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Percentage-of-Completion Method Definition

Definition

The word percentage-of-completion method identifies a accounting approach which recognizes earnings and costs connected with longterm endeavors. The percentage-of-completion method makes it possible for organizations to record earnings as progress has been made prior to completion of the undertaking. Even a cost-to-cost calculation is typically employed as the foundation for specifying the conclusion percent.

Calculation

Using a cost-to-cost procedure, the following calculation can be used to Ascertain the conclusion percentage:

Percent Complete = Cost Incurred to Date / Total Cost Estimate

The present period earnings to be realized throughout creation would subsequently be:

Current Period Revenue = (Percent Complete x Total Contract Revenue) – Revenue Recognized in Prior Periods

Explanation

The FASB Concept Statement No. 5 countries which organizations can’t recognize earnings because being got until they’re realized or realizable, and also the organization has significantly finished exactly what it should accomplish to be able to qualify to payment. Revenue might be realized at the purpose of purchase, before, and after delivery, or even as an ingredient of a distinctive earnings trade.

Long-term projects often-times require the client to make obligations as certain milestones are reached. This can be a frequent structure within the construction and other heavy equipment businesses which may demand customized projects or services and products which could take years to finish or build.

The percentage-of-completion method recognizes revenues and costs each accounting period while the job progresses. Businesses which make use of this method think that waiting until a job is complete before comprehending the possible earnings linked to the job mis-aligns costs and earnings. The largest barrier for the strategy is that the capacity to accurately determine the proportion of a longterm endeavor that’s complete.

The cost-to-cost procedure is just one of the popular methods for solving this issue. This method determines the proportion of this job that’s complete with a percentage of their costs incurred so far on this whole project expenses. This value is subsequently employed to the entire revenue related to the undertaking.

Example

Company A has contracted Company Z to upgrade their customer information platform. The entire value of this contract together with Company Z is currently worth $22 million, and the job is likely to take 36 months to finish. Company Z’s internal quote indicates the job will probably cost $15 million to finish. The initial milestone payment from Company A doesn’t happen until eight months to the job, but Company Z want to recognize revenue in their income announcement within their second yearly report. At the point in time, the Company Z would’ve expended $5 million in costs.

Using the percentage-of-completion process, the percent total Would-be:

= $5 million / $ 1-5 million, or 3 3% absolute

The present phase earnings would subsequently be calculated because:

= 33 percent $22 million
= 7.26 million

Note: Since that may be the very first conclusion of earnings, there’s not any requirement to correct this value for earlier periods.