The Percentage of Completion (POC) method is an accounting method where companies recognize revenue and expenses for long-term contracts as work progresses. Rather than waiting until a project is finished, contractors recognize revenue over time based on the percentage of work completed.
HVAC, plumbing, electrical, construction, and other contracting companies commonly use percentage of completion accounting. It helps improve the accuracy of income statements, balance sheets, and job costing reports. Additionally, progress billing may help contractors improve cash flow by allowing them to invoice customers as work progresses.
Although people often use the terms interchangeably, percentage of completion accounting and progress billing are not exactly the same. Percentage of completion determines when and how much revenue a company recognizes. In contrast, progress billing determines when and how much a contractor invoices the customer.
The percentage of completion method is an accounting method that recognizes revenue and related expenses over the life of a long-term contract as work progresses. Contractors, construction companies, and field service businesses commonly use it for large equipment replacements, installations, and other long-term projects.
Contractors, construction companies, and field service businesses commonly use percentage of completion accounting. It is particularly relevant to HVAC, plumbing, electrical, new construction, and design-build projects.
You typically calculate the percentage of completion by dividing costs incurred to date by the total estimated project costs. Alternatively, you can compare actual work completed, such as units installed, against the total work required.
Percentage of completion accounting recognizes revenue over time as work progresses. In contrast, the traditional completed contract method recognizes revenue when the project is finished. However, under current revenue recognition standards, contractors must determine whether their performance obligations qualify for over-time revenue recognition rather than simply choosing between these two methods.
If estimated total project costs exceed total contract revenue, the project is expected to incur a loss. Contractors must evaluate the loss under applicable accounting guidance and recognize it when required rather than waiting until the project ends.
You sell a job for $30,000, and it will take thirty days to complete. You can invoice the customer based on your progress. Typically, you negotiate the amounts in advance, and they may form part of a Work in Progress (WIP) schedule.
For example, when you deliver all the equipment, you might be able to send the customer an invoice for $7,500. Then, when you deliver the fabricated sheet metal, you might be authorized to invoice another $5,000.
When you create invoices, your financial statements and job costing records must reflect the revenue earned and associated costs under the applicable revenue recognition method. However, the amount invoiced does not automatically determine the amount of revenue earned.
For instance, a contractor may have completed 25% of a project but already invoiced the customer for 40% of the contract. This creates a difference between the revenue earned and the amount billed. Contractors must account for these differences when preparing their financial statements.
Percentage of completion accounting also requires a detailed estimate. The more line items your estimate contains, the more detailed your percentage of completion and job costing information will be. A well-organized estimate makes it easier to compare estimated costs against actual costs and determine how much work remains.
For more information about construction billing, see our guide to AIA billing and how AIA payment applications work.
Contractors can track the percentage of completion on a project in several ways. However, they should maintain detailed job records, create accurate estimates, and regularly compare actual costs against projected costs.
A few important practices include:
Accurate job costing is particularly important when using the percentage of completion method. Without reliable cost information, contractors may overstate or understate project progress and recognize the wrong amount of revenue.
Job costing software can help contractors track labor, materials, expenses, and estimated versus actual costs for individual jobs.
QuickBooks Enterprise offers progress invoicing capabilities that contractors can use to bill customers based on project estimates and completed work.
QuickBooks Enterprise provides progress invoicing tools. However, contractors should not assume that creating a progress invoice automatically satisfies all percentage of completion accounting requirements.
Instead, the accounting treatment must reflect the revenue earned under the applicable accounting standards. Depending on your company’s accounting setup, you may need to make adjusting journal entries at the end of an accounting period.
By following these practices, contractors can better manage progress invoices, monitor job profitability, and maintain accurate financial records. However, specific project circumstances and accounting practices may require adjustments or further customization.
You may have noticed that accounting documentation sometimes uses the words “billed” and “invoiced” interchangeably. When you send a customer an invoice, they have received a bill from you. That’s how they may word it.
A vendor creates an invoice and considers it a bill that must be paid. In contrast, the customer considers it an invoice that needs to be collected.
Although the terms describe the same billing transaction, contractors should distinguish invoiced amounts from earned revenue when using percentage of completion accounting. An invoice represents an amount requested from the customer, while recognized revenue represents the value of work performed under the applicable accounting rules.
The Financial Accounting Standards Board (FASB) published Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, on May 28, 2014. The new revenue recognition standard is primarily codified in FASB Accounting Standards Codification (ASC) 606.
The guidance introduces a five-step model for recognizing revenue. It requires entities to identify performance obligations in a contract and allocate the transaction price to each one. Consequently, contractors apply percentage of completion to a performance obligation rather than automatically to the entire contract price.
In addition, the new revenue guidance introduces the concept of transferring control to determine when a company should recognize revenue. A company may recognize revenue at a point in time or over time.
If a performance obligation qualifies for over-time recognition, the contractor must select an appropriate method to measure progress toward completing that obligation. This may include an input method, such as costs incurred compared with total expected costs, or an output method, such as measuring completed units or milestones.
The cost-to-cost approach is a common input method in construction accounting. It compares eligible costs incurred to date against the total estimated costs required to complete the project.
For example, if a contractor has incurred $25,000 in eligible project costs on a job with estimated total costs of $100,000, the project is 25% complete under this approach.
However, not every project cost necessarily represents progress toward satisfying a performance obligation. Costs associated with waste, rework, or certain uninstalled materials may require adjustments when calculating progress.
The AICPA’s guidance on construction industry revenue recognition explains several considerations contractors must evaluate when applying the revenue recognition standard, including measuring progress and accounting for project costs.
For contractors managing multiple long-term projects, a reliable Work in Progress (WIP) schedule is also essential. It helps track contract values, estimated costs, costs incurred, billings, and revenue earned. The AICPA’s overview of WIP schedules explains how these schedules help contractors evaluate project progress and financial performance.
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