Contract accounting with milestone billing is a method of tracking and managing project costs and revenues based on the completion of specific milestones. The organization performs work on the project and submits invoices to the client based on these milestones.
Milestone billing can take various forms, such as a percentage of the contract value, an agreed absolute amount, or the quantity delivered at an agreed price.
Direct costs, like labour and materials, and indirect costs, like overhead and administrative expenses, are typically included in contract accounting with milestone billing. These costs are tracked and recorded as a "contract asset" throughout the project's life and allocated to specific milestones when incurred.
When milestones are completed and invoices are sent to the client, the amount invoiced is recognized as revenue and the milestone-specific costs recorded in the contract asset account are transferred to cost of sale.
As an example, a company building custom software for a client could use this method of billing. The agreed-upon milestones include a technical blueprint, written specifications, programming work, User Acceptance Test, and a six-month warranty. Costs are allocated to each milestone as they are incurred, and revenue is recognized as each milestone is achieved.
In conclusion, contract accounting with milestone billing allows for better tracking and management of project costs and revenues. Costs and revenues are tied to specific milestones, which helps ensure project completion and profitability. This approach to revenue recognition complies with accounting standards (IFRS 15)