How to Find Gross Profit From Percentage-of-Completion Method
Companies generally use the percentage-of-completion accounting method for long-term contracts. The method follows the matching principle of accounting because it tries to match the appropriate expenses and revenues in each accounting period. Percentage of completion refers to the degree of completion of a project. It is equal to the ratio of the incurred costs to date and the total estimated costs.
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Instructions
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Get the total contract amount and the budgeted costs. The contract amount should be in the formal contract award notification or contract agreement documents. The budgeted costs for the contract should be in your internal project planning documents. Gross profit is equal to the total contract amount minus budgeted costs. For example, if you have received a $1.5 million long-term contract and your total budgeted costs are $1.2 million, the estimated or budgeted gross profit is $1.5 million minus $1.2 million, or $300,000.
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Determine the project costs that you have incurred to date. This information should be in your internal job costing system and would include both labor and raw materials costs. Accurate costing information is important for estimating percentage completion and variances of actual costs from estimated or budgeted costs.
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Compute the percentage of completion. Divide the costs incurred to date by the budgeted costs, and express the result as a percentage. Continuing with the example, if you have incurred $300,000 in costs at the end of the first quarter, the completion percentage is 25 percent ($300,000 divided by $1.2 million multiplied by 100).
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Multiply the contract amount by the percentage of completion to estimate the revenue. In the example, the revenue is 25 percent of $1.5 million, or $375,000 ($1,500,000 x .25 = $375,000).
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Calculate the gross profit, which is equal to revenue minus costs. Continuing with the example, gross profit is equal to $375,000 minus $300,000, or $75,000.
The gross profit is also equal to the product of the estimated gross profit and the percentage of completion. To conclude the example, the gross profit using this approach is also $75,000 (25 percent of $300,000 = .25 x $300,000 = $75,000).
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