What is the difference between the completed contract method and the percentage-of-completion method for long-term contracts?

These two methods handle long-term contract revenue very differently, and the distinction is a classic CFA Level I topic.

Percentage-of-Completion Method

Revenue is recognized proportionally as work is performed. The most common measure is cost-to-cost: you divide costs incurred to date by total estimated costs.

Example: Torrance Engineering signs a $5 million contract to build a water treatment plant. Total estimated costs are $4 million.

Each year, the income statement shows both revenue and a portion of the total $1M profit.

Completed Contract Method

No revenue or profit is recognized until the project is fully complete. Costs are accumulated on the balance sheet as construction-in-progress.

Using the same Torrance Engineering example, years 1 and 2 would show zero revenue and zero profit. In year 3, the entire $5M revenue and $1M profit hit the income statement at once.

Key financial statement effects:

1. Income smoothing: Percentage-of-completion produces smoother earnings. Completed contract creates lumpy, volatile income.
2. Balance sheet: Under percentage-of-completion, if billings exceed recognized revenue, a liability (deferred revenue) appears. If revenue exceeds billings, an asset appears.
3. Tax timing: Under completed contract, taxes on profit are deferred until completion, providing a cash flow advantage.

Modern standards note: Under IFRS 15 and ASC 606, the completed contract method is largely eliminated. Revenue is recognized over time if certain criteria are met (e.g., the customer controls the asset as it is built). Otherwise, revenue is recognized at a point in time. For the CFA Level I exam, understand both methods conceptually and know that current standards favor the over-time model when the outcome can be reliably measured.

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