What it means
A contractor building a bridge over three years has a problem the ordinary sale does not: when is the revenue earned? The completed contract method gives the conservative answer: when the bridge is finished.
Until then, the costs incurred are held on the balance sheet as an asset (contract work in progress, or costs in excess of billings) and the amounts billed to the customer are held as a liability (billings in excess of costs, or deferred revenue). At completion, the accumulated revenue and costs are released to the income statement and the profit or loss appears in that one period.
The method's appeal is that it avoids estimating. Percentage-of-completion requires the contractor to estimate total contract costs, measure progress and recognise a proportion of expected profit, and every one of those estimates can be wrong; a project whose costs overrun in its final year reverses profit that had been recognised earlier.
The completed contract method recognises nothing until the outcome is known, so there is nothing to reverse. For contracts whose outcome is genuinely uncertain, whose duration is short, or whose scale is small relative to the business, it produces an acceptable result with less risk of error.
Its problems are equally clear. A contractor with several three-year contracts in progress reports no revenue and no profit for years, then a large amount in the year of completion, however steady the underlying activity.
Performance measurement, taxation, bonuses and lending decisions all suffer from the lumpiness. The balance sheet meanwhile carries large work-in-progress and billing balances that reveal little.
And the method offers scope for manipulation of a different kind: timing completion, and therefore profit, into a chosen year. The current revenue standards resolved the debate by removing the choice.
Revenue is recognised over time if any of three criteria is met: the customer simultaneously receives and consumes the benefit (services); the seller's work creates or enhances an asset the customer controls (construction on the customer's land); or the seller's work creates an asset with no alternative use to the seller and the seller has an enforceable right to payment for performance to date (a bespoke asset with progress payment terms). Most construction and engineering contracts meet one of these and are accounted for over time, using an input or output measure of progress.
Where none is met, typically for standardised goods built to stock and sold on delivery, or bespoke work where the seller has no right to payment until delivery, revenue is recognised at the point control transfers, which resembles the completed contract method in effect. Losses are treated the same under either method: when a contract is expected to make a loss overall, the whole expected loss is provided for immediately, not deferred to completion.
Tax rules diverge. Some jurisdictions permit the completed contract method for tax on contracts below a size threshold or below a duration, which defers tax; others require percentage-of-completion; the difference between book and tax treatment gives rise to deferred tax.
In practice
Real-world examples.
Example
A shipbuilder recognises revenue on a vessel only on delivery because the buyer does not control the ship during construction and has no obligation to pay until acceptance.
Example
A software company building a bespoke system with acceptance-based payment recognises revenue at go-live, having no enforceable right to payment for work in progress.
Example
A small contractor uses the completed contract method for tax on contracts under a size threshold, deferring tax on year-end work in progress.
Think of it
“Completed contract waits until the job is done to recognize any revenue-all or nothing at completion.
Formula
Calculation
During the contract:
Contract asset (costs in excess of billings) = Cumulative costs incurred minus Cumulative billings (if positive)
Contract liability (billings in excess of costs) = Cumulative billings minus Cumulative costs incurred (if positive)
Revenue recognised = 0; Profit recognised = 0 (unless a loss is expected, in which case the full expected loss is provided)
At completion:
Revenue recognised = Total contract price; Cost of sales = Total contract costs; Profit = Difference
Worked example. A contractor signs a $9,000,000 contract to build a specialised test facility over three years. Expected total cost $7,500,000; expected profit $1,500,000. Under the contract, the customer pays 30% on signature, 30% at the end of year 1, 20% at the end of year 2 and 20% on completion, and the contractor has no right to retain progress payments if it fails to complete (so the over-time criteria are not met and point-in-time recognition applies).
Costs incurred: year 1 $2,400,000; year 2 $3,300,000; year 3 $1,800,000 (total $7,500,000).
Billings: year 1 $5,400,000 (30% + 30%); year 2 $1,800,000; year 3 $1,800,000.
Completed contract method:
- Year 1: revenue nil; profit nil. Balance sheet: costs incurred $2,400,000; billings $5,400,000; contract liability (billings in excess of costs) $3,000,000. Cash received $5,400,000 less costs paid $2,400,000 = plus $3,000,000.
- Year 2: revenue nil; profit nil. Cumulative costs $5,700,000; cumulative billings $7,200,000; contract liability $1,500,000.
- Year 3: revenue $9,000,000; cost of sales $7,500,000; profit $1,500,000. Contract balances cleared.
Percentage-of-completion (cost-to-cost) for comparison:
- Year 1: progress 32% ($2,400,000 / $7,500,000); revenue $2,880,000; profit $480,000
- Year 2: cumulative progress 76%; cumulative revenue $6,840,000; year 2 revenue $3,960,000; profit $660,000
- Year 3: revenue $2,160,000; profit $360,000
Same total; the profit is spread rather than lumped.
Complication: at the end of year 2, the contractor revises expected total cost to $8,200,000 because of a design problem, so expected profit falls to $800,000. Under the completed contract method, nothing changes in year 2 (no profit had been recognised); the year 3 result is $800,000. Under percentage-of-completion, cumulative revenue at 69.5% progress ($5,700,000 / $8,200,000) is $6,255,000 and cumulative profit $555,000, so year 2 profit is $75,000 after reversing part of year 1's; year 3 is $245,000. The completed contract method's user never had the year 1 profit to reverse.
Further complication: expected total cost rises to $9,400,000 in year 2, so the contract is now expected to lose $400,000. Under both methods, a provision for the full $400,000 loss is recognised in year 2.
Cash and tax: under the completed contract method, tax on the $1,500,000 profit falls in year 3; under percentage-of-completion it falls across the three years. If tax follows the books, the completed contract method defers tax by two years on the year 1 and year 2 portions, a cash benefit of about $285,000 for two years at a 25% rate on $1,140,000.Case study
Seen in the real world.
A specialist engineering contractor with revenue of $60,000,000 used the completed contract method under its national framework, on the reasoning that its contracts were bespoke and their outcomes uncertain. Its reported revenue and profit swung from $30,000,000 and a loss in one year to $95,000,000 and a $7,000,000 profit in the next, depending on which contracts completed. Its bank's covenants, tested annually, were breached in the low years and comfortably met in the high years; its bonus scheme paid nothing in one year and doubled in the next for the same work; and a potential acquirer, seeing three years of accounts, could not tell whether the business was growing.
When the company adopted the current revenue standard, its adviser analysed each contract against the over-time criteria and concluded that 80% of its contracts, which were built on customer sites with monthly valuations and a right to payment for work done, qualified for over-time recognition; only the 20% built in its own workshop with acceptance-based payment remained point-in-time. Restated, the company's revenue ran between $55,000,000 and $65,000,000 in every year and its profit between $3,000,000 and $4,500,000.
The bank reset the covenants on the smoother figures at a lower margin; the bonus scheme was rebuilt on annual performance; and the acquirer, seeing a stable business, made an offer. The finance director's note recorded that the completed contract method had told the truth about each contract and lied about the company.
Watch out
Common mistakes.
- Assuming the completed contract method is still a free choice. Under current standards, recognition timing follows the transfer-of-control criteria, and most construction-type contracts are accounted for over time.
- Deferring an expected loss to completion. Losses on onerous contracts are recognised in full as soon as they are expected, under every method.
- Reading a completed-contract company's single-year results as representative. Revenue and profit are lumpy by construction; several years and the contract balances are needed.
Questions
People also ask.
When does revenue get recognised at completion under current standards?
When none of the over-time criteria is met: the customer does not control the work as it progresses and the seller has no enforceable right to payment for performance to date, typically for goods built to the seller's own specification or with acceptance-based payment.
What is the difference between the completed contract and percentage-of-completion methods?
Completed contract recognises the whole result at the end; percentage-of-completion recognises it progressively based on progress. Total profit is the same; timing and the risk of estimation error differ.
Is the completed contract method allowed for tax?
In some jurisdictions, for contracts below size or duration thresholds. Where book and tax methods differ, deferred tax arises on the difference.
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