Applying Section 23 of FRS 102: The Percentage of Completion Method

Section 23 of FRS 102 governs how UK construction companies recognise revenue and costs from long-term contracts. The principle is straightforward: revenue is recognised by reference to the stage of completion of the contract activity at the reporting date, not by reference to invoicing or cash collection. The mechanics are where the work happens, and the quality of the underlying cost forecast is what determines whether a year-end set of accounts withstands audit scrutiny.

The two methods of measuring stage of completion

Section 23 permits any reliable method of measuring the stage of completion. Two patterns dominate UK construction practice:

Cost-input method

Stage of completion = costs incurred to date / total expected costs to complete. The most common method in private construction firms because it leverages the cost-tracking systems that contractors already maintain. Sensitive to the quality of the cost-to-complete forecast: an under-estimated forecast produces over-stated stage of completion and over-recognised revenue.

Output method (surveyor valuations)

Stage of completion measured by an independent surveyor or QS valuation of work physically performed at the reporting date. Common on civil engineering and infrastructure contracts where independent valuations are part of the contract administration anyway. Tends to produce more conservative figures than cost-input where contracts are running over budget.

The choice should be applied consistently across contracts of similar character and disclosed in the accounting policies. Switching methods mid-contract requires disclosure and is treated as a change in accounting estimate.

Worked example: cost-input method

A contract has the following position at year-end:

• Total expected contract revenue: £4,000,000.
• Total expected contract costs: £3,200,000 (so total expected profit: £800,000).
• Costs incurred to date: £960,000.

Stage of completion = £960,000 / £3,200,000 = 30%.

Revenue recognised in the period = 30% × £4,000,000 = £1,200,000.

Costs recognised in the period = £960,000 (the actual costs incurred).

Profit recognised in the period = £1,200,000 − £960,000 = £240,000 (which is 30% of the £800,000 total expected profit).

The cost forecast: where the audit risk lives

The percentage-of-completion calculation is only as good as the total-cost-to-complete forecast. A contractor systematically under-forecasting costs to complete will systematically over-recognise revenue and over-state profit. This is the single highest area of audit risk in construction company accounts.

Audit-defensible cost forecasting requires:

1. 1A formal monthly cost-value reconciliation (CVR) process for each significant contract.
2. 2Cost categories that map clearly to the original tender (labour, plant, materials, subcontract, preliminaries, overheads).
3. 3A documented procedure for updating the forecast to reflect actual run-rate, scope changes, and known risks.
4. 4Sign-off by the project manager and commercial team on each update.
5. 5Cross-reference to programme dates and physical progress milestones.
6. 6Specific provision for known issues (defects, accepted variations not yet priced, foreseeable claims against the contractor).

Reconciling POC revenue to cumulative applications

Cumulative POC revenue and cumulative valuations or applications to the customer rarely match exactly. The difference sits in two balance-sheet positions:

• Amounts due from customers (debit balance): where POC revenue exceeds cumulative valuations issued. Recognised as a current asset.
• Amounts due to customers (credit balance): where cumulative valuations exceed POC revenue. Recognised as a current liability.

These positions are reviewed contract-by-contract, not netted off across the portfolio. A company with both positive and negative positions across different contracts shows them gross, with separate disclosure of each.

Common questions

Can we use a simplified method for small contracts?

No. Section 23 applies regardless of contract size. The administrative overhead of POC for small short-duration contracts can be reduced by combining contracts of similar character or by recognising revenue at completion if the contract is short enough that no reporting date falls within its life. But the underlying principle stands.

How does CIS interact with revenue recognition?

CIS deductions affect cash collection and balance sheet presentation but not revenue recognition. Revenue is recognised gross of CIS deductions; the deductions appear as withholdings against tax due and are reclaimed via the company's monthly returns.

What if the contract is in significant dispute?

Where the disputed amount is material relative to the contract revenue, the outcome typically cannot be estimated reliably and the cost-recovery method applies. Disclose the dispute, the position taken, and the potential range of outcomes in the accounts.

Are there any specific FRS 102 amendments coming?

The Financial Reporting Council's 2024 amendments to FRS 102 introduce IFRS 15-aligned revenue recognition for periods beginning on or after 1 January 2026, including for construction. Companies should review the amendments now and prepare for the transition; the practical impact for ordinary construction contracts is generally limited but the underlying framework moves to performance obligations.