Percentage-of-completion method
Percentage of completion (PoC) is an accounting method of work-in-progress evaluation, for recording long-term contracts. GAAP allows another method of revenue recognition for long-term construction contracts, the completed-contract method.
The accounting for long term contracts using the percentage of completion method is an exception to the basic realization principle. This method is used wherein the revenues are determined based on the costs incurred so far. The percentage of completion method is used when:
Losses are recognized in the year when they are discovered, the same way as for the completed contract method. The balance sheet presentation is the same as in the completed contract method.
Revenues and gross profit are recognized each period based on the construction progress, in other words, the percentage of completion. Construction costs plus gross profit earned to date are accumulated in an asset account (construction in process, also called construction in progress), and progress billings are accumulated in a liability account (billing on construction in process). Construction-in-progress are generally not classified as inventory as it would not be in-line with IAS2.9 (Inventories to be stated at lower of cost or NRV).
Although the formula for recognizing income in the current period can vary, a widely accepted one is as follows:
where... the number of periods lapsed since the inception of the contract.
For example, let's say our total estimated cost for the contract is $10,000 and our contract value is $12,000. We know that project will be completed in 2 years. Now, after the first year we see that total cost incurred in this first year is $3,000. So according to the percentage-of-completion method: Cost percentage = 3000/10000 = 30%; so we will recognize 30% revenue in the income statement for the first year.
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