Oops! Something went wrong while submitting the form.
Start a Free Trial
See your data in HubiFi < 2 days
See your data in HubiFi < 2 days
Understand the percentage of completion method in accounting, its benefits, and how to apply it effectively for long-term projects with practical steps.
Managing long-term projects comes with its own set of accounting challenges. How do you accurately represent your financial progress when the work spans multiple reporting periods? The answer lies in percentage of completion method accounting. This method provides a more realistic view of your financial health by recognizing revenue and expenses as work progresses, rather than waiting until the project is finished. This guide will walk you through the ins and outs of percentage of completion method accounting, offering practical examples and actionable steps to implement it effectively. Whether you're in construction, software development, or any industry with long-term contracts, understanding this method is crucial for accurate financial reporting.
The percentage of completion method is an accounting method used to recognize revenue and expenses for long-term contracts. Instead of waiting until a project finishes, revenue gets recognized based on how much work is done over time. This gives a more accurate financial picture of a company's performance, especially for projects that last longer than a single accounting period. It's a way to evenly distribute revenue and expenses instead of recording everything at the end when the project is complete.
This method spreads out revenue and expenses over the project's lifespan, matching them with the percentage of work completed. This offers a clearer view of profitability at any point during a long-term project, unlike the completed contract method, which only recognizes revenue and expenses at the very end. This is particularly useful for accurately assessing the financial health of ongoing projects and making informed business decisions. Learn more about this method in our percentage of completion accounting guide.
The percentage of completion method is especially helpful in industries with long-term projects, such as construction, engineering, and software development. These projects often span multiple accounting periods, making it essential to recognize revenue and expenses as the work progresses. For example, if you're building a bridge over two years, using this method lets you recognize a portion of the revenue and expenses each quarter, reflecting the progress made. This method is also valuable when measuring progress is relatively straightforward, like tracking milestones in a software project. By tying revenue to demonstrable progress, companies can present a more realistic view of their financial performance. This approach ensures financial statements stay up-to-date and reflect the true status of ongoing projects.
This section explains how to calculate the percentage of completion, breaking it down into easy-to-follow steps.
The percentage of completion method recognizes revenue and expenses of long-term contracts in proportion to the work completed. This method provides a more accurate view of profitability during a project, rather than waiting until the end. It’s especially useful for long-term projects where revenue and expenses are spread out over time.
Calculating the percentage of completion involves a straightforward formula:
For more details and examples, see our guide to percentage of completion accounting.
Accurate cost estimation is crucial for this method. Underestimating or overestimating costs can significantly impact revenue recognition and your financial reporting. Regularly review and refine your cost estimates as the project progresses. Changes in material prices, labor costs, or project scope can all affect your initial estimations. For tips on managing these changes, see our blog post on change orders. By carefully tracking costs and refining estimates, you can ensure your financial statements reflect the true progress and profitability of your projects, minimizing the risk of issues during audits and ensuring compliance with accounting standards.
Knowing when to use the percentage of completion method is key for accurate financial reporting. It's best suited for specific situations where other methods might fall short. Let's explore some factors that signal the percentage of completion method is the right choice for your business.
The percentage of completion method is particularly relevant for long-term contracts, those spanning multiple reporting periods. Think of large-scale construction projects or software development engagements that take months or even years to complete. For these extended projects, recognizing revenue and expenses only upon completion wouldn't accurately reflect the ongoing work and value being delivered. The percentage of completion method, as explained in this guide to accounting methods, allows for a more consistent and realistic view of financial performance over time. Shorter-term projects, on the other hand, might be better suited to simpler accounting methods.
Reliable cost estimation is crucial for the percentage of completion method to work effectively. You need a reasonable degree of confidence in your projections of total contract costs. This accuracy is essential because the percentage of completion calculation directly relies on these estimates. If your initial cost estimates are significantly off, your revenue recognition will be skewed, potentially leading to misstatements in your financial reports. This explanation of the percentage of completion method highlights the importance of minimizing credit risk and ensuring accurate measurement of contract completion. If you're dealing with a project where costs are highly uncertain or volatile, this method might not be the best fit. Consider exploring alternative methods for these scenarios. For more insights into managing complex financial data, explore HubiFi's data consultation services.
While not a strict requirement, a high degree of payment assurance strengthens the case for using the percentage of completion method. When you're reasonably certain about receiving payment for the work performed, recognizing revenue as you progress makes sense. This approach aligns with the underlying principle of matching revenues with the associated expenses. As this article on construction accounting points out, the percentage of completion method provides an accurate snapshot of profitability at any given time. However, if there's significant uncertainty about payment collection, using this method could lead to overstated revenues and an inaccurate picture of your financial health. Consider the payment terms, the client's creditworthiness, and any other factors that might affect payment reliability. For help streamlining revenue recognition processes and ensuring compliance, learn more about HubiFi's automated solutions.
Understanding the advantages and disadvantages of the percentage of completion method helps businesses decide if it's the right fit. Let's break down the pros and cons.
The percentage of completion method offers several advantages, especially for long-term projects. Instead of waiting until the end to recognize revenue and expenses, this method distributes them across the project's lifespan, providing a more accurate view of your company's financial health. Imagine building a custom home. Rather than showing zero profit until the keys are handed over, this method lets you recognize revenue and expenses as each stage of construction is finished—framing, roofing, plumbing, etc. This offers a clearer picture of your financial performance and leads to smoother cash flow projections, making it easier to manage resources and plan for future investments.
While the percentage of completion method offers valuable insights, it also presents some challenges. One key drawback is the complexity of accurately estimating the percentage of a project completed. This requires careful tracking of costs, milestones, and potential roadblocks. Inaccurate estimations can lead to misrepresented financials and potential compliance issues. Another consideration is the potential for revenue manipulation if estimates are not managed carefully and ethically. Overestimating completion percentages can artificially inflate revenue figures. This method also demands meticulous record-keeping. You need systems in place to track progress, manage change orders, and document everything thoroughly, which can be time-consuming and requires a robust system for managing project details.
The percentage of completion and completed contract methods offer distinct approaches to recognizing revenue and expenses for long-term projects. Understanding these differences is crucial for accurate financial reporting. With the percentage of completion method, revenue and expenses are recognized proportionally to the project's progress. For instance, if 40% of a project is complete, you recognize 40% of the total estimated revenue and expenses in your financial statements. This provides a real-time view of project profitability and aligns financial reporting with the actual work performed. For a practical guide to applying this method, explore our insights on percentage of completion accounting.
Conversely, the completed contract method defers revenue and expense recognition until the project is fully finished. This method can create fluctuations in reported income, as all financial impacts are recorded at once. This can make it challenging to track performance and profitability during the project lifecycle. The completed contract method is often favored for shorter projects or those with uncertain outcomes, as it avoids the complexities of estimating progress. For more details on this method, review this helpful resource on the completed contract method.
Choosing between these methods significantly impacts your financial statements. The percentage of completion method offers a more consistent view of a company's financial health during long-term projects. By tying revenue and expenses directly to project progress, it provides a clearer picture of profitability at any given point. This real-time insight is invaluable for making informed business decisions and managing resources effectively. Learn how this method provides a more accurate financial picture during long-term projects.
The completed contract method can sometimes distort financial performance, especially for companies engaged in multiple long-term projects. The lack of ongoing revenue recognition can understate performance during the project's execution and create a sudden surge in reported income upon completion. This makes it harder to assess true profitability and can sometimes mislead stakeholders. For businesses dealing with high-volume transactions and complex revenue recognition scenarios, HubiFi offers automated solutions to ensure accuracy and compliance. Schedule a demo to see how HubiFi can streamline your financial operations.
Successfully using the percentage of completion method requires a systematic approach. Here’s how to implement it effectively:
The percentage of completion method is a cornerstone of financial accounting for companies engaged in long-term projects. Setting up the right systems from the start is crucial for accurate financial reporting. This involves choosing accounting software capable of handling complex calculations and ensuring your team understands the method’s principles. Meticulous record-keeping is essential, so establish clear processes for documenting costs, progress, and any changes. This sets the foundation for reliable financial statements and informed decision-making. Consider integrating your chosen software with other business tools, like project management platforms, to streamline data and reduce manual entry.
Tracking project progress is the heart of the percentage of completion method. Since revenue recognition is tied to the proportion of work completed, accurate tracking is paramount. Establish clear metrics and milestones upfront to measure progress objectively. Regularly update these metrics, ideally using a project management system that integrates with your accounting software. This real-time data flow provides a clear picture of how much work has been done and how much remains, enabling you to calculate revenue and expenses accurately. Consistent progress tracking also helps identify potential roadblocks early on, allowing for timely adjustments.
Construction projects rarely go exactly as planned. Regularly review and adjust your initial cost and revenue estimates to reflect the project's current reality. Unexpected issues, change orders, or market fluctuations can all impact your initial projections. By incorporating these changes into your calculations, you maintain the accuracy of your financial reporting. Don't hesitate to revise your estimates as needed; this ensures your financial statements provide a reliable view of your project’s profitability. Accurate estimations are key to realizing the benefits of the percentage of completion method.
Change orders are a common occurrence in long-term projects. Implement a clear process for documenting and incorporating these changes into your cost and revenue calculations. Each change order should be thoroughly evaluated for its impact on the project timeline and budget. Update your progress metrics and financial projections accordingly to reflect the revised scope of work. Effective change order management ensures that your financial reporting remains accurate despite project modifications, contributing to a more stable cash flow. Consistent and transparent change management is crucial for the success of any project using the percentage of completion method.
The percentage of completion method, while beneficial, presents some inherent challenges. Let's explore these common roadblocks and how to address them effectively.
The core of the percentage of completion method hinges on accurate cost estimations. However, as projects evolve, initial estimates can prove inaccurate due to unforeseen issues or project changes. Inaccurate estimations can significantly impact cash flow, as explained by Procore. One way to mitigate this is by diligently tracking change orders and updating cost estimates to reflect these changes. Regularly reviewing and adjusting your initial estimations based on real-time project data helps maintain accuracy in revenue recognition. Consider using project management software to help track costs and changes in real time.
Adhering to accounting standards like ASC 606 and IFRS 15 is critical when using the percentage of completion method. These standards provide a framework for consistent and reliable financial reporting. Maintaining detailed records of all project costs, estimated profits, and the rationale behind your percentage of completion calculations ensures a smooth audit process. For a deeper dive into these standards and their impact, explore resources like this article on the Percentage of Completion Method.
Because this method relies on estimations, there's a potential risk of manipulating these figures to artificially inflate revenue or smooth earnings. Investopedia highlights this risk and emphasizes the importance of transparent and verifiable estimation practices. Implementing strong internal controls, independent reviews of cost estimates, and clear documentation of all adjustments can help prevent and detect any attempts at revenue manipulation. Prioritizing ethical accounting practices not only protects your business's reputation but also builds trust with stakeholders. Consider working with a financial professional to ensure your estimations are reasonable and well-documented.
Technology plays a crucial role in effectively applying the percentage of completion method. It streamlines complex calculations, improves accuracy, and provides real-time insights into project financials. Let's explore how technology simplifies this accounting method.
The percentage of completion method demands precise record-keeping and clear reporting. As noted by AccountingInsights.org, using technology for data tracking is essential for this method. Automated systems track costs, labor hours, and materials, ensuring accurate data capture. This eliminates manual data entry, reducing errors and saving time. Real-time dashboards and reports offer immediate visibility into project performance, making it easier to monitor progress against the budget and identify potential issues early. Software like HubiFi offers automated solutions for revenue recognition, simplifying complex accounting processes for high-volume businesses.
Integrating your financial systems with project management tools creates a powerful synergy. This connection lets you directly link revenue and expenses to the percentage of work completed. With real-time data flowing between systems, you gain a more accurate view of project profitability at any point. This integration minimizes the need for manual reconciliations and ensures data consistency across departments. Explore HubiFi's integrations to see how it connects with various accounting software, ERPs, and CRMs.
Technology not only helps track project progress but also strengthens risk management and forecasting. By analyzing historical data and real-time project performance, you can identify potential cost overruns, delays, or other risks. This allows for proactive adjustments to project plans and budgets, minimizing the impact of unexpected events. Advanced analytics tools can even generate forecasts based on current trends, helping you make informed decisions about resource allocation and project timelines. For more insights on financial operations and accounting, explore the HubiFi blog.
The percentage of completion method isn’t a static accounting practice. It continues to evolve alongside changes in accounting standards and technology. Understanding these shifts is key to staying ahead and ensuring accurate financial reporting for your projects.
One significant trend is the increasing emphasis on recognizing revenue over time. The introduction of ASC 606 has reinforced this approach, aligning perfectly with the core principles of the percentage of completion method. This focus allows for a more realistic view of a company's financial health throughout a project's lifecycle. As businesses adapt to these changes, the percentage of completion method becomes even more relevant, especially when project progress can be reliably measured. For high-volume businesses, this real-time insight is invaluable for making informed decisions.
Technology also plays a crucial role. The accounting world is embracing tools that leverage data analytics and forecasting to provide real-time project insights. This shift toward data-driven decisions means more accurate cost tracking and revenue recognition. Automating these processes streamlines accounting and empowers businesses to make informed choices. At HubiFi, our automated revenue recognition solutions are designed specifically for this purpose, helping high-volume businesses achieve ASC 606 compliance with ease.
ASC 606 further solidifies the percentage of completion method by recommending it for contracts where control is transferred over time. As long as you can create reliable progress estimates, this method remains a valid approach for recognizing revenue as you meet performance obligations. This continued relevance underscores the importance of understanding and correctly applying this method. Consider scheduling a data consultation with HubiFi to discuss how we can help you implement these practices.
Looking ahead, accounting standards will continue to change. Businesses need to remain adaptable and adjust their revenue recognition practices accordingly. The percentage of completion method may undergo refinements to align with new standards and best practices. This flexibility is essential for maintaining compliance and ensuring accurate financial reporting. Staying informed and adapting to these changes will be crucial for continued success. Explore our blog for more insights into financial operations and accounting best practices.
Why is the percentage of completion method preferred over the completed contract method for long-term projects?
The percentage of completion method offers a more accurate reflection of a company's financial status throughout a long-term project. By recognizing revenue and expenses as work progresses, it provides a clearer picture of profitability at any given time, unlike the completed contract method, which waits until the very end. This real-time insight is invaluable for making informed business decisions, managing resources, and securing financing.
How can I improve the accuracy of my cost estimations for the percentage of completion method?
Start with a detailed breakdown of all expected costs, including materials, labor, and overhead. Use historical data from similar projects and consult with experts to refine your initial estimates. As the project progresses, diligently track actual costs and compare them to your initial projections. Regularly review and adjust your estimates to reflect any changes in project scope, material prices, or labor costs. This ongoing refinement ensures your revenue recognition stays aligned with the project's true progress.
What are the key steps involved in calculating the percentage of completion?
First, estimate all costs associated with completing the project. Next, track all costs incurred up to the reporting period. Divide the costs incurred to date by the total estimated costs to calculate the percentage of completion. Finally, multiply the total contract revenue by this percentage to determine the revenue you can recognize in the current period.
What are the biggest challenges when implementing the percentage of completion method, and how can I overcome them?
The most significant challenge is maintaining accurate cost estimations throughout the project lifecycle. Unexpected issues, change orders, and market fluctuations can all impact your initial projections. Regularly reviewing and adjusting your estimates is crucial. Another challenge is ensuring compliance with accounting standards. Meticulous record-keeping and a clear understanding of the relevant standards are essential. Finally, be mindful of the potential for revenue manipulation. Establish strong internal controls and independent reviews to mitigate this risk.
How can technology help me effectively use the percentage of completion method?
Technology streamlines many aspects of this method. Project management software helps track costs and progress in real time. Accounting software automates complex calculations and generates reports, providing immediate insights into project financials. Integrating these systems ensures data consistency and reduces manual effort. Look for solutions that offer robust reporting features, integrate with your existing tools, and support compliance with relevant accounting standards.
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.
Copyright © 2024 HubiFi | Powered by HubiFi
