Lesson 50: Percentage of Completion Method
We've reviewed the different types of long term contract methods for public and
private companies including the percentage of completion method, cost recovery
method and completed contract method. For the purpose of this lesson, we will
be reviewing the percentage of completion method in greater detail.
Let's first take a look at an example of how the percentage of completion
method is used.
We will go back to the same example from
the previous lesson of a long-term contract for constructing a government
laboratory building. Let's say the total contract price is $16,000,000 for a
3-year time period.
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We will use the costs incurred figures above to
calculate the percentage of completion for each year and ultimately determine
how much revenue should be recognized.
As you can see from the table, the contract price is a set amount and
the estimated costs left decrease over time based on the amount of costs
incurred during that time period.
Next, lets use a standard template format to calculate the percentage of
completion and how much revenue should be recognized each year. We will start
by pre-filling the contract price, costs incurred in the period and estimated
costs left. The costs to date are simply calculated by adding the costs from
the previous period to the current period.
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The next part of the cost section is to calculate the percentage complete which
will ultimately help us to determine the revenue that should be recognized. We
calculate this percentage by dividing the costs to date by the total estimated
costs.
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Now, in order to calculate the revenue to date, we simply multiply the
percentage complete by the contract price. For example in 2013, $16,000,000
would be multiplied by 0.269 to come up with a revenue to date figure of $
4,304,000. Since 2013 is the first year we are reporting, that figure will be
carried down to the revenues this year field. For 2014 and 2015, we simply
subtract the revenues from previous years from the revenue to date to come up
with the revenues this year.
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The final section we need to calculate is the gross profit fields. The gross
profit to date is found by subtracting the costs to date from the revenue to
date. For example in 2014, the costs to date of $3,700,000 are subtracted from
the revenues to date of $6,368,000 to come up with the gross profit to date of
$2,668,000.
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To come up with the gross profit this year, the gross profit from previous
years is subtracted from the gross profit to date. For example in 2015, the
gross profit from previous years of $2,668,000 is subtracted from the gross
profit to date of $6,700,000 to get a gross profit this year of $4,032,000.
This template may seem a little complex at first glance but the more you
practice calculating the percentage complete and revenue figures, the easier it
will be to understand how this method works.
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Make sure you use this format to
make the process as easy as possible by looking at the costs and percentage
completed first, then calculating revenue and gross profit amounts.