The completed contract method of revenue recognition is a concept in accounting that refers to a method in which all of the revenue and profit associated with a project is recognized only after the completion of the project.
In addition to the completed contract method, another way to recognize revenue for a long-term contract is the percentage of completion method. The two revenue recognition methods are commonly seen in construction companies, engineering companies, and other businesses that mainly generate revenue on long-term contracts for projects.
Understanding the Completed Contract Method
The completed contract method defers all revenue and expense recognition until the contract is completed. The method is used when there is unpredictability in the collection of funds from the customer. It is simple to use, as it is easy to determine when a contract is complete. In addition, under the completed contract method, there is no need to estimate costs to complete a project – all costs are known at the completion of the project.
Journal entries for the completed contract method are as follows:
StrongBridges Ltd. was awarded a $20 million contract to build a bridge. The estimated time to complete the project is three (3) years with an estimated cost of $15 million. Assuming that the cost estimates do not change, the project is expected to generate $5 million in profit. The following is a schedule on the project using the alternate percentage of completion method:
Costs Incurred is the costs incurred to build the bridge as estimated by the company’s engineer.
Billings is the amount of money StrongBridges Ltd. billed for the construction of the bridge. Billing amounts are set by the company.
Cash Collected is the amount of money StrongBridges Ltd. received for the construction of the bridge. The variation in billings and cash collected is due to timing differences.
% Completed is determined as costs incurred divided by estimated total costs.
For the completed contract method, revenue and expense are only recognized at the end of the contract. The journal entries are as follows:
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