23 Feb HOW TO COMPUTE PERCENTAGE-OF-COMPLETION for Your Tax Return
As most CFMs know, the PCM calculation is a ratio of two figures: The numerator is the cost incurred on a contract and the denominator is the total estimated cost on that contract. (This is the cost-to-cost method.) Then, that ratio is multiplied by the contract amount to derive the revenue to be recognized.
Revenue recognition is not dependent on, or related to, billings – even though the next step is the comparison of the computed revenue to billings. That comparison is only to adjust the booked revenue based on billings to the PCM-computed revenue.
Calculating the PCM
The PCM is computed on the contract as a whole; line-item PCM is not allowed. There is no difference between a dollar of labor, a dollar of materials, or a dollar of subcontract costs. If the cost is incurred, it’s in the numerator.
However, some items in the contract may require separate accounting. For example, costs related to contingencies, pre-contract expenses, post-completion maintenance, and follow-on contracts are not accounted for in the same manner as other contract costs, and are excluded from the PCM calculation.
The 95% Rule
When a contract is considered complete because: 1) the owner uses the product (beyond testing it) and 2) the contract is at least 95% complete at the end of the year, the PCM calculation can become more complex.
In construction, the percentage-of-completion method (PCM) is required for revenue recognition, unless
certain exceptions apply.
Even if an exception is met for regular tax purposes, the PCM is still required for calculating the AMT’s long-term contract adjustment. So, familiarity with the PCM is essential for all types of contractors and their CFMs.