Accounting: The Language of Business - Vol. 2 (Intermediate: Part 129)

"A person should not go to sleep at night until the debits equal the credits" -Luca Pacioli (1447-1517) - The "Father of Accounting"

 Revenue Recognition (Part P)

by

Charles Lamson

Completed-Contract Method 

Companies use the completed-contract method only when they do not meet the criteria required to use percentage-of-completion (discussed in Part 128). The timing of revenue and gross profit recognition is the key to the completed-contract and percentage-of-completion methods. Under the completed contract method, a company recognizes revenue each year equal to the actual costs incurred. Thus, the company reports 0 gross profit until the project is complete. At the conclusion of the project, the total gross profit is recognized. This approach is slightly different than the U.S. GAAP revenue recognition rules that were effective prior to December 15th, 2017. The completed contract approach used previously did not recognize any costs or revenue used until the completion of the project. However, FASB ASC 606-10-25-37 states that revenue should be recognized to the extent of the costs incurred. Also, this new approach is simplified somewhat. Some costs will actually be capitalize and amortized to a systematic basis consistent with the transfer of the good or service to the customer. The completed-contract approach involves the following accounting procedures:

1. Accumulate construction costs by debiting an asset (inventory) account called construction in progress (CIP).

2. Increase accounts receivable with a debit and increase with a credit in the account billings on CIP when the contractor bills the customer.

3. Increase cash with a debit and decrease accounts receivable with a credit when the contractor receives cash from the customer.

4. Recognize the actual costs incurred and the same amount of revenue each year. Create revenue from long-term contracts and debit the construction costs. Record the total gross profit only at the conclusion of the project.

5. Report the net amount of the CIP and billings on CIP on the balance sheet at each balance sheet date. An asset, costs in excess of billings, is reported if the CIP is higher than the billings on CIP. A liability, billings in excess of costs, is reported if the billings on CIP are higher than the CIP. at the end of the project, remove from the books the CIP account with a credit and the billings on construction in progress account with a debit.

The completed-contract method accounting procedures in Steps 1, 2, 3, and 5 are the same as the percentage-of-completion method. The timing of revenue and gross profit recognition in Step 4 is the key difference between the completed-contract and percentage-of-completion methods. Example 8.23 illustrates the completed-contract method. 

  

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 407-410*

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