Percentage of Completion in Construction Accounting

Percentage of completion analysis is a vital tool in construction accounting, especially for long-term projects. Contractors often adopt this method to achieve more accurate financial reporting and efficient project cost management.

Applying percentage of completion analysis can provide more timely financial reporting by allowing contractors to recognize revenue and expenses as work progresses rather than waiting until the project's completion.

Exploring the Comprehensive Benefits of the Percentage of Completion Method in Long-Term Construction Projects

Percentage of completion analysis is a vital tool in construction accounting, especially for long-term projects. Contractors often adopt this method to achieve more accurate financial reporting and efficient project cost management.

The percentage of completion approach provides numerous advantages for both contractors and stakeholders involved in construction projects, including:

Accurate Financial Reporting

Percentage of completion analysis enables more accurate and timely financial reporting by recognizing revenue and expenses in proportion to the completion of the project. It also reflects the actual progress of the project rather than waiting until the project is complete, providing a more accurate picture of financial performance.

Matching Expenses with Revenue Recognition

Traditional accounting methods may not accurately match expenses with revenue recognition over the life of a long-term contract. The percentage of completion method allows for a more accurate reflection of costs incurred during specific periods compared to revenue generated.

Cash Flow Management

Using percentage of completion analysis helps contractors understand cash flow better. It allows for accurate cash flow predictions by linking revenue recognition to the ongoing project progress.

Recognizing revenue as costs are incurred also gives contractors significant benefits. It helps them manage cash flow effectively by billing clients based on the percentage of completed work.

This careful financial approach empowers contractors to make informed decisions about their working capital needs, contributing to overall operational efficiency and financial prudence.

Timely Financial Reporting

Applying percentage of completion analysis can provide more timely financial reporting by allowing contractors to recognize revenue and expenses as work progresses rather than waiting until the project's completion. This can be especially important for contractors with ongoing long-term projects that span several reporting periods.

Accurate Profitability Assessment

The percentage of completion method enables contractors to recognize revenue and expenses based on the proportion of work completed. This can lead to a more accurate assessment of the project's profitability rather than waiting until the project is finished, as under the completed contract method.

Compliance with Accounting Standards

Adhering to accounting standards and regulations is crucial for financial reporting integrity. The percentage of completion accounting method may align more closely with recognized accounting principles, ensuring compliance with accounting standards and industry regulations, particularly for construction contracts that span multiple reporting periods.

This method also provides a systematic approach for recognizing revenue and expenses in accordance with generally accepted accounting principles (GAAP).

Contract Performance Evaluation

The percentage of completion method enables better decision-making, as project managers can monitor progress and address potential issues early in the construction process.

Using these tools, project managers can assess contract performance and identify potential issues early in the project lifecycle. This enables proactive management, addressing issues before they escalate and ensuring the project remains on track.

It also helps identify and manage project completion risks, as discrepancies between estimated and actual completion percentages can signal potential problems. Lastly, this method provides a more accurate estimation of future costs to complete the project.

Improved Stakeholder Confidence and Financial Visibility

Accurate and transparent financial reporting can enhance stakeholder confidence, whether dealing with investors, lenders, or project owners.

Precise and up-to-date financial information contributes to a better understanding of a contractor's financial health and performance. Using the percentage of completion method enhances transparency by showing how much of the project has been completed and what revenues and costs have been recognized.

Facilitates Audits

The percentage of completion method simplifies the auditing process by providing a clear and systematic approach to revenue recognition and expense allocation. It also supports the credibility and reliability of financial statements during external audits.

Contract Negotiation and Bidding

Contractors may use alternative accounting methods to estimate project costs more accurately during contract negotiation and bidding. This can help set competitive prices, win contracts, and avoid potential losses due to inaccurate cost estimates.

Completing Long-Term Projects

Construction contractors should carefully consider the percentage of completion method for long-term contracts to achieve more accurate financial reporting, better match expenses with revenue, manage cash flow effectively, and enhance overall project and financial management.

Choosing the right approach for your circumstances

While percentage of completion analysis offers these benefits and more, contractors should consult with accounting professionals to determine the most suitable method for their circumstances.

Frequently Asked Questions

Find out the top questions that our clients in the construction industry typically ask.

What is the percentage of completion method in construction accounting?

The percentage of completion method recognizes revenue and expenses as a project progresses. Instead of waiting until the job is finished, contractors record financial results based on how much of the contract has been completed during a reporting period.

Why do construction companies use percentage of completion?

It can provide a clearer, more timely view of financial performance on long-term projects by matching revenue to the work performed and costs incurred during each period.

How do you calculate percentage of completion?

Many contractors use a cost-to-cost approach: percentage complete = costs incurred to date ÷ total estimated costs. Revenue recognized to date is then based on that percentage applied to the contract value, with current-period revenue being the difference between this period and prior periods.

What’s the difference between percentage of completion and the completed contract method?

Percentage of completion recognizes revenue and profit over time as work progresses. The completed contract method generally defers revenue and profit recognition until the project is substantially complete, which can cause bigger swings in reported results.

Does percentage of completion improve cash flow?

It doesn’t change cash receipts by itself, but it can improve cash flow planning and forecasting by aligning billing, WIP reporting, and financial visibility with actual project progress.

What is a WIP report and how does it connect to percentage of completion?

A Work-in-Progress (WIP) report tracks job status by comparing contract value, costs to date, estimated costs to complete, billings to date, and recognized revenue. It’s a key tool for applying percentage of completion consistently and spotting overbillings/underbillings.

What are common mistakes contractors make with percentage of completion?

Common issues include:

• Inaccurate or outdated cost-to-complete estimates

• Missing or late cost coding (costs not tied to the correct job or phase)

• Not updating change orders and contract values promptly

• Weak documentation supporting estimates and assumptions

• Treating billings as revenue instead of separating billing from revenue recognition

How are change orders handled under percentage of completion?

Change orders should be evaluated and incorporated into contract value and estimated costs as they become approved and realizable. Delays in updating change orders can distort percentage complete, revenue recognition, and profitability reporting.

What happens if estimated total costs change during the project?

If the estimate changes, the percentage complete and total expected profit/loss may change too. This typically results in a “catch-up” adjustment so recognized revenue and profit reflect the most current estimate of total contract results.

Is percentage of completion required under GAAP?

For many long-term construction contracts, revenue recognition “over time” is common when certain criteria are met, and percentage of completion (or similar progress-based measures) is often used to measure that progress. The best approach depends on the contract terms and the applicable revenue recognition guidance.

How does percentage of completion help with audits?

When supported by consistent processes and documentation, it can make audits more efficient because it provides a systematic method for recognizing revenue and allocating costs. Auditors typically focus heavily on the reasonableness of estimates, job cost controls, and change order support.

Who should consider using percentage of completion?

It’s often a fit for contractors with long-term projects that span multiple reporting periods and need clearer visibility into profitability, backlog performance, and financial reporting. A construction-focused accounting professional can help determine whether it’s the most suitable method for your circumstances.