What is the Percentage of Completion Method?

The percentage of completion method calculates the ongoing recognition of revenue and expenses related to longer-term projects determined by the proportion of work completed. By using this method, a company can recognize any gains or losses related to a project during each accounting period in which the project is active.

This method works best when the stages of project completion can be estimated on an ongoing basis. At the very least, it must be feasible to estimate the remaining costs to complete a project. Conversely, this method is not suitable when there are significant uncertainties about the percentage of completion or remaining costs to be incurred.

The percentage of completion method allows an organization to recognize as income the percentage of total income that matches the percentage of completion of a project. Percentage of completion may be measured in any of the following ways:

Cost-to-Cost Approach

This approach compares the contract cost incurred to date to the total expected contract cost. The cost-to-cost approach is used most commonly for measuring the percentage of completion. However, there are two conditions for this approach: collections by the company must be assured within reason, while costs and project completion must be estimated reasonably as well.

Consideration must be given for costs incurred in relation to the estimated total cost to complete the project when using the cost-to-cost approach. Therefore, the percentage complete equals the cost incurred to date divided by the estimated total cost.

Unless specifically produced for a contract, items already purchased for the contract but not yet installed should not be included in the determination of percentage complete for a project. Additionally, the cost of equipment is generally allocated over the period of the contract rather than up-front.

Units-of-Delivery Approach

This approach compares the percentage of units delivered to the buyer to the total number of units to be delivered under the terms of the contract. This approach is best used when the contractor produces a number of units based on the specifications of the buyer. Recognition is based on revenue (the contract price of units delivered) and expenses (the costs assigned to the potential units delivered).

Efforts-Expended Approach

For this approach, the proportion of effort expended to date is compared to the total effort expected to be expended for the contract. For instance, the percentage of completion may be based on machine hours, material quantities, or direct labor hours.

Other Considerations

Using the same measurement approach for similar types of contracts improves the consistency of results when figuring the percentage of completion over time. However, there are a few additional steps needed for the percentage of completion method:

  1. To compute the total estimated gross margin, subtract total estimated contract costs from total estimated contract revenues.
  2. Using the approaches above, measure the extent of progress toward completion.
  3. To figure the total amount of revenue that can be recognized, multiply the total estimated contract revenue by the estimated completion percentage.
  4. For each accounting period, subtract the contract revenue recognized to date through the preceding period from the total amount of revenue that can be recognized.
  5. The cost of earned revenue is calculated in the same manner by multiplying the same percentage of completion by the total estimated contract cost. Then subtract the amount of cost already recognized to calculate the cost of earned revenue to be recognized in the current accounting period.