Construction business owners have been dealt many challenges in the past several years. Although some
construction indicators show improvement, many construction business owners are still addressing concerns in operating their companies. A key component in managing a construction company is accurate financial reporting. One area that needs particular attention is revenue recognition in accordance with the percentage-of-completion method.
Most construction companies are familiar with maintaining cost by jobs and monitoring job cost throughout the contract period, but recording revenues may be another story. A basic concept in accrual accounting under generally accepted accounting principles (GAAP) is the matching principle which reflects revenues in the period in which they have been earned. For the construction industry, this result is normally achieved by the use of the percentage-of-completion method. The percentage-of-completion method considers the cost incurred to-date on a contract compared to estimated total cost of the contract to determine the percentage of revenues earned for a specific period. Therefore, revenue is recognized in proportion to the cost incurred, which satisfies the matching principle under GAAP.
A major component of the percentage-of-completion calculation is the estimated cost to complete on each contract in progress. Should management’s estimate of the cost to complete on a contract prove to be significantly different from the actual cost to complete, recognition of revenue in the proper period can be greatly impacted. Therefore, the responsibility of providing the cost to complete for a contract should only be performed by professionals skilled in estimating job cost. As an estimate to the financial statements, revenues are not restated for changes in estimates; however, they can impact the subsequent year.
The balance sheet reflects two financial statement titles used in the percentage-of-completion method. These statement titles are:
- Cost and estimated earnings in excess of billings on uncompleted contracts. Current asset which is reflected on the balance sheet due to the fact that billings on a contract are less than the revenue to be recognized.
- Billings in excess of cost and estimated earnings on uncompleted contracts. Current liability which is reflected on the balance sheet due to the fact that contract billings are more than the revenue to be recognized.
Financial reports using percentage-of-completion more precisely reflect the operations of the construction company. In an environment with pressure on job margins, they provide management with a tool to monitor the profitability of jobs on an ongoing basis and allow management to make changes on a real time basis to improve job performance. Financial statements utilizing this method are preferred by third-parties, such as bankers and sureties.
Stack the deck in your favor by utilizing the percentage-of-completion method in your financial reporting model – and call CRI’s construction CPAs to potentially start your winning streak.