Completed-Contract Method

The completed-contract method is an accounting approach where net profit on a long-term contract is reported only when the contract is fully completed. Pre-completion expenses are also deferred until the project is finished.
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Definition

The completed-contract method (CCM) is an accounting technique used to defer all revenue and expense recognition until the completion of a long-term project. This method is primarily used for fixed-price contracts where the extent of the project’s completion may be difficult to estimate, or where there are uncertainties about the collectibility of the project costs.

Examples

  1. Home Construction Project:

    • A small construction company undertakes a home building project. Instead of recognizing revenue and expenses as the project progresses, the company will report all profits and deduct all related costs in the tax year when the home construction is completed.

  2. Software Development Contract:

    • A tech firm enters into a contract to develop a custom software system over two years. The company will defer recognizing revenue and expenses until the software system is delivered and accepted by the customer at the end of the contract.

Frequently Asked Questions

What are the main benefits of the completed-contract method?

  • Simplicity: Simplifies accounting for projects where cost estimates and project completion progress are challenging to assess.
  • Tax Deferral: By deferring revenue recognition, companies can potentially defer tax liabilities until the project completion date.

When is the completed-contract method typically used?

The completed-contract method is generally used for home construction contracts and small construction projects. It is also applicable when consistent and reliable project completion estimates are challenging to obtain.

What are some limitations of the completed-contract method?

  • Revenue Uncertainty: Delays profit recognition, which might not accurately reflect company performance within fiscal periods.
  • Limited Use: Not applicable for financial reporting under Generally Accepted Accounting Principles (GAAP), primarily used for specific tax purposes.

Is it allowed for all types of construction contracts?

No. Generally, it is only applicable for small construction contracts and not large-scale construction projects except under certain documented circumstances agreed upon by tax authorities.

Percentage of Completion Method (POC)

An accounting method where revenue and expenses are recognized based on the project completion percentage. Useful for long-term projects where progress can be reliably estimated.

Fixed-price Contract

A contract where the payment amount does not depend on resources used or time expended.

Revenue Recognition

An accounting principle that determines the specific conditions under which revenue is recognized and defines how to account for it.

Deferred Revenue

Money received by a business for goods or services yet to be delivered or performed.

Online References

Suggested Books

  1. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
    This book covers various accounting methods comprehensively, including the completed-contract method.

  2. “Accounting for Dummies” by John A. Tracy
    Offers a straightforward look at accounting principles and methods in a digestible format.

  3. “Construction Accounting and Financial Management” by Steven J. Peterson
    Targeted toward the construction industry, this book provides detailed insight into various accounting methods used in construction, including the completed-contract method.

Fundamentals of Completed-Contract Method: Accounting Basics Quiz

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