Percentage of Completion Method

What it is

The percentage of completion method is an accounting approach for long-term contracts that recognizes revenue and expenses as work progresses, rather than waiting until project completion. It provides ongoing reflection of a contract’s profitability and is commonly used in industries with multi-period projects.

How it works

Revenue and expenses for each reporting period are recorded based on the proportion of the contract completed during that period. A common measurement is:

Percent complete = Costs incurred to date / Total estimated costs

Example:
– Year 1: project 20% complete → recognize 20% of total contract revenue and related expenses.
– Year 2: project 35% complete → recognize the incremental 15% of revenue and expenses in Year 2.

Other methods of measuring progress include completed milestones, labor hours, or units delivered. The accuracy of recognized income depends on reliable estimates of total costs and progress.

Conditions to use it

Two primary conditions are typically required:
* Collections from the customer must be reasonably assured.
* The company must be able to make reasonably reliable estimates of total contract costs and the stage of completion.

Financial statement presentation

• Income statement: Revenue and gross profit are recognized incrementally as work progresses.
• Balance sheet:
• If income recognized exceeds billings, the excess is reported as a current asset (e.g., “contract work in progress”).
• If billings exceed income recognized, the excess is reported as a current liability (e.g., “advance billings on contracts”).

Changes to total estimated contract costs or anticipated losses are recognized in the period they are determined.

Typical users

Industries and situations that commonly use this method:
* Construction contractors (buildings, infrastructure, energy projects)
* Defense contractors (long-term equipment and systems)
* Custom software development for multi-year, client-specific projects

Risks and ethical considerations

Because revenue recognition depends on estimates, the method can be susceptible to manipulation—shifting income and expenses between periods to achieve desired results. Inaccurate cost estimates or overstated progress can materially mislead stakeholders. Historical corporate scandals have illustrated the consequence of abusing this flexibility.

Mitigations include robust internal controls, independent review of estimates, conservative assumptions, and transparent disclosure of accounting policies and significant changes.

Key takeaways

• The percentage of completion method recognizes revenue and expenses according to project progress, offering real-time financial insight for long-term contracts.
• It requires reasonably assured collections and reliable cost/progress estimates.
• Proper application improves transparency, but the method can be misused if estimates are manipulated.
• Clear disclosures and strong controls are essential to ensure accurate and trustworthy financial reporting.