What it means
When working on projects that span several months or even years, waiting until the very end to record revenue can create wildly misleading financial statements. For example, a construction firm might spend millions on labour and materials in year one, but receive no final payment until the building is handed over in year two.
The percentage of completion method solves this by allowing the business to match revenues with the expenses incurred during the exact same accounting period. This approach provides a much clearer, more accurate picture of a company's financial health at any given moment.
To use this method, managers typically measure progress by comparing costs incurred so far against the total estimated costs of the entire project. Alternatively, they might use physical milestones, such as completing structural framing or finishing interior wiring.
Once the progress percentage is calculated, the company applies that same percentage to the total contract price to determine how much revenue it can officially record on the income statement for that period. While this method requires careful estimation and ongoing oversight, it prevents massive financial spikes and dips, giving investors, lenders, and managers steady visibility into ongoing profitability.
Imagine baking a massive wedding cake that takes four hours to make. Instead of waiting until the final slice is served to claim credit and get paid, you measure how many layers are baked each hour and log your progress gradually.
In practice
Real-world examples
Example 1
An app development agency signs a $50,000 contract to build a custom software platform over six months. After spending $15,000 of their $30,000 estimated total budget, they report 50% completion and $25,000 of revenue. Their costs to date are $15,000, so the profit recognised so far is $10,000.
Example 2
A commercial landscaping business secures a $40,000 contract for an office park. By completing half of the planting and paving phases, they officially record $20,000 of revenue for the current quarter, matching their incurred costs. Because the work is measured by physical milestones, the site manager signs off each phase before the accountant records the revenue.
Example 3
An interior design studio takes on a $60,000 hotel renovation. After finalising the architectural blueprints and ordering all fixtures, they determine they are 30% done, allowing them to book $18,000 in revenue. The studio documents how it measured the 30% so that the same method is used each period.
Think of it
Imagine baking a massive wedding cake that takes four hours to make. Instead of waiting until the final slice is served to claim credit and get paid, you measure how many layers are baked each hour and log your progress gradually.
Formula
Calculation
Percentage Complete = (Costs Incurred to Date / Total Estimated Project Costs) x 100
Recognised Revenue = Percentage Complete x Total Contract Value
Example: you have spent $20,000 of a $100,000 total cost estimate, so you are $20,000 / $100,000 = 20% complete. On a $200,000 contract, you recognise 20% x $200,000 = $40,000 in revenue.
The profit for the period is the revenue less the costs incurred: $40,000 - $20,000 = $20,000. This matches the expected total profit of $200,000 - $100,000 = $100,000 multiplied by 20%.
If the estimate changes, the percentage changes. Suppose the next period brings costs to $60,000 and the revised total cost estimate rises to $120,000. The project is now $60,000 / $120,000 = 50% complete, so cumulative revenue is 50% x $200,000 = $100,000. Subtracting the $40,000 already recognised leaves $60,000 of revenue for this period.Case study
Seen in the real world
This is a fictional, illustrative scenario. Apex Bridge Builders secured a contract to construct a regional bypass for $2,000,000, with estimated total costs of $1,500,000. During the first year, unexpected supply chain delays meant Apex spent $450,000 on materials and labour. To calculate their revenue for the annual accounts, the finance team divided the $450,000 spent by the $1,500,000 estimated budget, resulting in a 30% completion rate. They then applied that 30% to the $2,000,000 contract value, allowing Apex to report $600,000 of revenue for the year.
This ensured that the costs paid out to suppliers were properly matched with incoming revenue, giving the bank an accurate view of the company's profitability and cash flow position without waiting for the bypass to open. The profit reported for the year was $600,000 - $450,000 = $150,000. Later in the year, the estimate of total cost rose to $1,800,000 after steel prices increased. The completion percentage would then have been $450,000 / $1,800,000 = 25%, giving revenue of $500,000 and a profit of only $50,000. The fictional finance team updated the estimate each quarter for this reason, because the percentage is only as reliable as the cost forecast behind it.
Watch out
Common mistakes
- Failing to update total estimated costs when scope changes occur, which distorts the progress percentage.
- Confusing cash received from the client with actual work completed, leading to inaccurate revenue recognition.
- Using inconsistent methods to measure progress from one accounting period to the next.
Questions
People also ask
Why not just wait until the project is finished to record revenue?
Waiting until the end creates massive distortions in financial statements, making profitable companies look broke one year and overly wealthy the next.
What happens if total project costs end up higher than originally estimated?
You must adjust the calculation immediately, which usually reduces the percentage of completion and can even force you to record an immediate loss.
Is this method mandatory for all long-term projects?
Accounting standards usually require it for significant long-term contracts, provided you can reliably estimate your progress and ultimate costs.