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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
A B C D E TOTAL
A. Contract Revenue 145 520 380 200 55 1300
recognised
B. Contract Expenses 110 450 350 250 55 1215
recognised
C. Expected Losses 40 30 70
recognised
D. Recognised Profits 35 70 30 (90) (30) 15
less losses
E. Contract Costs 110 510 450 250 100 1420
incurred in the period
F. Contract Costs 110 450 350 250 55 1215
incurred recognised as
contract expense in the
period
ILLUSTRATION - DISCLOSURE WORKING
A B C D E TOTAL
G. Contract Costs that 60 100 45 205
relate to future activity
H. Contract Revenue 145 520 380 200 55 1300
J. Unbilled Contract 45 - - 20 - 65
Revenue
K. Advances - 80 20 - 25 125
ILLUSTRATION Contd…
Construction Contracts
Contract revenue recognised as
revenue for the year
ended 31st December XXX 1300
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 cost-
to-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