Accounting for Long-Term Contracts (Portfolio 575)

Tax Management Portfolio, Accounting for Long-Term Contracts, No. 575, provides taxpayers with guidance in applying the long-term contract accounting methods.

The initial question in working with these rules is their scope. A long-term contract is generally defined as a contract for the construction, installation, building, or manufacturing of property that begins in one year and is completed in a later tax year. Manufacturing contracts are treated as long-term contracts only if (1) they involve the manufacture of unique items not carried in finished goods inventory or (2) the manufacturing of each item produced pursuant to the contract normally takes longer than 12 months. The Portfolio discusses the definition of a long-term contract in detail.

Long-term contracts generally must be accounted for using the percentage of completion method (PCM) of accounting. However, in certain limited situations, long-term contracts may be accounted for using other long-term contract methods, such as the percentage of completion capitalized cost method (PCCM) or the completed contract method (CCM). A unique feature of the PCM and PCCM is the look-back rule, which requires the hypothetical recomputation of estimated contract costs and contract income when the contract is completed, and perhaps again thereafter. Special rules apply in determining which costs are allocable to contracts using the PCM. Taxpayers who enter into construction and/or manufacturing contracts will find this Portfolio useful in (1) deciding the extent to which the long-term contract rules apply and (2) applying these complex rules, including the look-back rules.