Imagine you’re standing on the jobsite and someone says, “Nice piece of equipment. What did it cost you?” Your mind might immediately go to how much you paid for the asset in question. But, as you’re surely aware, contractors must continually account for the cost of their equipment over time. It’s a good idea to review and, if necessary, fine-tune this critical process regularly.
To begin, you must understand the real cost of owning each piece of your equipment. In addition to the purchase price, costs related to fuel, labor, maintenance, off-season or downtime storage, insurance, taxes and depreciation all play a role.
But knowing these expenses isn’t enough; you must also allocate them — as direct and indirect costs — to each job. To do so, you’ll need to match the cost of the item with its per-project use.
Establishing a consistent costing method is important for both tax and financial reporting. It’s also critical in the development of claims for delays and time extensions. Generally, you can recover anything spent on recovering costs in one claim.
Choose the right approach
One option is to use internal equipment rates. Here you estimate the cost of owning and operating each machine over its life span, determine the hourly rate you’ll need to charge to cover that cost, and charge each job that rate.
Another possibility is to include equipment costs in the amount you charge for the operator’s labor in running the machine. Once you determine the amount of time it’ll take to recoup the purchase price, you reduce the asset’s cost to an hourly rate that you add to the operator’s labor rate.
A third alternative: Charge for use based on rates published in equipment manuals such as the Rental Rate Blue Book for Construction Equipment or the U.S. Army Corps of Engineers’ Construction Equipment Ownership and Operating Expense Schedule. Remember, however, that the rates in these publications are almost always higher than actual costs.
Regardless of how you allocate your equipment costs, you’ll need to decide for tax and financial reporting purposes whether to capitalize or expense the equipment. If you don’t already have a capitalization policy in place, develop one to establish the purchase price cutoff at which you’ll expense or allocate equipment to indirect costs rather than depreciate it.
Last, beware of the effects of idle equipment. They can substantially alter your costing calculations and should be discussed with your financial advisor.
Depreciation is another key point in accounting for your equipment. Currently, under the new law (TCJA) which updated Section 179 of the Internal Revenue Code, a business can expense up to $1,000,000 in qualified new or used assets. But this amount does begin to phase out, dollar for dollar, once the taxpayer hits and exceeds $2.5 million in asset acquisitions. Please note: there is an income limitation requirement in order to claim Sec. 179 deduction. If the business is at a loss position, the Sec. 179 deduction is carried forward indefinitely.
The new law also allows 100% expensing for bonus depreciation in the first year instead of 50% and this election now available for both new and used assets. For bonus to apply, the asset must be qualified property. Additionally, there were changes to depreciation limits on luxury automobiles for the better, increasing available deductions.
Bear in mind that depreciation methods for accounting purposes may be different from those for tax purposes. From a tax perspective, depreciation is generally based on a double declining balance, meaning equipment is depreciated more in the earlier years, and then at a given percentage of the remaining balance each year.
For accounting purposes, Generally Accepted Accounting Principles (GAAP) allow various depreciation methods. Contractors often use the straight-line approach, which involves subtracting the equipment’s anticipated salvage value from the purchase price and dividing by its total estimated useful life.
But watch out: The estimated useful life of a piece of equipment may differ for tax and accounting purposes. Under GAAP, for instance, the life of a heavy truck is based on its estimated useful life. Meanwhile, the IRS establishes a “recovery period” to recover equipment costs, regardless of how long the asset is expected to last.
Know what you’ve got
Construction companies often have a variety of equipment, each piece potentially being of a different age and value. As your collection evolves, ensure your equipment costing processes still make sense. Frazer, LLP is here as a resource to double-check your numbers and suggest helpful refinements. Please contact us for help.
Brian Tunnelle, CPA, CGMA, MBA, CCIFP