Definition
The percentage-of-completion method is an accounting technique used to recognize revenue and expenses for long-term projects. This method measures the progress towards completion, and thereby allocates a proportion of total contract revenue and expenses to each accounting period. Revenue and expenses, in essence, are recognized as the work is performed rather than when the contract is completed.
Key Aspects:
- Measurement of Progress: This can be based on cost expended, physical progress, or other measurements.
- Revenue Recognition: Reallocated according to the cost to cost, output, or input methods.
- Cost Incurred and Estimated Costs: Required for accurate measurement and accounting entries.
Examples
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Construction Projects:
- Scenario: A construction company is building a skyscraper over three years with a total contract value of $90 million.
- Progress Calculation: After the first year, 30% of the project is complete.
- Revenue Recognition: $27 million ($90 million contract value * 30%).
-
Software Development for Customized Software:
- Scenario: A tech company working on a multi-year software development project valued at $50 million.
- Progress Calculation: At the end of one year, 40% of the software modules are delivered and functional.
- Revenue Recognition: $20 million ($50 million contract value * 40%).
Frequently Asked Questions
What is the percentage-of-completion method best suited for?
This method is primarily used for long-term contracts, especially in industries like construction, aerospace, and software development where projects span multiple accounting periods.
How does the percentage-of-completion method differ from completed contract method?
Under the completed contract method, all revenue and expenses are recognized only once the project is fully completed, whereas, under the percentage-of-completion method, revenue and expenses are recognized in relation to how much of the project is complete during each accounting period.
What are the main benefits of using the percentage-of-completion method?
This method provides a more accurate reflection of a company’s financial performance during periods of significant contract work. It aligns revenue recognition with the accounting expenses and improves the matching of revenue with the related expenses.
What accounting standards govern the percentage-of-completion method?
Accounting standards such as the International Financial Reporting Standards (IFRS 15) and the Generally Accepted Accounting Principles (GAAP) in the U.S. provide guidelines for revenue recognition including the percentage-of-completion method.
Related Terms
Long-term Contract
An agreement to deliver goods or services over a period of time exceeding one year. This term is pivotal in industries where large-scale projects are common such as construction and aerospace.
Revenue Recognition
The process of accounting for revenue when it is realized and earned, not necessarily when cash is received. This has implications for both the percentage-of-completion and completed contract methods.
Cost-to-Cost Method
A method under the percentage-of-completion approach where progress toward completion is measured by comparing costs incurred to date with the estimated total costs required to complete the project.
Completed Contract Method
A contrasting accounting method to percentage-of-completion in which all revenue and related expenses are recognized only upon the completion of the project.
Online Resources
Suggested Books for Further Studies
- “Financial and Managerial Accounting for School Administrators: Tools for School” by R. E. Everett and J. E. Cater
- “Revenue Recognition: Rules and Scenarios Illustrated” by Alex Kogan
- “Accounting for Construction Contracts” by Steven M. Bragg
Accounting Basics: “Percentage-of-Completion” Fundamentals Quiz
Thank you for using this detailed guide on the percentage-of-completion accounting method. We hope this comprehensive entry and engaging quiz enhance your understanding and application of this important accounting principle!
