In the complex and sometimes chaotic world of long-term construction projects, many contractors find themselves struggling to accurately align the revenue coming in with the expenses being paid out. This is where the percentage of completion method of accounting often comes in handy. When executed properly, it offers a real-time reflection of income and costs in close alignment with a project's life cycle.
Generally, the percentage of completion method is used when: 1) a job will likely take at least two years to complete from the contract's start date, 2) revenue collection is reasonably expected to occur without disruption, and 3) project progress and completion are reasonably expected to be measurable and achievable.
This widely used accounting method is among the most accurate ways to recognize revenue from long-term projects, and it can help ensure those jobs remain financially viable by splitting tax-reporting obligations for them over the multiple years involved.
Under the percentage of completion method, rather than waiting until a job is finished, the construction business invoices in stages (monthly is typical) for work performed to date and records the earned revenue and expenses at each stage. Doing so not only better maintains accuracy, but also tends to please other project stakeholders because of its precision.
The method becomes particularly advantageous when construction companies encounter projects that become delayed or stopped completely. By recognizing revenue in stages, contractors can bill and (one hopes) obtain payment for work already executed, mitigating the financial risks associated with delayed or incomplete projects.
Construction businesses can measure percentage of completion in several ways. Each approach comes with its own advantages and complexities. The optimal choice will depend on factors such as the nature of the job and how accurately the project's costs can be estimated. Here's a brief summary of each:
Along with tightly aligned revenue and expenses, other upsides often accompany use of the percentage of completion method. For example, it can facilitate timely decision-making for project managers. Because jobs are accounted for in stages, your project managers may be able to better identify operational bottlenecks, such as cash flow issues or labor shortages, and update cost estimates throughout the job.
In addition, as mentioned, the percentage of completion method tends to clarify financial reporting to the extent that it builds confidence in external project stakeholders. Banks, other lenders, investors and sureties are often inclined to more generously support a construction business with sound, well-documented accounting practices.
To be clear, the percentage of completion method isn't the only accounting method applicable to long-term projects and may not be appropriate in every case. But it can do the job quite well under the right circumstances. Please contact our firm for help choosing the right method and applying it.
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