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Completed Contracts Method of Revenue Recognition



Two points I want to emphasize with completed contracts method of revenue recognition:


  1. Billings to date and cost to date on open projects camp out on the balance sheet until the project is complete. Let's assume you progress billed the project owner $100,000. You will debit receivables for $100,000 and credit a liability for $100,000.


debit(credit)

Receivables $100,000

Jobs in Progress- Liability $(100,000)

Sounds funny doesn't it? Normally you debit receivables and credit revenue. Well, the idea with completed contracts method is that you don't recognize revenue until the project is substantially complete. "Substantially complete" is fairly subjective, but my understanding is that when you have minimal costs remaining to complete the project, you can consider it complete.


Costs incurred on the other hand are recorded as an asset. So, if you incur costs of $50,000, you debit an asset account and credit payables.


debit(credit)

Jobs in Progress- Asset $50,000

Payables $(50,000)


This should sound funny too. Normally you debit cost, an expense, and credit payables. However, those costs remain an asset until the project is complete.


Note: We credit a liability when we progress bill because we haven't earned the revenue yet. It ultimately works similar to unearned revenues. We owe the project owner a completed project before we can recognize the revenue.


Debiting an asset account for costs incurred is similar to recording a prepaid asset. We haven't obtained a "benefit" from them until the project is complete.


2. When the project is complete, all the activity, billings and costs, move to the income statement.


Sticking with our initial example, assume we had additional billings of $75,000 and costs of $50,000, at which time we complete the project.


We would record the following entry to recognize revenue and costs on the project upon completion:


debit(credit)

Jobs in Progress- Liability 175,000 (100,000+75,000)

Jobs in Progress- Asset (100,000) (-50,000-50,000)

Revenue (175,000) (100,000+75,000)

Costs 100,000 (50,000+50,000)


We wipe out the entire activity from this project from the jobs in progress accounts and move it to the income statement. Now, we have gross profit of $75,000 and zero assets or liabilities associated with this project!


Note: You can use one account for the jobs in progress activity on the balance sheet. I just split it up here to make it easier to follow.


Hope that helped!


Thanks!


Ara

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