How does percentage of completion accounting work?

What does that look like on a real job?

Over billed by $35,000 means you are holding $35,000 of the customer’s money you have not earned yet. Spend it like profit and that job comes up short later. Under billed by the same amount would mean the opposite: you did the work and are financing it out of your own account.

Percentage of completion, answered

What is percentage of completion accounting?

Percentage of completion recognizes revenue on a long-term contract as the work gets done, instead of waiting until the job closes. If a job is 40% complete, you recognize roughly 40% of the contract value as earned revenue. It matches revenue to the period the work actually happened, which is why lenders, sureties, and auditors expect it from contractors.

How do you calculate percentage of completion?

The common method is cost-to-cost: divide costs incurred to date by total estimated costs for the job. That percentage times the contract value is your earned revenue to date. Subtract what you have already billed and you get over or under billings. The accuracy of the whole calculation rests on your total estimated cost being honest and updated.

What is a worked example?

A $500,000 contract with $400,000 in estimated total cost. You have spent $100,000 so far, so you are 25% complete ($100,000 / $400,000). Earned revenue is 25% of $500,000, or $125,000. If you have billed $160,000, you are over billed by $35,000, meaning you are holding cash you have not yet earned. If you had billed $90,000, you would be under billed by $35,000 and financing the job yourself.

What is the difference between percentage of completion and completed contract?

Completed contract defers all revenue and cost until the job finishes, so your P&L swings wildly and shows nothing during the months you are actually building. Percentage of completion spreads both across the life of the job so each month reflects the work done. Completed contract is simpler, but it hides how a job is performing while you can still act on it.

Which method should a contractor use?

Most contractors use percentage of completion for financial reporting, because it is what banks and bonding companies expect and it is required under current revenue-recognition standards for contracts that transfer value over time. Smaller contractors may be eligible to use completed contract for tax purposes under an IRS size exception that is adjusted for inflation each year. Your books and your tax return can use different methods, so confirm the current threshold with your CPA.

What is construction in progress (CIP) accounting?

Construction in progress, sometimes called construction in process, is the balance sheet side of the same idea. Costs accumulate in a CIP account while the job is open rather than hitting expense immediately, then clear when the work is recognized. Percentage of completion decides how much moves and when. The two are the same mechanism seen from the income statement and the balance sheet.

How does percentage of completion connect to a WIP schedule?

The WIP schedule is the report that shows the calculation for every open job at once: contract value, cost to date, estimated total cost, percent complete, earned revenue, amount billed, and the resulting over or under billing. Percentage of completion is the method. The WIP schedule is what your banker actually asks to see.

What goes wrong with percentage of completion in practice?

Stale cost estimates. The math is only as good as your total estimated cost, so if a job's budget has not been updated since the bid, your percent complete is fiction and profit fade shows up at closeout as a surprise. The second problem is costs that never make it onto the job, like unbilled change orders, which quietly understate both cost and revenue.