Construction is a unique industry, and because of that, it has several unique (and potentially complicated) accounting methods and rules. The good news though, is that you don’t necessarily have to follow one set standard. Depending on your business’s needs, you can choose the methodology that works best for you.
One accounting method contractors can use to recognize revenue and expenses is called the completed contract method (CCM). Unlike the percentage of completion method, this approach is used to report income and expenses after a contract is completed. In this quick guide, we’ll take a closer look at everything this strategy entails, and where it’s most useful.
Key Takeaways
- In construction, CCM is an accounting method that allows companies to defer revenue and expense reporting until after a contract is completed.
- The completed contract method is particularly useful for companies working on short-term contracts with highly unpredictable scope and/or timelines.
- For internal stakeholders, CCM can be a much more straightforward accounting method to use, though it might not offer the most nuanced view of your company’s finances.
What is the Completed Contract Method?
The completed contract method (CCM) is a construction accounting method that’s primarily used for revenue recognition. As its name implies, this approach allows construction companies to recognize all revenue, expenses, and gross profit after a project has been completed. It’s a particularly useful method of accounting when it comes to short-term contracts, and/or those with an unpredictable timeline and set of costs.
With CCM, the revenue from a contract is matched with the costs incurred, allowing you to reflect the actual financial outcome of the contract in the accounting period the work was completed in. This ensures your financial statements represent a clear and accurate picture of each specific contract. What’s more, the completed contract method not only impacts your tax liabilities but also the perceived financial health and performance of your construction firm overall, which is why it’s important to recognize revenue at the right time when using this approach.
TL;DR – The completed contract method is a construction accounting technique used to recognize revenue and profit once a contract is fully completed. The main goal of using CCM is to get a clear, straightforward measure of profitability on a per-contract basis, especially on shorter contracts with a relatively unpredictable scope and costs.
Key characteristics of the completed contract method include:
- Revenue Recognition: Revenue and associated costs are only recorded when a contract is fully completed.
- Profit Calculation: Profit is determined at the end of the contract, providing a lump-sum margin that reflects the entire project.
- Tax Implications: Taxes on the income from the contract are deferred until completion, which can affect cash flow and financial planning.
- Simplicity: Because this method doesn’t require ongoing estimation of progress, CCM is an easier method than percentage-of-completion.
If you typically work on short-term projects with outcomes that aren’t well-defined, this could be a useful accounting method.
When Can You Use the Completed Contract Method in Construction?
The completed contract method is particularly beneficial when there’s a high chance of unpredictability and uncertainty around a job’s revenue and completion date.
Unpredictability in Total Costs
Let’s say you’re building out a shell for a tenant and they have no idea what they want to build, but they want to go ahead and mobilize you to get started on the basics. Or maybe you’re working on a job that’s experiencing frequent change orders. Either way, these are the kinds of unpredictable scenarios when CCM is a good accounting approach to use.
Uncertainty in Completion Date
CCM is also appropriate when a job’s timeline is in danger of being impacted, either by extreme weather, changes in law, or simply because of the project’s complexity.
Recognizing Revenue With the Completed Contract Method
By deferring revenue and expense recognition, using CCM ensures that your company’s financial outcomes will be reported only after a contract is finished. Here’s a more detailed breakdown of how revenue recognition, cost allocation, and financial reporting work under this method.
Revenue Recognition
Under the Completed Contract Method, revenue is recognized when a contract is fully completed. This means no revenue is reported on your income statement during the construction period, regardless of any payments received or work completed. Once the project is finalized and the client accepts the work, the total contract revenue is recognized.
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Cost Allocation
Costs are accumulated during the project but are not matched with revenue until completion. These costs include direct costs like materials, labor, equipment, subcontractor, and other costs, along with indirect costs like job site utilities, rentals, and insurance.
Costs are recorded on your balance sheet as a work-in-progress (WIP) asset until the project is completed. At completion, costs are then transferred to the income statement and matched with the recognized revenue.
Financial Reporting
CCM’s impact on financial reporting is pretty significant, especially for long-term contracts. On the balance sheet, the Work in Progress has an asset that shows costs incurred to date – and any advance payments from customers are recorded as a liability. On the income statement, full contract revenue and associated costs will only appear after project closeout.
This means that your financial statements will only reflect the actual performance of the construction project at the end of the contract, offering a more conservative view of your financial position during your work on the job.
Disadvantages of the Completed Contract Method
While there are several advantages to using the completed contract method of accounting, it can also lead to uneven revenue recognition, along with some potential challenges in consistent cost calculation throughout a project.
Uneven Revenue Flow
Because of the timing of when revenue is received, CCM can lead to large valleys and spikes in your revenue flow, potentially making it harder to conceptualize overall revenue for your company in the short term. Even if you’re using a combination of PoC and CCM reporting, you’ll need to make sure you’re still projecting your revenue as best as possible.
Inaccurate Cost Estimates
The completed contract method requires total costs to be estimated upfront and accumulated throughout the project. Given the long duration of many construction projects, your initial project cost estimates can be inaccurate, making it more likely you’ll have to make financial adjustments once the contract is completed. If the cost were to change, for instance, you’d have to make adjustments to your estimates.
Without recognizing revenue as your work progresses, it can be hard to correctly allocate costs to the right accounting period, which can lead to skewed financial results.
An Example of How CCM Works
Here’s a real-world example of how you can apply the completed contract method in your accounting.
Say you’re awarded a contract for $1,000,000 by Bill the Developer in June, and you don’t know when you’ll finish the project. You believe you could make 10% profit on the project when it’s done, no matter when you finish it. You’ll have costs you pay and billings to collect as you are doing the project, and in this example, it takes you untill the next year in July to finish the project. You would record the cost to Construction in Progress in your accounting system.
You could potentially think about this account like some manufacturing companies do: When a manufacturing company takes raw materials and builds products out of them, they have a Goods/Works in Progress which turn into Inventory/Finished Goods when it is finished. CCM is a similar process to this: when you complete the project, you have delivered a finished product.
Back to our example: In year one, you had $400,000 worth of cost, you billed $550,000, and were paid $500,000. The entries for the billings and what you would have been paid would be like any normal entry in your accounting system. The one journal entry that would be different in year one would be the Construction in Progress entry.
Here’s what this could look like:
Year One
| Debit | Construction in Progress | $400,000 |
| Credit | Bank Account | $400,000 |
In year two, you had $450,000 in cost, billed $450,000, and were paid the remaining $500,000. You’re now going to record the revenue and expenses. The entries which are different will again be the Construction in Progress entry, and also the Revenue and Expense entries.
Year Two
Costs Incurred
| Debit | Construction in Progress | $450,000 |
| Credit | Bank Account | $450,000 |
| Revenue | Billings will need to be offset | |
| Debit | Billing – Bill the Developer | $1,000,000 |
| Credit | Revenue | $1,000,000 |
| Expense | Expenses are recognized and Construction in Progress is offset | |
| Debit | Direct Construction Costs | $850,000 |
| Credit | Construction in Progress | $850,000 |
Completed Contract vs. Percentage of Completion Method
When accounting for your contracts, your choice between the completed contract method or percentage of completion method can have significant implications for your revenue recognition and presentation of financial statements.
If you’re trying to figure out which method is best for your business, consider this:
CCM is More Straightforward for Internal Stakeholders
The completed contract method is going to be much more straightforward and easy to understand for you and those working in your company because of how it defers revenue/expense recognition. Still, while this approach can offer more clarity at the completion of the contract, it can make it harder to get the full financial picture during the actual term of the contract. If you decide to use this method, just remember that you’ll continue to bill your customer, suppliers, employees, and other contractors during the job.
On the other hand, the percentage of completion method can offer you a more nuanced view of financial progress by recognizing revenue and expenses in proportion to the completeness of the contracted work (in accordance with Generally Accepted Accounting Principles, or GAAP)
PoC Can Be More Informative for External Stakeholders
Given that financial statements are an important decision-making tool, stakeholders outside your company may find the percentage of completion method more informative. PoC reflects ongoing performance and can facilitate smoother income recognition over time.
Meanwhile, the completed contract method might be less intuitive for external stakeholders. The fluctuations in income and expenses can drastically alter the financial portrayal of a company from one period to the next, especially when looking at it on a monthly basis.
Should You Take a Job That Uses the Contracts Complete Method?
If you’re a contractor considering taking on a job that uses CCM, make sure you understand the business context. If your client (or the construction industry overall) is facing uncertainty, this method can help you take a conservative approach to your financials. On a more long-term job where revenue recognition over time better reflects work completed, you might find that PoC is a better method for you.
One of the biggest considerations to think about when it comes to CCM is the question of when the project will actually be done. If a project’s scope and timeline isn’t well-defined, consider if it would actually be a good fit for your business. If you can figure out a job’s potential date of completion, it can make it easier to plan out what you’ll be bidding on next.
If you take all of these factors into consideration, CCM can be a great accounting tool for construction businesses – especially if your goal is to minimize potential tax liabilities.
Want to dive deeper into the building a more profitable construction accounting system? Check out our Ultimate Guide to Construction Accounting.