How does the percentage-of-completion method recognize revenue on long-term construction contracts?

Under the percentage-of-completion method (now framed as "over time" recognition under IFRS 15 / ASC 606), a company recognizes revenue proportionally as it completes a long-term contract, rather than waiting until delivery. This method applies when the company can reliably measure progress toward completion.

The Key Formula:

% Complete = Costs Incurred to Date / Estimated Total Costs

Revenue Recognized to Date = % Complete × Total Contract Price

Revenue for Current Period = Cumulative Revenue to Date − Revenue Recognized in Prior Periods

Worked Example — Ridgeway Construction:

Ridgeway wins a $12,000,000 contract to build a distribution center. Estimated total costs =$9,600,000. Construction spans three years.

Year-by-Year Calculations:

Year 2024: % Complete = $2,880,000 /$9,600,000 = 30% Revenue to date = 30% × $12,000,000 = **$3,600,000** Gross profit = $3,600,000 −$2,880,000 = $720,000

Year 2025: % Complete = $6,720,000 /$9,600,000 = 70% Cumulative revenue = 70% × $12,000,000 =$8,400,000 Revenue this year = $8,400,000 −$3,600,000 = $4,800,000** Gross profit this year =$4,800,000 − $3,840,000 = **$960,000

Year 2026: % Complete = $9,600,000 /$9,600,000 = 100% Revenue this year = $12,000,000 −$8,400,000 = $3,600,000** Gross profit this year =$3,600,000 − $2,880,000 = **$720,000

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Total Profit Check: $720K +$960K + $720K =$2,400,000 = $12M −$9.6M

Key Exam Points:

1. Progress is typically measured using the cost-to-cost method (input method), but output methods (milestones, units delivered) also qualify.
2. If estimated total costs increase mid-project, the percentage changes and cumulative catch-up adjustments occur.
3. The asset "Construction in Progress" appears on the balance sheet, offset by "Billings on Contract."

Check our CFA Level I FRA practice questions for more construction contract scenarios.