Under the percentage of completion formula, projects under construction, engineering, and manufacturing, as well as other expense recognition projects, allow revenue and expenses to be recorded as the projects progress instead of at the end of the project life. Such industries engage in long-term contracts which take several accounting periods to cover. This method of revenue recognition ensures that the time-based financial statements being analyzed show performance and profitability as of the date of the statements.
Step 1: Determine Total Contract Revenue and Costs
First, contract value should be received for revenue recognition. After that, the expected project costs should be estimated which should include the value of materials, labor, overhead, and costs for subcontractors. Without these values, calculating the revenue that has been completed in the contract as of the date in the statements would be impossible.
For example:
- Total contract value: $1,000,000
- Total estimated costs: $800,000
Step 2: Calculate Costs Incurred to Date
The next step is determining the cost incurred to date. This amount should come directly from the company’s accounting records. In order to project the value for costs incurred to date for the revenue recognition custom, all expenses directly related to project completion should be entered.
Suppose the company has incurred $400,000 so far in costs for materials and labor.
Step 3: Apply the Percentage of Completion Formula
The formula for calculating the percentage of completion is straightforward:
Percentage of Completion = Costs Incurred to Date ÷ Total Estimated Costs
Using the example above: 400,000 ÷ 800,000 = 0.50 or 50%
This means 50% of the project is complete.
Step 4: Recognize Revenue and Expenses
Once you know the completion percentage, multiply it by the total contract revenue to determine how much revenue should be recognized for the reporting period. Then, match the corresponding expenses for accurate profit recognition.
- Revenue Recognized = 1,000,000 × 50% = 500,000
- Expenses Recognized = 800,000 × 50% = 400,000
Thus, $500,000 in revenue and $400,000 in expenses would be recorded in the current period.
Key Takeaway
Calculating the percentage of completion method involves comparing costs incurred to total estimated costs, then applying that ratio to recognize revenue. This approach provides a more accurate picture of project progress and financial performance, ensuring compliance with GAAP and ASC 606 standards for long-term contracts. If you are not sure how to apply such calculation methods, contact us today. Dimov Tax stands ready to present professional support.