Fundamentals of the Percentage of Completion Method in Accounting

The percentage of completion method is a vital accounting approach used to recognize revenue over the life of long-term contracts. This method is especially important in industries such as construction, infrastructure, engineering, and custom manufacturing, where projects often span multiple accounting periods.

Unlike the completed contract method, where revenue is only recognized when the project is entirely finished, the percentage of completion method allows companies to recognize revenue and expenses proportionally throughout the project’s life. This ensures a more accurate reflection of a company’s financial position and provides better insight into its operational performance.

Understanding the Basis of the Method

The percentage of completion method offers a systematic approach to aligning financial reporting with the actual progress of work performed. This is especially critical for long-term contracts, where waiting until a project’s completion to recognize revenue could significantly distort a company’s financial performance over multiple periods. Recognizing revenue incrementally allows stakeholders to assess profitability and operational efficiency with greater accuracy. It also enhances the usefulness of financial statements by providing timely information that reflects ongoing economic activity rather than deferred results.

Additionally, this method promotes transparency between contractors and clients by offering a structured basis for billing. Clients are billed in proportion to the work completed, reducing disputes over payment and improving cash flow predictability for both parties. Internally, the approach helps management monitor project performance and identify issues early—such as cost overruns or delays—by comparing actual progress with financial outcomes.

Moreover, adhering to the criteria for using this method safeguards against arbitrary or overly aggressive revenue recognition. When the scope of work and responsibilities are well-documented, and both parties are committed to fulfilling their roles, the reported figures become a trustworthy reflection of economic activity. This level of precision is invaluable for auditors, investors, and other users of financial information seeking consistency and credibility in financial reporting.

How the Method Works

The percentage of completion method calculates the proportion of revenue and expenses to recognize based on the extent to which the project has been completed during a given period. This involves regular assessment and documentation of project progress.

If a construction firm has completed 40 percent of a housing development project by year-end, 40 percent of the contract’s total revenue and corresponding costs should be recorded in the income statement for that year.

This approach provides stakeholders with a transparent view of financial progress and helps businesses manage their cash flow and profit expectations more effectively.

Recording Journal Entries

Accounting under the percentage of completion method involves systematic journal entries that reflect the revenue, costs, and gross profit proportionate to the completion percentage of the project. The basic flow of journal entries includes:

• Recording construction costs as incurred
• Recognizing revenue and gross profit based on the percentage of completion
• Billing the client as per the project terms
• Adjusting entries at the end of the period to reconcile actual progress with billed amounts

For example, if a company determines that 25 percent of a project is complete, it will recognize 25 percent of the total contract revenue and related expenses. Upon completion, any over or underbilling is adjusted to ensure financial statements reflect actual project status.

Methods to Measure Project Completion

Determining the accurate percentage of completion is essential. There are two broad categories of methods used to measure progress: input-based and output-based.

Input-Based Methods

Input-based methods focus on the resources consumed during the project to assess completion levels. These include labor hours, costs incurred, and materials used.

Cost-to-Cost Method

The cost-to-cost method is the most common input-based technique. It measures the percentage of project completion by comparing the costs incurred to date with the total estimated cost of the project.

The formula is:

Percentage of Completion = (Costs Incurred to Date) / (Total Estimated Costs)

Revenue to be recognized is then calculated as:

Revenue Earned = Contract Amount × Percentage of Completion

For instance, if the estimated cost of a construction contract is $600,000 and $150,000 has been spent so far, then:

Percentage Completion = $150,000 / $600,000 = 25%

If the total contract value is $900,000, the revenue recognized would be:

Revenue Recognized = 25% × $900,000 = $225,000

Efforts Expended Method

Another input-based method evaluates the percentage of total expected effort used so far. This method might track labor hours, machine time, or material quantities. It is useful when labor effort is a major component of the project and provides a more dynamic picture of project status.

For example, if a software development project is expected to require 10,000 labor hours and 2,500 hours have been logged, then the project is 25 percent complete, and revenue can be recognized accordingly.

Output-Based Methods

Output-based methods measure the physical results achieved to date. This includes units produced, deliverables completed, milestones achieved, or other tangible outputs that reflect project progress.

This method is often used in manufacturing or standardized product delivery projects where outputs can be easily counted. However, it may not always capture the complexity or value of partially completed work.

For instance, a company manufacturing 100 specialized machines under a contract and delivering 30 units during the first year can recognize revenue based on 30 percent completion, assuming each unit has an equal value.

Benefits of the Percentage of Completion Method

This method offers several strategic and financial advantages:

• Provides a consistent stream of revenue over the life of the project
• Offers stakeholders real-time insights into operational progress
• Aligns expenses and revenue for accurate profitability reporting
• Supports better financial planning and resource allocation
• Enhances transparency with clients and investors

By recognizing revenue in alignment with actual project work, businesses avoid sudden profit spikes or drops that can distort their financial picture.

Key Challenges and Limitations

Despite its benefits, the method also comes with challenges. These include:

• Estimating total costs accurately
• Managing project scope changes
• Tracking progress consistently and objectively
• Complying with evolving regulatory standards
• Handling unexpected delays or budget overruns

Accurate estimation is critical; any misjudgment in total project cost can lead to incorrect revenue recognition. Businesses must update their forecasts regularly and ensure rigorous project monitoring to avoid financial misstatements.

Regulatory Considerations

Both IFRS and U.S. GAAP provide guidance on how to apply the percentage of completion method. IFRS 15, Revenue from Contracts with Customers, outlines criteria for revenue recognition based on performance obligations and control transfer.

When using input methods, IFRS 15 cautions against including costs that don’t represent progress, such as uninstalled materials. Including such costs may inflate the percentage of completion inaccurately. Under the output method, incurred costs associated with fulfilled or partially fulfilled obligations must be recognized in the income statement when incurred.

Compliance with these guidelines is essential for producing credible financial statements and maintaining investor trust. Companies should establish clear accounting policies and audit trails to demonstrate adherence to regulatory standards.

Financial Implications

By recognizing revenue over time, companies smooth their earnings, making financial results less volatile. This improves the reliability of earnings forecasts and supports better long-term planning.

For example, consider a firm engaged in a five-year infrastructure project worth $50 million. Using the percentage of completion method, the firm reports revenue proportionately each year based on actual work completed. This helps analysts and investors understand performance trends without being misled by the delayed recognition typical of the completed contract method.

Project Management and Integration

Implementing the percentage of completion method effectively demands a coordinated effort across various departments within an organization. Project managers must maintain up-to-date records on the project’s physical and financial progress, while finance teams need to ensure that these metrics align with accounting and regulatory requirements. Operational staff play a critical role by providing on-the-ground data, including labor hours, equipment usage, and material consumption. This triad of collaboration ensures that the reported percentage of completion is both accurate and defensible.

The reliability of this method heavily depends on precise cost estimation at the outset and consistent monitoring throughout the project lifecycle. Small deviations in projected versus actual costs can significantly impact the recognized revenue and profit margins. As such, ongoing analysis and forecasting adjustments are essential to maintain alignment with the project’s evolving scope and expenditures.

In today’s business environment, the use of digital tools and integrated enterprise resource planning (ERP) systems has become indispensable. These systems facilitate real-time tracking of costs and project milestones, providing a unified view of financial and operational data. Automation streamlines data entry, minimizes human error, and supports compliance with complex standards such as IFRS 15 or GAAP. By leveraging technology, companies can enhance accuracy, improve transparency, and make more informed decisions throughout the contract’s duration.

Implementing the Percentage of Completion Method in Real-World Scenarios

Following the foundational understanding of the percentage of completion method, we focus on its practical application. From implementation steps and industry examples to tools, compliance, and risk management, this article aims to bridge the gap between theory and day-to-day operations.

For companies dealing with long-term contracts, applying this accounting method accurately can significantly influence financial health, decision-making, and transparency.

Getting Started with Implementation

Implementing the percentage of completion method begins with assessing your organization’s readiness and the nature of the projects you undertake. Since this accounting approach relies heavily on accurate cost estimation and consistent measurement of progress, it is crucial to establish a structured and disciplined financial and operational framework before adoption. This means evaluating whether your internal teams have the capacity and expertise to produce reliable cost forecasts and monitor work completion against predefined benchmarks.

The first step is to ensure that contracts are clearly written, outlining deliverables, timelines, and responsibilities for both parties. Ambiguity in scope or obligations can compromise the integrity of progress assessments and revenue recognition. Project teams should be trained to document work completed in a systematic way, using quantifiable data that can be validated by the finance department.

In addition, the organization should develop or refine its cost tracking systems to categorize direct and indirect expenses accurately. Establishing clear lines of communication between departments will help synchronize financial reporting with operational updates. Regular internal audits and variance analyses between estimated and actual costs can strengthen the reliability of reported figures and enable timely corrections.

By adopting these preparatory steps, businesses position themselves to implement the method in a way that ensures compliance, enhances reporting accuracy, and provides valuable insights into project performance.

Assessing Project Suitability

Not all projects qualify for this method. Projects best suited include those that:

• Have a clear contract scope and timeline
• Involve performance obligations that are fulfilled over time
• Are of long duration (spanning multiple accounting periods)
• Have well-defined billing terms and schedules

If a contract lacks sufficient detail or measurable progress indicators, alternative methods may be more appropriate.

Building an Implementation Framework

The process of integrating this method into financial systems involves several steps:

• Contract Analysis: Understand the contract’s terms, payment schedules, milestones, and obligations.
• Cost Estimation: Develop a reliable and detailed budget outlining total expected costs.
• Progress Tracking: Select appropriate measurement metrics (input or output method).
• Accounting Integration: Set up journal entries and revenue recognition templates in your accounting system.
• Compliance Check: Align practices with local and international accounting standards.

This structured approach ensures that revenue recognition remains accurate, consistent, and compliant throughout the project.

Case Study: Construction Industry

The construction industry is one of the most common users of the percentage of completion methods. Consider a mid-sized firm contracted to build a commercial office block over two years.

Project Overview

• Contract Value: $10 million
• Estimated Costs: $7 million
• Timeline: 24 months
• Billing Milestones: Quarterly, based on progress reports

By the end of the first year, the company has incurred $3.5 million in costs. Using the cost-to-cost method:

• Percentage of Completion = $3.5 million / $7 million = 50%
• Revenue Recognized = 50% of $10 million = $5 million

The company would record:

• Construction Revenue: $5 million
• Construction Expense: $3.5 million
• Gross Profit: $1.5 million

This aligns revenue and expenses for the period, allowing stakeholders to evaluate project performance accurately.

Managing Change Orders

Construction projects often involve change orders. These adjustments must be incorporated into cost estimates and revenue calculations.

If a change order increases the contract value to $11 million and estimated costs to $7.7 million, updated calculations are required. Real-time adjustments ensure that revenue recognition reflects the actual project status.

Beyond Construction: Other Industry Applications

While construction is a classic example, several other industries benefit from this method.

Engineering and Design

Custom engineering projects, like aerospace system design or industrial automation, involve long timelines and client-specific solutions. Using labor hours or milestones, firms can report revenue proportionally.

Software Development

Long-term custom software contracts with phases such as requirements analysis, development, testing, and deployment are well-suited for this method. Efforts expended (developer hours, sprints completed) provide measurable progress indicators.

Shipbuilding and Manufacturing

Large equipment manufacturing or shipbuilding contracts, which often span years, use output-based methods to recognize revenue as units or components are delivered.

In all these industries, the key is the ability to define clear deliverables, estimate costs, and measure progress reliably.

Tools and Technologies for Effective Implementation

Leveraging the right tools simplifies the application of this method and minimizes human error.

Project Management Software

Integrated platforms like Microsoft Project, Oracle Primavera, or industry-specific solutions provide real-time tracking of project progress, costs, and milestones.

Enterprise Resource Planning (ERP) Systems

ERPs like SAP and NetSuite allow direct integration of project data with accounting functions. This supports automated revenue recognition and reduces the need for manual calculations.

Time and Cost Tracking Tools

Tools that track labor hours, materials usage, and expenses—such as QuickBooks or TSheets—enable businesses to use the effort expended method more accurately.

Data accuracy is crucial. Companies must ensure input from the field or shop floor is reliable and timely to support financial reporting.

Compliance with Accounting Standards

Applying this method requires adherence to relevant accounting frameworks such as IFRS 15 or ASC 606. These standards emphasize the identification of performance obligations and proper revenue recognition.

IFRS 15 Overview

• Recognize revenue when a performance obligation is satisfied
• Input or output methods may be used based on contract nature
• Costs associated with uninstalled materials are excluded from progress metrics
• Revenue must reflect the value delivered to the customer

ASC 606 Considerations

The U.S. equivalent also centers on performance obligations and contract fulfillment. Documentation of contract modifications, variable consideration, and progress methods is critical.

Non-compliance may result in financial restatements or audit issues. Companies should regularly review their accounting policies and consult with auditors to ensure proper application.

Common Challenges and Solutions

Despite its usefulness, businesses face several implementation hurdles. Addressing them proactively helps maintain accuracy and compliance.

Inaccurate Cost Estimates

Underestimating or overestimating total project cost leads to flawed revenue recognition.

Solution: Use historical data, expert input, and contingency buffers to build reliable budgets.

Inconsistent Progress Tracking

Without clear metrics, determining completion percentage becomes subjective.

Solution: Choose the most appropriate method—cost-based, labor hours, milestones—and standardize the measurement process.

Change Orders and Scope Creep

Frequent contract modifications complicate calculations.

Solution: Document every change order and revise both contract value and cost estimates immediately.

Lack of Integration

Manual tracking across departments increases error risk.

Solution: Implement integrated systems that align finance, operations, and project management functions.

Auditing and Internal Controls

Effective internal controls ensure the integrity of financial data under the percentage of completion method.

Key controls include:

• Segregation of duties between project management and finance teams
• Regular reconciliations of actual costs to budgets
• Review and approval of cost estimates and billing reports
• Documentation of all assumptions and changes

External auditors will focus on these areas to verify the accuracy of financial statements. Having robust policies and an audit trail reduces audit risk.

Financial Analysis and Management Reporting

This method provides a dynamic view of a company’s financial performance, useful for internal and external stakeholders.

Internal Benefits

• Informs cash flow forecasting
• Supports resource allocation decisions
• Identifies early signs of project delays or cost overruns

External Stakeholder Communication

Investors, lenders, and partners gain a transparent view of project-based earnings. Regular reports highlighting project progress, revenue recognized, and gross margin trends enhance credibility and trust.

Management dashboards can display real-time data on project performance, completion percentage, and variance from estimates. This improves strategic decision-making.

Handling Tax Implications

Revenue recognized under this method impacts taxable income. Companies must coordinate with tax advisors to:

• Ensure consistency between financial and tax reporting
• Address timing differences in revenue recognition
• Leverage any available deferral or amortization options

In jurisdictions with specific tax treatments for long-term contracts, compliance becomes even more critical.

Preparing for Transition and Scaling

As businesses grow, the volume and complexity of long-term contracts increase. Scaling the use of this method requires:

• Training staff on principles and procedures
• Enhancing systems for automation and accuracy
• Establishing repeatable workflows for different project types

A phased rollout, starting with high-value or low-risk projects, allows companies to refine their approach before full adoption.

Ethical Considerations

Revenue recognition is a sensitive area with significant financial implications. Ethical practices are vital.

Companies must avoid manipulating completion percentages or cost estimates to achieve desired financial outcomes. Transparent reporting and third-party validations help maintain integrity.

Advanced Strategies and Comparative Insights for the Percentage of Completion Method

We move beyond the fundamentals and implementation of the percentage of completion method to explore more advanced strategies, nuanced comparisons, and industry-specific adaptations. This comprehensive perspective aims to equip organizations with the knowledge necessary to make informed decisions about revenue recognition for long-term projects.

Comparing Revenue Recognition Methods

Before diving into industry-specific applications and optimizations, it is essential to understand how the percentage of completion methods compares to other commonly used methods.

Completed Contract Method

The completed contract method delays revenue and expense recognition until the project is fully completed. This approach is more conservative and is often used when project outcomes are uncertain or when it is difficult to measure progress reliably.

• Revenue is recognized at the end of the project
• Gross profit is only reported upon completion
• Suitable for short-term contracts or where project risk is high

Installment Method

This method recognizes revenue as cash is received. It is generally used when there is uncertainty about collection.

• Revenue and gross profit are recognized proportionally to cash collections
• More applicable to consumer-based transactions with extended payment terms

Advanced Cost Management Techniques

Accurate cost tracking is the backbone of effective revenue recognition under the percentage of completion method. As projects grow in complexity, sophisticated cost management becomes essential.

Use of Standard Costs and Variance Analysis

Implementing standard cost systems allows for consistent budgeting. Any deviation from standard costs is analyzed through variance reports.

• Material Variance: Differences in expected vs. actual material costs
• Labor Variance: Variations in labor hours or wage rates

By identifying trends, companies can adjust estimates promptly and maintain accurate financial records.

Forecasting and Rolling Budgets

Ongoing projects benefit from rolling forecasts, which are updated regularly as new data becomes available. This ensures that cost estimates remain realistic and reflect actual conditions.

Earned Value Management (EVM)

EVM integrates project scope, cost, and schedule metrics to assess performance.

Key components:

• Planned Value (PV): Budgeted cost of scheduled work
• Earned Value (EV): Budgeted cost of completed work
• Actual Cost (AC): Actual cost incurred

These metrics help determine cost and schedule variance, supporting more informed revenue recognition decisions.

Customizing Output Metrics for Unique Contracts

Choosing the right output metric ensures that the percentage of completion reflects true performance.

Milestone-Based Contracts

In service industries like consulting, billing may be tied to milestones. Each milestone achieved represents a portion of the total project.

• Ensure milestones are objectively verifiable
• Each milestone should reflect a consistent portion of the total effort

Unit-Based Measurement

In manufacturing and shipbuilding, progress is measured by units completed or shipped.

• Contracts must define what constitutes a completed unit
• Partial units may need prorated revenue calculations

Customer Acceptance Clauses

Contracts may include clauses requiring customer sign-off. In such cases, revenue recognition must wait until acceptance, even if work is technically complete.

Organizations should work with legal and finance teams to align contract terms with revenue policies.

Industry-Specific Adaptations

Different sectors require tailored approaches to apply the percentage of completion method effectively.

Telecommunications and Infrastructure

Projects involve multiple phases: planning, installation, testing, and activation. Each phase can represent a separate performance obligation.

• Use input method during installation
• Use output method once services begin

Oil and Gas

Pipeline construction, exploration drilling, and facility upgrades span long durations with large budgets. Progress may be measured using materials used, work hours, or project inspections.

• Contracts often include joint ventures requiring revenue sharing
• Progress billing is common, requiring reconciliation with project milestones

Defense and Aerospace

Government contracts typically require detailed cost and progress documentation.

• Earned value management is frequently mandated
• Cost-plus contracts may involve different revenue recognition criteria

Real Estate Development

Revenue recognition depends on the transfer of control to the buyer.

• For multi-unit projects, each sale may represent a separate contract
• Developers must carefully define performance obligations to apply the percentage of completion method

Handling Contract Modifications and Multiple Performance Obligations

Projects often evolve, with new scope items added or delivery dates adjusted. These changes must be carefully integrated into revenue calculations.

Identifying Contract Modifications

Modifications may include:

• Additional deliverables
• Changes in scope or pricing
• Timeline extensions

Assess whether the modification represents a new contract or an update to the existing one. If it modifies an existing obligation, revise the percentage of completion accordingly.

Managing Bundled Services

Contracts may bundle products and services, such as hardware installation and maintenance. Separate each performance obligation and apply appropriate revenue recognition methods.

This granular approach ensures compliance and reflects actual project progress.

Strategic Use of the Method for Business Benefits

When implemented correctly, the percentage of completion methods can enhance transparency, planning, and financial strategy.

Enhancing Investor Confidence

Consistent and accurate revenue recognition reassures investors about financial stability and project performance. This is especially important for publicly traded companies or those seeking investment.

Improving Cash Flow Management

Understanding earned revenue allows for better alignment of invoicing and cash collection. Companies can avoid liquidity issues by forecasting cash flows based on project progress.

Supporting Strategic Planning

Management can use insights from project progress to inform:

• Resource allocation
• Pricing strategies
• Project selection criteria

Over time, this contributes to improved profitability and competitiveness.

Challenges in Scaling the Method

As businesses expand, so do the complexities of applying this method consistently across multiple projects, teams, and geographies.

Standardizing Practices

To ensure consistency:

• Develop company-wide revenue recognition policies
• Use standardized templates for cost estimation and progress reporting
• Train finance and project management staff regularly

Integrating Multiple Systems

Large organizations often use different software for accounting, project management, and procurement.

• Invest in integrations or middleware to connect systems
• Automate data synchronization to reduce manual errors

Managing Global Compliance

Companies operating in multiple jurisdictions must navigate local accounting standards.

• Maintain clear documentation for auditors and regulators
• Adapt policies to reflect regional regulatory nuances

Leveraging Technology for Long-Term Gains

Digital transformation plays a crucial role in optimizing the application of this method.

Predictive Analytics

Machine learning can enhance forecasting accuracy by analyzing historical project data and identifying cost trends.

• Predict delays or overruns
• Refine budget estimates based on real-time insights

Real-Time Dashboards

Custom dashboards provide visibility into:

• Project completion status
• Revenue and expense tracking
• Profitability trends by contract or department

Accessible insights empower better decisions at all organizational levels.

Cloud-Based Collaboration

Remote project teams and finance departments benefit from cloud-based platforms that centralize information and support real-time updates.

Ethical and Legal Safeguards

Maintaining the integrity of financial reporting is paramount.

Preventing Revenue Manipulation

Strict policies must guard against inflating completion percentages to boost short-term earnings.

• Implement internal review and approval workflows
• Encourage whistleblowing policies for unethical conduct

Legal Disclosures

Companies must provide transparent disclosures in financial statements regarding revenue recognition methods, assumptions, and changes in estimates.

Failure to disclose adequately may result in legal consequences or damage to reputation.

Preparing for Audits and Reviews

Auditors assess the application of the percentage of completion method to verify that:

• Revenue recognition aligns with contract terms
• Estimates are reasonable and supported by documentation
• Internal controls are effective and consistently applied

Prepare by maintaining:

• Detailed project files
• Change order documentation
• Estimate backup and review logs

Periodic internal audits can preempt issues during external reviews.

Conclusion

The percentage of completion method stands as a cornerstone in the realm of long-term project accounting, offering businesses a structured and transparent way to recognize revenue and assess profitability throughout the life of a contract. Across this series, we’ve explored the foundational principles, the step-by-step implementation process, and advanced strategic considerations that make this method both powerful and indispensable.

We established the core concepts behind the percentage of completion method, emphasizing its alignment with the matching principle and its importance for industries like construction, real estate, and engineering. We examined how businesses calculate revenue based on either input or output measures and how this method ensures that financial reporting reflects actual progress.

We built on that foundation by detailing the practical application of the method. We covered journal entries, calculation methods, compliance with IFRS 15, and the implications of choosing between cost-to-cost, effort expended, and output-based approaches. This section also addressed how organizations can manage performance obligations, calculate partial revenue, and track project milestones efficiently.

Finally, we delved into advanced techniques and strategic insights. From comparing the percentage of completion methods with other revenue recognition approaches to exploring industry-specific adaptations, we highlighted how this method can serve as a competitive advantage. We also explored challenges such as standardizing practices across complex organizations, integrating technology, managing legal compliance, and preparing for audits.

In summary, the percentage of completion method offers a dynamic and highly effective approach to managing revenue recognition in projects that extend over multiple accounting periods. Its benefits include better financial visibility, more accurate forecasting, improved stakeholder trust, and stronger alignment between operational execution and financial performance. When implemented correctly, it transforms financial management from a reactive task into a proactive tool for strategic decision-making.

For organizations that navigate long-term contracts, mastering this method is not just an accounting requirement—it is a business imperative.