Construction Revenue Recognition: Completed Contract Vs Percentage of Completion Method

Whatever industry you are in, your business is required to choose an accounting method to report income and expenses. In construction, the percentage of completion and completed contract methods are often used by contracts since they often work on long-term contracts for large projects. Once you’ve chosen the method, it can’t be changed without special permission from the Internal Revenue Service (IRS). Therefore, it’s crucial to fully understand the chosen method to stay on top of tax compliance.

In the construction industry, choosing the right accounting method is a foundational decision that can significantly impact a company’s financial health and regulatory compliance. Construction companies often deal with long-term projects that span several months or even years, making it essential to adopt accounting methods that accurately reflect their financial activities. The two most common methods are the percentage of completion method and the completed contract method.

The percentage of completion method recognizes revenue and expenses as the project progresses, providing a steady view of financial performance and supporting better cash flow management. In contrast, the completed contract method defers revenue recognition until the entire project is finished, which can delay the reflection of income and expenses in financial statements. Understanding these accounting principles helps construction companies align their financial reporting with industry standards, manage cash flow effectively, and make informed business decisions as each project advances.

Overview of Revenue Recognition Methods

Revenue recognition methods are at the heart of construction accounting, as they determine when and how a company can record revenue and expenses in its financial statements. The percentage of completion method is a preferred revenue recognition method for many construction companies because it recognizes revenue and expenses in proportion to the work completed, offering a more accurate picture of ongoing financial performance. This method ties revenue recognition directly to project milestones, making it easier to track profitability and demonstrate value to stakeholders throughout the project lifecycle.

On the other hand, the completed contract method recognizes revenue and expenses only when the project is fully completed. While this approach can simplify accounting for certain projects, it may result in financial statements that do not fully reflect the company’s current financial position, especially for long-term contracts. Both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) provide clear guidelines for revenue recognition, and construction companies must adhere to these standards to ensure transparent and reliable financial reporting. Selecting the appropriate revenue recognition method is crucial for maintaining compliance, supporting business growth, and providing stakeholders with a true view of the company’s financial performance.

The Percentage of Completion Method (PCM)

The percentage of completion method allows for the periodical recognition of revenues, expenses, and taxes according to the percentage of the work completed during the period. This method involves using the percentage of work completed to determine the amount of revenue and expenses to recognize for each period. Since the expense and revenue are reported frequently during the project execution, this accounting method can reduce the risk of fluctuations while affording tax deferral benefits.

PCM must be used if the revenues and costs of a project are reasonably estimated and the parties involved are expected to be able to complete all duties according to the contractual obligations. Reliable estimates of total contract value, total costs, and associated costs are necessary for accurate revenue recognition. If these conditions have not been met, then the completed-contract method should be a better option.

Also, you have to closely review the construction bookkeeping practices to ensure the accuracy of cost reporting that is attributed to each completed part or defined milestone.

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The Completed Contract Method (CCM)

The completed-contract method allows deferring all income and expenses directly related to a long-term contract until work is completed. This method is often used to defer taxes and manage tax liability until project completion, as income recognition and related expenses are postponed until the project is completed. The timing difference between the completed contract method (CCM) and the percentage of completion method (PCM) affects when income recognition occurs and can impact the balance sheet and reported gross profits. The day of completion is spelled out in the contract.

This construction revenue recognition method is often the best option for income tax deferral. For example, if a contract is set for completion in two years, you may not incur taxes during this period until it is completed, allowing you to defer taxes and manage your tax liability. The completed contract method is often chosen for construction contracts with uncertain costs or timelines, and it is subject to IRS rules such as the gross receipts test, which determines eligibility for using this method. Under CCM, revenue and expenses are only recognized when the project is completed, and payments received for uncompleted contracts are recorded as liabilities on the balance sheet. Compared to the cash method, which also delays income recognition until cash is exchanged, CCM has different requirements and implications for construction businesses. Actual costs incurred during the project are tracked but not recognized on the income statement until project completion, at which point the total contract price and total contract value are used to determine final revenue and gross profits.

However, tax laws can be changed from year to year, you can face the risk of increases in tax rates and missing tax incentives. In other words, if the tax rates were to increase during that period of two years, you have to pay higher tax than it would have if reporting occurred sooner in the process.

Furthermore, if you’re looking for investors or creditors, it can be challenging to prove the real value of your company since revenues on ongoing projects have not yet been recorded.

Percentage of Completion vs Completed Contract: What’s the Difference?

Before exploring the difference, it should be emphasized that the total profit on the construction project is the same under both methods. Also, the percentage of completion and completed contract methods allow contractors to defer tax liabilities. The key difference between these two methods lies in how revenue and expense recognition is handled: the completed contract method recognizes all revenue and expenses at job completion, while the percentage of completion method recognizes them gradually as the project progresses. This impacts project profitability reporting, as PCM provides a more continuous view of profitability over the project's duration, whereas CCM defers it until the end.

Choosing the right revenue recognition method is essential for accurately reflecting project profitability and ensuring proper revenue and expense recognition throughout the project lifecycle.

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Best Practices for Implementation

Successfully implementing the percentage of completion method requires a disciplined approach to project management and financial tracking. Construction companies should start by establishing a comprehensive system for monitoring project costs, including both costs incurred to date and total estimated costs for completion. Regularly updating these figures allows companies to accurately calculate the percentage of completion and recognize revenue in line with actual project progress.

Maintaining detailed documentation is essential—every project should have clear records of job costs, revenue milestones, and any changes to project estimates. This not only supports accurate revenue recognition but also ensures compliance with accounting principles and facilitates smooth audits. Leveraging specialized accounting software can further streamline the process, enabling real-time tracking of financial data, automated calculations, and timely financial reporting.

By prioritizing accurate cost estimation, ongoing project reviews, and thorough documentation, construction companies can effectively use the percentage of completion method to enhance financial performance, improve cash flow management, and provide stakeholders with reliable, up-to-date financial information.

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