The completed contract method records income and expenses of a project only when it’s complete, mainly used for long-term contracts. It affects tax payments and is an exception to accounting standards. The percent complete method is more common, and tax requirements may affect which method can be used.
The completed contract method is an accounting method that records the income and expenses of an ongoing project only when it is complete. The most relevant use of this method is for long-term contracts such as those issued by the government. Using the completed contract method affects when tax payments are made.
Most accounting standards require that all expenses and income be recorded in accounts as and when they occur or are received. The completed contract method is an exception to this. Its main advantage is that it overcomes long-term project problems by giving a misleading impression in the accounts. For example, an organization building a soccer stadium would spend a lot of money upfront, but may not receive payment until it is completed. Since the company knows that it will eventually receive the money and will have planned for this situation, it could be considered unfair if its accounts show serious losses during the construction phase.
Even with long-term projects, the use of the completed contract method is relatively rare. The most common option is known as the percent complete method. This means that each year’s accounts show a percentage of your total projected income and expenses. This is usually only possible for a long-term project with an agreed commission and controlled costs, such as building a facility for a client. It works quite simply: If a project is expected to last four years, then at the end of each year, the company will include 25% of the projected expenses in the cost section of its accounts and 25% of the agreed fee in the revenue section.
Using the completed contract method has implications for tax payments. In a sense, it is an advantage for the company as its profits do not appear until the project is completed, which means it can delay paying the relevant taxes. In another sense, it can be an inconvenience as the company is unable to count its expenses while the project is still underway, meaning it cannot use these expenses to reduce its overall tax liability.
Some countries have tax requirements that affect which method can be used. In the United States, the 1986 Tax Reform Act and follow-up legislation effectively prohibits simply using the completed contract method in most cases. A company engaged in a long-term project simply needs to use the percent complete method or choose to represent 40% of the total value using the percent complete method and the remaining 60% by its normal accounting method, which may include the completed contract method.
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