Work-in-progress revenue recognition means recording revenue on a long-term contract as the work is performed rather than when the project finishes. Under ASC 606, you recognize revenue over time whenever one of three control-transfer criteria is met, measure progress with a consistent method (cost-to-cost is the dominant choice in construction and manufacturing), and carry the running difference between revenue earned and amounts billed as either a contract asset or a contract liability. For federal tax purposes, IRC Section 460 imposes its own percentage-of-completion requirement with a look-back interest calculation when the contract closes.1FASB. Implementing Revenue Recognition
When Over-Time Recognition Applies
ASC 606-10-25-27 permits over-time revenue recognition when any one of three criteria is met:
- The customer simultaneously receives and consumes the benefits of the work as it happens (an ongoing maintenance service, for example).
- The entity’s work creates or enhances an asset the customer controls as it is built, 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 work completed to date, including a reasonable profit margin.
If none of these apply, revenue is recognized at a single point in time when control transfers, and WIP accounting doesn’t come into play. The third criterion generates the most judgment. “Enforceable right to payment” turns on the contract terms and applicable law, not on the entity’s intent. A contract that lets the customer terminate for convenience without paying for completed work fails this test.
Measuring Progress with the Cost-to-Cost Method
Once over-time recognition applies, you need a consistent method to measure how far along the project is. ASC 606 allows input methods (costs, labor hours, machine hours) and output methods (milestones, units delivered, surveys of work performed). Whatever method you choose, apply it consistently to similar obligations in similar circumstances.
The cost-to-cost input method is the workhorse for construction and custom manufacturing. Completion percentage is:
Percentage Complete = Cumulative Costs Incurred ÷ Total Estimated Contract Costs
Take a $1,000,000 contract with $800,000 of estimated total cost. If you’ve spent $200,000 to date, the project is 25% complete, and cumulative recognized revenue should be $250,000. If $100,000 was recognized in a prior period, this period picks up the remaining $150,000.2Deloitte. Revenue Recognition Methods
Two mechanics of this method are easy to get wrong. First, costs that don’t reflect actual progress, such as wasted materials or unabsorbed overhead, must be excluded from the numerator. Second, when total estimated costs change, the completion percentage changes with them. A mid-project cost increase can slash the percentage overnight and reduce revenue in the current period. That adjustment is treated as a change in accounting estimate, not a prior-period correction.
Uninstalled Materials
Uninstalled materials distort the cost-to-cost calculation because they add cost without adding progress. Say a contractor takes delivery of $300,000 of HVAC equipment sitting in a warehouse. Counting that in costs incurred would inflate the completion percentage and pull profit forward.
ASC 606 handles this by requiring you to carve the cost of uninstalled materials out of the progress calculation. Measure progress using only costs that reflect actual work performed. Then, separately, recognize revenue equal to the cost of the uninstalled materials at zero margin.3CFMA. Revenue Recognition: What to Know About Uninstalled Materials The materials hit revenue at cost, and the completion percentage stays undistorted.
Change Orders and Contract Modifications
Change orders are constant in construction and custom manufacturing, and every one triggers an accounting assessment, not just a commercial negotiation. A modification is treated as a separate new contract only when both conditions are met: the additional work is distinct (the customer can benefit from it independently), and the price increase reflects the standalone selling price of that additional work.4Deloitte Accounting Research Tool. 9.2 Types of Contract Modifications When it is, the original contract’s accounting stays untouched.
When those conditions aren’t met, the modification folds into the existing contract in one of three ways:
- Termination and new contract. The remaining undelivered goods or services are treated as though the old contract ended and a new one began. This applies when the remaining work is distinct from what was already delivered.
- Cumulative catch-up adjustment. The modification rolls into the existing contract, and you recalculate completion percentage and revenue recognized to date. Any resulting increase or decrease in revenue lands entirely in the current period. This is the most common construction treatment.
- Combination approach. Some modifications contain elements of both and must be split, with the appropriate treatment applied to each piece.
Approving a change order without updating total estimated costs and the transaction price will pull the WIP schedule out of alignment with the actual project.
When a Contract Becomes a Loss
If total estimated costs exceed expected revenue on a contract, the full projected loss must be recognized immediately in the period it becomes evident. You don’t spread the loss over remaining periods or offset it against hoped-for future work.5DART – Deloitte Accounting Research Tool. 13.5 Onerous Performance Obligations
Consider a contractor with a $1,000,000 contract originally estimated at $800,000 of cost. Half a million dollars of cost incurred looks fine on the surface. But if revised estimates now put total cost at $1,100,000, the entire $100,000 projected loss hits the income statement immediately, even though the project is only half finished.
On the income statement, the loss provision typically shows up 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 can alternatively reduce the accumulated contract costs on the balance sheet instead of recording a separate liability.
Contract Assets, Contract Liabilities, and Receivables
Revenue recognized and amounts billed rarely match, and the difference lives on the balance sheet. Companies report these amounts 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
Contract Assets
A contract asset appears when you’ve recognized revenue based on work performed but haven’t yet earned the right to bill for it. The right to payment is conditional on something other than the passage of time, typically a future milestone.7Deloitte Accounting Research Tool. 4.8 Contract Assets and Contract Liabilities If you’ve recognized $250,000 of revenue but billed only $150,000, the $100,000 gap sits as a contract asset.
A contract asset is not a receivable. A receivable represents an unconditional right to payment where only the passage of time separates the entity from collection. Once the billing conditions attached to a contract asset are satisfied, it reclassifies to a receivable.
Contract Liabilities
A contract liability arises when the customer pays, or the entity bills, before enough work has been performed to recognize that amount as revenue. This is essentially deferred revenue. If a contract has been billed $300,000 but only $250,000 of revenue has been recognized, the $50,000 difference is a contract liability. Customer prepayments and milestone billings issued ahead of the underlying work are the most common causes. As work progresses and revenue is recognized, the contract liability draws down.
Retainage
Retainage, the portion of a progress billing the customer withholds until the project is substantially complete, has its own classification question. The answer turns on whether the right to payment is unconditional. If only the passage of time stands between the entity and collection, the retainage is a receivable. If the right to payment is contingent on future performance or a final inspection, the retainage stays inside the contract asset balance.8Financial Accounting Standards Board (FASB). FASB Staff Educational Paper – Topic 606: Presentation and Disclosure of Retainage for Construction Contractors Receivables and contract assets carry different impairment assessment requirements, so the classification is not cosmetic.
Backlog Disclosure
ASC 606 requires you to disclose the total transaction price allocated to performance obligations that remain unsatisfied or partially unsatisfied at period end, together with when you expect to recognize that revenue. Timing can be shown 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.9DART – Deloitte Accounting Research Tool. 15.2 Contracts With Customers
The Tax Side: IRC Section 460
Financial accounting rules and tax accounting rules for long-term contracts are not the same, and treating them as interchangeable is expensive. For federal income tax purposes, IRC Section 460 generally requires the percentage-of-completion method for any long-term contract, which the IRS defines 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 if two conditions are met: the taxpayer estimates the contract will be completed within two years, and average annual gross receipts for the three preceding 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 contractor size.
Qualifying contractors can use the completed contract method for tax, deferring revenue and cost recognition until the project finishes and creating a real timing advantage. Financial statements prepared under ASC 606 still require over-time recognition, so a qualifying contractor typically runs two treatments on the same project: percentage-of-completion for GAAP, completed contract for the tax return.
The Look-Back Interest Calculation
Taxpayers required to use percentage-of-completion for tax face an added step when a contract is completed. Section 460(b)(2) mandates a look-back calculation comparing the tax actually paid during the contract (based on estimates) 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 steps. First, reapply percentage-of-completion using actual contract costs and prices instead of estimates. Second, compute the hypothetical overpayment or underpayment of tax for each affected year. Third, apply the IRS overpayment interest rate, compounded daily, to each year’s hypothetical discrepancy. If costs were underestimated (accelerating taxable income), the IRS owes the taxpayer interest. If costs were overestimated (deferring income), the taxpayer owes the IRS interest.
Report the calculation on IRS Form 8697. File it for any tax year in which a long-term contract accounted for under percentage-of-completion is completed, and for any subsequent year in which the contract price or costs are adjusted.13IRS. Instructions for Form 8697 (Rev. December 2025) The look-back method doesn’t change the original tax liability; it only charges or credits interest for the timing difference between what was paid and what should have been paid.