The CC method recognizes income only upon completion (or substantial completion) of a contract. All costs incurred during contract performance as well as related revenues are deferred until the contract is complete and the costs and revenues are recognized. (For income tax reporting purposes, the Internal Revenue has put severe limits on use of this method limiting it to (1) general construction contracts completed within two years from commencement and only if average annual gross receipts were less than $10 million over the last three years and (2) home construction contracts if at least 80 percent of the total contract costs relate to buildings containing four or fewer units)

A contract is considered complete if the remaining costs to be incurred and potential risk to the contractor are insignificant. Examples of completeness include delivery of product, acceptance by customer, when the contractor leaves the work site or when the contractor has complied with all performance specifications. Contractors may define their own criteria for completeness as long as they follow it consistently.

The basic steps in accounting for contracts under the CC method are:

All allocable direct and indirect costs are charged to a work-in-progress account which is treated as an asset.

Billings, progress payments and advances are credited to an account usually called "advances on work in progress" which is a liability.

At interim balance sheet dates, the excess of the work-in-progress account over the advances account is classified as a current asset. Excess of advances over work-in-progress would be classified as a current liability.

Losses must be recognized in full in the year they are discovered. Losses occur whenever the estimated costs to complete a contract plus all cost incurred to date exceed estimated future revenues plus the sum of billings, advances and progress billings. If the contract is profitable, this profit cannot be recognized until the contract is completed.

Upon completion of the contract the gross profit or loss is recognized according to the simple formula: contract revenue minus total costs equal gross profit or loss.

An example of journal entries for a contract whose first year incurred costs were $1,000,000, progress billing were 750,000 and collections from billings were $600,000 would be:

1. Contracts in progress $1,000,000

Various Accounts $1,000,000

2. Accounts Receivable 750,000

Billings on Contracts

in progress 750,000

3. Cash 600,000

Accounts Receivable 600,000

In the last year where total incurred costs were $4,500,000 and profit was $500,000 the journal entries, in addition to that years recording of it annual incurred costs, progress billings and collections would be:

Billings on contracts

In progress $5,000,000

Contracts-in-progress $4,500,000

Realized gross profit 500,000

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