The Percentage-of-completion method Made Easy: A Comprehensive Guide

The percentage-of-completion method is a way to account for the progress of a project over time. This method is commonly used in construction and manufacturing.

It recognizes that a project is not a single event, but rather a series of events that happen over time.

The percentage-of-completion method is based on the idea that a project is complete when it is finished, not when it is started.

It's a method that allows you to match the revenue and expenses of a project to the work that has been completed.

The percentage-of-completion method is a revenue recognition approach that measures the percentage of work completed against the total project scope. This method provides a clearer picture of a business's financial health by recognizing revenue as a project advances.

The POC method is particularly useful for industries with prolonged project timelines, including construction, software development, infrastructure, and manufacturing. By measuring the percentage of work completed, revenue is realized following the percentage complete, providing a more precise financial outlook.

This approach allows businesses to recognize revenue incrementally, rather than deferring it until the project is complete. The completed contract method, on the other hand, recognizes revenue only when the project is finished, which can lead to a less clear depiction of financial health.

To calculate revenue recognition using the POC method, you can use the formula: Revenue = (% of work completed) * Total contract value.

Here's a breakdown of the benefits of using the percentage-of-completion method:

The percentage-of-completion method is widely used in the construction industry, as it allows contractors to recognize revenue as a project advances, rather than deferring it until the project is complete.

The percentage-of-completion (POC) method is a crucial tool for companies with projects spanning multiple accounting periods. It helps companies accurately realize their revenue and present a realistic view of their earnings and ongoing activities.

By using the POC method, companies can provide stakeholders with a more accurate snapshot of their current finances, as long as they have a reasonable expectation of receiving payment for the work completed. This approach also helps manage cash flow by allowing companies to include partial revenue on their statements instead of conserving it until the project is completed.

The POC method is particularly beneficial for construction companies, as it aligns with ASC 606's and GAAP's rateable criteria for revenue recognition. However, companies must ensure they have a robust accounting process in place to accurately calculate and report POC.

To achieve accurate POC recognition, companies should follow procedures such as reviewing their performance obligations and original contract with each instance of revenue recognition, and getting written documentation and authorization for each expenditure that falls outside the original scope of the contract.

The percentage of completion method is particularly important in construction because it allows companies to accurately reflect their revenue and financial health on their financial statements. This transparency boosts stakeholders' trust and safeguards the organization's financial integrity.

By using the percentage of completion method, construction companies can provide a more realistic and comprehensive view of their earnings and ongoing activities. This is achieved by recognizing revenue in proportion to project completion.

The total contract price is the project's overall value, which is the cornerstone of the revenue calculation. This helps companies accurately calculate their revenue and financial commitments.

Costs incurred to date are a critical piece of knowledge to assess the project's advancement and forecast future requirements. Precisely estimating and diligently tracking these costs is vital in accurately recognizing revenue each accounting period.

Implementing the percentage of completion method not only upholds compliance with regulatory bodies but also paints an unambiguous picture of a company's financial health.

In the construction industry, accurate Project and Outcome (POC) recognition is crucial for businesses to avoid errors and maintain reliable data. Blue Gilia Construction reported 116% POC on a key project, which is an impossibility.

Companies like Blue Gilia can benefit from strengthening their internal controls by having all relevant teams meet to evaluate their accounting processes. This helps minimize errors and ensures accurate POC recognition.

Reviewing performance obligations and original contracts with each instance of revenue recognition is also essential. This helps identify and correct errors in the reporting process.

Getting written documentation and authorization for each expenditure outside the original contract scope is another crucial step. This ensures that all costs are accounted for and reported accurately.

To achieve accurate POC recognition, companies can follow the procedures suggested by revenue recognition professionals. These include:

There are three primary methods to calculate percentage of completion: Cost-to-cost, Efforts-expended, and Units-of-delivery. To use the Cost-to-cost method, you need to compare the contract cost incurred to date to the total expected contract cost.

The Cost-to-cost formula is POC = (Costs incurred to date / total estimated costs) * 100. This method is the basic POC calculation we've already covered and is used when a company inserts its own expenses into the formula.

For example, let's say you have a four-year project worth $10,000,000 and you've incurred $1,250,000 in costs to date. Using the Cost-to-cost method, you would calculate POC = (1,250,000 / 10,000,000) * 100, which equals 25%.

To find the amount of revenue to report in this period, you simply multiply the total contract value by the POC: $10,000,000 * 25% = $2,500,000.

The Efforts-expended method compares the amount of effort you've expended to date to the total necessary for the project. This approach is generally measured in total estimated labor hours or machine hours.

Using the same example as above, if you've completed 2,500 of 10,000 labor hours, your POC would be 25%. This means you would recognize $2,500,000 in revenue for the period.

The Units-of-delivery method uses a concrete, measurable factor, such as the number of apartments completed in a building, to assess progress on your project. For example, if you've completed 250 units out of 1,000, your POC would be 25%, and you would recognize $2,500,000 in revenue for the period.

To summarize, the three methods are:

Calculating the percentage of completion requires accurate cost estimates. This can be a challenge, especially when dealing with ongoing expenses or prepaid labor contracts that cloud current expenditure.

Estimating costs is a crucial part of the cost-to-cost approach. This involves comparing actual costs to estimated total project costs to determine the completion percentage.

POC = (Costs incurred to date / estimated total costs) * 100.

Revenue recognition occurs after applying this percentage to the transaction price. This ensures that revenue is matched with related expenses.

The percentage of completion method can help companies correctly match revenue to expenses and measure work completed against the total project scope.

The cost-to-cost approach is a simple formula: Percentage of completion = Cost-to-date / Cost-to-completion. This can be used to calculate the percentage of completion.

For example, if the cost-to-date is $40,000 and the cost-to-completion is $120,000, the project is 33% complete.

Revenue to date can be calculated by multiplying the percentage of completion by the total contract price. For instance, if the total contract amount is $1,000,000, the revenue to date would be $330,000.

Here's a summary of the revenue recognition formula:

The percentage of completion method is a widely used approach in industries like construction, real estate, and software development. It allows companies to recognize revenue as work progresses, reflecting the true value of the services rendered.

To accurately calculate revenue recognition, it's essential to consistently update your cost estimates and project progress. This can be done by maintaining a clear, open line of communication between project managers and your accounting team.

In the case of a construction project, if the total estimated cost is $10,000 and the contract value is $12,000, a 30% revenue can be recognized in the income statement for the first year, assuming a cost of $3,000 incurred during that period.

By following these best practices and using accounting software like RightRev, companies can ensure accurate and timely revenue recognition, reducing the risk of errors and inconsistencies in financial reporting.

Change Orders can be a hassle, but they're a necessary part of most projects. Contractors have a duty to account for change orders as soon as they're approved, because income recognition is based on each project's completion percentage.

If a change order is approved, you must adjust your estimates, revise your budget, and alter your numbers immediately. This ensures your accounting calculations stay accurate and consistent.

Let's look at an example from the article. In the second year of the contract, the expected cost changed to $11,000. But what if a change order was approved during the second year, increasing the expected cost to $13,000? In this case, you would need to recalculate the percentage completed and the revenue to be recognized.

Here's a summary of the steps to follow when handling change orders:

By following these steps, you can ensure that your accounting calculations stay accurate and consistent, even with change orders.

Examples of the percentage of completion method can be seen in various industries such as construction, real estate, and software development. These industries use this method to recognize revenue as work progresses, reflecting the true value of the services rendered.

A construction firm building a stadium, skyscraper, or bridge would likely use this approach to measure the percentage of work completed against the total project to recognize revenue accordingly. This method is suitable for these industries because it allows them to recognize revenue as work progresses.

For example, a software company that employs long-term service contracts or projects that extend over multiple accounting periods might also use this method to report revenue. This approach helps ensure that revenue is accurately recorded throughout long-term projects or contracts.

The percentage of completion method can be applied using the cost-to-cost approach, efforts-expended method, or units-of-delivery approach. The cost-to-cost approach involves dividing the current costs by the total costs to determine the percentage of completion.

Here's a table illustrating how to calculate the percentage of completion using the cost-to-cost approach:

In addition to the cost-to-cost approach, the efforts-expended method involves dividing the labor hours worked by the total labor hours to determine the percentage of completion. The units-of-delivery approach involves dividing the units delivered by the total units to determine the percentage of completion.

The percentage of completion method aligns with accrual accounting, a generally accepted accounting principle (GAAP). Revenue is matched with related expenses to accurately represent a company's financial performance during an accounting period.

A company like Logger Construction Company can use the percentage of completion method to recognize additional revenue as work progresses. For example, if a project's total costs are $10 million and its current costs are $4 million, the company can recognize additional revenue of $500,000 using the following journal entry:

This journal entry recognizes the additional revenue and the proportional amount of expense to offset the amount of revenue recognized.

Consistently updating cost estimates and project progress is key to accurate POC calculations. This involves keeping a running total of both figures.

Maintaining a clear line of communication between project managers and the accounting team is crucial for staying on top of updates. Every material purchase and labor hour approved needs to be recorded and added to the totals.

Relying on accounting software like RightRev can save a huge amount of time and reduce the risk of human error. Manual book entries are slow and tedious, and can lead to inaccuracies.

Consulting with auditors to determine the best revenue recognition method is always a good idea.

Implementing the percentage-of-completion method can be a challenging task for contractors. Difficulties estimating costs are a common roadblock, making it hard to detach an accurate idea of ongoing expenses from the total cost of the project.

Prepaid labor contracts and unforeseen circumstances can further complicate the process. Changes in the project, such as delays beyond your control, can also affect your POC and forecasted revenue.

Tracking percentage of completion requires many variables to be consistently tracked and reported. This can be a significant administrative effort, requiring additional systems in place to consistently report on metrics like hours, costs, or units.

The POC method is not without its risks. Delays and unforeseen circumstances can lead to increased costs and a need to adjust your initial quote. This can affect your POC and forecasted revenue, making it difficult to determine an accurate figure to recognize at different points in your project.

Here are some common roadblocks to implementing the POC method:

The IRS requires contractors to use accrual accounting for long-term projects, but there are exceptions for smaller contractors and projects.

For contractors with $25 million or less in gross receipts over the last three years, and projects expected to be completed in two years or less, percentage of completion is not always required.

If a contract is mainly for home construction and expected to account for 80% or more of estimated total costs, contractors may be exempt from IRS regulations.

Contractors should be aware that any change in accounting methods will likely require IRS approval, and they can review IRS code 460 for more information.

To accurately report on contracts in progress, entities should present the gross amount due from customers as an asset, and then subtract the sum of recognized losses and progress billings from costs incurred plus recognized profits.

Here are the key disclosures required by IAS 11.42-43:

Accounting for long-term projects can be complex, but the IRS has some clear guidelines to follow. The IRS requires accrual accounting for these types of projects.

Percentage of completion accounting is often the best way to go, but there are some exceptions. The IRS typically requires percentage of completion for large contractors working on projects spanning two or more years.

The size of the job and the contractor are key factors in determining if an exception applies. If a contract can be completed in two years or less and the contractor has no more than $25 million in gross receipts over the last three years, they may be exempt.

The type of project also plays a role in determining if an exception applies. If 80% or more of the estimated total costs are attributed to home construction, the contractor may be eligible for exemption from IRS regulations.

When presenting the balance sheet, it's essential to accurately reflect the financial position of a company.

In current assets, excess of costs over billings is shown in the "due on accounts" and "construction in progress" accounts. These accounts represent costs incurred that haven't been billed to customers yet.

The excess of costs over billings is also reflected in current liabilities as "progress billings" on uncompleted contracts. This is the amount of billings received from customers that exceeds the costs incurred.

The gross amount due to customers for contract work is shown as a liability, representing the total amount owed to customers for work completed but not yet paid.

To calculate the gross amount due from/to customers for contract work, you need to consider the net amount of costs incurred plus recognized profits, minus the sum of recognized losses and progress billings.

Here's a summary of the balance sheet presentation for contract work: