If you’ve worked on long-term jobs that stretch out over months, you know just how difficult it can be to keep up with income and expenses as the job progresses. It’s easy to find yourself in a position where you’ve overbilled or underbilled, especially on projects that have gone on longer than you might have expected. This is where percentage of completion (POC) accounting can be extremely helpful.
In this guide we’ll walk through how to calculate revenue and expenses using the POC method and how this plays into the way you recognize revenue in the accounting period.
Key Takeaways
- Percentage of completion (POC) is a method of accounting that contractors use to determine income and expenses based on how far along a job is.
- POC is particularly helpful for long-term projects and is calculated either monthly, or as a job reaches certain milestones.
- With consistent POC reporting, you can make sure your reported revenue and cost numbers match as closely as possible with the actual billing and spending on the job.
What is the Percentage of Completion Method in Construction?
The percentage of completion method (POC) is a common accounting process that contractors use on long-term contracts to determine income and expenses based on the percent of work completed. Instead of calculating a lump sum at the end of a contract (using the completed contract method), POC lets you pull revenue and job cost data on a monthly basis, or as a job reaches certain milestones.
Recognizing Revenue With POC
While POC is one of the best ways to track and measure longer jobs, generally accepted accounting principles (GAAP) no longer allows percentage of completion accounting to be used in its purest form. We break this down in our article on revenue recognition for contractors but it’s important to note that while many contractors still use POC methods to calculate recognized revenue, they must follow the standards outlined in ASC 606 in their financial reporting.
However, while FASB and IASB have placed certain requirements on how you can recognize revenue, the IRS allows for different methods, including the percentage of completion method. Accurately calculating your revenue in the correct accounting period will ensure that your tax liabilities are properly represented.
When using the percentage of completion method, you’ll recognize revenue on your income statement via work-in-progress (WIP) reports. To get an accurate POC, you’ll not only need revenue data but a few other numbers as well:
- Cost to date – the total amount spent during the current period
- Total estimated cost – AKA cost to completion, or the predicted expenses for the entire project
- Contract price – the total amount charged to the project owner
Methods for Calculating Percentage of Completion
You can use a few different methods to calculate POC, although the most commonly used approach is the cost-to-cost method. If you have accurate direct labor hours, you can also use the efforts-expended method to calculate POC, though it is rarely used.
In some rare cases, percentage of completion can be calculated using a units-of-delivery method. This requires you to commit to producing and delivering several identical products/services. It’s not something we see often, but it’s good to know this approach exists if you ever find yourself in a similar situation.
If that all sounded like a lot to wrap your head around, don’t worry – we’ll walk through some real-world examples to explain just how this method of accounting works.
How to Calculate POC Using Cost-to-Cost
The most common method you’ll use to calculate POC is the cost-to-cost method. This method divides your total cost-to-date by the total estimated project expenses, like this:
Cost to Date / Total Project Costs = POC
For instance, if you’ve got $50,000 in current expenses on a project you’ve estimated at $250,000 total, the percentage of completion calculation would be:
$50,000 Cost to Date / $250,000 Cost to Completion = .20, or 20%
This example brings you to a 20% percentage of completion. Once you’ve got your POC, you can then use this percentage to calculate the amount of revenue to recognize for a given payment period or milestone.
Let’s assume your total project price is $300,000. With 20% POC, the revenue recognized for this period ends up being $60,000 based on this formula:
$300,000 contract price x 20% POC = $60,000 recognized revenue
How to Calculate POC Using the Efforts-Expended Method
Though less common, POC can also be calculated using your direct labor hours through the efforts-expended method. The formula looks like this:
Labor Hours to Date / Total Estimated Labor Hours = POC
So, for example, a job with 2,000 current labor hours on a project estimated to require a total of 10,000 hours would result in a POC of 20%, based on the formula:
2,000 Labor to Date / 10,000 Total Project Labor = .20, or 20%
Calculating POC by Units-of-Delivery
In those uncommon instances where your contract might ask you to deliver several similar products or services, you can use the units-of-delivery method to find your POC. It’s another straightforward formula – one that asks you to divide the units delivered to date by the total units defined in the contract:
Units Delivered To Date / Total Contracted Units = POC
For example, you’ve delivered 1,000 and the project is contracted for 5,000 total units. That would result in a POC of 20% based on the formula:
1,000 Units Delivered to Date 5,000 Total Units Contracted = .20, or 20%
Whatever method you use to calculate POC, the key is to be consistent. This way, you’ll ensure your recognition of revenue is accurate and that you can take home the maximum profit from a job. Consistently calculating your POC helps you avoid overbilling or underbilling, and allows you to make revisions on your estimates as needed.
Take Advantage of the Percentage of Completion Method for More Accurate Revenue Recognition
The percent complete method is preferred by many construction companies because it allows you to match your revenue recognition with the costs incurred to earn that revenue as a project progresses. This gives you the ability to report revenue more accurately based on work you have done or been billed. This allows for revenue to be reported on your income statement and balance sheet more correctly throughout the life of the project. Like we’ve covered, this is most useful on long-term construction contracts because it gives a better representation of your company’s financial position than the completed contract method.
Once general contractors reach a certain size, they are likely to use some form of the POC method to calculate their revenue in each accounting period. Make sure you have a mechanism in your accounting software to do this efficiently so you can maintain accurate reporting on the health of your construction business.
Note that as of 2024, businesses over $30 million in annual revenue must move to accrual accounting per IRS publication 538. The percentage of completion method is one process for recognizing revenue under accrual accounting.
Frequently Asked Questions
What is POC accounting in construction?
-
POC (percentage of completion) accounting is an accounting method used in the construction industry to recognize revenues and expenses over the course of a long-term construction project. It allows builders to account for construction projects based on the amount of work completed, rather than waiting until the entire project is finished.
How does POC accounting differ from traditional accounting methods?
-
Traditional accounting methods, like completed contract, recognize revenue and expenses only when payment is exchanged or contract is completed. POC accounting spreads out revenue, expenses, and profit across the lifespan of the project based on the completed percentage, providing a more accurate picture of financial performance.
What are the common methods to calculate POC in accounting?
Three common methods to calculate percentage of completion are:
-
Cost-to-cost method – percentage of total costs incurred to estimated total costs
-
Efforts-expended method – labor hours spent compared to budgeted hours
-
Units of delivery – milestone unit completions, such as floor levels
Can POC accounting help in accurate revenue recognition?
-
Yes, POC accounting allows for revenue recognition throughout a construction project and allows for proper recognition of revenue instead of what has been billed. This matches revenues with project progress to provide useful financial information for management.
Why is accurate POC reporting crucial in construction accounting?
-
Accurate POC reporting is crucial for properly allocating revenues, direct expenses, and gross profit over time. Incorrect POC estimates can lead to understated or overstated revenue figures in financial statements. Also, lenders often require POC reporting.