In most cases, it is simple to determine the timing for Revenues Earned, once ownership of a product is transferred or a service is complete, revenue is considered to have been earned. But if revenue recognition is delayed until the end of a long term contract, the Matching Principle of tying revenues and their direct costs can be challenging. The solution to this problem is the Percentage or Unit of Complete Method of Revenue Recognition.
Contract Revenues are tied to Costs, but Billings on Contracts are not always tied to Costs. Sometimes elements of a contract are billed in advance or sometimes they are delayed by mutual agreement (or disagreement). This mismatch between actual billed revenue and earned revenue will require an adjusting entry but since the Percentage or Unit of Complete Method adjusts billed revenue to reflect earned revenue, billings are posted to revenues and adjusted later to reflect the correct earned revenue amount. (Debit Accounts Receivable, Credit Sales).
Long Term Contracts will have estimates for both sides of a contract, Costs and Revenues. Calculating Percent or Unit of Complete requires both total actual and total estimated numbers to calculate a percentage so it uses the side where both the actual and estimated numbers can be known, Costs.
Percent Complete = Actual Costs to Date / Total Estimated Costs
The Percent Complete is then applied to the Total Estimated Revenue to determine Earned Revenue to Date.
Earned Revenue to Date = Percent Complete * Total Estimated Revenue
Finally, the Earned Revenue to Date is compared to the Billings on Contract to Date. The difference is either added to or subtracted from the Revenue.
Total Billings on Contract – Earned Revenue to Date = Over/Under Billed Revenue
**The Over/Under Billed Revenue accounts are Balance Sheet Accounts and they are often called either Billings in Excess of Costs (liability account that reflects over-billings) or Costs in Excess of Billings (asset account that reflects under-billings).
Work In Progress Statement:
A Work in Progress Statement is used to compile the information necessary for the percentage of completion calculations but also to provide crucial information about the total value and progress of work completed.
Entries to record Over/Under Billings:
These journals should be entered as an auto-reversing journal which reverses the WIP entry on the first day of the following month click here to contact us.