The #percentage of completion (POC) technique is regularly used with construction based projects that continue to run over the course of many years. The approach of percentage completion #accounting is preferred over the Completed Contract Method by the accountants because it provides a more rational outlook of the company and its revenue streams and cash flows. This #revenue recognition method avoids variation in the P&L where costs and revenues have to be matched.
The formula for Percentage of completion basically takes a projected percentage of how close the project or task is to being fulfilled by taking the cost to date for the project over the sum of the estimated cost. Then the percentage calculated is multiplied by the total projected revenue through, which the calculation of revenue for the period is computed. The income for construction then can be derived by subtracting the cost from the period revenue.
The percentage completion formula and other associated formulas can be simplified as follows:
Period Costs (annual, quarterly, etc.) = Percentage Completed
Total Estimated Cost
Percentage Completed * Total Project Revenue = Period Revenue
Period Revenue – Period Costs = Project Income
Example 1 of the Percentage of Completion Method
The Boulders Construction Company is constructing a modern style office building for a company specializing in clothing wholesale business. Thus far, Boulders has accumulated $810,000 in expenses on the project and billed the customer $1,000,000. The estimated gross margin on the project is 28%.
The total of expenses and estimated gross profit can be calculated by:
$810,000 divided by 0.72 (1 – 0.28) = $1,125,000
Since this figure exceeds the billings to date of $1,000,000, the company can recognize additional revenue of $125,000.
Costs + Profit $1,125,000 -/- Billed to Customer $1,000,000 = $125,000
The resulting journal entry is:
Unbilled contract receivables 125,000
Contract revenue earned 125,000
Since, Boulders must also recognize a proportional amount of expenses in relation to the revenues recognized because of this it should credit the construction in progress #account and debit the cost of goods sold account.
The cost of goods sold is derived by multiplying the recognized revenue figure of $125,000 by one minus the gross margin, or 72%.
Cost of Goods sold: $125,000 x 0.72 (1 – 0.28) = $90,000
Example 2 of the Percentage of Completion Method
Under an alternative scenario, Boulders has billed the customer $1,200,000, while all other information remains the same. In this case, the amount of revenue earned is $1,125,000 which is $75,000 less than the amount billed. Consequently, the company must record a $75,000 liability for the incremental amount of work it must still complete before it can recognize the remaining revenue that has already been billed. The resulting journal entry would be:
Contract revenue earned 75,000
Billings exceeding project costs and margins 75,000
Key #requirements for Using this Method:
See also our article on SAB 104 Revenue Recognition but in addition:
#profitability of the project needs to be reasonably determinable
This method should give a more realiable measure of progress towards completion than recognizing income than when the contract would be completed (matching principle)
- Periodic recognition opposed to irregular streams of income only when contracts are completed
- More accurate way of reporting income and expenses
- Estimations are used in the process making this method a subjective one
- Accounting system needs to be projects based with ability to keep track of projects over several years
Full #fasb 56 Statement (supplemented by AICPA Statements of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and 81-2, Reporting Practices concerning Hospital-Related Organizations)