Lesson Objectives:- When revenue and expenses are recognized with the completed contract method
- Journal entries for when the contract is in process
- How to journalize the contract completion
The completed contract is used for private enterprise companies as an alternative to the percentage of completion method. This method is much more conservative than the POC method because gross profit and revenue figures are not recognized until the contract is actually completed. As we talked about in previous lessons, the point at which the revenue is recognized is known as the critical point.
Let's review how to account for the completed contract method and how the journal entries are recorded. Again, we will take a look at the same template of values for cost, revenue and gross profit.
We will start with the year of 2013 and list out the Construction in Process (CIP) account which represents the inventory and the accounts payable account which is the cash and materials that are expensed. The CIP account will be debited for the costs of $2,500,000 and the accounts payable will be credited for $2,500,000.
The next entry for billing will debit the accounts receivable account for $2,000,000 and credit the billings on CIP account for $2,000,000. The third entry will account for the collections in which case the cash account is debited for $2,000,000 and the accounts receivable is credited for $2,000,000.
As you can see these first three journal entries are identical to the entries we recorded when looking at the percentage of completion method.
Since we are using the completed contract method and the construction contract is still in process, we will not be recording a journal entry for the revenues and gross profits.
For 2014, we will use the same format as we used in 2013 as the contract is still not completed at this point.
Now, let's look at the entry for 2015 when the revenues and gross profits can be recorded.
When the contract is finally completed, we will be recording all of the revenues and expenses at that time. Let's take a look at the journal entry that would be recorded in 2015 to show that we are recognizing the revenue.
We would still have the first three entries for inventory, billings and collections but for the purpose of this example, let's skip right to the final journal entry for the revenue recognition.
As you can see from the journal entry, the construction expense account is debited by the total expense of $9,300,000 and the total revenue on the long term contract is recorded as a credit for $16,000,000. In order to balance out the transaction, the gross profit amount of $6,700,000 is recorded through the construction in process account for this entry.
Hopefully now you should have a more thorough understanding of how the completed contract method works and how the journal entries are recorded while the contract is in process versus when it is completed.