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
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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.
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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
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“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
This book covers various accounting methods comprehensively, including the completed-contract method.
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“Accounting for Dummies” by John A. Tracy
Offers a straightforward look at accounting principles and methods in a digestible format.
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“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
### What is the primary accounting basis under the completed-contract method?
- [ ] Revenue and expenses are recognized as incurred.
- [x] Revenue and expenses are recognized upon completion of the contract.
- [ ] Revenue is recognized as incurred, expenses upon project completion.
- [ ] Expenses are recognized as incurred, and revenue upon project completion.
> **Explanation:** The completed-contract method defers the recognition of revenue and expenses until the completion of the project.
### Which type of project is typically suitable for the completed-contract method?
- [ ] Large infrastructure projects
- [x] Small home construction contracts
- [ ] Continuous service agreements
- [ ] Non-profit tasks
> **Explanation:** This method is particularly suited for small home construction contracts and certain other small construction projects.
### What is one benefit of using the completed-contract method?
- [ ] Immediate tax recognition
- [x] Simplicity in accounting
- [ ] Immediate revenue recognition
- [ ] Continual cost distribution
> **Explanation:** It simplifies accounting for projects where cost estimates are tough to assess as revenue and expenses are only recognized at completion.
### Under which scenario might the completed-contract method cause issues?
- [x] When the company's financial performance is expected to be transparent periodically.
- [ ] When project risks are high.
- [ ] When contract modifications are prevalent.
- [ ] When labor costs inflate.
> **Explanation:** It can cause issues when periodic financial transparency is required because revenue and expenses are only recognized at completed points, which may not reflect ongoing performance.
### How does the completed-contract method impact tax liability?
- [ ] Increases immediate tax liability
- [x] Defers tax liability until project completion
- [ ] Reduces overall tax liability
- [ ] Has no effect on tax liability
> **Explanation:** This method defers the tax liability to the accounting period in which the related project's revenue is recognized.
### Can the completed-contract method be used for public company financial reporting?
- [ ] Yes, always
- [ ] No, never
- [x] Generally no but can be used for specific tax purposes
- [ ] Only for international contracts
> **Explanation:** Generally, public companies may not use this method for financial reporting, but it can be utilized for specific tax purposes.
### What is deferred until a contract's completion under the completed-contract method?
- [ ] Only expenses
- [x] Both revenue and expenses
- [ ] Only revenue
- [ ] Nothing
> **Explanation:** Both revenue and expenses are deferred until the completion of the contract.
### In which instance might a company prefer the percentage of completion method instead?
- [x] When progress can be reliably estimated
- [ ] To simplify tax filing
- [ ] For financial unpredictability
- [ ] When immediate revenue recognition isn't needed
> **Explanation:** When progress can be reliably estimated, identifying revenue per progressive completion can provide better insights into the company’s financial performance.
### What type of estimate poses a challenge to the completed-contract method?
- [ ] Labor estimates
- [ ] Material cost estimates
- [ ] Overhead allocation estimates
- [x] Progress completion estimates
> **Explanation:** Reliable progress completion estimates are crucial but often challenging, thus supporting the use of this method for projects where such estimates can be inconsistent.
### When a contract is completed, when do expenses relating to the project get recognized?
- [ ] After revenue recognition
- [x] At the same time as revenue recognition
- [ ] Before project starts
- [ ] Progressively throughout the contract
> **Explanation:** Expenses are recognized simultaneously with revenue when the project is completed, aligning with the completed-contract method principles.
Thank you for engaging in our comprehensive review of the completed-contract method and tackling these challenging quiz questions. Keep striving for excellence in your accounting knowledge!
