A lot of contractors recognize revenue after every billing. Meaning, the entire amount of that progress billing you just sent out for $100,000 shows up as revenue on your income statement (P&L). Whether it’s a progress billing for a construction project, an invoice for service and maintenance, or cash received without an invoice, it’s all revenue to you when you record it. You may know right off the bat that you fit into that category. If you have doubts, pull up your general ledger detail for your revenue account(s) and see what’s in there. If all you see are invoices and maybe some adjustments to billings, you’re a part of the club.
Now what does it all mean? The method you are using doesn’t take into consideration your obligations to the project owner. You owe the owner a building. Sure, you may have incurred costs, but it never factors into how much revenue you’re recognizing. Just because you billed the project owner $100,000 doesn’t mean that money is free and clear. You have to earn it. And how do you earn it? By working towards the completion of a building. AKA incurring costs like material, labor, subcontract costs to construct a building little by little.
Now, the way you do that is to recognize revenue on the percentage of completion basis. The percentage of completion method to recognize revenue takes into consideration your incurred costs as a percentage of the total estimated costs on the project and your estimated gross profit. The idea behind this is to stabilize how much revenue recognize throughout the life of the project to avoid significant swings in revenue recognition. Balance is key here.
If you’re looking to take on larger projects through bonded work, you’ve got some work to do. You’ll want to work towards recognizing revenue on the percentage of completion basis.
Path to percentage of completion (WIP).
Start with the following lessons on reconciling your contract activity to your books:
Once you’ve got that down, you can start the lessons on WIP:
Feel free to reach out with any questions!