Percentage-of-Completion method
Encyclopedia
Percentage of completion (PoC) is an accounting method of work-in-progress evaluation, for recording long-term contracts. For such tasks, this is the only method authorized by the International Financial Reporting Standards
(IFRS).
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 inventory account (construction in process), and progress billings are accumulated in a contra inventory account (billing on construction in process).
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.
Now after first year we see that total cost incurred in first year is $3,000. So according to PoC method-
Cost percentage = 3000/10000 = 30%
So we will recognize 30% revenue in first year's income statement.
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz
| Sales >
| Cost of goods style="border-top: 2px solid gray;"
| Profit
from next year, some more complicated part enters in the game
Lets say after completion of the second year, our expected cost changed to 11,000 and our cost to date is 5,500 then
percentage completed = 5,500/11,000 = 50%
Revenue to be recognized = (50% of 12,000) – 3,600 (previously recognized) = 2,400
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz+1
| Sales >
| Cost of goods style="border-top: 2px solid gray;"
| Loss
Now let's say for the next year, our total cost estimation is increased to 15,000 due to increases in raw material and labor costs.
So we know that we are going to incur a loss of 3000 at the end of contract period.
For third year our cost to date reaches 10,500 so according to Poc-
Percentage completion = 10,500/15,000 = 70%
Revenue = 70% of 12,000 – previously recognized = 8,400 – 6,000 = 2,400
However, because we are going to have a total loss of 3,000 on the contract, we must recognize the total loss in the period it is estimated. As a result, our Cost of goods will be 5,900 (total loss recognized because of 500 profit recognized in previous periods [3,500] + Sales [2,400]); we reached this inductively by figuring the Sales and the Loss before the Cost of goods.
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz+2
| Sales >
| Cost of goods style="border-top: 2px solid gray;"
| Loss
In final year, our cost is 4,500 and revenue is 3,600. But we record only 3,600 in Cost of goods because we already recognized the total loss in the last period.
|-
| Sales >
| Cost of goods style="border-top: 2px solid gray;"
| Profit/loss
Total Profit/Loss from the contract = 600-100-3,500= 3,000 Net Loss
International Financial Reporting Standards
International Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....
(IFRS).
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 inventory account (construction in process), and progress billings are accumulated in a contra inventory account (billing on construction in process).
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.
-
the expected length of the contract.
the current period.
Examples
For example lets 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 4 years.Now after first year we see that total cost incurred in first year is $3,000. So according to PoC method-
Cost percentage = 3000/10000 = 30%
So we will recognize 30% revenue in first year's income statement.
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz
| Cost of goods
| Profit
from next year, some more complicated part enters in the game
Lets say after completion of the second year, our expected cost changed to 11,000 and our cost to date is 5,500 then
percentage completed = 5,500/11,000 = 50%
Revenue to be recognized = (50% of 12,000) – 3,600 (previously recognized) = 2,400
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz+1
| Cost of goods
| Loss
Now let's say for the next year, our total cost estimation is increased to 15,000 due to increases in raw material and labor costs.
So we know that we are going to incur a loss of 3000 at the end of contract period.
For third year our cost to date reaches 10,500 so according to Poc-
Percentage completion = 10,500/15,000 = 70%
Revenue = 70% of 12,000 – previously recognized = 8,400 – 6,000 = 2,400
However, because we are going to have a total loss of 3,000 on the contract, we must recognize the total loss in the period it is estimated. As a result, our Cost of goods will be 5,900 (total loss recognized because of 500 profit recognized in previous periods [3,500] + Sales [2,400]); we reached this inductively by figuring the Sales and the Loss before the Cost of goods.
Income statement of AnantPurohit corporation Pvt. Ltd. for the year ended on xx/yy/zzzz+2
| Cost of goods
| Loss
In final year, our cost is 4,500 and revenue is 3,600. But we record only 3,600 in Cost of goods because we already recognized the total loss in the last period.
| Sales >
| Cost of goods
| Profit/loss
Total Profit/Loss from the contract = 600-100-3,500= 3,000 Net Loss