Accounting & Reporting

Contract Revenue Over Time

Learn how a long contract turns into revenue before anyone is billed, and why the profit on that line is an estimate of a cost that has not been incurred yet.

  • Advanced
  • 9 min total
  • 12 chapters

What decision this helps you make: Whether a contract qualifies for over-time recognition, which measure of progress is defensible, and how much of a reported margin is really a forecast that can reverse.

What this topic is

Over-time revenue recognition books revenue as work is performed rather than when the job finishes or when an invoice goes out. Progress is measured, usually by comparing costs incurred to total costs expected, and that percentage is applied to the contract price. The difference between what has been earned and what has been billed sits on the balance sheet as a contract asset or a contract liability.

Why it matters

This is the one place in the accounts where reported profit is a direct function of a forecast. The margin on a long contract is not observed, it is computed from an estimate of costs not yet spent. Move that estimate two points and this quarter's profit moves, sometimes by more than the quarter's actual work. Anyone reading a contractor, engineering firm, defence supplier, or implementation-heavy software business is reading estimates presented as results.

Who should learn it

Analysts and lenders reading contract-heavy financials, finance teams who own the estimate-at-completion file, buyers diligencing a project business, and owners who need to know why a profitable-looking year produced no cash.

What you will understand

  • The three tests that force revenue to be recognized over time rather than at a point in time
  • Cost-to-cost mechanics end to end, including how a revised estimate hits the current period
  • Why contract assets are not receivables, and what lenders do about that
  • The specific ways this model is gamed, and the tells that show up before the write-down

Prerequisites

Common misconception

"Percentage of completion is an accounting policy: some companies choose it, others wait until the job is done." It stopped being a choice. Under the current standard, if the contract meets any one of three criteria, over-time recognition is mandatory; if it meets none, point-in-time is mandatory. The completed-contract method survives only where the contract fails all three tests. What is still a choice, and the whole ballgame, is the estimate of total cost that drives the percentage.