The Percentage of Completion Method Explained

Accounting for income and expenses can present a real challenge for contractors, especially on long-term projects. The percentage of completion method is one of the most common methods of accounting used in construction. In this article, we’ll explain the percentage of completion method, how it works, and look at some real-life examples.

What is the percentage of completion method?

Percentage of completion is a method of accounting for long-term projects in which revenue and expenses are recognized based on the percentage of work a project team has completed during the period. Using the percentage of completion method, a contractor recognizes project income and expenses as the project progresses, usually on a monthly basis.

In contrast with the percentage of completion, the completed contract method is used to recognize project revenue and costs only when the contract is complete. The completed contract method is usually used in the residential sector and on small projects of short duration.

To calculate the percentage of completion for a project, there are three indicators contractors can use. The most common is costs incurred to date, but they can also use units completed or labour hours.

Once the contractor has determined the percentage of completion for a project, the percent is multiplied by the total expected revenue. The answer is the amount of income that can be recognized on the project to date. This income is recognized on the income statement through the work-in-progress report.

How to Calculate the Percentage of Completion

The most common way to determine a project’s percentage of completion is by comparing estimated and actual project costs, known as the “cost-to-cost” method:  

Percent complete = Total costs to date ÷ total estimated costs

Using this calculation, the total percentage of costs that have been incurred is the percentage of completion for the project. This percentage is multiplied by the total contract amount to determine the revenue to be recognized during the period. 

Revenue recognized = Percent complete x contract amount

Instead of costs, the percentage of completion can also be calculated using units or labour hours, depending on the nature of the business. The important thing to remember is that contractors must be consistent in how they calculate the percent complete.

The work-in-progress report provides a summary of the information used in the percentage of completion calculation. It includes the total revised contract amount, total costs to date, percent complete based on cost, amount billed to date, and the difference between the amount billed and the percent of revenue that can be recognized.

Percentage of Completion Example

For example, a project that has estimated costs of CAD 100,000 has incurred CAD 50,000 in costs so far. Dividing the costs (CAD 50,000) into total estimated costs (CAD 100,000), you find that the project is 50% complete. 

Percent complete: CAD 50,000 ÷ CAD 100,000 = 0.5 (50%)

This means the contractor can recognize half of the total revenue for the project. If the contract is for CAD 120,000, the contractor would record revenue of CAD 60,000 for the period, which would be reflected in their income statement.

Revenue recognized: CAD 120,000 x 50% = CAD 60,000

CRA Requirements

In Canada, the Canada Revenue Agency (CRA) generally requires contractors to use the percentage of completion method for long-term construction projects. However, there are specific exceptions that apply. 

Exceptions for Small Contractors

The CRA defines small contractors and small contracts based on the following criteria:

• Small Contracts: Projects that will be completed within two years are classified as small contracts.
• Small Contractors: Contractors with gross revenues not exceeding CAD 25 million in the previous three years are considered small contractors.

Both criteria must be satisfied for a contractor to use the completed contract method for tax purposes.

Under Canadian accounting standards, revenue should be recognized in the period it is earned, aligning with the Generally Accepted Accounting Principles (GAAP) in Canada. For long-term projects, this typically necessitates the use of the percentage of completion method.

International Financial Reporting Standard (IFRS) 15 governs the treatment of revenue from contracts with customers, including guidance on the recognition of stored materials. In Canada, stored materials are viewed as not representing completed work, and as such, they are treated differently when recognizing revenue.

Risks of the Percentage of Completion Method

The percentage of completion method is an internal accounting process that can differ from the reality on the jobsite. This can present challenges when the revenue and expenses recognized are different from the actual amounts billed or spent on the project. This can create cash flow problems for the contractor if they aren’t careful. 

Overbilling & Underbilling

When the amount billed to date is more than the revenue that is recognized by the percentage of completion method, that’s called overbilling. If a company consistently overbills, they will have trouble covering remaining costs as the project continues. 

Underbilling is the opposite scenario when the amount billed to date is less than the recognized revenue. 

These differences in the billing amount are recorded as journal entries in the general ledger. They increase or decrease the amount of revenue recognized on the income statement and create an asset or a liability on the balance sheet.

These adjustments ensure that the income shown on the income statement is reflective of the percentage of the completion method.

Change Orders

Project expenses never exactly equal the estimated costs. When using the percentage of completion method, it’s important for contractors to revise their estimates anytime changes occur on the job. This ensures the accuracy of their accounting calculations and helps to avoid cash flow challenges. 

When change orders are included and estimates change as the project goes along, calculating the percentage complete can get complicated. Because income recognition is based on a percentage of the revised contract for each project, it’s important that contractors enter change orders into the system as soon as they are approved.

Percentage of completion helps accurately recognize revenue.

Most commercial contractors — both general contractors and specialty contractors — use the percentage of completion method to report their income. When most of their projects last at least a few months, it can be one of the most accurate ways for contractors to recognize revenue.

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