Percentage-of-completion accounting and performance obligation revenue recognition are 2 construction industry tools for calculating total estimated revenue.
In the construction industry, time is money. As professionals, contractors provide clients with key deliverables over a specified timeline, basing costs on the number of resources necessary to complete the job. Therefore, determining when you’ve ‘earned your pay’ is a key component of recognizing and documenting revenue to avoid potential budgeting issues.
One of the recent changes in construction site budgeting is the introduction of performance obligation revenue recognition, which means that when using the percentage-of-completion accounting method, you must separate revenues and expenses and only recognize revenues that occur as the transfer of goods or services to your client.
So why is using the percentage-of-completion accounting method important?
Sureties require financial statements based on this method for bonding purposes because it recognizes revenue as progress is made toward contract completion. This method is especially preferable when the following criteria are met:
- Estimates are dependable
- The contract clearly specifies a party’s rights and obligations
- The owner can be expected to satisfy contractual obligations
- The contractor can be expected to satisfy contractual obligations
Recognizing Revenue: Billed + WIP
Using a billed plus WIP (work in progress) approach, contractors can recognize revenue based on what was invoiced to customers as well as work that was performed on projects that is “chargeable” but not yet invoiced. This allows contractors to recognize revenue for additional services as they’re performed, provides project managers with visibility into the amount of time that’s passed between billing cycles, and allows owners to review all work in progress before billing.
While this method is often employed by midsized to large firms with experienced accounting teams and project managers, it also works well for firms that perform large amounts of time-and-expense work for their customers or who can bill projects on a consistent basis and bill relatively close to their actual percentage-of-completion.
Implementing the right systems and tools can help you make adjustments when necessary to avoid costly mistakes. For more information about Cabbage’s solutions and services, contact us today.