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CandleFocus Glossary Editor
The percentage of completion method is a method used in accounting to report revenues and expenses based on how much work has been completed for a project. This is usually used for long-term contracts where payment is assured and completion can be estimated with relative accuracy. For example, if a company is contracted to build a house, using the percentage of completion method, they would recognize income at various stages of the project, with the amount being proportional to the estimated total cost of the project.
Under this method, revenue is recognized based on the percentage of the project that has been completed. If a project is projected to cost $100,000 and 25 percent of the project has been completed, the company would recognize $25,000 in revenue. Expenses are also recognized at each stage of the project based on the estimated cost of the total project.
In addition to being used in accounting, the percentage of completion method is often a measure used to determine the profitability of a project. By comparing the estimated costs to the recognized revenue at each stage of the project, companies can easily determine whether the project is worth continuing or if modifications need to be made.
Unfortunately, the percentage of completion method has been misused by some companies for their own benefit. This abuse usually occurs when companies give overly-optimistic estimates of completion and illegally accelerate revenue. In these cases, a company may recognize a large amount of revenue before all of the work has been done, falsely inflating their bottom line and creating an inaccurate portrait of their financial situation.
The percentage of completion method can be an effective tool for both accounting and measuring profitability of projects when used honestly. However, companies must be careful to ensure that the method is used accurately and in accordance with ethical standards. If the percentage of completion method is not used correctly, it can create a misleading estimation and portray an inaccurate financial situation.
Under this method, revenue is recognized based on the percentage of the project that has been completed. If a project is projected to cost $100,000 and 25 percent of the project has been completed, the company would recognize $25,000 in revenue. Expenses are also recognized at each stage of the project based on the estimated cost of the total project.
In addition to being used in accounting, the percentage of completion method is often a measure used to determine the profitability of a project. By comparing the estimated costs to the recognized revenue at each stage of the project, companies can easily determine whether the project is worth continuing or if modifications need to be made.
Unfortunately, the percentage of completion method has been misused by some companies for their own benefit. This abuse usually occurs when companies give overly-optimistic estimates of completion and illegally accelerate revenue. In these cases, a company may recognize a large amount of revenue before all of the work has been done, falsely inflating their bottom line and creating an inaccurate portrait of their financial situation.
The percentage of completion method can be an effective tool for both accounting and measuring profitability of projects when used honestly. However, companies must be careful to ensure that the method is used accurately and in accordance with ethical standards. If the percentage of completion method is not used correctly, it can create a misleading estimation and portray an inaccurate financial situation.