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Percentage of Completion Method

Overview of the Percentage of Completion Method

The percentage of completion method is an accounting calculation under which a percentage of the income associated with a project is recognized in proportion to the estimated percentage of completion of the project. It is heavily used in the construction industry, where very long-term construction projects would otherwise keep a company from revealing any revenues on its financial statements until its projects are completed, which might occur only at long intervals.  Under this approach, the accounting staff creates a new asset account for each project, in which it accumulates all related expenses.  At the end of each reporting period, the budgeted gross margin associated with each project is added to the total expenses accumulated in each account, and subtracted from the accumulated billings to date.  If the amount of expenses and gross profit exceeds the billings figure, then the company recognizes revenue matching the difference between the two figures.  If the expenses and gross profit figure are less than the amount of billings, the difference is stored in a liability account.

Example of the Percentage of Completion Method

The Hephaestus Construction Company is building a log cabin-style office building for a company specializing in rustic furniture.  Thus far, it has accumulated $810,000 in expenses on the project and billed the customer $1,000,000.  The estimated gross margin on the project is 28%.  The total of expenses and estimated gross profit is therefore $1,125,000, which is calculated as $810,000 divided by (1 – 0.28).  Since this figure exceeds the billings to date of $1,000,000, the company can recognize additional revenue of $125,000.  The resulting journal entry is:

Since Hephaestus must also recognize a proportional amount of expenses in relation to the revenues recognized, it should credit the construction in progress account and debit the cost of goods sold account for $90,000.  This cost of goods sold is derived by multiplying the recognized revenue figure of $125,000 by one minus the gross margin, or 72%.

Under an alternative scenario, Hephaestus has billed the customer $1,200,000, while all other information remains the same.  In this case, the amount of revenue earned is $1,125,000 which is $75,000 less than the amount billed.  Consequently, the company must record a $75,000 liability for the incremental amount of work it must still complete before it can recognize the remaining revenue that has already been billed.  The resulting journal entry would be:

Related Topics

Completed contract method
Cost recovery method
Cost to cost method
Installment method
Revenue recognition criteria