Percentage-of-Completion Accounting for Construction Companies
An introduction to percentage-of-completion accounting, job costing, WIP reporting, estimated costs to complete, and long-term contract considerations.
Why Long-Term Contracts Require Special Attention
Construction companies often begin a project in one tax year and finish it in another.
That creates an important accounting and tax question:
When should the project's revenue and profit be recognized?
IRC §460 generally requires certain long-term contracts to use the percentage-of-completion method (PCM) for federal income tax purposes, although exceptions can apply, including rules for certain home construction contracts and qualifying small contractors.
How Percentage-of-Completion Works
Under PCM, income is recognized as work progresses rather than waiting until the project is finished.
A common cost-to-cost calculation is:
Costs Incurred to Date ÷ Estimated Total Contract Costs = Percentage Complete
That percentage can then be used in determining the amount of contract revenue and gross profit recognized.
Example
Assume:
- Contract price: $2,000,000
- Estimated total cost: $1,600,000
- Costs incurred to date: $800,000
The project is approximately:
$800,000 ÷ $1,600,000 = 50% complete
The accounting system therefore needs reliable estimates of both costs incurred and expected costs to complete.
Why Accurate Job Costing Matters
Percentage-of-completion accounting is only as reliable as the underlying job-cost information.
Construction companies should maintain accurate records for:
- Direct labor
- Materials
- Subcontractors
- Equipment
- Allocated costs
- Change orders
- Estimated costs to complete
Poor job costing can distort revenue recognition and project profitability.
Work in Progress Reporting
A strong WIP schedule can help management compare:
- Contract Value
- → Costs Incurred
- → Estimated Cost to Complete
- → Percentage Complete
- → Revenue Recognized
- → Billings
- → Expected Gross Profit
This isn't only a tax-compliance exercise. It can help owners identify deteriorating margins and problematic projects earlier.
Look-Back Rules
Certain contracts accounted for under PCM may also be subject to the §460 look-back rules after completion. Form 8697 is used in applicable circumstances to calculate interest due or refundable when actual contract results differ from prior estimates.
At Akato & Associates, we help construction and A&E businesses strengthen job-cost accounting, WIP reporting, and tax planning around long-term contracts.
This material is provided for general information only and does not constitute accounting, tax or legal advice. It does not take account of your particular circumstances. Contact the firm before acting on anything you read here.