Completed contract

Definition

A completed contract is a method of revenue recognition in accounting where revenue and expenses related to a long-term project are recognized only when the project is fully completed. This approach contrasts with other methods, as it defers all revenue and expense recognition until the final completion, reflecting a conservative stance in financial reporting.

5 Must Know Facts For Your Next Test

1. The completed contract method is often used in construction and similar industries where projects may span multiple accounting periods.
2. By using this method, companies can avoid estimating costs and revenues, which can lead to potential inaccuracies in financial statements.
3. The completed contract approach provides clarity for stakeholders by showing the project's financial outcomes only upon completion, simplifying financial reporting.
4. If a contract is terminated before completion, companies must assess the percentage of work completed and recognize any applicable revenue or losses.
5. Companies must disclose their accounting policies related to revenue recognition in their financial statements, providing transparency to investors.

Review Questions

• How does the completed contract method differ from the percentage of completion method in terms of recognizing revenue?
  • The completed contract method recognizes revenue only when a project is fully completed, while the percentage of completion method allows for revenue to be recognized proportionally as work progresses. This means that under the completed contract method, there is no revenue or expense reported until project completion, which may provide less immediate insight into ongoing project performance compared to the percentage of completion method that reflects ongoing financial activity.
• Discuss the advantages and disadvantages of using the completed contract method in long-term projects.
  • The completed contract method has the advantage of simplicity and clarity since it defers all revenue and expense recognition until project completion, which can help prevent errors in estimating revenues. However, a significant disadvantage is that this approach may not provide timely financial information to stakeholders about ongoing operations. Additionally, during long projects, it may lead to large fluctuations in reported earnings once the project is completed, which could mislead investors regarding a company's performance over time.
• Evaluate how changes in accounting principles might impact a company's decision to switch from the completed contract method to another revenue recognition method.
  • Changes in accounting principles, such as new regulations or standards from governing bodies like the FASB or IASB, might prompt a company to reconsider its use of the completed contract method. If these changes favor more proactive methods like percentage of completion, companies may find benefits in providing more timely financial insights into their ongoing projects. Such a transition could enhance stakeholder engagement by presenting a clearer picture of business performance over time, but it would require careful planning and communication to manage any resulting fluctuations in reported earnings during the transition period.

Related terms

percentage of completion: A revenue recognition method where revenues and expenses are recognized proportionally as work on a project progresses.

revenue recognition: The accounting principle that determines the specific conditions under which income becomes realized as revenue.

contract accounting: The area of accounting focused on the financial reporting of contract-related activities, including revenue recognition and expense matching.