 Hello and welcome to the session in which we would look at the completed contract method. The completed contract method is part of contract accounting. There are two methods to account for long term construction project or long term contract or contract accounting and those are the percentage of completion method which we looked at in the prior session. So if you did not look at the percentage of completion method I suggest you go back and view it and understand it before we cover the completed contract method which we would look at in this session. So in this session we're going to focus on the completed contract method but it's very important to review both method the completed contract method as well as the percentage of completion method to just kind of put things into perspective. When do we use the percentage of completion method and what does that mean? It means you can recognize some revenues and gross profit before the project is completed. There are certain conditions that you have to meet in order to use the percentage of completion method. Again this is a review. I'm going to review them but if you need a more depth explanation go back to the prior session. First you must be able to estimate the progress somehow estimate the progress of the project. How? By using some sort of a measuring stick to account for that progress. Cost can be used to estimate the progress. So cost can be used as a reasonable estimate not the only measuring stick but the most common one. In addition to measuring your progress you have to have three other conditions to exist. You have to have an enforceable and clear contract where the rights and the obligation of both parties are spelled out including consideration how much money we're going to be exchanging. The buyer is expected to make the payment to satisfy their obligation otherwise it's useless in a sense that you can't recognize the revenue. Two the seller also expected to satisfy their obligation under the contract. Under those conditions we will be able to use the percentage of completion method. Completed contract method is usually used for short term project because it's for one year therefore you don't need to use the percentage of completion method or it's used when we fail the percentage of completion method condition so we fail some of those conditions. Well remember you have to meet all three. So even here when you have enforceable contract buyer expected to make the payment seller expected to satisfy if you fail any of them or obviously if you cannot measure your progress toward the project then you have a problem. Also the contract could have inherent risk beyond the normal reoccurring business risk for example you could have a political risk and the main example I usually give is airbus or Boeing contracting with the country of Iran. Iran is under sanctions from the US. So what happened is Boeing signed a contract with the Iranian aviation agency. Well there's always a good chance where the US administration asked Boeing to cancel that contract. In other words you cannot go into that contract you cannot implement you cannot deliver. Therefore it's that political risk because of that Boeing cannot recognize any revenue although they might be doing some work because of the inherent risk that they may not be able to complete the project. So when to recognize revenue under the completed contract method well from the word completed contract at the end of the project you can only recognize revenue and this is important this is the difference now this is new information now this is new. It's when you complete the project you can recognize the revenue. This is what the completed contract method is. So simply put as you are going throughout the years throughout the periods you don't make any entries for revenues cost or gross profit as we are doing the work you don't do that. Why? Because we really don't know how much revenue we are going to have until we finish the project. Once we finish the project we completed the project now if we completed the project now we are expected to be paid now we are expected to well we basically we assuming we are expected to be paid we satisfied our obligation and we don't have to measure our progress we are done with the work therefore it's time to recognize the revenue. The best way to illustrate this concept is actually to work an example but before we look at an example for the completed contract method I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com I don't replace your CPA review course I don't replace your accounting course. 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So let's take a look at this example Adam Construction Company had a contract to construct a one million dollar highway the contract to start March 1st and to be completed March 1st X1 and to be completed December X3 Adam Company cannot measure the progress toward completion simply put they signed this contract but there's a lot of uncertainty about cost so they cannot measure their cost toward completion well that's going to fail a major condition to be able to use the percentage of completion method they cannot use it because they cannot they don't have a yardstick they cannot use a certain yardstick then what's going to happen is this under those circumstances they're going to have to use the completed contract method so using the same data that we used in the prior example I'm going to show you what entries do you make under the completed contract method again real quick I'm going to explain the information given but again if you want more detailed about the information you have to go back to the percentage of completion method but basically you are giving cost to date how much cost you incur up to this point in year one two hundred thousand estimated cost to complete the project five hundred and fifty thousand progress billing during the year one hundred and seventy five cash collected 140 now also although you are estimating the cost to complete you're saying well I can estimate the cost to complete but we really don't know how much it's going to change substantially this is just we don't have a good idea but this is just basically an estimate and we cannot measure the progress because it could change because the nature of the work so this is what we're going to be assuming so we're going to go ahead and look at the journal entries first at the balance sheet journal entries well guess what balance balance sheet journal entries are the same as percentage of completion what does it mean the same let's go over them as well we spent 200,000 in year one on the project we debit construction and process and please keep track of a T account for each account we're going to debit construction and process which is an inventory account for 200,000 credit material cash payable wherever we paid this is for the 200,000 account receipt we build the client one hundred and seventy five thousand we're going to debit account receivable one hundred and seventy five thousand however we are going to credit billing on construction we don't credit sales you're saying but aren't am I not billing the customer yes you are billing the customer and you created an asset of one hundred and seventy five thousand but what's going to happen is you cannot count it as a sales yet what you're going to do you're going to have it in an account called billing on construction so what is the billing account the billing account is a contra CIP a contra construction and process or construction and progress what does that mean it means you did the work you build a client you have a financial asset of one hundred and seventy five thousand now at the same time you cannot have a financial asset and physical asset because you also building the highway and you are you are counting accounting for the 200,000 also is inventory so what's going to happen is you're going to account for the financial asset which is you're going to build a customer but you're going to have to reduce your CIP your CIP is two hundred thousand it's going to be reduced by one seventy five because you build the client so you cannot have the physical asset that you are building on the books because you did not deliver it yet and have the financial asset related to it so if you build the client you have to reduce your physical asset you cannot have both so billing on construction is a contra CIP then the cash collected is one hundred and forty thousand we debit cash credit account receivable to reduce the account receivable because we collected from the client year two cost to date is five hundred thousand therefore we debit construction and process three hundred thousand hold on a second is this a mistake no it's not remember how the information is giving be careful I emphasize this in the prior session you are giving cost to date if cost to date is five hundred thousand in year two you're already accounted for two hundred thousand so it means in year two so so another word cost in year two alone is three hundred thousand therefore we debit CIP three hundred thousand credit material cash payable or ever we spent three hundred thousand same thing we build them three forty we debit account receivable credit billing then we collected three hundred thousand debit cash credit account receivable and hopefully you'll be able to do the entry for year three so those are the balance sheet entries so where are the income statement entries so why didn't I computed the percentage of completion for year one year two and year three I don't do this why not because I am using the completed contract method I cannot accurately or have a good estimate about my progress in this project therefore I cannot use those percentage of completion I have to use the completed contract method well so what do I have to do guess what do I have to do I be but before we look at the income statement account or whatever related to the income statement I'm gonna go back also and cover this how things are presented on the balance sheet because it's important just in case you did not view the prior session that's why I would do it and year one you have an account receivable of thirty five thousand which is you build the client one seventy five the client paid one forty what's left is thirty five then you have a CIP of two hundred thousand you have a two hundred thousand dollar CIP you have a billing of one seventy five remember billing is a contra CIP therefore CIP minus the billing will give you CIP and access of billing as a current asset of twenty five thousand so this is a current asset let's take a look at the balance sheet in year two in year two your account receivable is seventy five because in the prior year it was thirty five then you build the client three forty then you collected three hundred thousand that's gonna give us hopefully my math is right seventy five now in by year two your CIP is half a million your CIP is half a million you build the client five hundred and fifteen thousand what happened in year two is you build the client more than your CIP so you build the client for more for more work than you have done well now we have billing an account called billing and access of CIP when you build the client more than the word that you have done this this difference becomes a current liability why because you have more billings than CIP you have more obligations you have more work to do to satisfy your obligation and obligation is a liability so make sure you know because on the CPA exam they ask about this how things are presented on the balance sheet again let's go ahead and ask where are the income statement account because in the prior session when we when we when we when we when we when we use this example using the percentage of completion method we had income statement entries for year one year two and year three this is for the percentage of completion obviously I'm not gonna go over this you can view the prior recording so for the completed contract method guess what you have nothing for year one you have nothing for year two and in year three you recognize all the revenue and all the cost and all the gross profit all at once so let me show you if you account for cost year one year two and year three it will be 200,000 this is I'm sorry yeah CIP construction and process which is the profit is 200,000 for the project if you look at the expenses 200,000 300,000 and 300,000 they add up to 800,000 you do it all at once in year three when you complete the project and if you account for the revenue to 66,667,358,333 and 375 you have a total revenue of a million therefore those three entries you combine them and you book them in year three when you did complete the project now obviously what you would kept track of is CIP and billing and hopefully you did this as I as I suggested you do your CIP account will have a million dollar your billing will have a million dollar what you do you close the project you debit billing you debit billing for a million you credit CIP you debit billing you credit CIP to finish the project what should you do now go to farhatlectures.com and work MCQs and use other resources to reinforce the concept that you have learned once you understand the completed contract once you understand the percentage of completion method it's easy to understand the completed contract method invest in yourself don't shortchange yourself your accounting education is important it will pay you dividend down the road your CPA certification is important your accounting certification is important any any and each one of them good luck study hard and of course stay safe