The Accounting Percentage-of-Completion Method for Billing
Construction companies sign contracts with customers to complete long-term projects. These projects extend for months or years until the company finishes the final requirements of the project. The company completes a portion of its responsibilities each year until the project completes. In these cases, the construction company uses the percentage-of-completion method for billing and accounting.
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Definition
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The percentage-of-completion method refers to a process of recognizing revenue throughout the life of the contract. This coincides with the accounting principle of matching. Matching refers to the company's ability to recognize revenues as it provides the service. It also refers to the process of recording the revenues and corresponding expenses at the same time. The company recognizes the work performed each year and records the revenues earned and expenses incurred. A company must use this method if it can estimate the revenues and costs, it has the ability to perform, the customer expects the company to perform and the contract specifies the payment terms and each party's rights.
Calculating Costs and Revenues
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At the end of each period, the company needs to estimate its expenses incurred and revenues earned for the period. Prior to starting the project, the company estimates the total cost of completing the project. At the end of each period, the company reviews the expenses it paid for, such as materials or labor costs, along with those it owes money for, such as items purchased on credit. These costs represent expenses incurred during the period and will be recorded for the year. The company divides the expenses incurred by the total estimated cost of the project to determine the percentage completed. The company multiplies this percentage by the total price stated in the contract. This is the amount of revenue the company will record for the year.
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Recording Costs and Revenues
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After determining the amounts to record for the contract's revenue and expenses, the company needs to enter these amounts in the accounting records. The company records the expense amount by increasing an account called Contract Costs. The company also decreases Cash for the total expenses it paid for and increases Accounts Payable for the expenses it still owes money for. The company records the revenue by increasing the Construction Billings account and increasing the Contract Revenue account.
End-of-Year Reporting
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The company reports the revenue earned and expenses incurred on the income statement. The income statement lists the revenues, subtracts the expenses and calculates the net income. The Contract Revenue balance appears with the revenue accounts. The Contract Costs appear with the expenses.
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