Construction Accounting Methods: Cash, Accrual, Completed Contract, and Percentage of Completion

Job costing is the system that assigns every dollar of cost to the project that consumed it. The accounting method is the set of rules that determines when those costs, and the revenue they produce, show up on the tax return. A contractor who tracks costs perfectly but uses the wrong accounting method will file a wrong return, and a contractor who picks the right method but does not track costs at the project level has no way to apply it. The two are linked, and the IRS treats both as mandatory for any construction company working on contracts that span more than one tax year. The choice of method is not purely elective: IRC 460 forces certain contractors onto the percentage-of-completion method, and IRC 448 limits who can use the cash method at all. The rest of this guide walks through what gets tracked, how each method works, and which one the tax code requires (or allows) for your situation.

What costs does a job costing system need to capture?

Every cost that touches a project must be captured in one of two categories: direct costs (traceable to a single job) and indirect costs (allocated across multiple jobs). The IRS expects the job costing system to support whichever accounting method the contractor uses, and a PCM contractor who cannot produce a credible cost-to-cost ratio for each contract is inviting an audit adjustment.

Direct costs are the straightforward category. Materials include everything purchased for a specific project: concrete, lumber, steel, pipe, fixtures, and specialty items. Each purchase order or supplier invoice should carry the job number so the cost flows to the right project without manual reclassification. Direct labor is the burdened cost of hours worked on a specific job, meaning the hourly wage plus employer payroll taxes, workers’ compensation premiums, health insurance, and retirement contributions. The burdened rate is typically 25% to 40% above the base wage, and using the base wage instead of the burdened rate understates job cost by a material amount. Subcontractor costs are the invoiced amounts from subs working on the project, including any retainage withheld. Equipment costs are either third-party rental charges or internal charges at an ownership cost rate that reflects depreciation, insurance, maintenance, and fuel. Other direct costs include permits, dumpsters, temporary utilities, and inspection fees.

Indirect costs (overhead) are the costs that benefit all projects but cannot be traced to one: office rent, administrative salaries, general liability insurance, accounting fees, marketing, and vehicle costs for supervisors who visit multiple sites. These costs are allocated to each project through an overhead rate, typically calculated as a percentage of direct labor cost or total direct cost. The allocation method must be consistent year to year. If you allocate overhead as 15% of direct labor cost this year, you cannot switch to 10% of total direct cost next year without a defensible reason. The IRS can, and occasionally does, challenge overhead allocation methods that produce results inconsistent with economic reality, particularly when the effect is to shift income between tax years.

For a deeper treatment of cost tracking mechanics, the WIP schedule, and chart-of-accounts setup, see the job costing and tax compliance guide.

Who can use the cash method?

The cash method is the simplest: income is recognized when received, expenses are recognized when paid. For a contractor, that means a progress billing is income when the owner’s check clears, and a materials invoice is an expense when the contractor pays it. The cash method naturally defers income on retainage (which is held until project completion) and accelerates deductions for materials purchased and paid before installation.

Not every contractor qualifies. Under IRC 448(a), C corporations and partnerships with a C corporation partner generally cannot use the cash method. However, IRC 448(c) provides an exception for entities that meet the gross receipts test: average annual gross receipts of $31 million or less for the three prior tax years (2025 figure, indexed annually for inflation under IRC 448(c)(4)). S corporations, partnerships without C corporation partners, and sole proprietors can use the cash method without regard to the gross receipts test, subject to the IRC 460 rules for long-term contracts discussed below.

The practical advantage of the cash method is cash flow alignment: you pay tax on money you have actually received, and you deduct costs you have actually paid. The disadvantage is that the cash method does not reflect economic reality on multi-year projects. A contractor who front-loads billings and defers payments can show artificial profits in early years and artificial losses later, which is exactly why the IRS restricts the cash method for large contractors and requires PCM for long-term contracts above the threshold.

How does the accrual method differ for construction?

Under standard accrual accounting, income is recognized when earned (typically when the work is performed and the right to payment exists) and expenses are recognized when incurred (when the liability arises, not when the bill is paid). For a non-construction business selling widgets, this is straightforward: ship the widget, record the revenue. For construction, “earned” is more complex because a single contract can span years, and the work performed in any one year is a fraction of the total.

Standard accrual is a valid method for construction contractors, but it is rarely the best choice on its own. Without a construction-specific overlay (either CCM or PCM), a pure accrual contractor recognizes revenue when progress billings are issued and expenses when materials are received or labor is performed, regardless of whether the project is complete. This can produce distorted results on contracts where billings do not track closely with costs, which is common in construction. Over-billings (billing ahead of work) inflate current-year income; under-billings (performing work before billing) defer income. The WIP schedule exists to quantify these distortions and adjust the financial statements accordingly.

In practice, most construction contractors who use accrual accounting pair it with either the completed-contract method or the percentage-of-completion method. The “accrual method” standing alone (without CCM or PCM) is most common at very small contractors who have few multi-year contracts and whose projects start and finish within the same tax year.

What’s the completed-contract method, and who qualifies?

The completed-contract method (CCM) defers all revenue and all costs on a contract until the contract is complete. No income, no deductions, and no profit or loss until the job is done. For a two-year project, this means zero tax impact in Year 1 and the entire contract’s profit (or loss) reported in Year 2.

CCM is attractive because it defers tax. If a contractor has multiple overlapping projects, CCM creates a steady stream of deferrals: as one contract completes and its profit is recognized, another contract is starting and its costs are accumulating with no offsetting income. The deferral is real and can be substantial for a contractor with a multi-year backlog.

The catch: CCM is not available to everyone. Under IRC 460, long-term contracts (contracts not completed within the tax year they are started) generally must use the percentage-of-completion method. CCM is available only through two exceptions.

The first is the small contractor exemption under IRC 460(e)(1)(B). A contractor qualifies if: (1) the contract will be completed within two years of the start date, and (2) the contractor’s average annual gross receipts for the three tax years preceding the year the contract is entered into do not exceed $31 million (2025, indexed for inflation). Both conditions must be met for each contract. A contractor who qualifies can elect CCM (or any other permissible method) for that contract instead of PCM.

The second is the home construction exception under IRC 460(e)(1)(A). A “home construction contract” is a contract where 80% or more of the estimated total costs are for the construction, building, or improvement of dwelling units in buildings with four or fewer units. This exception has no gross receipts limit, so even a large home builder can use CCM for qualifying contracts. The 80% test is applied at the contract level, and it includes land development costs directly associated with the dwelling units.

“Complete” under CCM means the earlier of: (1) 95% of the total allocable contract costs have been incurred, or (2) the contract is accepted by the customer. Punch list items and minor remaining costs do not prevent a contract from being treated as complete once the 95% threshold is met.

When is percentage of completion required?

The percentage-of-completion method (PCM) is required under IRC 460(a) for any long-term contract that does not qualify for the small contractor exemption or the home construction exception. In practice, this means PCM is mandatory for contractors with average annual gross receipts above $31 million (2025) on any contract that spans more than one tax year (and is expected to take more than two years, or the contractor exceeds the gross receipts threshold). It is also mandatory for any contractor, regardless of size, on a contract expected to take more than two years that does not qualify as a home construction contract.

Under PCM, revenue is recognized each year based on the cost-to-cost ratio: cumulative costs incurred divided by total estimated costs at completion, multiplied by the total contract price. The resulting figure is cumulative revenue to date, and the current year’s revenue is the difference between cumulative revenue this year and cumulative revenue through the prior year.

The deep-dive guide on percentage of completion covers the cost-to-cost calculation, the look-back method under IRC 460(b)(2), the 10% method for simplified reporting, and the interaction between PCM and change orders. The critical point here is that PCM recognizes income before it is received: a contractor who has incurred 60% of estimated costs has taxable income equal to 60% of the contract price, whether or not the contractor has billed or collected that amount. This creates a cash flow mismatch that is one of the most significant tax planning issues in construction.

How does the gross receipts threshold work?

The gross receipts test under IRC 448(c) is a three-year average. For a contract entered into in 2025, the contractor averages gross receipts for 2022, 2023, and 2024. If the average is $31 million or less, the contractor meets the small contractor threshold (the Tax Cuts and Jobs Act of 2017 raised it to $25 million from $10 million, and it is adjusted annually for inflation; $32 million for 2026). For the IRC 460(e)(1)(B) exemption, the same gross receipts threshold applies, and the contract must also be expected to be completed within two years.

Gross receipts include all revenue: contract revenue, equipment sales, insurance proceeds, interest income, and any other receipts. For affiliated groups of companies, the gross receipts of all members are aggregated under IRC 448(c)(2), so a contractor cannot split operations among multiple entities to stay below the threshold.

A contractor who crosses the threshold does not immediately lose the small contractor exemption on existing contracts. The test is applied at the time each contract is entered into. But new contracts entered into in the year the three-year average exceeds the threshold ($31 million for 2025, $32 million for 2026) must use PCM (unless they qualify as home construction contracts). Crossing the threshold also triggers additional requirements: the contractor must capitalize certain costs under IRC 263A (the uniform capitalization rules), and the change in accounting method requires filing Form 3115 with the IRS.

Which method should a contractor choose?

For contractors below the gross receipts threshold, the choice between CCM and PCM is primarily a question of tax deferral versus financial statement accuracy. CCM maximizes deferral: no income until the job is done. PCM produces financial statements that more accurately reflect the economic activity in each year, which matters for bonding, bank lending, and owner financial reporting. Many contractors below the threshold use CCM for tax and PCM for their financial statements (book-tax differences are common in construction accounting). This dual approach requires the CPA to maintain a book-tax reconciliation, but the tax deferral is often worth the complexity.

For contractors above the threshold, PCM is mandatory on long-term contracts. The planning moves to managing the cash flow impact: accelerating costs into the current year (purchasing materials, mobilizing subs) increases the cost-to-cost ratio and pulls revenue recognition forward, but it also increases the denominator of estimated total costs, which can actually reduce the percentage complete if the estimate grows faster than costs incur. Deferring billings does not help under PCM, because PCM ignores billings entirely and looks only at costs. The real planning lever is the accuracy of the total estimated cost, which must be updated each year to reflect change orders, scope changes, and actual cost experience.

The entity structure guide covers how the choice of entity (S corp, C corp, LLC, partnership) interacts with the accounting method election. The equipment depreciation guide addresses how Section 179 and bonus depreciation on equipment purchases affect the cost side of the PCM calculation. And the contractor tax deductions guide covers the full range of deductible costs that flow through the job costing system into whichever method the contractor uses.

What happens if a contractor uses the wrong method?

The IRS can adjust the contractor’s tax return to reflect the correct method and assess additional tax, interest, and penalties. A contractor who uses CCM without qualifying for the small contractor exemption (either because gross receipts exceed the threshold or because the contract exceeds two years) will be recomputed under PCM, which typically accelerates income into earlier years and produces a tax deficiency with interest running from the original due date. Changing to the correct method requires filing Form 3115 (Application for Change in Accounting Method), which can be filed voluntarily or under IRS examination. A voluntary change filed before the IRS identifies the issue is generally more favorable: the adjustment is spread over four years (for a positive Section 481(a) adjustment) rather than recognized entirely in the year of change.

The more common problem is not a deliberate wrong method but an accidental one: a contractor who has grown past the threshold ($31 million for 2025, $32 million for 2026) and has not updated the method election, or a contractor who uses CCM on a contract that takes longer than two years. Annual monitoring of gross receipts and contract durations is a basic compliance obligation that many contractors overlook until the CPA catches it at year-end, or until the IRS catches it on audit.

What should I do next?

If you are a construction contractor and you are not sure whether your current accounting method is correct for your gross receipts level and contract mix, that is the single most important question to resolve before filing your next return. The method drives everything: taxable income timing, WIP schedule requirements, financial statement presentation, and bonding capacity.

• Job costing and WIP schedule mechanics, the cost tracking system that feeds every accounting method
• Percentage of completion deep dive, the cost-to-cost calculation, look-back method, and 10% method
• Contractor tax deductions, the full catalog of deductible costs that flow through job costing
• Equipment depreciation and Section 179, how equipment purchases affect the PCM cost ratio
• Entity structure for contractors, how entity choice interacts with the accounting method election
• Change order revenue recognition, the treatment of approved, pending, and disputed change orders under each method
• Retainage accounting and tax treatment, when retainage is taxable under each method

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.