The Completed-Contract Method (CCM) is an accounting technique wherein the revenue and expenses of a long-term contract are recognized only upon the project’s completion. This method contrasts sharply with the Percentage of Completion Method (PCM), where revenues and expenses are reported as work progresses.
Definition
In the Completed-Contract Method, a contractor defers both the recognition of revenue and the expenses until the entire project is finalized. Therefore, the net profit for the project is recorded entirely in the accounting period when the contract is completed.
Detailed Explanation
Accounting Procedures
- Revenue Recognition: Under CCM, no revenue is reported during the ongoing phases of the contract.
- Expense Recognition: Expenses are similarly deferred and recorded only in the year the contract is completed.
- Financial Reporting: Profit is calculated as follows once the contract is complete:
$$ \text{Net Profit} = \text{Total Revenue} - \text{Total Expenses} $$
Applicability
- Home Construction Contracts: Allowed for tax purposes under specific guidelines for home construction projects.
- Certain Small Contracts: Small-scale construction contracts, subject to regulatory limitations, can also use this method for tax reporting.
Special Considerations
- Tax Implications: Since revenue and expenses are matched in the same fiscal year, temporary differences between book and tax income are minimized.
- Revenue Fluctuations: The method may cause significant fluctuations in revenue across different accounting periods.
- Risk: Over the life of the project, this method could potentially hide performance issues until the project’s completion.
Historical Context
The Completed-Contract Method has been a historically preferred approach for some contractors due to its simplicity and deferment benefits. However, its use is restricted under the Internal Revenue Service (IRS) guidelines primarily to certain constructions.
Comparisons
- Percentage of Completion Method (PCM): In contrast to CCM, PCM recognizes revenue and expenses proportionally as the contract progresses, reducing volatility in financial statements.
Related Terms
- Long-Term Contracts: Contracts that span over a year or more requiring different accounting methods.
- Revenue Recognition: Principles on how and when to recognize revenue in accounting.
- Deferred Revenue: Liability accounts used in the CCM before completion.
FAQs
Q1: Can every contractor use the Completed-Contract Method?
Q2: How does CCM affect financial reporting?
Q3: What happens if a contract is unexpectedly terminated?
References
- IRS Publication 537, “Installment Sales” for detailed IRS guidelines.
- Financial Accounting Standards Board (FASB) for accounting standards updates.
Summary
The Completed-Contract Method defers revenue and expense recognition to the year of contract completion, offering simplicity and certain tax advantages. Its restricted applicability to specific contracts and potential for causing fluctuations in financial reporting must be carefully considered.
