Completed-contract method

Definition

The completed-contract method is an accounting approach used to recognize revenue and expenses only when a long-term project is fully completed. This method is particularly relevant for contracts where the outcome cannot be reliably estimated until the project is finished, allowing companies to avoid recognizing revenue prematurely. It contrasts with other methods that might recognize revenue incrementally over time, offering a clearer financial picture at the project's conclusion.

5 Must Know Facts For Your Next Test

1. The completed-contract method is often used in industries such as construction and engineering, where projects can span several years and their outcomes are uncertain.
2. Under this method, all costs incurred during the project are accumulated and reported as expenses only upon completion, which can lead to large fluctuations in reported income.
3. Companies using the completed-contract method must ensure that they are able to clearly identify when a project is finished before recognizing any revenue.
4. This method can help reduce the risk of misstatements in financial reports, as it avoids recognizing revenues or profits until there is certainty about project completion.
5. The completed-contract method is permitted under both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), but each framework has specific guidelines on its application.

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 revenue only when a project is fully completed, while the percentage-of-completion method recognizes revenue incrementally based on the proportion of work completed at various stages. This difference means that under the completed-contract method, all expenses related to a project are also recorded at once upon completion, which can result in more volatile income statements compared to the smoother income recognition provided by the percentage-of-completion method.
• What are some advantages and disadvantages of using the completed-contract method for long-term contracts?
  • Advantages of the completed-contract method include reduced risk of misstatement in financial reports due to the avoidance of premature revenue recognition, and it provides a clear view of profit once a project is complete. However, disadvantages include potential large fluctuations in reported income and cash flow issues, as expenses are recognized upfront and income only recognized upon completion, which may not reflect ongoing business performance accurately during the project duration.
• Evaluate how a company's choice between using the completed-contract method versus other revenue recognition methods can impact its financial reporting and stakeholder perception.
  • A company's choice between the completed-contract method and other revenue recognition methods can significantly impact its financial reporting. For instance, if a company consistently uses the completed-contract method, it may experience large swings in reported income based on when projects are finished, potentially leading stakeholders to view its earnings as less stable or predictable. Conversely, employing a percentage-of-completion method might provide smoother income reporting and better align with ongoing operations. Stakeholders may perceive companies using more progressive methods as being more transparent and operationally effective, influencing their investment decisions and overall trust in the company.

Related terms

Percentage-of-Completion Method: An accounting method that recognizes revenue and expenses as a project progresses, based on the percentage of work completed.

Contract Revenue: The total revenue expected to be earned from a long-term contract, which can be recognized based on the chosen accounting method.

Cost Estimation: The process of predicting the total costs associated with a project, crucial for determining whether to use the completed-contract method or another revenue recognition approach.