Q: I have two companies within the same division. One does petrochemical projects for lump sums, and the other is a construction outfit involved in long-term projects.
I believe that the first business can recognize revenue along the project based on progressive cost spending, and other group can recognize revenue when long-term contract is closed.
Is there any right or wrong practice? Why or why not?
Your question seems to fall under the aegis of SOP 81- 1, “Accounting for Performance of Certain Construction-Type and Certain Production-Type Contracts.”
SOP 81-1 prescribes two methods of accounting for contracts: percentage-of-completion and completed-contract. With the limited information you provide, it appears that you have a division with “lump sum” projects that recognize revenue using the completed-contract method and another division with “progressive cost spending” projects that recognize revenue using the percentage-of-completion method.
The authoritative accounting bodies believe that the percentage-of- completion method is the better method to more accurately represent the matching of costs and expenses over the appropriate periods of time. However, there are two main exceptions where the completed-contract (“lump sum”) method are more appropriate: 1) the results obtained using the completed-contract method don’t differ significantly from the percentage-of-completion method due to the short duration of the project, or 2) the company isn’t able to dependably estimate the cost inputs necessary for calculations under the percentage-of-completion method.
Assuming that these factors are consistent with the situations in your divisions, it is perfectly appropriate to have two types of revenue recognition within one company.
Scott Martin, President & CEO
See previous “Ask the Experts” columns:
Ask the Experts is a weekly column that aims to help finance executives like you find answers to difficult questions.
Submit your questions by E-mailing them to [email protected]. Unfortunately, we cannot answer all questions individually.
While we will enlist professionals to try to answer your questions, Ask the Experts is meant only to create a dialogue on the topics. Consult legal or financial professionals before acting on any of the advice given by our expert panel.