Long-term construction jobs raise a basic accounting question: when do you count the revenue and profit? The Florida Business and Finance exam expects you to know the two methods contractors use, percentage of completion and completed contract, and to run the percentage-of-completion math quickly. Conducting Accounting Functions (Content Area D) is the largest area on the exam at 32% of questions, and job-cost and revenue questions are a regular part of it.
The two methods
| Percentage of completion | Completed contract | |
|---|---|---|
| When revenue is recognized | Gradually, as work progresses | All at once, when the job is complete |
| When gross profit is recognized | In proportion to progress | All at once, at completion |
| Needs reliable cost estimates | Yes | No |
| Income statement effect | Smooth, matches revenue to the period work is done | Lumpy, large swings in the year jobs finish |
| Balance sheet items | Overbillings and underbillings | Costs and billings carried on the balance sheet until completion |
| Expected loss on the job | Recognize the full loss immediately | Recognize the full loss immediately |
The last row is the one many candidates miss. Under either method, once you can see that a job will lose money, you book the whole expected loss right away. You do not spread a loss over the life of the job.
For federal tax, 26 U.S.C. 460 generally requires the percentage-of-completion method for long-term contracts and measures progress with the cost-to-cost method, with exceptions for certain contracts. Tax method rules are detailed and can change, so check the current code and IRS guidance for any real tax filing.
The cost-to-cost formula
Cost-to-cost measures progress by comparing what you have spent with what you expect to spend in total.
- Percent complete = costs incurred to date ÷ total estimated costs
- Revenue earned to date = percent complete × contract price
- Gross profit to date = revenue earned to date − costs incurred to date (or percent complete × estimated total gross profit; you get the same answer)
- Revenue this period = revenue earned to date − revenue recognized in earlier periods
- Over/underbilling = billings to date − revenue earned to date - Positive: overbilled ("billings in excess of costs and estimated earnings"), a current liability - Negative: underbilled ("costs and estimated earnings in excess of billings"), a current asset
Always use the latest estimate of total cost. If the estimate changes, the percent complete changes, and so does the cumulative revenue.
Worked example 1: one period
A contractor signs a $2,400,000 fixed-price contract to build a warehouse. Estimated total cost is $2,000,000, so expected gross profit is $400,000. At year end, costs incurred are $700,000 and the contractor has billed the owner $900,000.
Step 1. Percent complete $700,000 ÷ $2,000,000 = 0.35 = 35%
Step 2. Revenue earned to date 35% × $2,400,000 = $840,000
Step 3. Gross profit to date $840,000 − $700,000 = $140,000 Check: 35% × $400,000 = $140,000
Step 4. Over or underbilled? Billings $900,000 − earned revenue $840,000 = $60,000 overbilled
The $60,000 is reported as a current liability, billings in excess of costs and estimated earnings. The contractor has collected or billed ahead of the work it has actually performed.
Under the completed-contract method, the same contractor would recognize no revenue and no gross profit on this job this year.
Worked example 2: two years with a revised estimate
A $3,000,000 contract has an original cost estimate of $2,500,000.
Year 1: costs incurred $1,000,000. Estimate unchanged at $2,500,000.
- Percent complete: $1,000,000 ÷ $2,500,000 = 40%
- Revenue earned to date: 40% × $3,000,000 = $1,200,000
- Gross profit to date: $1,200,000 − $1,000,000 = $200,000
- Year 1 gross profit: $200,000
Year 2: cumulative costs are $2,040,000. Prices went up, and the revised total cost estimate is $2,720,000.
- Percent complete: $2,040,000 ÷ $2,720,000 = 0.75 = 75%
- Revenue earned to date: 75% × $3,000,000 = $2,250,000
- Year 2 revenue: $2,250,000 − $1,200,000 = $1,050,000
- Gross profit to date: $2,250,000 − $2,040,000 = $210,000
- Year 2 gross profit: $210,000 − $200,000 = $10,000
Check with the profit approach: revised expected profit is $3,000,000 − $2,720,000 = $280,000, and 75% × $280,000 = $210,000 cumulative. Year 2 is the cumulative figure minus what was already recognized.
The revised estimate is handled in the current period. You do not go back and restate Year 1.
What if the estimate shows a loss?
Suppose in Year 2 the revised estimate was $3,100,000 instead. The job will now lose $100,000 ($3,000,000 − $3,100,000). The contractor recognizes the full $100,000 expected loss on the job right away, and because $200,000 of profit was already booked in Year 1, the Year 2 loss reported is $300,000. That brings the cumulative result to the −$100,000 expected for the whole job.
Common traps
| Trap | What to do instead |
|---|---|
| Dividing costs by the contract price | Divide costs incurred by total estimated cost |
| Using billings to measure progress | Billings are not costs. Use costs incurred |
| Reporting cumulative revenue as this year's revenue | Subtract revenue recognized in prior periods |
| Keeping the old estimate after a revision | Always use the latest total cost estimate |
| Mixing up the balance sheet labels | Overbilling is a liability; underbilling is an asset |
| Spreading an expected loss | Recognize the entire expected loss immediately, under either method |
| Recognizing profit under completed contract before the end | Nothing is recognized until the job is complete |
Key numbers to tab in your book
- Percentage-of-completion method and cost-to-cost measure
- Completed-contract method
- Billings in excess of costs and estimated earnings (overbillings)
- Costs and estimated earnings in excess of billings (underbillings)
- Provision for anticipated losses on contracts
- Work-in-progress (WIP) schedule
- Long-term contract tax rules (Section 460)
Practice it until it is automatic
Percentage-of-completion questions are pure math, so they are points you can bank without opening a book. Our Florida Business and Finance Exam Prep includes original job-cost and revenue recognition questions with every step of the calculation shown, along with 90 days of practice across all six content areas. For the full exam format, see the Florida Business and Finance exam guide.
Practice questions
A job's estimated total cost is $800,000 and costs incurred to date are $280,000. Using the cost-to-cost method, the percentage of completion is:
- A28%
- B35%
- C65%
- D40%
Show answer
Answer: B. Percent complete = costs to date / estimated total costs = $280,000 / $800,000 = 35%. 65% is the remaining portion.
Source: Standard accounting/construction-management principle
A contract price is $1,200,000; estimated total cost is $1,000,000; costs to date are $450,000; revenue previously recognized is $400,000. Under percentage of completion (cost-to-cost), revenue to recognize this period is:
- A$540,000
- B$50,000
- C$140,000
- D$90,000
Show answer
Answer: C. Percent complete = 450,000/1,000,000 = 45%; revenue to date = 45% x $1,200,000 = $540,000; less $400,000 previously recognized = $140,000. $540,000 is the cumulative figure, not the period's.
Source: Standard accounting/construction-management principle
A contractor uses the cost-to-cost percentage-of-completion method on a $1,200,000 contract with estimated total costs of $960,000. Costs incurred to date are $360,000. How much contract revenue has been earned to date?
- A$360,000
- B$288,000
- C$450,000
- D$90,000
Show answer
Answer: C. Percent complete = $360,000 / $960,000 = 37.5%. Revenue earned = 37.5% x $1,200,000 = $450,000. Using costs incurred alone ($360,000) ignores the profit margin built into the contract.
Source: 26 U.S.C. 460(b)(1)(A) (cost-to-cost measure)
Same facts: $1,200,000 contract, $960,000 estimated total cost, $360,000 incurred to date (cost-to-cost percentage of completion). What gross profit should be recognized to date?
- A$450,000
- B$72,000
- C$240,000
- D$90,000
Show answer
Answer: D. Total estimated gross profit = $1,200,000 − $960,000 = $240,000. Percent complete = 37.5%, so gross profit to date = 37.5% x $240,000 = $90,000 (equivalently $450,000 revenue − $360,000 cost). Recognizing the full $240,000 is what the completed-contract method would do only at completion.
Source: 26 U.S.C. 460(b)(1)(A)
Continuing the same job: earned revenue to date is $450,000 and the contractor has billed the owner $500,000 to date. How is the difference reported on the balance sheet?
- AOverbilling of $50,000, a current liability (billings in excess of costs and estimated earnings)
- BUnderbilling of $50,000, a current asset (costs and estimated earnings in excess of billings)
- COverbilling of $140,000, a current liability
- DAccounts receivable of $50,000
Show answer
Answer: A. Billings ($500,000) − earned revenue ($450,000) = $50,000 billed ahead of the work, which is an overbilling and is shown as a current liability. Comparing billings to cost ($140,000) leaves out the earned gross profit.
Source: Standard construction accounting principle (calculation verified in Python)
Midway through a fixed-price job, a contractor's updated estimate shows total costs will exceed the contract price by $40,000. Under generally accepted accounting principles, how should the expected loss be handled?
- ARecognize the loss only when the job is completed if using completed-contract
- BRecognize the entire $40,000 anticipated loss immediately, under either percentage-of-completion or completed-contract
- CIgnore it until the final change orders are settled
- DRecognize the loss proportionally as the remaining work is performed
Show answer
Answer: B. Construction accounting principles require a provision for the full anticipated loss in the period it becomes evident, regardless of the revenue method. Spreading the loss, or deferring it under completed-contract, would overstate current income.
Source: Standard construction accounting principle (provision for anticipated losses, ASC 605-35)
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