Percentage of Completion Method

The construction Industry is by far different from any Industry I’ve worked in. The (our) standard industry month end close accounting policy, we’d have your typical month end close process. We used a purchase order system for our expenses. And, any PO’s that we didn’t have an invoice for, we accrued in the current month and reversed in the following month. Almost all revenue was booked or Expenses were booked in the month they occurred (with each other)(on the accrual method).

The Construction Industry however,

We have to take into consideration “cut off dates for billing”. Let’s say we have a client who states in their contract, we must submit our invoice on or before the 14th of the month in order to get paid in 30 days, otherwise it would be the following month before we can submit our invoice and then another 30 days before we get paid. By submitting our invoices early in the month, some of our revenue might be booked in the following month, and our expenses might be booked in this month and vice versa. Missing deadlines to get our billings submitted to our clients, delays cash in our accounts.

And, we ALL know CASH IS KING!!! So get those Client billings out the door on time!

But, when it comes to revenue recognition, we can use the cost to cost percentage of completion method – (In this case we also would make sure we get all our costs into this period (as much as possible). Cost drives revenue recognition on the cost to cost percentage of completion method ( and let’s not forget to mention the Estimates (revised Estimates) which we will discuss in another post and discuss the under and over billings!

So, how do we get around this to make sure that our costs and revenues are recognized in the same period? Revenue Recognition —

According to the Construction Contractors Audit and Accounting Guide (May 2015 Edition), FASB ASC 605-35-25-57 states that the percentage of completion method is preferable as an accounting policy when estimates are reasonably dependable and all of the following conditions exist:

  • Contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the considerations to be exchanged, and the manner and terms of settlement.
  • The buyer can be expected to satisfy all obligations under the contract
  • The contractor can be expected to perform all contractual obligations

In the Construction Contractors Auditing and Accounting Guide, refer to AAG-CON 2.01  to read further on the Basic Accounting Policy for Contracts

The major factors that must be considered in determining total estimated revenue:   (Income Determination – Revenue 2.13 (2015, AICPA)

  • (a) The basic Contract Price
  • (b) Contract options
  • (c) Change orders
  • (d) Claims
  • (e) Contract provisions for penalty and incentive payments, including award fees and performance incentives

“Revenue is one of the most important measures used by investors in assessing a company’s performance and prospects. However, revenue recognition guidance differs in Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)—and many believe both standards are in need of improvement”.  READ FURTHER

More to come!!

NEXT POST – IMPACT OF CHANGE ORDERS ON REVENUE

 

Author: Terry Kelley MBA

Controller in the Construction industry. Over the past 30 years I have worked as an electrician (studied 3 years at CCVTC -for Electrical) for 6 years. I've owned my own construction company for over 15 years (where I wore many hats) to include accounting and finance. And, for the remainder of my career I have and still are working as a Controller in the Construction Industry. I have earned my Bachelors degree and MBA in accounting. Now, I am working to earn my CCIFP certification. I have put together this study group in hopes of working together with other CCIFP candidates.

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