# Percentage of Completion Method

Course: Income Tax Planning

Lesson 10: Recognition of Expenses, Losses, and Deductions

## Student Question:

Question 5 (below) did not make sense to me. I started out by breaking down by year: 400,000 / 2,100,000 * 3,000,000 and so forth but did not arrive at the correct answer. So, then I tried adding up 3 year: 400 + 650 + 700 / 2100000 * 3,000,000. That wasn’t correct either.

Weiss Enterprises signs a $3 million contract in June Year 1 to construct a new office building. The project is scheduled to be completed in March of Year 4 at a cost to Weiss of $2,100,000. Actual costs resulted as follows:

Year 1: $400,000

Year 2: $650,000

Year 3: $700,000

Year 4: $350,000

Using the percentage of completion method, how much gross profit will Weiss Enterprises report in Year 3?

$0$50,000$300,000$400,000Weiss Enterprise cannot use the percentage of completion method

Could you help me arrive at the correct answer?

Thanks,

*Laura*

## Instructor Response:

Hi Laura,

The percentage of completion method for accounting for long term contracts can be counter-intuitive.

We need to know two things to recognize profits in any one year.

- How much of the contract was completed in the current year, and
- The total estimated gross profit for the contract.

**We determine % complete by determining % of total costs expended in the current year.**

- We know that estimated total costs for the entire contract equals $2.1MM and we know that $700M in costs were incurred in Year 3.
- Dividing the latter by the former tells us that the contract was 33% completed in Year 3.

**We know that the estimated gross profit for the entire contract is $900,000 ($3MM – 2.1MM).**

- We multiply 33% by $900,000 to arrive at $300,000 in recognized gross profit.

Let me know how fully this answers your question.

Have a great weekend.

*Bruce*