The completed contract method is one of the most popular accounting methods in the construction industry. It’s the preferred method for short-term contracts and residential projects because of its simplicity and the ability to shift costs and tax liability to the end of the project. If you manage long-term projects, you know that recognizing revenue isn’t always straightforward.

Key Benefits of the Completed Contract Method:

Under the CCM, the company would not recognize any revenue from the project until the bridge is fully completed and accepted by the client. This could result in the company showing minimal income and potentially operating losses for the first two years, followed by a substantial profit in the third year when the project is completed. This pattern could mislead stakeholders about the company’s financial health and operational efficiency during the contract period.

When to Use Completed Contract Method Work

Four commonly used methods, and what will be discussed in this article, are the percentage of completion method (PCM), completed contract method (CCM), cash method and accrual method. Under the completed contract method, you would only recognize $2,500 of revenue since you have only completed 50% of the project. net sales The completed-contract method is an accounting technique used to report revenue from long-term contracts. Under this method, contractors recognize revenue once all deliverables specified in the contract have been completed and delivered to the customer. A preferred accounting method for residential projects and other short-term contracts is that the completed contract method features simplicity due to the shifting of liability.

• The key difference, however, is that construction accounting requires you to track the financial performance of many distinct jobs at once.
• This approach differs from methods where you recognize revenue in stages as you hit certain milestones.
• Your contracts should explicitly define what constitutes „completion” or outline the milestones for progress payments.
• A contractor using the completed contract method is required to use a dedicated balance sheet to record their revenues and expenses.
• This treatment reflects the incomplete nature of the construction contract under the completed contract approach.
• In late 2024, the LB&I division issued additional guidance for developers and subcontractors engaged in the construction of improvements such as water lines, utilities, roads, sewers, and parks.

Disadvantages of CCM

The completed contract method of accounting is the practice of deferring all revenue, expenses, and gross profits until the completion or substantial completion of the project. This is a more straightforward and conservative approach than other accounting methods. It will still yield the same results as the commonly used percentage of completion method, except that revenue recognition comes at the end of the project.

However, it requires a robust system for tracking progress and costs to ensure the integrity of financial reporting. The method’s reliance on estimates also introduces a degree of subjectivity, which necessitates conservative judgment and transparency to maintain trust among stakeholders. From the perspective of a financial analyst, the Percentage of Completion Method is favored when reliable estimates of the costs to complete and the extent of progress toward completion of the contract are available. This method allows for revenue and expenses to be recognized as the work is performed, providing a more continuous reflection of financial performance over the period of the contract. From the perspective of a contractor, the CCM offers a simplified accounting process throughout the project’s duration, as it eliminates the need for ongoing revenue estimation. However, this can lead to significant fluctuations in financial results, with periods of minimal reported income followed by substantial income upon project completion.

• But, if the contractor becomes aware that the contract will end in a loss, it should be recorded on the income statement as soon as possible.
• For construction companies looking to streamline their accounting practices, consider professional assistance to ensure accurate and efficient financial management.
• For example, situations where political instability or natural disasters may interfere with project completion.
• When the job is completed at the end of year 2, final receivables are collected, and job costs have been paid, the cumulative income for regular income tax and AMT are the same, which is as it should be.
• This could lead to a surge in investor perception, as the financial statements reflect a robust financial performance.
• At completion, costs are then transferred to the income statement and matched with the recognized revenue.

Businesses often prefer the cash method because it permits more flexibility in managing the amount of taxable income reported in a tax year. For example, under the cash method, cash basis taxpayers don’t report accounts receivable as revenue until received, and expenses are deducted in the tax year actually paid. Near the end of a tax year, cash method taxpayers can defer the receipt of income and accelerate the payment of expenses to minimize taxable income for that year.

You’ll hear this concept referred to as the “matching principle.” This principle solves the biggest problem from cash basis accounting, which is the misalignment of revenues and expenses. In doing so, it can also help you gain powerful insights into the profitability and financial health of your business. For example, let’s say you won a contract to build a fence with a total contract price of $5,000 with net-60 payment terms. If you complete the fence in July, you’ll record $5,000 in revenue in July because that’s when you earned that revenue. Even if Retained Earnings on Balance Sheet you receive payment 30 days later in August, you’ll still record the revenue from this job in July to reflect when you physically built the fence and earned payment. If you incurred costs in July, you’ll recognize them in July (whether you actually received the materials or not).