Understanding the Rules of Revenue Recognition for Government Contractors

Revenue recognition is a very critical and highly scrutinized aspect of accounting for government contractors. Whether you're working on cost-plus contracts, time and materials, or firm fixed price agreements, how and when you recognize revenue can significantly impact your financial reporting and compliance with government regulations.

Why Revenue Recognition Matters

Government contracts often span months or even years. Some are cost–plus, others are T&M, or maybe even firm fixed price, all of which can impact the way you recognize revenue (discussed in detail later). Without clear and compliant revenue recognition practices, it’s easy to overstate or understate revenue, which could trigger audit issues or misrepresent your financial position to owners, management, lenders, or any other party who relies on your financial data for making key decisions. When it comes to revenue recognition, the stakes are high, so you want to ensure you get it right the first time. Read our article on common accounting mistakes that get government contractors in trouble to learn more about other areas that may impact compliance and financial accuracy.

Visualizing the Impact of Revenue Recognition

The difference between poor and proper revenue recognition becomes immediately clear when you look at the financials. Below are two versions of a 6-month profit and loss statement. The first shows the result of inconsistent revenue recognition, while the second reflects what it should look like when revenue is aligned with the work actually performed. In both examples, the costs are identical. The key differentiator is how revenue is recognized and recorded. Notice how the gross margin in the first example swings wildly from month to month. Now imagine handing those financials to an auditor or a lender. As a government contractor, this is exactly the kind of avoidable issue that can raise red flags when it comes to your financial data.

Inconsistent Revenue Recognition Example

Proper Revenue Recognition Example

The Basics of Revenue Recognition

The foundation of revenue recognition under ASC 606 (Revenue from Contracts with Customers) involves five core steps:

1. Identify the contract with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognize revenue when (or as) the entity satisfies a performance obligation

This framework applies broadly, but government contracts add layers of complexity.

Contract Types and Their Impact on Revenue Recognition

Firm-Fixed-Price (FFP) Contracts

Fixed-price contracts can sometimes create the most challenges for government contractors. Revenue is typically recognized based on progress toward completion. This is usually done by using the percentage-of-completion method or as milestones are achieved. Contractors must estimate total costs and track progress closely. If the total cost is expected to change in the middle of the contract, the estimates should be updated, and the impact of revenue recognition should be recognized appropriately. For example, maybe you’re now expecting total labor costs to be $600k instead of $500k over the life of the project. This will impact your revenue recognition calculations.

Cost-Reimbursable (CR) Contracts

Revenue is generally recognized as allowable costs are incurred, plus any applicable fees. For cost-reimbursable contracts, it is essential to clearly distinguish between allowable and unallowable costs per FAR Part 31. (Read our article on what is really important to know about FAR Part 31 for a deeper understanding of these requirements.) You should do this regardless of contract type, but it is especially important for cost-reimbursable contracts since your indirect rates are used in the build-up of your customer invoices.

Time and Materials (T&M) Contracts

Revenue is recognized based on the amount of time worked and materials used, usually at agreed-upon billing rates. For example, if a contractor bills $100 per hour and spends 10 hours on a job, plus $500 in materials, the customer would be billed $1,500.

Ensuring Accuracy in Your Financial Reporting

Navigating revenue recognition isn’t just about following GAAP. It’s about staying in compliance with federal requirements while providing a true picture of your business performance. Proper job costing, careful tracking of incurred costs, and consistent application of accounting principles are key to avoiding issues down the line. Related considerations include understanding FAR-based contracts and grants and being aware of the different CAS accounting practice changes that can affect reporting.

What we’ve covered here is just a small piece of a much larger puzzle. The rules can get complex quickly, especially when dealing with contract modifications, indirect rates, and varying contract types. If you’re not confident in your current process (or maybe your P&L looks like the one in the example above), it’s worth getting expert help.

Maintaining Accuracy and Compliance in Revenue Recognition

Accurate revenue recognition is essential for maintaining compliance, financial stability, and transparency. For government contractors, revenue recognition practices must meet both GAAP and federal requirements while adapting to the specifics of each contract type. Redstone GCI supports contractors with services that strengthen accounting processes, improve cost tracking, and enhance audit readiness. Our team provides guidance on compliant revenue recognition, system configuration, and training for complex requirements so contractors can reduce risk, produce reliable financial data, and maintain confidence in their reporting.