ACCOUNTING STANDARD-7

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ACCOUNTING STANDARD-7

• CONSTRUCTION CONTRACTS

CA. PANKAJ AGRWAL B.Com(Hons), LL.B., FCA
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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.

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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.

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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.

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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.

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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.

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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.

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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

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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.

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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.

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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.

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Contract Costs

• It comprises of
• Direct Costs
• Attributable Costs
• Specifically chargeable costs as per the terms of
  the contract.

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Recognition of Revenue and Expenses

• To be recognised when the outcome can be
  estimated reliably
• Contract Revenue and Costs should be recognised
  as revenue and expenses
• by reference to the stage of completion of the
  contract activity at the reporting date.
• Expected Loss to be recognised immediately.

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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

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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

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Stage of completion

• Proportion of costs to the estimated total cost
• Surveys of work performed
• Physical proportion of contract work

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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.

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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.

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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

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Disclosure

• Amount of advances received
• Amount of retentions
• Gross amount due from and due to customers.

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ILLUSTRATION
Rs. In Lacs
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ILLUSTRATION
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ILLUSTRATION
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ILLUSTRATION
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ILLUSTRATION
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ILLUSTRATION - DISCLOSURE WORKING
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ILLUSTRATION - DISCLOSURE WORKING
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ILLUSTRATION Contd
Construction ContractsContract revenue
recognised as revenue for the year ended 31st
December XXX 1300 Aggregate amount of
Contract costsincurred and recognised profits
(less recognised losses) upto 31st December XXX
for all the contracts in progress 1435
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ILLUSTRATION Contd
The amount of customer advancesoutstanding for
contracts in progressas 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)
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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.
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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.
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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.
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From Published Accounts

• Mukand Limited
• Accounting for Long Term Engineering Contracts
• 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.
• 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.

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From Published Accounts
Mukand Limited Accounting for Long Term
Engineering Contracts (e) All facilities in the
nature of assets created at the customers site
and which are to be abandoned at the end of the
contract, are, when under construction, carried
forward at Direct cost-to-date as Facilities at
Customers site Under construction. Upon
subsequent completion, they are carried forward
as Facilities at Customers 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.
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Issues

• Builder Vs Contractor
• Value of Turnover