Percentage of Completion and Work in Progress
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The Revenue Principle of GAAP requires Revenue to be recorded in the period it is Earned regardless of when it is billed or when cash is received.
In some cases, it is simple to determine the timing for Revenues Earned, once ownership of a product is transferred or a service is complete, revenue is considered to have been earned. But if revenue recognition were delayed until the end of a long term contract, the Matching Principle of tying revenues and their direct costs to each other would be violated. The solution to this problem is the Percentage of Completion method of Revenue Recognition.
Contract Revenues are tied to Costs, but Billings on Contracts are not always tied to Costs. Sometimes elements of a contract are billed in advance or sometimes they are delayed by mutual agreement (or disagreement). This mismatch between actual billed revenue and earned revenue will require an adjusting entry but since the Percentage of Completion method adjusts billed revenue to reflect earned revenue, billings are posted to revenues and adjusted later to reflect the correct earned revenue amount. (Debit Accounts Receivable, Credit Sales).
Long Term Contracts will have estimates for both sides of a contract, Costs and Revenues. Calculating Percentage of Completion requires both total actual and total estimated numbers to calculate a percentage so it uses the side where both the actual and estimated numbers can be known, Costs.
- Percent Complete = Actual Costs to Date / Total Estimated Costs
The Percent Complete is then applied to the Total Estimated Revenue to determine Earned Revenue to Date.
- Earned Revenue to Date = Percent Complete * Total Estimated Revenue
Finally, the Earned Revenue to Date is compared to the Billings on Contract to Date. The difference is either added to or subtracted from the Revenue.
- Total Billings on Contract - Earned Revenue to Date = Over/Under Billed Revenue
**The Over/Under Billed Revenue accounts are Balance Sheet Accounts and they are often called either Billings in Excess of Costs (liability account that reflects over-billings) or Costs in Excess of Billings (asset account that reflects under-billings).
Work In Progress Statement:
A Work in Progress Statement is used to compile the information necessary for the percentage of completion calculations but also to provide crucial information about the total value and progress of work on hand inventory.
| Description | Contract Value | Actual Billings to Date | Actual Costs to Date | Total Est. Costs | Est. Costs to Complete | Estimated Gross Profit | % Complete | Earned Revenue to Date | Over Billings | Under Billings |
| Contract A | 50,000 | 35,000 | 30,000 | 40,000 | 10,000 | 10,000 | 75% | 37,500 | … | 2,500 |
| Contract B | 52,500 | 27,500 | 22,500 | 45,000 | 30,000 | 7,500 | 50% | 26,250 | 1,250 | … |
| Totals | 102,500 | 62,500 | 52,500 | 85,000 | 40,000 | 17,500 | 62% | 63,750 | 1,250 | 2,500 |
| 1,250 |
So, for Contract A
- Percentage Complete = 30,000 / 40,000 = .75
- Earned Revenue = 50,000 * .75 = 37,500
- Over/Under Billings = 37,500 - 35,000 = 2,500 (Under-Billed)
Entries to record Over/Under Billings:
| Account | Description | Debits | Credits |
| 1250 | Costs in Excess of Billings | $2,500 | |
| 2050 | Billings in Excess of Costs | $1,250 | |
| 4000 | Sales | $1,250 | |
| $2,500 | $2,500 |
What if there were prior balances in the Costs and Billings in Excess Accounts?
The amounts from Work in Progress Statement are either Total Estimates or Total Amounts to Date. This means that the over/under amounts are also total to date amounts. Over/Under adjustment entries are made to adjust total numbers to their “To Date” amounts. If there were previous entries, there would also be previous balances in the Costs/Billings in excess accounts. New entries should bring their balances to the new “To Date” amounts.
Assume that the Costs in Excess of Billings account had a previous balance of 1,000 and the Billings in Excess of Costs account had a previous balance of 500. The net prior amount is Costs in Excess of 500 meaning that earned revenue has already been adjusted for that 500 and only requires an additional adjustment of 1,250 - 500 = 750. Instead of the entries listed above, the entries to adjust Earned Revenue in this case would be.
| Account | Description | Debits | Credits |
| 2050 | Billings in Excess of Costs | $500 | |
| 1250 | Costs in Excess of Billings | $2,500 | |
| 1250 | Costs in Excess of Billings | $1,000 | |
| 2050 | Billings in Excess of Costs | $1,250 | |
| 4000 | Sales | $750 | |
| $3,000 | $3,000 |
Notice that I completely removed the previous balances from both the Costs and Billings in Excess Accounts instead of just making net entries to bring them up to the current balance. This creates a good audit trail for future account analysis.
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**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.