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CONSTRUCTION ACCOUNTANTS CPA William Brighenti, Certified Public Accountant, Certified QuickBooks ProAdvisor Completed-Contract Method of Accounting 46 Mildrum Road, Berlin, Connecticut Telephone: (860) 828-3269 Website: http://www.cpa-connecticut.com |
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Hartford Construction Accountants CPA
The Completed-Contract Method of Accounting The completed-contract method of accounting is used by manufacturers and contractors. Unlike the percentage-of-completion method, which attempts to recognize revenues and gross profit in the applicable periods of construction, and not soley in the period when the construction has been completed, under the completed-contract method of accounting, revenue, expenses, and gross profit is deferred until the completion of the contract. If at the end of the business fiscal year of a company work on a contract remains incomplete, no revenue, expenses, and profit on that contract is recognized in the current year on the income statement; all costs and billings are accumulated in respective balance sheet accounts. Although the completed-contract method does not accurately reflect revenues, expenses, and profits in the period in which they are earned and incurred, the tax advantages of the use of its method are obvious: the deferral of tax liability to future periods. Generally this method of accounting may be used by contractors and manufacturers averaging less than $10 million in annual revenues if it is initially elected as their tax accounting method. The journal entries required under the completed-contract method are similar to those of the percentage-of-completion method, except for the absence of entries recognizing revenue or gross profit during the construction process: no transactions relating to that contract are posted to revenue and expense accounts until its completion. Assume the same facts as used in our example illustrating the use of the percentage-of-completion method of accounting, except now include results for year 3, the year of completion of the contract:
As was done under the percentage-of-completion method of accounting, during year 1, costs are accumulated in an asset account variously entitled "Construction in Process" (CIP), "Contracts in Process" (CIP), "Work in Progress" (WIP), or "Work in Process" (WIP):
And during year 1, billings are posted to a contra account to Construction in Process, often entitled "Progress Billings", or "Billings on Contract", as is done under the Percentage-of-Completion Method:
However, unlike the Percentage-of-Completion Method, no entry is made at the end of year 1 to reflect the gross revenues, expenses, and gross profit earned and incurred during the current year. Any excess in total amount of Progress Billings over Construction in Process would be reflected on the company's balance sheet as a liability. Consequently, here $10,000 would be classified as a liability at the end of year 1. During years 2 and 3, similar entries are made for costs of construction and billings. Year 2:
Year 3:
But now in year 3, since the contract is complete, we record the following entries to close out the accounts used to accumulate costs and billings throughout the entire construction period and to recognize all of the contract's revenues and costs in the year of the contract's completion:
Of course, the above illustration is a simplified example of the completed-contract method ignoring change orders and many other issues. For more information on the Completed Contract Method, please contact William Brighenti, CPA, at Hartford Construction Accountants CPA. |
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