What is the Percentage of Completion Method?The percentage of completion method calculates the ongoing recognition of revenue and expenses related to longer-term projects based on the proportion of work completed. By doing so, the seller can recognize some gain or loss related to a project in every accounting period in which the project continues to be active. The method works best when it is reasonably possible to estimate the stages of project completion on an ongoing basis, or at least to estimate the remaining costs to complete a project. Conversely, this method should not be used when there are significant uncertainties about the percentage of completion or the remaining costs to be incurred. The estimating abilities of a contractor should be considered sufficient to use the percentage of completion method if it can estimate the minimum total revenue and maximum total cost with sufficient confidence to justify a contract bid. Show
The ability to create dependable contract estimates may be impaired when there are conditions present that are not normally encountered in the estimating process. Examples of these conditions are when a contract does not appear to be enforceable, there is litigation, or when related properties may be condemned or expropriated. In these situations, use the completed contract method instead. Methods for Calculating the Percentage of CompletionIn essence, the percentage of completion method allows you to recognize as income that percentage of total income that matches the percentage of completion of a project. The percentage of completion may be measured in any of the following ways:
Use the same measurement method for similar types of contracts. Doing so improves the consistency of the percentage of completion results over time. How to Calculate the Percentage of CompletionWhen the contractor has difficulty deriving the estimated cost to complete a contract, base the recognition of profit on the lowest probable profit, until the profit can be estimated with more accuracy. In cases where it is impractical to estimate any profit, other than to be assured that a loss will not be incurred, assume a zero profit for revenue recognition purposes; this means that revenues and expenses should be recognized in equal amounts until such time as more accurate estimates can be made. This approach is better than the completed contract method, since there is at least some indication of economic activity that spills over into the income statement prior to project completion. The steps needed for the percentage of completion method are as follows:
Example of the Percentage of Completion MethodLogger Construction Company is building a maintenance facility on a military base. Logger has thus far accumulated $4,000,000 of costs related to the project, and billed the customer $4,500,000. The estimated gross margin on the project is 20%. Therefore, the total of expenses and estimated gross profit for the project is: $4,000,000 Expenses ÷ (1 – 0.20 Gross margin) = $5,000,000 Since this figure is higher than the to-date billings of $4,500,000, Logger can recognize additional revenue of $500,000, using the following journal entry: Fraudulent Use of the Percentage of Completion MethodThis method is subject to fraudulent activity, usually to over-estimate the amount of revenue and profit that should be recognized. Doing so accelerates the recognition of profit associated with a project, making a contractor look more profitable in the short-term than is really the case. Detailed documentation of project milestones and completion status can mitigate the possibility of fraud, but cannot eliminate it. What are the 5 steps in revenue recognition?The FASB has provided a five step process for recognizing revenue from contracts with customers:. Step 1 – Identify the Contract. ... . Step 2 – Identify Performance Obligations. ... . Step 3 – Determine the Transaction Price. ... . Step 4 – Allocate the Transaction Price. ... . Step 5 – Recognize Revenue.. What is one of the more popular input measures used to determine the progress toward completion in the percentage of completion method?It is commonly measured through the cost-to-cost method. There are two conditions to use the percentage of completion method: Collections by the company must be reasonably assured. Costs and project completion must be reasonably estimated.
In which of the following instances has the firm satisfied its performance obligation?20. A company satisfies its performance obligation when the customer obtains control of the good or service.
How should the balances of progress billings and construction?The balances of progress billings and construction in process should be shown at net, as a current asset if a debit balance, and as a current liability if a credit balance.
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