Any public works contractor, or any construction firm anticipating public works projects will have or will need to have a relationship with a surety bond company. (The provider of bid bonds and performance and payment bonds necessary to pursue public works projects.) The surety will, at some point, require CPA prepared financial statements, prepared using the percentage of completion accounting method. In simple terms, the percentage of completion accounting method is simply recognizing revenue based on the progress of the individual jobs. If a job has a projected profit of $100,000 and is 50% complete, $50,000 of profit will be recognized. While this may seem simple enough, most contractors have more than one job and calculating the revenue recognition can be a bit tricky. Add to that, the surety underwriters will be using the schedules provided in your financial statements to reconcile the revenue and profit as a check and balance. As such, it is important to understand how revenue should be recognized.
Percentage of Completion Method Accounting Revenue Recognition
Estimated Cost and Profit to Date on Open Jobs +
Estimated Costs and Profits on Jobs Closed in the accounting period –
Costs and profits on those jobs from prior periods.
Yes that mouthful is revenue recognition in a percentage of completion accounting. When first starting out, most contractors use the cash basis of accounting. This is very simple, cash in less cash out equals profit. The underlying problem with this method for the surety bond underwriters is it ignores both underbillings and overbillings. Additionally, the Internal Revenue Service will have issue with the cash basis once a contractor reaches certain revenue limits.
Let’s break down the formula in the beginning of this paragraph.
- Estimated costs and profit to date on open jobs – easy enough, take all the costs and profit on all jobs in progress and add them up.
- Estimated costs and profits on Jobs Closed – also easy enough , just add these up.
- Subtract the costs and profits on both open and closed jobs earned in prior periods.
With Percentage of Completion Method Accounting, the surety bond underwriters should be able to match the revenue and gross profit from the income statement to the open and closed job schedules. (For information on what job schedules click: What is a Work in Progress Schedule? ).
For example, lets assume the current accounting period is ending as of 12/31/2022.
Job #001 is an open job and has costs to date of $950,000 and earned profit to date of $50,000, however the job actually started in 2021 and as of 12-31-2021 this job had costs to date of 800,000 and earned profit to dat of $55,000. In this case, because this project suffered profit fade, the actual revenue and profit recognized in the current period would be $145,000 and $(5,000) respectively.
Job #010 is a closed job with final costs of $1,000,000 and final profit of $100,000. As of 12-31-2021, the job had cost to date of $500,000 and earned profit to date of $25,000. In this case the revenue recognized as of 12/31/22 would be $575,000 with the profit recognized in the current period of $75,000. This job had an increase in both contract price and profit form the previous period.
If these were the only 2 jobs performed during the period ending 12-31-2022, using Percentage of Completion Method Accounting, the construction revenue would be $720,000 and the gross profit recognized would be $70,000 (the recognized loss on Job#001 + the recognized profit from job #010).
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