Percentage of completion accounting is a revenue recognition method that reports revenue and cost on a long-term contract as the work progresses, rather than holding both back until the job is handed over. How much lands in a period is set by a measure of progress toward completion, most often the ratio of contract costs incurred so far to the total cost the job is expected to take. On the books, Topic 606 carries no method under that name and keeps that familiar arithmetic only as one permitted measure of progress. On the return, section 460 makes the percentage of completion method the general rule for a long-term contract.
The Two Authorities Behind the Term
On the Books
Topic 606 requires an entity to recognize revenue over time where one of three criteria is met, one of which is that the entity’s performance creates or enhances an asset the customer controls as it is created (FASB, Accounting Standards Update 2014-09, paragraph 606-10-25-27).
Where the test is met, the entity recognizes revenue by measuring progress toward complete satisfaction of the performance obligation, applying one method consistently and remeasuring it at the end of each reporting period (FASB, Accounting Standards Update 2014-09, paragraphs 606-10-25-31 and 606-10-25-32). Cost is one permitted input among several, and the standard names no default. Input methods recognize revenue on the basis of the entity’s efforts or inputs, such as resources consumed, labor hours expended, costs incurred, time elapsed, or machine hours used, relative to the total expected inputs (FASB, Accounting Standards Update 2014-09, paragraph 606-10-55-20). Which period revenue belongs to at all is the revenue recognition principle; this method answers the narrower question of how far along the work is.
On the Return
In the case of any long-term contract, the taxable income from such contract shall be determined under the percentage of completion method (26 U.S.C. 460(a)). A long-term contract means any contract for the manufacture, building, installation, or construction of property that is not completed within the taxable year in which it is entered into (26 U.S.C. 460(f)(1)).
For a building, installation or construction contract that definition turns on the taxable year, not on the length of the job. A manufacturing contract is narrower, because it is a long-term contract only where it involves a unique item of a type not normally included in the taxpayer’s finished goods inventory, or an item that normally requires more than 12 calendar months to complete (26 U.S.C. 460(f)(2)). For construction, length instead belongs to a separate exemption, which reaches a construction contract the taxpayer estimates at the time it is entered into will be completed within the 2-year period beginning on the contract commencement date and that meets the gross receipts test (26 CFR 1.460-3(b)(1)(ii)). That exemption, the home construction one, and the look-back interest computation that settles the estimates up afterward are worked through in construction accounting outsourcing.
The Completion Factor Formula
The tax regulation specifies the arithmetic rather than leaving it to preference (26 CFR 1.460-4(b)(2)).
completion factor = cumulative allocable contract costs incurred to date
---------------------------------------------------
estimated total allocable contract costs
revenue to date = completion factor x total contract price
this year's revenue = revenue to date - revenue reported in prior yearsCumulative allocable contract costs incurred to date are the costs allocated to that one contract and incurred by the close of the taxable year, so the numerator is actual cost rather than a forecast. Estimated total allocable contract costs are what the taxpayer reasonably expects the whole job to cost, so the denominator moves every time the cost to complete is rebuilt. Total contract price is the amount the taxpayer reasonably expects to receive under the contract, including holdbacks, retainages and cost reimbursements (26 CFR 1.460-4(b)(4)(i)(A)), so it reaches further than the contractor’s cash position does, as retainage shows.
A Worked Example
Say a contractor signs a fixed price job that spans two tax years, and the estimate of total cost comes down in the second year as the work settles.
Total contract price 2,000,000
Year 1
Allocable costs incurred to date 600,000
Estimated total allocable costs 1,600,000
Completion factor 600,000 / 1,600,000 37.5%
Revenue to date 0.375 x 2,000,000 750,000
Reported in prior years 0
Revenue, year 1 750,000
Year 2
Allocable costs incurred to date 1,240,000
Estimated total allocable costs, revised 1,550,000
Completion factor 1,240,000 / 1,550,000 80.0%
Revenue to date 0.80 x 2,000,000 1,600,000
Reported in prior years 750,000
Revenue, year 2 850,000Nothing in the second year turns on what was billed or collected. When the estimate moves, the first year’s figure is not restated and the whole correction runs through the current year, so the cost to complete is what moves the reported number.
What the factor produces is an earned amount, and it seldom equals what the contractor has billed. That gap is the position tracked job by job on a WIP schedule, set out in work in progress.
Percentage of Completion and the Completed Contract Method
The completed contract method leaves a job out of income until the year it finishes, while percentage of completion reports revenue and cost as the work is performed. On a US return it is not a free choice. The regulation makes the percentage of completion method the one a taxpayer generally must use for a long-term contract, and it describes the completed contract method only as one of the permissible methods of accounting for an exempt construction contract (26 CFR 1.460-4(a)), so the exemptions are the gateway to it. Books and tax are answered separately, which is why one job can sit on a measure of progress for the financial statements and on the completed contract method for the return.
Common Questions
No. Topic 606 sets no method under that name. It requires revenue over time where one of the criteria in 606-10-25-27 is met, then requires a measure of progress toward complete satisfaction of the performance obligation, with output methods and input methods both available (FASB, Accounting Standards Update 2014-09, paragraphs 606-10-25-31 and 606-10-55-16). The familiar arithmetic survives as one measure of progress rather than as a named method.
Revenue and cost on a contract are reported in the periods the work is performed, not in the period the job is handed over or the money arrives, which spreads one contract’s profit across every year it touches.
Divide costs incurred to date by estimated total costs, then multiply that factor by the total contract price. The denominator is where the judgment sits, and on the books a cost based input method should exclude inputs that do not depict performance, with an adjustment to the measure of progress that may be required where a cost incurred does not contribute to progress, such as the cost of unexpected amounts of wasted materials or labor that the contract price never reflected (FASB, Accounting Standards Update 2014-09, paragraph 606-10-55-21).
CCM is the completed contract method and PoC is percentage of completion. Under CCM the gross contract price and all allocable contract costs incurred by the completion year are taken into account in that year (26 CFR 1.460-4(d)(1)), while under PoC a share of both lands in every year the work runs.
Accountably places trained offshore accountants inside US CPA and EA firms, and a firm carrying contractor clients can put a block of its own WIP and completion factor schedules through a trial task before anything client facing depends on it.
