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Understand percentage completion accounting, its benefits, and how to implement it effectively for long-term projects. Learn key strategies and industry applications.
Handling long-term contracts? Then you know how tricky it can be to accurately represent your financial progress when revenue doesn't come in until the very end. That's where percentage completion accounting comes in. This method lets you recognize revenue gradually as you complete project milestones, giving a much clearer picture of your financial health along the way. This post breaks down everything you need to know about percentage completion accounting, from how it works and when to use it, to calculating it correctly and staying compliant. We'll even touch on how technology can simplify the process. Ready to get a firmer grasp on your project financials? Let's dive in.
Percentage of completion accounting is a method used to recognize revenue and expenses for long-term projects or contracts. Instead of waiting until a project is finished, revenue gets recognized gradually as work progresses. This approach is especially important for long-term contracts where recognizing revenue only upon completion wouldn't accurately reflect the ongoing work and associated costs. Think of a multi-year construction project—percentage of completion accounting allows the company to recognize revenue for the portion of the building completed each year, rather than waiting until the entire project is finished. This gives a clearer picture of the company's financial performance over time. This method offers a more consistent and accurate view of a company's financial health, especially for long-term projects. For a deeper dive, check out our essential guide on percentage of completion accounting.
This method is all about matching revenue with the expenses incurred during a specific accounting period. It provides a more realistic view of a company's financial status by recognizing revenue as it's earned, not just when the project is complete. This is particularly relevant for projects spanning multiple accounting periods. By recognizing revenue incrementally, companies can show a steadier income stream and avoid large fluctuations in their financial statements. This also helps stakeholders understand the true progress and profitability of ongoing projects.
The percentage of completion method is a cornerstone of financial accounting for companies engaged in long-term projects. It helps accurately track the financial progress of long-term contracts. It's particularly useful in industries with long-term, complex projects where recognizing revenue and expenses as work progresses paints a more accurate financial picture. Consider industries like construction, engineering, or large-scale manufacturing where projects often take months or even years to complete. Using percentage of completion accounting in these scenarios provides a more timely and relevant view of the company's financial performance. For more specific examples and guidance, our accounting guide offers a comprehensive overview. If you're unsure whether this method is right for your business, consulting with a financial professional or exploring additional resources like Accounting Insights can be valuable.
Figuring out the percentage of completion on a project helps you recognize revenue accurately. There are a few different ways to calculate this, each with its own advantages.
The most common approach is the cost-to-cost method. It’s pretty straightforward: divide the total costs incurred to date by the total estimated costs for the entire project. This gives you the percentage of completion. You then multiply this percentage by the total contract amount to figure out how much revenue you should recognize. For a deeper dive, check out this guide on the percentage of completion method.
Another option is the efforts-expended method. This one focuses on labor hours. By comparing the labor hours spent so far to the total estimated labor hours, you get your percentage of completion. This method works well when labor is a significant driver of project costs. Learn more about this and other methods from this resource on percentage of completion in construction.
Finally, the units-of-delivery method is useful for projects involving many identical deliverables. Simply divide the number of units completed by the total number of units to find the percentage of completion. This straightforward approach is best when each unit represents a similar portion of the total project effort. This method is also covered in the resource on percentage of completion in construction.
Before you implement percentage-of-completion accounting, make sure your business meets a few key conditions. These safeguards help ensure accurate revenue recognition and financial reporting.
Reliable cost estimation is the foundation of the percentage-of-completion method. Inaccurate estimates can lead to misstated revenue and potential compliance issues with the IRS. Develop a robust cost estimation process that accounts for materials, labor, overhead, and any potential cost overruns. Regularly review and refine your estimates as the project progresses to maintain accuracy. For more tips on accurate cost estimation, check out our essential guide to percentage-of-completion accounting.
You need reasonable assurance that you’ll receive payment for the project. This is a critical condition for applying the percentage-of-completion method. Clearly defined payment terms in your contracts protect your business and provide the necessary assurance for revenue recognition. For a deeper dive into this concept, Investopedia offers a helpful explanation of the percentage-of-completion method.
The percentage-of-completion method is particularly relevant for long-term contracts. Recognizing revenue only upon completion wouldn't accurately reflect the ongoing work and associated costs in these scenarios. This method aligns revenue recognition with the project timeline, providing a more accurate picture of your financial performance. Consider the duration and complexity of your projects when deciding if the percentage-of-completion method is the right fit. Shorter, simpler projects might be better suited for other accounting methods. Learn more about choosing the right accounting method in our percentage-of-completion guide.
Understanding the pros and cons of percentage of completion accounting helps you decide if it's the right method for your business. Let's explore the benefits and drawbacks.
Percentage of completion offers a more realistic view of your company's financial health, especially for long-term projects. This method distributes revenue recognition across the project's timeline, aligning it more closely with the work performed, rather than waiting until the end of a multi-year project. This provides a clearer picture of your financial progress. This is particularly helpful for long-term contracts where recognizing revenue only upon completion wouldn't accurately reflect ongoing work and associated costs. For a deeper dive, check out our essential guide on percentage of completion accounting. As a cornerstone of financial accounting for companies engaged in long-term projects, understanding this method is crucial. You can find additional insights on the percentage of completion method from Accounting Insights.
While beneficial, percentage of completion also presents some challenges. Accurate cost and completion estimates are essential for calculating the percentage of completion, which forms the basis of revenue recognition. Inaccurate estimations can lead to significant errors in your financial reporting. This method requires meticulous record-keeping and clear presentation to ensure accuracy. While offering a more accurate financial picture for long-term projects, simply using any percentage of completion calculation isn't enough for GAAP compliance.
Percentage completion accounting isn’t for every business. It’s generally best suited for long-term, complex projects with reliable cost estimates. Let’s look at some of the industries that commonly use this method.
Think about a large-scale construction project, like a skyscraper or a bridge. These projects often span years, with costs incurred progressively. The percentage of completion method makes sense here. It allows construction companies to recognize revenue and expenses as the project progresses, rather than waiting until the very end. This provides a more accurate picture of the company's financial performance during the project's lifecycle. This also reduces financial risk by allowing for billing and payment for completed work, even if the entire project isn't finished.
Long-term manufacturing contracts, such as those for aircraft or specialized equipment, also benefit from percentage completion accounting. Similar to construction projects, these manufacturing endeavors involve substantial costs spread over an extended period. Using this method, manufacturers can recognize revenue aligned with the production progress. This approach offers a clearer financial view, especially helpful for businesses with project-based revenue streams. For a deeper dive, explore our guide on percentage of completion accounting.
Large software development projects, particularly those involving customized solutions or multi-year implementations, often employ percentage completion. These projects typically involve ongoing development, testing, and deployment phases, each incurring costs. By recognizing revenue based on project completion milestones, software companies can accurately reflect their financial performance throughout the project. This method is particularly relevant for subscription-based software services, where revenue is recognized over the contract term. Learn more about revenue recognition for software companies.
Staying compliant with accounting standards is crucial for any business using the percentage of completion method. This section clarifies how this method aligns with key accounting principles like ASC 606 and IFRS 15, and why adhering to these regulations matters for your business.
ASC 606, the revenue recognition standard in the United States, provides a framework for recognizing revenue when goods or services are transferred to customers. For long-term projects, the percentage of completion method offers a structured approach to revenue recognition that aligns with these principles. Similarly, IFRS 15, the international equivalent, emphasizes recognizing revenue over time for long-term contracts. Using the percentage of completion method helps ensure compliance with these standards and provides a consistent approach for international business operations. For more detailed information on applying ASC 606, check out this Roadmap from Deloitte. You can also explore the percentage of completion method in relation to IFRS 15 at the Corporate Finance Institute.
Accurate financial reporting is paramount for maintaining transparency and building trust with stakeholders. The percentage of completion method, while offering valuable insights into project profitability, requires diligent record-keeping and clear presentation. This ensures your financial statements accurately reflect your company's position and are easily understood by investors, regulators, and other interested parties. For a deeper dive into the intricacies of this method, explore this resource on demystifying the percentage of completion method in accounting. Furthermore, adhering to GAAP (Generally Accepted Accounting Principles) through consistent application of the percentage of completion method, when applicable, strengthens your financial integrity and helps you meet regulatory requirements. This proactive approach simplifies audits and demonstrates your commitment to financial transparency. Smolin provides further insights into GAAP requirements and the percentage of completion method.
Successfully implementing the percentage of completion method requires diligence and attention to detail. Here’s how to make this method work for your business:
Under the percentage of completion method, you recognize revenue and expenses as the project progresses, typically monthly. This differs from the completed contract method, where you only recognize revenue upon the project's completion. Regular monitoring is key. Track costs, milestones, and any changes to the project scope. This consistent tracking helps you accurately calculate the percentage of completion and make necessary adjustments to your financial reporting. Think of it like checking your speedometer on a road trip—regular checks keep you informed of your pace and help you estimate your arrival time. For more information, see Procore's explanation of the percentage of completion method.
Accurate record-keeping is paramount for financial reporting using this method. Meticulous records ensure that your company's financial position and performance are both accurate and easy to understand. This includes detailed records of all costs incurred, such as materials, labor, and overhead. Maintaining organized documentation simplifies the calculation process and prepares you for audits, ensuring compliance with accounting standards. For additional guidance, review these insights on the percentage of completion method.
Consistency is essential when calculating the percentage of completion. The most common approach is the cost-to-cost method, which compares total costs incurred to date against total estimated costs. This straightforward calculation provides a clear picture of project progress. However, other methods, like efforts-expended and units-of-delivery, might be more suitable depending on your project. SSA CPA offers a helpful guide to understanding these different methods. Choose the method that best aligns with your project's specifics and stick with it throughout the project lifecycle. For instance, if you choose the cost-to-cost method, use it consistently for all project calculations and reporting periods. This consistency simplifies analysis and provides a reliable basis for financial decisions.
Implementing percentage-of-completion accounting requires careful planning and execution. While it offers a more accurate view of financial performance for long-term projects, some common challenges can arise. Let's explore these hurdles and how to address them effectively.
Change orders are common in many projects. They represent modifications to the original project scope and can significantly impact costs, timelines, and revenue recognition. Handling these changes promptly and accurately is crucial for keeping your percentage-of-completion calculations current. As Knowify explains in its guide to percentage of completion in construction, adjust your cost estimates and overall budget as soon as a change order occurs. This ensures your revenue projections remain aligned with the evolving project. Delays in incorporating change orders can lead to skewed revenue figures and potential compliance issues.
One complexity of the percentage-of-completion method is that the revenue recognized might not always match the amount billed. This can create cash flow challenges. As Procore highlights in its explanation of the percentage-of-completion method, you might overbill (billing more than the revenue recognized) or underbill (billing less than the revenue recognized). Overbilling can tie up cash if clients withhold payment until project completion, while underbilling can lead to short-term cash shortages. Carefully monitor billing and revenue recognition schedules to anticipate and mitigate these cash flow fluctuations. Establish clear payment terms with clients and explore financing options to bridge any potential gaps.
Maintaining ethical practices is paramount in any accounting method, and percentage-of-completion is no exception. The subjective nature of estimating project progress can create opportunities for misrepresentation. As Investopedia points out in its discussion of the percentage-of-completion method, some companies might manipulate the percentage of completion to inflate short-term profits or present a rosier financial picture. Accurate and honest estimations are crucial for compliance and building trust with stakeholders. Establish clear internal controls and review processes to ensure estimations are based on verifiable data and professional judgment, not desired outcomes. Remember, accurate estimations, as highlighted by Knowify, are vital for compliance with IRS regulations. Transparency and integrity are key to successfully applying percentage-of-completion accounting.
Technology plays a crucial role in simplifying and streamlining percentage completion accounting. It helps manage the complexities of long-term contracts and ensures accurate revenue recognition.
Dealing with long-term contracts requires careful tracking of costs, revenue, and the overall project's progress. Using software designed for percentage completion accounting automates these tasks. A good system will track contract details, costs incurred, revenue earned, and the percentage of completion for each contract, reducing manual effort and minimizing errors. This automation frees up your team to focus on strategic tasks instead of getting bogged down in spreadsheets. You can explore HubiFi's automated revenue recognition solutions to see how this works in practice. For more information on automating this accounting method, check out this helpful article on using technology for accounting tasks.
Real-time visibility into your financials is essential for making informed business decisions. Technology enables you to generate up-to-the-minute reports and perform real-time data analysis, giving you a dynamic view of your financial health. This allows you to quickly identify potential issues, adjust project plans, and ensure you're on track to meet your financial goals. Modern accounting software often integrates with other business tools, like your CRM and ERP, to provide a holistic view of your operations. HubiFi offers several integrations to streamline data flow and enhance the accuracy of your financial reporting. You can learn more about the role of technology in modern accounting from this HighRadius blog post.
The percentage of completion method significantly impacts how you recognize revenue. Instead of recognizing revenue only at the end, this method acknowledges the ongoing work and associated costs, which is especially important for long-term contracts. This gives a more consistent and accurate picture of your company's financial health for longer projects, as discussed in HubiFi's guide to percentage of completion accounting. Accurate record-keeping and clear presentation in your financial reporting are essential for transparency and accuracy. For further insights, explore resources on the percentage of completion method.
Precise cost and completion estimates are the foundation of accurate revenue recognition using this method. These estimates directly affect the calculated percentage of completion, the core of this accounting method. This approach provides a more accurate view of a long-term project's profitability by distributing revenue and expenses throughout the project's duration, as explained in our accounting guide. Consider exploring resources on modern accounting technology to see how you can streamline these processes and improve your profit reporting.
Why should my business consider using the percentage of completion method instead of waiting until the project is finished?
The percentage of completion method offers a more accurate reflection of your financial performance for long-term projects. By recognizing revenue and expenses as work progresses, you gain a clearer understanding of your financial health throughout the project lifecycle, rather than waiting until the very end. This is particularly helpful for stakeholders who want to see how a project contributes to your overall financial picture over time.
How do I decide which calculation method (cost-to-cost, efforts-expended, or units-of-delivery) is best for my projects?
The best method depends on the nature of your project. Cost-to-cost is the most common and works well when costs are a reliable indicator of progress. Efforts-expended is suitable when labor is the primary driver of costs. Units-of-delivery is ideal for projects with many identical deliverables. Consider which factor best reflects the progress of your specific projects.
What are the biggest challenges in implementing percentage of completion accounting, and how can I address them?
Accurately estimating costs and managing change orders are two key challenges. Develop a robust cost estimation process and update it regularly to reflect any project changes. For change orders, promptly adjust your budget and revenue projections to maintain accuracy. Cash flow management is another potential hurdle. Closely monitor billing and revenue to anticipate potential shortfalls or surpluses.
How can technology help me with percentage of completion accounting?
Accounting software designed for percentage of completion can automate many tasks, such as tracking costs, calculating revenue, and generating reports. This reduces manual effort and minimizes errors. Real-time reporting and analytics tools provide immediate insights into your financial performance, enabling you to make informed decisions quickly.
What are the tax implications of using the percentage of completion method?
The percentage of completion method affects when and how you recognize revenue, which directly impacts your tax liability. Because revenue is recognized gradually, your taxable income is spread out over the project's duration, rather than all at once upon completion. Consult with a tax professional to understand the specific implications for your business and ensure you comply with all applicable tax regulations.
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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