The completed contract method is used to recognize all of the revenue and profit associated with a project only after the project has been completed. This method is used when there is uncertainty about the collection of funds due from a customer under the terms of a contract.
This method yields the same results as the percentage of completion method, but only after a project has been completed. Prior to completion, this method does not yield any useful information for the reader of a company’s financial statements. However, the delay in income recognition allows a business to defer the recognition of related income taxes.
Also, since revenue and expense recognition only occurs at the end of a project, the timing of revenue recognition can be both delayed and highly irregular. Given these issues, the method should only be used under the following circumstances:
- When it is not possible to derive dependable estimates about the percentage of completion of a project; or
- When there are inherent hazards that may interfere with completion of a project; or
- When contracts are of such a short-term nature that the results reported under the completed contract method and the percentage of completion method would not vary materially.
If a contract is being accounted for under this method, record billings issued and costs incurred on the balance sheet during all periods prior to the completion of the contract, and then shift the entire amount of these billings and costs to the income statement upon completion of the underlying contract. A contract is assumed to be complete when the remaining costs and risks are insignificant.
If there is an expectation of a loss on a contract, record it at once even under the completed contract method; do not wait under the end of the contract period to do so.
Example of the Completed Contract Method
Logger Construction Company is building housing for a disaster relief agency, and is doing so at great speed, so that displaced citizens can move in as soon as possible. Logger’s management expects that the entire facility will be complete in just two months. Given the short duration of the project, Logger elects to use the completed contract method. Accordingly, Logger compiles $650,000 of costs on its balance sheet over the period of the project, and then bills the customer for the entire $700,000 fee associated with the project, recognizes the $650,000 of expenses, and recognizes a $50,000 profit.