Construction Contractors: Accounting, Auditing and Tax

• Chapter 0 - Overview
  • Course Goals
  • Introduction
  • Organization
  • Conclusion
• Chapter 1 - Nature of the Construction Industry
  • Learning Objectives
  • Introduction
  • Construction Industry Overview
  • Types of Contractors
  • Players in the Industry
    • Players within the Contractor Client
  • The Construction Process
    • Preparing Cost Estimates and Bids
    • Entering into the Contract
    • Starting the Job
    • Project Management
  • Characteristics Unique to Contractors
    • Unique Projects
    • Pricing
    • Construction Contracts
    • Construction Projects Take a Long Time
    • Change Orders and Other Contract Modifications
    • Surety and Bonding
    • Subcontractors
    • Managing Cash Flow
  • Understanding the Environment in Which the Contractor Operates
  • Summary
    • Membership Organizations
    • Publications
  • Questions
• Chapter 2 - Contract Accounting
  • Learning Objectives
  • Introduction
  • Background
  • Determining the Profit Center
    • Combining
    • Segmenting
  • Determining the Proper Accounting Method
    • Percentage-of-Completion Method
    • Zero-Profit Method
    • Completed-Contract Method
  • The Percentage-of-Completion Method
    • Estimated Total Contract Price Equals Original Contract Price Plus Modifications
    • Estimated Total Costs Equal Costs to Date Plus Estimated Costs to Complete
    • Determining the Percentage Complete
    • The Mechanics of Applying the Percentage-of-Completion Method
    • The Balance Sheet
  • The Completed-Contract Method
  • Accounting for Loss Contracts
  • Construction Manager Contracts
    • Construction Manager at Risk
  • Summary
  • Case Study: Desert Drywall
    • Step One
    • Step Two
• Chapter 3 - Financial Statements for the Contractor
  • Learning Objectives
  • Introduction
  • Financial Statements
  • Current Assets Unique to Contractors
  • Current Liabilities Unique to Contractors
  • Contractor Balance Sheet
  • Contractor’s Income Statement and Retained Earnings
  • Contractor’s Statement of Cash Flows
  • Specific Disclosures for Contractors
  • Schedule of Supplementary Information
  • Summary
• Chapter 4 - Working with a Surety
  • Learning Objectives
  • Introduction
  • What Is a Surety Bond
  • The Surety Process
    • Surety Insurance Compared to Traditional Insurance
  • Bond Agent vs. Surety Underwriter
  • What the Surety Looks For
    • Character
    • Capacity
    • Capital
    • Continuity
    • CPA
  • How the Surety Uses a Contractor’s Financial Statements
    • Accounts Receivable Aging
    • Marketable Securities and Notes Receivable
    • Overbillings and Job Borrow
    • Property and Equipment
    • Debt
    • Underbillings
    • Profitability
    • Statement of Cash Flows
  • Maximizing Surety Credit
  • Summary
  • Case Study: XYZ Contractors
  • Intermission
    • Impress Your Friends with Your Knowledge of Construction History
    • Solution
• Chapter 5 - Audit Planning and Preliminary Analytical Procedures
  • Learning Objectives
  • Introduction
  • Professional Skepticism
  • Risk Assessment
  • Contractors and Estimates
  • Assessing Risk at the Overall Entity Level
  • Audit Planning at the Contract Level
    • Phase One
    • Phase Two
    • Phase Three
  • Other Areas for Preliminary Audit or Review Analyses
    • General and Administrative Expenses
    • Cost of Revenue Analysis (CORA)
    • Property and Equipment Analysis
    • Receivable and Payables Analysis
    • Gross Profit Gain/Fade Analysis
    • Balance Sheet Ratios
  • Summary
  • Questions
  • Appendix 5-A – Job History Reports
• Chapter 6 - Substantive Auditing Procedures
  • Learning Objectives
  • Introduction
  • Contractor’s Audit Model
  • Read the Contract
  • Confirmation with Owner
  • Review Unapproved Change Orders
  • Test Cost Accumulation
  • Review Estimated Cost to Complete
  • Job-Site Visits
  • Summary
  • Questions
  • Appendix 6-A – Practice Alert 00-3 – Auditing Construction Contracts
• Chapter 7 - Other Auditing Considerations
  • Learning Objectives
  • Introduction
  • Considering Fraud in a Financial Statement Audit
    • Overview of SAS No. 99
    • Applying SAS No. 99 to the Audit of a Construction Contractor
  • Worker’s Compensation Insurance
  • Financial Statement Disclosures
  • Evaluating a Contractor’s Ability to Continue as a Going Concern
    • Step 1: Estimate Future Gross Profit Needs
    • Step 2: Estimate Gross Profit Remaining on Uncompleted Contracts
    • Step 3: Compare Gross Profit Remaining to Gross Profit Required
    • Step 4: Can the Contractor Generate the Required New Work?
  • Summary
  • Question
  • Appendix 7-A – Construction Sector Checklist
  • Epilogue – How Does the Auditing Guidance Apply to a Review
  • Intermission – Impress Your Friends with Your Contractor Tax Accounting Humor
• Chapter 8 - Overview of Tax Accounting for Construction Contractors
  • Learning Objectives
  • Introduction
  • A Primer on Code Section 460
    • Long-Term Construction Contracts
    • Residential and Home Construction Contracts
    • Non-Applicable Activities
  • The Small Contractor Exemption
    • Pros and Cons of the Small Contractor Exemption
  • Regulation 1.460-3
    • 1. Definition of Long-Term Contract
    • 2. Date Taxpayer Completes a Long-Term Contract
    • 3. Severing and Aggregating Contracts
    • 4. Hybrid Contracts
    • 5. Contracts of Related Parties
    • 6. Unique Items
    • 7. Twelve Month Completion Period
    • 8. Percentage-of-Completion Method
    • 9. Cost Allocation Rules
    • 10. Simplified Cost-To-Cost Method
    • 11. Statute of Limitations and Compound Interest on Look-Back Interest
  • Deferred Taxes
  • Summary
  • Questions
  • Appendix 8-A – Code Section 460 – Special Rules for Long-Term Contracts
  • Appendix 8-B
    • Rev. Proc. 97-27, 1997-1 CB 680, 5/08/1997, IRC Sec(s). 446; 460; 481
    • Rev. Proc. 97-30, 1997-1 CB 702, 6/23/1997, IRC Sec(s). 168
• Chapter 9 - Taxation of Small Contractors
  • Learning Objectives
  • Introduction
  • Who Qualifies for the Small Contractor Exemption?
    • The Two-Year Completion Test
    • The $10 Million Gross Receipts Test
  • Revenue Recognition Methods for Small Contractors
    • Applying the Completed-Contract Method
    • Cash Method
    • Accrual Method
    • Completed-Contract Method
    • The Percentage-of-Completion Method (Old Rules)
    • Cash Method
    • The Good, the Bad, and the Ugly
    • Financial Reporting and the Cash Method
    • Accrual Method
    • Completed-Contract Method
  • Cost Capitalization and Allocation
    • Cost Capitalization
    • Cost Allocation
  • AMT Considerations for Small Contractors
    • The Exemption for Certain Small C Corporations
    • Example of AMT Calculation
  • Summary
  • Case Study: The Gross Receipts Test for Entities under Common Control
  • Appendix 9-A – Common Control
  • Appendix 9-B – Determining When a Contract Is Complete Contracts Entered into on or after January 11, 2001
  • Appendix 9-C – Determining When a Contract Is Complete Contracts Entered into before January 11, 2001
  • Examples of Determining Completion for the Completed-Contract Method
  • Appendix 9-D – Completed-Contract Accounting for Disputes Contracts Entered into on or after January 11, 2001
  • Appendix 9-E – Completed Contract Accounting for Disputes Contracts Entered into before January 11, 2001
  • Examples of Applying the Tax Rules in Disputes
• Chapter 10 - Taxation of Large Contractors
  • Learning Objectives
  • Introduction
  • The Percentage-of-Completion Method
    • The Percentage-of-Completion Formula
    • Determining Total Estimated Contract Price
    • Determining Percentage Complete
    • Simplified Cost-to-Cost
    • The 10% Method
  • Cost Capitalization and Allocation
  • Look-Back
    • When to Calculate Look-Back
    • The Look-Back Calculation
    • Special Considerations in Applying Look-Back
  • Summary
  • Questions
• Chapter 11 - Latest Developments
• Value Aids
• AICPA Audit and Accounting Guide, Construction Contractors
• Audit Risk Alert, Real Estate and Construction Industry Developments

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Chapter 0

Overview

Course Goals

• Provide an application-oriented review of all the specialized accounting and auditing requirements that affect construction contractors.
• Explain the particular tax rules applying to construction contractors (especially those contained in Internal Revenue Code Section 460), with practical tax-saving tips interspersed.

Introduction

Construction contracting is a unique and complex industry, and the work of CPAs in providing accounting, auditing, and tax services to construction contractors is a unique and complex niche in the accounting profession. The purpose of this course is to give you the specialized and detailed information you need, whether you are a practicing CPA with construction contractors as clients or on the staff of a construction contractor.

Organization

The materials for this course consist of this manual, the AICPA's Audit and Accounting Guide, Construction Contractors, and the Audit Risk Alert, Construction Contractors Industry Developments. SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, is reproduced in Appendix A of the Audit Guide. SOP 81-1 is often referred to in this manual.

The manual is divided into three main sections. The first section explains how construction contracting is different from other industries. It introduces you to the particular characteristics of the industry with an emphasis on those that have accounting, audit, or tax consequences. Accounting for long-term construction contracts is covered in this section. The section closes with a chapter on the contractor-surety relationship and how sureties use a contractor's financial statements.

The second section of the course focuses on audit issues and approaches that are unique to construction contractors. Included here are detailed analytical review procedures for contractors, coverage of internal controls, and the typical substantive procedures performed in an audit. In this section you will also find a description of how the guidance in the auditing chapters can be

adapted to perform a review in accordance with Statements on Standards for Accounting and Review Services (SSARS).

The third section walks you through the tax rules for construction contractors. It begins with a survey of the tax rules and how they differ from GAAP. The final two chapters of the course deal with the taxation of"small" contractors and "large" contractors.

Surveys show that more than 90% of all construction bonds are in amounts of $1 million or less. In other words, most jobs are for less than $1 million, and most contractors are not very large. So this course emphasizes issues that affect the small- to medium-size contractor. Wherever possible, it offers practical guidance and tips based on the experience of the author and those who helped with the preparation of the course.

Conclusion

The manual is designed to be a permanent reference tool. We hope your reading of it enriches your professional learning experience.

Note. We use the terms he and she alternately throughout the course (except when a particular person is mentioned) since both men and women are well represented throughout the profession.

Chapter 1

Nature of the Construction Industry

Learning Objectives

• Be familiar with the types of construction contractors and the work they typically perform.
• Be familiar with the construction process.
• Be aware of the characteristics that are unique to the construction industry and that have accounting, audit, tax, or consulting consequences.
• Know where to go to get more information on the construction industry.

Introduction

The construction industry offers many opportunities for the small practitioner. There are several reasons for this:

• The construction industry employs more people and contributes more to the GNP than any other industry in this country. It is one of the largest segments of the national economy, and, therefore, a large market for CPAs.
• Historically, because of the ease of entry into the industry, many construction contractors have been small, family-owned businesses. These kinds of businesses are well-suited to the services provided by smaller CPA firms.
• Most contractors are required to post a bid or performance bond in order to obtain the contract. These bonds are issued by sureties who require audited or, at a minimum, reviewed financial statements. In some situations, the surety will also require interim statements.
• The taxation of construction contractors can be complex and typically requires the expertise of a CPA.

If you have ever been involved with a home renovation project, or followed the progress of a public construction project in the newspaper (for example, a highway or an airport), then you know something about the construction business.

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