Under the PC method, contract revenue and costs are recognized periodically over the life of the contract. The percentage of completion existing at any given time should be based on (1) the relationship between the costs incurred to date to the total estimated costs (2) engineering estimates of the work performed to date relative to the total work required or (3) some other measure that is appropriate to the work performed. Interim billings are ordinarily not one of the measures used.

The first method above is the most common approach and the expected profit on the contract is then assigned to each period based on the costs incurred through the end of that period. The problem with this approach is two-fold: it assumes the contractor earns profit as costs are incurred – in effect, each dollar spent produces the same amount of profit – whereas in fact significant up-front dollars may be expended with little or no progress being made toward completing the contract. Secondly, total costs is the denominator and total costs are difficult to estimate. When significant upfront dollars are expended a percentage of completion based on engineering estimates may be superior. Another common method, particularly when there is a high volume of deliverables and not an extensive lead time before deliverables begin, is to use the unit-of-delivery method where sales and costs of sales are measured as units are delivered.

The basic steps for accounting for contracts under the PC method include:

1. Like the CC method, all direct and indirect costs are charged to a work-in-progress account and billing, progress payments and advances are credited to an "advances on work in progress" account.

2. The estimated gross profit earned in each accounting period is charged to the work-in-progress account and credited to realized gross profits in the income statement. Gross profit is calculated under the following formula: Total estimated profit or loss times percentage of completion equals profit or loss recognized to date. When changes to estimates of future costs arise, the necessary adjustments should be made in the year the estimates are revised. For example, assuming estimated total costs for a three year contract to be $4,500,000, incurred cost of $1,125,000 and $3,375,000 in the first two years respectively and estimated gross profit of $500,000 with a change in profit estimate the third year to $450,000:

Year 1 Gross Profit

$1,125,000 X $500,000 = $125,000

$4,500,000

Year 2 Gross Profit

$3,375,000 X $500,000 = $400,000

$4,500,000

Less Year 1 Profit 125,000

275,000

Year 3 Gross Profit

Gross Profit 450,000

Less Prior Years 400,000

50,000

3. An estimated loss on the total contract is recognized immediately in the year it is discovered and any previous gross profit or loss reported in prior years must be deducted from the total estimated loss.

The first three journal entries under the PC method are the same as under the CC method while the PC method recognizes the gross profit as follows:

Year 1

Contracts in progress $125,000

Realized gross profit $125,000

Year 3

Contract in progress 50,000

Realized gross profit 50,000

Billings on contracts

In progress 5,000,000

Contract in progress 5,000,000

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