Percentage of Completion vs. Completed Contract: Construction Revenue Recognition Explained
Revenue recognition is the accounting rule that determines when a company can record revenue on its books. For most businesses, the rule is simple: recognize revenue when a product is delivered or a service is rendered. Construction doesn't fit that pattern. A general contractor building an office building over 24 months doesn't deliver anything until substantial completion. Applying the simple rule literally would mean no revenue for 23 months and a giant revenue spike in month 24, which is useless for investors, lenders, and the construction company itself.
Two accepted methods solve this problem: percentage of completion (PoC) and completed contract. Both have been foundational to construction accounting for decades. ASC 606 — the revenue recognition standard that took effect in 2018 — largely preserved the PoC concept while changing some of the mechanics. Understanding both methods and how they differ is essential for anyone working in construction finance or AP.
The percentage of completion method recognizes revenue and expenses on long-term contracts as the work progresses, based on the percentage of the project that has been completed at the reporting date. If the project is 40% complete at quarter end, 40% of the total contract revenue and 40% of the estimated total cost have been recognized through that date.
The standard formula for percent complete is 'cost-to-cost': actual costs incurred to date divided by total estimated costs at completion. A project with $2M of actual costs against a $5M total estimate is 40% complete. 40% of the contract revenue ($10M contract × 40% = $4M) is recognized as earned revenue to date. 40% of the estimated costs ($5M × 40% = $2M — equal to the actuals) is recognized as cost of revenue to date. The resulting gross profit is $2M at this point of the project.
Cost-to-cost is not the only way to measure percent complete. Some contracts use units-of-delivery, labor hours, or physical progress observations. Cost-to-cost is the most common because it's objective and flows naturally from job cost data, but it can produce misleading results if the cost structure front-loads material or back-loads labor relative to physical progress.
Completed contract recognizes revenue and costs only when the project is substantially complete. Throughout construction, costs accumulate on the balance sheet as construction in progress and billings accumulate as customer deposits or advance billings. At substantial completion, the entire contract revenue and the entire accumulated cost flip to the income statement in a single period.
Under US GAAP, completed contract is only allowed in limited situations — typically short-duration contracts (under one year) or contracts where the outcome can't be reliably estimated. The method is far more common for tax purposes, where smaller contractors (with average gross receipts under a certain threshold) can use it under IRC §460 rules, deferring tax on long-term contracts until substantial completion.
ASC 606 (Revenue from Contracts with Customers) replaced the prior revenue recognition rules effective 2018 for public companies and 2019 for most private companies. The new standard is conceptually different — it focuses on performance obligations and control transfer rather than costs and progress — but for most construction contracts, the practical result is similar to traditional percentage of completion.
Under ASC 606, a construction contract typically represents a single performance obligation (building a completed project), and control transfers to the customer over time (rather than at a point in time at the end). Revenue is recognized using an input measure (usually cost-to-cost, mirroring traditional PoC) or an output measure (physical progress, units delivered). The calculation looks a lot like pre-606 PoC because the underlying economics of long-term construction haven't changed.
The choice between PoC and completed contract affects financial statements in ways that matter to lenders, bonding companies, investors, and the company's own operations.
How PoC vs. Completed Contract affects different stakeholders
- Lenders and sureties — PoC shows smoother earnings over time; completed contract shows lumpy, large swings at project completion
- Working capital calculations — PoC builds receivables (contract assets) and customer deposits (contract liabilities) that show the actual state of under/over-billing; completed contract hides this in cost-heavy balance sheet lines
- Tax implications — completed contract defers tax until project completion, which can be a meaningful cash benefit for eligible smaller contractors
- Operational visibility — PoC requires continuous estimate updates and job cost accuracy; completed contract doesn't pressure the accounting to be current
- Bonding capacity — sureties generally prefer PoC because it gives them better visibility into project health during the work
Under PoC, the ratio of actual billings to earned revenue determines whether a project is over-billed or under-billed. Over-billed means the company has billed more than it has earned (billings exceed earned revenue) — the excess becomes a liability on the balance sheet. Under-billed means earned revenue exceeds billings — the difference is an asset.
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Over-billing is sometimes called 'billings in excess of costs' and under-billing is 'costs in excess of billings.' Both are normal. A project that is aggressively billed up front to fund early material purchases may sit over-billed for months; a project where substantial work has been performed but not yet billed may be under-billed at month end. Tracking these balances across the portfolio is central to the WIP report.
Percentage of completion is only as good as the estimate of total costs at completion. Estimates get revised — scope changes, productivity surprises, material price shifts — and when they do, the revenue and gross profit already recognized need to be adjusted to reflect the new percent complete.
The adjustment is handled through a cumulative catch-up. Suppose a project is at $2M actuals against what was thought to be a $4M total cost estimate — so 50% complete. Contract revenue is $8M, so $4M has been recognized. Now the estimate increases to $5M total. The new percent complete is $2M / $5M = 40%. Revenue recognized should be $3.2M ($8M × 40%), not $4M. The difference of $800K is reversed in the current period as negative revenue. This kind of cumulative catch-up is a normal part of PoC accounting and a regular source of earnings volatility.
Under both PoC and completed contract, when a project is forecasted to finish at a loss, the entire projected loss must be recognized immediately — not spread across the remaining duration of the project. This is a conservative accounting principle: losses are booked when they are probable, gains when they are earned. A project that's 30% done with a forecasted $500K loss books the full $500K loss in the current period, not $150K (30% of $500K).
This creates an operational incentive to identify loss projects early. The month a PM realizes that a project is going to lose $500K is the month the $500K loss hits the income statement. Delaying recognition by 'hoping' the project recovers is a form of earnings management that auditors watch for and that sureties pay attention to.
Many construction companies use different methods for book and tax purposes. For book (financial reporting to lenders, sureties, investors), PoC is standard. For tax, smaller contractors under the IRC §460 small contractor exception (average annual gross receipts under the threshold, generally indexed annually) can use completed contract, deferring tax until project completion. The difference between book and tax treatment shows up as deferred tax on the balance sheet.
This dual-method approach is specific to construction and is a meaningful tax-planning lever for eligible contractors. The bonding and banking relationship requires the conservative book treatment; the tax treatment defers cash outflow to the completion of each project.
Percentage of completion is the default and most-used revenue recognition method in construction, because it produces financial statements that meaningfully reflect what's happening on active long-term projects. Completed contract exists as a permitted method in specific situations but is more often used for tax than for book. ASC 606 updated the framework without substantially changing the practical accounting for most construction contracts. The skill is not in choosing the method — the method is largely determined by the company's size and circumstances — but in running either method with the job cost accuracy and estimate discipline that produces reliable results.
Written by
Sarah Blake
Head of Product
Former AP Manager at a $200M construction firm, now leads product at Covinly. Writes about what AP teams actually need from automation — beyond the marketing promises.
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