Percentage-of-completion

Definition

The percentage-of-completion method is an accounting approach used to recognize revenue and expenses for long-term projects based on the progress made towards completion. This method connects the timing of revenue recognition with the actual work completed, ensuring that revenue and expenses are matched correctly, reflecting the economic reality of the project over its duration.

5 Must Know Facts For Your Next Test

1. The percentage-of-completion method is commonly used in industries like construction and engineering, where projects span multiple accounting periods.
2. Under this method, revenue is recognized based on the proportion of work completed, often calculated using costs incurred compared to total estimated costs.
3. This approach helps companies align their financial results with the actual economic performance of long-term projects, offering a clearer picture of profitability over time.
4. To use this method effectively, reliable estimates of total project costs and progress must be made throughout the project lifecycle.
5. Changes in estimates related to cost or project completion can significantly impact revenue recognition, requiring adjustments to previously reported figures.

Review Questions

• How does the percentage-of-completion method enhance the matching principle in financial reporting?
  • The percentage-of-completion method enhances the matching principle by ensuring that revenue and expenses are recorded in the same accounting period based on the actual progress of a project. By recognizing revenue as work is completed, companies can more accurately reflect their financial performance and profitability during each reporting period. This alignment helps stakeholders understand the financial impact of ongoing projects rather than waiting until completion for financial results.
• Discuss how changes in accounting principles might affect a company's use of the percentage-of-completion method.
  • Changes in accounting principles can significantly impact a company's application of the percentage-of-completion method by altering how revenue and expenses are recognized. For instance, if a new standard requires more stringent cost estimation or progress assessment criteria, it could affect how much revenue is recognized at various stages of a project. Companies may need to adopt new guidelines for estimating costs and measuring progress, which could lead to fluctuations in reported earnings and financial stability.
• Evaluate the implications of using the percentage-of-completion method for a construction company transitioning to new revenue recognition standards.
  • Transitioning to new revenue recognition standards can have profound implications for a construction company using the percentage-of-completion method. New standards may require more detailed disclosures about estimates and judgments used in determining progress toward completion. This shift could increase scrutiny from investors and regulators regarding how accurately projects are being represented. Additionally, adjustments to past revenue figures might be necessary, impacting reported earnings and potentially affecting stock prices and investor confidence during the transition period.

Related terms

Completed Contract Method: An accounting method that recognizes revenue and expenses only when a long-term project is completed, contrasting with percentage-of-completion.

Revenue Recognition Principle:

The accounting principle that dictates how and when revenue is recognized in financial statements, fundamental to understanding percentage-of-completion.

Cost Estimation: The process of forecasting the costs associated with a project, which is critical for accurately applying the percentage-of-completion method.