The Percentage of Completion Method Explained

The percentage of work completed in a period calculates revenue, expenses, and estimated gross profit. To calculate the percentage of completion for a project, there are three indicators contractors can use. The most common is costs incurred to date, but they can also use units completed or labor hours. Percentage of completion method is commonly measured through the cost-to-cost method which compares costs incurred to total estimated costs. To estimate the percentage of completion, you divide the total expenditure incurred from inception to date with the total estimated costs of the contract.

• 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.
• Underbilling is the opposite scenario, when the amount billed to date is less than the recognized revenue.
• Staying on top of it can be an immense challenge, especially when dealing with large projects, various phases, and change orders.
• Still, even with these risks, the completed contract method is the most conservative accounting method for companies working on long-term contracts.

AccountingTools

In this article, I am sharing with you how to calculate the percentage of completion in Excel. To determine your estimated revenue, you can multiply the 33% by the total revenue expected from the project. If that same project is expected to bring the business $30,000, multiplying $30,000 by 20% will give the business $6,000. The percentage of completion method spreads tax liability out over multiple years and helps free up cash flow.

• Note this excel template is formatted to print out on 11×17 sized paper (due to the number of columns).
• However, a specialized method is needed specifically for long-term contracts, and this specialized method would generally be the PCM.
• Doing so improves the consistency of the percentage of completion results over time.
• It includes costs that have been incurred to date and costs that are expected to be incurred in future periods.
• The firm will also report 40% of the $3 million in expenses ($3 million x 0.4).

Understanding percentage of completion in construction

The amounts billed in the current period now reflect the actual current costs over the estimated  total costs of the project. Overbilling and underbilling are two thorns in the side of the percentage of completion method. This is because revenue and expenses can be tricky for contractors to get right, especially on long-term projects. When revenue figures don’t quite match up with what’s already been billed, it can result in major cash flow problems. Percentage of completion (POC) is an accounting method used to recognize revenues and expenses based on the percent of work done.

Revenue Recognition

The method works best when it is reasonably possible to estimate the stages of project completion on an ongoing basis, or at least to estimate the remaining costs to complete a project. Conversely, this method should not be used when there are significant uncertainties about the percentage of completion or the remaining costs to be incurred. The percentage of completion schedule calculates the amount of revenue to be recognized for long-term construction-type contracts. There are other acceptable methods of revenue recognition, but the cost-to-cost method used in this template is one of the more popular. The cost-to-cost method provides for proportional recognition of revenue to costs. The contractor is going charge the end customer $100, and at the end of the year $35 of costs had been incurred.

Percentage of Completion Method

At the end of the first month, with project completion at 20%, an invoice reflecting 20% of the total ($20,000) will be sent. Construction accounting brings a different set of rules when compared to more traditional styles percentage of completion calculation example of accounting. Enter the job-specific information into all of the columns that are not shaded gray (gray columns include formulas). All formulas are unprotected and can be seen so you can evaluate them for yourself.

The manager of Project A overbilled the customer by $2,000 in the first month, and the manager of Project B underbilled the customer by $3,625. The billing discrepancies probably arose as the managers billed before the end of the month and estimated the percentage of completion as of the billing date rather than the actual month-end. Most construction companies use the cost-to-cost method of percentage of completion accounting. When the amount you bill exceeds the amount you bring in—you’re overbilling.

• Most construction companies earn revenue and pay job costs throughout the duration of each project.
• Total costs include costs incurred to date and costs expected to be incurred over the remaining period.
• Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
• If you used a different revenue recognition method in a prior year, you’ll need to file Form 3115 with your tax return and file a second copy with the IRS address provided on the Form 3115 instructions.
• This is where percentage of completion (POC) accounting can be extremely helpful.
• XYZ Ltd. took a contract to build an airport at a contract price of $125 million.
• Because the projects are usually long term lasting several years, it estimates completion for the company.

How to Calculate POC Using the Efforts-Expended Method

Since income and expenses are often deferred during work on these long-term projects, companies seek to defer tax liabilities as well. Both the percentage of completion and https://www.bookstime.com/bookkeeping-services/manchester completed contract methods allow for such tax deferral. The cost-to-cost method is one of the most commonly used calculations by those who use this system of accounting.

We’ll review each so that you can determine the strategy that will work best for you, your business, and your contract. Businesses interested in using the percentage of completion method will find there are a few options for calculating this accounting measure. It’s important as you begin to calculate your percentage of completion that you are mindful of GAAP and International Financial Reporting Standards (IFRS) guidelines. These two sets of accounting rules aim to make accounting books transparent around the world so that people can easily understand how accounts are maintained and the financial health of businesses. The percentage of completion method is a means of recognizing income in which a percentage of profit is reported annually, representing the percentage of the project that has been completed. Having calculated the percentage of completion, the next step is to apply this percentage to the estimated total revenue from the project.

What Is The Percentage Of Completion Method?