Cash vs. Accrual Accounting in Construction: Understanding the Impact on WIP and Project Financials
Written By Mary Johnson, Cleanup Specialist at BEC CFO & CPA
In the construction industry, where projects span weeks, months, or even years, choosing the right accounting method is more than an administrative decision—it’s a strategic imperative. Construction companies must account for long-term contracts, job costs, and progress billing. This makes the choice between cash accounting and accrual accounting especially important, particularly in how it impacts Work-in-Process (WIP) accounting.
The Unique Nature of Construction Accounting
Unlike many other industries, construction accounting must track:
· Costs and revenues by individual job
· Timing differences between billing and actual work performed
· Retainage, change orders, and complex payment terms
This complexity makes the accounting method you choose a key factor in financial reporting, cash flow management, and tax planning.
Cash Accounting in Construction
Under the cash method, income and expenses are recognized only when cash is received or paid. While this method can work for very small contractors, it often fails to reflect the true financial position of a project.
Pros:
· Simple and cash-focused: Easy to manage for small contractors with few jobs and minimal receivables.
· Delayed taxation: Income is not taxed until it is received, offering short-term tax deferral.
Cons:
· Poor job matching: Costs may be incurred in one period while revenue is recognized in another, distorting job profitability.
· Limited visibility: Does not track WIP effectively—contractors may appear profitable while overbilled and behind schedule.
· IRS limitations: Contractors with average gross receipts over $25 million or that hold inventory (e.g., materials) cannot use this method.
Accrual Accounting in Construction
The accrual method records income when earned and expenses when incurred, regardless of cash flow. This aligns revenues and costs to the actual progress of a job and supports Work-in-Process schedules.
Pros:
· Better WIP tracking: Enables detailed job costing
· More accurate profitability: Matches revenue and expenses to the same period for clearer financial performance.
· Required for GAAP and larger firms: Essential for companies seeking bonding, financing, or preparing for audits.
Cons:
· Complexity: Requires diligent tracking of receivables, payables, and job progress.
· Timing issues with cash: Profit may be shown before cash is received, which can cause liquidity problems if not carefully monitored.
Work-in-Process (WIP) and Accrual Accounting
A WIP schedule is a core part of construction accounting under the accrual method. It tracks each job’s:
· Contract value
· Costs incurred to date
· Revenue earned
· Billings to date
This allows stakeholders to:
· Monitor project profitability in real time.
· Detect early warning signs (overbilling, underbilling, cost overruns).
· Accurately forecast future cash flow and earnings.
Choosing the Right Method for Construction Firms
Cash Accounting:
· Appropriate for small firms with simple operations and under $25M in revenue.
· Best when few projects are active and cash flow is tightly controlled.
Accrual Accounting:
· Necessary for growing firms, bonded contractors, or those seeking financing.
· Provides true visibility into job health, crucial for long-term planning and performance analysis.
· Required for building accurate WIP reports and GAAP compliance.
Conclusion
In construction, where cash flow, billing, and cost recognition are rarely aligned, choosing the right accounting method is foundational. While cash accounting might serve small, cash-based contractors, accrual accounting—combined with robust WIP tracking—is essential for managing projects profitably, securing financing, and making strategic decisions.
Contractors should work closely with construction-savvy accountants to build a system that not only meets IRS requirements but also provides the insights needed to grow a stable, profitable business.