How does the percentage-of-completion method recognize revenue on long-term construction contracts?
I'm working through CFA Level I FRA revenue recognition and I find the percentage-of-completion method confusing. How do you calculate revenue and profit each year for a multi-year contract? I understand you need to estimate total costs, but the mechanics of recognizing revenue proportionally are tripping me up.
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 | Costs Incurred This Year | Cumulative Costs | Est. Total Costs |
|---|---|---|---|
| 2024 | $2,880,000 | $2,880,000 | $9,600,000 |
| 2025 | $3,840,000 | $6,720,000 | $9,600,000 |
| 2026 | $2,880,000 | $9,600,000 | $9,600,000 |
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
Total Profit Check: $720K + $960K + $720K = $2,400,000 = $12M − $9.6M
Key Exam Points:
- Progress is typically measured using the cost-to-cost method (input method), but output methods (milestones, units delivered) also qualify.
- If estimated total costs increase mid-project, the percentage changes and cumulative catch-up adjustments occur.
- 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.
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