The Completed Contract Method of Accounting in Construction

Most construction companies earn revenue and pay job costs throughout the duration of each project. They record income and expenses using the Percentage of Completion method of accounting, which provides an accurate, ongoing reflection of the company’s financial picture.

However, for some developers and their subcontractors, revenue isn’t realized until the project is complete and units are sold. They don’t want to pay taxes on income they haven’t earned yet.

For these companies, the Completed Contract Method of accounting allows revenue and expenses to be recognized — on certain long-term projects — only when the project is complete. 

What is the Completed Contract Method?

The Completed Contract Method (CCM) is an accounting method in which revenues and expenses are recognized upon the completion of the contract. Deferring recognition of revenue allows the company to defer their tax liability until the project is complete and the building or units are sold. 

CCM is an offshoot of the accrual method of accounting. In this method, revenues and expenses are recorded when the sale is closed. It is specifically useful for longer-duration projects that span multiple accounting periods. Accounting periods in the context of CCM are normally monthly, with closure and recognition of revenue and costs occurring at month-end.

This method is mostly used by homebuilders and speculative developers because the sale price is not known until the project is complete. Subcontractors on these projects may also be able to use the Completed Contract Method, depending on the construction agreement. Contracts under CCM may involve milestone payments (e.g., 50% payment at a certain project stage), but the timing of these payments can be unpredictable.

In the Completed Contract Method, construction costs are recorded as work in progress inventory and must include indirect construction costs. This inclusion of indirect costs is known as absorption costing. Completed homes are recorded as inventory – once the home is sold the sales price is recorded as revenue and the construction costs are removed from inventory and recorded as expenses.

CCM allows companies to defer revenue, which could be a tax advantage. However, this also means postponing expense recognition, potentially affecting future tax liabilities should the tax laws change.

Advantages of the Completed Contract Method

• The Completed Contract Method simplifies the accounting process during the project by deferring revenue and cost recognition.
• This method can reduce the administrative burden throughout the project's life.
• CCM also defers tax liability until the project is complete.

Drawbacks to the Completed Contract Method

• The Completed Contract Method may create uncertainty regarding when revenue is realized.
• CCM could potentially lead to less consistent cash flow and challenges in assessing project profitability in real time.
• Using CCM could result in in a significant burden of work at the project's conclusion — especially for compliance and documentation.
• There may be strained relationships with subcontractors due to unpredictable payment schedules.
• Using CCM may increase future liability if tax laws change.
• The value of inventory may be over or understated because partially completed projects are sometimes sold at a discount when a project is liquidated — inventory is overvalued when market demand and prices drop, and inventory is undervalued when market demand and prices increase.

Tax Liability

Because CCM allows the developer or subcontractor to defer tax liability, its use is restricted by the IRS. According to an IRS publication on accounting for long-term contracts, “the general rule is that taxpayers must compute the taxable income from long-term contracts using the [Percentage of Completion Method].”

However, according to IRS guidance, the Completed Contract Method is permitted in two scenarios:

1. Any home construction project.

2. Projects where the taxpayer estimates both of the following:

• The contract will be complete within two years.
• The company’s average annual revenue was less than $25 million in the past three years.

Land developers or subcontractors whose situation matches either of these two exceptions are generally allowed to use the Completed Contract Method for accounting purposes.

Impact on the Chart of Accounts

The Completed Contract Method often requires the accounting team to make adjustments to the chart of accounts. They may need to add accounts for short-term assets, like:

• Construction work in progress
• Finished units or homes
• Funds due on construction and development loans 

These may also include accounts for long-term assets, like:

• Land and lots
• Finished units
• Model homes
• Model home furnishings for assets that are not expected to be sold within a year 

Additional liability accounts include warranty reserves to account for any future warranty claims. Construction cost accounts include land and design fees. And finally, accounts for general overhead expenses like marketing, model homes and sales office, closing costs, and bad debts.

Using the Completed Contract Method Wisely

The accounting method used by the construction company affects the structure of the chart of accounts and the items that appear on the balance sheet and income statement. For accurate reporting and analysis, any additional accounts required for CCM will often be called out on the balance sheet. 

While Percentage of Completion is the preferred method of accounting for the vast majority of construction companies, developers and subcontractors may benefit from using the Completed Contract Method in certain situations.

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