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Get clear on accounting entries for percentage of completion method with this practical guide. Learn how to track revenue, costs, and project progress accurately.
Are you tired of waiting until a project is completely finished to know if it was profitable? That's the old way. The percentage of completion method offers a smarter, real-time financial snapshot. It allows you to recognize revenue as you earn it, giving you a consistently clear picture of your project's profitability. This isn't just about better reporting; it's about making smarter decisions and managing cash flow effectively. But to get it right, you need to master the specific accounting entries for the percentage of completion method. This guide breaks down everything you need, from the core calculations to the essential journal entries.
The percentage of completion method is an accounting method used to recognize revenue and expenses on long-term projects. Instead of waiting until the project is finished, this method distributes revenue and costs proportionally as work progresses. This gives a more accurate view of a company's financial health over time, especially for projects spanning multiple accounting periods. Think of it like paying for a custom-built house: you wouldn't pay everything upfront, but rather in installments as different stages are completed. Similarly, the percentage of completion method recognizes revenue as milestones are reached. This approach aligns with the core principle of matching revenues with the expenses incurred to generate them.
This method relies on a few key components. It requires a reliable estimate of total project costs, which forms the basis for calculating the percentage of completion. As the project moves forward, you track actual costs incurred. The ratio of incurred costs to estimated total costs determines the project's completion percentage. This percentage is then applied to the total estimated revenue to recognize revenue for the period. This process ensures that revenue recognition is tied to the actual progress of the project. For a practical guide on using this method, see this explanation. The cost-to-cost method is a common way to calculate the percentage of completion, as explained in this guide. This method hinges on accurate cost tracking and estimation, which are crucial for successfully applying the percentage of completion method.
The percentage of completion method recognizes revenue and expenses in proportion to a project's progress, unlike methods that wait until the end. Let's break down how it works.
To properly use the percentage of completion method, you need to get familiar with two specific accounts on your balance sheet: Construction in Process (CIP) and Billings on Construction in Process. These accounts work together to give you a clear financial picture of your long-term projects. Let's look at what each one does.
Think of the Construction in Process (CIP) account as a temporary inventory account for your project. It's an asset account where you accumulate all the project-related costs—like materials, labor, and overhead. As you recognize revenue using the percentage of completion method, you also add the gross profit earned so far into this account. This way, the CIP account reflects the total value of the project on your books at any given time, allowing you to effectively monitor its financial progress. Keeping this account meticulously updated is fundamental to accurate financial reporting and is a key part of revenue recognition accounting.
The Billings on Construction in Process account is what’s known as a "contra-asset" account. In simple terms, it works in the opposite way of a normal asset account and reduces the balance of the CIP account. Its job is to track the total amount you have billed your customer throughout the project's life. This is incredibly important because it prevents you from overstating your assets. By comparing the CIP account (costs + profit) with the Billings account (what you've billed), you can see if you've billed more than the value of the work completed (a liability) or less (an asset). Managing these interconnected accounts accurately is where an automated revenue recognition system can be a game-changer, ensuring compliance and clarity.
This method hinges on calculating the project completion percentage. The most common approach, the cost-to-cost method, divides the costs incurred to date by the total estimated project costs. For example, if you've spent $30,000 on a $100,000 project, it's 30% complete. Accurate cost estimation is essential for reliable revenue recognition. For a deeper dive into cost accounting, check out this helpful guide.
The most common way to figure out your completion ratio is the cost-to-cost approach. This method is straightforward: you compare the costs you've already spent on the project to the total estimated costs for the entire project. The formula is simply the total costs incurred to date divided by the total estimated costs. For instance, if your total project budget is $200,000 and you've spent $50,000 so far, your project is 25% complete. This approach provides a clear, financially-based measure of progress, making it a reliable choice for many industries, especially construction. Its accuracy, however, depends entirely on how well you can estimate your total project costs from the start.
While the cost-to-cost method is popular, it isn't the only option. Depending on your project's nature, you might use an input or output method. The input method focuses on the resources used, such as labor hours or materials consumed, to gauge progress. It's useful when there's a direct relationship between the effort put in and the project's completion. The output method, on the other hand, measures progress based on results achieved. This could mean tracking units produced, milestones completed, or sections of a project delivered. This approach is great for projects where tangible results are easier to measure than the costs or effort involved in producing them.
Regardless of the calculation method you choose, success hinges on two critical rules. First, you must be able to make a reliable estimate of the total project cost at the outset. Second, you need a robust system for tracking all incurred costs as the project progresses. Without these two elements, your revenue recognition will be inaccurate and could lead to compliance issues. This is where having a unified financial system becomes invaluable. When your accounting software, ERP, and CRM are all connected, you can pull real-time data to ensure your cost tracking is always up-to-date. These integrations are essential for maintaining the data integrity required for the percentage of completion method.
With the completion percentage, you apply it to the total estimated revenue and expenses. If your estimated revenue is $150,000 and your project is 30% complete, you'd recognize $45,000 in revenue. Similarly, with total estimated expenses of $100,000, you'd recognize $30,000. This reflects the project's financial status throughout its lifecycle. You can explore various revenue recognition methods to find the best fit for your business.
The percentage of completion method uses specific accounting entries to record revenue and expenses, reflecting the project's ongoing progress and ensuring accurate financial reporting. This data flows to your income statement and balance sheet, providing a clearer view of your financial performance. Learn more about this method and how it impacts your financial statements. This method is especially useful for long-term projects, offering a realistic snapshot of your financial position. For more financial insights, visit the HubiFi blog.
As your project gets underway, you'll start spending money on materials, labor, and other direct costs. Each time you do, you need to record it. This is done by debiting an account called "Construction in Process" (CIP). Think of the CIP account as a temporary bucket that holds all the costs associated with the project. To balance the entry, you'll credit either "Cash" if you paid immediately or "Accounts Payable" if you bought on credit. This simple entry is fundamental because it tracks your total investment in the project as it grows, giving you a clear, real-time view of the resources you've committed.
When you reach a project milestone and it's time to invoice your client, you'll make another journal entry. This one records the amount you've billed them for the work completed so far. You'll debit "Accounts Receivable" for the invoice amount, which shows that the customer now owes you money. The corresponding credit goes to an account called "Billings on Construction in Process." This entry is crucial for managing your cash flow and keeping your balance sheet accurate, as it clearly separates the costs you've incurred from the amounts you've billed to your client throughout the project's lifecycle.
This is the entry where you actually recognize the revenue and profit you've earned during the accounting period. It's a bit more complex and brings everything together. First, you'll debit "Construction Expenses" for the costs incurred during the period. Next, you'll debit the "Construction in Process" (CIP) account for the gross profit you've calculated. Finally, you'll credit "Revenue on Long-Term Contract" for the total revenue recognized. This entry perfectly aligns the revenue earned with the expenses that generated it, providing a clear picture of the project's profitability on your income statement. Managing these entries can be complex, which is why many businesses use platforms that offer seamless integrations to automate the process.
When you use the percentage of completion method, your balance sheet will reflect the unique financial state of your long-term projects. Two key terms you'll encounter are underbilling and overbilling. These aren't necessarily signs of poor management; rather, they are natural outcomes of the billing cycle for long-term contracts. Understanding how to present them correctly is crucial for accurate financial reporting and gives stakeholders like investors and lenders a clear view of your project's financial standing. Let's look at what each term means and how to manage them effectively.
Underbilling happens when you've completed more work on a project than you've invoiced your client for. Essentially, you've earned more revenue than you've billed. Think of this as an asset on your balance sheet, often listed as "costs and estimated earnings in excess of billings." It represents money that is owed to you for work already performed. While it shows progress, significant underbilling can strain your cash flow since you're covering project costs before getting paid. Regularly monitoring underbilling helps you stay on top of invoicing and maintain a healthy financial position throughout the project's lifecycle.
Overbilling is the opposite scenario: you've billed your client for more than the value of the work you've completed so far. This might happen if you bill for milestones that are still in progress or receive an upfront deposit. On the balance sheet, overbilling is recorded as a liability, often under "billings in excess of costs and estimated earnings." It signifies that you have a future obligation to complete the work for which you've already been paid. While it can be good for short-term cash flow, it's important to manage overbilling carefully to ensure your financial statements accurately reflect your company's obligations.
A Work in Progress (WIP) schedule is your best tool for managing both underbilling and overbilling. This detailed report tracks the financial status of each long-term project, comparing costs incurred to date against the total estimated costs to determine the percentage of completion. By regularly updating your WIP schedule, you get a clear, real-time view of each project's profitability and billing status. This proactive approach helps you identify discrepancies early and make informed decisions. For businesses with high transaction volumes, automating this process with a robust revenue recognition solution ensures your WIP schedule is always accurate, helping you pass audits and maintain compliance with standards like ASC 606.
Knowing when to use the percentage of completion method is crucial for accurate financial reporting. This method recognizes revenue and expenses proportionally as work progresses on a long-term project, rather than waiting until the project is finished. This provides a more realistic view of your company's financial health, especially for projects spanning multiple accounting periods.
The percentage of completion method is best suited for long-term projects with a clear start and end date. Think large-scale construction projects, complex engineering endeavors, or substantial manufacturing efforts. These projects often involve significant resources and time, making the percentage of completion method more relevant than simply recording all revenue and expenses at the very end. For shorter projects, the added complexity might not be worthwhile.
Before using this method, you must meet two key conditions. You need to be reasonably certain about collecting payment for the project. This usually means having a solid contract in place with a reliable client. You also need to be able to accurately estimate both the total project costs and the percentage of completion at any given point. Get a demo to see how HubiFi can help you track these metrics. Without these reliable estimates, the percentage of completion method won't provide an accurate financial picture. For more information on applying this method, explore these key concepts.
To successfully use the percentage of completion method, your project contract needs to lay a very specific groundwork. First and foremost, the agreement must ensure you can reliably collect payment from your client. This method also hinges on your ability to make accurate cost estimations from the very beginning, as these figures form the basis of all your calculations. The contract should also include clearly defined start and end dates to frame the project timeline. Finally, you must have a robust system for ongoing project tracking and monitoring. Having the right tools to integrate project data with your financial software is critical for maintaining this level of accuracy and ensuring compliance.
As mentioned, the percentage of completion method is frequently used in industries with long-term projects. Construction is a prime example, where revenue is recognized based on the percentage of work completed. Similarly, engineering firms involved in extensive infrastructure projects often use this method. Large-scale manufacturing, where production cycles can stretch over months or even years, also benefits from this approach. The cost-to-cost method, a way to calculate the percentage of completion by tracking the ratio of incurred costs to total estimated costs, is often used in these sectors. This allows for precise measurement of progress and corresponding revenue recognition. Learn more about how HubiFi integrates with construction accounting software.
The percentage of completion method offers several advantages, especially for long-term projects. Instead of waiting until the project’s end to recognize revenue and expenses, this method distributes them across the project's timeline based on the work completed. This provides a clearer and more accurate picture of your financial health at any given point. Think of it like building a house: with the percentage of completion method, you recognize revenue and expenses as each stage is finished (foundation, framing, roofing, etc.), rather than waiting until the entire house is complete. This approach smooths out revenue recognition, leading to more predictable financial reporting and better insights into project profitability. It also improves cash flow management by matching revenues with the expenses incurred, giving you a realistic view of your project's financial performance.
While the percentage of completion method offers significant advantages, it also presents some challenges. The method relies heavily on accurate estimations of total project costs and the percentage of completion at various stages. Inaccuracies in these estimations can lead to misstated financial reports. For example, if you underestimate a project's total cost, you might initially recognize too much revenue, which you’d need to correct later. This can create fluctuations in your financial statements and potentially mislead stakeholders. Another challenge is the complexity of tracking and measuring project progress. Accurately determining the percentage of completion requires diligent project management and detailed record-keeping.
Beyond the risk of inaccurate estimates, the method itself demands a high level of operational rigor. Staying on top of project progress isn't simple; it requires meticulous project management and very detailed records to accurately measure completion. This method is also best suited for long-term projects with clear timelines. For shorter contracts, the administrative effort involved might outweigh the benefits of more granular reporting. Without a robust system to integrate project data with your financial software, you can easily get bogged down in manual tracking, which only increases the risk of errors and misstated financials.
One of the most important advantages of the percentage of completion method is that it helps ensure compliance with accounting standards like ASC 606 and IFRS 15. These standards require revenue recognition as it's earned, which aligns perfectly with the principles of the percentage of completion method. By adopting this method, you demonstrate a commitment to accurate financial reporting and build trust with investors and other stakeholders. This is particularly important for publicly traded companies and businesses seeking investment. This method provides a standardized framework for revenue recognition, making it easier for investors to compare the financial performance of different companies. At HubiFi, we specialize in helping businesses implement automated revenue recognition solutions that ensure compliance with these standards.
Beyond accounting standards, U.S. tax law also has specific rules for long-term projects. Federal tax regulations often mandate that construction companies and other businesses with long-term contracts use the percentage of completion method for tax reporting. This isn't just a best practice; for many, it's a requirement. While there are some exceptions for smaller contractors or certain types of projects, the default is to recognize taxable income as you earn it throughout the project's life. This alignment between financial accounting and tax reporting underscores the importance of maintaining accurate project data. Having a system that provides reliable estimates and tracks costs meticulously is essential to satisfy these tax obligations and avoid potential compliance issues down the road.
The main alternative to the percentage of completion method is the completed contract method. The difference is straightforward: while the percentage of completion method recognizes revenue and expenses as you make progress, the completed contract method waits until the project is almost entirely finished. With this approach, you don't record any income or costs until the job is about 90-95% done. This can create a skewed financial picture. For long-term projects, it can lead to significant fluctuations in reported income, showing no profit for several periods and then a large lump sum at the end. The percentage of completion method, on the other hand, provides a much more realistic and consistent view of your company's financial health over time, which is why it's often the preferred choice for projects that span multiple accounting periods.
Using the percentage of completion method successfully relies on keeping a close watch on some key metrics. Accurate tracking and careful monitoring will help you recognize revenue appropriately and make informed business decisions.
One of the most critical aspects of this method is accurately estimating your project costs. This includes everything from materials and labor to overhead and any other expenses directly related to the project. Create a detailed budget early on and categorize all expected costs. As the project progresses, diligently track your incurred costs, keeping meticulous records of all expenditures. Regularly compare your incurred costs against your initial estimates. This comparison helps you identify any potential cost overruns early on, allowing you to take corrective action and adjust your revenue recognition accordingly. For more information on cost estimation, check out this helpful resource on estimated costs.
The percentage of completion is the core of this revenue recognition method. The most common approach is the cost-to-cost method, which calculates the percentage by dividing the costs incurred to date by the total estimated costs. For example, if you've incurred $50,000 in costs on a project estimated to cost $100,000, your project is 50% complete. Regularly recalculate this percentage as costs are incurred. This updated percentage is then used to determine the amount of revenue and expenses to recognize in each accounting period. Learn more about the cost-to-cost method and how it applies to your projects.
While the percentage of completion method focuses on matching revenue with expenses based on project progress, it's crucial to also monitor your cash flow. This method can sometimes create a timing difference between when revenue is recognized and when cash is actually received. For example, you might recognize revenue based on 50% completion, but you may not have billed the client for that full amount yet. Keep a close eye on your cash inflows and outflows to ensure you have enough liquidity to cover your project expenses and other operational needs. A healthy cash flow is essential for the smooth execution of your projects and the overall financial health of your business. For further insights into managing cash flow with this method, explore this article on the percentage of completion method in construction.
Successfully using the Percentage of Completion Method (PCM) requires diligence and attention to detail. Here are some best practices to ensure effective implementation:
Accurate cost estimation is the cornerstone of the PCM. This involves creating a detailed budget that considers all project-related expenses, from materials and labor to overhead and contingencies. Don’t just estimate the total costs upfront—regularly review and refine your estimates as the project progresses. Changes in material prices, unexpected delays, or changes in project scope can all impact your initial estimations. Reliable cost estimation ensures your financial statements accurately reflect the project's true financial state. For help with accurate revenue forecasting, explore HubiFi’s pricing information.
A robust project tracking system is essential for applying the PCM effectively. This means accurately and consistently measuring project progress. Use project management software or other tools to track milestones, deliverables, and costs. By monitoring these elements, you can tie revenue recognition directly to the work completed. This not only improves the accuracy of your financial reporting but also provides valuable insights into project performance. For more information on streamlining your data, consider scheduling a data consultation with HubiFi.
Manually tracking project data across different spreadsheets and software is not only time-consuming but also leaves a lot of room for error. This is where automation can make a huge difference. Automated revenue recognition solutions connect all your essential business tools, like your CRM, ERP, and accounting software, into a single, cohesive system. This integration provides a real-time, accurate view of project costs and progress without the manual data entry. By having a single source of truth, you can confidently calculate your completion percentage and ensure your financial reporting is precise. This streamlined process not only simplifies compliance with standards like ASC 606 but also supports better strategic decision-making. You can see how different systems work together by exploring HubiFi’s integrations.
Regular audits are crucial for mitigating the inherent risks associated with the PCM. Periodic reviews of project progress, cost estimations, and financial records allow you to identify discrepancies early on. This proactive approach enables you to adjust estimates, ensuring your financial statements remain accurate and your cash flow stays stable. Think of audits as a regular health check for your project’s finances, helping you stay on track and avoid potential issues down the line. Learn more about how HubiFi helps businesses maintain accurate financial records by exploring our integrations with popular accounting software. For further insights into financial operations, visit the HubiFi blog.
Why is the percentage of completion method preferred over other revenue recognition methods for long-term projects? It provides a more accurate and realistic view of a company's financial performance by recognizing revenue and expenses as the project progresses, rather than waiting until the very end. This approach aligns revenue with the actual work completed, offering better insights into project profitability and overall financial health.
What are the key criteria for using the percentage of completion method? You need two things: a reasonable assurance of collecting payment (like a solid contract) and the ability to reliably estimate total project costs and the percentage of completion at any given time. Without these, the method won't give you a dependable financial picture.
How do I calculate the percentage of completion for my project? The most common way is the cost-to-cost method. Divide the total costs incurred to date by the total estimated project costs. For example, $30,000 spent on a $100,000 project means it's 30% complete. Remember, accurate cost estimation is key here.
What are the potential downsides of using this method? The biggest challenge is the risk of inaccurate estimations. If your initial cost estimates are off, your revenue recognition will also be incorrect, potentially impacting your financial statements. The method also requires diligent project tracking and can be more complex to implement than other methods.
What industries commonly use the percentage of completion method? Industries with long-term projects, like construction, engineering, and large-scale manufacturing, frequently use this method. It aligns well with the nature of these projects, where work and related expenses occur over an extended period.
Former Root, EVP of Finance/Data at multiple FinTech startups
Jason Kyle Berwanger: An accomplished two-time entrepreneur, polyglot in finance, data & tech with 15 years of expertise. Builder, practitioner, leader—pioneering multiple ERP implementations and data solutions. Catalyst behind a 6% gross margin improvement with a sub-90-day IPO at Root insurance, powered by his vision & platform. Having held virtually every role from accountant to finance systems to finance exec, he brings a rare and noteworthy perspective in rethinking the finance tooling landscape.
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