The Completed Contract Method and ASC 606

Construction in Process and Progress Billings will continue to accrue until the project wraps up. Once Build-It Construction completes the contract, they may finally move these onto the income statement. To clear the full contract amount from Progress Billings, they’ll perform a debit, then credit revenue. To recognize the costs of the contract, they’ll credit Construction in Progress and debit their expenses. GAAP allows a contractor to figure the completion factor based on how much work has occurred divided by the estimated total amount of work needed. Work measurements include labor hours, labor dollars, machine hours and material quantities.

Under Sec. 460, taxpayers with long-term construction contracts must generally use the percentage-of-completion method to determine their reportable income. Next, we subtract the contract revenue recognized to date through the prior period from the recognized revenue to obtain the result in the present accounting period. The ability to create dependable contract estimates may be impaired when there are conditions present that are not normally encountered in the estimating process. Examples of these conditions are when a contract does not appear to be enforceable, there is litigation, or when related properties may be condemned or expropriated.

What Is a Work in Progress Schedule? Construction Accounting

The revenue recognition standards that ASC 606 introduced changed the equation slightly for contractors reporting under U.S. This is because instead of looking at contract completion, ASC 606 looks at the completion of performance obligations. The completed contract method is a rule for recording both income and expenses from a project only once the entire project is complete.

The completed-contract method is best suited for projects where costs and progress are difficult to estimate, many small jobs are ongoing simultaneously, and the duration of these jobs is short. Generally accepted accounting principles (GAAP) require that revenue be recognized in the period it was earned. Stored materials don’t represent completed work, so they have to be treated differently. Because income and expenses hit all at once, income statements become less useful in the short term and can show major, sudden swings. Completed-contract-method projects also must be completed under a specified timeframe.

What is the percentage of completion method?

A primary advantage of the percentage-of-completion method over the completed-contract method is that it reports income evenly over the course of the contract. As a result, it presents a more accurate picture of a construction company’s financial position. The cost-to-cost method uses the formula actual job costs to date / estimated job costs. This percentage is then multiplied by estimated revenue to get the contract earned. Once upon a time, contractors essentially chose between a contract-complete method or a percentage-of-completion method for recording revenue.

To calculate how much revenue they’ve earned for a billing period, the contractor might choose a method such as cost-to-cost or estimated percent to complete. One glaring disadvantage of the percentage of completion method is that it can be easily abused. In conditions where litigation exists, where the contract looks unenforceable, or issues exist with some of the properties related to the project or contract, do not use the percentage of completion method. If there is an expectation of a loss on a contract, record it at once even under the completed contract method; do not wait until the end of the contract period to do so.

Over Time

Therefore, if the project is deemed to be 40% complete, the business would report 40% of the $4 million project revenue ($4 million x 0.4). This calculation will result in a current gross profit of $400,000 ($4 million x 0.4) – ($3 million x 0.4). Regardless of the accounting method your construction business is using, it’s important to take steps to secure your payments on every project. This means the contractor can recognize half of the total revenue for the project. If the contract is for $120,000, the contractor would record revenue of $60,000 for the period, which would be reflected in their income statement. For example, a project that has estimated costs of $100,000 has incurred $50,000 in costs so far.

There’s no more Jones Realty to take control of the performance obligation — or to pay them! Avoiding “phantom revenue” from this situation is one reason why it’s good they don’t record their collections as income right away. In this case, however, Build-It should be able to finish the property and turn it over to another buyer. And this demonstrates another reason why point-in-time recognition may be appropriate for them to use. Once they do, their costs and income will shift from the balance sheet to their income statement.

Who Uses the Percentage of Completion?

Though a construction company may enjoy a break from taxes during the working phase—and sometimes may even qualify for certain tax incentives in the meantime—this method can be a riskier way to account for operations. Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser. The Work In Progress (WIP) schedule is an accounting schedule that’s a component of a company’s balance sheet. Underbilling occurs when a contractor does not bill for all the labor and materials delivered in a billing cycle. Underbilling is the opposite scenario, when the amount billed to date is less than the recognized revenue. Carbon Collective is the first online investment advisor 100% focused on solving climate change.

Join the free certificate course to learn the foundations of financial management and accounting in construction, taught by the man who wrote the textbook (literally). We follow ethical journalism practices, which includes presenting unbiased information and citing reliable, https://personal-accounting.org/completed-contract-method-of-revenue-recognition/ attributed resources. Much of our research comes from leading organizations in the climate space, such as Project Drawdown and the International Energy Agency (IEA). Carbon Collective partners with financial and climate experts to ensure the accuracy of our content.