Updates
Leveraging Percentage of Completion Analysis in Construction Contracts
March 5, 2024
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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