage of completion method, the complete contract method, etc., are some of the methods for revenue recognition.

Using suitable accounting software

Using suitable accounting software can be more beneficial for contractor accounting. It can automate most of the accounting tasks for the business of contractors.

These are some important tips for accounting for contractors that can improve the quality. Understanding the contractor's business pattern is essential to bring accounting efficiency.

Tools and Software for Accounting for Contractors

Using software makes accounting for contractors easier. Many tools automate the process. Here are some popular ones:

QuickBooks: Used to track income, expenses, and payroll.
Xero: Simple to use for tracking finances and making reports.
Sage 50: Helps track project costs and manage payroll.

If you are a contractor who is looking for experts to provide accounting for contractors, then Accounts Junction is a better option. Accounts Junction has the expertise in handling contractor accounting for contractors. We have good knowledge of the working of the contractors. Accounts Junction is a quality contractor accounting service providing agency across the globe.