What is percentage-of-completion accounting?

Percentage-of-completion is a method of recognizing revenue and expenses on long-term contracts based on how much work has been done so far. Instead of waiting until a project is completely finished, you record income and costs gradually as the work progresses. It is most commonly used in construction and contracting.

Here is the problem it solves. Say you take on a $500,000 project that starts in October and finishes the following May. If you only record revenue when the project wraps up, your books show almost nothing for the first year even though you spent real money on labor, materials, and subs. Then the next year you show a huge spike of income. That distorts your financial picture and creates tax headaches.

With percentage-of-completion, you recognize revenue as work gets done. The most common approach is the cost-to-cost method. You divide costs incurred so far by total estimated costs to get a completion percentage, then apply that percentage to total contract revenue. If you’ve spent $200,000 of an estimated $400,000 in total costs, you’re 50% complete and recognize 50% of the contract price. Your financial statements then reflect the work you’ve actually performed, which gives you, your bank, and your bonding company a much more accurate view.

The IRS generally requires percentage-of-completion for long-term contracts, meaning contracts that start in one tax year and finish in another. But there is an important exception for smaller contractors. If your average annual gross receipts are $29 million or less (adjusted for inflation), you can often use the completed contract method instead on contracts expected to be completed within two years. Most small and mid-size contractors in the Tampa Bay area qualify for this exception.

The completed contract method is simpler. You don’t recognize revenue or expenses until the project is done. It can also defer taxable income into a future year since nothing hits your return until completion. However, it gives you almost no useful financial information while the project is in progress, which makes it harder to spot problems early.

Percentage-of-completion is only as good as your cost estimates. If you underestimate total costs, your completion percentage will be too high and you’ll recognize too much revenue too early. When actual costs come in higher than expected, you have to make adjustments that can create messy corrections in your financials. Accurate construction job costing is essential for making this method work. Tracking labor, materials, and subcontractor costs per project gives you the data you need to calculate completion percentages you can actually rely on.

If you’re a contractor working on projects that cross tax years, understanding which revenue recognition method you’re using and why it matters is worth your time. It affects when you pay taxes, how your profit margins look on paper, and whether your financials tell a reliable story. Our Tampa Bay bookkeeping services help contractors get this right so their books reflect what’s actually happening on the job site, not just what’s been invoiced or collected.