Revenue looks strong on paper – but ASC 606 compliance in construction tells a different story.

In construction and specialty contracting, revenue recognition under ASC 606 is one of the most judgment-heavy areas on the income statement, and one of the most common sources of misstated earnings in quality of earnings work. Unlike product-based businesses where revenue recognition is relatively straightforward, construction companies operate on long-duration contracts where reported revenue depends on a continuous stream of estimates: percentage-of-completion calculations, cost-to-complete projections, variable consideration assessments for change orders and claims, and the timing of constraint releases on contingent revenue. Each of these inputs requires management judgment, and each creates an opportunity for earnings to drift away from underlying economic reality, intentionally or not.

The KPIs that matter most in this context are not always visible at the income statement level. Estimated cost-to-complete accuracy, measured by comparing initial project estimates to final actual costs, reveals whether management's assumptions are grounded or systematically optimistic. Change order approval rates distinguish between revenue that has been contractually confirmed and revenue that is still contingent on owner acceptance. Over and under billing trends, expressed as a percentage of revenue, are among the most reliable leading indicators of whether earnings are tracking ahead of or behind actual project performance. When these metrics are deteriorating or inconsistent, the quality of reported revenue warrants serious scrutiny.

In a recent construction services engagement, normalized EBITDA appeared healthy at first glance. But a project-level review of ASC 606 compliance surfaced a pattern of issues that materially changed the earnings picture. Cost-to-complete estimates were being revised downward late in project life cycles, a pattern that had the effect of pulling revenue into earlier periods and front-loading reported margin. Unapproved change orders were being recognized as variable consideration without the constraint analysis required under ASC 606, introducing revenue tied to outcomes that were still uncertain and in some cases actively disputed. Over-billings had been trending upward as a percentage of contract value, a signal that billings were outpacing actual performance obligations satisfied. Taken individually, each issue might have been defensible. Together, they reflected a revenue recognition posture that consistently favored earlier and higher recognition over conservative, supportable estimation. Once we recast revenue on a project-by-project basis using estimates we could substantiate, trailing twelve-month EBITDA came in meaningfully below what management had presented.

This pattern is more common than buyers expect, and it is rarely the result of deliberate manipulation. Construction accounting is genuinely complex, and companies under growth pressure often develop estimation habits that lean optimistic without anyone raising a flag. That is precisely why ASC 606 compliance deserves the same rigor in diligence as working capital analysis or debt-like items.

At The McLean Group, our Financial Consulting and Transaction Due Diligence teams stress test ASC 606 inputs at the project level in every construction quality of earnings engagement, examining cost-to-complete assumptions, variable consideration constraints, and billing-to-revenue alignment across the contract portfolio. The goal is to ensure PE sponsors are underwriting earnings tied to real project performance and defensible accounting judgments, not estimation optimism embedded quietly in a revenue schedule.