What is attributable profit?

Attributable profit is a special kind of profit. Companies use it for really long projects that take a lot of time to finish. These projects could be things like constructing a big building or creating a new software system. The project usually lasts way longer than one year.

Figuring out attributable profit

To calculate attributable profit, the company looks at how much of the project they’ve already done. Let’s say they’ve finished half of the building. Well, then they can count half of the profit they think they’ll make on the whole project. But they have to subtract how much they think it will cost to complete the rest.

It’s not like regular profit where you just look at the money you made and subtract your costs. With attributable profit, you’re trying to figure out how much profit to “attribute” or assign to the work you did this year. Even though you haven’t finished the project and gotten all the money yet.

Why companies use attributable profit

The reason companies do this is to make their financial reports more accurate. If they have a project that takes five years, they don’t want to show zero profit for four years and then a giant chunk of profit in the fifth year. That wouldn’t give an accurate picture of how the company is doing.

Instead, they attribute some of the profit to each year, based on how much of the project they completed. This helps smooth out their profit over time. It gives a clearer sense of the company’s ongoing performance.

How to calculate attributable profit

Calculating attributable profit can get kind of tricky. You have to make some educated guesses. Here are the basic steps:

Step 1: Estimate the total profit

First, the company has to estimate how much total profit they think they’ll make on the entire project. Let’s say they think they’ll make $1,000,000 in total.

Step 2: Determine the completion percentage

Next, they have to figure out what percentage of the project they’ve completed so far. Maybe they’ve done 60% of the total work.

Step 3: Calculate the attributable profit

Now, they multiply the total estimated profit by the completion percentage. So in this example, it would be:

$1,000,000 x 60% = $600,000

That means the attributable profit so far is $600,000.

Step 4: Subtract estimated remaining costs

But wait, we’re not done yet! The company still has to estimate how much it will cost them to finish the rest of the project. Let’s say they think it will cost another $300,000.

They subtract that from the attributable profit:

$600,000 – $300,000 = $300,000

So the final attributable profit is $300,000. That’s the amount they can put on their financial statements for this year.

The risks of attributable profit

Using attributable profit has some risks. Remember, it’s based on estimates and educated guesses. If those estimates are way off, it can cause problems.

Overestimating profit

One risk is that the company might overestimate how much total profit they’ll make on the project. Maybe they thought they’d make $1,000,000 but they only end up making $800,000.

If they’ve already attributed too much profit to previous years, they might end up having to show a loss later on. That can make their financial statements look really inconsistent.

Underestimating costs

Another risk is underestimating the remaining costs. If the company thinks it will only cost $300,000 to finish the project but it actually costs $500,000, that cuts into their profit.

They might have already reported a higher attributable profit than they should have. Then they have to go back and adjust their numbers later.

Why attributable profit matters

Despite the risks, attributable profit is an important concept in accounting. It helps companies give a more accurate picture of their financial performance, especially for long-term projects.

Better financial reporting

Without attributable profit, companies with long projects would have really erratic-looking financial statements. They might show no profit at all for several years, then a huge spike in profit when the project is done.

That doesn’t really reflect how the company is doing on an ongoing basis. Attributable profit helps smooth that out and give a clearer picture.

Improved decision making

Attributable profit can also help companies make better decisions. By seeing how much profit they’re earning on a project as they go along, they can spot problems earlier.

If the attributable profit is lower than they expected, it might be a sign that the project is going over budget or taking longer than planned. They can then make adjustments before things get too far off track.

Increased transparency

Using attributable profit can also make a company’s financial reporting more transparent. It shows that they’re not just waiting until a project is completely done to recognize the profit.

Instead, they’re giving a more real-time view of their financial performance. This can be reassuring to investors and lenders.

The role of accounting standards

Accounting standards play a big role in how companies calculate and report attributable profit. Different countries and industries may have their own specific rules.

International Financial Reporting Standards (IFRS)

Many countries use IFRS as their accounting standards. IFRS has specific rules for how to recognize revenue and profit on long-term contracts.

Under IFRS, companies generally use the “percentage of completion” method for attributable profit. That’s where they recognize profit based on how much of the project is done, which is what we’ve been talking about.

Generally Accepted Accounting Principles (GAAP)

In the United States, companies follow GAAP. GAAP also has rules for long-term contracts, but they’re a bit different from IFRS.

Under GAAP, companies can choose between the percentage of completion method and the “completed contract” method. With the completed contract method, they don’t recognize any profit until the project is entirely finished.

Industry-specific guidelines

Some industries, like construction or defense contracting, may have their own specific accounting guidelines. These often provide even more detailed rules for how to calculate attributable profit.

Companies have to make sure they’re following the right standards for their situation. Getting it wrong can lead to financial restatements and even legal problems.