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// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Percentage-of-Completion Revenue: a Worked Example

The profit is an estimate until the last claim is paid.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED · 6 MIN READ

// THE SHORT ANSWER

For a lender to a contractor, percentage-of-completion revenue explains why the profit and loss account and the bank balance tell different stories. Each long contract's revenue and margin are booked as the work proceeds, measured by the contractor's own view of how far the job has gone, most often the costs spent against the total it now expects to spend. Billing follows the contract's timetable instead. So a year's reported profit rests on a forecast of costs not yet incurred, and when that forecast rises, profit reported in an earlier year comes back out. A lender reads the forecast, contract by contract, before it reads the profit.

BASIS  Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

Issue 07 — Coastline Retail Group. NPAT up 9%. Operating cash flow down 31%. The dividend consent request is on your desk. Your call first, then the senior banker's.

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PART OF Credit Analysis for Beginners

// 01 — WHY A LENDER READS THE ESTIMATE FIRST

A contractor on a two-year job that booked nothing until handover would report an empty first year and a crowded second, though it worked steadily through both. Recognising revenue as the work proceeds spreads the result across the years in which it was earned. The price of that accuracy is that every reported margin depends on management's forecast of the cost to complete. The EBITDA in the lender's covenant, its leverage ratio and its view of the business's trend all inherit that forecast.

The international standard, adopted as NZ IFRS 15 and AASB 15, recognises revenue over time when a contract meets one of three tests: the customer receives the benefit as the work is performed, the work creates or improves an asset the customer controls, such as a structure on the customer's land, or the work has no other use to the contractor and the contract gives an enforceable right to payment for work done to date. A contract that meets none of them is recognised at a point in time, often on completion. In the UK, FRS 102's revised Section 23 brings in a five-step model built on IFRS 15's principles for periods beginning on or after 1 January 2026; earlier FRS 102 accounts already used stage of completion for construction contracts. Many private companies in New Zealand and Australia need not prepare general purpose accounts, so a lender asks which basis the accounts in front of it use.

// 02 — HOW PROGRESS IS MEASURED

Progress, input (cost-to-cost) = costs incurred to date ÷ total expected costs
Progress, output = work surveyed, milestones reached or units delivered
Revenue to date = progress × expected contract price
Revenue this period = revenue to date − revenue booked in earlier periods
Contract expected to lose money = whole expected loss provided at once

Input methods measure the contractor's effort; output methods measure what the customer has received. Cost-to-cost is common in construction because the cost records already exist. The standard asks for one method for each performance obligation, applied consistently, and strips out inputs that do not show progress: waste and inefficiency the price did not allow for, and bought-in plant delivered before it is installed, which may carry revenue only at cost, so buying early does not bring margin forward. Where progress cannot yet be reasonably measured but costs will be recovered, revenue is booked only to the extent of costs. Variations and claims enter the expected price only so far as a significant reversal is highly unlikely. A revised estimate is a change in accounting estimate, so its whole effect on the work done to date lands in the current period.

// 03 — THE EXAMPLE

A marine contractor, constructed for this page like every figure in it, is rebuilding a ferry wharf under a fixed-price contract of US$18m. At the start it expects to spend US$15m, a margin of US$3m, and it measures progress by cost. In US$m:

Year 1 cost to date 6.0 of 15.0 expected = 40%
revenue 18 × 40% = 7.2, cost 6.0 profit 1.2
billed 5.5 contract asset 1.7
Year 2 piling meets harder rock; expected cost now 17.0
cost to date 10.2 of 17.0 = 60%
revenue to date 18 × 60% = 10.8
revenue this year 10.8 − 7.2 = 3.6, cost 4.2 loss 0.6

The wharf moved forward in year 2, yet the year shows a loss. The contract's whole margin has fallen from US$3.0m to US$1.0m. On the new estimate, the work done to date has earned 60% of US$1.0m, or US$0.6m, in total. Year 1 has already booked US$1.2m, so year 2 takes back the difference. If the estimate rises again, to US$19.0m, the contract is expected to lose money and the onerous-contract rules, in IAS 37 as adopted in New Zealand and Australia and in Section 21 of FRS 102 in the UK, require a provision for the unavoidable loss on the work still to do, so the whole expected loss is recognised now:

Expected result on the contract 18.0 − 19.0 = −1.0, recognised in full
Year-2 result −1.0 − 1.2 = −2.2

A lender that set a leverage covenant on year-1 EBITDA was lending against US$1.2m of profit that partly existed only in an estimate. Measured by surveyed output instead, the same wharf could have produced a different year-1 figure again, which is why the method and its consistency matter as much as the arithmetic.

// 04 — HOW IT DIFFERS FROM BILLING

Readers confuse revenue recognised with revenue billed. Revenue follows the work; billing follows the contract, through progress claims, milestones or certificates. When revenue runs ahead, the difference is a contract asset, as the US$1.7m in year 1 was. When billing runs ahead, it is a contract liability, the contractor's version of customer prepayments. Percentage of completion is the method; those balances are its footprint on the balance sheet. Its other neighbour is recognition at a point in time, which books nothing until control passes: lumpier, but with no profit resting on a cost forecast before then.

DEFINED IN ONE PARAGRAPH → · CONTRACT ASSETS → · THE PROGRESS CLAIM →

// 05 — WHERE IT DECIDES A FILE

A lender to a contractor asks for a contract schedule, often called a work-in-progress report: for each job, the price with approved variations, the margin expected at tender and now, cost to date, billed to date, cash received and retention held. Read across successive schedules, it shows margin fade, contracts whose margin holds steady until the last months and then collapses, unapproved variations counted in the price, and a year-end schedule more hopeful than the one three months later.

What the lender finds changes the file. It may test leverage on a case where the largest contracts lose part of their margin, ask for the schedule quarterly as a reporting undertaking, and read operating cash flow beside EBITDA, because a contractor whose estimates are optimistic shows it first in cash. A guarantee line for performance bonds is sized on the same schedule.

FINANCIAL REPORTING, READ BY A LENDER → · CASH FLOW ANALYSIS →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

  1. Australian Accounting Standards Board, AASB 15 Revenue from Contracts with Customers (compilation applicable to periods beginning on or after 1 January 2023 and before 1 July 2026), the Australian text of IFRS 15 — paragraphs 35, 39–45 and B14–B19 — Sets the three tests for recognising revenue over time, requires one measure of progress applied consistently, treats changes in it as changes in estimate, and describes output and input methods, including excluding inputs that do not depict progress — sections 01 and 02.
  2. Financial Reporting Council, FRS 102 Factsheet 9: Initial application of the Periodic Review 2024 amendments — Confirms the amendments, including a new Section 23 built on a five-step revenue model, apply to UK accounting periods beginning on or after 1 January 2026 — section 01.

// QUESTIONS PEOPLE ASK

What is the difference between the input method and the output method?
An input method measures progress by what the contractor has put in, such as costs incurred, labour hours or machine hours, against the total it expects to put in. An output method measures what the customer has received, such as work surveyed, milestones reached or units delivered. Both are allowed. The standard asks for the method that best shows the transfer of the work to the customer, applied consistently to similar contracts, and it removes inputs, such as wasted materials, that do not reflect progress.
What happens when a contractor revises its cost estimate?
The revised estimate is applied to the whole contract to date, and the difference falls into the current period. If expected cost rises, the share of the contract already treated as complete falls and the margin on the work done shrinks, so profit booked in earlier years is reversed now. If the contract is now expected to lose money, the whole expected loss is provided at once rather than as the work proceeds. That is why one revision can turn a year's profit into a loss.
Is percentage of completion still used under IFRS 15?
The name is no longer the standard's, but the mechanism is. IFRS 15 and its New Zealand and Australian versions recognise revenue over time, measured by progress towards completion, when a contract meets one of three tests. A long construction contract on the customer's site usually meets them. UK accounts under FRS 102 follow a closely aligned model for periods beginning on or after 1 January 2026, and earlier FRS 102 accounts used the stage of completion for construction contracts.
Why can a profitable contractor run out of cash?
Because the profit is booked on work done and the cash arrives on billing and payment, which can be months behind. Unbilled work, retentions held back and claims under dispute all sit in the accounts as assets while the contractor pays wages and suppliers every month. If cost estimates are also too low, part of the profit did not exist. A lender reads operating cash flow against EBITDA over several years to see which of the two explains the gap.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

  • Transaction bankerSells and structures the plumbing a business runs on — accounts, payments, collections, liquidity and trade finance.
  • Personal bankerThe bank's face in a branch or on a phone: everyday accounts, cards, personal lending and the first conversation about a home loan.
  • Operations analystRuns the processing every product depends on — payments, onboarding, settlements, servicing — at volume.

THE IN-TRAY · ONE MINUTE

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A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE FIRST QUESTION · THE BORROWER · EARNINGS

A distributor's EBITDA rose from US$4.0m to US$5.1m. The CFO's bridge adds back US$0.9m of 'one-off' restructuring costs. There have been restructuring costs in each of the last three years.

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1 FILES · PICK A CALL ON ANY OF THEM

6 MORE ON THE BORROWER · EARNINGS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHPercentage-of-completion revenue (input and output methods) What is percentage-of-completion revenue, and why can profit run ahead of cash?