Completed Contract Method Definition
The completed contract method is also known as the contract completion method. It is a form of revenue recognition used for project based accounting such as construction. The completed contract method of accounting records all revenue earned on the project in the period when a project is done.
Completed Contract Method Meaning
The Completed Contract Method of revenue recognition is normally only used in the short-term. For example, projects that last less than a year are considered short-term. It is anything over a year, then most firms prefer the percentage of completion method because it paints a more realistic picture in the long term. However, for firms that are more conservative the complete contract method becomes appropriate because the revenue will not be recognized until the total cost has been accounted for and all the revenue has been received.
Completed Contract Method Example
The following represents an example to help explain completed contract method accounting:
Bob works for Whistle-at-You Construction Co. (WAY). He has obtained the following information via a contract with a company. This company is in need of refurbishing some office space. Whistle-at-You believes that they will be able to complete the project in 8 months. WAY uses the completed contract method of revenue recognition when it is dealing with projects that will only lasts under a year. The contract states that the company will pay WAY $5 million upon completion of the project. The estimated costs equal $4 million.
At the end of the construction, which ended up being 9 months instead of 8 months, the company pays the $5 million to WAY. But the actual cost for the project amounted to $4.5 million dollars. Because the project is completed Bob will recognize revenue in the amount of $5 million and the actual cost of construction of $4.5 million. Therefore, he will correctly state the income at $500,000.
Note: If Bob had used the percentage of completion method, then the company would have made some adjusting entries to correct for the extra costs and the extended month. This is one major advantage that completed contract method revenue recognition has over the percentage completion method.