The completed contract method of accounting is a popular accounting method that is regularly used in construction, manufacturing, and other industries. It is a way of accounting for long-term contracts that are typically spread out over several years and often involve various stages.
The completed contract method of accounting recognizes revenue and expenses only when a contract is considered complete. In other words, revenue is only recognized when the project is finished, and all the costs associated with the project have been incurred. This means that the method is a form of accrual accounting, where revenue is not recognized until it has been earned, and expenses are recorded when they are incurred.
The biggest advantage of the completed contract method of accounting is that it allows businesses to avoid recognizing revenue and expenses until the project is complete. This helps to reduce the variability of the financial statements, leading to a more accurate and stable reflection of the company`s financial performance. This, in turn, helps investors and stakeholders to make better business decisions.
Another advantage of the completed contract method is that it can also help to simplify accounting procedures. Since the method only recognizes revenue and expenses when the project is complete, businesses don`t need to worry about tracking progress frequently. This can be especially helpful in complex projects that involve a lot of accounting work.
However, the completed contract method of accounting also comes with some disadvantages. One of the biggest drawbacks is that it can result in lumpy financial statements. Since revenue is only recognized when the project is complete, there can be huge fluctuations in revenue and net income in different years. This can make it difficult for investors and stakeholders to get a clear picture of the company`s performance.
Another disadvantage of the completed contract method is that the method can be somewhat imprecise. Since revenue is only recognized when the project is complete, it can be challenging to estimate the outcome accurately. This can result in inaccuracies in financial reporting, which can lead to problems down the line.
In conclusion, the completed contract method of accounting is a popular accounting method that is often used in construction, manufacturing, and other industries. While it has its advantages, it also comes with some disadvantages, and businesses need to weigh these factors when considering whether to use the method or not. Ultimately, the choice of accounting method will depend on a variety of factors, including the nature of the business, the complexity of the projects, and the preferences of the investors and stakeholders.