Percentage of Completion Method

Yeah, uh...has nothing to do with whether or not Aaron Rodgers is having a good day behind center.

The Percentage of Completion Method is an accounting system that deals with relatively complex methods of figuring out proper attribution of revenues and expenses, usually as they relate to long-term build projects.

For example, Joe’s ship-building company, Ship Happens, agrees to build the SS Nuke-a-nator for the U.S. government for a billion dollars. It’ll take 4 years to build, and the Navy releases 250 million bucks in what will become annual revenues to Ship Happens. Joe’s cost to build the ship will be 800 million bucks, and by the time the Nuke-a-nator is built, Joe will have made 200 million dollars in operating profit.

But along the way, Joe has to figure out how he’ll count the beans. That is, how he’ll attribute expenses. And this is not easy, because he’s spent a fortune hiring the thousands of workers and leasing the dock space and pre-ordering millions of tons of steel, and so on. If he uses the percentage of completion method of accounting, then he’d just figure out his total costs to build the ship, and if he spent 320 million that first year, then it would be 320 divided by 800 million, or 40 percent of the total.

So even though only 25 percent of the time has passed, i.e. one year out of four, Joe would recognize 40 percent of his total expenses...because he's using the percent of completion method. And financially, the ship is now 40% complete. And because we’re using this method, where expenses kind of drive the bus, we’ll then attribute that 40% to the revenues line, so he’d recognize 40% of his billion dollars in revenues, or $400 million, as recognized revenues in Year One...to show operating profits of $80 million, pre-tax.

A percentage of completion approach to revenue recognition works well when the following is true:

1. There are clear and definitive contract terms and price;

2. The customer will likely pay the full amount;

3. You have a good idea of when the contract will be completed; and

4. There’s a clear way to identify progress.

Check those four boxes, and it’s probably percentage of completion time.

And the crowd goes wild.