Finance: What is the percentage of completion method?

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Transcript

00:22

as they relate to long term build projects For example

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Jos Shipbuilding Company Ship Happens agrees to build the SS

00:30

Neuquen ater for the US government for a billion dollars

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It'll take four years to build than the Navy releases

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two hundred fifty million bucks in what become annual revenues

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to ship happens Well Joe's cost to build the ship

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will be eight hundred million box and by the time

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the Neuquen Aitor is built Jo will have made two

00:47

hundred million dollars in operating profit But along the way

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Joe has to figure out how he'll count the beans

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That is how he'll attribute expenses along with the revenues

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that air coming in in blobs Yes and this is

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not easy because he spent a fortune hiring the thousands

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of workers and leasing the dock space and pre ordering

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millions of tons of steel and so on Well if

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he uses the percentage of completion method of accounting well

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then he just figure out the total cost to build

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the ship And if he spent three hundred twenty million

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dollars that first year well then it would be three

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twenty Divided by that eight hundred million or forty percent

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of the total right thirty two over eighty is forty

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So even though only twenty five percent of the time

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has passed I e Only one year out of four

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Joe would recognize forty percent of his total expenses because

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well he's using the percentage of completion method And financially

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the ship is now forty percent complete to this should

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make sense And because we're using this method where expenses

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kind of drive the bus well then at tribute that

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forty percent to the revenues line So he'd recognize forty

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percent of his billion dollars in revenues or four hundred

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million bucks as recognized revenues in Year one to show

01:55

operating profits of well eighty million bucks pretax a percentage

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of completion approached to revenue recognition works well When the

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following is true there are clear and definitive contract terms

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and price The customer will likely pay the full amount

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You have a good idea of when the contract will

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be completed and there's a clear way to identify progress

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Check those four boxes and it's probably percentage of completion 00:02:19.14 --> [endTime] time And yes the crowd goes wild