Are you a construction firm struggling to accurately reflect project profitability over several months? Is your law firm finding it challenging to track revenue on those drawn-out contingency cases? Or perhaps you’re in property management and need a clearer view of the financials during major renovations? The percentage of completion method offers a solution. NorthStar Bookkeeping specializes in guiding businesses in Orange County, CA, and across the United States, through the complexities of this accounting method, ensuring financial clarity and strategic advantage.
Why the Percentage of Completion Method Matters
The percentage of completion method is essential because it provides a more accurate representation of a company’s financial performance on long-term projects. Instead of waiting until a project is finished to recognize revenue and expenses, this method allows businesses to recognize them progressively as the project advances.
This approach offers several benefits:
- Accurate Financial Reporting: By recognizing revenue and expenses throughout the project, businesses can avoid significant fluctuations in their financial statements. This leads to more stable and reliable reporting.
- Improved Decision-Making: The percentage of completion method provides a clearer picture of the project’s profitability in real-time, enabling better decision-making during the project lifecycle.
- Enhanced Transparency: This method offers greater transparency to stakeholders, including investors, lenders, and clients, as it provides a more detailed view of the project’s financial status.
“The percentage of completion method is not just an accounting procedure; it’s a strategic tool that offers insights into the financial trajectory of your long-term projects,” says Heather Kirstein, co-owner of NorthStar Bookkeeping. “It allows businesses to make informed decisions proactively, rather than reactively.”
Here are a few examples of industries where Northstar Bookkeeping monitors Percentage of Completion.
Construction Accounting
In the construction industry, projects often take months or even years to complete. The percentage of completion method is widely used here due to its ability to match revenue and expenses in the periods they are incurred. This is in line with the GAAP principle that expenses should be matched with the revenues they help to generate, ensuring that financial statements accurately reflect the costs associated with specific projects during the same period revenue is recognized.
Here’s how it works in construction:
- Cost Estimation: At the start of a project, the total estimated costs are determined.
- Progress Measurement: The project’s progress is measured regularly, often based on costs incurred to date compared to total estimated costs, or by engineering estimates of work completed.
- Revenue Recognition: Revenue is recognized based on the percentage of the project that is complete. For example, if a project is 50% complete, 50% of the total revenue is recognized.
- Expense Recognition: Expenses are also recognized in the same period as the revenue, ensuring that the income statement accurately reflects the project’s profitability.
“For construction companies, the percentage of completion method aligns financial reporting with the actual work being performed,” says Paul Yee, co-owner of NorthStar Bookkeeping. “This not only provides a realistic view of profitability but also aids in managing cash flow and project budgets effectively.”
NorthStar Bookkeeping specializes in GAAP construction accounting, offering expertise to construction firms looking for reliable financial guidance and accurate reporting. If you’re a construction firm seeking assistance with GAAP compliance, call us today at (714) 608-1526.
Law Firm Accounting
While it might not be as obvious, the percentage of completion method can also be applicable to law firms, especially those handling long-term cases such as:
- Contingency Fee Cases: In cases where the law firm’s fee is contingent on a successful outcome, the percentage of completion method can be used to recognize revenue as the case progresses.
- Complex Litigation: Large, complex litigation cases can take years to resolve. Recognizing revenue and expenses as the case develops provides a more accurate picture of the firm’s financial status.
Here’s how it can be applied:
- Effort Measurement: Instead of measuring costs, law firms might measure the effort expended on a case, such as billable hours or milestones achieved.
- Revenue Recognition: Revenue is recognized in proportion to the effort expended. For example, if a firm has completed 70% of the anticipated work on a case, 70% of the expected fee could be recognized.
- Expense Recognition: Expenses related to the case, such as research costs and court fees, are recognized in the same period.
“For law firms, the percentage of completion method brings a level of financial predictability to what can often be unpredictable revenue streams,” says Kirstein. “It ensures that the firm’s financial statements reflect the ongoing effort and investment in these long-term cases.”
Property Management Accounting
Property management companies also deal with long-term contracts and ongoing services, making the percentage of completion method relevant in certain situations. While the core revenue stream in property management is often recurring (e.g., monthly management fees), specific projects or services can benefit from this method:
- Long-Term Renovation Projects: If a property management company oversees a long-term renovation or rehabilitation project on a property, the percentage of completion method can be used to recognize revenue and expenses as the project progresses.
- Contract-Based Services: For property management companies that offer contract-based services, such as long-term maintenance agreements, the percentage of completion method can provide a clear view of the financial performance of these contracts.
Here’s how it applies:
- Project Milestones: Progress can be measured based on achieving specific milestones in the renovation or service contract.
- Cost Tracking: Costs associated with the project or service are tracked to ensure accurate expense recognition.
- Revenue and Expense Recognition: Revenue and expenses are recognized in alignment with the project’s progress, providing a real-time view of profitability.
“In property management, applying the percentage of completion method to specific long-term projects brings financial clarity to what can be complex undertakings,” says Yee. “It allows property management firms to monitor profitability and make informed decisions throughout the project’s duration, ensuring financial stability and success.”
NorthStar Bookkeeping specializes in setting up and managing property management charts of accounts. To learn more about how we can streamline your property management accounting, give us a call at (714) 608-1526.
Key Considerations
While the percentage of completion method offers many benefits, it’s essential to consider a few key factors:
- Accurate Estimates: The accuracy of this method depends heavily on the reliability of cost and revenue estimates. Businesses must have robust systems in place for project estimation and tracking.
Consistent Application: Consistency is crucial. Once a business chooses to use the percentage of completion method, it should be applied consistently across all similar projects. - GAAP Compliance: The application of the percentage of completion method must comply with Generally Accepted Accounting Principles (GAAP) to ensure financial statements are accurate and reliable.
Violating GAAP can lead to adverse outcomes for firms, including financial restatements, regulatory scrutiny, and damaged investor confidence.
Ensuring Financial Integrity
The percentage of completion method is a powerful tool for businesses in construction, law, property management, and other industries dealing with long-term contracts. It provides accurate financial reporting, aids in decision-making, and enhances transparency. However, it requires careful implementation and adherence to accounting standards.
“The percentage of completion method, when applied correctly, is more than just an accounting practice; it’s a reflection of a company’s commitment to financial integrity,” says Kirstein. “It ensures that stakeholders have a clear and reliable view of the company’s financial health, fostering trust and confidence.”
For businesses looking to navigate the complexities of the percentage of completion method and ensure their financial practices are compliant and effective, partnering with experts is essential.
NorthStar Bookkeeping serves law firms, construction companies, and property management firms in Orange County, CA, and across the United States. By entrusting your bookkeeping and back-end administration to a responsive and responsible partner, you’ll free up your working hours for the tasks that only you can do. Contact us to talk about outsourced bookkeeping for your business.