The Completed Contract Method (CCM): Deferring Revenue and Expenses in Accounting
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Summary:
Dive into the intricacies of the completed contract method (CCM), an accounting technique widely employed in project-based contracts. This comprehensive guide explores how CCM defers revenue and expenses until a contract is completed, addressing uncertainties in payment and project timelines. Delve into its working mechanism, requirements, and a detailed comparison with the percentage of completion method. Uncover the advantages, disadvantages, and gain insights into real-world scenarios through an illustrative example. Navigate through FAQs to ensure a holistic understanding of this strategic accounting approach.
What is the completed contract method (CCM)?
The completed contract method (CCM) is a nuanced accounting strategy providing companies flexibility in recognizing income and expenses. In this approach, financial transactions related to a contract are postponed until the project reaches completion. This unique method allows businesses to navigate uncertainties associated with payment timings and the completion dates of projects, particularly prevalent in industries like construction.
How the completed contract method (CCM) works
The operational essence of the CCM lies in its ability to defer the recognition of both revenue and expenses until the contract is fully completed. Unlike the cash accounting method, where financial events trigger recognition, CCM aligns more closely with the accrual method. Under accrual accounting, activities contributing to revenue or incurring expenses are recorded regardless of the actual cash movements.
For businesses, this method becomes advantageous when facing unpredictable payment schedules from customers and uncertainties surrounding project completion timelines. By delaying the recognition of revenue and expenses until the contract concludes, companies can achieve a more accurate reflection of their financial performance.
Requirements for the completed contract method
While CCM offers flexibility, it is not a one-size-fits-all solution. Certain conditions make it more suitable for specific situations:
- If a contract has a short-term end date and a significant portion of the revenue is expected to be recognized upon project completion.
- In projects prone to potential hazards or delays that might extend the completion date.
- When forecasting the completion date of a project is uncertain due to various factors.
These requirements emphasize the importance of strategic decision-making when opting for the completed contract method.
Completed contract vs. percentage of completion method
For long-term projects where revenue and expenses are incurred at various intervals, companies often consider an alternative: the percentage of completion method.
The percentage of completion method involves establishing milestones throughout a project’s lifespan and assigning completion percentages to each milestone. This method allows for the attribution of revenue and expenses to different stages of project completion, offering a more even distribution over time. Both parties involved must reasonably ensure their ability to fulfill contract obligations.
While the percentage of completion method provides a consistent revenue stream and aids in managing cash flow throughout a project, the completed contract method remains a strategic choice in scenarios where uncertainties persist.
Frequently asked question
Can the completed contract method be applied to any type of contract?
The suitability of the completed contract method depends on the specific characteristics of the contract. It is commonly used in projects with short-term end dates and uncertainties in payment schedules or completion timelines.
How does CCM affect a company’s financial statements?
The completed contract method can lead to sudden surges in revenues or expenses when multiple contracts finish simultaneously. This may impact the income statement and balance sheet, potentially making a company’s financial performance appear inconsistent to outside investors.
What considerations should companies make before choosing CCM?
Before opting for the completed contract method, companies should assess the nature of their projects, potential hazards, and the predictability of payment schedules. Consulting with financial experts and considering long-term financial goals is crucial to making informed decisions.
How does CCM impact tax liabilities?
By deferring the recognition of revenue and expenses until the completion of a project, CCM can postpone tax liabilities. However, in changing tax environments, this delay might result in higher tax obligations if tax laws change during the project’s duration.
Key takeaways
- The completed contract method defers revenue and expense recognition until a contract is completed.
- It suits contracts with short-term end dates and unpredictable payment schedules.
- Comparing it with the percentage of completion method helps understand project accounting alternatives.
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