Percentage of completion is an accounting method of work-in-progress
evaluation, for recording long-term contracts. GAAP allows another method of
revenue recognition for long-term construction contracts, the
completed-contract method. When to use
The accounting for long term contracts using the percentage of completion
method is an exception to the basic realization principle. This method is
used wherein the revenues are determined based on the costs incurred so far. The
percentage of completion method is used when:
Collections are assured The accounting system can:
Estimate profitability Measure progress toward completion.
Losses are recognized in the year when they are discovered, the same way as for
the completed contract method. The balance sheet presentation is the same
as in the completed contract method. Formulas used
Revenues and gross profit are recognized each period based on the construction
progress, in other words, the percentage of completion. Construction costs plus
gross profit earned to date are accumulated in an asset account, and
progress billings are accumulated in a liability account.
Construction-in-progress are generally not classified as inventory as it would
not be in-line with IAS2.9. Although the formula for recognizing
income in the current period can vary, a widely accepted one is as follows:
where... the number of periods lapsed since the inception of the contract.
the expected length of the contract. the current period.
Examples For example, let's say our total
estimated cost for the contract is $10,000 and our contract value is
$12,000. We know that project will be completed in 2 years. Now, after the
first year we see that total cost incurred in this first year is $3,000.
So according to the percentage-of-completion method: Cost
percentage = 3000/10000 = 30%; so we will recognize 30% revenue in the income
statement for the first year. Income statement of AnantPurohit
corporation Pvt. Ltd. for the year ended on xxzzzz:
In the next year, some more complicated parts enter the game. Let's say that
after completion of the second year, our expected cost changes to 11,000. Assume
our cost to date is 5,500, the percentage completed is 5,500/11,000 =
50%. Thus, the revenue to be recognized is – 3,600 = 2,400
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended
on xxzzzz+1: Now let's say that for the next year,
our total cost estimation is increased to 15,000 due to increases in raw
material and labor costs. We know that we are going to incur a loss of 3000 at
the end of the contract period. For the third year, our cost to date reaches
10,500, so according to PoC: Percentage completion = 10,500/15,000 = 70% Revenue
= 70% of 12,000 – previously recognized = 8,400 – 6,000 = 2,400. However,
because we are going to have a total loss of 3,000 on the contract..... we
must recognize the total loss in the period it is estimated. As a result, our
Cost of goods will be 5,900; we reached this inductively by figuring the Sales
and the Loss before the Cost of goods. Income statement of AnantPurohit
corporation Pvt. Ltd. for the year ended on xxzzzz+2:
In final year, our cost is 4,500 and revenue is 3,600. But we record only
3,600 in Cost of goods because we already recognized the total loss in the
last period. Total Profit/Loss from the contract =
600-100-3,500= 3,000 Net Loss Disclosures
As per IAS 11.42-43, an entity shall present:
(a) the gross amount due from customers for contract work as an asset; and
(b) the gross amount due to customers for contract work as a liability.
(These should be separate line-items on the face on the balance sheet.)
The gross amount due from/to customers for contract work is the net amount of:
(a) costs incurred plus recognized profits; less
(b) the sum of recognized losses and progress billings
for all contracts in progress. External links
Percentage-Of-Completion Method at Answers.com