Lesson 54: Completed Contract Method and Journal Entries
In this lesson,
we will learn when revenue and expenses are
recognized with the completed contract method. We will record journal entries
for when the contract is in process and learn 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.
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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.
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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.
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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.
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For 2014,
we will use the same format as we used in
2013 as the contract is still not completed at this point.
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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.
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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.
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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.