AS 7 (Revised): Construction Contracts

By: CA Kamal Garg

Objective
To establish principles for recognition of revenue and costs relating to construction contracts

Scope
Accounting in the financial statements of Contractors Also Applicable: Service contracts directly related to construction of asset Contracts for destruction or restoration of assets Contracts for restoration of environment following demolition of assets Not Applicable: Own Account Construction Contracts, Contractee

Types of Construction Contracts

Fixed Price: Contract price or rate p.u. of output is fixed, with or without escalation clause Cost Plus: Revenue = Cost + Agreed Percentage

Combining & Segmenting of Construction Contracts

1. 2. 3.

Combining if: Can be treated as single package; Part of single project; Performed concurrently or in a continuous sequence Segment if: Separate proposals for each asset; Each asset has been subject to separate negotiation and can be accepted or rejected; Costs & Revenues of each asset can be identified

1. 2. 3.

Construction of Additional Assets or Contract Options

1.

2.

Combine if: Assets do not differ significantly in design, technology or function from original contracts assets; Price is not independent with regard to original contract price ELSE Segment

Contract Revenue & Expense

1. 2. 3.

4.

Revenue Initial Amount Agreed Escalations, Claims, etc. Variations in contract work, claims, incentive payments Decrease, if any, due to penalties

Expense 1. Direct Costs 2. Allocable Costs 3. Costs specifically chargeable to the customer

Contract Costs
1. 2. 3. 4. 5. 6.

7.

Inclusions Site labour Material Depreciation on plant used on contract Cost of hiring, designing Claims from III Party Pre Contract Costs, if it is probable that contract will be obtained Net off Incidental Income if not included in Revenue (e.g. sale of scrap material)

1. 2. 3. 4. 5. 6.

7.

Exclusions General Admn. O/hs. Selling costs R&D Depreciation of Idle Plant Cost incurring in securing the contract Contract Costs such as material set aside but not used and applied Payments made to subcontractors in advance of work performed under the sub-contract

Contract Costs Relating to Future Activity

Recovery Probable Treated as an ASSET i.e. amount due from customer Recovery Not Probable Treated as an EXPENSE of the period

Recognition Principles
Revenue recognised in the period in which work is performed Expense recognised in the period in which the work to which expense relate is performed If there is uncertainty in collection of amounts already included in revenue and recognised in P & L A/c, then it should be recognised as expense rather than adjusting revenue

Method of Measurement
Completed Contract Method NOT ALLOWED Percentage Completion Method ALLOWED

Percentage Completion Method

Cost to Cost Method:
1.

2.

% of Completion = [(Cost to Date) x 100] / (Cumulative Cost Incurred + Estimated Cost of Completion) Current Contract Revenue = (Step 1 x Contract Price) less Revenue Previously Recognised

Survey Method

Recognition Criteria Contract Revenue

Can be Reliably Estimated 1. Apply % Completion Method Cant be Reliably Estimated 1. Recognise only to the extent of such contract costs incurred the recovery of which is probable

Recognition Criteria Contract Expenses

Can be Reliably Estimated 1. % Completion Method; 2. Any expected loss also to be charged off ** Cant be Reliably Estimated 1. Treat as a period expense 2. Any expected loss also to be charged off

Recognition Criteria Contract Expenses

** Where it is probable that total contract costs will exceed (>) total contract revenue: Expected losses should be recognised as an expense Irrespective of: Commencement of work; Stage of completion; Amount of profits on other contracts that are not treated as single contracts

1. 2. 3.

Changes in Estimates
% 0f Completion is based on Estimates which may vary For this Apply AS 5

ASI 29: Turnover

Whether Contract Revenue as per AS 7 = Turnover YES

Disclosures
Method & Policy Contract Revenue & Contract Expenses Expected Losses Recognised Profits less Recognised Losses Progress Billings (i.e. Payments Recd + Payments billed but not Recd) Retentions (i.e. billed but not received from Contractee) Gross Amount due to Customers Amount Due From Customers = Contract Costs + Recognised Profits Recognised Losses Progress Billings Amount Due to Customers = If above is Negative