Companies using CCM must ensure clear communication with stakeholders to avoid misinterpretation of financial results. To illustrate these points, consider a construction company that enters into a three-year contract to build a bridge. Under the CCM, the company would not recognize any revenue from the project until the bridge is fully completed and accepted by the client. This could result in the company showing minimal income and potentially operating losses for the first two years, followed by a substantial profit in the third year when the project is completed. This pattern could mislead stakeholders about the company’s financial health and operational efficiency during the contract period.
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XYZ, Inc. is a construction company who entered into a contract for $100,000 in August of 2018. The $100k of revenue and $25k of profit won’t be recognized until 2019, despite the costs incurred in 2018. Contractors must carefully evaluate these methods in the context of their specific operations, contract terms and financial goals to select the most appropriate approach. By doing so, contractors can optimize their financial reporting, ensure compliance with tax regulations and strategically position their business for long-term success. Next, contractors should consider whether there is uncertainty around costs or payments. Since COVID-19, construction supply chains have been notoriously disrupted, causing ongoing material cost volatility.
This can make a construction company look unfavorable to banks when applying for loans since there isn’t a constant stream of income. If tax rates are expected to go up, paying a percentage of taxes on a project sooner, via PCM, may be ideal. We have clients who prefer to be settled up with the IRS at all times, and use PCM for that reason alone. While most construction companies have migrated toward the percentage of completion method, CCM remains a viable option for certain types of construction contracts and business situations. One accounting method contractors can use to recognize revenue and expenses is called the completed contract method (CCM).
- But, if the contractor becomes aware that the contract will end in a loss, it should be recorded on the income statement as soon as possible.
- It’s especially useful in industries like construction or government contracting, where projects span multiple years and the risk of non-completion is non-trivial.
- Under the CCM, the company would recognize the entire revenue from a perpetual license sale at the point of contract completion.
- From a financial reporting perspective, PCM allows a company to recognize income as work progresses on a long-term project.
- When project scope is fluid or client requirements evolve, estimating completion percentages becomes difficult.
- They’ll continue to bill and receive payment, much like they would under a different revenue recognition method.
Furthermore, under IFRS, the company recognizes revenue equal to costs incurred during the period. The choice between CCM and PCM hinges on the nature of the industry, the predictability of contract outcomes, and the company’s preference for financial reporting stability versus real-time accuracy. Each method has its merits and drawbacks, and the decision should be tailored to the specific circumstances of each contract and company. The key is to ensure that whichever method is chosen, it is applied consistently and transparently, providing stakeholders with a clear understanding of the company’s financial performance. While the CCM offers a conservative approach to revenue recognition, aligning with GAAP’s prudence principle, it introduces several tax considerations that businesses must navigate. By understanding these implications, companies can better plan for their tax obligations and maintain robust financial strategies.
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For accurate reporting and analysis, any additional accounts required for CCM will often be called out on the balance sheet. The accrual accounting method recognizes revenue and expenses when they occur, meaning the revenue doesn’t need to be received by the company before accounting for it. In other words, the activities that earned the revenue or created the expenses are recorded even though the actual money did not change hands at that time.
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Although there are several different revenue recognition methods, we’ll explore the completed contract method in more detail throughout this blog. Finally, when assessing and choosing revenue recognition methods, contractors should consult with their construction-specific CPA. While guidance for revenue recognition may have changed in recent years, contractors will find much from the completed contract method alive and well. If the gist is to hold off revenue from the income statement until it’s assured, ASC 606 point-in-time recognition uses a similar procedure. Therefore, during the construction progress, Jones Realty doesn’t gain anything from the work done.
Financial statement analysis serves as a barometer for a company’s financial health, operational efficiency, and future viability. When it comes to the construction industry, where long-term contracts are prevalent, the method of accounting used can significantly sway the financial narrative. The Completed Contract Method (CCM) defers all revenue and expense recognition until a contract is fully completed. This approach starkly contrasts with the Percentage-of-Completion Method, which recognizes revenues and expenses completed contract method in proportion to the work completed.
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Construction Accounting & The Completed Contract Method (CCM)
- If a contractor falls under this exception, they can opt out and use the contract completion method.
- Glendys Zuniga is a tax manager and Ashlie Forum, CPA, is a managing director in CBIZ’s Fort Lauderdale, Florida, office.
- If you typically work on short-term projects with outcomes that aren’t well-defined, this could be a useful accounting method.
Understanding the timing and recognition of revenue and expenses under this method is essential for assessing the credibility of financial reporting and making sound investment decisions. The Completed Contract Method (CCM) is a pivotal accounting strategy for recognizing revenue and expenses on long-term contracts, particularly under the Generally Accepted Accounting Principles (GAAP). This method defers the recognition of income and expenses until a contract is fully completed. Choosing the right revenue recognition method can significantly impact your construction company’s financial health and tax obligations. For contractors managing multiple projects with varying timelines and cost certainty, understanding when and how to apply the completed contract method becomes crucial for accurate financial reporting. Primarily used in the construction industry for projects with uncertain costs or timelines, CCM follows accrual accounting principles but delays income statement effects until project delivery.
You believe you could make 10% profit on the project when it’s done, no matter when you finish it. You’ll have costs you pay and billings to collect as you are doing the project, and in this example, it takes you untill the next year in July to finish the project. Here’s a real-world example of how you can apply the completed contract method in your accounting.
An Example of How CCM Works
For longer-term projects in which revenue and expenses might be earned and paid out at various intervals throughout the project’s lifetime, companies can use the percentage of completion accounting method. Contractors should think carefully about their long term business goals and tax liabilities before choosing. Here are two of the biggest factors construction businesses might want to consider when assessing the completed contract method of accounting. Costs are recorded on your balance sheet as a work-in-progress (WIP) asset until the project is completed. At completion, costs are then transferred to the income statement and matched with the recognized revenue. Under CCM, the company would not recognize any revenue from the project until its completion at the end of the third year.
The project is expected to take three years to complete and cost the company $1 million. Specialized installations or unique architectural features create unpredictable costs, making percentage completion calculations unreliable. Revenue is credited, and the corresponding expenses are debited, resulting in the full recognition of both at the same time. A company is hired to construct a building in which the company will charge the customer $2 million, and the project will take two years to complete. The company establishes milestones in which the customer will pay $500,000 or 25% of the project’s cost every six months.
The choice between completed contract and percentage of completion methods represents one of the most significant decisions construction companies face when establishing their accounting system. Each approach offers distinct advantages and creates different patterns of financial reporting that can significantly impact business operations and stakeholder perceptions. Billing does not trigger revenue recognition during construction, regardless of payment timing or contract terms.