Percentage of Completion Method

Refers to an accounting method that recognizes revenue for different periods for a long-term project or contract

Author: Osman Ahmed
Osman Ahmed
Osman Ahmed
Investment Banking | Private Equity

Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology. He's currently a VP at KCK Group, the private equity arm of a middle eastern family office. Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.

Osman holds a Bachelor of Science in Computer Science from the University of Southern California and a Master of Business Administration with concentrations in Finance, Entrepreneurship, and Economics from the University of Chicago Booth School of Business.

Reviewed By: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Last Updated:November 16, 2023

What Is The Percentage Of Completion Method?

The percentage of completion is an accounting method that recognizes revenue for different periods for a long-term project or contract. The percentage of work completed in a period calculates revenue, expenses, and estimated gross profit.

Many companies misuse this method to bolster their short-term results. However, this method should be used only when there is very little credit risk and the percentage of contracts completed can be measured effectively and efficiently.

The current period costs and current period revenue are balanced with total estimated costs to calculate tax liability for a particular period. 

For example, let's say there's a construction project which was 55% completed after the end of the second year and only 30% at the start of the 2nd year. 

This would mean that only 25% of the contract was completed in the second year, and revenues relating to that 25% of work should be recognized for the current period.

When using this method, the balance sheet is prepared just as in the case of a completed contract method; the adjustments have to be made in the P&L statement only.

Key Takeaways

  • The Percentage of Completion method is used in accounting to recognize revenue and expenses for long-term projects or contracts over different periods.

  • Companies should use this method cautiously, ensuring there is minimal credit risk and accurate measurement of contract completion.

  • Three different methods to calculate the Percentage of Completion include: Cost-to-cost, Efforts-expended, and Units-of-delivery methods.

  • The method helps in recognizing revenue and expenses based on the progress of the project, allowing for more accurate financial reporting.

  • While advantageous in providing a detailed view of a company's financial performance, the method's reliance on estimates can lead to uncertainties and potential manipulation of profits and losses.

Different methods to calculate the percentage of completion

Calculating the percentage of completion is essential in many fields, especially in accounting and project management. There are three different ways in which it can be calculated, which are explained below.

Cost-to-cost method

This method is based on the ratio between the cost incurred to date on the contract to the total estimated project cost. If the cost of raw materials has not been taken into use until the end of the period, then it should not be considered when calculating the percentage of completed contracts. 

Moreover, the cost of fixed assets used in the construction for only the contract period should be included in the cost of the contract, i.e., the depreciation and amortization of assets used.

    Efforts-expended method

    In this method, we replace the costs incurred and estimated costs with efforts expended till now and total expected efforts for the contract. Total labor hours, machine hours, or quantity of raw material can be used to measure the completion percentage.

    In this method, we replace the costs incurred and estimated costs with efforts expended till now and total expected efforts for the contract. Total labor hours, machine hours, or quantity of raw material can be used to measure the percentage of completion.

    Units-of-delivery method

    In this method, a contract's completion percentage is measured by the number of units delivered to the total number of units to be delivered for a specific contract. 

    However, this method can only be used when the producer produces products according to customer specifications.

    • The contract price of units delivered is used to recognize revenue.
    • The costs reasonably allocable to the units produced are used to identify expenses.

    Percentage of Completion Method Examples

    XYZ Ltd. took a contract to build an airport at a contract price of $125 million. The estimated cost for the contract is $100 million within three years.

    Assuming the estimated cost is constant, the company would make a profit of $25 million. Following is the schedule related to the project:

    Schedule related to the project
      2018 2019 2020
    Costs Incurred (Cumulative) $20,000,000 $50,000,000 $100,000,000
    Total Estimated Costs $100,000,000 $100,000,000 $100,000,000
    Cash Collected $20,000,000 $50,000,000 $30,000,000
    % Completed 20% 50% 100%

    From the schedule above, revenues are recognized under the percentage of completion method:

    • The year 2018: 20% completed. Revenue recognized = 20% x $125 million (contract price) = $25,000,000
    • The year 2019: 50% completed. Revenue recognized = 50% x $125 million (contract price) - $25 million (previously recognized) = $37,500,000
    • The year 2020: 100% completed. Revenue recognized = 100% x $125 million (contract price) – $25 million – $37.5 million (previously recognized) = $62,500,000
    Revenues recognized under the Percentage of Completion Method
    Year Cost Recognized Revenue Recognized Profit Recognized
    2018 $20,000,000 $25,000,000 $5,000,000
    2019 $30,000,000 $37,500,000 $7,500,000
    2020 $50,000,000 $62,500,000 $12,500,000
    Total $100,000,000 $125,000,000 $25,000,000

    Percentage of Completion Method Advantages and Disadvantages

    Advantages of the Percentage of Completion Method

    • Allows for the estimation of costs and revenues over a specific period based on the completed portion of the contract, aiding in the assessment of project value and income recognition to date.
    • Encourages the provision of a comprehensive estimate of all associated costs and revenues, even if certain expenses have not yet been incurred in the project.
    • Facilitates the spreading of tax liabilities across multiple years, which can prevent a company from overpaying taxes in a given period.
    • Enables companies to report expenses annually, potentially lowering tax liabilities and taking advantage of tax deductions.
    • Particularly useful in construction project accounting, this method aligns revenues and expenses with the progress of the project, providing a clearer picture of financial performance over the long term.
    • Offers a contrast to the completed contract method, recognizing revenue and expenses incrementally as the project advances, rather than waiting until project completion.

    Disadvantages of the Percentage of Completion Method

    • The revenue reported is based on estimates, which introduces a degree of uncertainty and the potential for bias, making the recognized revenue somewhat speculative.
    • There is a risk of profit and loss manipulation through this method as companies might understate or overstate recognized revenue or expenses to influence perceived company performance.
    • Accountants may use the flexibility in revenue and expense recognition to shape financial results, which can distort the actual financial health of a company during a particular accounting period.

    Researched and Authored by Kunal Goel Linkedin

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