The primary difference between the completed contract method (CCM) and the percentage of completion method (PCM) is the timing of income recognition
Quick Comparison of Completed Contract vs Percentage of Completion Method
| Percentage of Completion | Completed Contract | |
|---|---|---|
| Definition | Method of accounting for long-term contracts | Method of accounting for long-term contracts where income is recognized upon completion of the contract |
| Who Should Use? | Any taxpayer who does not meet the small contractor or home construction contract exception | Taxpayers who meet the small contractor or home construction contract exception |
| Timing of Income Recognition | Income recognized in phases as the work is completed | Income recognized upon completion of the contract |
| Reliance on Estimates | Strong reliance on estimates | Estimates not required; actual numbers are known at the end of the contract |
| Recordkeeping | Income and expense allocation recorded regularly on the income statement | Income and expense allocation recorded on the balance sheet; recognized on the income statement at the end of the contract |
| Cash Flow Impact | Cash may need to be available every year for tax liabilities | Cash for tax liabilities not required until final year of contract |
While both methods have advantages and disadvantages, the CCM is more advantageous if annual cash flow is a concern. The PCM may be preferable when the company’s books are expected to be reviewed regularly by external parties over the contract’s life. However, in general, most users of the PCM are doing so as a result of this method being the mandatory default.
Pros & Cons of Percentage of Completion and Completed Contract Methods
| Percentage of Completion | Completed Contract |
|---|---|
| Advantages | |
| Clearer picture of earnings for banks and investors | Useful when project completion timing is unknown |
| Tax liabilities spread over multiple years instead of a lump sum payment in final year | No tax paid until end of contract; cash flow preserved during earlier years of the contract |
| Regular analysis of income and expense activity helps management pinpoint production issues | |
| Disadvantages | |
| Heavily reliant on estimates, which could be incorrect and lead to manipulation of financial information | No tax benefit of expenses until revenue recognized at the end of the contract |
| Taxes paid sooner than with completed contract | Irregular-looking balance sheet; could be confusing for financial statement users |
| Potentially large lump sum cash flow at end of the contract for taxes | |
| May result in a book-to-tax difference | |
Who Should Use Percentage of Completion vs Completed Contract?
The IRS generally requires that companies with long-term contracts use the PCM—unless one of the exceptions below applies. Most companies will want to use the CCM if they qualify under one of these exceptions.
| Small Contractor | Home Construction Contract |
|---|---|
|
|
Example of Accounting Under Each Method
ABC Co. enters into a two-year contract with DEF Township to build a bridge. The contract states that ABC Co. will receive $25 million for this project. Estimated costs under the PCM will be $18 million, for an estimated profit of $7 million.
The fact summary is as follows:
- Total gross revenue: $25 million
- Total estimated costs: $18 million
- Estimated profit: $7 million
- Year one estimated costs: $11 million
- Year two estimated costs: $7 million
Under the PCM, ABC Co. would allocate costs and recognize income, as shown below. The revenue recognized under the PCM is derived using the cost-to-cost calculation.
| Year 1 | ||
|---|---|---|
| Percentage of Completion | Completed Contract | |
| Revenue Recognized | 15,250,000 | 0 |
| Costs Recognized | 11 million | 0 |
Using the cost-to-cost method, the following calculation would be performed:
- Percentage of completion progress %: (11 million ÷ 18 million) = 61%
- Revenue recognized: 0.61 ×x 25 million = 15,250,000
- Costs recognized = Actual costs for the year
Details for this method, along with a separate example showing related journal entries, can be found in our guide on
. Also, you can learn the exact calculations and journal entries for the CCM in our article on
.
Under the CCM, no revenue or expense is recognized in year one—and the full contracted amount of expense and revenue is recognized in year two.
| Year 2 | ||
|---|---|---|
| Percentage of Completion | Completed Contract | |
| Revenue Recognized | 9,750,000 | 25 million |
| Costs Recognized | 7 million | 18 million |
Using the cost-to-cost method, the following calculation would be performed for year two:
- Percentage of completion progress %: (7 million ÷ 18 million) = 39%
- Revenue recognized: 0.39 × 25 million = 15,277,500
- Costs recognized = Actual costs for the year
Total revenue and costs recognized over the life of the contract were the same under either method.
Frequently Asked Questions (FAQs)
Which of the two methods is better?
The completed contract method is generally preferred over the percentage of completion. Taxpayers may be eligible to use CCM when the home construction contract or small contractor exceptions apply.
Which of the two methods is easier to record?
The CCM requires fewer entries and does not involve the income and expense estimates that the PCM requires, making it the easier method to record.
Where do I record contract activity for the completed contract method?
In contrast with the PCM, incremental contract activity is not recorded in the income statement with CCM. Instead, your costs are recorded as “work in progress” (an inventory account), and your revenue is recorded to progress billing. Both accounts are on the balance sheet and will be transferred to the income statement at the end of the contract.
Bottom Line
The key differences between completed contract vs percentage of completion method revolve around timing and use of estimates. Either method could be advantageous for a company, depending on the intentions of the organization at the time of the contract. Both are permissible methods of accounting for long-term contracts for taxes in the United States. While the PCM generally is required, the CCM can be used if an exception applies.
