Percentage of completion accounting, often shortened to POC accounting, is a method that recognizes revenue and expenses on a long-term project in proportion to the work finished during each reporting period, instead of waiting for the whole job to close out. A contractor halfway through a $10 million bridge doesn’t report zero income for years and then a sudden windfall at the end. Revenue shows up as the bridge takes shape, matched to the costs incurred to build it. The approach gives lenders, investors, and management a truer picture of financial health than the completed contract method, which stays silent until the final invoice. For federal tax purposes, the percentage of completion method is mandatory for most long-term contracts unless a specific exemption applies.
How the Method Works
The logic is straightforward. If you’re delivering value to a customer as work progresses, your financial statements should reflect that value period by period. A contractor who pours foundations in January and erects steel in March is earning money in both months, even if the client won’t cut the final check until December. POC captures that economic reality by matching costs and revenue to the same reporting period.
When a company spends $400,000 on labor and materials in a given quarter, the revenue tied to that effort appears on the same income statement. Stakeholders can see actual margins at each stage rather than a lump-sum result at the end. Years of reported losses followed by a single giant gain would make it nearly impossible for creditors to evaluate ongoing performance or for management to spot problems early.
When POC Is Required Under GAAP
Under ASC 606, the current U.S. GAAP revenue standard, a company recognizes revenue over time when at least one of three conditions is met: the customer simultaneously receives and consumes the benefit of the work; the work creates or enhances an asset the customer controls; or the work creates an asset with no alternative use to the contractor and the contractor has an enforceable right to payment for work completed to date. Construction, aerospace, shipbuilding, and custom software development almost always satisfy one of these conditions.
Before any revenue hits the books, five baseline requirements have to be present in the contract. Both parties must approve the agreement, each side’s rights and the payment terms must be identifiable, the contract must have commercial substance, and the company must conclude it will probably collect the amount owed. If management cannot produce reliable estimates of total costs and total revenue, POC doesn’t apply, and the company defers recognition until reasonable estimates become possible.
Federal Tax Rules Under IRC Section 460
The tax side has its own mandate. Under Section 460 of the Internal Revenue Code, taxable income from any long-term contract must be determined using the percentage of completion method. A “long-term contract” for tax purposes is any contract for the manufacturing, building, installation, or construction of property that is not completed within the same tax year it was entered into.1Office of the Law Revision Counsel. 26 USC 460 Special Rules for Long-Term Contracts A contract signed and finished entirely within one calendar year doesn’t trigger the requirement, even if the job took eleven months.
Section 460 also specifies how to calculate the completion percentage for tax purposes: compare the costs allocated to the contract and incurred before the end of the tax year with the estimated total contract costs. That is the cost-to-cost method, and it is the default under federal tax law.
Small Business and Construction Exemptions
Not every contractor is stuck with mandatory POC. Section 460 carves out exceptions for certain construction contracts, and the threshold that matters most is the gross receipts test under Section 448(c). For tax years beginning in 2026, a company meets this test if its average annual gross receipts over the prior three tax years do not exceed $32 million.2Internal Revenue Service. Revenue Procedure 2025-32 The figure adjusts for inflation each year.
Two categories of exempt contracts exist. Small construction contracts are any construction contracts the taxpayer estimates at inception will be completed within two years, provided the taxpayer meets the $32 million gross receipts test. These contractors can use the completed contract method or another permissible method instead of POC. Home construction contracts qualify when 80% or more of the estimated total costs go to building or improving dwelling units in buildings with four or fewer units, again subject to the two-year and gross receipts tests.1Office of the Law Revision Counsel. 26 USC 460 Special Rules for Long-Term Contracts
Residential construction contracts for larger buildings, meaning more than four dwelling units, also receive an exemption but with a three-year completion window rather than two. If a company’s revenue crosses the $32 million threshold, the switch to mandatory POC is treated as a change in accounting method initiated by the taxpayer. No IRS consent is required, but the change applies on a cut-off basis to all similarly classified contracts going forward.
Measuring Project Progress
Once a company is on the POC method, the question each reporting period is how far along a project is. Two broad approaches exist, and the company must apply its chosen method consistently across similar contracts.
Cost-to-Cost and Other Input Methods
Input methods measure progress based on resources consumed relative to resources expected. Cost-to-cost is by far the most common. The formula divides total costs incurred to date by total estimated costs for the project. If a company has spent $500,000 on a job it estimates will cost $2,000,000 in total, the project is 25% complete. Applied to a $3,000,000 contract price, that means $750,000 in revenue for the period.
The calculation gets updated every reporting period. When costs run over budget or the scope changes, the estimated total shifts and so does the completion percentage. Accountants track direct costs like labor, materials, and subcontractor payments while excluding items that don’t reflect genuine progress, such as wasted materials sitting in a dumpster or deposits on equipment not yet delivered to the site.
Output Methods
Output methods measure results: milestones reached, units delivered, or physical progress like floors completed in a high-rise. A building that’s five stories up out of a planned ten is visibly 50% done. The tradeoff is that output methods often require a third-party engineer or architect to certify progress, adding cost and complexity, and they tend to work poorly for projects where effort isn’t evenly distributed across milestones.
The 10-Percent Method Election
For tax purposes, Section 460 allows an election called the 10-percent method. Under this approach, the company defers recognizing any income from a long-term contract until at least 10% of the estimated total contract costs have been incurred. All income that would have been recognized before hitting the 10% mark gets pushed into the first year that crosses the threshold.1Office of the Law Revision Counsel. 26 USC 460 Special Rules for Long-Term Contracts The election is useful for projects with heavy upfront mobilization costs that don’t represent real construction progress. It applies to all long-term contracts entered into during the tax year of the election and going forward.
Handling Change Orders
Scope changes are a constant reality on long-term projects, and the accounting treatment depends on whether the change creates a distinct new obligation or simply modifies the existing one. That distinction determines whether the company adjusts revenue going forward or recalculates from the start of the contract.
When a change order adds work that is not distinct from the original scope, the typical situation where added work is intertwined with everything already in progress, the company treats the modification as part of the original performance obligation. The transaction price and the measure of progress both get updated, and the company records a cumulative catch-up adjustment to revenue in the period of the change. If a $5 million contract gets a $400,000 change order for upgraded mechanical systems, the new total of $5.4 million becomes the basis for all future progress calculations, and prior-period revenue is trued up.
When a change order adds work that is distinct, meaning a genuinely separate deliverable, the company accounts for it prospectively. Revenue already recognized stays in place, and the new consideration gets allocated to the new obligation going forward. In practice, most construction change orders fall into the first category because the added work is too intertwined with the original scope to stand on its own.
When a Project Turns Into a Loss
This is where POC accounting gets unforgiving. If at any point the estimated total costs on a contract exceed the expected revenue, the company must recognize the entire anticipated loss immediately. Not the proportional share of the loss based on completion percentage. The full loss, in the period it becomes evident. A contractor 30% through a job who realizes the project will lose $1 million books the entire $1 million loss right then, even though 70% of the work hasn’t happened yet.
The rule exists to prevent companies from hiding bad news. POC lets you recognize profits gradually, but it forces you to swallow losses all at once. Companies that fail to update their cost estimates honestly can face audit adjustments that hit financial statements in a single restatement.
Balance Sheet Accounts POC Creates
Long-term contracts produce balance sheet accounts that don’t appear in most other businesses. The Construction in Progress (CIP) account is an asset that accumulates all costs incurred on a project plus the profit recognized to date. Billings on Construction in Progress tracks the invoices sent to the customer. The two accounts are compared at the end of each reporting period, and the net result drives the balance sheet presentation.
If CIP exceeds billings, the company has earned more than it has billed. The difference shows up as a current asset, commonly called “costs and estimated earnings in excess of billings” or “underbillings.” If billings exceed CIP, the company has billed more than the value of work performed, and the difference is a current liability called “billings in excess of costs” or “overbillings.” Both figures can appear on the balance sheet at the same time across different contracts. Sureties and lenders watch these balances closely, because persistent underbillings on projects that should be winding down can signal billing disputes or costs that will never convert to cash, while heavy overbillings can indicate that one project’s cash is funding another.
The Look-Back Rule and Form 8697
The percentage of completion method for tax purposes relies on estimates that are, by definition, imperfect. The look-back rule under Section 460(b) corrects for that imperfection. When a long-term contract is completed, the taxpayer must recalculate what the tax liability would have been in each prior year if the actual contract price and costs had been known from the start.1Office of the Law Revision Counsel. 26 USC 460 Special Rules for Long-Term Contracts
If the recalculation shows the company underpaid taxes in a prior year because it underestimated costs or overestimated the contract price at the time, the company owes interest to the IRS. If it overpaid, meaning the estimates caused it to recognize too much income too early, the IRS refunds interest to the company. The interest rate is the federal overpayment rate under Section 6621, compounded daily.3eCFR. 26 CFR 1.460-6 Look-Back Method
The calculation is reported on IRS Form 8697. When you owe interest, the form attaches to your income tax return. When the IRS owes you interest, you file Form 8697 separately. The form is also required in any later year when the contract price or costs are adjusted for a previously completed contract.4Internal Revenue Service. Instructions for Form 8697 Interest Computation Under the Look-Back Method for Completed Long-Term Contracts Interest received through the look-back method is taxable income; interest paid is treated as interest expense from a tax underpayment.3eCFR. 26 CFR 1.460-6 Look-Back Method
Getting the Estimates Right
Every number in POC accounting flows from two estimates: total contract revenue and total contract costs. Get those wrong, and the revenue recognition, the tax payments, the balance sheet presentation, and eventually the look-back interest calculation all fall apart. This is the area where auditors spend the most time and where restatements most often originate.
Reliable estimation starts with the original bid documents and project schedule. As the job progresses, accountants need to compare actual costs in the general ledger against the budget on a regular basis, monthly at minimum for any project large enough to move the needle on financial statements. Direct costs like labor, materials, equipment, and subcontractor billings form the core of the calculation. Indirect costs need consistent allocation policies that hold up under audit.
The most common failure is optimism. Project managers resist revising cost estimates upward because doing so shrinks reported margins and can trigger the immediate loss recognition rule. But the longer a company delays acknowledging cost overruns, the larger the eventual adjustment and the more suspicious it looks to auditors, sureties, and regulators. Companies that survive in this space build review processes where the project manager’s estimate gets independently challenged by someone without a stake in the project’s reported performance.