The main advantage of EPCM is that income is reported over the life of the contract and any losses will be recognized based on the percentage of the contract completed, called the completion factor. The completion factor is the amount of work that has been completed compared to the estimated amount remaining. The completion factor must be certified by an engineer or an architect, or supported by appropriate documentation. The contract price must include cost reimbursements, all agreed changes to the contract, and any retainages receivable.

As mentioned, the completed contract method is somewhat similar to the percentage of completion method, but it’s a very simplified version that requires much less admin work. This is because there is no need to track and calculate payments and match them to work completed. Instead, you’ll wait until you hit substantial completion and then recognize everything all at once. The percentage of completion method requires the use of progress invoices–a billing document used to bill for partial project completion as you complete work.

There will be a timing difference between revenue and expense recognition using cash basis. You may not get paid for all completed work in July until August or even September. In this case, September will look like your most profitable month when in reality, you earned this money in July. In the income statement, the company does not recognize revenues or expenses in the first year. Accrual excluding retainage is similar to accrual; however, it has the advantage of not recognizing retainage until it is received. Retainage receivable is common in certain types for contractors, and this method helps to postpone paying tax on some income until the taxpayer receives the cash to pay the taxes.

In US GAAP, during the construction process, the company does not recognize revenues or expenses. For contracts on the POC method, an additional deferral is available with the opportunity to elect the 10% method. Under this election, income and expenses are not recognized https://personal-accounting.org/completed-contract-method-of-revenue-recognition/ for tax purposes until the contract is over 10%. Depending on the size of the contract, this could create a sizable deferral. Any additional costs incurred in completing the performance of the contract are deductible against the recognized disputed revenue.

Last year’s tax reform resulted in sweeping changes affecting a broad swath of the economy. The construction industry was particularly impacted by the small contractor revenue exemption increase from $10 million to $25 million, beginning on January 1, 2018. It’s important to look at each contract to determine if a method is available to create a tax deferral and postpone paying taxes to a future date. As they say in the business of construction, cash is king—so creating these deferrals could be beneficial to the daily operations of our construction clients. As an additional bonus, this method eliminates the problem of estimating errors that can occur using the percentage of completion as a guidepost. There’s no need to estimate costs when using the completed contract method since those costs are readily apparent at the end of the contract.

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Furthermore, if a business seeks outside investors, it can be challenging to prove to them the value of the company during times of little-to-no incoming revenues. Still, even with these risks, the completed contract method is the most conservative accounting method for companies working on long-term contracts. 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.

Let’s assume you pay for all the materials, build the fence, and receive payment in cash, all within the same day.
Let’s say you wanted to analyze how profitable you were in July of last year (during your busiest time of the year).
This method requires contractors to use a separate, dedicated balance sheet to record their expenses and revenues.
Even if the contractor receives payment during project implementation, he or she can still delay the reporting of such revenue.
However, one of the main drawbacks of POC is that it relies heavily on estimates.

So if you’re a large company or growing business with your sights set on growing even more, we suggest you steer clear of cash basis accounting. It won’t give you the tools you need to manage your business in a way that facilitates long-term growth. When in doubt, work with a certified professional accountant to set up the accounting system that will work best for your business. A contractor’s tax return can have more than one method of accounting at the same time.

How does the Completed Contract Method (CCM) Work?

Under cash basis accounting, you will record the $2,000 in revenue and $1,000 in expenses for this job on the same day. A controlled group of corporations includes structures such as a parent-subsidiary group, a brother-sister corporate group, and a combined group under common control. In addition, the proportionate share of construction-related gross receipts of any person that a contractor has a 5 percent or greater interest in must also be included. However, despite its benefits, below are three pitfalls that should not be overlooked when considering converting to a cash or completed contract method for tax reporting purposes. If a taxpayer is not a small contractor or performing home construction contracts, they are working on nonexempt contracts.

When to use the completed-contract method

The completed contract method is one of the most popular accounting methods in the construction industry. It’s the preferred method for short-term contracts and residential projects because of its simplicity and the ability to shift costs and tax liability to the end of the project. The completed contract method has advantages, but it comes with risk as well. 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.

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You’ll accumulate all billing and related costs in a balance sheet using a percentage of completion or construction in progress account. There is much more to understand especially concerning complex and multi-year projects that require meticulous handling of revenue recognition. Check out the following guide to learn everything a contractor needs to know about the percentage of completion method. Under cash basis, you’ll record transactions when money is physically exchanged. On assets, cash decreases by Rp220 in the first year because the company spends it on construction costs. To keep the financial position balanced, the company reports a construction-in-progress account of Rp220.

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For example, situations where political instability or natural disasters may interfere with project completion. For this reason, the completed contract method can be a tool for hedging against unpredictable circumstances. Since percentage of completion follows the principles of accrual accounting, it satisfies this requirement. Deciding which method to choose depends on the size and complexity of your business.

Effects of the completed-contract method on financial statements

In doing so, it can also help you gain powerful insights into the profitability and financial health of your business. In effect, unpaid bills or future payments are only recognized when those funds physically transfer hands. Under cash basis accounting, you’ll have to report that income in the earlier year to reflect when that transaction took place.

The method of accounting will depend on the types of contracts the contractor works on. For example, a contractor will be using the POC method for non-exempt long-term contracts, completed contract method on home construction contracts, and accrual less retainage on short-term contracts. Another common method for exempt construction contracts is the cash method. When using the cash method, income and expenses are recognized when received or when paid. This is helpful when the taxpayer has large receivable balances and small payables. Finally, when assessing and choosing revenue recognition methods, contractors should consult with their construction-specific CPA.