Work-in-progress revenue recognition is the practice of recording revenue on a long-term contract as the work is performed rather than waiting until the project is finished. Under ASC 606 in the United States and IFRS 15 internationally, a contractor whose work transfers control to the customer over time must measure how far along the project is at each reporting date and recognize a proportional share of the contract price as revenue.1FASB. Implementing Revenue Recognition The result is an income statement that reflects value delivered during the period instead of a single spike when the job closes out.
When Over-Time Recognition Applies
A contract qualifies for over-time revenue recognition when control of what’s being built or delivered passes to the customer gradually. ASC 606-10-25-27 sets three alternative criteria, and meeting any one of them is enough:
- The customer receives and consumes the benefits of the work as it happens, as with ongoing maintenance.
- The work creates or enhances an asset the customer already controls, such as construction on the customer’s land.
- The work product has no alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date, including a reasonable profit margin.
Most commercial construction, custom manufacturing, and bespoke software contracts qualify under the second or third criterion. If none of the three is met, revenue cannot be recognized over time; it waits until control transfers at a single point. The third criterion is where judgment calls concentrate, because “enforceable right to payment” turns on the written contract and governing law rather than the contractor’s expectation of being paid. A contract that lets the customer walk away without paying for work already completed will fail that test.
The other four steps of the ASC 606 model still apply in the background. The entity has to identify the contract, pin down each distinct performance obligation, determine the transaction price (including variable consideration subject to the constraint against significant reversals), and allocate that price across the obligations.2Deloitte. Revenue Recognition Methods For WIP purposes, the live question each period is how much of that allocated price has been earned so far.
Measuring Progress with the Cost-to-Cost Method
Once a contract qualifies for over-time recognition, the entity needs a consistent way to measure progress. ASC 606 permits input methods (which look at resources expended) and output methods (which look at results delivered to the customer). Output methods are generally preferred when milestones or units delivered are easily observable, but complex customized projects rarely have clean output markers. That is why the cost-to-cost input method dominates construction and manufacturing WIP accounting.
The calculation is a ratio:
Percentage Complete = Cumulative Costs Incurred ÷ Total Estimated Contract Costs
That percentage is then multiplied by the transaction price to arrive at cumulative revenue earned to date. Subtract whatever revenue has already been recognized in prior periods, and the remainder is current-period revenue.
A worked example: a $1,000,000 contract with total estimated costs of $800,000 and $200,000 spent so far is 25% complete, so cumulative recognized revenue should be $250,000. If $100,000 was recognized in a prior period, the current period picks up $150,000.
The method only works if costs in the numerator actually represent progress. Wasted materials, rework, and unabsorbed overhead have to be excluded. The method is also only as reliable as the denominator; when total estimated costs are revised, the completion percentage shifts immediately, and the revision is treated as a change in accounting estimate rather than a prior-period correction.
Uninstalled Materials
Materials that have been purchased but not yet installed distort the ratio. A contractor who takes delivery of $300,000 of HVAC equipment sitting in a warehouse would show a jump in costs incurred without any corresponding progress on the building. Counting those dollars in the numerator inflates the percentage complete and pulls revenue forward.
ASC 606 handles this by requiring the entity to strip the cost of uninstalled materials out of the progress measurement, then separately recognize revenue equal to the cost of those materials at zero margin.3CFMA. Revenue Recognition: What to Know About Uninstalled Materials The materials pass through revenue at cost, no profit is recognized on them until they’re installed, and the completion percentage reflects actual work performed.
Loss Contracts and Mid-Project Estimate Changes
When revised estimates show that total expected costs will exceed total expected revenue, the contract is a loss contract. The full projected loss has to be recognized immediately in the period it becomes evident. It is not spread across remaining periods, and it cannot be offset against anticipated profits on other work.4DART – Deloitte Accounting Research Tool. 13.5 Onerous Performance Obligations
Consider a contractor who estimated $800,000 of costs on a $1,000,000 contract and has incurred $500,000. On paper the project looks fine. If revised estimates then push total costs to $1,100,000, the entire $100,000 projected loss hits the current period, even though only half the physical work is done.
On the income statement, the loss provision typically appears as an additional contract cost rather than a reduction in revenue. On the balance sheet, a material loss provision is presented as a separate current liability, though a company may instead reduce the accumulated contract costs on its balance sheet.
Change Orders and Contract Modifications
Change orders are a routine part of long-term contracts, and each one requires an accounting assessment, not just a commercial decision. A modification is accounted for as a separate new contract when the added work is distinct (the customer can benefit from it on its own) and the price increase reflects the standalone selling price of that added work.5Deloitte Accounting Research Tool. 9.2 Types of Contract Modifications In that case the original contract’s accounting is unchanged.
When those conditions aren’t met, the modification is absorbed into the existing contract in one of three ways:
- Termination of the old contract and creation of a new one, applied when the remaining work is distinct from what has already been delivered.
- A cumulative catch-up adjustment, where the modification rolls into the existing contract and the completion percentage and recognized revenue are recalculated, with the full catch-up effect landing in the current period. This is the most common construction treatment, since change orders usually alter the same overall project.
- A combination approach, where parts of the modification are treated separately and others are rolled in.
Approving a change order without updating total estimated costs and the transaction price will cause the WIP schedule to drift away from economic reality within a single reporting cycle.
Contract Assets, Contract Liabilities, and Retainage
The gap between what’s been earned and what’s been billed shows up on the balance sheet. Companies report contract balances on a net basis at the individual contract level, so a single contract appears as either an asset or a liability but never both at once.6CFMA. Topic 606: Classification and Presentation of Retainage and Contract Assets and Liabilities
A contract asset arises when revenue has been recognized but the entity has not yet earned the right to bill, because the right to payment is conditional on something other than the passage of time (often a future milestone).7Deloitte Accounting Research Tool. 4.8 Contract Assets and Contract Liabilities If $250,000 of revenue has been recognized but only $150,000 has been billed, $100,000 sits as a contract asset. This is distinct from a receivable; a receivable represents an unconditional right to payment where only time stands between the entity and collection. Once the billing conditions attached to a contract asset are satisfied, it reclassifies to a receivable.
A contract liability arises in the opposite situation: a customer has paid, or has been billed, before enough work has been performed to recognize that amount as revenue. This is effectively deferred revenue. A contract billed $300,000 against which only $250,000 of revenue has been recognized sits as a $50,000 contract liability. Customer prepayments and milestone billings issued ahead of the underlying work are the common causes.
Retainage, the share of a progress billing a customer withholds until substantial completion, gets its own classification question. If the only thing standing between the entity and collection of the retainage is the passage of time, it is classified as a receivable. If the right to payment depends on something else, such as further performance by the contractor or a final inspection, the retainage stays within the contract asset balance.8Financial Accounting Standards Board (FASB). FASB Staff Educational Paper – Topic 606: Presentation and Disclosure of Retainage for Construction Contractors The distinction matters because receivables and contract assets carry different impairment assessment requirements.
Disclosing Remaining Performance Obligations
Beyond the balance sheet and income statement figures, ASC 606 requires an entity to disclose the total transaction price allocated to performance obligations that remain unsatisfied or partially unsatisfied at period end, often called backlog.9DART – Deloitte Accounting Research Tool. 15.2 Contracts With Customers The entity must also indicate when it expects to recognize that revenue, either through quantitative time bands (within 12 months, 13–24 months, and so on) or through qualitative narrative. Contracts with an original expected duration of one year or less are exempt from this disclosure.
Tax Treatment Under IRC Section 460
Financial accounting rules and tax rules for long-term contracts are not the same, and treating them as interchangeable is an expensive error. Section 460 of the Internal Revenue Code generally requires taxpayers to use the percentage-of-completion method for any long-term contract, defined as a building, installation, construction, or manufacturing contract that will not be completed in the same tax year it started.10Office of the Law Revision Counsel. 26 U.S. Code 460 – Special Rules for Long-Term Contracts
The Small Contractor Exception
Section 460(e) exempts certain construction contracts from the percentage-of-completion requirement if two conditions are met: the taxpayer estimates the contract will be completed within two years, and the taxpayer’s average annual gross receipts for the preceding three tax years don’t exceed the Section 448(c) threshold. For tax years beginning in 2026, that threshold is $32 million.11IRS. Rev. Proc. 2025-32 Residential construction contracts are exempt regardless of the contractor’s size.
Qualifying contractors can use the completed contract method for tax purposes and defer all revenue and cost recognition until the project is finished. The ASC 606 financial statements still require over-time recognition, so a qualifying contractor often runs two parallel treatments on the same project: percentage-of-completion for GAAP and completed contract for the tax return.
The Look-Back Method
Taxpayers required to use percentage-of-completion for tax purposes face an additional step when a contract closes. Section 460(b)(2) mandates a “look-back” calculation that compares the tax actually paid during the contract (based on estimated costs) with the tax that would have been owed using actual final costs.12eCFR. 26 CFR 1.460-6 – Look-Back Method
The computation has three stages. First, the entity reapplies percentage-of-completion using actual contract costs and prices rather than estimates. Second, it computes the hypothetical overpayment or underpayment of tax for each affected year. Third, it applies the IRS overpayment interest rate, compounded daily, to each year’s hypothetical discrepancy. If costs were underestimated and taxable income was accelerated, the IRS owes interest to the taxpayer. If costs were overestimated and income was deferred, the taxpayer owes interest to the IRS.
The look-back is reported on IRS Form 8697, which must be filed for any tax year in which a long-term contract accounted for under percentage-of-completion is completed, and for any later year in which the contract price or costs are adjusted.13IRS. Instructions for Form 8697 (Rev. December 2025) The look-back doesn’t change the original tax liability; it only charges or credits interest for the time-value difference between what was paid and what should have been paid.