What Is POC (Percentage of Completion) in Accounting?

Accounting involves systematically recording, summarizing, and analyzing financial transactions to provide a comprehensive view of a company’s financial health. This information is crucial for stakeholders, including investors, creditors, and management, to make informed business decisions.

The Percentage of Completion (POC) method is particularly relevant for businesses engaged in long-term projects. This approach allows companies to report earnings and assess financial performance in alignment with the ongoing progress of extended contracts. The POC method helps ensure that financial statements accurately reflect the company’s current financial standing throughout the duration of a project.

What Percentage of Completion Is

The Percentage of Completion (POC) method is an accounting practice used to recognize revenue and expenses for long-term contracts. Instead of waiting until a project is entirely finished, this method allows businesses to record a portion of the total contract revenue and associated costs over the life of the project.

This approach provides a more accurate representation of a company’s financial performance over time, especially for projects that span multiple accounting periods. It aligns with the accrual basis of accounting, which dictates that revenues should be recognized when earned and expenses when incurred. The matching principle is also supported, as expenses are recognized in the same period as the revenues they helped generate. By applying POC, companies can reflect the financial outcomes of ongoing work, offering a clearer picture of profitability and financial health before a project’s final delivery. This contrasts with methods that defer all revenue and expense recognition until project completion, which can distort financial reporting for lengthy endeavors.

When Percentage of Completion is Used

The Percentage of Completion method is applied to long-term contracts where the outcome can be reliably estimated. This typically includes projects that extend beyond one fiscal year, commonly found in industries like construction, aerospace, defense, and large-scale manufacturing. These projects involve significant financial commitments and extended timelines, making immediate revenue recognition impractical and potentially misleading.

For a company to use the POC method, certain criteria must be met to ensure the reliability of the financial reporting. The business must reliably estimate the total contract revenues and costs associated with the project from its inception. Progress towards completing the contract must also be reliably measurable, often through metrics like costs incurred, work performed, or milestones achieved. If these conditions cannot be reasonably assured, the Percentage of Completion method may not be appropriate.

For example, a company building a large bridge or a complex aircraft would likely use this method. The method helps to avoid a situation where a company appears unprofitable for years, only to show a massive profit in the single year the project concludes. This continuous recognition provides stakeholders with a more consistent and realistic view of the company’s ongoing financial activity.

How Percentage of Completion is Calculated

Calculating the Percentage of Completion involves determining the proportion of work completed during an accounting period, which then dictates the amount of revenue and expenses to recognize. The most common approach for establishing the “percentage of completion” is the cost-to-cost method. This involves comparing the total costs incurred on the project to date against the total estimated costs for the entire project.

For instance, if a project has an estimated total cost of $1,000,000 and the costs incurred to date are $200,000, the project is 20% complete ($200,000 / $1,000,000). Once the percentage of completion is determined, the amount of revenue to be recognized for the current period is calculated. This is done by multiplying the total contract revenue by the percentage of completion, then subtracting any revenue that has already been recognized in prior periods.

To illustrate, consider a contract with a total price of $1,500,000. If the project is 20% complete, the total revenue recognized to date would be $300,000 ($1,500,000 20%). If no revenue was recognized in prior periods, then $300,000 would be recognized in the current period. The expenses to be recognized for the period are typically the actual costs incurred during that specific period.

Presenting Financial Results

When the Percentage of Completion method is applied, the recognized revenue and associated expenses are reported on a company’s income statement. The portion of the total contract revenue earned during a specific period, as determined by the percentage of completion, appears as revenue. Correspondingly, the costs incurred to achieve that percentage of completion are recorded as expenses in the same period.

On the balance sheet, specific accounts are used to manage the financial aspects of these contracts. If the costs incurred plus the recognized profit exceed the amount billed to the customer, a contract asset, often termed “Costs and Estimated Earnings in Excess of Billings,” is reported. This indicates that the company has earned more revenue than it has billed or collected. Conversely, if the billings to the customer surpass the costs incurred plus recognized profit, a contract liability known as “Billings in Excess of Costs and Estimated Earnings” is reported. This represents amounts billed that have not yet been earned.