Completed Contract Method Defined, With Examples

Construction accounting is its own specialized field, with unique revenue recognition challenges derived from long-term projects and uncertain completion timelines. One way companies can simplify revenue recognition is to opt for the completed contract method (CCM) of accounting, but this approach is limited under current Generally Accepted Accounting Principles (GAAP) guidelines, making it a better fit for smaller, private companies than for larger ones. Here’s how CCM works, how it relates to GAAP, and why the percentage completion method (PCM) is often preferred by construction companies.

What Is the Completed Contract Method (CCM)?

CCM is an accounting approach that defers the recognition of all revenues and expenses associated with a contract until the entire project is fully completed. During the project, the company tracks costs and any payments received on its balance sheet, but it doesn’t officially record them as profit or loss in its financial statements until the project is finished. CCM is usually used for projects where final costs and timelines are difficult to estimate, making it particularly relevant to the construction industry.

Key Takeaways

• CCM is a revenue-recognition approach used in construction accounting.
• CCM is straightforward in that it recognizes revenue upon project completion, rather than over time.
• In order to use CCM, a company and project must meet specific requirements, and its use is restricted under GAAP.
• Therefore, CCM is generally more applicable to smaller, private construction firms.

The Completed Contract Method Explained

The core principle of CCM is straightforward: Delay profit recognition until a project is finished to avoid the risk of overstated profits on incomplete work. This conservative approach aligns income and expenses with the certainty of a project’s outcome.

A major advantage of CCM in construction accounting is its ability to minimize the risk of reporting inaccurate profits on projects with uncertain outcomes. Consider a construction company taking on a two-year project to build an offshore wind farm with an estimated profit of $5 million. Unforeseen obstacles—materials cost inflation, labor disputes, regulatory changes, geological challenges, adverse weather conditions—could significantly increase costs and chip into, or even eliminate, profits. By waiting to recognize profits until the project is completed, CCM avoids prematurely reporting inaccurate gains.

Still, this method has notable drawbacks. GAAP limitations aside (more on that to come), CCM can lead to significant fluctuations in reported income from year to year, especially for companies with only a small number of large projects. For example, a shipbuilding company that completes one large vessel every two years might report no profit in Year 1, followed by a substantial $50 million profit in Year 2 when the ship is delivered. This volatility can make it harder to assess the company’s ongoing financial performance, even when work was performed consistently across both years.

CCM Requirements

To use CCM, GAAP requires that the construction contract must be relatively short-term, which generally refers to contracts expected to be completed within a year or less. CCM can be used for long-term contracts if the company is genuinely unable to reasonably and dependably estimate project completion progress or the total costs required to complete the project. This usually relates to projects with significant uncertainties, such as those involving unpredictable site conditions, complex regulatory requirements, or any other circumstances that make reliable estimation difficult. Private companies generally have more flexibility when using CCM, since they’re not legally required to follow GAAP unless mandated by creditors, investors, or other stakeholders.

CCM Example

Consider BuildRite, a hypothetical private construction firm that signs a three-year contract to build a manufacturing facility for $10 million. It’s a complex project with unique requirements, making it a suitable candidate for CCM.

In Year 1:

• BuildRite incurs $2 million in costs, recorded as an asset on the balance sheet and labeled as “construction in progress.”
• The client pays a $3 million advance, recorded as a liability on the balance sheet and labeled as “billings on uncompleted progress.”
• No revenue or expense is recognized on the income statement.

In Year 2:

• BuildRite incurs an additional $4 million in costs, increasing the construction-in-progress asset to $6 million.
• The client pays another $4 million, increasing the billings-on-uncompleted-progress liability to $7 million.
• Still no revenue or expense is recognized on the income statement.

In Year 3:

• The project is completed.
• BuildRite incurs final costs of $3 million, for a total project cost of $9 million.
• The client pays the remaining $3 million.
• Revenue of $10 million and expenses of $9 million are recognized on the income statement, resulting in a profit of $1 million.
• Both the construction-in-progress asset and billings-on-uncompleted-progress liability are reduced to zero.

Note that this example is simplified. In practice, there might be additional considerations, such as potential losses. These losses would need to be recognized immediately, even under CCM.

Completed Contract Method Journal Entries

When using CCM, journal entries during the project’s life cycle primarily focus on balance sheet accounts, with minimal impact to the income statement until the project is completed. This method of journaling reflects the core principle of CCM: postponing profit or loss recognition until the contract is substantially complete and the final outcome is known with certainty.

During a project’s life cycle, costs are recorded as assets as they are incurred and are usually labeled as construction in progress or similar. Under CCM, costs are recorded as an asset because they represent works in progress. Any payments received from customers are recorded as liabilities and are often labeled as billings on uncompleted progress, customer advances, or similar. Though it may seem counterintuitive, cash from the customer is a liability because the company has an obligation to fulfill the contract in order to earn the revenue. Once the project is completed, all accumulated revenues and expenses are moved to the income statement—unlike in the standard accrual method of accounting, which recognizes revenue and expenses as they are earned and incurred throughout the project’s span. If a loss becomes apparent at any point during the contract, it must be recorded immediately, even if the project isn’t yet completed.

CCM Example Journal Entry

Using the same BuildRite bridge construction example, here’s a look at what the journal entry might look like when using CCM.

In Years 1 and 2, only balance sheet accounts are affected. Costs increase the construction-in-progress asset, while client payments increase the billings-on-uncompleted-contracts liability. In Year 3, when the project is completed, the final costs and payments are recorded similarly to previous years. Then, two additional entries are made to recognize all revenue and expenses at once, clearing out the construction-in-progress and billings-on-uncompleted-contracts accounts. The final two entries in Year 3 are what impact the income statement, showing the entire $10 million in revenue and $9 million in expenses, resulting in the $1 million profit.

Is the Completed Contract Method Compliant With GAAP?

CCM’s relationship with GAAP is complex. While GAAP doesn’t completely prohibit use of the CCM approach, its guidelines for the method have become increasingly restrictive over time, particularly following updates to revenue recognition standards under GAAP’s Accounting Standards Codification 606, a comprehensive framework for recognizing revenue from contracts with customers. This shift reflects GAAP’s desire to provide stakeholders with timely and relevant financial information throughout the life cycle of a project, rather than solely at a project’s completion.

Under the most current guidance of ASC 606, CCM has effectively been replaced by a new, broader framework for revenue recognition, called the point-in-time approach, which is used when a company can’t adequately recognize revenue over time. Say a construction company builds prefabricated, standardized modular homes in its own facility. In this case, because the customer doesn’t control the asset as it’s being created, the company could potentially redirect the modules to other customers, and the contract might not provide an enforceable right to payment for performance completed to date. Therefore, revenue could appropriately be recognized at a single point in time—usually when control of the modular home is transferred to the customer, which could be when a project is completed. Note that the point-in-time approach can also be used for appropriate short-term contracts.

Under ASC 606, the over-time revenue recognition approach, which is aligned with PCM, is generally preferred for construction contracts and similar long-term projects because it better reflects ongoing financial performance and provides more consistent reporting periods.

Pros and Cons of the Completed Contract Method

Though used less frequently than PCM, where revenue and expenses are recognized as work is performed, some companies can benefit from CCM when appropriate. Here’s a look at the revenue recognition method’s pros and cons.

Pros of CCM:

• Reduces risk: Lessens the chance of overstating profits on incomplete projects and protects against recognizing profits on ultimately unprofitable contracts.
• Straightforward implementation: Requires fewer estimates and judgments than PCM, making it easier to apply.
• Provides certainty: Gives a complete and accurate picture of a project’s profitability upon completion.
• Minimizes restatements: Reduces the need to run financial restatements caused by estimation errors.
• Aligns with cash flows: Often aligns more closely with actual cash flows.

Cons of CCM:

• Suggests income volatility: Can lead to significant fluctuations in reported income between periods.
• Limits performance insight: Doesn’t reflect ongoing financial performance for long-term projects.
• Restricts GAAP compliance: Can only be used in specific circumstances where reliable estimates cannot be made.
• Misaligns revenue and expenses: Expenses may be incurred in different periods from when revenue is recognized.
• Reduces comparability: Makes it harder to compare performance with companies using other accounting methods.
• Delays performance metrics: Key performance indicators being monitored may not reflect current project status.
• Weakens investor perception: May be viewed unfavorably by investors seeking consistent, predictable earnings.

The Completed Contract Method vs. the Percentage of Completion Method: What’s the Difference?

CCM and PCM approach revenue recognition in fundamentally different ways. While both methods aim to accurately reflect a company’s revenue and profitability, they go about the process differently—particularly with regard to timing and impact on financial statements.

Unlike CCM, which recognizes revenue and expenses only when a project is substantially completed, PCM recognizes both revenue and expenses as work is performed, based on estimated percentages of project completion. This approach provides a current view of ongoing financial performance, which typically leads to smoother, more consistent income reporting throughout the project’s life cycle. PCM, however, requires continuing estimation of project completion percentages and total expected costs, so it’s more complex to implement and maintain. It also carries a higher risk of profit overstatement if estimates prove inaccurate.

In general, CCM may be better suited to short-term projects or those with highly uncertain costs and completion timelines, while PCM is generally preferred for projects where the scope of work is well defined and costs can be estimated with reasonable accuracy throughout the construction process.

Eliminate Costly Guesswork With Construction Accounting Software

Construction accounting is complex. Not only are accounting rules subject to change, but companies can use different revenue recognition methods for different contracts, and it’s rare that any two contracts are ever alike. NetSuite Construction ERP eliminates these headaches.

NetSuite offers automated construction accounting tools designed to effortlessly handle each project’s distinct requirements, ranging from revenue recognition method to type of contract. A cloud-based enterprise resource planning system (ERP), the solution provides a single source of accurate data, in real time, to help businesses phase out spreadsheets and make smarter decisions. Meanwhile, its flexible controls can help companies strengthen GAAP compliance, including ASC 606 requirements.

Beyond accounting and compliance, NetSuite makes it possible to track projects, plan material and labor costs, and bill customers, all through a single, integrated platform that supports companywide efficiency and scalable growth.

CCM is a straightforward approach to revenue recognition for construction companies, but it can be used only in particular circumstances. It’s also not always GAAP-compliant, so it’s often used by smaller, private firms. PCM is generally preferred for construction accounting because it offers a better look at a company’s revenue and profitability over time. Regardless of the chosen approach, construction accounting software can make it easier for businesses to manage the revenue-recognition requirements for each unique contract.

Completed Contract Method FAQs

Is the completed contract method cash or accrual?

The completed contract method is accrual-based. Revenue and expenses are recognized only when the project is completed, regardless of when cash changes hands.

Is the completed contract method more beneficial than the percentage of completion method?

It depends. Under GAAP and International Financial Reporting Standards (IFRS), the percentage of completion method (PCM) is generally preferred for long-term contracts when certain criteria are met. The completed contract method (CCM) isn’t explicitly allowed under IFRS, and GAAP limits its application to situations where project completion can’t be reliably estimated. Compliance aside, PCM is generally better for long-term projects with predictable outcomes and when reliable estimates are possible, while CCM might be preferable for short-term or highly uncertain projects—especially for smaller, private companies, which are not required to follow GAAP.

Which construction accounting methods are GAAP-compliant?

Under current GAAP standards (i.e., ASC 606), there are two primary methods for recognizing revenue in construction contracts:

1. Over-time recognition: Revenue is recognized gradually as the construction progresses. This is the most common method for construction contracts.
2. Point-in-time recognition: Revenue is recognized all at once when the project is completed and control is transferred to the customer. This is less common in construction but may apply to certain short-term projects.