Percentage Completion Method (Formula, Example, Journal Entries)

Accounting Tutorials

What is Percentage of completion method?

Percentage of completion method is an accounting method for recognizing not only revenue but also expenses for long-term projects which span over more than one accounting year. In this method, revenue is recognized on a yearly basis as a percentage of work completed during that year.

Revenue for a given year is calculated as follows:

Revenue to be recognized = (Percentage of Work Completed in the given period) * (Total Contract Value)

Here, the biggest challenge is to calculate the percentage of work completed.

How to Calculate the Percentage of Work Completed?

To estimate the progress of work or the completion percentage, companies can use either of the three methods:

#1 – Cost Method to Calculate Percentage Completion

In case of huge projects, the total cost which will be incurred on the project is estimated at the start of the project itself so that the company can accordingly quote a fee for the same. This cost can be taken as the basis for calculating the percentage of completion method as it is assumed that the revenue will go hand-in-hand with the cost incurred.

To determine the percentage of work completed you can use the following formula:

Percentage of work completed = (Total Expenses incurred on the project till the close of the accounting period) ÷ (Total Estimated Cost of the Contract)

The above formula gives the cumulative percentage of work completed until the close of the accounting period. From this, you need to subtract the percentage of work completed up to the last accounting period to arrive at the percentage of work completed in the current accounting year.

Percentage Complete Method Example 1:

A company named Roads & Bridges has won a contract for the construction of a foot overbridge near a crowded railway station. It has estimated that the total cost for this project will be $ 10,00,000. The policy of the company is to add a margin of 20% on its cost estimate. So the finalized quotation for this project which is agreed by both the parties is $ 12,00,000. It is estimated the company will be able to finish the project in a span of 3 years.

The company has incurred the following costs during the life of the project:

Year 1: $ 1,00,000
Year 2: $ 3,50,000
Year 3: $ 4,75,000
Year 4: $ 1,00,000

On the basis of the cost method of percentage completion, revenue can be recognised as follows:

Year	Cost	Cumulative cost incurred	Cumulative % of completion	Year on year %	Cumulative revenue to be recognized	Year on year revenue
1	$ 1,00,000	$ 1,00,000	10.00%	10.00%	$ 1,20,000	$ 1,20,000
2	$ 3,50,000	$ 4,50,000	45.00%	35.00%	$ 4,20,000	$ 3,20,000
3	$ 4,75,000	$ 9,25,000	92.50%	57.50%	$ 6,90,000	$ 2,70,000
4	$ 1,00,000	$ 10,25,000	102.50%	102.50%	$ 12,30,000	$ 5,40,000
Total	$ 10,25,000					$ 12,30,000

If you must have noticed, the revenue recognized is exceeding the total project contract value which was finalized. This is because Roads & Bridges has exceeded the cost by $ 25,000 and revenue is exceed by exactly $ 25,000 + 20% = $ 30,000

However, revenue cannot be exceeded more than the contract value as the contractee will not pay any more than $ 12,00,000.

So the key take away from the above is that in the last year of the contract, revenue should be recognised only to the extent of the total contract value and the cumulative completion percentage cannot exceed 100%. Following will be the revised working for the above:

Year	Cost	Cumulative cost incurred	Cumulative % of completion	Year on year %	Cumulative revenue to be recognized	Year on year revenue
1	$ 1,00,000	$ 1,00,000	10.00%	10.00%	$ 1,20,000	$ 1,20,000
2	$ 3,50,000	$ 4,50,000	45.00%	35.00%	$ 4,20,000	$ 3,20,000
3	$ 4,75,000	$ 9,25,000	92.50%	57.50%	$ 6,90,000	$ 2,70,000
4	$ 1,00,000	$ 10,25,000	100.00%	100.00%	$ 12,00,000	$ 5,10,000
Total	$ 10,25,000					$ 12,00,000

#2 – Efforts Expended Method to Calculate Percentage Completion

This method is similar to the cost method, however, instead of using the cost companies can use the efforts involved in completing the project. The efforts mentioned in this method imply any of the following:

Direct man hours which are required to complete the project – This should be used when the project is a labor dominated, the major cost is also of labor and the project can be broken down into a number of man-hours.
Machine hours which are required to complete the project – As opposed to the above, machine hours should be used as the basis for the percentage of completion method when the project is automated in nature and requires machinery for the completion of the project. In this case, the major cost will be attributable to the machinery
Material consumed can also be one of the key requirements for the project. In this case, the quantity of material consumed will be taken as the basis.

Percentage Complete Method Example 2

ABC Company has won a contract of excavation of an area which will take 2 years to complete. The excavation has to be done manually as it is an archaeological site on account of which labor cost will be the key cost for completion of the project.

The company has estimated that it will require 50,000 man hours to complete the work. It has also decided to opt to calculate the percentage of completion by using the efforts expended method.

Total estimated cost for the project = $ 5,00,000

Year	Man Hours	Cumulative man hours	Cumulative % of completion	Year on year %	Cumulative revenue to be recognized	Year on year revenue
1	17,000	17,000	34.00%	34.00%	$ 1,70,000	$ 1,70,000
2	13,000	30,000	60.00%	26.00%	$ 3,00,000	$ 1,30,000
3	18,000	48,000	96.00%	36.00%	$ 4,80,000	$ 1,80,000
Total	48,000					$ 4,80,000

In the above case, the actual man hours are lesser than the estimated man-hours. As per the percentage of completion method, the company has to recognize only $ 4,80,000. However, as per contract, the company will receive $ 5,00,000. So during the last year of the project, the company can recognize the balancing revenue and the cumulative % of completion should be 100% instead of 96%.

Revised revenue recognition will be as follows:

Year	Man Hours	Cumulative man hours	Cumulative % of completion	Year on year %	Cumulative revenue to be recognized	Year on year revenue
1	17,000	17,000	34.00%	34.00%	$ 1,70,000	$ 1,70,000
2	13,000	30,000	60.00%	26.00%	$ 3,00,000	$ 1,30,000
3	18,000	48,000	100.00%	40.00%	$ 5,00,000	$ 2,00,000
Total	48,000					$ 5,00,000

#3 – The Units-of-Delivery Method to Calculate Percentage Completion

Many times, a long-term contract can be split into multiple smaller units which are delivered to the customer and the price, delivery schedule, units, etc. of each separate unit are mentioned in the contract itself.

Percentage Complete Method Example 3

The following is the extract of deliverables of a contract where the contractor is involved in certain activities of construction of business:

Sr. No.	Particulars	Timelines for completion	Amount per unit	No. of units	Total Amount
A.1	Air purification system	01-Feb-18	$ 1,00,000	5	$ 5,00,000
A.2	Elevators	01-Mar-18	$ 2,22,000	10	$ 20,22,000
A.3	Drainage system	15-Apr-18	$ 3,00,000	15	$ 45,00,000
A.4	Fire Protection system	31-May-18	$ 1,60,750	2	$ 3,21,500
A.5	Emergency alarm system	31-Jul-18	$ 11,00,367	2	$ 22,00,734
A.6	Other miscellaneous equipment	31-Aug-18	$ 53,00,000	1	$ 53,00,000
A.8	Generators & Transformers	31-Dec-18	$ 2,65,700	7	$ 18,59,900
A.9	Telecommunication system	15-Jan-18	$ 8,18,550	8	$ 65,48,400
A.10	Treated water system	01-May-18	$ 5,90,000	12	$ 70,80,000
	Total				$ 305,30,534

From the above, the following is the actual delivery in the financial year Jan 2017 to Dec 2017:

Sr. No.	Particulars	Amount per unit	Delivered units	Total Amount
A.1	Air purification system	$ 1,00,000	2	$ 2,00,000
A.2	Elevators	$ 2,22,000	3	$ 6,66,000
A.3	Drainage system	$ 3,00,000	3	$ 9,00,000
A.4	Fire Protection system	$ 1,60,750	1	$ 1,60,750
A.5	Emergency alarm system	$ 11,00,367	–	–
A.6	Other miscellaneous equipment	$ 53,00,000	–	–
A.8	Generators & Transformers	$ 2,65,700	4	$ 10,62,800
A.9	Telecommunication system	$ 8,18,550	2	$ 16,37,100
A.10	Treated water system	$ 5,90,000	–	$ 2,00,000
	Total			$ 46,26,650

As per the units-of-delivery method of Percentage Completion, the company can recognize $ 46,26,650 as revenue in the given financial year.

Pre-requisites for Percentage of Completion Method

One of the basic principles of accounting is to Prudence. This accounting principle requires that a certain degree of caution should be exercised while recording revenue in the books of accounts.

Keeping this principle in mind, the use of percentage of completion method should be used for booking revenue in the books of accounts only when the following can be assured about the contract:

Collections with regards to the contract are assured. To ensure this; companies ask for bank guarantees, performance guarantees from the debtor. They can also check the creditworthiness of the company before entering into a contract with them.
The company can fairly determine the progress of work done on the contract. This is important because the revenue is directly related to the progress. If the progress itself is incorrect, the revenue presented in the financial statements will be incorrect. There are chances of fraudulent activities if this part is not properly reviewed by the top management.
Both the parties to the contract should be in a state to fulfill the contractual obligations. The contractor (company recognizing the revenue) should be in a state to complete the project and the contractee (company who wants the work to be done) should not only be able to pay but also be able to take the complete responsibility of the project once the work is completed and the risk is transferred to them.

Journal Entries for Percentage Completion Method

The revenue recognized under this percentage completion method is not billed to the customer. Revenue recognition, in this case, should be routed to a different account – “Unbilled contract receivables”.

Example 1 (Continued):

Company Roads and Bridges will pass the following journal entries in its books of accounts for revenue recognized under the percentage of completion method:

Year 1

To Unbilled Contract Receivables A/c	$ 1,20,000
By Contract Revenue Earned A/c	$ 1,20,000

Year 2

To Unbilled Contract Receivables A/c	$ 3,20,000
By Contract Revenue Earned A/c	$ 3,30,000

Year 3

To Unbilled Contract Receivables A/c	$ 2,70,000
By Contract Revenue Earned A/c	$ 2,70,000

Year 4

To Unbilled Contract Receivables A/c	$ 5,10,000
By Contract Revenue Earned A/c	$ 5,10,000
To Accounts Receivable A/c	$ 12,00,000
By Unbilled Contract Receivables A/c	$ 12,00,000

At the end of the contract, the company will raise an invoice and can then transfer the Unbilled Contract Receivable A/c to Accounts Receivable A/c. Till then, Unbilled Contract Receivable A/c will be shown as a shown as an asset in the balance sheet.

If advance is received towards the contract, the following entry can be passed in the books:

Bank A/c	$ 2,00,000
Advance received A/c	$ 2,00,000

This can be reduced from the Unbilled Contract Receivable A/c while preparing the balance sheet.

Percentage of Completion Method

What is Percentage of completion method?