Percentage Completion Method What Is It, Journal Entries

With the POC method, revenue and costs are recognized as work on the project progresses based on the percentage completed during each period. This allows builders to better match revenues with expenses incurred over the duration of a project rather than having to recognize all revenues when the project is finished. 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.

The Basics of Percentage of Completion Accounting in Construction

This offers a realistic snapshot of your financial performance at any given time, rather than a large influx all at once. This improved reporting leads to more informed decision-making and better insights into your company’s overall financial trajectory. Cash flow can make or break a construction business, and the percentage of completion method helps stabilize it by recognizing revenue in proportion to the work completed. Unlike the completed contract method, where revenue is delayed until project completion, this approach allows contractors to invoice for progress, keeping funds flowing consistently. ASC 606 impacts any business that enters into contracts with customers to provide goods or services.

Leverage Technology for Accurate Tracking

• The percentage of completion method (POC) is a common accounting process that contractors use on long-term contracts to determine income and expenses based on the percent of work completed.
• The main objective of the method is to match the revenue with the corresponding expense incurred as the project progresses.
• Another viable approach, this method compares the actual effort expended to date with the estimated total effort required for the project.
• Regularly updating your project data also helps identify potential cost overruns or delays early on, giving you more time to take corrective action.
• The percentage of completion method aligns with these standards, ensuring that your financial records are not only accurate but also audit-ready.
• This also provides a clear audit trail, making it easier to justify your accounting choices and demonstrate compliance.

This aligns with accounting principles like IFRS 15, which aims to provide a more faithful representation of a company’s financial position. By recognizing revenue gradually, companies can avoid large swings in profitability from one period gross vs net to the next, leading to smoother financial statements. This method is particularly useful for long-term contracts where recognizing all revenue and expenses at the end could distort the true financial picture. It offers a clearer view of project profitability as it progresses, allowing for better management and more informed decision-making.

Risks and Challenges of the POC Method

• However, the method requires meticulous estimation, ongoing monitoring, and robust internal controls to ensure accuracy and compliance.
• As mentioned, there are many revenue recognition methods that a company can choose to employ.
• By recognizing revenue gradually, companies can avoid large swings in profitability from one period to the next, leading to smoother financial statements.
• Projected gross margins should be compared to historical gross margins to assess the reasonableness of management’s estimates.
• This method is often used in manufacturing or standardized product delivery projects where outputs can be easily counted.
• Revenue is recognized based on the percentage of work completed, not the cash received.

The balance on the construction in progress account is now 750, representing costs of 300 plus percentage of completion method income recognized to date of 450, which is also the amount of recognized revenue. Percentage of completion method is vulnerable to abuse by unethical companies. Those who wish to engage in creative accounting can easily move around income and expenses from one period to another period, understating or overstating amounts. This game would not be sustainable, however, as Toshiba Corp. discovered in 2015. The infrastructure unit of the Japanese conglomerate understated operating costs by approximately 152 billion yen ($1.2 billion) between 2008 and 2014.

Tax Implications

These variations can lead to discrepancies between billing and the revenue you can recognize. Financial teams need to be prepared to handle these discrepancies and adjust their forecasts accordingly. This requires a flexible system that can adapt to project changes and provide real-time insights into your financial performance. Explore HubiFi’s pricing to see how we can support your business with these challenges. The foundation of the percentage of completion method lies in accurate cost estimations.