Understanding Percentage of Completion Accounting

"What gets measured gets managed."

In the construction industry, that principle applies not only to project schedules and productivity, but also to your financial reporting.

A project can appear highly profitable on paper while cash flow tells an entirely different story. At the same time, a project that is performing well may look underwhelming if the financial information is not presented correctly. That is why percentage of completion accounting has become such an important tool for construction businesses and the common users of the financial statements (lenders, sureties, and bonding agents).

Unlike many industries, contractors often perform work over months or even years. Costs are incurred long before a project is complete, and owners need reliable financial information throughout the life of a job, not just when the project wraps up. Percentage of completion accounting provides that visibility by helping contractors understand where jobs stand today and where potential opportunities or challenges may be emerging.

What Percentage of Completion Accounting Is and Why It Matters

Percentage of completion accounting is a method of recognizing revenue and costs as work is performed rather than waiting until a project is completed.

Simply put, if a project is 60% complete, your financial statements should generally reflect approximately 60% of the expected revenue and costs associated with that project.

For construction business owners, that visibility is critical. Projects often span many months, and waiting until the end of a job to evaluate performance can make it difficult to identify issues early enough to take corrective action.

Percentage of completion accounting helps answer some of the most important questions business owners face:

• Are projects performing as expected?
• Are margins improving or declining?
• Are cost estimates still realistic?
• Is the company generating sufficient profitability and cash flow to support future growth?
• Are there emerging risks that leadership should address before they become larger problems?

Rather than viewing financial statements as a historical report card, percentage of completion accounting allows contractors to use their financial information as a management tool. It provides a more complete picture of project performance throughout the lifecycle of a job and helps support better business decisions.

In addition, the typical users of the financial statements often expect to see financial statements prepared using percentage of completion reporting because it provides meaningful insight into ongoing project activity and performance.

How Revenue and Costs Are Recognized

The most commonly used approach is the cost-to-cost method, which measures progress by comparing costs incurred to date against total estimated project costs.

Consider the following example:

• Contract Value: $1,000,000

• Estimated Total Costs: $800,000

• Costs Incurred to Date: $400,000

Because $400,000 represents 50% of the total estimated costs, the project is considered 50% complete. As a result:

• Revenue Recognized: $500,000

• Costs Recognized: $400,000

• Gross Profit Recognized: $100,000

While the calculation itself is straightforward, its accuracy depends entirely on the quality of the information behind it.

That is why strong job costing and realistic project estimates are so important. If projected costs are inaccurate, the resulting financial statements may also be misleading. In many cases, percentage of completion accounting is only as reliable as the estimates supporting it.

Understanding Contract Liabilities (Overbillings) and Contract Assets (Underbillings) 

One area that often creates confusion for contractors is the relationship between project billings and project progress.

The reality is that billing activity rarely aligns perfectly with work completed. That difference creates either a contract asset or contract liability, formerly known as underbillings and overbillings, respectively.

Contract Assets

Contract assets related to billings and progress towards completion occur when the amount of work completed exceeds the amount billed to the customer.

These generally appear as an asset on the balance sheet because the contractor has earned revenue that has not yet been billed or collected.

While occasional contract assets are normal, consistently large balances may create unnecessary pressure on cash flow and working capital. They may also indicate billing delays, collection challenges, or projects where estimated margins have deteriorated.

Contract Liabilities

Contract liabilities related to billings and progress towards completion occur when billings exceed the amount of revenue earned based on project completion.

These balances appear as liabilities because billings exceed the amount of revenue earned based on the progress made toward completing the project.

From a cash flow perspective, a reasonable over-billed position is often advantageous. Construction businesses that are able to bill ahead of costs incurred generally have greater control over working capital and are less likely to fund a project's cash needs with internal resources or external debt.

That said, over-billings should still be monitored closely. An unusually large over-billed position may indicate that a significant amount of work remains to be completed or that project estimates need to be revisited. In some cases, excessive over-billings can result in revenue and profit being deferred into future periods, which may make current project performance appear weaker than it actually is.

Another important consideration is where the offsetting balance is located on the balance sheet. Has the contract liability already been converted to cash, or is it still sitting in accounts receivable? If the balance has been collected, the contractor has already realized the cash flow benefit from billing ahead of performance.

However, if a significant portion remains in accounts receivable, management should carefully evaluate the aging of those balances and the customer's payment history. A contract liability only improves cash flow once the related receivable has been collected.

Regular analysis helps ensure these balances remain intentional and manageable. The goal is not necessarily to eliminate over-billings or under-billings, but to understand why they exist and ensure they are consistent with the project's status, billing strategy, and estimated profitability.

What Your Financial Statements Are Communicating

Construction financial statements do more than provide information to management.

They also communicate a story to:

• Banks
• Sureties
• Bonding companies
• Investors
• Other stakeholders

These groups are not just reviewing profitability. They are evaluating how effectively the business manages risk.

They often focus on:

• Work-in-progess schedules
• Over-billing and under-billing trends
• Gross profit performance
• Estimate accuracy
• Working capital and liquidity

Contractors that maintain accurate reporting and regularly update project estimates often present a stronger financial picture and are better positioned when discussions arise regarding bonding capacity, credit facilities, or future growth opportunities.

Key Areas to Review in Your WIP Schedule

The work in progress (WIP) schedule is one of the most valuable management tools available to a construction business. It provides a snapshot of every active project and serves as the foundation for percentage of completion reporting.

When reviewing your WIP schedule, pay close attention to the following:

1. Completion Percentage vs. Billing Percentage

Significant differences between these figures should be understood and monitored. Large gaps may indicate collection challenges, billing delays, or project timing issues that deserve further investigation.

2. Estimated Gross Margin by Project

Project margins should be reviewed regularly. When margins decline across multiple projects, it may signal broader issues involving estimating, production, purchasing, or project management.

3. Project Fade

Fade occurs when estimated profitability decreases as a project progresses. Some fluctuations are normal. However, repeated fade across multiple projects often points to a systemic issue that leadership should address.

4. Projects Nearing Completion

The final stages of a project frequently present the greatest risk for unforeseen costs, closeout challenges, and margin adjustments. Giving extra attention to projects approaching completion can help avoid unwelcome surprises.

Common Mistakes to Avoid

Even well-run contractors encounter challenges with percentage of completion accounting.

Some of the most common include:

• Relying on outdated job cost estimates.
• Failing to update projections when project conditions change.
• Treating the annual financial statement process as the first-time project estimates and WIP schedules are thoroughly evaluated.
• Focusing solely on revenue rather than profitability.
• Treating the WIP schedule as a compliance requirement instead of a management tool.

The most successful contractors use their WIP schedule regularly, often monthly, to identify trends early and make proactive decisions.

The Bottom Line

Percentage of completion accounting is much more than an accounting exercise. At its best, it is a business management tool that helps contractors gain visibility into project performance, strengthen communication with lenders and sureties, and make more informed decisions.

Like most management tools, its value depends on how consistently it is used.

Accurate estimates, reliable job costing, and regular review of your WIP schedule can provide meaningful insight into where your business stands today and where it is headed tomorrow. When used effectively, percentage of completion accounting does not just help you report your results. It helps you manage them.

Have questions about what your financial statements are telling you about project performance? Our construction team at LGT can help you better understand the story behind the numbers and identify opportunities to strengthen your business for the future.

To learn more about LGT and how we can serve you, contact us here.