It is important to recognize revenues and gross profit in the period in which the activity occurred, but this in not always possible with construction contracts that take more than a year to complete. In contrast to the completed contract method -- which allows the deferral of revenues and gross profit until the project is completed -- the percentage-of-completion method allows businesses to record a percentage of the revenues and expenses based on the total cost estimate of the project.

Calculating Percentage Completed

Project completion is based on an estimate of the total costs associated with a particular project. The percentage complete is therefore equal to the total actual construction costs divided by the total estimated construction costs. Total estimated gross profit is then calculated by multiplying the percentage completed by the total estimated gross profit.

Percentage Complete Example

Assume your company is working on a project with an estimated total cost of $100,000. The contract is expected to last for three years. The actual costs to date total $20,000. The percentage complete is calculated by dividing the total actual costs by the expected total costs -- $20,000 by $100,000 -- which is 20 percent. Gross profit is then calculated by multiplying the percentage complete by the total estimated gross profit, which is $300,000. The gross profit to record is $60,000 -- 20 percent of $300,000.

Journal Entries

To record the dual entry in year 1, you will need to record two balancing entries for a total of four line items: one balancing entry for accumulated costs or accounts payable, with a balancing line item for construction costs, and one balancing entry for accumulated sales or accounts receivable, with a balancing line item for revenue in progress. In this example, the accumulated costs are $20,000 and the estimated sales for the year are $60,000.

Construction Costs: $20,000 Accounts Payable (or Cash): $20,000

Sales are posted using a contra asset account that tracks construction costs.

Construction Accounts Receivable: $60,000 Revenue in progress: $60,000

Determining Incremental Gross Profit

If the project is 60 percent complete in year 2 it means an additional 40 percent of the project has been completed. The percentage complete is calculated again by dividing the total actual costs by the expected total costs -- $40,000 by $100,000 -- which is 40 percent. Gross profit is then calculated by multiplying the percentage complete by the total estimated gross profit, which is $300,000. The gross profit to record is $120,000 -- 40 percent of $300,000.

In the final year -- year 3 -- 100 percent of the project is completed and the remaining 40 percent of gross profit is recorded. Gross profit is calculated by multiplying the remaining percentage completed by the total estimated gross profit, which is $300,000. The gross profit to record is $120,000 -- 40 percent of $300,000.