Completed contract method

Definition

The completed contract method is an accounting approach used to recognize revenue and expenses on long-term contracts only when the contract is fully completed. This method is especially relevant for construction and manufacturing industries, as it allows companies to defer revenue recognition until the project is entirely finished, providing a clearer picture of profitability and financial performance at that point.

5 Must Know Facts For Your Next Test

1. The completed contract method can lead to significant fluctuations in reported income since all revenue and expenses are recognized at once upon completion of the project.
2. This method is often preferred when projects are not easily estimated, reducing the risk of recognizing revenue prematurely.
3. Companies using the completed contract method may face different tax implications compared to those using the percentage of completion method, especially regarding when income is recognized for tax purposes.
4. The completed contract method can sometimes create challenges in assessing ongoing project performance, as no revenue or expense information is available until project completion.
5. This method is allowed under both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), but its use may vary based on the specific industry context.

Review Questions

• How does the completed contract method differ from the percentage of completion method in terms of revenue recognition?
  • The completed contract method recognizes all revenue and expenses only when a project is fully completed, resulting in income being reported at one point in time. In contrast, the percentage of completion method recognizes revenue gradually as work progresses on a long-term project. This difference impacts financial reporting, as one method can show steady income over time while the other may cause significant fluctuations in reported earnings.
• What are some potential advantages and disadvantages of using the completed contract method for accounting long-term projects?
  • Advantages of the completed contract method include reduced risk of premature revenue recognition and clearer visibility on project profitability upon completion. However, disadvantages include possible income volatility, as earnings may not reflect ongoing project performance during its duration. This can also complicate financial analysis for stakeholders who are interested in continuous performance metrics throughout the project's lifecycle.
• Evaluate the implications of using the completed contract method on a company's financial statements and tax obligations over time.
  • Using the completed contract method can significantly affect a company's financial statements by concentrating all revenue and expenses into a single reporting period, which may obscure ongoing operational performance. For tax obligations, companies might experience timing differences in income recognition compared to cash flow, as taxes are often assessed based on realized income. This could lead to periods of fluctuating taxable income and affect cash flow management strategies for businesses engaged in long-term contracts.

Related terms

percentage of completion method: An accounting method where revenue and expenses are recognized based on the percentage of work completed on a long-term project, allowing for revenue recognition throughout the life of the contract.

contractual obligations: Legal commitments in a contract that outline specific responsibilities, deliverables, and timelines for both parties involved in a project.

revenue recognition principle: A fundamental accounting principle that dictates how and when revenue is recognized, ensuring that it is recorded in the period it is earned, regardless of when cash is received.