# Understanding the Percentage of Completion Method: A Guide With Examples

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*— Investopedia / Tara Anand*

## What Is the Percentage of Completion Method?

The percentage of completion method is a widely used [accounting practice](https://www.investopedia.com/terms/a/accountingmethod.asp), particularly in the construction industry, where revenue and expenses are recognized based on the project's progress. This approach stands in contrast to the [completed contract method](https://www.investopedia.com/terms/c/completed-contract-method.asp), deferring final results until a project is finished. By understanding this method, businesses can accurately report financial results throughout the duration of long-term contracts.

### Key Takeaways

*   The percentage of completion method allocates revenues and expenses based on the proportion of work completed on long-term contracts.
*   Unlike the completed contract method, this approach allows for income and expense recognition before the project is fully completed.
*   Construction firms, defense contractors, and software developers with long-term projects widely use this method.
*   The accuracy of revenue recognition under this method depends on reliable cost estimations and assurance of payment.
*   The method has potential for manipulation, evidenced by historical cases of financial misreporting.

## Exploring How the Percentage of Completion Method Works

This method requires reporting revenues and expenses each period based on the contract's completion percentage. [Current income](https://www.investopedia.com/terms/c/currentincome.asp) and expenses are compared to total estimated costs to determine annual [tax liabilit](https://www.investopedia.com/terms/t/taxliability.asp)y. For instance, if a project is 20% complete in year one and 35% in year two, only the additional 15% revenue is recognized in the second year. Income and expenses are recognized incrementally in the income statement, while the balance sheet is treated like the completed contract method.

Two main conditions must be met to use the percentage of completion method. First, collections by the company must be reasonably assured; second, the company must be able to reasonably estimate costs and the rate of project completion.

## Real-World Applications of the Percentage of Completion Method

The percentage of completion accounting method is commonly used by construction firms that are contractors for buildings, energy facilities, public sector infrastructure, and other long-term physical projects. It has also been used by defense contractors (think nuclear submarines or aircraft carriers) and software developers whose projects represent a multi-year commitment of resources. For software developers, the product must be a significant custom-designed project for a client.

Fluor Corporation, a global engineering and construction firm, provides details about its use of the percentage of completion method in its [10-K](https://www.investopedia.com/terms/1/10-k.asp) filing under "Note 1 - Major Accounting Policies" of the notes to the consolidated financial statements. An analyst would learn that changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined by the company. Income recognized in excess of billed amounts is booked as a current asset under "contract work in progress" and billed amounts to clients in excess of income recognized to date are booked as a current liability under "advance billings on contracts."

## Risks and Ethical Considerations of the Percentage of Completion Method

Percentage of completion method is vulnerable to abuse by unethical companies. Those who wish to engage in [creative accounting](https://www.investopedia.com/terms/c/creative-accounting.asp) can easily move around income and expenses from one period to another period, understating or overstating amounts. This game would not be sustainable, however, as Toshiba Corp. discovered in 2015. The infrastructure unit of the Japanese conglomerate understated operating costs by approximately 152 billion yen ($1.2 billion) between 2008 and 2014. Shortly after the scandal broke, the CEO was forced to resign, and half the Board of Directors stepped down.

## The Bottom Line

The percentage of completion method is a prevalent accounting practice for industries with long-term contracts, such as construction, as it provides a real-time reflection of revenues and expenses based on project progress.

This method requires assured payment and a reliable estimation of completion stages. While it offers transparency and accuracy in financial reporting, it is susceptible to misuse if not correctly managed, as highlighted by past scandals. Companies and analysts must ensure diligence and integrity in applying this method to prevent misleading financial statements.