Completed Contract Method

What is the Completed Contract Method?

The completed-contract method is one of the methods where the business entity decides to postpone its revenue and profit recognition till the time the project is completed or finished and usually business organizations adopt such methods when they are doubtful about the recovery of their debts.

It is the concept in accounting for the revenue recognition wherein all the revenues and the profits associated with the project is to be recognized only when the project has been finished or completed. Mainly this method is followed if a company is uncertain about the dues collection from the customer under the contract.

Completed Contract Method

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Source: Completed Contract Method (wallstreetmojo.com)

Let’s say the company opts to account for the contract received by it as per the completed contract method. Then it has to compile all costs on the balance sheet for the project before the completion of the contract. And then bill the entire fee from a customer in the income statement once the underlying contract is completed. A contract thus is assumed as completed once the remaining costs and the risks of the project are insignificant.

Completed Contract Method Example

XYZ Construction Company is provided with the contract to build a warehouse for the Strong Product Ltd. company on an urgent basis as the company doesn’t have its warehouse to keep the products. Management of XYZ expected to complete the entire project in 3 months, and for that, they decided to adopt the completed contract method.

The total cost incurredCost IncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more in the project is $700,000, and the fee that is to be received from the Strong product Ltd. is $750,000. So, XYZ Construction Company has to consider the cost of $700,000 on the balance sheet for the project. After that, the company has to bill the customer an entire $750,000 fee, which is associated with the project. Finally, recognize a profit of $50,000 and an expense of $650,000.

Advantages

Disadvantages

  • The main disadvantage of this method is that the contractor does not necessarily recognize the income in the period it is earned. As a result, there is a possibility that additional tax liability can be created as the whole project revenue will occur in a single period for tax reporting.
  • In the completed contract method of accounting, there is a disadvantage to the investor that if the project takes a long time to complete than the anticipated time, then also the contractor is not entitled to receive any extra compensation.
  • The completed-contract method can be used only by the home construction projects or other small projects. Long term contractors always prefer a percentage of completion method.
  • The clear information on the operations is not shown in the records and books.
  • If there is a loss during the completion of the project, then such losses are deductible only after project completion.

Important Points

Conclusion

As per the completed contract method of accounting, all the revenues and costs accumulate on the balance sheet until the project completion and delivery to the buyer.  Once the project is delivered to the buyer, the items in the balance sheetItems In The Balance SheetAssets such as cash, inventories, accounts receivable, investments, prepaid expenses, and fixed assets; liabilities such as long-term debt, short-term debt, Accounts payable, and so on are all included in the balance sheet.read more are then moved to the income statement. It is used by the company when unpredictability prevails with respect to the collection of the funds from customers.

In case the company is expecting to incur the loss on the contract, then it is to be recognized as and when such expectation arises. Under the completed contract approach, companies have to report the cost and revenue incurred based on the actual results. It helps the company in avoiding the errors which can be caused when estimation is made on various aspects like in case of the percentage completion method.

This article has been a guide to what is the Completed Contract Method of Accounting and its meaning. Here we top examples of the completed contract method, along with its advantages & disadvantages. You may learn more about finance from the following articles –

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