For long-term commercial construction projects, the percentage-of-completion (POC) method recognizes revenue based on the progress you've made toward completing the contract—not based on when you invoice or collect cash. Under both U.S. GAAP (through Financial Accounting Standards Board's revenue standard) and International Accounting Standards Board standards, the goal is to match revenue with the work actually performed.
The key point is that customer billings and cash receipts are generally separate from revenue recognition.
The basic calculation
The most common approach for construction contracts is the cost-to-cost method.
The formula is:
Percentage complete = Costs incurred to date ÷ Latest estimated total contract costs
Then:
Revenue recognized to date = Percentage complete × Total transaction price (contract revenue)
Finally:
Current-quarter revenue = Revenue recognized to date − Revenue recognized in prior periods
Example
Suppose:
- Contract price: $20,000,000
- Estimated total cost: $16,000,000
- Costs incurred through the end of Q2: $6,400,000
- Revenue already recognized through Q1: $5,000,000
Step 1:
Percentage complete
[
6.4M \div 16M = 40%
]
Step 2:
Revenue that should be recognized to date
[
40% \times 20M = 8.0M
]
Step 3:
Revenue to recognize in Q2
[
8.0M - 5.0M = 3.0M
]
So even if:
- you billed the customer $10 million, or
- you only collected $7 million,
your Q2 revenue would still be $3 million, assuming the cost estimates remain valid.
Gross profit
Once revenue is determined:
Current-quarter gross profit is:
Revenue recognized this quarter − Costs incurred this quarter
For example:
- Revenue recognized: $3,000,000
- Costs incurred during Q2: $2,500,000
Gross profit:
[
3.0M - 2.5M = 0.5M
]
Why estimates matter
The most difficult part is estimating total expected project cost.
Every reporting period you update estimates for:
- Remaining labor
- Material prices
- Subcontractor costs
- Equipment
- Change orders
- Claims (when appropriate)
- Expected inefficiencies
- Contingencies
If total estimated cost changes, the percentage complete changes immediately.
Example:
Originally:
- Total estimated cost = $16M
Later:
With costs incurred of $6.4M:
Old completion:
[
6.4 / 16 = 40%
]
New completion:
[
6.4 / 18 = 35.6%
]
Revenue recognized is recalculated using the updated estimate, and the adjustment flows through the current reporting period.
Change orders
Approved change orders generally increase the transaction price.
Unapproved change orders, claims, incentives, or bonuses may only be included when the applicable accounting standard's criteria are met and it is sufficiently probable that a significant reversal of recognized revenue will not occur (under U.S. GAAP) or the relevant threshold under IFRS.
Billings vs. revenue
These are often confused:
- Progress billings determine what the customer owes.
- Cash collections determine cash flow.
- Revenue recognition reflects performance completed.
They usually differ.
For example:
| Item | Amount |
|---|
| Revenue recognized | $8.0M |
| Customer billed | $10.0M |
| Cash collected | $7.0M |
These three numbers can all be correct simultaneously.
Loss contracts
If updated estimates show the project will lose money overall, accounting standards generally require recognizing the expected loss immediately rather than spreading it over the remaining life of the project.
Can you calculate the "exact" amount?
Not from the information you've provided. The amount you can recognize depends on facts and judgments that must be updated each reporting period, including:
- Total contract transaction price
- Costs incurred to date
- Current estimate of total costs to complete
- Revenue recognized in prior periods
- Approved and pending change orders
- Variable consideration (bonuses, claims, incentives)
- Any contract modifications
- Whether the chosen measure of progress faithfully depicts performance under the applicable accounting framework
If you provide those figures for one project, I can walk through the calculation step by step and compute the revenue that would be recognized under the cost-to-cost percentage-of-completion method. Keep in mind that the accounting treatment can vary depending on your jurisdiction, the specific contract terms, and whether you're reporting under U.S. GAAP, IFRS, or tax accounting rules. For financial statements and tax filings, it's appropriate to have the final treatment reviewed by your company's CPA or accounting adviser.
