Percentage of Completion Method

Percentage of completion method is a basis for revenue recognition in long-term construction contracts which span over more than one accounting periods. In case of long-term contracts, accountants need a basis to apportion the total contract revenue between the multiple accounting periods. Percentage of completion method provides one of those bases, other being full-contract method. The percentage of completion is an accounting method that recognizes revenue for different periods for a long-term project or contract. The percentage of work completed in a period calculates revenue, expenses, and estimated gross profit. The percentage-of-completion method enables companies to recognize revenue and expenses systematically over the life of long-term construction projects.

While both methods have advantages and disadvantages, the CCM is more advantageous if annual cash flow is a concern. The PCM may be preferable when the company’s books are expected to be reviewed regularly by external parties over the contract’s life. However, in general, most users of the PCM are doing so as a result of this method being percentage of completion calculation example the mandatory default. To determine your estimated revenue, you can multiply the 33% by the total revenue expected from the project. For example, if you have a project that you estimated will take 30,000 manual labor hours, and you have completed 10,000 hours thus far, you will divide 10,000 by 30,000 to get 33% of the project completed.

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Percentage of completion is a method of accounting for long-term projects in which revenue and expenses are recognized based on the percentage of work they have completed during the period. Using the percentage of completion method, a contractor recognizes project income and expenses as the project progresses, usually on a monthly basis. Total labor hours, machine hours, or quantity of raw material can be used to measure the completion percentage. When you notice discrepancies, ensure your accountant is aware so they can record them as journal entries.

If progress is irregular or uncertain, period-by-period basis recognition may offer a more stable representation of financial performance over time. If the project progresses steadily and estimation is reliable, ongoing basis recognition may be the preferred choice for providing detailed and up-to-date financial information. The company must be reasonably assured of collections and capable of reasonably estimating costs and the project completion rate. Once you’ve got your POC, you can then use this percentage to calculate the amount of revenue to recognize for a given payment period or milestone. Taxpayers must use the PCM for all long-term contracts—unless they meet the exceptions the IRS provides for small contractors and home construction contracts.

What are the benefits of using the percentage of completion method?

Expenditures incurred from inception to date represent costs incurred from the start of the project to the date of estimation. These figures provide the baseline for measuring progress and recognizing revenue over time and are basic inputs for the percentage of completion method. The percentage of completion method should be avoided in cases of significant uncertainties about completion percentage or remaining costs. Liz Smith is an experienced tax specialist with focused expertise in compliance and financial planning.

These adjustments ensure that the income shown on the income statement is reflective of the percentage of completion method. When using this method, the balance sheet is prepared just as in the case of a completed contract method; the adjustments have to be made in the P&L statement only. For example, let’s say there’s a construction project which was 55% completed after the end of the second year and only 30% at the start of the 2nd year. However, this method should be used only when there is very little credit risk and the percentage of contracts completed can be measured effectively and efficiently. Properly applying this method requires robust cost estimation and progress tracking to determine accurate completion percentages.

How to calculate the percentage of completion

Therefore, no special election is required to use the PCM as long as you haven’t used a different method in the past. If you have previously used a different method to account for long-term contracts and you choose to change to PCM, file form 3115 and attach it to your business tax return. File a separate copy and mail it to the address on the form 3115 instructions. Doing so improves the consistency of the percentage of completion results over time.

One common error is using an incorrect formula to calculate percentage of completion. Accurately tracking the percentage of completion is essential for several reasons. Additionally, it helps in effectively communicating project status to stakeholders and ensures that the project stays on track towards successful completion. When you can confidently keep up your accounting books and know how much money is in your accounts at all times, you’ll find it easier to understand how to invest to grow your business.