Key Takeaways
- Recognizes revenue based on project progress.
- Requires reliable estimates and measurable completion.
- Immediate loss recognition if contract becomes unprofitable.
What is Percentage of Completion Method?
The percentage of completion method (PCM) is an accounting technique used to recognize revenue and expenses on long-term contracts based on the proportion of work completed. This method aligns with GAAP and other standards, ensuring revenues are matched to costs incurred during a project rather than waiting until final completion.
PCM provides a more accurate financial picture for projects spanning multiple periods, especially when reliable estimates of progress and costs are available.
Key Characteristics
The percentage of completion method has several defining features that make it suitable for long-term projects:
- Revenue recognition: Revenue is recognized periodically based on project progress rather than at completion.
- Reliable estimates: Requires accurate estimation of total costs and progress toward completion.
- Matching principle: Aligns expenses with revenues during the project life cycle.
- Cost inputs: Uses actual costs incurred versus total estimated costs to calculate completion percentage.
- Accounting entries: Involves T-accounts to track work-in-progress and billings.
How It Works
The core of PCM lies in calculating the percentage of work completed, typically using the cost-to-cost method, where costs incurred to date are divided by total estimated costs. This percentage is then multiplied by the total contract price to determine revenue recognized to date.
As the project progresses, these estimates can be updated, and any losses must be recognized immediately. The method ensures continuous revenue and expense recognition, improving financial reporting accuracy for ongoing contracts.
Examples and Use Cases
PCM is widely used in industries with long-term contracts, allowing companies to reflect ongoing work in their financial statements.
- Airlines: Companies like Delta use similar accounting principles to manage multi-period projects and investments.
- Construction firms: Often apply PCM to large-scale building projects, updating revenue as milestones are met.
- Technology firms: Recognize revenue on software development contracts over time using PCM.
- Investment selection: Investors researching best large-cap stocks may consider how companies recognize revenue for insights into financial health.
Important Considerations
While PCM offers advantages in matching revenues to expenses, you must ensure reliable cost estimates and progress measurement. Uncertainty in these inputs can lead to inaccurate financial reporting.
Additionally, you should be aware of alternative methods like the completed-contract method when estimates are unreliable. Understanding how deferred acquisition costs and billing practices interact with PCM can help you interpret financial statements more effectively.
Final Words
The Percentage of Completion Method offers a precise way to match revenues with project progress, improving financial transparency on long-term contracts. Review your current projects to ensure you meet the criteria for reliable estimates and accurate progress measurement before applying this method.
Frequently Asked Questions
The Percentage of Completion Method is an accounting approach used to recognize revenue and expenses on long-term contracts based on the proportion of work completed, rather than waiting until the project is finished. It provides a more accurate reflection of financial performance over multiple periods.
This method should be applied when the contract outcome can be reliably estimated, progress can be measured accurately, and collection from the customer is assured. If these conditions aren't met, alternatives like the completed-contract method might be more appropriate.
Revenue is calculated by determining the percentage of the project completed, usually using the cost-to-cost approach, which divides costs incurred to date by total estimated costs. This percentage is then multiplied by the total contract price to find the revenue recognized to date.
The core inputs include the total contract price, total estimated costs for the entire project, and the costs incurred so far. These inputs help calculate the percentage of completion and the revenue and profits to recognize.
If a loss is projected on a contract, the entire expected loss must be recognized immediately, regardless of how much work has been completed. This ensures that financial statements reflect the anticipated setback promptly.
The most common method is the cost-to-cost approach, which uses costs incurred as a measure of progress. Alternatives include efforts expended, such as labor hours, or units of delivery, like number of floors built, but whichever method is chosen should be applied consistently.
The method aligns with IFRS 15 and U.S. GAAP standards, which require revenue recognition based on reliable estimates of contract progress. It ensures revenues and expenses are matched appropriately across reporting periods.
