Percentage of Completion Revenue Recognition for Contractors
Imagine your construction company is 50% complete on a 14-month commercial build. Your crews are working hard, materials are arriving, subcontractors are submitting invoices, but are you actually earning money yet? The answer depends on how your company handles revenue recognition. If you regularly work on long-term projects, the percentage of completion method is the key accounting concept to understand. In this blog, we’ll show you what construction revenue recognition means, help you understand the accounting standards that govern revenue recognition, and outline why the percentage of completion method is the ideal choice for contractors who want a clear, accurate picture of their company’s financial health.
What is Construction Revenue Recognition?
Construction revenue recognition is the accounting rule that governs how and when you can count income as earned. It’s not just getting the check in the mail. Rather, it’s when you have completed your obligations on a construction project, according to your contract. Another way to understand revenue recognition is correctly identifying when income is yours. It’s a critical part of understanding your company’s financial health.
Construction is a unique and complex industry in how it records income. Unlike a retailer who sells a dozen hammers and is paid on the spot, construction projects run for months or sometimes years. That means you have to account for payments in phases, track change orders, handle retainage, and meet contract standards over years.
All of that complexity makes revenue timing very complicated, and it’s one of the main reasons that common construction cost accounting mistakes can be very costly.
There is more than one accounting method for contractors to choose from. Picking the right one for your company makes a difference for your financial clarity.
The Governing Standard: ASC 606
ASC 606 is the main standard for recognizing construction revenue. ASC 606 was developed by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). This framework helps construction companies, and many others, recognize revenue from all sorts of contracts in a standardized way.
The standard lays out a five-step process:
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- Identify the contract: What agreement do you have with your client?
- Identify your performance obligations: What specific goods or services have you promised to deliver?
- Determine the transaction price: How much do you expect to be paid?
- Allocate the price: If there are multiple deliverables, how much of the total price applies to each one?
- Recognize revenue: Record the income as you fulfill each obligation.
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The benefit of ASC 606 is that it provides consistency. Abiding by the standard means that financial statements are reliable. When you present your financial statements to a bonding agency, a lender, or your company leadership, these are reports that are trustworthy and meet the industry standard.
Within the ASC 606 standard, there are two common construction accounting methods that contractors use.
Two Construction Accounting Methods: A Quick Comparison
Before we get to our main topic, here’s a short summary of the completed contract method of construction accounting.
Using the completed contract method, a company only recognizes revenue and expenses once a project has been fully finished. This method allows companies to eliminate the risk of prematurely recording inaccurate gains. But there are some serious hassles caused by using this revenue recognition method.
If you are a contractor that finishes up several multi-year contracts in one fiscal year, but none in the following two years, using the completed contract method will mean your income statements are going to be wildly uneven. With this kind of volatile financial picture, it’s not easy to get a real understanding of how your business is performing and it can cause hesitation in lenders who just want steady, consistent financial results.
It’s because of that unpredictability that most contractors use the percentage of completion method.
The Percentage of Completion Method
The percentage of completion method tracks revenue and expenses by measuring the amount of work completed compared against the total project scope. The big advantage is you don’t have to wait until the end of a project to recognize revenue. Instead, you recognize it as you go, which gives you a much more realistic and consistent view of your company’s financial performance throughout the life of a project.
You’ll also hear this method called POC accounting sometimes in accounting software and financial reports.
There are two principal ways to measure progress under POC accounting:
- Input method: This method rests on costs incurred to date compared to total estimated costs. If you’ve spent $500,000 of a projected $1,000,000 budget, you’re 50% complete and can recognize 50% of the contract revenue.
- Output method: This method is based on physical deliverables or milestones such as square footage completed, floors framed, or concrete poured.
In fact, the percentage of completion method is the foundation of AIA-style progress billing, which is one of the most common billing methods in construction.
Here’s a simple example. Say you’ve signed a contract for a $2,000,000 office building with a total estimated cost of $1,600,000. At the end of six months, you’ve incurred $800,000 in costs or 50% of the total budget, which means you can recognize $1,000,000 in revenue (50% of $2,000,000). At month nine, costs have reached $1,200,000 (75%), so you recognize another $500,000 in revenue, bringing your running total to $1,500,000. By the time the project closes, revenue has been recognized steadily and proportionally the whole way through.
The real strength of the percentage of completion method is that your income statement reflects what’s happening in the field, no matter where you are in the project.
In comparison to the completed contract method where all $2,000,000 would hit your books at once, it’s easy to see why POC accounting is the preferred choice for contractors managing complex, long-term work.
Why This Matters for Your Business
Accurate construction revenue recognition protects your business from misleading financial statements. You don’t want to overstate your profits during the good times, nor should you understate profits during slower times.
Lenders and surety guarantors comb over your construction financial reports closely before they approve a loan or a bond. They want to see consistent financial data as a reassurance for their support of capital for your growing business.
It can also help you catch problems early. If you projected 15% margins on a project but your POC accounting is showing 8% when you reach the halfway mark, you see this discrepancy right away instead of after the final invoice. With this kind of financial insight, you can change course before you reach a crisis.
The right construction accounting software can automate percentage of completion tracking for you. Rather than using spreadsheets to manually track percentage of completion, construction accounting software handles the calculations, keeps your WIP schedule updated, and makes sure your process stays ASC 606 compliant, which saves you time and prevents administrative headaches.
Conclusion
Revenue recognition in construction is how you keep an honest, real-time tally on your business. Using the percentage of completion method gives you the clearest, most consistent way to do that. By recognizing revenue as your projects progress rather than waiting until the end, you get financial statements that reflect the work your team is doing every single day.
Understanding the concept is the first step. Having the right tools to execute it is the next.
If you’re ready to see how our construction accounting software handles percentage of completion, WIP reporting, and ASC 606 compliance all in one place, schedule a personalized demo today.