Construction Contractors Can Benefit From Tax Reform Changes to Long-Term Contracts Exception

Construction Contractors Can Benefit From Tax Reform Changes to Long-Term Contracts Exception

 

LUTZ BUSINESS INSIGHTS

 

Construction Contractors Can Benefit From Tax Reform Changes to Long-Term Contracts Exception

The 2017 Tax Cuts and Jobs Act is the most comprehensive reform to the U.S. tax code in more than 30 years. As taxpayers sort out the changes, construction company contractors should take notice of a very positive change in the tax reform package—the increase in the gross receipts limit to qualify for the small construction contract exception to the percentage of completion method (PCM) by $15 million. The following provides information on what has changed and who can benefit.

 

Overview

While taxpayers must use either the cash or accrual accounting method for short-term contracts, they must account for long-term contracts using the rules under Code Sec. 460 (e). For long-term contracts, taxable income is generally determined using either the PCM or the completed-contract method. Under the PCM method, taxpayers must include in gross income for the tax year an amount equal to the product of the gross contract price, and the percentage of the contract completed during the year.

 

Old

Before the tax reform package was enacted, construction companies with average gross receipts of $10 million or less in the preceding three years were entitled to an exception from the requirement to use the PCM method for long-term contracts as long as they met certain requirements. They were allowed to instead deduct costs associated with construction when they were paid and to recognize income when the building was completed.

 

New

The Tax Cuts and Jobs Act increased the amount of gross receipts from $10 million or less to $25 million or less. For contracts entered into after Dec. 31, 2017, the exception for small construction contracts from the requirement to use the PCM is expanded to apply to contracts for the construction or improvement of real property if the contract: 1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract, and 2) is performed by a taxpayer that (for the tax year in which the contract was entered into) meets the $25 million gross receipts test.

Use of this PCM exception for small construction contracts is applied on a cutoff basis for all similarly classified contracts. That means there is no adjustment under Code Sec. 481 (a) for contracts entered into before Jan. 1, 2018.

 

Effect of AMT Rule Changes

Alternative minimum tax (AMT) still requires the use of PCM on all long-term contracts, so there will still be an AMT adjustment required for any contract accounted for using the completed contract method. However, the AMT thresholds have increased significantly under the Tax Cuts and Jobs Act, causing fewer taxpayers to be subject to the AMT.

The exception under AMT for a married filing joint taxpayer increased from $78,750 to $109,400. The income threshold (AMTI) also increased from $150,000 for a married filing joint taxpayer to $1 million. For a single taxpayer, the exception increased from $50,600 to $70,300. The income threshold for single taxpayers was $112,500 and has increased to $500,000.

Please contact us or your tax advisor for more information.

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Strengthening the Contractor-Surety Relationship

Strengthening the Contractor-Surety Relationship

 

LUTZ BUSINESS INSIGHTS

 

Strengthening the Contractor-Surety Relationship

NATE HAGGE, AUDIT MANAGER
If you are a contractor seeking a long-lasting relationship with a surety, it helps to first understand how that surety views certain factors related to you and your ability to perform and complete jobs.  

THE THREE C’S

Sureties and bonding agents rely on the three “C’s” when evaluating a potential contractor: Capital: Refers to the ability for a contractor to financially complete the job, examining working capital and equity Capacity: Refers to the skill and expertise that the contractor possesses in order to complete the job Character: Refers to the faithfulness of the contractor to complete the job  

THE THREE M’S

Once the relationship between the contractor and the surety has begun, the three “M’s” lay the groundwork in order to build the relationship: Meeting: Meet regularly with your surety, bonding agent, and CPA to discuss updates to the industry review financial information. Maintain: Maintain the relationship refers to the quality of the meetings and to develop trust between the surety and contractor.  Sureties are always appreciative when the contractor lets them know immediately when serious problems arise. Mature: Maturing the relationship develops over time and can mean the difference in getting the work or being rejected.  The surety is more likely to be receptive to a contractor that has invested time to mature the relationship. Contractors that work on the three “M’s” to strengthen and grow their relationship with their surety have a much better chance at running a successful business.   Would you like more information about Surety Bonds? Check out our blog “What are Surety Bonds, and When Might you Need One?” Or visit the construction industry page to learn more about the services we offer.

ABOUT THE AUTHOR

402.496.8800

nhagge@lutz.us

LINKEDIN

NATE HAGGE + AUDIT MANAGER

Nate Hagge is an Audit Shareholder at Lutz with over nine years of experience. He has significant experience in providing accounting, auditing and consulting services to privately-held companies.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • American Institute of Certified Public Accountants, Member
  • Construction Financial Management Association, Affliate Member
  • Construction Industry CPAs/Consultants Association, Member
  • National Utility Contractors Association, Affiliate Member
  • Associated General Contractors, Affliate Member
  • Certified Public Accountant
EDUCATIONAL BACKGROUND
  • BSBA in Accounting, University of Nebraska, Lincoln, NE
  • MPA, University of Nebraska, Lincoln, NE
COMMUNITY SERVICE
  • Alpha Tau Omega - Gamma Theta Chapter, Alumni Board Member

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What Are Surety Bonds, and When Might You Need One

What Are Surety Bonds, and When Might You Need One

 

LUTZ BUSINESS INSIGHTS

 

What are Surety Bonds, and When Might You Need One

JARED HARDY, AUDIT PARTNER

Surety bonds are used in the real estate and construction industries to ensure the completion of a contract in the event of a contractor default. If you as a contractor are bidding on work, there is a possibility that contract requires a surety bond. Therefore, let’s first look at the components of a surety bond and then consider how to go about obtaining one.

A surety bond acts as an insurance policy between the contractor, the client and a third-party surety bonding company that is designed to protect customers financially, ensuring that the contractor follows through on their contractual obligations. In the event of a default, the surety company steps in to find another contractor to finish the job or to compensate the project owner for the financial loss incurred.

STEP 1

Your first step is to figure out if a surety bond is required for your project or business. If you want to bid on public construction contracts and many private contracts, you’ll likely need a surety bond. Any federal construction contract valued at $150,000 or more requires a surety bond when bidding. Most state and municipal governments, as well as private entities, have similar surety bonding requirements.

STEP 2

Next, determine what type of surety bond is required for your project. Below are different types of surety bonds:

  • Bid Bond: Bid bonds ensure the bidder on a contract will enter into the contract and furnish the required payment and performance bonds if awarded the contract.
  • Payment Bond: Payment bonds ensure suppliers and subcontractors are paid for work performed under the contract.
  • Performance Bond: Performance bonds ensure the contract will be completed in accordance with the terms and conditions of the contract.
  • Supply Bond: Supply bonds mandate that suppliers provide materials, equipment and/or supplies as defined in purchase orders. If the supplier fails to provide the supplies as agreed, the bond amount can be used to reimburse the purchaser for the resulting loss.
  • Maintenance Bond: Maintenance bonds guarantee against defective materials and workmanship for a specific time period following a project’s completion. If the project is found to be defective during this time, the bond amount can be used to pay for repairs that need to be made as a result.
  • Subdivision Bond: Subdivision bonds require contractors to build and/or renovate public structures within subdivisions – such as streets, sidewalks and waste management systems – according to local specifications. If a contractor fails to do so, the bond amount can be used to complete the subdivision project appropriately.

STEP 3

Your final step is to secure your surety bond. Once you’ve found a surety company or agent, you can get started. Most basic bonds can be processed and issued on the same day, but some surety bonds require a CPA prepared financial statements.

ABOUT THE AUTHOR

Jared Hardy

308.385.1167

jhardy@lutz.us

3320 JAMES ROAD

SUITE 100

GRAND ISLAND, NE 68803

JARED HARDY + AUDIT SHAREHOLDER

Jared Hardy is an Audit Shareholder at Lutz with over 13 years of experience. He has significant experience in public accounting providing accounting, auditing and consulting services to privately-held companies in a variety of industries.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • American Institute of Certified Public Accountants, Member
  • Nebraska Society of Certified Public Accountants, Member
  • Certified Public Accountant
EDUCATIONAL BACKGROUND
  • BS in Accounting, University of Nebraska, Lincoln, NE
COMMUNITY SERVICE
  • NOVA Treatment, Board Member
  • Knights of Columbus, Member

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Assets Matter When Valuing Construction Companies

Assets Matter When Valuing Construction Companies

 

LUTZ BUSINESS INSIGHTS

 

Assets Matter When Valuing Construction Companies

RYAN COOK, AUDIT & CONSULTING SHAREHOLDER

 

Most construction companies own significant assets such as heavy machinery, vehicles, real estate and miscellaneous equipment. Yet time and time again, these assets are marginalized – or even ignored – when it comes time to value that business. What is the reason this occurs?

An example may help illustrate the issue. Many of our readers own rental properties, and if you ask them, they will probably tell you that a major reason for the investment was the opportunity to generate some extra cash flow over time. Of course, an investment’s ability to generate cash flow is a key component in determining its value. For the rental property owner, however, an owner may also derive value from the property based on the price that a buyer would pay to acquire the property (as opposed to its stream of expected future cash flows). In lieu of projected cash flows, factors such as location, property condition, economic conditions, and even mortgage rates can dramatically impact the property’s actual value. These metrics (cash flow and asset value) can drive meaningful yet divergent values of the property.

In a situation where the value of the cash flows far exceeds the expected sales price of the asset, the owner of the property (and any potential buyer of that property) would most likely focus on the property’s ability to generate cash flows as opposed to the asset value. The opposite should also hold true. Therefore, the dismissal of the asset value in favor of the value indicated by an income-approach may explain why your construction company valuation may appear to “forget” the assets. The issue is, if the value of the business under the asset-based approach is higher than the income-based value, yet the asset-based value is dismissed, the company may wind up being undervalued.

When applying an asset-based approach to valuing a construction business (such as the adjusted net asset method), the valuator computes the net value of all assets less all liabilities of the company. These assets may be tangible (e.g., machinery, equipment, receivables, work in progress) or intangible (e.g., customer relationships, project backlog, name recognition, subcontractor/vendor relationships). Tangible assets like machinery and equipment, which the company may have accumulated over many years, must be considered through the prism of “fair market value” (as opposed to depreciated levels as reported on the company’s books). In order to adjust these assets from book value to fair market value, appraisals of individual assets may be appropriate, which can add cost to the valuation project.

What about intangible assets, though? Since the values of intangible assets are typically derived through income- and market-based methods, their value is already embedded in income- and market-based approaches to valuing the business. Therefore, if a company has not demonstrated the ability to generate cash flows sufficient to generate a value of the business under an income- or market-based approach that is greater than the value indicated by the asset-based approach, it stands to reason that these underlying intangibles may have little to no value.  However, even if the asset-based approach is utilized consideration should be given to the value of the “gross profit” in the backlog as the Company has a contract to complete this work.  Thought needs to be given to how much additional value this provides to the Company’s overall value considering there still is risk to perform the work and make the estimated margins.

After analyzing the company’s assets, the valuator moves on to liabilities. Liabilities may be recorded on the books at a value that resembles fair market value (e.g., payables and, in many cases, bank debt). Complicating the matter, however, are unrecorded liabilities. Because accounting requirements do not require every potential liability to be recorded on the enterprise’s books, there may be meaningful unrecorded liabilities such as regulatory claims (e.g., an unresolved IRS audit), legal disputes (e.g., litigation against the company) or, in the case of union contractors, multi-employer benefit plan withdrawal liabilities. While not recorded on the books, these claims and contingent liabilities may have a significant impact on a hypothetical buyer’s perception of the value of the business. Valuation of these contingent liabilities may involve complex modeling. Therefore, these items should be given careful consideration.

As discussed above, the asset-based approach may have been “forgotten” in your construction company’s valuation. You need to find out…was it properly considered and dismissed because income- and market-based approaches indicated a higher value? If so, the valuation report should indicate that. On the other hand, if the asset approach was ignored without any explanation (or not given any weight, even though its value was higher than the income- and market-based approaches applied), it may be worth a conversation with your valuator to better understand his/her basis for doing so.  As a take home the asset-based approach is a good rule of thumb when initially considering what a construction company is worth.

 

ABOUT THE AUTHOR

Ryan Cook

402.827.2085

rcook@lutz.us

LINKEDIN

115 CANOPY STREET

SUITE 200

LINCOLN, NE 68508

RYAN COOK + AUDIT & CONSULTING SHAREHOLDER 

Ryan Cook is an Audit and Consulting Shareholder at Lutz with over 11 years of experience in accounting and assurance and five years in business valuation. He provides accounting, auditing, and consulting services to privately-held companies, with in-depth experience in the construction industry.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • American Institute of Certified Public Accountants, Member
  • Nebraska Society of Certified Public Accountants, Member
  • Certified Public Accountant
  • Accredited in Business Valuation
EDUCATIONAL BACKGROUND
  • BSBA in Finance and Accounting, University of Nebraska, Lincoln, NE
COMMUNITY SERVICE
  • The University of Nebraska at Lincoln School of Accountancy, Advisory Board
  • Boys and Girls Club of Lincoln, Board Member
  • Habitat for Humanity's Annual Fundraiser (Brew Haha), Past Committee Member

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Accounting & Consulting Services + Construction Industry

Accounting & Consulting Services + Construction Industry

 

LUTZ BUSINESS INSIGHTS

 

Accounting & Consulting Services + Construction Industry

Succeeding in the construction industry takes accurate bidding, quality work, savvy management, cost controls and the assistance of advisors who know the business and can help move your company ahead. The Lutz team excels in helping construction companies stay competitive while solidifying their financial position. We offer a full range of tax, audit, accounting, business consulting and financial planning services tailored to the unique needs of the construction industry.

Our experienced professionals are dedicated to delivering timely, accurate and personalized service that meets the highest standards of quality and integrity. As a result, we have built a strong reputation for helping companies like yours increase their profitability and success.

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Financial Statements: What do the Banks/Bonding Companies Really Want to See?

Financial Statements: What do the Banks/Bonding Companies Really Want to See?

 

LUTZ BUSINESS INSIGHTS

 

Financial Statements: What do the Banks/Bonding Companies Really Want to See?

RYAN COOK, AUDIT & CONSULTING SHAREHOLDER
Construction business owners regularly have to report to financial institutions. Whether they are requesting a bank to increase their line of credit, or asking for a loan, or they may need to get bonded or insured for an upcoming project, it’s important that the owners have all of their financial statements in order before they approach the bank or bonding agent. Fortunately, there are rules and guidelines that owners can follow to ensure they are preparing the right types of statements and doing so correctly. Called GAAP (Generally Accepted Accounting Principles), these rules are set by the FASB and promote transparency in accounting.  

GAAP requires the following 5 statements to be included in a complete set of financial statements:

  1. Balance Sheet.
  2. Income statement.
  3. Statement of stockholders equity.
  4. Statement of cash flow.
  5. Footnotes. Footnotes break down the balance sheets and provide more detail on each account.
 

Key Footnotes for construction companies should include:

 

1. Contract Receivables

Contract Receivables show how much money a company has billed but has not collected yet. They should be separated out into categories showing the aging of the receivables (0-30 days outstanding, 30-60 days outstanding, 60-90 days outstanding, etc.). Retainage on contracts should also be in a separate category. Banks and bonding agents may feel it is a red flag if a company has an excess of contract receivables that are over 90 days overdue excluding retainage.  

2. Contracts in progress

This gives a snapshot of the company’s year-long activity and should include completed contracts, jobs in progress and indirect costs which ultimately reconciles revenue earned and costs of construction to the income statement.  

3. Debt footnote

This describes the company’s financing arrangements, such as line of credit (how much are they extended?) and long-term debt and terms (when will it be repaid?). This helps the users of the financial statements determine how much cash flow is needed to service debt and also if there is any large balloon payments coming due.  

4. Backlog

The backlog shows how many contracts have been signed, but on which the work has not been done. Banks/Bonding companies like to see a healthy backlog as this provides assurance there is more work in the pipeline to pay off future debt obligations.  

What do I need to show the bank?

A construction company may need to present financial statements to banks when they are requesting an increase in their line of credit or are applying for a loan. They also need to make sure they have all their financials in order as they go into year-end tax planning. Banks tend to focus heavily on balance sheet, which tells the story of how strong the company is financially. Additionally, banks like to see footnotes included, which tell a more in-depth story of the company’s financial stability.  

What do I need to show bonding companies?

While bonding companies will also be looking at the above financial statements and footnotes, they will also be focused on Supplemental Schedules. These include:  

1. Summary of earnings

This is a snapshot of completed contracts, jobs in progress and indirect costs. This summary of earnings should paint a picture of the margin the contractors are making and should also give an accurate picture of how well jobs are being estimated. For example, if a contractor is routinely estimating to make 30% on projects and most completed projects come in at 20%, the reason for the profit fade may need to be addressed. It could indicate that projects are being aggressively estimated, that project managers are fading on the job or that indirect costs are not being allocated correctly.  

2. Schedule of contracts in progress

This gives the details on the margins a company is expected to make, how far along in the process jobs are and billing to date. Bonding companies are looking to make sure contractors are up-to-date on billing jobs and are again making sure estimated margins and actual margins are consistent. This detail on a job by job basis is an important feature to bonding agents.   Here at Lutz, we know what the banks, bonding and insurance agents are looking for and can help you prepare financials that follow GAAP standards and present your company in the best possible light. Preparing these financial statements can also help us get an accurate picture of the health of your construction company and identify red flags before they become emergencies. If you have questions about preparing GAAP financial statements or other accounting questions, please feel free to call Ryan Cook at 402.827.2085.

ABOUT THE AUTHOR

Ryan Cook

402.827.2085

rcook@lutz.us

LINKEDIN

115 CANOPY STREET

SUITE 200

LINCOLN, NE 68508

RYAN COOK + AUDIT & CONSULTING SHAREHOLDER 

Ryan Cook is an Audit and Consulting Shareholder at Lutz with over 11 years of experience in accounting and assurance and five years in business valuation. He provides accounting, auditing, and consulting services to privately-held companies, with in-depth experience in the construction industry.

AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
  • American Institute of Certified Public Accountants, Member
  • Nebraska Society of Certified Public Accountants, Member
  • Certified Public Accountant
  • Accredited in Business Valuation
EDUCATIONAL BACKGROUND
  • BSBA in Finance and Accounting, University of Nebraska, Lincoln, NE
COMMUNITY SERVICE
  • The University of Nebraska at Lincoln School of Accountancy, Advisory Board
  • Boys and Girls Club of Lincoln, Board Member
  • Habitat for Humanity's Annual Fundraiser (Brew Haha), Past Committee Member

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We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.

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Toll-Free: 866.577.0780Privacy Policy | All Content © Lutz & Company, PC 2021