Percentage of Completion Method of Revenue Recognition
For the purpose of preparing fair and true financial statement of the company, it has to take the correct decision about the revenue for the period. The percentage of completion method refers to the income earned by the contractor determined on the basis of progress of the contract. Under this method, current assets may include costs and recognized income not yet billed with respect to certain contracts. This method is most commonly used in the construction industry, where very long-term construction projects would otherwise keep a company from revealing any revenues or expenses on its financial statements until its projects are completed, which might occur only at long intervals.
Under this approach, the accountant develops a percentage of project completion based on the total costs incurred as a percentage of the estimated total cost of the project, and multiplies this percentage by the total revenue to be earned under the contract (even if the revenue has not yet been billed to the customer). The resulting amount is recognized as revenue. The gross profit associated with the project is proportionally recognized at the same time that revenue is recognized.
The trouble with this method is that one must have good cost tracking and project planning systems in order to ensure that all related costs are being properly accumulated for each project, and that cost overruns are accounted for when deriving the percentage of completion. For example, if poor management results in a doubling of the costs incurred at the half-way point of a construction project, from $5,000 up to $10,000, this means that the total estimated cost for the entire project (of $10,000) would already have been reached when half of the project had not yet been completed. In such a case, one should review the remaining costs left to be incurred and change this estimate to ensure that the resulting percentage of completion is accurate.
If the percentage of completion calculation appears to be
Under this approach, the accountant develops a percentage of project completion based on the total costs incurred as a percentage of the estimated total cost of the project, and multiplies this percentage by the total revenue to be earned under the contract (even if the revenue has not yet been billed to the customer). The resulting amount is recognized as revenue. The gross profit associated with the project is proportionally recognized at the same time that revenue is recognized.
The trouble with this method is that one must have good cost tracking and project planning systems in order to ensure that all related costs are being properly accumulated for each project, and that cost overruns are accounted for when deriving the percentage of completion. For example, if poor management results in a doubling of the costs incurred at the half-way point of a construction project, from $5,000 up to $10,000, this means that the total estimated cost for the entire project (of $10,000) would already have been reached when half of the project had not yet been completed. In such a case, one should review the remaining costs left to be incurred and change this estimate to ensure that the resulting percentage of completion is accurate.
If the percentage of completion calculation appears to be