Download ACCOUNTING STANDARD-7

ACCOUNTING
STANDARD-7
CONSTRUCTION CONTRACTS
CA. PANKAJ AGRWAL
B.Com(Hons), LL.B., FCA
OBJECTIVE & SCOPE
 To prescribe the accounting treatment of
revenue and costs associated with construction
contracts because the date at which contract
activity is entered into and the activity gets
completed fall in different accounting periods.
 Therefore, the primary issue is the allocation of
contract revenue and contract costs to the
accounting periods in which construction work is
performed.
OBJECTIVE & SCOPE
 This statement uses the recognition criteria
established in the ‘Framework for the
Preparation and Presentation of Financial
Statements to determine when contract revenue
and contract costs should be recognised.
 It applies to the accounting for construction
contracts.
DEFINITIONS
 CONSTRUCTION CONTRACT
is a contract specifically negotiated for the
construction of an asset or combination of
assets
that are closely interrelated or interdependent
in terms of their design, technology and
function or their ultimate purpose or use.
DEFINITIONS
 Fixed Price Contract
is a construction contract in which
the contractor agrees to a
fixed contract price or fixed rate per unit of
output, which
in some cases is subject to cost escalation.
DEFINITIONS
 Cost plus Contract
is a construction contract in which
the contractor is reimbursed for allowable or
otherwise defined costs,
plus percentage of these costs or a fixed rate.
Construction Contracts
 It includes contracts for rendering
of services which are directly
related to the

Construction of the asset

Destruction or restoration of assets

Restoration of the environment following
demolition of assets.
Combining and Segmenting
 If the contract covers number of assets,
construction of each asset be treated as a
separate construction contract when:
 Separate proposals have been made
 Each asset has been subject to separate
negotiation and the contractor and the
customer has been able to accept or reject
that part of the contract
 The costs and revenues of each asset can
be identified
Combining and Segmenting
 A group of contracts, whether with a single
customer or with several customers, should be
treated as a single construction contract when:
 The group of contracts is negotiated as a
single package
 Contracts are closely interrelated that they
are, in effect, part of a single project with an
overall profit margin; and
 The contracts are performed concurrently or
in a continuous sequence.
Contract Revenue
 It Comprises:
 Initial amount agreed
 Variations in the contract work, claims and
incentive payments to the extent it is
probable that they will result in revenue and
can be measured.
Contract Revenue
 A variation is an instruction by the customer for a
change in the scope of the work to be performed
under the contract.
 A claim is an amount that the contractor seeks to
collect from the customer or another party as
reimbursement for costs not included in the
contract price.
 Incentive payments are additional amounts
payable to the contractor, if specified performance
standards are met or exceeded.
Contract Costs
 It comprises of :
 Direct Costs
 Attributable Costs
 Specifically chargeable costs as per the
terms of the contract.
Recognition of Revenue and
Expenses
 To be recognised when the outcome can be
estimated reliably
 Contract Revenue and Costs should
recognised as revenue and expenses
be
 by reference to the stage of completion of
the contract activity at the reporting date.
 Expected Loss to be recognised immediately.
Conditions for reliable estimate
In case of Fixed Price Contracts:
• Total revenue can be measured reliably;
• Economic benefits will flow to the enterprise
• Contract costs to complete and the stage of
completion can be measured at the reporting
date
• Contract costs attributable to the contract can
be identified and measured
Conditions for reliable estimate
In case of Cost Plus Contracts:
• Economic benefits will flow to the enterprise
• Contract costs attributable to the contract can
be identified and measured
Stage of completion
• Proportion of costs to the estimated total cost
• Surveys of work performed
• Physical proportion of contract work
Estimation of Outcome not possible
• Revenue to be recognised to the extent of costs
incurred of which recovery is probable.
• Contract costs be recognised as an expense of
the period.
• When the uncertainties that prevented the
outcome of the contract being estimated cease
to exist, revenue and costs be recognised.
Expected Loss
• Expected Loss be recognised immediately when
the total costs are likely to exceed the total
revenue.
• Loss is to be recognised
• even if no work has commenced on the
project.
• Irrespective of the stage of completion
• Irrespective of the profits accruing on other
contracts.
Disclosure
• Amount of Contract Revenue recognised
• Method used to determine the contract revenue
• Method used to determine the stage of
completion
• For contracts in progress, it should also
disclose:
• Aggregate amount of costs incurred and
recognised profits;
Disclosure
• Amount of advances received
• Amount of retentions
• Gross amount due from and due to customers.
ILLUSTRATION
Rs. In Lacs
YEAR
I
YEAR
II
YEAR
III
9000
9000
9000
200
200
9000
9200
9200
Contract Costs incurred
2093
upto the reporting date
Contract costs to complete 5957
6168
8200
2032
0
Total Estimated costs
8200
8200
Initial amount of revenue
agreed in contract
Variation
Total Contract Revenue
8050
ILLUSTRATION
YEAR
I
Estimated Profit
950
YEAR
II
1000
Stage of Completion
26%
74%
YEAR
III
100%
1000
ILLUSTRATION
Upto
Recognised
Reporting in prior year
date
Recognised in
current year
Revenue (9000 x
0.26)
2340
2340
Expenses (8050 x
0.26)
2093
2093
Profit
247
247
Year I
ILLUSTRATION
Upto
Recognised
Reporting in prior year
date
Recognised in
current year
Revenue (9200 x
0.74)
6808
2340
4468
Expenses (8200 x
0.74)
6068
2093
3975
Profit
740
247
493
Year II
ILLUSTRATION
Upto
Recognised
Reporting in prior year
date
Recognised in
current year
Revenue (9200 x
1.00)
9200
6808
2392
Expenses (8200 x
1.00)
8200
6068
2132
Profit
1000
740
260
Year III
ILLUSTRATION - DISCLOSURE WORKING
A
B
C
D
E
TOTAL
A. Contract Revenue
recognised
145
520
380
200
55
1300
B. Contract Expenses
recognised
110
450
350
250
55
1215
40
30
70
C. Expected Losses
recognised
D. Recognised Profits
less losses
35
70
30
(90)
(30)
15
E. Contract Costs
incurred in the period
110
510
450
250
100
1420
110
F. Contract Costs
incurred recognised as
contract expense in the
period
450
350
250
55
1215
ILLUSTRATION - DISCLOSURE WORKING
A
G. Contract Costs that
relate to future activity
B
C
60
100
D
E
TOTAL
45
205
H. Contract Revenue
145
520
380
200
55
1300
I. Progress Billing
100
520
380
180
55
1235
J. Unbilled Contract
Revenue
45
-
-
20
-
65
K. Advances
-
80
20
-
25
125
ILLUSTRATION Contd…
Construction Contracts
Contract revenue recognised as
revenue for the year
ended 31st December XXX
1300
Aggregate amount of Contract costs
incurred and recognised profits
(less recognised losses)
upto 31st December XXX
for all the contracts in progress
1435
ILLUSTRATION Contd…
The amount of customer advances
outstanding for contracts in progress
as at 31st December XXXX
125
Gross amount due from customers for
contract work presented as an asset
220
Gross amount due to customers for contract
work presented as a liability
(20)
From Published Accounts
TRF LIMITED
Profit on contract is recognised on percentage completion
method. The stage of completion is determined as a proportion
that contract costs [including the cost of WIP in factory relating
to contracts entered into on or after 01.04.2003 to be in line
with revised Accounting Standard 7, (AS7)] incurred for work
performed upto the reporting date bear to the estimated total
costs. Profit (contract revenue less contract cost) is recognised
only when stage of completion is 40% or more when the
outcome of the contract can be estimated reliably. When it is
probable that the total cost will exceed the total contract
revenue the expected loss is recognised immediately.
From Published Accounts
Mukand Limited
Accounting for Long Term Engineering Contracts:
(a) Revenue for engineering contract work executed (including
supplies & services) is recognised on the basis of percentage
completion method and only after the work has progressed to
the extent of 10% in each composite contract. Till such time,
all the costs are carried forward to the next accounting year as
“Accumulated Contract Costs” under “Inventories”.
Recognition of revenue is matched with expenses incurred (on
accrual basis) after considering the contract value with
associated costs. Costs and Revenue are both recognised
upto 90% and debtors are reflected accordingly. Balance is
recognised only upon the Preliminary/Final acceptance of job
by the client. Periodic advances received from customers are
not considered as income.
From Published Accounts
Mukand Limited
Accounting for Long Term Engineering Contracts:
(b) Income which arises out of invoicing of contract work and the
contract costs which are accounted on accrual basis, are, both
credited to income or charged to revenue, as the case may
be, only after at least 10% of the total estimated contract costs
(i.e. direct and indirect costs) are incurred (on accrual basis).
Till such time, all the costs are carried forward to the next
accounting year as “Accumulated Contract Costs” under
“Inventories” and recognition of revenue is correspondingly
postponed. Direct costs include all expenses specifically
attributable to the contract. Variation in estimates of contract
costs are updated each year by technical certification.
From Published Accounts
Mukand Limited
Accounting for Long Term Engineering Contracts:
(c) “Accumulated Contract Costs”, after the stage when they are
not any further to be carried forward in terms of (b) above, are
charged to revenue to the extent not specifically attributable to
the contract and balance is transferred to “Incomplete
Contract Work” under “Inventories”.
(d) Variations by way of escalation in price and quantum of work
is recognised as revenue in the year in which claims are
lodged as per the terms of contract. Other claims are
recognised as revenue only upon final acceptance by
customer.
From Published Accounts
Mukand Limited
Accounting for Long Term Engineering Contracts:
(e) All facilities in the nature of assets created at the customer’s
site and which are to be abandoned at the end of the contract,
are, when under construction, carried forward at Direct costto-date as “Facilities at Customer’s site – Under construction”.
Upon subsequent completion, they are carried forward as
“Facilities at Customer’s site – Completed” (both being
grouped as “Other Current Assets”). The completed facilities
are written off in equal annual installments over the period
commencing from the year of completion of the facility upto
the contracted year for completion of the contract. Billable
reimbursements against such facilities, if separately identified
in a contract, are similarly credited in equal annual
installments against the write-off over the said period.
Issues
 Builder Vs Contractor
 Value of Turnover