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 labor 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.
In practice
Real-world examples.
Example
An app development agency signs a 50,000 pound contract to build a custom software platform over six months. After spending 15,000 pounds of their 30,000 pound estimated total budget, they report 50 percent completion and 25,000 pounds of revenue.
Example
A commercial landscaping business secures a 40,000 pound contract for an office park. By completing half of the planting and paving phases, they officially record 20,000 pounds of revenue for the current quarter, matching their incurred costs.
Example
An interior design studio takes on a 60,000 pound hotel renovation. After finalizing the architectural blueprints and ordering all fixtures, they determine they are 30 percent done, allowing them to book 18,000 pounds in revenue.
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) * 100. Recognized Revenue = Percentage Complete * Total Contract Value. Example: If you spend 20,000 pounds out of a 100,000 pound total budget, you are 20 percent complete. On a 200,000 pound contract, you recognize 40,000 pounds in revenue.Case study
Seen in the real world.
Apex Bridge Builders secured a contract to construct a regional bypass for 2 million pounds, with estimated total costs of 1.5 million pounds. During the first year, unexpected supply chain delays meant Apex spent 450,000 pounds on materials and labor. To calculate their revenue for the annual accounts, the finance team divided the 450,000 pounds spent by the 1.5 million pound estimated budget, resulting in a 30 percent completion rate. They then applied that 30 percent to the 2 million pound contract value, allowing Apex to report 600,000 pounds 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 bridge to open.
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.
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