PERCENTAGE OF COMPLETION METHOD UNDER CIVIL CONSTRUCTION CONTRACTS

Percentage of completion method is a method used  in civil constrution contract to recognise the revenue of a particular period.  Percentage of contract cost incurred against the total estimated contract cost is base to  determine the percentage of completion.

The percentage-of-completion method is generally the required method of financial and tax accounting of larger construction companies for long-term contracts. Its justification relies largely on the matching principle in accounting, where revenues and expenses are matched in the applicable accounting period.

The percentage-of-completion method attempts to recognize revenues and gross profit in the applicable periods of construction, and not soley in the period when the construction has been completed, as in the completed contract method. 

The degree of completion of the construction, i.e., the percentage-of-completion, is typically estimated by dividing the total construction costs incurred to date by the total estimated costs of the contract, or job.

% complete = Total construction costs to date/Total estimated costs of contract

Total estimated revenues or gross profit is then multiplied by this percentage of completion to derive the total revenues or gross profit that have been earned to date.

Gross profit to date = % complete X Total estimated gross profit

The journal entry required to recognize the current year's revenues or gross profit is the difference between total revenues or gross profit earned to date less revenues or gross profit recognized in prior years.

Current year's gross profit = Gross profit to date - Gross profit in prior years

  

For eg.

Total contract price of project A is  AED 1,000,000, Period of contract 3 years starting  from 2015. Estimated total cost AED 800,000. Incurred cost up to 2015  AED 300,000 and up to 2016 AED 700,000. Then

Percentage of completion in  2015 =  300,000/800,000 *100 = 37.50%

So corresponding revenue in 2015 = 1,000,000 *37.50% = AED 375,000

Profit  of 2015  = 375,000 - 300,000 = 75,000

Percentage of completion in  2015 =  700,000/800,000 *100 = 87.50%

So corresponding revenue in 2015 = 1,000,000 *87.50% = AED 875,000

Cumulative  Profit of   = 875,000 - 700,000 =     1,75,000

Less: Profit in 2015                                            =    75000

Profit in 2016 (175,000-75,000)                  =      Aed  100,000/-