A contract that begins and ends within the taxpayer’s taxable year is classified as a short-term contract. Under a short-term contract, construction costs are current period costs under all methods of accounting except the cash method. If the cash method is chosen, construction costs are current period costs only if the expense is also paid during the year.
A contract that cannot be completed within the taxable year it is entered into is classified as a long-term contract. However, a long-term contract’s term does not have to be for a year or more.
For example, consider a construction contract entered into by a calendar-year taxpayer on December 31, 2019 and concluded on January 1, 2020. Even though this was only a two-day contract, because it could not be completed in the taxpayer’s tax year it was entered into (2019), it is considered a long-term contract.
A construction contract for an agreed upon price, regardless of potentially unforeseen expenses, is classified as a fixed price or lump sum contract.
Cost-plus contracts arise when the contract amount is the cost of the job plus a fee. The fee may be based on a variety of factors.
Time and material contracts are contracts that provide payments to the contractor based on direct labor hours at a fixed rate plus the cost of materials and other specified costs.
A unit price contract is a type of Fixed Price or Lump Sum contract where the contractor bids a set price per unit. This type of contract is utilized when the number of units required has not been determined during contract bidding.
A change order modifies an original contract and may increase or decrease the costs and/or price stated in an existing contract.