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Learn how percentage of completion accounting works for long-term projects. Understand its benefits, challenges, and best practices for accurate financial reporting.
Handling long-term projects? Then you know that recognizing revenue all at once at the end doesn't always reflect the ongoing work and financial reality. Percentage of completion accounting offers a more accurate way to track your financial progress, especially for projects spanning multiple periods. This method lets you recognize revenue and expenses gradually as you complete stages of the project, giving you a clearer, more realistic view of your financial health. This guide breaks down percentage of completion accounting, explaining how it works, when to use it, and how to implement it effectively. We'll also explore the key differences between this method and the completed contract method, helping you choose the best approach for your business.
Percentage of completion accounting is a method used to recognize revenue and expenses for long-term projects or contracts. Instead of waiting until the project is finished, revenue is recognized gradually as work progresses. This provides a more accurate financial picture of a company's performance, especially for projects spanning multiple accounting periods.
The core idea behind percentage of completion accounting is to match revenue with the expenses incurred in earning that revenue. Think of a large-scale construction project that takes several years to complete. Using this method, revenue is recognized incrementally as milestones are reached, rather than all at once upon completion. This approach aligns revenue recognition with the actual progress of the project, offering a more realistic view of the company's financial health. This differs from methods like the completed contract method, where revenue is only recognized at the very end. For a deeper dive into the completed contract method and other revenue recognition methods, check out our resources on revenue recognition. The percentage of completion method is particularly relevant for long-term contracts where recognizing revenue only upon completion wouldn't accurately reflect the ongoing work and associated costs. For a more detailed understanding of revenue recognition principles, explore our insights.
Several industries rely on the percentage of completion method for accurate financial reporting. Construction is a prime example, where projects often span multiple years. Imagine building a skyscraper—recognizing revenue only after several years wouldn't reflect the ongoing progress and value creation. Similarly, defense contracting often involves long-term, complex projects where the percentage of completion method provides a more accurate financial representation. Software development, especially for large, customized projects, also benefits from this method. These industries, characterized by long project timelines and substantial upfront investments, find the percentage of completion method essential for matching revenue with the associated costs and effort. To see how HubiFi supports these and other industries, explore our integration options.
This section breaks down the core elements of the Percentage of Completion (POC) method and helps you determine when it's the right fit for your business.
The POC method centers around recognizing revenue and expenses in proportion to the progress you make on a project. Think of it as a real-time reflection of your project's financial status. Instead of waiting until the end to book everything, you're acknowledging the work and associated costs as they happen. This provides a more accurate picture of your financial health, especially for long-term projects. For a deeper dive into revenue recognition, check out this guide from the Corporate Finance Institute.
Here are the key elements:
The POC method isn't universally applicable. It's particularly relevant for long-term projects where recognizing revenue only at the end wouldn't accurately reflect the ongoing work and financial activity.
Here's a closer look at when it makes sense:
This section provides a practical, step-by-step guide to calculating the percentage of completion. We'll focus on the widely-used cost-to-cost method and explore alternative approaches.
The cost-to-cost formula is a reliable method for calculating revenue recognition on long-term contracts. It helps determine what portion of a project is financially complete, based on the costs you've incurred compared to the total estimated costs. Think of it like baking a cake: if you've used half your expected ingredient budget, you're probably about halfway done.
Here's how it works:
Determine Total Costs to Date: Calculate all costs incurred on the project so far. This includes materials, labor, and other direct expenses. Accurate record-keeping is essential for this step.
Estimate Total Costs: Develop a realistic estimate of all costs expected for the entire project. This requires careful planning and consideration of potential cost overruns.
Determine the Contract Amount: This is the total value of your contract with the customer.
Apply the Formula: Calculate the revenue recognized using the cost-to-cost formula:
Revenue Recognized = (Total Costs to Date / Total Estimated Costs) * Contract Amount
For example, imagine a construction project with a contract amount of $1 million. You've spent $250,000 so far, and estimate the total project cost to be $500,000. Your revenue recognized would be ($250,000/$500,000) * $1,000,000 = $500,000. You can find more detailed examples and explanations of the percentage of completion method from resources like the Corporate Finance Institute.
While the cost-to-cost method is popular, other methods can also determine the percentage of completion, offering flexibility depending on your projects. These include:
Units Completed: This method tracks progress based on the number of units produced or delivered. It works best for projects with easily measurable units, like manufacturing a set number of products. Procore's guide offers more information on this and other methods.
Labor Hours: This method measures progress based on the number of labor hours logged. It's useful when labor is the primary driver of project costs, such as consulting or service-based businesses.
Efforts-Expended Method: Similar to tracking labor hours, this method considers the overall effort put into the project. This can be helpful when various resources contribute to progress. Learn more about POC accounting methods from CrewCost.
Units-of-Delivery Method: This method suits projects with multiple, identical deliverables. It tracks progress based on the number of units delivered compared to the total due.
The right method depends on your specific project and industry. Consistency is key after selecting a method to ensure accurate and comparable financial reporting. While you have flexibility in choosing a calculation method, remember that adhering to Generally Accepted Accounting Principles (GAAP) is crucial for compliant financial reporting.
Before you implement the percentage of completion method, you must meet two crucial conditions. These conditions ensure the method's reliability and compliance with accounting standards. Let's explore each one.
The first condition revolves around payment certainty. You need reasonable assurance that you'll receive payment for the work performed. This doesn't require absolute certainty, but a high probability based on the customer's financial stability, the contract terms, and historical payment patterns. Think of it like this: would a reasonable person, looking at all the facts, expect the customer to pay? Factors like a signed contract with clear payment terms, a customer with a good credit history, and a history of timely payments on past projects all contribute to this assurance. If you're working with a new client, obtaining a credit report or requesting upfront payment can strengthen this confidence. Without this reasonable assurance, using the percentage of completion method could misrepresent your financial position. For more insights on managing credit risk, explore resources like those available from the Credit Research Foundation. Remember, securing payment is as crucial as completing the project itself.
The second condition focuses on project predictability. You must reasonably estimate both the total project costs and the percentage of completion at each reporting period. This requires detailed project planning, accurate cost tracking, and regular progress assessments. Think of building a house: you need to know the expected cost of materials, labor, permits, and other expenses. As the project progresses, you track these costs against the budget and assess the completion percentage based on milestones achieved—like completing the foundation, framing, or roofing. Accurately estimating these figures is essential for correctly recognizing revenue and expenses. Resources like the Project Management Institute offer valuable guidance on project planning and cost estimation. If you find it difficult to estimate costs or project completion with reasonable accuracy, the percentage of completion method may not be suitable, and you might consider alternatives like the completed contract method. Choosing the right method ensures your financial reporting accurately reflects your project's progress.
Using the percentage of completion method comes with both benefits and drawbacks. Understanding these will help you decide if it's the right fit for your business.
The percentage of completion method offers several advantages, especially for long-term projects. By recognizing revenue based on the progress of work, it provides a more accurate and timely view of your company's financial health. This is a significant improvement over the completed contract method, which only recognizes revenue at the very end. This real-time insight allows stakeholders to understand the ongoing profitability of projects and make more informed business decisions. The percentage of completion method also promotes better project alignment by connecting reported financials with actual performance. This transparency helps keep everyone on the same page and fosters a shared understanding of project health. For a deeper dive into accurate revenue recognition, explore HubiFi's blog for more insights. You can also learn more about how HubiFi helps streamline financial operations on our About Us page.
While the percentage of completion method offers valuable insights, it also presents challenges. The most significant hurdle is the need for accurate cost and progress estimations. These estimations are complex and can be affected by unforeseen project changes, such as change orders, requiring constant revisions. Inaccurate estimations can lead to misreported financials, impacting project management and potentially creating cash flow problems. Overestimating completion, for example, could lead to premature revenue recognition, while underestimating it could delay revenue and distort the financial picture. Managing these estimation complexities requires a robust process and diligent tracking. Schedule a demo to see how HubiFi can help you manage these complexities through automated solutions. For more on how HubiFi integrates with existing systems, visit our Integrations page. If you're curious about pricing, you can find details on our Pricing page.
Understanding the nuances between the percentage of completion and completed contract methods is crucial for sound revenue recognition. Both methods address long-term contracts, but they differ significantly in when you recognize revenue and expenses.
The core difference lies in the timing. The percentage of completion method recognizes revenue and expenses gradually, based on the proportion of work completed. This provides a real-time view of a project's financial performance. Think of it like tracking progress on a road trip—you acknowledge the miles covered as you drive, not just at the destination. The completed contract method, however, waits until the project is finished before recognizing anything. This can create uneven financial statements, where periods of high activity show no results until the project's end. This is like only acknowledging your road trip mileage after arriving.
This timing difference impacts financial reporting. The percentage of completion method offers a more consistent and accurate reflection of a company's financial health, especially for long-term projects. It aligns revenue with the actual work performed, giving stakeholders a clearer picture. Learn more about this method. The completed contract method can obscure the financial status of ongoing projects, potentially delaying profit and loss recognition. This article further explains the differences.
The best method depends on several factors: project characteristics, company specifics, and accounting standards. The percentage of completion method generally suits long-term projects with reliable cost and timeline estimates. It provides more accurate reporting and better project insights. This resource explains the importance of accurate reporting. If a project's outcome is uncertain or reliable estimates are difficult, the completed contract method might be better.
Compliance with standards like Generally Accepted Accounting Principles (GAAP) is also critical. GAAP often requires specific revenue recognition criteria. For example, ASC 606 offers guidance on revenue recognition, impacting how the percentage of completion method is applied. The right method ensures accurate financials and compliance. For personalized guidance, schedule a HubiFi demo. We can help you determine the best approach for your business and ensure accurate, compliant revenue recognition.
Staying compliant with accounting standards is crucial when using the percentage of completion method. This section clarifies how this method aligns with both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS 15).
While the percentage of completion method offers a more accurate financial picture for long-term projects, especially in industries like construction where projects often span multiple reporting periods, it's important to note that simply using any percentage of completion calculation isn't enough for GAAP compliance. GAAP, specifically ASC 606, outlines specific criteria for revenue recognition. This standard requires a more nuanced approach than traditional percentage of completion calculations might suggest, emphasizing the importance of accurately measuring progress toward satisfying performance obligations. Inaccurate cost estimations or overlooking change orders can lead to significant issues, impacting not only project profitability but also your ability to comply with these standards. For a deeper understanding of the percentage of completion method and its nuances, resources like this Procore article can be helpful.
The percentage of completion method aligns closely with IFRS 15, which provides guidance on revenue recognition from customer contracts. This standard specifies that revenue tied to performance obligations fulfilled over time should be recognized using the percentage of completion method. This reinforces the method's validity as a robust accounting practice internationally. The Corporate Finance Institute offers a clear explanation of how this method works, including practical examples, highlighting how recognizing revenue, expenses, and gross profit throughout a project's lifecycle provides a more accurate and timely view of financial performance. This aligns with the core principles of IFRS 15, ensuring consistent and transparent financial reporting.
Getting the percentage of completion method right requires diligence and attention to detail. Here are a few best practices to keep your accounting accurate and reliable.
Pick a calculation method and stick with it. Consistency is key for accurate tracking and reporting. Changing your method mid-project can distort your financial picture and make comparisons across projects difficult. Whether you're using the cost-to-cost method or another approach, maintaining consistency ensures reliability and simplifies audits. Document your chosen method clearly for internal reference and audit trails. This promotes clarity within your team and with external stakeholders. For complex projects, consider consulting with a financial professional to ensure your chosen method aligns with your specific circumstances.
Construction projects rarely follow the initial budget perfectly. Regularly review and revise your cost estimates to reflect the project's reality. Unexpected issues, material price fluctuations, and labor changes can all impact your overall costs. Updating your estimates ensures your reported revenue and profit are as accurate as possible. This dynamic approach allows you to catch potential cost overruns early and adjust your strategy accordingly. Discuss your pricing strategy with your team to ensure everyone is aligned on cost management.
Detailed tracking of costs, progress, and milestones is crucial for accurate percentage of completion calculations. Implement systems to monitor actual costs against your budget. This might involve using project management software, regular progress reports, and diligent invoice tracking. Strong controls help prevent errors and ensure the integrity of your financial data. Consider integrating your systems to streamline data flow and reduce manual data entry, minimizing the risk of mistakes. This also provides a clear audit trail, making it easier to justify your accounting choices and demonstrate compliance. Schedule a demo to see how automated solutions can improve your tracking and controls.
Technology plays a crucial role in streamlining and enhancing the accuracy of percentage of completion (POC) accounting. By leveraging the right tools, you can simplify complex calculations, improve data visibility, and free up valuable time for your team.
Generic accounting software may not offer the specialized features needed for effective POC calculations. Look for construction accounting software designed specifically for the construction industry, like CrewCost, which simplifies POC calculations and other complex accounting tasks. These specialized solutions often include features tailored to the nuances of POC, such as automated cost tracking, progress billing, and revenue recognition calculations. This targeted functionality helps ensure accurate financial reporting and reduces the risk of errors. Integrating your chosen software with other business systems, such as your CRM and ERP, further enhances efficiency by centralizing data and automating workflows. For robust integrations, explore options like those offered by HubiFi.
Automation is key to efficient POC accounting. Automated reporting tools can generate real-time reports on project progress, costs, and revenue, giving you immediate insights into your financial performance. This eliminates manual data entry and reduces the risk of human error, ensuring accurate and timely reporting. Automated tools can also flag potential issues, such as cost overruns or discrepancies between billing and actual spending, allowing you to address them proactively. Accurate and timely reporting is not only essential for internal decision-making but also for meeting the reporting requirements of lenders and stakeholders. HubiFi's automated revenue recognition solutions can enhance your reporting capabilities and ensure compliance with ASC 606 and 944. To discuss your specific needs and see how HubiFi can transform your financial processes, schedule a demo.
Percentage of Completion (POC) accounting offers valuable insights into long-term projects, but it also presents unique challenges. Successfully navigating these complexities requires careful planning and diligent execution.
Accurately reporting revenue and costs under the POC method is crucial for healthy cash flow. Your reported financials should mirror your actual billing and spending. This alignment helps prevent overbilling or underbilling, both of which can distort your financial picture and create cash flow problems. For example, if you overbill based on inflated progress estimates, you might face a cash crunch later when actual costs exceed the cash you've received. Conversely, underbilling can lead to a temporary cash surplus but leave you short on funds down the line. Maintaining a clear link between reported revenue, costs, billing, and spending is essential for predictable cash flow.
Inaccurate cost estimations can also significantly impact cash flow, especially in long-term construction projects where unexpected expenses or change orders can arise. For a more detailed look at cost estimations in the percentage of completion method, see this article. Accurately forecasting and tracking costs helps you anticipate potential cash flow issues and take proactive steps to address them.
The POC method relies heavily on estimations of project costs and completion percentages. These estimations introduce the risk of financial misstatement. If your cost estimates are too low or your progress is overstated, your reported revenue will be inflated, leading to an inaccurate financial picture. Conversely, underestimating costs or understating progress can underrepresent your revenue. This explanation of the percentage of completion method provides further insights into these potential pitfalls.
To minimize these risks, establish strong internal controls for tracking costs and measuring progress. Regularly review and update your cost estimates as the project progresses. Independent audits can also provide an additional layer of assurance, verifying the accuracy of your financial reporting and helping you maintain compliance with accounting standards. This proactive approach to risk management is essential for reliable financial reporting and informed decision-making. For more information on mitigating financial misstatement risks and ensuring accurate reporting, explore this helpful resource on the percentage of completion method. Accurate and reliable financial data is the foundation of sound business decisions. Consider exploring how automated revenue recognition solutions, like those offered by HubiFi, can streamline these processes and enhance accuracy. You can schedule a demo to learn more.
Why is the percentage of completion method better than just waiting until the end of a project to recognize revenue?
The percentage of completion method gives you a much clearer picture of your financial health throughout a long-term project. Instead of waiting until the very end, you recognize revenue and expenses as you make progress. This helps you make more informed decisions based on real-time data, rather than waiting for a potentially outdated snapshot at the project's completion.
How do I know if the percentage of completion method is right for my business?
This method is generally best for long-term projects with predictable costs and timelines. If your projects span several months or years and you can reasonably estimate the total costs involved, this method might be a good fit. However, if your projects are short-term or have highly unpredictable costs, other methods might be more suitable. Talking to a financial advisor can help you make the best choice for your specific situation.
What's the biggest challenge with using this method?
Accurately estimating costs and the percentage of project completion can be tricky. Unexpected issues, changing material prices, and other unforeseen factors can impact your initial estimates. Regularly reviewing and revising your estimates is crucial for maintaining accurate financial reporting.
What are some practical tips for implementing the percentage of completion method effectively?
Choose a consistent calculation method and stick with it throughout the project. Regularly review and revise your cost estimates to reflect any changes or unexpected expenses. Implement robust tracking systems to monitor costs, progress, and milestones. Using specialized software can automate many of these tasks and improve accuracy.
How does using the percentage of completion method help with compliance and audits?
By accurately recognizing revenue and expenses as they occur, this method provides a transparent and auditable financial record of your project. This makes it easier to demonstrate compliance with accounting standards and provides a clear picture of your financial performance to stakeholders and auditors. Consistent application of the method and detailed documentation further strengthen your compliance efforts.
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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