How to recognize revenue in construction Contracts

In order to prepare the income statement for each period, there is a need to identify the relevant sales revenue and related cost to come up with the profit figure. In order to judge how to recognize revenue in construction, there are two methods which are mostly used in the industry:

1. Percentage of Completion Method 

This method is also called PC method and here, the professional surveyor performs his or her survey and provide a report according to the percentage of the completeness. Over this basis, the financial statements are prepared.

2. Completed Contract

Under this method, a construction contract is divided into various points in such a way that these points indicate a certain percentage completion of the project. For example, if the project is for the construction of the residential house, shops, parks, swimming pool, and school etc. Then each of these could be given a certain percentage of completion. At the end of the period, if any one of these gets completed, sales revenue and related cost are recognized in the preparation of the financial statements.

Example

Alpha is a real estate builder and developer. Following details are available for one of  its recent projects:

Total contract value $140 million
Total Cost estimated on the project $80 million
Duration of the project 02 years
The project is 40% complete in first and remaining will be finalized in the last year of the project.

Solution

  Year 1 Year 2
Sales revenue 56 84
Cost of sales (32) (48)
Profit on contract 24 36