The percentage of completion method is a revenue recognition method used to recognize revenue from a construction contract. Since construction contracts may take several years to complete, a company still incurs expenses and must abide by the matching principle. The goal behind this method of accounting is to recognize revenue based upon the matching principle.
This methods primary goal is to recognize revenue based upon the percentage of completion of the construction project. One advantage behind the usage of this method is that it accurately reports the status of the completed contract. A disadvantage of this method is that it relies on estimates.
The first step is to calculate the gross profit. Then calculate the percentage of completion. Multiply both numbers and that amount is considered your revenue earned during the first year. For contracts that are in the second or third year and beyond, you must subtract the previously earned revenue from the profit earned in the current year. This is to avoid double accounting of the same revenue.
Example:
Adequate Disclosure began work for a contract it exclusively signed to provide accounting and auditing services too. The contract price is $800,000.
2011 2012
Cost Incurred During the Year $120,000 $400,000
Estimated Costs to Complete $360,000 -0-
Calculate the gross profit to be earned for the year 2011:
$800,000 – $480,000 = $320,000
120,000/480,000 = 25%
320,000 x 25% = 80,000
$80,000 is recognized in the year of 2011
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