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PERCENTAGE-OF-COMPLETION METHOD

7 April, 2016 - 15:58
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The percentage-of-completion method is recommended for businesses involved in long-term projects or contracts, such as construction firms. In such circumstances, revenue is recognized periodically throughout the life of the project.

  1. An initial profit is estimated based on the contract price and anticipated future costs.
  2. The total revenue is spread evenly over the years or in proportion to the annual estimated costs. The actual costs incurred during each time period are subtracted from revenue.
  3. In the final year the actual remaining profit is recognized.

For example, a person sold a $500,000 machine with an upfront payment of $100,000 and payments of $80,000 over 5 years. The accounting would be as follows:

GENERAL JOURNAL YEAR X1
Date Title and Account explanation Debit Credit
Jan 01 ACCOUNTS RECEIVABLE   $500,000  
Jan 01 INSTALLMENT SALES   $500,000
Jan 01 COST OF MACHINE SOLD $300,000  
Jan 01 INVENTORY   $300,000
    (To record machine sale)    
 
GENERAL JOURNAL YEAR X1
Date Title and Account explanation Debit Credit
Jan 15 ACCOUNTS RECEIVABLE   $180,000
Jan 15 CASH $180,000  
         
         
    (To record upfront and 1st payment of machine)    
 
GENERAL JOURNAL YEAR X1
Date   Title and Account explanation Debit Credit
Dec 31 INSTALLMENT SALES $500,000  
Dec 31 COST OF MACHINE SOLD   $300,000
Dec 31 DEFERRED GROSS PROFIT   $200,000
         
    (To record gross profit in year X1)    
 
GENERAL JOURNAL YEAR X1
Date Title and Account explanation Debit Credit
Dec 31 DEFERRED GROSS PROFIT $72,000  
Dec 31 NET GROSS PROFIT   $72,000
         
         
    (To record Net profit in year X1)    
 
  • Gross profit percent: (INSTALLMENT SALES-COSTS)/INSTALLMENT SALES. (500,000-300,000)/500,000 = 0,4.
  • Net profit: AMOUNT COLLECTED*GROSS PROFIT PERCENT. $180,000 ($100,000 upfront payment + $80,000 1st payment) * 0,4 (gross profit percent) = $72,000.
GENERAL JOURNAL YEARS X2 TO X5
Date   Title and Account explanation Debit Credit
Dec 31 DEFERRED GROSS PROFIT $32,000  
Dec 31 NET GROSS PROFIT   $32,000
         
         
    (To record Net profit in years X2 to X5)    
 

For years X2 to X5, the same method is applied to remaining payments.

The accounting of a $100,000 construction contract under percentage-of-completion method, would be like this.

GENERAL JOURNAL YEAR X1
Date Title and Account explanation Debit Credit
Dec 31 CONSTRUCTION IN PROGRESS $35,000  
Dec 31 ACCOUNTS PAYABLE   $35,000
         
         
    (To record expenses in year X1)    
 
GENERAL JOURNAL YEAR X1
Date Title and Account explanation Debit Credit
Dec 31 ACCOUNTS RECEIVABLE $55,000  
Dec 31 PROGRESS BILLINGS   $55,000
         
         
    (To record earnings in year X1)    
 
GENERAL JOURNAL YEAR X2
Date Title and Account explanation Debit Credit
Dec 31 CONSTRUCTION IN PROGRESS $20,000  
Dec 31 ACCOUNTS PAYABLE   $20,000
         
         
    (To record expenses in year X2)    
 
GENERAL JOURNAL YEAR X2
Date Title and Account explanation Debit Credit
Dec 31 ACCOUNTS RECEIVABLE $45,000  
Dec 31 PROGRESS BILLINGS   $45,000
         
         
    (To record earnings in year X2)    
 

The revenues are recorded according to the job percent of completion. In this example, the $100,000 contract was completed in two time periods: 55% in year X1 and 45% in year X2. The cost incurred during each time period must be recorded and subtracted from revenues in order to get the Net profit (or loss) for the period.

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