Completed-contract method

Definition

The completed-contract method is an accounting approach used for recognizing revenue and expenses associated with long-term contracts. Under this method, revenue and expenses are only recognized once the contract is fully completed, which helps ensure that all costs and income are matched together at the end of the project. This method is especially beneficial in industries where projects take a long time to complete, as it allows for clearer financial reporting at the project's conclusion.

5 Must Know Facts For Your Next Test

1. The completed-contract method is often used in construction and other industries where the duration of contracts can span several years.
2. This method can lead to significant fluctuations in reported income and expenses since all related amounts are recorded at once upon completion.
3. It is more conservative than the percentage-of-completion method, as it prevents premature revenue recognition before project completion.
4. If a project experiences losses while using this method, those losses are also recognized only when the project is completed.
5. The completed-contract method may not be permitted under certain accounting standards if the outcome of the contract can be estimated reliably.

Review Questions

• How does the completed-contract method align with the principles of revenue recognition and expense matching?
  • The completed-contract method aligns with revenue recognition principles by deferring revenue until a project is fully completed. This approach ensures that expenses incurred during the contract are matched with the corresponding revenue only when all aspects of the project are finalized. This enhances the accuracy of financial statements by preventing the recognition of income that may not be realized until later, thereby supporting the expense matching principle.
• Discuss the advantages and disadvantages of using the completed-contract method compared to other long-term contract accounting methods.
  • One major advantage of using the completed-contract method is its simplicity; it eliminates complexities associated with estimating progress on long-term contracts. However, a key disadvantage is that it can lead to significant swings in reported earnings since all revenue and expenses are recorded at once upon completion. This can create volatility in financial statements and may not accurately reflect a company's performance during the contract's duration compared to methods like percentage-of-completion.
• Evaluate how the choice between using the completed-contract method and percentage-of-completion can impact financial decision-making within a business.
  • The choice between using the completed-contract method and percentage-of-completion can have substantial implications for financial decision-making. If a company opts for the completed-contract method, it may face sudden spikes or drops in reported income, affecting its ability to secure financing or attract investors. Conversely, using percentage-of-completion provides a more gradual recognition of revenue, offering stakeholders a clearer picture of ongoing profitability. This choice influences not only internal management decisions but also external perceptions of financial stability and performance.

Related terms

percentage-of-completion method:

A revenue recognition method that recognizes income and expenses proportionately as work on a long-term contract progresses.

contract cost: The total costs incurred by a contractor to complete a long-term project, including materials, labor, and overhead.

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