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Updates

Leveraging Percentage of Completion Analysis in Construction Contracts

March 5, 2024

Percentage of Completion Analysis

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 allows for better decision-making as project managers can monitor progress and address potential issues early in the construction process. Using these tools, project managers can evaluate contract performance and identify potential issues early in the project life cycle. This allows for proactive management, addressing problems before they escalate and helping to ensure that 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.

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. 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.

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About Bowers CPAs & Advisors

Bowers aims to offer helpful information to our clients and friends. Learn more about how we can help should your construction business need consulting and financial services.

Bowers CPAs & Advisors has served private and closely held businesses with strategic financial advice for over 40 years. Whether traditional Tax and Audit, Business Valuation, Accounting/Bookkeeping, Forensic Accounting, or Financial Planning services, our approach is the same:

"Master an in-depth knowledge of our clients and their industry to provide proactive, innovative analysis and recommendations to build and maintain net worth."

At Bowers CPAs & Advisors, we set the tone by being readily available to our clients and maintaining close relationships built on integrity and trust. With 31 Partners and a staff of more than 130 professionals, Bowers CPAs & Advisors has offices in Syracuse, Rochester and Watertown, New York. 

Disclaimer: To ensure compliance with requirements imposed by the Department of Treasury, we inform you any U.S. federal tax advice contained in this document or video is not intended for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

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