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Percentage-of-completion accounting for construction recognizes revenue as qualifying work is performed, rather than simply when invoices are sent or cash is collected. In U.S. financial reporting, the familiar term describes a common way to apply ASC 606’s over-time revenue framework: first determine that the performance obligation qualifies for over-time recognition, then measure progress with a method that faithfully depicts the work transferred to the customer. Cost-to-cost is common, but it is not automatic for every job.
The distinction matters because recognized revenue can be higher or lower than billings, and because revised cost estimates can change the completion percentage and reported revenue. Federal income-tax accounting is a separate analysis: long-term contracts are generally subject to the percentage-of-completion method under IRC section 460, subject to specific exceptions.
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Percentage-of-completion accounting is a way to recognize revenue over the period a contractor performs work, when the contract’s performance obligation meets the applicable over-time recognition criteria. It connects revenue to progress on the job instead of treating the invoice schedule, payment schedule, or project finish date as the measure of performance.
The phrase remains common in construction, but it should not be mistaken for a stand-alone, all-purpose current GAAP rule. Under ASC 606, a contractor evaluates the customer contract and its performance obligations, determines the transaction price, and decides whether an obligation is satisfied over time. If it is, the contractor selects a measure of progress that depicts its performance in transferring the promised goods or services. Cost-to-cost is one common input method; an output measure, such as an engineering assessment, may be appropriate in some circumstances. CBIZ’s construction accounting overview and Deloitte’s discussion of measuring progress under ASC 606 explain the financial-reporting context.
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That distinction prevents a common mistake: assuming every construction project qualifies for over-time revenue recognition, or that a calculation based on costs is valid just because it is easy to produce. The method and its inputs must represent actual progress under the accounting framework.
How does the cost-to-cost calculation work?
In a cost-to-cost input method, a contractor compares eligible costs incurred so far with its latest estimate of total eligible contract costs. The resulting percentage is applied to the transaction price allocated to the performance obligation to calculate cumulative revenue.
Percent complete = cumulative eligible costs incurred to date ÷ latest estimated total eligible contract costs
Cumulative revenue = percent complete × transaction price allocated to the performance obligation
Current-period revenue = current cumulative revenue − revenue recognized in prior periods
For example, suppose a qualifying performance obligation has a $3 million transaction price and the latest estimate of eligible total costs is $2 million. If $1 million of eligible costs has been incurred, the cost-to-cost calculation indicates 50% progress. Cumulative revenue would be $1.5 million: 50% multiplied by $3 million. If the contractor had already recognized $900,000 in an earlier period, current-period revenue under this calculation would be $600,000, bringing cumulative recognized revenue to $1.5 million.
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The calculation is cumulative. It is not a new percentage applied independently to each month’s costs, and it does not mean that current-period revenue equals current-period costs. The contractor compares progress to date with the latest total-cost estimate, calculates the revenue that should have been recognized through the reporting date, then subtracts amounts recognized in prior periods.
Cost-to-cost is an input measure: resources consumed are used as an indicator of performance. That makes the cost base and cost-to-complete estimate consequential. Under ASC 606, costs that do not depict performance may need adjustment; including every cost mechanically can make the calculation overstate or understate the work transferred. A contractor should be able to explain why the costs included in the numerator and denominator represent progress on the relevant performance obligation.
Why can recognized revenue differ from billings?
Revenue recognition measures performance; billings follow the contract’s invoicing schedule. Those schedules can diverge while both sets of records are correct. A billing milestone may arrive before or after the contractor has performed the corresponding share of the work.
The IRS illustrates the difference in Publication 5522, its Construction Industry Audit Technique Guide. In the example, the contract’s estimated price is $3,000,000, estimated total costs are $2,000,000, Year 1 costs are $1,000,000, and Year 1 billings are $1,200,000. The cost-based completion factor is 50% ($1,000,000 divided by $2,000,000). Applying that factor to the contract price produces $1,500,000 of cumulative income under the example’s percentage-of-completion calculation. Because that amount exceeds the $1,200,000 billed, the example shows $300,000 of costs and estimated earnings in excess of billings.
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- Recognized revenue exceeds billings: the contractor has performed work for which it has not yet billed an equivalent amount. Depending on the contract terms and presentation requirements, the balance may be a contract asset. The older label used in the IRS example is “Costs and Estimated Earnings in Excess of Billings.”
- Billings exceed recognized revenue: the customer has been billed more than the revenue recognized for performance to date. This commonly results in a contract liability, sometimes described in older construction schedules as “Billings in Excess of Costs and Estimated Earnings.”
Neither balance should be interpreted by its label alone. An underbilling is not automatically an unconditional receivable: the contractor must consider whether its right to payment is conditional and apply the relevant balance-sheet presentation rules. Likewise, an overbilling does not mean the contractor has already earned all the revenue billed. The balances reflect different timing between performance and billing.
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What happens when the estimated total cost changes?
Because the denominator is the latest estimated total eligible cost, a revised forecast can change the completion percentage and cumulative revenue even if costs incurred to date and billings do not change. That is why a percentage-complete schedule is only as dependable as the job-cost information and cost-to-complete estimate behind it.
Suppose costs incurred remain $1 million, but the estimate of eligible total costs rises from $2 million to $2.5 million. The cost-to-cost percentage falls from 50% to 40%. With the same $3 million transaction price, the revised cumulative revenue calculation would be $1.2 million rather than $1.5 million. Conversely, a lower estimate of total costs can increase the measured percentage. The example isolates the formula’s effect; it is not a claim about how any particular contract’s full accounting should be adjusted.
In practice, cost forecasts may change as project facts develop. The contractor should update its estimate regularly, investigate significant movements, and retain support for the assumptions and cost categories used. If the estimate is stale, the calculation may report progress that no longer matches the project. If the cost base includes items that do not depict performance, the percentage may also be misleading even if the arithmetic is correct.
A revised percentage is not the same thing as a change in billings, nor does it automatically settle what the customer owes. Keep cost estimates, revenue calculations, invoices, collections, and contract asset or liability balances distinguishable in the project records.
Does every construction contract use percentage-of-completion for GAAP?
No. A contractor must first assess the contract and performance obligation under ASC 606, including whether the obligation qualifies for over-time recognition. If it does, the selected input or output method must faithfully depict the transfer of work to the customer. The familiar percentage-of-completion calculation is not a shortcut around those judgments.
Cost-to-cost may be a useful measure where eligible costs track the contractor’s performance. But the method can misstate progress if costs are incurred before corresponding work is transferred or otherwise fail to represent performance. In that case, the contractor needs to consider whether the input measure should be adjusted or whether another measure, such as an output method, better depicts progress. OpenStax’s explanation of revenue recognition for long-term projects introduces cost-based and engineering-estimate approaches, while Deloitte’s ASC 606 discussion addresses the requirement to measure progress appropriately.
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The accounting analysis also involves more than multiplying a percentage by a contract amount. The contractor considers the performance obligations, transaction price, variable consideration, contract modifications, contract assets and liabilities, and required disclosures. Amounts such as retainages, reimbursements, and contingent compensation can require analysis. Tax rules for those amounts should not simply be imported into the GAAP transaction-price calculation.
How is federal tax percentage-of-completion different?
Federal tax accounting has its own rules and purpose. Treasury Regulation §1.460-4 generally applies the percentage-of-completion method (PCM) to long-term contracts, with specific contract and taxpayer exceptions. The regulation describes the tax completion factor as allocable contract costs incurred divided by estimated total allocable contract costs, then applies that factor to the contract price to determine cumulative gross receipts. Current-year gross receipts are derived by subtracting the preceding year’s cumulative amount.
The regulation states: “The percentage of completion must be determined by comparing allocable contract costs incurred with estimated total allocable contract costs.” See 26 CFR §1.460-4. This tax calculation resembles cost-to-cost financial reporting, but resemblance does not make the regimes interchangeable. They can use different definitions, contract rules, and purposes.
The regulation also describes methods available for certain exempt construction contracts, including the completed-contract method and other permitted approaches in specified circumstances. That is not a blanket election for every construction business. Whether an exception applies depends on the taxpayer and contract facts, so a contractor should not choose a tax method based only on a financial-statement schedule or a general description of “construction accounting.”
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Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.What should a contractor keep in its records?
A useful project accounting process makes it possible to explain both the progress calculation and the difference between revenue and billings. The exact documentation depends on the contract and accounting policies, but the records should support the judgments that drive the reported result.
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- Identify the accounting question. Distinguish financial reporting under ASC 606 from federal income-tax accounting under section 460. Do not assume a conclusion for one regime answers the other.
- Support the over-time conclusion. Document the contract and performance-obligation analysis rather than assuming that a construction label automatically determines the treatment.
- Define the measure of progress. Record why cost-to-cost or another input/output measure depicts performance for the obligation being accounted for.
- Support eligible costs and total-cost estimates. Maintain job-cost detail and a current estimate to complete, with explanations for material changes and for items excluded or adjusted because they do not depict progress.
- Reconcile cumulative revenue to prior periods. Apply the current completion measure to the relevant transaction price, then subtract revenue already recognized to derive current-period revenue.
- Reconcile revenue to invoices and contract balances. Track billings separately, identify contract asset or liability positions as appropriate, and assess whether any right to payment is conditional.
- Review tax treatment independently. Check the current regulation and IRS guidance for the contract and tax year, including whether a specific exception applies.
This structure helps answer practical questions such as “Why does the revenue schedule not equal billings?” or “What exactly does this liability represent?” A liability balance generally reflects billing ahead of recognized performance, not a separate measure of project loss or cash owed to the contractor. Its precise accounting meaning depends on the underlying contract rights and applicable presentation rules.
What are the most common percentage-of-completion mistakes?
The most damaging errors usually come from treating a useful calculation as a substitute for accounting judgment.
- Using percent billed or percent collected as percent complete. Invoices and receipts measure billing and cash timing, not necessarily performance.
- Assuming every construction contract qualifies for over-time recognition. The ASC 606 analysis comes first; the label “percentage of completion” does not make the conclusion automatic.
- Including every cost without evaluating what it represents. An input measure needs to depict performance, so cost eligibility and possible adjustments matter.
- Leaving the total-cost estimate unchanged as the job evolves. An outdated denominator can distort the completion factor and cumulative revenue.
- Calling an underbilling a receivable or an overbilling earned revenue without analysis. Contract asset and liability classification depends on the nature and conditionality of the payment right as well as applicable presentation requirements.
- Using one schedule as both GAAP and tax accounting. Financial reporting and federal tax rules differ, and tax exceptions are specific rather than universal.
Percentage-of-completion accounting is most useful when the contractor treats it as a disciplined estimate of performance: establish the applicable accounting model, select a faithful progress measure, keep cost forecasts current, and keep revenue separate from billing activity. The resulting schedule can explain project performance and timing differences, but it cannot replace the contract analysis or a separate review of tax rules.
Frequently Asked Questions
Does percentage-of-completion accounting mean the contractor has collected that percentage of the contract price?
No. The completion factor concerns measured performance, while collections reflect cash received. A customer may pay ahead of or behind performance, so a cash report alone cannot establish revenue recognized to date.
Can a contractor use its tax percentage-complete calculation for its financial statements?
Not automatically. Tax and financial reporting use related-looking calculations for different purposes and may define costs, contract price, and exceptions differently. A schedule can be a starting source of project data, but each regime needs its own accounting conclusion.
What does a contract liability say about the customer’s payment?
It indicates that the contractor has billed or received consideration ahead of the revenue recognized for performance, subject to the applicable contract-balance rules. It does not, by itself, show that the customer owes no further amount or that the contractor has performed the billed work.
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Is the $31 million IRS threshold a general cutoff for small construction companies?
No. The December 2025 Form 8697 instructions tie that amount to a specified 2025 average-annual-gross-receipts test. It should not be treated as a universal small-business definition or as a standalone determination that a contract is exempt from PCM.
