Cash vs. Accrual Accounting for Contractors: Which Method and When
Cash vs. accrual is a fundamental accounting method choice that affects when revenue and expenses appear on financial statements and tax returns. For contractors, the choice has consequences beyond most industries because construction projects often span multiple tax years, involve retention held for long periods, and have progress billings that get cashed in different months than the underlying work happened.
Choosing between cash and accrual, and then layering the right construction-specific method on top (percentage of completion, completed contract, or something else), determines how a contractor's profitability appears each year — and how much tax gets owed when.
Under cash-basis accounting, revenue is recognized when cash is received and expenses are recognized when cash is paid. A contractor who invoices for $200,000 in June but doesn't collect until August recognizes the $200K in August. Expenses paid in June hit June's books regardless of when the underlying work was done.
Cash basis is simple. The books align with the bank account. Revenue for a period is cash collected; expense is cash paid out. There's no complex accrual calculation, no reversing entries, no unbilled receivables on the balance sheet. Small contractors often prefer cash basis for this simplicity.
But cash basis distorts project economics. A contractor who spent $400K on a project in one tax year and collected $500K in the next year shows a huge loss in year one and a huge profit in year two — even though the project was moderately profitable overall. The timing mismatch between cash and work hides the underlying reality.
Under accrual accounting, revenue is recognized when earned and expenses when incurred, regardless of cash movement. Revenue earned in June (even if not yet invoiced or collected) hits June's books as revenue with a corresponding receivable. Expenses incurred in June (even if not yet paid) hit June's books with a corresponding payable.
Accrual matches revenue with the expenses that produced it. A project that ran from June through December shows each month's revenue alongside that month's costs, giving a cleaner picture of profitability over time. GAAP requires accrual for financial statement purposes; the IRS requires accrual for most businesses above certain size thresholds.
Accrual accounting is more complex. It requires tracking receivables, payables, prepaid expenses, accrued liabilities, inventory — a larger number of balance sheet accounts. Month-end close involves accruing for work performed but not yet invoiced, accruing for expenses incurred but not yet paid, and reversing those accruals as the invoices come in. The accounting team's workload is higher, but the financial reporting is more accurate.
The IRS sets size thresholds that determine whether a contractor has a choice. Under current rules (2026):
Cash vs accrual eligibility based on gross receipts
- Gross receipts under $30M (3-year average) — contractor may elect cash basis
- Gross receipts above $30M (3-year average) — must use accrual for tax purposes
- C corporations (other than certain personal service corporations) — traditionally required accrual, though the $30M threshold now applies to most C corps too
- Contractors with inventory — may still need accrual for inventory-related revenue and expense even if cash basis for other items (though construction in progress is treated differently from regular inventory)
The $30M threshold adjusts annually with inflation. Historically it was $25M (post-TCJA), and before that $10M for certain contractors. Contractors near the threshold should track their rolling 3-year average gross receipts to know when they'll be required to convert.
For long-term contracts (generally, those spanning multiple tax years), contractors use specific construction accounting methods that sit on top of the cash vs. accrual choice. The two main methods:
Long-term contract accounting methods
- Percentage of Completion (POC) — revenue and expense are recognized progressively as the contract is performed, based on costs incurred to date divided by total estimated costs. Matches income with the work that produced it across tax years.
- Completed Contract Method (CCM) — revenue and expense are deferred until the contract is complete. Available for home construction contracts and for small contractors under certain thresholds, but generally not available for larger contractors or for most commercial work.
POC is the default for long-term contracts under IRC Section 460. CCM is available as an exception for home construction contracts (residential construction for personal-residence buyers) and for contractors with gross receipts under $30M (3-year average) on contracts expected to complete within 2 years.
Under percentage of completion, the contractor estimates total contract cost and total contract revenue at the start. Throughout the contract, the cost-to-date is divided by the total-estimated-cost to calculate the percentage complete. That percentage is applied to total contract revenue to calculate revenue earned to date.
Example: a $1M contract with estimated costs of $850K (estimated profit $150K). At month 6, costs to date are $425K, which is 50% of total. Revenue earned to date is 50% of $1M = $500K. If the contractor has billed $550K to date, the $50K excess is over-billing (unearned revenue). If they've billed only $450K, the $50K shortfall is under-billing (earned but unbilled revenue).
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POC requires accurate cost-to-date tracking and realistic total-cost estimates. Contractors whose estimates are systematically off (either too high or too low) produce financial statements that misrepresent progress and profit. Estimates should be updated periodically as actual costs reveal the real total.
The accuracy of POC depends on the accuracy of the estimate-to-complete. Contractors who refresh the ETC monthly produce accurate WIP; contractors who rely on the original bid estimate for the whole project produce reports that get less accurate as the project progresses.
Under the completed contract method, no revenue or expense is recognized for a project until it's complete. All costs accumulate on the balance sheet as construction-in-progress (an asset); all billings accumulate as deferred revenue (a liability). At completion, the accumulated amounts flow through the P&L.
CCM is simpler than POC but defers all revenue recognition. For tax purposes, this can be a significant benefit — a $500K profit on a project that completes next year pushes the tax into next year. For financial statement purposes, it's problematic — the income statement shows nothing during months of active work, then a huge spike at completion.
Most larger contractors don't have the option of CCM for their primary business. Home builders and smaller contractors under the threshold have it as a choice, and for them, the tax deferral can be material.
For larger contractors using POC, there are some tax-specific twists. Contractors may be subject to alternative minimum tax (AMT) provisions that require separate AMT calculations for long-term contracts. And after a contract completes, the IRS runs a "look-back" calculation that compares actual contract results to what was estimated each year — if the estimates were off enough that tax was paid too early or too late, interest may be owed or refunded.
The look-back interest rules are complex and tax-professional territory. Contractors who use POC should have a tax advisor running the look-back calculations annually. Smaller contractors typically don't face these issues because their method choices and thresholds exempt them.
Accounting method changes require IRS consent in most cases, filed on Form 3115 (Application for Change in Accounting Method). A cash-to-accrual change, a CCM-to-POC change, or a change in the specific POC cost allocation method all require the Form 3115 filing. Some common changes are automatic (don't require specific IRS approval); others require case-by-case review.
When a contractor crosses the gross receipts threshold and is required to move from cash to accrual, the transition creates a Section 481(a) adjustment that spreads the income effect of the change over up to 4 tax years. The mechanics are managed by the tax advisor, but the contractor should plan for it financially — the change can accelerate substantial taxable income into the transition period.
Cash and accrual accounting differ in when revenue and expense get recognized. For contractors, accrual is more accurate for project economics and required for most firms above the $30M gross receipts threshold. Construction-specific methods (POC, CCM) layer on top of accrual and determine how long-term contracts are accounted for across tax years. The choice of methods affects tax timing, financial statement accuracy, and compliance complexity. Contractors near the thresholds, or considering method changes, should work with a tax advisor — the filing mechanics and transition calculations aren't self-service territory.
Written by
Sarah Blake
Head of Product
Former AP Manager at a $200M construction firm, now leads product at Covinly. Writes about what AP teams actually need from automation — beyond the marketing promises.
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