Percentage-of-Completion Accounting for Contractors

Percentage-of-completion accounting is the method contractors use to recognize revenue and profit incrementally as work is performed on a long-term contract, rather than waiting until the project is finished. Under U.S. GAAP, this approach is governed by FASB Accounting Standards Codification Topic 606 (ASC 606), issued through ASU 2014-09, which replaced the older ARB 45 and SOP 81-1 rules. ASC 606 was effective for public companies for annual reporting periods beginning after December 15, 2017, and for private companies for annual reporting periods beginning after December 15, 2018, so most private contractors adopted it starting with fiscal years in 2019. The method matches earned revenue to the costs incurred in each reporting period, giving the most accurate picture of profitability on any job that spans more than one accounting period.

How Percentage-of-Completion Accounting Works

The core mechanics are straightforward: at any point during a project, you calculate how far along you are, apply that percentage to the total contract value to determine how much revenue you have earned, and compare earned revenue to what you have billed. The difference produces either a contract asset (you have earned more than you have billed) or a contract liability (you have billed more than you have earned).

The standard five-step framework under ASC 606 drives the process:

1. Identify the contract. A contract must have commercial substance, approved terms, and a sufficiently certain collection of consideration.
2. Identify the performance obligations. On most construction contracts, building or delivering the project is a single performance obligation, though a contract may bundle multiple distinct deliverables.
3. Determine the transaction price. The transaction price is the amount the contractor expects to receive, including variable consideration such as incentive bonuses, claims, and approved change orders, estimated using either the expected value or most-likely-amount method.
4. Allocate the transaction price. For contracts with a single performance obligation, the full transaction price is allocated to that obligation.
5. Recognize revenue as the performance obligation is satisfied. For most construction contracts, revenue is recognized over time as the work progresses.

Qualifying for Over-Time Revenue Recognition

ASC 606 permits revenue recognition over time only when one of three criteria is met. The criterion most construction contractors rely on is that the work creates an asset with no alternative use to the contractor and the contractor has an enforceable right to payment for performance completed to date. A building constructed on land the customer owns is the classic example: the contractor cannot redirect that structure to another buyer once construction is underway.

Measuring Progress: The Cost-to-Cost Method

Once a contractor establishes that revenue is recognized over time, a single method must be selected to measure progress for each performance obligation. The most common input method in construction is the cost-to-cost approach: divide costs incurred to date by total estimated costs at completion. The resulting percentage, applied to the contract price, gives earned revenue for the period.

For example, a $5 million contract with $1.5 million in costs incurred and $3 million in total estimated costs yields a 50% completion rate and $2.5 million in earned revenue. If the contractor has billed $2.2 million to date, the $300,000 excess of earned revenue over billings is a contract asset, sometimes called underbillings in legacy terminology.

One important adjustment involves uninstalled materials. When significant materials have been purchased and delivered to a job site but not yet incorporated into the work, ASC 606-10-55-21 requires an adjustment to the measure of progress. The contractor excludes the cost of those materials from both the numerator and the denominator of the cost-to-cost calculation and recognizes revenue on them only up to the cost incurred, with zero profit until they are installed. Their cost does not represent progress toward completing the performance obligation, and counting them in full would front-load revenue and profit in a way that does not reflect actual construction activity.

Output Methods

Contractors may also use output methods that measure progress based on results achieved rather than costs consumed. Common output measures include units completed, milestones reached, and surveys of work performed. Output methods are often more intuitive when projects have clearly defined deliverables, but they require reliable, up-to-date measurement data. The selected method should be applied consistently across similar contracts and documented in the contractor’s accounting policies.

The WIP Schedule: Translating Completion Percentages Into Financial Statements

The work-in-process (WIP) schedule is the working document that brings percentage-of-completion accounting into the financial statements. As AICPA & CIMA guidance on WIP schedules explains, contractor revenue is generated by measured progress on each job rather than by billing the customer. It assembles, for each open contract, the four data inputs that drive every calculation: contract value, costs incurred to date, total estimated costs at completion, and billings to date. From those inputs, the schedule derives the completion percentage, earned revenue, recognized gross profit, and the net contract asset or liability position on every job.

A well-maintained WIP schedule gives management a real-time view of job profitability and cash-flow exposure. It also serves as the primary audit exhibit for any CPA firm performing a review or audit of contractor financial statements, because the schedule links directly to revenue, costs, and balance-sheet positions. For contractors that rely on bonding or bank credit, a clear and supportable WIP schedule is not optional: sureties and lenders read it carefully.

Contract Assets and Contract Liabilities

Under ASC 606, the terminology has shifted from “underbillings” and “overbillings” to “contract assets” and “contract liabilities,” though the concepts remain the same. A contract asset arises when earned revenue exceeds billings on a given contract. A contract liability arises when billings exceed earned revenue. Importantly, ASC 606 requires that these positions be netted on a contract-by-contract basis: a contractor cannot show gross underbillings on some jobs and gross overbillings on others without netting within each contract first.

Contract assets and contract liabilities are separate from retainage receivables, which represent the portion of billings withheld by the owner pending satisfactory project completion. The presentation of retainage on the balance sheet depends on whether it is expected to be collected within twelve months.

Keeping the Estimated Cost at Completion Current

The estimated cost at completion (EAC) is the most consequential number in the WIP schedule, and the one most commonly allowed to go stale. Because the completion percentage is a function of costs incurred divided by total estimated costs, an outdated EAC produces an inaccurate percentage complete, which cascades directly into earned revenue and gross profit. A project manager who underestimates remaining costs will show an inflated completion percentage, report phantom profit, and then absorb a sharp margin correction when the true cost lands.

Best practice is to update the EAC on every open contract at each reporting period, with project managers formally signing off on revised estimates. Finance teams should flag any contract where the EAC has not changed in two consecutive periods, because no active construction project has perfectly static costs. Reviewing the EAC regularly is also one of the first things a construction CPA will focus on when auditing contractor financial statements.

Common Mistakes in Percentage-of-Completion Accounting

Several errors recur in contractor accounting, most tracing back to the WIP schedule or to incorrect transaction-price estimates.

• Including uninstalled materials in the cost-to-cost base. Counting the cost of materials delivered but not yet installed inflates the percentage complete and accelerates revenue recognition beyond what the work actually justifies.
• Stale or overly optimistic EAC estimates. Not updating the estimated costs at completion masks job losses until they become unavoidable, creating sudden profit fade at closeout.
• Mishandling variable consideration. Contractors sometimes include unapproved change orders or disputed claims in the transaction price without applying the constraint that variable consideration can only be included to the extent it is probable that a significant revenue reversal will not occur. Over-counting variable consideration inflates contract value and earned revenue.
• Failing to separate performance obligations on bundled contracts. A contract that includes both construction and long-term maintenance may contain two distinct performance obligations that require separate revenue recognition treatment. Treating the whole contract as a single performance obligation can front-load or back-load revenue incorrectly.
• Netting errors on contract assets and liabilities. Presenting underbillings and overbillings on a portfolio basis rather than contract by contract violates ASC 606 and can overstate or understate both the asset and liability sides of the balance sheet.
• Inadequate documentation of the over-time criteria. If a contractor cannot document why its contracts qualify for over-time recognition, auditors will scrutinize the revenue recognition basis and may require adjustments.

For contractors with a construction audit on the horizon, cleaning up the WIP schedule and confirming the EAC on every open job before year-end reduces audit time, lowers the risk of adjustments, and keeps the engagement on schedule.

What Construction CPAs Review During an Audit

An audit of a construction contractor’s financial statements centers heavily on revenue recognition and the WIP schedule. Auditors typically:

• Reconcile the WIP schedule to the trial balance, confirming that aggregate contract assets, contract liabilities, revenue, and costs tie to the financial statements.
• Test a sample of contracts for the appropriateness of the over-time recognition criteria and the selected method of measuring progress.
• Evaluate the reasonableness of EAC estimates by comparing them to historical job performance data and reviewing project-manager sign-offs.
• Assess whether variable consideration has been constrained appropriately, particularly on contracts with unapproved change orders or active claims.
• Examine whether uninstalled materials have been excluded from the cost-to-cost calculation.
• Review contract assets for collectibility and assess whether any contract losses should be recognized immediately.

When a loss contract is identified, U.S. GAAP requires immediate recognition of the full expected loss, regardless of how far along the project is. The FASB retained the existing loss provision guidance in ASC 605-35 rather than moving it into ASC 606, so contractors still record a provision for the entire anticipated loss in the period the loss becomes evident. This is one of the most judgmental areas in construction accounting and a frequent source of late audit adjustments when project managers are slow to acknowledge cost overruns.

Contractors who maintain clean, current WIP schedules and document their revenue recognition judgments throughout the year will consistently have smoother audits and more credible financial statements.

Related reading: Manufacturing Accounting: Is Standard Costing GAAP-Compliant?

Frequently Asked Questions

How does percentage-of-completion accounting work?

Percentage-of-completion accounting recognizes revenue and profit on a long-term contract as work is performed, proportional to the contractor’s progress toward completing the contract. Under ASC 606, the most common method for measuring progress is the cost-to-cost approach: divide costs incurred to date by total estimated costs at completion, then apply that percentage to the contract price to determine how much revenue has been earned in the period.

Is percentage-of-completion still allowed under ASC 606?

Yes, but the terminology has changed. ASC 606 does not use the phrase “percentage of completion,” but it permits over-time revenue recognition when the contract meets one of three criteria. For most construction contractors, revenue is still recognized as work progresses using a method that measures progress toward completion, and the cost-to-cost input method remains the most widely used approach. The practical effect for most contractors is similar to the old percentage-of-completion method, with more demanding documentation and disclosure requirements.

What is a WIP schedule in construction accounting?

A work-in-process (WIP) schedule is the document that tracks each open contract’s contract value, costs incurred to date, total estimated costs at completion, and billings to date. From those inputs, the schedule calculates the percentage complete, earned revenue, recognized gross profit, and the net contract asset or contract liability position for each job. The WIP schedule drives revenue recognition under the cost-to-cost method and is the primary document reviewed by auditors, lenders, and sureties.

What is the difference between a contract asset and a contract liability in construction?

A contract asset (formerly called underbillings) arises when a contractor has earned more revenue based on percentage of completion than it has billed the customer. It appears as an asset on the balance sheet. A contract liability (formerly called overbillings) arises when the contractor has billed more than it has earned. It appears as a liability. Under ASC 606, these positions must be calculated and presented on a contract-by-contract basis, not pooled across all jobs.

How are change orders handled under percentage-of-completion accounting?

Approved change orders that add to the contract price are included in the transaction price and affect both the contract value and, if costs change, the EAC. Unapproved change orders and claims are treated as variable consideration: they may be included in the transaction price only to the extent it is probable that a significant revenue reversal will not occur when the uncertainty is resolved. Contractors must assess each unresolved change order individually and document the basis for any amount included.

When must a contractor recognize a loss on a construction contract?

When current estimates indicate that the total costs to complete a contract will exceed the total contract revenue, the full expected loss must be recognized immediately in the period the loss becomes apparent, regardless of the percentage of completion. This requirement lives in ASC 605-35, which the FASB carried forward when it issued ASC 606. It creates one of the most important asymmetries in construction accounting: profits are recognized over time, but losses are recognized all at once as soon as they are foreseeable. Keeping the EAC current is the primary defense against being surprised by a loss contract late in a project.