To calculate the percentage of completion on a long-term contract, divide the costs incurred to date by the total estimated costs for the project, multiply that ratio by the total contract price to get cumulative revenue earned, and subtract whatever revenue you already recognized in prior periods. The remainder is the revenue you record for the current period. The arithmetic is short. The judgment behind the numbers, and the tax rules that decide when you must use this method, are where projects go wrong.
Put in a single line:
Percentage Complete = Costs Incurred to Date ÷ Total Estimated Costs
Current-Period Revenue = (Percentage Complete × Total Contract Price) − Revenue Recognized in Prior Periods
A quick example. You have a $2,000,000 contract. Estimated total costs are $1,000,000. You have spent $400,000 so far. You are 40% complete. Cumulative revenue earned to date is $800,000. If you booked $300,000 last year, current-period revenue is $500,000.
The Three Inputs You Need First
Three figures drive every calculation. Get them right before you touch the formula.
Total contract price. The full amount the customer has agreed to pay for the finished work. Pull it from the signed contract, master service agreement, or formal bid documents. If approved change orders have modified the scope, use the updated figure.
Total estimated costs. Every dollar you expect to spend completing the project: labor, materials, subcontractors, equipment, and allocated overhead. This figure typically comes from the original project budget or internal bid worksheets, and it must be updated whenever circumstances change.
Actual costs incurred to date. Every dollar already spent through the current reporting cutoff, drawn from your project accounting ledger or job-cost system.
Sloppy estimates do not just distort one quarter. They cascade forward into every future period, and for tax purposes they can trigger interest charges when the IRS compares your estimates to the final results.
Turning the Percentage Into Current-Period Revenue
Two steps convert a completion percentage into a period revenue figure.
First, multiply the percentage complete by the total contract price. That gives cumulative revenue earned from day one through today. Second, subtract every dollar of revenue you already recognized in prior periods. What is left is what you report this period.
The subtraction is the part people skip. Every period you recalculate cumulative revenue from scratch using updated numbers, then back out what you have already booked. Using stale prior-period figures, or forgetting the subtraction, is one of the most common errors in project accounting.
When Estimates Change Mid-Project
Estimates almost always shift during a long-term project. Material prices move, subcontractors run over budget, or a client approves a change order. When that happens, you do not restate prior periods. You use a cumulative catch-up adjustment.
Suppose you are building a warehouse originally estimated at $1,000,000 in total costs on a $1,250,000 contract. By the end of Year 1 you have spent $400,000 and recognized $500,000 in revenue (40% of $1,250,000). Early in Year 2 you learn total costs will actually be $1,100,000. Your new completion percentage at the same $400,000 of costs incurred is roughly 36.4% ($400,000 ÷ $1,100,000). Cumulative revenue should be about $454,545. Since you already recognized $500,000, you record a negative adjustment of about $45,455 in the current period.
Always recalculate from the beginning using the best available estimates, then true up the difference. Applying new estimates only to future periods, while leaving past errors alone, distorts every subsequent report.
Alternatives to Cost-to-Cost
Cost-to-cost is the standard approach and the one federal tax law prescribes. Under IRC Section 460, percentage of completion is determined “by comparing costs allocated to the contract and incurred before the close of the taxable year with the estimated total contract costs.”1Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts
Financial reporting under GAAP gives more flexibility. ASC 606 asks you to pick the method that most faithfully depicts control transferring to the customer. Methods split into two categories.
Input methods measure your effort toward completing the obligation. Cost-to-cost is the most common, but labor hours or machine hours work the same way. If a contract requires 2,000 total labor hours and your crew has logged 500, you are 25% complete. Input methods suit projects where effort tracks delivery closely.
Output methods measure the value already delivered. Units delivered, milestones reached, or surveys of work performed all qualify. A manufacturer producing 1,000 identical components under one contract might count finished units shipped. Output methods can be more accurate when costs and deliverables do not track linearly, but they are harder to apply when output is difficult to observe before the project finishes.
Whichever method you choose, apply it consistently across similar contracts. Switching methods mid-project without justification invites scrutiny from auditors and the IRS.
When You Are Required to Use This Method
Under ASC 606, over-time revenue recognition is available only if the contract meets at least one of three criteria: the customer receives and consumes the benefit of your work as you perform it; the customer controls the asset as it is built; or the asset has no alternative use to you and you have an enforceable right to payment for work completed to date. If none apply, you recognize revenue at a single point in time, usually upon delivery. Most construction and custom manufacturing contracts satisfy at least one criterion.
Federal tax law is more direct. Section 460 requires the percentage-of-completion method for any contract involving the manufacture, building, installation, or construction of property that is not finished within the tax year it starts.1Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts The cost-to-cost formula is not optional. IRS auditors watch for estimates that inflate early (depressing reported income) then shrink toward completion, and the look-back rule is designed to catch that pattern.
Exemptions From the Tax Mandate
Two exemptions from Section 460 matter for smaller contractors.
Residential construction contracts are always exempt, regardless of contractor size. A residential construction contract is one where at least 80% of estimated total costs go toward dwelling units in structures with four or fewer units, plus related site improvements.1Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts Each townhouse or rowhouse counts as a separate building. These contractors can use the completed-contract method or other permissible alternatives.2eCFR. 26 CFR 1.460-3 – Long-Term Construction Contracts
Small construction contracts also qualify if two conditions are met: the taxpayer estimates the contract will be completed within two years, and average annual gross receipts for the prior three years do not exceed the inflation-adjusted threshold under Section 448(c). For tax years beginning in 2026, that threshold is $32 million.3IRS. Revenue Procedure 2025-32 Tax shelters barred from cash-method accounting under Section 448(a)(3) cannot use this exemption regardless of receipts.
The 10-Percent Election
Even when percentage-of-completion is required, Section 460(b)(5) allows a timing election. Under the 10-percent method, you recognize no income from a long-term contract until the tax year in which you have incurred at least 10% of estimated total costs.1Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts The mobilization and early planning phase generates no taxable income. Once you cross 10%, all the income that would have been recognized in earlier periods hits at once. The election applies to every long-term contract entered into during the year you make it and carries forward. Taxpayers using the simplified cost allocation method under Section 460(b)(3)(A) cannot combine it with this election.
The Look-Back Rule at Completion
When a long-term contract finishes, Section 460(b)(2) requires you to recalculate what taxable income would have been in each prior year if you had used the actual final contract price and costs instead of estimates.1Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts
Three steps. First, reapply the percentage-of-completion method to each prior year using actual figures. Second, compare the recalculated tax liability for each year to what you actually reported, producing a hypothetical underpayment or overpayment. Third, the IRS applies interest, compounded daily at the overpayment rate under Section 6621, running from the original due date of each affected return through the due date of the return for the completion year.4eCFR. 26 CFR 1.460-6 – Look-Back Method
If your cost estimates were too low, you likely reported too much income too early, and the IRS owes you interest. If you overestimated costs and deferred income, you owe the IRS interest. The mechanism runs both directions.
You report the calculation on Form 8697, required for any tax year in which you complete a long-term contract under percentage-of-completion, and again in later years if the contract price or costs are adjusted after completion.5IRS. Instructions for Form 8697
When a Contract Turns Unprofitable
If revised estimates show total costs will exceed the contract price, you cannot spread the loss across the remaining project life. Under GAAP, the entire anticipated loss must be recognized immediately in the period you identify it, even if the project is only partially complete. For tax purposes, the loss flows through the ordinary percentage-of-completion calculation as costs mount and reported income shrinks or turns negative. The GAAP obligation to front-load the full expected loss is what catches people off guard, especially on fixed-price contracts where overruns cannot be passed to the client. If profitability starts deteriorating, revisit total estimated costs immediately rather than waiting for the next scheduled review.