The purpose of the percentage of completion method is to report financial results more accurately especially during interim periods of accounting. It benefits management in identifying potential financial losses and helps them avoid pitfalls. The following sections cover fundamentals of percentage of completion; why work in process (WIP) is used to assist with this method; proper application and a comprehensive example is illustrated.
When done, the accountant will have a greater understanding of why percentage of completion method of accounting is the best tool for project accounting.
Fundamentals of the Percentage of Completion Method of Accounting
The idea behind this accounting system is to turn a long-term financial investment into short-term segments for monitoring purposes. Any type of project that is generally long-term, i.e. more than 90 days in duration, is an ideal candidate for percentage of completion accounting. In business, management is interested in understanding financial performance during each accounting cycle. Businesses that operate 30 day accounting cycles want to know how is that particular extended time period project performing financially. Percentage of completion resolves this problem.
This method simply matches the percentage completed to date against the costs incurred to date. Here is a simple example.
Daramar installs bowling alley equipment including pin management equipment, lanes, seating, ball returns and software. Most systems are turnkey contracts. A typical project is 120 days start to finish with design and equipment purchases the first phase in the project. In general the design and equipment purchases cost 55% of the estimated total costs. This step is generally completed 30 days into the contract. To report this information to the books of record, costs are reported in cost of contracts (cost of sales) section and at the same time the revenue account records 55% of the contract’s negotiated value.
During the second thirty-day period (month) any additional costs are posted against the estimated marginal revenue earned. This is the essence of the percentage of completion method.
An accountant keeps a separate spreadsheet for each project identifying phases and associated percentages of completion for each phase. Most phases will account for as little as 7% of a project to as much as 25%. This percentage value is in the form of actual work and not in dollars. At the end of each accounting cycle the project manager reports the approximate percentage of the project completed to date for each phase. This work value is converted to dollars and matched against costs to date. For a good example look at a PDF file on this site for a New Home Construction Phase Breakout Spreadsheet.
To calculate the value earned on a project, simply multiply the percentage completed to date and subtract any revenue previously recognized. This is the marginal revenue earned during the accounting period.
Not everything is this simple. Many projects require cost outlays for stages well into the future. This makes it difficult to estimate the percentage of the contract earned. To address this, accountants use a temporary account called work in process (progress) to accumulate costs.
Work in Process or Progress (WIP)
Most businesses use an inventory account to process they( entries for the cost value of products held for sale. This is very common in retail and manufacturing. With companies that build projects, the project itself is the item sold. So the project’s costs are accumulated together as if it were a single cost. In reality it is hundreds of line items adding up to a single value. The dollar value is accumulated in a single current asset account located where inventory is customarily placed as illustrated below. This account is named either:
A) Work in Process (WIP
B) Work in Progress (WIP)
C) Construction in Process (CIP)
D) Contract Costs
E) Project Costs
Simply choose the name that most closely describes the business model for your operation. For example, a boat builder may call the account: Boats Under Construction. Anyway, here is the current assets section for a new home builder.
Accounts Receivable ZZ,ZZZ
Construction in Progress ZZZ,ZZZ
Escrowed Funds ZZ,ZZZ
Prepaid Items ZZ,ZZZ
Sub-Total Current Assets $ZZZ,ZZZ
Just like accounts receivable, the WIP account is a control account whereby every dollar is assigned to a project. Back in Lesson 4 I explained that asset accounts customarily have debit ending balances. Well cost of sales have debit ending balances too. When a project is invoiced for a particular percentage of completion, revenue is recorded by crediting sales and debiting accounts receivable (or contract billings as described later). At the same time, the WIP account is credited for the associated costs and cost of sales is debited so a matching of revenue to costs exists on the income statement. This is no different from how a retailer records the sale of one of its products.
Now the current assets section has an increase in the A/R account and a decrease in the WIP account. The difference between the changes is the project’s direct profit as explained in Lesson 72.
To help you better understand work in process as a control account and how costs are transferred read the following articles:
Proper Application of the Percentage of Completion Method
This method is very effective for complex long-term projects. If a project is less than 90 days in duration, use the completed contract method as described in Lesson 74. If the project is low dollar value in comparison to the financial sales in total for the project’s period, less than 3%, simply cost the materials and labor to the income statement and record revenue when done. In effect, the project’s accounting timing is immaterial to the overall financial status of the company.
This method is most appropriate for projects taking longer than 90 days and/or having multiple points of completion over the period. In addition, if the value of the project will exceed 3% of the total revenue stream during the accounting period and take more than 90 days, use this method.
When estimating the percentage completed, it is imperative to accurately determine the percentage completed as even a 1% deviation can greatly change the net profit earned during the period. As an example, suppose a road builder has a $3,000,000 contract to restore a small bridge. The contract is estimated to take seven months.
The actual costs are $2,300,000 over this period in equal amounts each month (this never happens by the way). So here are the month’s actual costs of construction and estimated revenues for all seven months:
Month 1 2 3 4 5 6 7 Total
Revenue $428,571 $428,571 $428,571 $428,571 $428,571 $428,571 $428,571 $3,000,000
Costs 328,571 328,571 328,571 328,571 328,571 328,571 328,571 2,300,000
Profit $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $700,000
But suppose in month 5 the percentage completed was estimated at 15.49% and not the usual 14.28%. Basically an additional 1.21% more. Look at the profit calculation:
Month 4 5
Sales $428,571 $464,700
Costs 328,571 328,571
Profit $100,000 $136,128
This means the company’s profit in month five is $36,128 higher than it really is; just because the estimated completed amount is overstated. This will have an equivalent opposite effect during the last two months as the overstated profit has to be adjusted or recaptured somewhere.
So it is imperative to have a well crafted engineered or reasonable method to accurately identify the actual percentage completed so financial reporting reflects the true profit derived during the accounting period.
As a word of caution, project managers have a tendency to overestimate the progress with a project. They don’t like to disclose actual performance because they fear the owner’s wrath. This is why there must exist a detailed spreadsheet determining actual percentage completed for each of the stages of completion. Somebody with knowledge and experience should approve the schedule. The owner or general manager should inspect all jobs at the end of the accounting period and approve of the percentage completed. To illustrate all this, a comprehensive example is appropriate.
Comprehensive Example – Percentage of Completion Method with Project Accounting
Wythe contracting is an interior decorator and hotel furnishings contractor. Most of their jobs are with new construction hotels. Bilton Hotels is building a 214 unit hotel on the beach in Florida and contracts with Wythe to furnish each room with furniture including mattresses, wall decorations, lamps, blinds, curtains and appliances. Wythe will have two weeks to complete the on-site work. Wythe has a lead time of six months and two weeks of post completion to address discrepancies. Total time frame is seven months. Bilton agrees to pay $1,378,500 for the contract. The contract calls for eight equal installments including the initial installment as a deposit.
How does the accountant handle this project using the percentage of completion method of accounting?
As explained in Project Accounting – Lesson 72 phases are identified. Wythe Contracting uses five phases for all of its contracts as identified below:
Phase Title Description
01 Design/Requisition This phase covers the administration function of a job. It includes all labor for designing curtains, room layouts, pattern selection and mock-ups for the rooms. In addition, any licensing, permitting and capitalization expenses are assigned here. Labor to order and follow-up on work orders is expensed to this phase.
02 Fabrication/Storage Curtain and blinds fabrication is cost to this phase. In addition, all furniture (kits) are bought and stored in a warehouse for delivery. All electronics, lamps, shades and kitchenette appliances are purchased and stored for delivery at the appropriate time. This phase has the greatest dollar value assigned.
03 Delivery Delivery includes transportation, on-site storage and any temporary equipment to move furniture at the job site.
04 Installation Mostly a labor function, each room’s furniture is assembled and staged. Final pieces are set in place. Curtains and blinds are installed first. Labor pool includes temporary help from local movers in the area.
05 Quality Control/Inspect Final testing of all rooms including a sign-off sheet for each room, discrepancies are noted and corrected; all finishing up costs are assigned to this phase.
Management assesses the production schedule and created the following percentage of completion schedule for selective points throughout all phases of the contract.
Design/Requisition – Once the respective curtain and blind models are fabricated and approved by the customer, the contract is 4% complete. Once all orders are submitted covering the 73 different furniture pieces and sizes, the contract is an additional 3% complete for a total of 7%.
Fabrication/Storage – Fabrication of all curtain sets and blind sets adds 12% of completion. Actual purchase of furniture, electronics, decorations and mattresses completes an additional 43% of the contract. Storage is 2% spread out over five months. This phase is 57% for a total of 64% of the contract.
Delivery – It is estimated that seven tractor-trailer loads will be needed to deliver all items. Loading, delivery and staging is 8% of the contract. Total through this phase is 72%. This stage includes trailer rentals for a month.
Installation – For the two-week period, six personnel from Wythe and twelve temporary laborers will be on-site. Wythe’s personnel require lodging and per diem. Included in this stage are tools and on-site costs. The phase is estimated at 21% of the total contract. Total through this stage is 93%.
Quality Control/Inspections – During the two-week post installation period two Wythe employees will stay on-site to correct any outstanding issues and ensure full compliance with the contract. The goal is an acceptance letter from Bilton Hotels. Total value of this phase is 7%. Total accumulated percentage equals 100%.
As stipulated in the Bilton makes an initial deposit of $172,312. This payment is recorded as a contract deposit under current liabilities with a debit to cash. During the first month, all of the mock-ups were constructed, tested and patterns approved by Bilton. In addition, all furniture, electronics, decorations, appliances and other items were ordered with 120 days for delivery. Mattresses were not ordered yet as negotiations were still ongoing. $50,000 of the furniture was delivered to the warehouse and stored. Per the contract, Bilton was billed and paid the second installment for $172,312. All costs were recorded to work in process (WIP). Costs include $82,000 for materials and labor to date, all paid with cash.
Prior to the end of the month, the balance sheet looks like this in regards to the Bilton contract.
For the First Month of Bilton Contract
Ending the Day Before the End of Month One
Cash $262,624 (2 payments of $172,312 – $82,000 for costs paid to date)
WIP (Bilton) 132,000 ($82,000 of costs Phase 01, + $50,000 owed for Phase 02)
Total Current Assets $394,624
Accounts Payable $50,000 (amount owed for delivered goods)
Contract Billings 344,624 (2 payments of $172,312 each)
Total Current Liabilities $394,624
Management estimates that 6% of the 7% involved in Phase 01 is complete. In addition, about 6.7% of the 57% value assigned to Phase 02 is complete. Therefore it is estimated the job is now 12.7% complete. It is time to record revenue and costs. The entry is as follows:
Date ID Ledger Control ID Phase Description DR CR
01/31/ZZ 1014 Sales Bilton-1217 – 12.7% of Project $175,070
. 1014 Contract Bill Bilton-1217 – 12.7% of Project $175,070
. 1014 Cost of Sales Bilton-1217 01 Labor & Mts Mock-Ups 82,000
. 1014 Cost of Sales Bilton-1217 02 Furniture Revd 50,000
. 1014 WIP Bilton-1217 – Month 1 Transfer 132,000
. $307,000 $307,000
Now let’s look at the balance sheet and income statement after the journal entry.
Last Moment of Month One of Bilton Contract
Work in Process -0-
Total Assets $262,624
Accounts Payable $50,000
Contract Billings 169,554
Sub-Total C/L $219,554
Current Earnings 43,070
Total Liabilities & Equity $262,624
30 Days Ending 1st Month of Bilton Contract
Cost of Sales 132,000
Profit $43,070 (Matches current earnings on balance sheet)
During months two, three and four, Bilton made their respective contract installments and all the furniture, electronics, decorations, appliances were delivered. In addition, the mattresses were ordered, completing phase 01. They were not delivered as they will be delivered directly to the job site during the second week of the install period. Furthermore, all the curtains and blinds were fabricated and stored for shipping. Finally, all materials and labor have been paid for during these periods. Total estimated percentage of completion is as follows:
Phase 01 – A full 100% complete, value of project = 7%
Phase 02 – Is 88% complete as the mattresses have not been delivered yet, value of this phase for the project = 50.16%
Phase 03 – 0%
Phase 04 – 0%
Phase 05 – 0%
Total value of project completed to date = 57.16%. Now let’s look at each of the respective line items more closely.
Bilton has made five installments to date for a total of $861,560 (5 * $172,312). Total transferred to sales equals $787,950 ($1,378,500 * 57.16%) leaving a balance in this account of $73,610.
Since the contract is 57.16% complete, total sales equals $787,950. The following is the income statement schedule assuming equal amounts for months two, three and four.
Sales Section – Bilton Hotels Contract
Month One Two Three Four Total to Date
Sales $175,070 $204,293 $204,294 $204,293 $787,950
Costs of Sales
Total costs to date are $628,800. All of it is paid out in cash leaving no accounts payable with a balance due. Wythe incurred costs during months two, three and four in equal amounts. The following is Wythe Contracting’s income statement by month with sales and costs.
Month One Two Three Four Total to Date
Sales $175,070 $204,293 $204,294 $204,293 $787,950
Costs 132,000 165,600 165,600 165,600 628,800
Profit $43,070 $38,693 $38,694 $38,693 $159,150
Cash position from month one balance sheet $262,624
Payments from Bilton Hotels (3 installments of $172,312/ea) 516,936
Cash payment for initial A/P balance of $50,000 (50,000)
Cash payment for labor and materials since month one (496,800)
Cash balance on the last day of fourth month $232,760
At this point the balance sheet is very simple related to the Bilton contract.
Balance Sheet – Bilton Hotels Contract
Last Day of Fourth Month of Activity on Contract
Work in Process -0-
Total Bilton Assets $232,760
Accounts Payable -0-
Contract Billings 73,610
Sub-Total C/L $73,610
Current Earnings YTD – Bilton 159,150
Total Bilton C/L & Earnings $232,760
A few side notes are prudent at this point in the accounting process.
1) With project costing it is rare to have a separate balance sheet for a contract. This is due to the fact that there is always overhead expenses in business. A project balance sheet reflects the direct profit earned from the project and does not include indirect and overhead expenses.
2) The contract billings line is customarily stated as ‘Contract Billings in Excess’ which reflects actual billings submitted to the customer less sales recorded to date. With percentage of completion accounting there is usually some work in process not transferred to cost of sales. The difference between contract billings and WIP is the obligation balance Wythe has to Bilton. The $73,610 is owed back to Bilton if Wythe fails to finish the contract or terminates at this moment in time. Fortunately it has cash assets to do this if necessary; in this ‘perfect’ example cash is available. Of course the contract will continue.
3) So far this contract is going smoothly as it has generated a direct margin of $159,150 through four months. But in business, it doesn’t always work this way.
During the last week of the fifth month, Wythe loads all seven trailers it rented for transportation during the first week of the sixth month. Everything went well except for an accident. While loading a pallet (14 units) of cadenzas (kits) the forklift driver accidentally tipped the forklift over the edge of the loading dock damaging all 14 kits. Now an emergency exists to find 14 kits of the same size, style and wood grain. The manufacturer no longer makes these kits in that color.
To make a special production run will cost Wythe $35,000 plus a $7,000 emergency rush/delivery fee to transport them directly to the hotel site by the end of the sixth month. Wythe has no choice but to special order the kits.
During the fifth month, management estimates an additional 1.65% completion towards the project. 0.65% relates to storage charges under phase 02 as the percentage of completion in this phase goes from 88 to 89.14% complete. The labor for loading and rental of the trailers is 1/8th of phase 03 (delivery). As of the end of the fifth month, the percentage of completion is as follows:
Phase % of Completion Weighted Value Total % Completed
01 100.00 7% 7.00
02 89.14 57% 50.81
03 12.50 8% 1.00
Total to Date 58.81%
% Accrued 57.16%
Fifth Month 1.65%
Because the credenza manufacturer has to perform an emergency production of 14 units, it requires all money up front. Wythe pays the following costs during the fifth month:
Labor to Load Trailers $4,388|
Rental of Trailers 7,000
Rent of Warehouse Space 3,500
Repairs to Forklift 2,798
Emergency Rush Order for 14 Credenzas 7,000
Prepayment of Credenzas 35,000
Cash out for Fifth Month $59,686
The income statement looks like this:
. Fifth Month Contract to Date
Sales $22,745 $810,695
Costs 59,686 688,486
Direct Profit ($36,941) $122,209
The balance sheet is as follows:
Total Bilton Contract Assets $345,386
Contract Billings in Excess $223,177
Current Earnings 122,209
Total Liabilities & Equity – Bilton $345,386
During the sixth month Wythe ships the seven trailers to the hotel in Florida. In addition, Wythe sends six employees to Florida during the last half of the sixth month and pays for lodging and per diem of $42 per day per person for 15 days. Temporary labor is hired from a moving company. Wythe agrees to pay $43,000 for the temporary labor. The following are the costs incurred during the sixth month:
Phase Description Cost
03 Transportation & Staging of Trailers $53,000
03 Rental of Forklift, Storage Units, Moving Equip 7,350
04 Wythe Labor for 15 Days 21,759
04 Transportation 4,607
04 Lodging/Per Diem/Incidentals 33,790
04 Temporary Labor 43,000
02 Mattresses 90,529
04 Additional Labor to Move Mattresses 3,950
04 Additional Hardware/Tools/Incidentals 7,317
Total Costs $265,302
Management created the following percentage of completion schedule:
Phase % of Completion Weighted Value Total % Completed
01 100 7% 7
02 100 57% 57
03 100 8% 8
04 93 21% 19.53
05 -0- 7% -0-
. 100% 91.53%
Contract Value $1,378,500
Completed to Date Value 1,261,741
Amount Billed to Date 810,695
Sales for the Sixth Month $451,046
Costs During the Sixth Month 265,302
Profit During the Sixth Month $185,744
At the end of the sixth month, Bilton pays it seventh installment of $172,312. The contract billings account has a credit balance of $223,177 at the end of the fifth month. The following is Bilton’s contract schedule:
Contract Billings End of Fifth Month $223,177
Bill Paid by Bilton @ End of Sixth Month 172,312
Balance Forward $395,489
Project Progress Billing (Debit to This Account) (451,046)
Amount Owed by Bilton on This Contract ($55,557)
As explained in Lesson 5 accountants do not allow debit ending balances in liability accounts. Therefore, the $55,557 is a debit to accounts receivable in the current assets section. Down below is the balance sheet related to the Bilton project. First let’s cover cash. The cash ledger has the following activity:
Cash Balance @ End of Fifth Month $345,386
Cash Out for Costs (265,302)
Receipt of Installment From Bilton 172,312
Cash Balance @ End of Sixth Month $252,396
Now let’s look at the balance sheet:
Balance Sheet – Bilton Hotels Project
End of Sixth Month of Project
Accounts Rcvd 55,557 (Due from Bilton)
Total Assets $307,953
Current Earnings $307,953
Current Earnings must match project to date earnings.
. Sixth Month Project to Date
Sales $451,046 $1,261,741
Costs 265,302 953,788
Profit $185,744 $307,953
At this point some insights are prudent to assist the reader in understanding the percentage of completion method.
1) Separate the Project’s Progress from the Customer’s Account Balance – This may seem strange but it will make sense. The customer’s actual balance owed or overpaid is totally separate from the progress of the project. This is because most contracts have threshold points in them to allow billing and get paid by the customer. As an example, many residential construction contracts use the ‘Dried In’ point as a billing trigger. This means the house is framed, roof is done, windows and external doors are mounted. So the contract may state that the contractor is allowed to bill for a certain percentage or amount. Let’s say 42% for this example. However, the project may be 53% complete as other items like the rough-ins from trades and external trim is complete. The percentage of completion deals with the project’s progress NOT the customer’s account.
In the Wythe example above, Bilton’s balance owed to Wythe is $55,557. But the contract stipulates Bilton will be billed and pay in 1/8th installments including the initial deposit. This is why the term ‘Contract Billings in Excess’ is a liability on the books. In effect, Bilton has prepaid on the contract during the first five months; it has been billed on the contract in excess of actual value delivered by Wythe. Wythe is obligated to return that balance if Wythe terminates at that moment in time.
2) Work in Progress (WIP) Acts as a Collection Tool – On the other side sits the project costs. Again costs accumulate in the work in process (WIP) account and are transferred to cost of sales at the appropriate project billing points (usually monthly). Notice I didn’t say the customer’s billing (customarily called ‘contract billing’). So continuing with the contractor’s house project from above, the contractor may bill and post to the income statement all 53% of the project. All costs associated with that 53% are transferred from WIP to costs of construction on the income statement. The contractor may elect to bill for a certain percentage due to engineering progress and keep the costs associated with the portion yet to be posted to the income statement in WIP.
In effect, WIP acts as a collection point and these costs are transferred to cost of sales as their respective phase or percentage value from sales is posted to the revenue section. This satisfies the matching principle of costs to sales. In the Bilton contract, Wythe automatically transfers all costs at the end of each month to match up against the project revenue recognized (notice I didn’t say contract billings). If you go back to the very first month of the project, I illustrate in the first balance sheet a WIP balance of $132,000. This is the balance prior to posting the sales for the first month. With this balance sheet you’ll notice no current earnings line in the equity section. Once the journal entry is posted, the WIP balance goes to zero.
WIP reflects costs associated with any unbilled project value when using the percentage of completion method.
An accountant may or may not have value in this WIP account at the end of the accounting period including interim accounting periods.
3) The Contract Billings in Excess Account Tracks Both Project and Customer Invoicing – This account tracks both the project and customer’s billings (invoices). Let’s look at the details for the history to date:
On day 1 of the contract, an invoice is sent to Bilton and paid by Bilton. The first moment is a credit to contract billings (current liability) in excess with a debit to accounts receivable. The second moment is a debit to cash from Bilton’s payment and a credit to accounts receivable. I’m simply eliminating the middle transaction and it is a credit to contract billings in excess and a debit to cash.
Ledger – Contract Billings in Excess DR CR Balance
Day 1 – Installment by Bilton (contract billing) 172,312 $172,312
End of Month 1 – Installment by Bilton (contract billing) 172,312 344,624
Sales on Project – Project billing 12.7% $175,070 169,554
End of Month 2 – Contract billing 172,312 341,866
Project Billing – 14.82% 204,293 137,573
End of Month 3 – Contract billing 172,312 309,885
Project Billing – 14.82% 204,293 105,591
End of Month 4 – Contract billing 172,312 277,903
Project Billing (Month 4) – 14.82% 204,293 73,610
End of Month 5 – Contract billing 172,312 245,922
Project Billing (Month 5) – 1.65% 22,745 223,177
End of Month 6 – Contract billing 172,312 395,489
Project Billing (Month 6) 451,046 (55,557)
Transfer to Accounts Receivable 55,557 -0-
The last entry reflects the clearing of a debit value as noted with parenthesis in a credit ending balance account. So a credit is issued for $55,557 and a debit is posted to receivables; an amount owed from Bilton Hotels. In effect Wythe is saying Bilton is now behind in paying their project balance. Wythe does not send the invoice to Bilton for two reasons. First the contract dictates frequency of invoicing, i.e. monthly and secondly, Bilton has paid regularly in accordance with the contract.
Now let’s finish the Bilton project.
During the seventh month, the 14 credenzas showed up and were installed. Two of the Wythe employees stayed behind and were there for three weeks to finish out quality control and obtain customer acceptance. Bilton made the final installment which includes the remaining balance. Here are the costs associated with the final month.
Temporary labor to move furniture $3,742
Waste/Debris removal 842
Wythe labor 7,902
Bonuses to staff 6,000
Lodging/Per Diem 11,663
Local permit/inspection 595
Replacement of stolen electronics 2,115
Decorations (not previously ordered) 20,758
Total all Costs for the Seventh Month $58,540
The percentage of completion schedule looks like this:
Phase % of Completion Weighted Value Total % Completed
01 100 7% 7%
02 100 57% 57%
03 100 8% 8%
04 100 21% 21%
05 100 7% 7%
. 100% 100%
Contract Value $1,378,500
% Completed as of End of Month Six (91.53%) $1,261,741
Project Billings 8.47% 116,759
Total Project Billings $1,378,500
. Seventh Month Project to Date
Sales $116,759 $1,378,500
Costs 58,540 1,012,328
Profit $58,219 $366,172
Bilton makes the final installment of $172,316 for a total of $1,378,500. This is posted as a debit and the accounts receivable debit value is transferred to contract billings to clear the contract billings account as follows:
Ledger – Contract Billings in Excess DR CR Balance
Previous balance -0-
Transfer back A/R amount $55,557 ($55,557)
End of seventh month contract billing $172,316 116,759
Project billing 8.49% last bill on project 116,759 -0-
Cash account looks like this:
Cash balance carry forward $252,396
Cash out on contract for 7th month costs (58,540)
Cash installment from Bilton Hotels 172,316
Ending Balance $366,172
The balance sheet for this project is one asset of cash for $366,172 and a current earnings line (equity) of $366,172. This was a good project for Wythe.
A final note about this comprehensive example. For those of you who are new to accounting, this may seem overwhelming. It is actually a reasonable depiction of contract work in small business. Go over the illustration again until you have a warm fuzzy that it makes sense. The first couple of interactions with this method will take a little longer because you will have to pause and think about how the entry must be posted to work properly. You will make mistakes at first, I did when I first started using this method. The best part is catching those mistakes when you review your initial reports. It is then the ‘AH-HA’ moment will happen and it will sink in; then you’ll get faster at this method. So don’t despair, this method will become second nature about the fourth or fifth project into learning this method.
Summary – Percentage of Completion Method
The percentage of completion method is the best financial tool to monitor a project’s financial performance throughout its production period. It is generally designed for contracted projects of long duration (more than 90 days) or for projects that have a significant impact on the revenue component of the business. The goal is to match costs against actual progress of the project. Two balance sheet accounts act as clearing accounts for costs and contract progression.
Work in process (WIP) in the current assets section of the balance sheet is a control account used to gather costs prior to transfer to the cost of sales section of the income statement. Contract billings in excess is used to record actual contract invoices to customers and is offset by the debit value of actual project completion posted to sales.
Each interim accounting period, management uses a schedule to report percentage of completion for the project. This sets the sales value and corresponding costs are moved from WIP to cost of sales to identify project profitability. Accountants should use spreadsheets to track progress with a project. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.