All You Need to Know About Cost-to-Cost Method

Have you ever wondered how companies recognize revenue for long-term projects before they’re completed? The answer lies in the cost-to-cost method, a widely accepted approach for revenue recognition that matches a project’s progress with its financial outcomes. Instead of waiting until the end, this method lets businesses recognize revenue gradually, based on how much of the total cost has already been incurred. It's particularly useful in industries where projects stretch over months or even years.

The cost-to-cost method plays a crucial role in ensuring accurate financial reporting and helps companies maintain a steady cash flow outlook. By aligning revenue with project completion, it provides a realistic snapshot of performance at any given point. This approach is especially relevant in construction, engineering, software development, and other industries dealing with long-term contracts.

However, applying the cost-to-cost method effectively requires precise tracking of expenses, accurate cost forecasting, and real-time visibility into project execution. That’s where a robust enterprise resource planning (ERP) system comes into play. Deskera ERP, for instance, offers integrated tools for project accounting, real-time cost tracking, and automated revenue recognition. With built-in features for budgeting, forecasting, and reporting, it empowers businesses to confidently implement the cost-to-cost method and stay compliant with accounting standards.

In this blog, we’ll dive into everything you need to know about the cost-to-cost method. Whether you're a finance professional or a business owner handling long-term contracts, understanding this method can significantly enhance how you manage your revenue and project reporting.

What is the Cost-to-Cost Method?

The cost-to-cost method is a revenue recognition technique used primarily for long-term projects that span multiple accounting periods—such as in construction, engineering, aerospace, and defense industries.

It falls under the broader category of the percentage-of-completion method, where revenue is recognized incrementally based on project progress rather than waiting until completion.

What sets the cost-to-cost method apart is its focus on financial inputs. Rather than tracking labor hours, units produced, or milestones achieved, this method measures progress by comparing the costs incurred to date with the total estimated cost of the project.

For example, if $4 million has been spent on a $16 million project, the job is considered 25% complete, and the company can recognize 25% of the total contract revenue in that period.

This approach provides a more accurate and timely reflection of financial performance during lengthy projects. It allows stakeholders to see how much revenue has been earned relative to the actual work completed.

However, its reliability depends on the precision of cost estimates and tracking systems. Inaccurate forecasting or unanticipated cost overruns can result in significant errors in reported revenue and profit.

While widely used, especially in project-based businesses, the cost-to-cost method isn’t suitable for every scenario. It works best when costs are predictable and directly tied to project progress. In contrast, for short-term contracts or industries with volatile expenses, alternative methods—such as completed contract or milestone-based recognition—may be more appropriate.

How Does the Cost-to-Cost Method Work?

The cost-to-cost method operates by measuring a project's progress using financial inputs—specifically, the costs incurred to date—rather than physical units or time-based milestones. This method helps companies recognize revenue proportionately over the course of a long-term contract, making financial reporting more accurate and timely.

Here’s a step-by-step breakdown of how it works:

Step 1: Estimate Total Project Cost

Begin by estimating the total cost required to complete the project. This includes direct costs like materials, labor, equipment, and subcontracting, as well as allocated indirect costs if applicable.

Step 2: Track Actual Costs Incurred

Calculate the costs incurred to date. This is the cumulative amount spent on the project up to the current reporting period.

Step 3: Calculate Percentage of Completion

Determine the project’s completion level using this formula:

Percentage of Completion = (Costs Incurred to Date / Total Estimated Costs) × 100

For example, if you’ve incurred $4,000,000 in costs on a project with estimated total costs of $16,000,000, then:

Percentage of Completion = ($4,000,000 / $16,000,000) × 100 = 25%

Step 4: Determine Revenue to Recognize

Apply this percentage to the total contract price to calculate the cumulative revenue to date:

Cumulative Revenue = Percentage of Completion × Total Contract Value

Continuing the example:

Cumulative Revenue = 25% × $20,000,000 = $5,000,000

Then subtract any previously recognized revenue to determine the amount to recognize in the current period:

Current Period Revenue = Cumulative Revenue – Revenue Previously Recognized

If no revenue has been recognized before, the full $5,000,000 is recorded for the current period.

Why Ongoing Updates Matter

Throughout the project, companies must continuously reassess cost estimates and track incurred expenses. This ensures that any changes—like delays, cost overruns, or scope changes—are reflected in the updated revenue calculations. It also supports accurate forecasting and financial transparency.

This method is especially powerful when integrated into systems like Deskera ERP, which automates cost tracking, updates project estimates in real time, and simplifies revenue recognition.

With features tailored for project-based accounting, Deskera ensures that businesses using the cost-to-cost method can maintain compliance and control at every phase of their contracts.

When to Use the Cost-to-Cost Method

The cost-to-cost method is best suited for long-term projects where progress and financial performance need to be measured continuously over time. This method works especially well when project outcomes are predictable and cost tracking systems are reliable.

Here are the most common scenarios where the cost-to-cost method proves to be both practical and advantageous:

1. Long-Term Contracts

Projects that span multiple accounting periods—such as construction, infrastructure, or large-scale engineering—benefit from the cost-to-cost method because it enables revenue recognition in stages rather than waiting for project completion.

2. Projects with Measurable Progress

When a project’s progress can be reasonably measured using incurred costs (e.g., labor, materials, overhead), the cost-to-cost method offers an accurate reflection of work performed and revenue earned at any given point.

3. Stable and Predictable Cost Environments

In industries where cost elements are relatively stable or can be estimated with reasonable accuracy, the method helps maintain consistent and reliable financial reporting.

4. Compliance with ASC 606 / IFRS 15

Companies that need to comply with revenue recognition standards under ASC 606 or IFRS 15 often use the cost-to-cost method, especially when the contract terms include performance obligations satisfied over time.

5. Industries with Milestone-Based Work

In sectors like defense contracting, software development, and shipbuilding, where work is delivered in phases and costs accumulate gradually, this method aligns well with how work and revenue are structured.

Advantages of the Cost-to-Cost Method

The cost-to-cost method benefits companies managing long-term contracts by tying financial performance directly to actual work completed. It offers clarity, control, compliance, and cash flow stability—all essential for sustained project success.

1. Aligns Revenue Recognition with Costs Incurred

The core strength of the cost-to-cost method lies in its ability to match revenue recognition with actual project expenditure.

This ensures that revenue is reported in proportion to the work truly completed, offering a faithful representation of a company’s financial performance at any given point in time.

Unlike methods that rely on project milestones or completion, cost-to-cost prevents artificial inflation or deferral of revenue, reducing the risk of revenue misstatements.

This is especially important for publicly traded or audit-sensitive firms, where transparency and compliance with accounting standards like ASC 606 and IFRS 15 are critical.

2. Improves Profitability Forecasting

Because this method requires regular monitoring of incurred costs and comparisons to total cost estimates, companies gain real-time visibility into project profitability trends.

Managers can identify deviations early—such as rising labor costs or supply chain disruptions—that could threaten margins. By continuously updating estimates and recognizing revenue incrementally, the method enables more informed projections of future profits, cash flows, and resource needs.

This is vital for organizations handling multiple large-scale or long-term projects, where strategic forecasting determines competitiveness and sustainability.

3. Enables Accurate and Timely Progress Measurement

The cost-to-cost method quantifies project completion as a percentage derived from financial inputs (i.e., costs incurred). This approach delivers a highly objective and quantifiable measure of progress, which is more reliable than subjective assessments or milestone-based methods.

Frequent evaluation of project status ensures that stakeholders—from project managers to CFOs—have up-to-date insights into both operational and financial performance. This timely data supports course correction if a project veers off track and strengthens communication across departments and with external clients or investors.

4. Supports More Stable and Predictable Cash Flow

By spreading revenue recognition over the project timeline rather than deferring it until completion, the cost-to-cost method smooths out revenue inflows, leading to steadier cash flow.

This is particularly beneficial for cash-sensitive sectors like construction, engineering, and infrastructure development, where projects can last months or years.

Regular recognition of earnings improves working capital, facilitates better payroll and vendor management, and reduces reliance on external financing. For CFOs, predictable cash flow simplifies financial planning and debt servicing.

5. Improves Project Management and Budget Oversight

The discipline imposed by the cost-to-cost method—requiring frequent cost reviews and updates—promotes greater accountability and tighter control over project budgets.

Since companies must monitor each cost element (materials, labor, overheads), they can quickly spot inefficiencies, overages, or scope creep. This promotes a proactive project management culture, where data-driven insights help optimize resource allocation and prevent budget overruns.

Additionally, real-time cost tracking helps firms stay compliant with contract terms, reducing disputes and client dissatisfaction.

6. Ensures Compliance with Revenue Recognition Standards

The method is fully aligned with international financial reporting standards like IFRS 15 and ASC 606, which mandate revenue recognition based on performance obligations.

By using actual cost data to determine fulfillment levels, companies ensure their revenue recognition practices are legally compliant and audit-ready. This reduces the risk of penalties, restatements, or reputational damage.

It also facilitates smoother audits and boosts investor confidence, especially for publicly listed or rapidly scaling companies.

7. Enhances Internal Reporting and Stakeholder Communication

Because the cost-to-cost method produces regular, data-backed revenue figures, internal reports such as profit & loss statements, project dashboards, and board updates become more accurate and insightful.

These real-time insights support faster, more confident decision-making at all levels—from frontline supervisors adjusting daily operations to executives making strategic portfolio decisions.

Moreover, clients and external stakeholders appreciate the transparency, which can strengthen trust and long-term relationships.

Limitations of the Cost-to-Cost Method

The cost-to-cost method is widely used for long-term project accounting because it ties revenue recognition to actual project costs. However, it comes with inherent risks and operational challenges that can undermine its effectiveness if not properly managed.

Below are the key limitations to consider:

1. Inaccurate Cost Estimates Can Distort Financial Results

The effectiveness of the cost-to-cost method depends heavily on accurate initial and ongoing cost estimates. If these estimates are flawed:

• Underestimated costs can lead to premature recognition of revenue and inflated profitability in early stages.
• Overestimated costs can delay revenue recognition, underrepresenting performance and profitability.

These discrepancies create distortions in financial reporting and can mislead stakeholders about a company’s actual performance and health. Given that estimates are often based on assumptions and forecasts, the risk of error is particularly high in complex, multi-year projects.

2. Cost Tracking is Complex and Time-Intensive

To apply the method correctly, companies must meticulously track and categorize costs on an ongoing basis:

• Direct and indirect costs must be identified and allocated with precision.
• Job costing must reflect real-time progress across materials, labor, equipment, and overhead.

This level of detail demands robust accounting systems, trained personnel, and often automation tools—making it resource-intensive. In smaller firms or those without integrated project management software, this can lead to inefficiencies, missed data, or inconsistent reporting.

3. Vulnerability to Unforeseen Changes and Cost Volatility

Projects spanning multiple periods are naturally exposed to external uncertainties such as:

• Labor shortages
• Material price fluctuations
• Supply chain delays
• Regulatory or tax changes

These factors can invalidate initial cost projections, requiring re-estimation mid-project. If changes are not promptly and accurately reflected, the method may report revenue based on outdated assumptions, leading to misalignment between reported and actual project progress.

4. Progress May Be Overstated or Understated

The method assumes that cost incurred equals work completed, but that correlation doesn’t always hold:

• High up-front spending (e.g., on equipment or materials stored for later use) can inflate progress even if little actual work is completed.
• Conversely, later-stage tasks might progress rapidly with relatively low incremental costs, understating true progress.

This misalignment can lead to misleading financials and flawed project status reports, especially when not cross-verified with physical progress or milestones.

5. Susceptible to Revenue Manipulation

Because revenue is tied to subjective cost estimates, there is potential for intentional manipulation:

• Management could adjust future cost estimates to accelerate or defer revenue recognition and smooth earnings.
• Inclusion or exclusion of specific costs can be selectively applied to influence short-term financial outcomes.

This makes the method vulnerable to earnings management, which may go undetected without rigorous internal controls and external audits. The subjective nature of inputs makes third-party validation challenging unless documentation is comprehensive and transparent.

6. Cost Estimation Bias and Competitive Pressure

In industries like construction or government contracting, firms are often incentivized to underbid in order to win projects. This creates:

• Unrealistic cost baselines used in revenue recognition.
• Increased likelihood of cost overruns and underreported revenue in later phases.

Even if internal revenue calculations adjust for actual cost-to-complete projections, the initial bias in estimation can still distort financial performance early in the project’s life cycle.

7. Highly Dependent on Documentation and Technology

Successful implementation demands:

• Real-time data capture from the field.
• Detailed documentation of all project costs.
• Integration between project management, accounting, and ERP systems.

Without reliable tools or trained personnel, organizations may struggle to maintain the accuracy and timeliness required. In such cases, the cost-to-cost method becomes vulnerable to human error, delayed updates, and fragmented reporting, undermining its core advantage—revenue integrity.

While the cost-to-cost method provides a systematic approach to revenue recognition, it is not foolproof. Its effectiveness hinges on cost accuracy, operational discipline, and robust systems.

Businesses considering this method must invest in strong controls, transparent estimation practices, and continuous monitoring to reap its benefits without exposing themselves to unnecessary financial and reputational risk.

Cost-to-Cost Method vs. Other Revenue Recognition Methods

Choosing the right revenue recognition method is critical to ensuring accurate financial reporting. The cost-to-cost method is one of several recognized approaches, each suited to different business models and contract types.

Below is a comparison of the cost-to-cost method with other commonly used revenue recognition methods:

1. Cost-to-Cost Method

• Basis: Revenue is recognized proportionally to the costs incurred relative to total estimated costs.
• Best For: Long-term, multi-phase projects with measurable progress and reliable cost tracking.
• Key Benefit: Provides a realistic view of ongoing project profitability and progress.
• Drawback: Requires highly accurate cost estimation and tracking; susceptible to cost fluctuations and estimation errors.

2. Completed Contract Method

• Basis: Revenue and expenses are recognized only when the contract is fully completed.
• Best For: Short-term projects or projects with unpredictable outcomes and progress metrics.
• Key Benefit: Simple to apply, avoids revenue recognition issues caused by cost estimation errors.
• Drawback: Can distort financials in interim periods by deferring all revenue until completion, impacting cash flow visibility.

3. Percentage-of-Completion Method (Alternative Input Method)

• Basis: Revenue is recognized based on a broader measure of progress, such as milestones, labor hours, or units produced—rather than costs alone.
• Best For: Projects where labor or other metrics better reflect progress than costs.
• Key Benefit: Flexible; aligns with performance-based metrics instead of only financial inputs.
• Drawback: May not reflect economic reality if chosen input isn’t closely tied to actual project performance.

4. Sales-Based or Output Method

• Basis: Revenue is recognized when control of goods or services is transferred to the customer (e.g., at delivery or invoicing).
• Best For: Retail, SaaS, or subscription-based businesses with clear delivery points.
• Key Benefit: Clear, transaction-based recognition tied to deliverables.
• Drawback: Not suitable for projects where value is delivered over time or through ongoing efforts.

By understanding how the cost-to-cost method compares to other recognition models, businesses can choose the approach that best reflects their operations and contract dynamics, while also meeting regulatory compliance standards.

How to Implement the Cost-to-Cost Method

Implementing the cost-to-cost method requires careful planning, accurate cost tracking, and ongoing project oversight. This approach links financial progress to actual costs incurred, making it crucial to set up a consistent process from the outset.

Below is a step-by-step guide to help you apply the method correctly and efficiently.

Step 1: Determine Project Scope and Contract Details

Before applying the method, ensure the project meets the criteria for percentage-of-completion revenue recognition:

• The project spans multiple accounting periods.
• There is a well-defined contract with enforceable rights.
• You can reliably estimate total project costs and revenues.
• You have the ability to track actual costs incurred.

Step 2: Establish the Total Estimated Costs of the Project

Work with project managers, engineers, and finance teams to develop a comprehensive and realistic cost estimate, which includes:

• Direct materials and labor
• Equipment usage and depreciation
• Subcontractor expenses
• Overhead allocations (if applicable)
• Permits, compliance, and miscellaneous fees

This serves as the denominator in the cost-to-cost revenue recognition formula.

Step 3: Track Actual Costs Incurred to Date

Implement job costing systems or accounting software to track all incurred project costs accurately and in real time. This should include:

• Payroll and labor hours
• Purchased and consumed materials
• Subcontractor invoices
• Allocated overhead and indirect costs

Regular updates and audits of cost records are essential to maintain accuracy.

Step 4: Calculate Percentage of Completion

Use the cost-to-cost formula to calculate project completion:

Percentage of Completion=Costs Incurred to Date/Total Estimated Project Costs

This figure reflects how much of the project is completed financially, not physically.

Step 5: Recognize Revenue Based on Project Completion

Once the percentage of completion is calculated, apply it to the total contract revenue to determine how much revenue to recognize in the current accounting period:

Revenue Recognized to Date=Percentage of Completion × Total Contract Revenue

Then subtract revenue recognized in prior periods to find current period revenue.

Step 6: Update Cost Estimates Periodically

As the project progresses, actual costs and forecasts will change. Regularly reassess and update:

• Remaining costs to complete
• Total estimated costs
• Any contract modifications or scope changes

Adjust the percentage of completion and revenue recognition as needed to maintain accuracy.

Step 7: Maintain Supporting Documentation

For audit and compliance purposes, retain:

• Original cost estimates and assumptions
• Actual cost reports with backup
• Calculations of percentage completion and recognized revenue
• Change orders and scope modifications
• Project timelines and progress reports

Step 8: Implement Internal Controls

To minimize the risk of manipulation or error:

• Segregate duties between project estimation and accounting
• Conduct periodic internal audits
• Use software that provides version control and audit trails
• Ensure management review and approval of estimates

Example Calculation

Suppose you have a 12-month project with a $2 million contract value and estimated total costs of $1.5 million. After three months, you’ve incurred $450,000 in actual costs.

Percentage of Completion: 450,000/1,500,000 = 30%

Revenue Recognized to Date: 30% x 2,000,000 = 600,000

If $400,000 was recognized in prior periods, current period revenue = $200,000.

How Deskera ERP Supports the Cost-to-Cost Method

Deskera ERP offers a powerful suite of tools that simplifies the implementation and management of the cost-to-cost method, especially for businesses handling long-term, complex projects. Here’s how Deskera can help:

1. Real-Time Cost Tracking

Deskera enables real-time tracking of all project-related costs, including labor, materials, and overheads. This allows businesses to calculate incurred costs with precision, which is essential for accurate revenue recognition under the cost-to-cost method.

2. Project-Based Accounting

With Deskera's project accounting module, you can link expenses and revenues directly to specific jobs or projects. This ensures that cost accumulation and revenue recognition stay aligned, enhancing financial transparency and compliance.

3. Advanced Reporting and Forecasting

Deskera provides customizable dashboards and reports that let you visualize project progress, forecast profitability, and monitor variances. These insights are invaluable for keeping your project on track and adjusting estimates when needed.

4. Automation of Revenue Recognition

Automate revenue recognition calculations based on costs incurred, reducing manual work and the risk of errors. Deskera’s system supports compliance with key standards like IFRS 15 and ASC 606, helping you meet regulatory requirements effortlessly.

5. Integrated Modules for Better Decision-Making

Deskera ERP integrates accounting, inventory, CRM, and HR into a single platform. This holistic view of operations allows project managers and financial controllers to make informed decisions quickly, based on up-to-date data across departments.

6. Mobile Accessibility and AI Assistance

With Deskera’s mobile-first design and AI-powered assistant David, you can track progress, view costs, and generate reports on the go—ensuring flexibility and responsiveness, especially for field teams and remote project leads.

Deskera ERP not only simplifies cost tracking and revenue recognition but also equips your team with the tools to manage projects proactively, stay compliant, and drive long-term profitability using the cost-to-cost method.

Key Takeaways

• The cost-to-cost method is a percentage-of-completion accounting technique where revenue is recognized based on the ratio of costs incurred to total estimated costs—ideal for long-term project accounting.
• Use this method for long-term, resource-intensive projects where progress can be reliably measured through costs incurred, such as construction, engineering, or manufacturing contracts.
• This method offers accurate revenue recognition, improved forecasting, real-time progress tracking, and better cash flow management—making it valuable for financial visibility in ongoing projects.
• Challenges include dependence on precise cost estimates, complex tracking requirements, sensitivity to project changes, and potential for revenue misstatements due to cost misalignment.
• Unlike completed-contract or milestone-based methods, cost-to-cost provides steady revenue flow during the project, offering better financial clarity but requiring more detailed cost tracking.
• Successful implementation requires robust cost estimation, continuous expense tracking, revenue calculation formulas, and consistent reviews of actual vs. projected costs throughout the project lifecycle.
• Deskera ERP simplifies cost tracking, automates revenue recognition, ensures compliance, and integrates project accounting with real-time reporting—making it a powerful tool for applying the cost-to-cost method efficiently.

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