What it means
Under this method, a contractor estimates how far through the work it is, applies that percentage to the total contract value, and books the resulting revenue. The matching costs are recognised at the same time, so profit emerges steadily across the life of the job.
The alternative, waiting until completion, is used only when progress cannot be reliably estimated. It matters because without it the accounts of any long-project business would be close to meaningless.
A construction or engineering firm would show two years of costs with no revenue at all, then a single enormous profit in the final month, telling readers nothing about how the business is actually trading. The most common way to measure progress is the cost-to-cost approach: costs incurred to date divided by total estimated costs for the contract.
That percentage is applied to the contract value to give cumulative revenue, and the amount recognised in the current period is the cumulative figure less whatever was recognised previously. Physical measures such as units delivered or surveys of work performed are also permitted.
Two conditions have to hold for the method to be defensible. The outcome of the contract must be reliably estimable, meaning total costs can be forecast with reasonable confidence, and collection from the customer must be probable.
Where those tests fail, revenue is limited to the costs the contractor expects to recover. The obvious weakness is that everything hangs on the estimate of total cost, which management controls.
Understating expected costs flatters the percentage complete and pulls profit forward, which is why auditors focus hard on cost forecasts and on contracts whose estimates keep moving. If a contract is expected to lose money overall, the entire expected loss is recognised immediately rather than spread across the remaining periods.
In practice
Real-world examples
Example 1
A shipbuilder with a four-year naval contract recognises revenue each quarter based on labour hours worked against total estimated hours. Its quarterly accounts show a steady margin instead of three years of losses followed by one spectacular year.
Example 2
A software integrator delivering a two-year system implementation recognises revenue on a cost-to-cost basis. When it discovers the data migration will take 40% more effort than planned, its percentage complete falls and it must reverse some previously recognised profit.
Example 3
A commercial fit-out contractor uses architect-certified surveys of work performed rather than costs, because expensive materials are delivered to site early and would otherwise overstate progress before any installation had happened.
Think of it
Imagine baking a massive wedding cake that takes four weekends to complete. Instead of waiting until the final bite is eaten to declare the job done, you get paid for one quarter of the cake each weekend as you finish each distinct tier.
Formula
Calculation
Percentage complete = Costs incurred to date / Total estimated contract costs
Cumulative revenue = Percentage complete x Total contract value
Revenue this period = Cumulative revenue - Revenue recognised previously
A civil engineering firm signs a three-year bridge contract worth $5,000,000. It estimates total costs of $4,000,000, giving an expected profit of $1,000,000.
Year 1: costs incurred are $1,600,000.
Percentage complete = $1,600,000 / $4,000,000 = 0.40, or 40%
Cumulative revenue = 0.40 x $5,000,000 = $2,000,000
Profit recognised = $2,000,000 - $1,600,000 = $400,000, which is 40% of the expected $1,000,000
Year 2: a further $1,400,000 of costs is incurred, so cumulative costs are $3,000,000.
Percentage complete = $3,000,000 / $4,000,000 = 0.75, or 75%
Cumulative revenue = 0.75 x $5,000,000 = $3,750,000
Revenue this year = $3,750,000 - $2,000,000 = $1,750,000
Profit this year = $1,750,000 - $1,400,000 = $350,000
Cumulative profit after two years is $400,000 + $350,000 = $750,000, exactly 75% of the total expected profit, which confirms the numbers are internally consistent.Case study
Seen in the real world
This is an illustrative and clearly fictional case. Ravensfield Construction held a $12,000,000 hospital wing contract with estimated costs of $10,200,000. At the end of its first year it had spent $5,100,000 and duly recognised 50% of revenue, $6,000,000, and $900,000 of profit.
Midway through the second year, the site team reported that ground conditions would add $1,300,000 to the cost estimate, taking total expected costs to $11,500,000 and expected profit down to $500,000. The revised percentage complete on cumulative costs of $6,900,000 was 60%, so cumulative revenue became $7,200,000 and cumulative profit just $300,000. The fictional company had to book a reduction against the $900,000 already reported.
The episode pushed Ravensfield to require a formal cost-to-complete review every quarter, signed off by both the site manager and the commercial director. Estimates still moved, but they moved earlier and in smaller steps, which made the reported results far less volatile.
Watch out
Common mistakes
- Treating cash received from the customer as revenue, when progress billings and revenue recognition are separate things that rarely match in timing.
- Including materials delivered but not yet installed in costs incurred, which overstates progress under the cost-to-cost approach.
- Spreading an expected contract loss across remaining periods, when accounting rules require the whole anticipated loss to be recognised as soon as it is foreseen.
Questions
People also ask
What happens if the total cost estimate changes?
The percentage complete is recalculated on the new estimate and the cumulative catch-up is taken in the current period.
Is this method still allowed under current standards?
Yes, in substance, since revenue standards permit recognition over time where the customer controls the asset as it is created or the work has no alternative use.
What is the alternative?
The completed contract method, which defers all revenue and profit until the job is finished and is used when the outcome cannot be reliably estimated.