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Learn how the percentage of completion method can improve financial reporting for long-term projects. Get practical tips and insights to implement it effectively.
Running a business with long-term projects requires a keen eye on financial reporting. But traditional methods can fall short when projects span multiple reporting periods. Enter the accounting percentage of completion method, a powerful tool for recognizing revenue and expenses as work progresses. This method offers a more realistic view of your financial health, allowing for better decision-making and improved project management. This guide will delve into the intricacies of the accounting percentage of completion method, covering its definition, calculation methods, benefits, and potential challenges. We'll also compare it to other methods and provide practical advice for implementation, ensuring you have a firm grasp on this essential accounting practice.
The percentage of completion method is an accounting method used to recognize revenue and expenses for long-term projects. Instead of waiting until the project is finished, revenue gets recognized periodically based on the progress made. This aligns with IFRS 15, which states that revenue from performance obligations recognized over time should be based on the percentage of completion. Think of it like building a house: you wouldn't wait until the entire house is built to get paid; payments are typically tied to stages of the project. This method provides a more accurate picture of a company's financial performance, especially for projects spanning multiple reporting periods. It contrasts with the completed contract method, which defers reporting until project completion. For more on revenue recognition methods, check out our blog.
When does it make sense to use the percentage of completion method? It's generally the preferred approach for long-term projects where revenue can be reliably measured as work progresses. Industries like construction, software development, and infrastructure projects often use this method. It's crucial that project completion is reasonably predictable and payment is reasonably assured. This allows for more accurate financial reporting during the project. If you're unsure whether this method is right for your business, consider scheduling a demo to discuss your needs. You can also explore our integrations to see how HubiFi can work with your existing systems.
Calculating the percentage of completion is crucial for accurate revenue recognition. Here's a breakdown of the most common methods:
The cost-to-cost method is the most frequently used approach. It's straightforward: compare the actual costs incurred to date to the total estimated costs for the project. This gives you a clear picture of how far along you are financially. The formula is: % Complete = (Costs Incurred to Date / Total Estimated Costs) x 100. For example, if you've spent $50,000 on a project estimated to cost $100,000, you're 50% complete. This method works well when costs are a reliable indicator of progress. If your project involves a lot of materials or labor, the cost-to-cost method is a solid choice. For complex projects, consider automating these calculations with HubiFi for increased accuracy. Learn more about how we can help.
Sometimes, costs aren't easily measurable. Think about design work or software development—how do you quantify the effort involved? That's where the efforts-expended method comes in. This method measures the percentage of completion based on the work performed relative to the total work required. This could be labor hours, machine hours, lines of code, or any other quantifiable measure of effort. This method is particularly useful when costs are difficult to track, but the effort is easily quantifiable. For more insights on revenue recognition and choosing the right method for your business, check out our blog.
The units-of-delivery method is perfect for projects with distinct, measurable outputs. Think manufacturing or construction projects with clear deliverables. This method recognizes revenue based on the number of units delivered compared to the total units in the contract. For example, if a contract calls for delivering 100 widgets and you've delivered 25, you're 25% complete. This method is especially helpful for projects with easily quantifiable outputs. HubiFi seamlessly integrates with various project management tools to streamline this process. See how our integrations work.
The percentage of completion method offers several advantages for businesses managing long-term projects. Let's explore some key benefits:
The percentage of completion method provides a more accurate view of your financial performance. Instead of waiting until the end of a project, revenue and expenses are recognized based on the work completed. This approach offers a realistic snapshot of your financial health throughout the project lifecycle, smoothing out revenue recognition and providing stakeholders with a clearer picture of your business's performance. This also leads to more insightful financial statements, which can be particularly useful for long-term projects where recognizing all revenue and profit at the very end can be misleading. For a growing business, this real-time financial clarity is essential for making informed decisions. For complex projects, using the percentage of completion method with a solution like HubiFi can simplify the process and ensure accuracy. Learn more about our integrations with leading accounting software.
With the percentage of completion method, you gain better visibility into your project's financial progress. By recognizing revenue incrementally, you get a more accurate sense of your cash flow. This improved cash flow management is crucial for making informed decisions about resource allocation, budgeting, and investments. Knowing where you stand financially empowers you to proactively address potential shortfalls or capitalize on opportunities. This granular view of your finances is especially helpful for complex projects with multiple phases. HubiFi's automated solutions can streamline this process, giving you more time to focus on strategic financial decisions. Explore our pricing to find the right plan for your business.
The percentage of completion method offers a powerful way to monitor project performance and profitability. By tracking costs and revenue as the project progresses, you can identify potential issues early on and take corrective action. This real-time insight allows for more effective project management and helps ensure projects stay on track and within budget. This method is particularly valuable for construction projects and other long-term engagements where accurate revenue recognition is essential for assessing profitability and making informed business decisions. For more insights on financial operations and accounting best practices, visit the HubiFi blog. Ready to see how HubiFi can transform your financial reporting? Learn more about us.
While the percentage of completion method offers several advantages, it also presents unique challenges. Understanding these complexities is crucial for accurate implementation and to avoid potential pitfalls.
One of the biggest hurdles is accurately estimating total project costs. This requires a deep understanding of the project scope, potential risks, and resource requirements. Inaccurate estimates can skew revenue recognition and impact your business's financial health. Regularly reviewing and refining cost projections throughout the project lifecycle is essential. For help with accurate revenue forecasting, consider exploring HubiFi's automated revenue recognition solutions. As highlighted in this article on calculating revenue recognition, even small discrepancies in cost estimations can have a significant impact.
Change orders, a common occurrence in many projects, can complicate percentage of completion calculations. It's vital to incorporate approved change orders into your cost and revenue projections promptly. Failing to do so can lead to cost underestimations and misrepresent project progress. Effectively managing scope creep—those incremental additions to project scope—is equally important. Clear communication with clients and robust project management practices can help mitigate these risks. Learn more about managing complex projects by scheduling a demo with HubiFi.
Staying compliant with accounting standards like ASC 606 and ASC 944 is non-negotiable when using the percentage of completion method. These standards provide specific guidelines for revenue recognition. Non-compliance can lead to penalties and damage your company's reputation. This resource emphasizes the importance of adhering to these standards, particularly for larger construction companies with long-term contracts. HubiFi offers services designed to ensure compliance with these standards. Explore our integrations with popular accounting software to streamline your compliance efforts. For more insights, check out our blog for articles on accounting and financial operations.
The percentage of completion (POC) method and the completed contract method (CCM) offer two distinct approaches to recognizing revenue and expenses for long-term projects. The key difference lies in when these figures are reported. POC recognizes revenue and expenses progressively, based on the project's completion percentage. It's like acknowledging your progress as you go. CCM, however, defers reporting until the entire project is finished. This means no revenue or expenses are recognized until the very end, even if the project spans several years.
CCM might be suitable for shorter projects or those in residential construction, where the timeline is usually more predictable. But for longer-term projects, this method can paint a skewed financial picture. Imagine a multi-year construction project—waiting until the end to report anything could cause significant swings in your financial statements from year to year. This makes it difficult to grasp your company’s true financial health and performance. The percentage of completion method provides a more accurate view of a long-term project's progress by distributing revenue and expenses across the project's duration. This aligns revenue with the associated costs, offering a clearer snapshot of profitability at each stage. This is essential for informed decision-making and accurate project profitability assessments. For a more detailed look at revenue recognition methods, this resource is helpful.
How do you determine the right method for your business? If your projects are typically short-term and relatively simple, the completed contract method might be sufficient. But for companies with long-term projects, especially those spanning multiple accounting periods, the percentage of completion method is often preferred. It offers a more accurate and consistent view of your financial performance. Accurately recognizing revenue and matching it with related expenses is crucial for understanding your project's profitability and making smart financial decisions. This is especially important for calculating revenue recognition and maintaining financial stability. Understanding the nuances of each method and their impact on your financial reporting is key. For complex, long-term projects, consider how HubiFi can help you implement the percentage of completion method effectively and streamline your revenue recognition process. Learn more by scheduling a demo.
The percentage of completion method is particularly useful in industries with long-term, complex projects where recognizing revenue and expenses as work progresses paints a more accurate financial picture. Here are a few examples:
Think large-scale construction projects like skyscrapers, bridges, or highway systems. These projects often span multiple years, and the percentage of completion method allows revenue to be matched with the costs incurred during each period. This is far more representative of the project's financial status than waiting until the end to book any revenue. As Procore explains in its guide to the percentage of completion method, this approach aligns revenue recognition with the actual progress of the work. For a general contractor managing numerous complex projects, this method becomes essential for accurate financial reporting and informed decision-making.
Defense contracts frequently involve multi-year projects with significant costs spread over time. Consider the construction of an aircraft carrier or the development of a new weapons system—these endeavors require ongoing resource allocation and progress tracking. The percentage of completion method, as Investopedia explains, works well in these situations, allowing for revenue and expense recognition aligned with project milestones. This gives a clearer picture of the financial health of these long-term contracts. For government agencies and contractors, this method offers better visibility into project profitability and helps ensure accurate budgeting and forecasting.
While some software projects are short and straightforward, custom-designed software development often involves lengthy development cycles and ongoing client collaboration. Think of enterprise resource planning (ERP) systems or complex software platforms tailored to specific business needs. Here, the percentage of completion method lets software companies recognize revenue as milestones are reached, rather than after the entire project is delivered. This approach, discussed by Miller Kaplan in their analysis of the percentage-of-completion method, provides a more realistic view of the company's financial performance during the development process. This is especially helpful for managing cash flow and making informed business decisions throughout the project. For software companies working on large-scale, custom projects, this method is a valuable tool for accurate financial management.
Successfully using the percentage of completion method requires diligence and attention to detail. Here are some best practices to help your team implement this method effectively:
Regularly reviewing and updating project estimates is crucial for accurate financial reporting. As projects progress, unforeseen issues can arise, impacting costs and timelines. Consistently reviewing your initial assumptions and making necessary adjustments ensures your financial statements reflect the project's current reality. Don't rely on outdated data; instead, update your estimates when change orders occur or the project scope shifts. This proactive approach, as highlighted by Procore in their guide to the percentage of completion method, maintains the integrity of your financial reporting and provides a clearer picture of project profitability. This dynamic approach allows you to recognize revenue and expenses more accurately, leading to better decision-making. Regularly updating your project data also helps identify potential cost overruns or delays early on, giving you more time to take corrective action.
Thorough documentation is essential when using the percentage of completion method. Maintaining detailed records of all project-related costs, including materials, labor, and overhead, supports the estimates used in your financial reporting. This documentation not only helps justify your revenue recognition but also proves invaluable during audits. Keep meticulous records of all contracts, change orders, and progress reports. As Accounting Insights explains in their analysis of the percentage of completion method, detailed record-keeping is crucial for accurate and comprehensible financial reporting. Organized documentation simplifies substantiating your financial statements and provides a clear audit trail. This transparency builds confidence in your financial reporting and strengthens your company's financial credibility.
Robust internal controls are vital for preventing errors and fraud when using the percentage of completion method. Establish clear procedures for estimating costs, tracking progress, and authorizing payments. Regularly review these processes to ensure they function as intended and remain aligned with your business needs. Segregating duties, where different individuals handle different aspects of the project, can further strengthen your internal controls. As Investopedia notes in their overview of the percentage of completion method, strong internal controls and independent audits are essential to prevent misuse. These controls protect your company's financial integrity and help ensure compliance with accounting standards. By prioritizing strong internal controls, you create a more secure and reliable financial reporting environment. Consider how automated solutions can streamline these processes and reduce the risk of human error. Learn how HubiFi's automated revenue recognition solutions can help implement these best practices and ensure accurate, compliant financial reporting by scheduling a demo.
Understanding the tax implications of the Percentage of Completion Method is crucial for accurate financial reporting and smart decision-making. This method can significantly affect your tax liability and overall financial strategy.
The Percentage of Completion Method changes when you recognize income, directly affecting your tax liability in any given year. Instead of recognizing all revenue at project completion, you recognize it incrementally as you progress. This aligns income recognition with the actual work performed, painting a more accurate picture of your financial performance. As Taxmann notes, this approach acknowledges that significant risks and rewards of ownership often transfer when signing a binding agreement, not just at the project's end. This timing shift can have big implications for your tax planning, especially for long-term projects.
While the Percentage of Completion Method offers a clearer view of your income, it's important to understand its impact on cash flow. This method ties revenue recognition to the costs incurred. This means you'll recognize income—and pay taxes on it—even if you haven't received full payment. This can create a temporary gap between reported income and actual cash on hand. Managing this difference is key to maintaining healthy cash flow throughout the project. For more insights, explore resources on navigating the Percentage of Completion Method and its cash flow implications.
New revenue recognition standards can impact businesses using the Percentage of Completion Method. Industries like software, entertainment, manufacturing, and construction may need to adjust existing accounting methods to comply. Evaluating your current practices and considering a change can ensure compliance and minimize potential tax issues. Resources are available to help you understand accounting method changes under new revenue recognition standards. For complex projects and changing regulations, consider consulting with a financial professional or exploring automated revenue recognition solutions like those offered by HubiFi to streamline compliance and ensure accuracy. Schedule a demo to see how HubiFi can help your business.
Even with the best intentions, applying the Percentage of Completion method can be tricky. Here are a few common pitfalls to watch out for:
Accurately estimating costs is crucial for this method. Underestimating throws off your financial reporting and misrepresents a project's profitability. A core principle of the Percentage of Completion method is that significant risks and rewards of ownership transfer to the buyer when they sign the sales agreement. This highlights the need for realistic cost projections from the start. Inaccurate estimations early on can snowball into larger issues. For large, complex projects, consider using HubiFi's automated solutions to maintain accurate cost estimates. Schedule a demo to see how we can help.
Don't just set it and forget it. Regularly updating cost estimates is essential for accurate financial reporting. As a project progresses, you might encounter unexpected expenses or changes in resource costs. Companies must use the more complex method under U.S. Generally Accepted Accounting Principles (GAAP) if they can make "sufficiently dependable" estimates. This ensures your financial statements stay up-to-date. Consistent reviews and revisions are key. HubiFi's real-time analytics can help you stay on top of these changes and update your estimates dynamically. Explore our pricing plans to find the right fit for your business.
Detailed record-keeping is paramount when using the Percentage of Completion method. Every cost requires meticulous tracking for accurate and transparent financial reporting. Inadequate tracking can cause errors in revenue recognition and even financial misstatements. For more information on accurate cost tracking, check out this helpful resource. HubiFi's integrations with popular accounting software make this process seamless. Learn more about our integrations and how they can simplify your cost tracking. Accurate, consistent data is the foundation of solid financial reporting.
Financial teams face unique challenges when implementing the percentage of completion method. Successfully adopting this method requires careful planning, accurate data collection, and a thorough understanding of accounting standards. Let's break down some key considerations:
The foundation of the percentage of completion method lies in accurate cost estimations. As Miller Kaplan points out, if reliable estimates can be made, companies should use this method for projects under U.S. Generally Accepted Accounting Principles (GAAP). This means your team needs access to robust data on project costs, including materials, labor, and overhead. Having a system that integrates this information from various sources, like your ERP and CRM, is essential for generating dependable estimates. Without clean, consistent data, your revenue calculations could be significantly off, impacting your financial statements. Learn more about how HubiFi can centralize and streamline your data collection.
Implementing the percentage of completion method isn't always straightforward. As Procore explains in their explanation, managing change orders and fluctuating project costs can create complexity. These variations can lead to discrepancies between billing and the revenue you can recognize. Financial teams need to be prepared to handle these discrepancies and adjust their forecasts accordingly. This requires a flexible system that can adapt to project changes and provide real-time insights into your financial performance. Explore HubiFi's pricing to see how we can support your business with these challenges.
Compliance with accounting standards is paramount when using the percentage of completion method. Accounting Insights emphasizes the importance of meticulous record-keeping and clear presentation in financial reporting. Your team needs to ensure that your processes and documentation align with the relevant accounting standards, such as ASC 606 and ASC 944. This includes maintaining detailed records of all costs incurred, estimated costs to complete, and the progress of each project. Read our blog for more on how HubiFi helps businesses maintain compliance.
Why is the percentage of completion method preferred over the completed contract method for long-term projects? The percentage of completion method gives a more accurate and consistent view of your financial performance throughout the project's lifespan. With long-term projects, waiting until the end to recognize revenue and expenses can create a misleading picture of your financial health, especially for stakeholders. The percentage of completion method smooths out revenue and expenses over the project's duration, providing a clearer, more realistic view of your financial standing.
What are the biggest challenges when using the percentage of completion method? Accurately estimating costs and managing changes throughout the project's lifecycle are two significant challenges. Getting the initial cost estimates wrong can skew your revenue recognition. Also, as projects evolve, change orders and unexpected issues can arise, impacting costs and timelines. Staying on top of these changes and adjusting your estimates accordingly is crucial for accurate financial reporting.
Which industries benefit most from using the percentage of completion method? Industries with long-term, complex projects, such as construction, engineering, defense contracting, and large-scale software development, often find this method most beneficial. These projects typically involve significant costs spread over time, and recognizing revenue as work progresses provides a more accurate reflection of the project's financial status.
What are some best practices for implementing the percentage of completion method effectively? Regularly review and update your project estimates, maintain detailed documentation of all costs and progress, and implement strong internal controls to prevent errors and ensure accuracy. Consistent review and meticulous record-keeping are essential for accurate financial reporting and successful audits.
How does the percentage of completion method impact my taxes? This method recognizes income as you progress through the project, rather than all at once at the end. This means you'll pay taxes on income as it's recognized, even if you haven't received full payment yet. Understanding this timing difference is crucial for managing your cash flow and planning your tax strategy effectively.
Former Root, EVP of Finance/Data at multiple FinTech startups
Jason Kyle Berwanger: An accomplished two-time entrepreneur, polyglot in finance, data & tech with 15 years of expertise. Builder, practitioner, leader—pioneering multiple ERP implementations and data solutions. Catalyst behind a 6% gross margin improvement with a sub-90-day IPO at Root insurance, powered by his vision & platform. Having held virtually every role from accountant to finance systems to finance exec, he brings a rare and noteworthy perspective in rethinking the finance tooling landscape.
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