What Is the Completed Contract Method (CCM)?
The completed contract method (CCM) is an accounting technique that allows companies to postpone the reporting of income and expenses until after a contract is completed. Using CCM accounting, revenue and expenses are not recognized on a company's income statement even if cash payments were issued or received during the contract period.
The completed contract accounting method is frequently used in the construction industry or other sectors that involve project-based contracts.
- The completed contract method (CCM) allows all revenue and expense recognition to be deferred until the completion of a contract.
- CCM accounting is helpful when there's unpredictability surrounding when the company will be paid and when the project will be completed.
- Since revenue recognition is postponed, tax liabilities might also be postponed, but expense recognition, which can reduce taxes, is likewise delayed.
How the Completed Contract Method (CCM) Works
The completed contract method allows all revenue and expense recognition to be deferred until the completion of a contract. CCM accounting is helpful when there is unpredictability surrounding when the company will be paid by their customer and uncertainty regarding the project's completion date.
Businesses have multiple options when recognizing revenue in preparing their financial statements. Some companies prefer the cash method of accounting for revenue and expenses. The cash method recognizes revenue when cash is received from clients, and expenses are recorded when they're paid. Although the cash method might be straightforward, it can delay recording revenue and expenses until the money is earned or paid out.
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.
Accrual accounting is typically the most common method used by businesses, such as large corporations. However, some small businesses use the cash method, which is also called cash-basis accounting. The completed contract method does not require the recording of revenue and expenses on an accrued basis. Instead, revenue and expenses can be reported after the project's completion.
Requirements for the Completed Contract Method
Typically, the completed contract method is reserved for certain situations since the revenue recognition is often delayed and unpredictable. As a result, there are a few instances when CCM accounting might be helpful:
- If a contract has a short-term end date and most of the revenue is likely to be recognized when the project is completed
- When a project may be subject to potential hazards that might delay its completion
- When there's uncertainty in forecasting the completion date of a project
Completed Contract vs. Percentage of Completion Method
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.
A company can establish milestones throughout the project's lifetime and assign percentages of completion for each milestone. The percentage of completion method allows the revenue and expenses to be attributed to each stage of completion. However, both parties involved must be reasonably certain that they can complete their obligation of the contract.
The percentage of completion accounting method helps to protect companies from fluctuations in their revenue stream by recording revenue at regular intervals. The percentage of completion method also helps companies with their cash flow needs since it avoids the company having to pay for all of the expenses throughout the project's lifetime before receiving any revenue, as in the case with the completed contract method.
Advantages and Disadvantages of the Completed Contract Method
The completed contract method has both advantages and disadvantages. Using CCM accounting can help avoid having to estimate the cost of a project, which can prevent inaccurate forecasts. Also, since revenue recognition is postponed, tax liabilities might be postponed as well. However, expense recognition, which can reduce taxes, is likewise delayed. From the client's perspective, the CCM allows for delayed cash outflows and ensures the work is fully performed and received before any payment is made.
On the downside, if a cluster of contracts finishes all at once, this may create a sudden surge of revenues or expenses, and account payable and account receivable, which can cause radical fluctuations in the income statement and balance sheet, respectively. From an optics perspective, this can make a company's revenue and profitability appear inconsistent to outside investors. For example, if a company needs to apply for credit from a bank, it may be challenging to prove how much revenue the company generates using the completed contract method.
By deferring the recognition of revenue and expenses until the end of the project, the company might put itself at risk of higher tax liabilities. For example, let's say a project is estimated to take three years to complete and tax laws change, leading to an increase in the business tax rate. The tax liability would be higher under the completed contract method versus using the percentage of completion approach since some of the revenue would have already been recognized.
Companies should consult a tax professional before deciding which accounting method is best from a tax standpoint.
Example of Completed Contract Method
To illustrate the completed contract method, the example below shows a construction project using both the percentage of completion and completed contract methods.
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.
At the end of year one, 50% of the project has been completed. The company will report its revenue of $1 million to recognize the two payments for $500,000 that the customer made at the end of the six-month and one-year milestones.
Conversely, under the completed contract method, the company would not record any revenue or expenses on its income statement until the end of the project. Assuming that the project was finished on time and the customer paid in full, the company would record revenue of $2 million and the expenses for the project at the end of year two.