Managing your construction company's finances might be stressful. Between progress billing, task costing, and revenue recognition, it's easy to lose sight of what's happening. However, one way stands out for its capacity to assist contractors accurately portray their financial performance: the percentage of completion approach.
In this article, we'll go over what the % of completion method is, how it works, the benefits and hazards, and why it's important for contractors. Whether you're new to construction bookkeeping or want to enhance your financial management, this tutorial has you covered.
What Is the Percentage of Completion Method?
The percentage of completion method is an accounting technique that recognizes revenue and expenses proportionally as a project moves forward. Unlike the completed-contract method, which only recognizes income when a project is done, this method provides real-time information about your project's financial status.
For example, if a $100,000 project is 50% completed, you record $50,000 in income and costs for that reporting period. This method accurately measures progress by referring to milestones, money incurred, or work done.
Why Percentage of Completion Method Important?
Accurate Financial Representation
Revenue recognition is crucial for contractors who work on building contracts. This strategy ensures that your financial statements provide a true representation of your earnings and expenses.
Improved Decision-Making
Real-time revenue tracking enables you to make informed decisions. Is your profit margin on track? Do you need to change the costs or timelines? The percentage of completion technique helps to answer these problems.
Compliance with Standards
The procedure is consistent with generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS). This is especially critical for contractors working on large-scale projects that require precise financial reporting.
Methods of Percentage of Completion Calculation
There are several POC calculation methods available, each suited to different types of projects and scenarios. These methods help you determine the proportion of revenue to recognize based on the progress of a project. Let’s explore the most common approaches.
Cost-to-Cost Method
The cost-to-cost method calculates the percentage of completion based on the ratio of costs incurred to date to the estimated total costs of the project.
Cost-to-Cost Method Formula = (Costs incurred to date / Estimated total costs) * Total contract revenue |
Example: If a project has incurred $500,000 in costs so far, and the estimated total cost is $1,000,000, with a total contract revenue of $1,200,000, the calculation would be:
(500,000 / 1,000,000) * 1,200,000 = $600,000
Efforts-Expended Method
The efforts-expended method is useful when costs alone are not a reliable indicator of project progress. It focuses on the actual effort expended, such as labor hours, machine hours, or materials used, to calculate the percentage of completion.
Example: If a project is expected to require 10,000 labor hours and 4,000 hours have been worked so far, the project is 40% complete.
This method is ideal for projects where labor or specific tasks are the primary drivers of progress, and it can provide a more accurate reflection of completion when cost data is not as precise.
Units-of-Delivery Method
The units-of-delivery method comes in handy for projects with distinct deliverables, such as construction phases or specific components of a larger project. Tracking progress is simple: Evaluating how many units you’ve finished relative to the total required units.
Example: If a project involves the construction of 10 buildings, and six are completed, the project is 60% complete. Use this method when each unit or deliverable represents a significant portion of the project’s value.
Examples of POC Method Applications
Road Construction
The cost-to-cost approach is popular here. The percentage of completion is calculated by comparing the costs incurred to date, such as labor, materials, and equipment rentals, to the expected total project costs. It enables project managers to monitor financial performance and make budget adjustments as needed.
Building Construction
Apply the units-of-delivery approach. For example, the number of constructed floors or structural elements is divided by the total number of intended units. This strategy assesses progress at specific milestones, ensuring that the project continues on track.
Custom Manufacturing
Opt for the effort-intensive method. To calculate the percentage of completion, labor hours and materials are evaluated. It gives information about resource allocation and efficiency throughout the production process.
Large-Scale Infrastructure Projects
A mix of strategies may be effective. The cost-to-cost method may apply to whole project expenditures, but the units-of-delivery method may focus on specific milestones such as building completion or equipment installation. This dual method provides a full picture of project progress and identifies potential cost overruns or delays early on, allowing for proactive management and appropriate modifications.
How Construction Cost Accounting Can Help
Managing the percentage of completion method on your own can be daunting, especially when juggling multiple projects. At Construction Cost Accounting, we specialize in simplifying the complex world of contract accounting and construction bookkeeping.
While you can manage it yourself by tracking construction progress, ensuring accurate job costing, and staying on top of WIP accounting, hiring experts can save you time and minimize errors. Let us handle your revenue recognition and financial reporting, so you can focus on what you do best: building great projects
Conclusion
The percentage of completion method is an invaluable tool for contractors who want real-time insights into their financial health. From improving decision-making to ensuring compliance, this approach offers numerous advantages. However, it also comes with risks that require careful management.
Whether you’re new to this method or looking to refine your financial practices, understanding the fundamentals is key. And if you’re ready to take the stress out of construction accounting, consider partnering with Construction Cost Accounting for accurate, hassle-free bookkeeping services.
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