Percentage-of-completion method

Definition

The percentage-of-completion method is an accounting technique used to recognize revenue and expenses for long-term projects as they are completed, rather than waiting until the entire project is finished. This method aligns revenue recognition with the actual progress of the project, providing a more accurate reflection of financial performance over time. It is particularly relevant for construction and engineering firms where projects span multiple accounting periods.

5 Must Know Facts For Your Next Test

1. The percentage-of-completion method is primarily used under both GAAP and IFRS for long-term projects that span multiple reporting periods.
2. Revenue is recognized based on the proportion of the total project that has been completed, typically measured by costs incurred relative to total estimated costs.
3. This method requires careful estimation of total costs and completion timelines to ensure accurate revenue recognition and financial reporting.
4. Under IFRS, the method is specifically outlined in IFRS 15, which focuses on revenue from contracts with customers.
5. If a project is deemed to have a loss, it must be fully recognized immediately, even if the project has not been completed.

Review Questions

• How does the percentage-of-completion method affect revenue recognition for long-term projects?
  • The percentage-of-completion method allows businesses to recognize revenue based on the project's progress rather than waiting until its completion. This means that as costs are incurred and work is completed, corresponding revenue can be recognized in the financial statements. This approach provides a more timely and accurate reflection of a company's financial performance, helping stakeholders assess ongoing project profitability.
• Compare and contrast how GAAP and IFRS treat the percentage-of-completion method in financial reporting.
  • Under both GAAP and IFRS, the percentage-of-completion method is utilized for long-term contracts, but there are differences in how they specify its application. GAAP emphasizes the use of specific guidelines for estimating revenues and costs while ensuring that estimates are revised if circumstances change. In contrast, IFRS 15 focuses on performance obligations in contracts with customers and requires that companies provide more detailed disclosures about their revenue recognition practices. This makes IFRS slightly more flexible in certain aspects compared to GAAP.
• Evaluate the implications of using the percentage-of-completion method on financial decision-making for stakeholders.
  • Using the percentage-of-completion method has significant implications for financial decision-making among stakeholders. For investors and creditors, it provides insight into how much revenue is being generated from ongoing projects, thus affecting assessments of profitability and risk. Accurate revenue recognition helps companies manage cash flow expectations better while allowing management to make informed decisions regarding resource allocation and future project bids. However, it requires careful cost estimation and monitoring, as inaccuracies can lead to misrepresentation of financial health and impact stakeholder trust.

Related terms

Revenue Recognition:

The accounting principle that determines the specific conditions under which income becomes recognized as revenue.

Contract Costs: The costs that are incurred to fulfill a contract, including labor, materials, and overhead.

Construction Contracts: Agreements between parties for the construction of a project, where terms are specified regarding scope, timeline, and payment.