Percentage of Completion Method
What Is the Percentage of Completion Method?
The percentage of completion method is a accounting method in which the revenues and expenses of long-term contracts are recognized as a percentage of the work completed during the period. This is rather than the completed contract method, which concedes the reporting of income and expenses until a project is completed. The percentage-of-completion method of accounting is common for the construction industry, yet companies in different sectors likewise utilize the method.
Understanding the Percentage of Completion Method
The percentage of completion method of accounting requires the reporting of revenues and expenses on a period-by-period basis, as determined by the percentage of the contract that has been satisfied. The current income and expenses are compared with the total estimated costs to determine the tax liability for the year. For instance, a project that is 20% complete in year one and 35% complete in year two would just have the incremental 15% of the revenue recognized in the subsequent year. The recognition of income and expenses on this work-in-progress basis applies to the income statement, however the balance sheet is taken care of the same way as the completed contract method.
There are two main conditions for the utilization of the percentage of completion method. To start with, collections by the company must be sensibly guaranteed; second, the company must have the option to estimate costs and the rate of project completion sensibly.
Instances of the Percentage of Completion Method
The percentage of completion accounting method is commonly utilized by construction firms that are contractors for buildings, energy facilities, public sector infrastructure, and other long-term physical projects. It has likewise been utilized by defense contractors (think nuclear submarines or aircraft transporters) and software engineers whose projects address a long term commitment of resources. For software engineers, the product must be a critical hand crafted project for a client.
Fluor Corporation, a global engineering and construction firm, gives insights regarding its utilization of the percentage of completion method in its 10-K filing under "Note 1 - Major Accounting Policies" of the notes to the consolidated financial statements. An analyst would discover that changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined by the company. Income recognized in excess of charged sums is booked as a current asset under "contract work in progress" and charged sums to clients in excess of income recognized to date are booked as a current liability under "advance billings on contracts."
Potential for Abuse of the Percentage of Completion Method
Percentage of completion method is vulnerable to abuse by exploitative companies. The people who wish to take part in creative accounting can without much of a stretch move around income and expenses starting with one period then onto the next period, understating or overstating sums. This game wouldn't be sustainable, in any case, as Toshiba Corp. found in 2015. The infrastructure unit of the Japanese conglomerate downplayed operating costs by roughly 152 billion yen ($1.2 billion) somewhere in the range of 2008 and 2014. Shortly after the scandal broke, the CEO was forced to leave, and half the Board of Directors ventured down.
Features
- The percentage of completion method has been abused by certain companies to help short-term results.
- The percentage of completion method reports revenues and expenses in terms of the work completed to date.
- This method must be utilized in the event that payment is guaranteed and it is somewhat direct to estimate completion.
