There are several different acceptable methods for recognizing revenue for long-term contract sales: percentage of completion, installment sales, cost recovery method, and completed contract method. The most preferred method is percentage of completion, if the information is readily available. Before I explain how this works, here’s what you need to know about the percentage of completion method.
- Definitive contract terms and price;
- The customer that is expected to pay the entire amount of the contract, especially for construction projects. For long-term service or consulting projects, this is less of a concern;
- Date the project is expected to be completed by the vendor. Again, this is a concern usually for construction projects, but should always be taken into consideration;
- A way of evaluating the progress of the project.
If all these things are easily defined and likely, you are allowed to use the percentage of completion method to recognize revenue on long-term contracts. This method it simple, it says that you are allowed to recognize revenue based on how much cost has been incurred on the project. For example, if you have spent 25% of your projected cost, you can recognize 25% of the revenue. This is where it is important to have a reasonable method of evaluating the progress of a project.
There isn’t one specific way to evaluate progress on a project. It helps to have historical examples and experience to base your evaluation. For servicing or consulting projects, a great way to evaluate is based on hours. Estimated hours for completion of the entire project are used when determining what percentage has been completed. However, this can be tricky. You want to make sure that our estimated hours are reasonable; otherwise, you can have a very unfavorable result when the project is completed because you have underestimated the hours. Keep in mind that you can revise your estimate as the project progresses and you find that it will take more or possibly fewer hours than originally estimated. That can cause a favorable or unfavorable impact on your project margin in the current period, so it is very important to carefully evaluate what it takes to complete a project before you start. There are other methods evaluating based on things like predetermined milestones. It is up to you to figure out what is a fair representative of your business and projects.
To help figure out how to implement this kind of accounting, call your TGG account expert today.Written by: Ashley Peth TGG Accounting