Companies delivering a long-term project with multiple phases often struggle to define how and when to recognize revenue. Given all the potential variables, this question often causes considerable confusion and headaches, yet recognizing revenue at the correct time and using the right method is critical.
When done right, revenue recognition ensures businesses accurately reflect their earnings, providing transparency for stakeholders and helping maintain compliance with accounting regulations. This is why it’s important for accountants to utilize the best recognition method for their company to avoid misrepresenting its financial earnings..
Compared to alternative methods, the milestone method of revenue recognition typically works well for the pharmaceuticals, construction, and software development industries, among others. Because projects are long-term, they recognize revenue as project milestones are reached, as opposed to waiting for the entirety of the contract to be completed.
This article explores the milestone method, explaining how it works, when to use it, how it compares to other methods, and related best practices so readers can make informed decisions about implementing it in their organization.
Understanding the Milestone Method
Let’s start by defining one of the core accounting principles: revenue recognition. Simply put, revenue recognition is the process of recording income when earned but not necessarily when cash is received.
According to Accounting Standards Codification (ASC 606) and International Financial Reporting Standards (IFRS 15), companies must recognize revenue to reflect the transfer of goods or services to their customers.
Issued by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) in 2014 to standardize revenue recognition practices globally, this helpful accounting guidance helps ensure that revenue is reported consistently across industries to increase transparency and improve financial reporting.
Performance obligations are a key aspect of revenue recognition, representing a company’s commitment to deliver specific products or services to its clients. Once a performance obligation is fulfilled, the related revenue must be recorded in compliance with FASB and IASB guidelines. Additionally, financial reports need to include detailed disclosures that specify the recognized revenue’s amount, nature, and timing.
Several revenue recognition methods exist, including percentage-of-completion, completed contracts, and the sales basis method, each suited to different types of transactions. For large, complex projects with extended timelines, the milestone method of revenue recognition is frequently used to track revenue.
What Is the Milestone Method?
The milestone method allows companies to recognize revenue when specific, predefined milestones are reached during a project (a revenue recognition event). These milestone events are typically tied to significant achievements, such as completing a project phase, meeting contract deliverables, or hitting performance targets.
Commonly used in industries like construction, software development, and pharmaceuticals, where projects are multifaceted and long-term; the milestone method is often used when there’s a defined project timeline with measurable and deliverable tasks throughout the lifecycle of the obligation but where incremental progress is difficult to obtain.
How the Milestone Method Works
To use the milestone method successfully, various teams must work together to identify and define key milestones in a contract, such as project phases or deliverables. Revenue is then recognized upon the completion of each milestone.
For example, consider these potential milestones within industries commonly employing this revenue recognition method:
- Construction: Finished foundation, passed inspections
- Software development: Delivering a specific feature
- Pharmaceuticals: Clinical trial stages, regulatory agency approval
In industries like these, development arrangements frequently include detailed contracts outlining milestones and deliverables so the company can recognize revenue and track projects.
There are also considerations to take into account. In revenue recognition, factors such as variable pricing, discounts, and incentives are considered.
When using the milestone method, the amount of consideration recognized depends on achieving specific milestones, reflecting the company’s past performance and the actual progress and value delivered at each stage. In this case, revenue aligns with the work completed and accounts for any adjustments related to variable elements without involving advanced payments.
Understanding how to calculate revenue recognition properly using the milestone method is essential for businesses in certain industries. This method ties customer payments and revenue recognition to measurable achievements, helping accountants generate accurate financial statements.
When to Use the Milestone Method
The milestone method is ideal for long-term contracts and project-based industries. One of the most common revenue recognition methods is that it directly connects revenue recognition with project progress and the associated costs of completing each phase or deliverable. This helps provide a clear picture of a company’s financial health.
However, the method has some drawbacks. Determining precise milestones can be challenging, and accountants’ and others’ subjective judgments can impact consistency. Revenue recognition is often postponed following milestone delays, affecting cash flow projections and financial reporting.
Comparison With Other Revenue Recognition Methods
As previously discussed, the milestone method recognizes revenue based on completing specific, predefined milestones. This makes it a great choice for projects with clear stages or deliverables.
In contrast, the percentage-of-completion method recognizes revenue continuously as work progresses, according to the percentage of the project completed. This method typically suits long-term contracts where progress can be reliably measured.
The completed contract method, meanwhile, delays revenue recognition until the entire project is finished. This method may be preferred for short-term projects or when uncertainty about completion exists.
The key difference between these methods lies in timing. The milestone method provides intermittent revenue recognition, while the percentage-of-completion method allows ongoing recognition. The completed contract method, on the other hand, postpones all recognition until the project’s end.
Hence, businesses with clearly defined project stages may opt for the milestone method, while those with ongoing work may prefer percentage completion. The completed contract method is often favored for contracts with uncertainty or short durations.
Long-Term Projects Revenue Recognition Method Comparison Chart
| Milestone Method | Percentage of Completion Method | Completed Contract Method | |
| Revenue Recognition Timing | Intermittent, as project milestones are reached | Ongoing, as project completion percentages are met | Point in time, as the project is completed |
If these revenue recognition methods don’t fit a company’s circumstances, others worth considering include:
- Sales-based method
- Installment sales method
- Cost recovery method
- Subscription method
- Proportional performance method
Best Practices for Implementing the Milestone Method
To effectively implement the milestone method, accountants and their colleagues should consider adhering to the following best practices:
- Define clear and measurable milestones: Make sure milestones represent significant project progress, such as phase completions or key deliverables, and are easy to track and verify.
- Align milestones with operational and financial criteria: Collaborate with finance, project management, and legal teams to ensure milestones meet contract terms, business objectives, and revenue recognition standards.
- Maintain thorough documentation: Keep detailed records for each milestone, including descriptions, achievement criteria, and related costs, to support compliance with ASC 606, IFRS 15, and audits.
- Cultivate collaboration across teams: Encourage regular communication between various teams to prevent misunderstandings and ensure milestones receive correct and timely recognition.
By following these best practices, businesses substantially increase the odds of achieving accurate revenue recognition and maintaining financial transparency throughout a project’s lifecycle.
Master the Milestone Method
With so many different revenue recognition methods available, it can certainly be a challenge to choose the best one for a specific company’s circumstances. However, when operating in an industry known for complex, long-term projects, the milestone method of revenue recognition provides a great option to consider. As always, we recommend you consult with your auditors or accounting consultants on the best revenue recognition method for your business.
Offering a strategic approach to recognizing revenue based on achieving certain project milestones, the method helps accountants generate financial statements that are organized, transparent, and accurate.
The milestone method for revenue recognition can be difficult to track with manual, error-prone efforts. RightRev helps automate tedious revenue accounting processes by automatically recognizing revenue based on your pre-defined distribution methods. Our team is here to help you implement a revenue recognition solution for the milestone method so you can spend less time tracking milestones and revenue in spreadsheets and more time doing strategic revenue analysis. Request a demo to see your specific use cases automated in RightRev.
