Navigating the percentage-of-completion method

The percentage of completion method is a contrast to the completed contract method, which measures and records expenses and revenue at the end of the project. Generally accepted accounting principles (GAAP) require that revenue be recognized in the period it was earned. This means for most long-term projects, the percentage of completion method should be used. International Financial Reporting Standards (IFRS 15) provides guidance on the treatment of stored materials in income recognition. Stored materials don’t represent completed work, so they have to be treated differently.

• ABC Company has won a contract for excavation of an area which will take two years to complete.
• You can use a few different methods to calculate POC, although the most commonly used approach is the cost-to-cost method.
• This way, you’ll ensure your recognition of revenue is accurate and that you can take home the maximum profit from a job.
• Consistently calculating your POC helps you avoid overbilling or underbilling, and allows you to make revisions on your estimates as needed.

IRS requirements

Alternatively, the percentage of completion can also be calculated using units labor hours or labour hours, depending on the nature of the business. The key is consistency in the method used to calculate the percent percentage complete. The completion of work is measured by the percentage of efforts expended till date as compared to estimated total effort expected to be expended for each contract. The percentage of completion is based on labor hours, machine hours or material. To determine the percentage of completion for a project, divide current costs by total costs, and multiply by 100. The percentage of completion method evaluates work-in-progress that’s applied to long-term projects, in which expenses and revenues are recorded as a percentage of the completed work during that period.

How Does the Percentage of Completion Method Impact Taxation?

Underbilling, on the other hand, can lead to lower business profitability and financial difficulties. Always consult with a tax professional to ensure compliance with IRS guidelines when using the percentage of completion method. Tax laws can be complex and may vary based on the project and business structure. Doing so improves the consistency of the percentage of completion results over time. These adjustments ensure that the income shown on Law Firm Accounts Receivable Management the income statement is reflective of the percentage of completion method.

Step 3: Determine Revenue To Be Reported for the Year

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Ongoing Basis Recognition vs. Period by Period Basis Recognition

In addition, it helps positioning your company as a reliable and well-managed business. Although the percentage-of-completion method is complicated, if your estimates are reliable, it can provide more current insight into financial performance on long-term contracts. Contact us to help train your staff on how this method works — or we can perform the analysis for you. BuildStuff entered into a three-year contract to construct a building complex for the City of Kalona, Iowa. The contract between BuildStuff and Kalona states that BuildStuff will invoice the city 20% each year in years 1 and 2 and the balance in year 3. In recording transactions some rare cases, the percentage of completion can be calculated using the units-of-delivery method.

• The percentage of completion method of accounting is a procedure for recognizing the revenue and expenses related to projects spanning multiple accounting periods.
• This approach is better than the completed contract method, since there is at least some indication of economic activity that spills over into the income statement prior to project completion.
• However, of these three methods, the most commonly used is the Cost-to-Cost method.
• BuildStuff entered into a three-year contract to construct a building complex for the City of Kalona, Iowa.
• This progress percentage is then used to determine how much revenue you can recognize and how much expense you can deduct in the current year.
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This percentage is multiplied by the total contract amount to determine the revenue to recognize during the period. Once the contractor has determined the percentage of completion for a project, the percent is multiplied by the total expected revenue. The answer is the amount of income that can be percentage of completion calculation example recognized on the project to date. This income is recognized on the income statement through the work in progress report.