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CONSTRUCTION CONTRACTS (AS 7)
Basics
Construction Contract is a contract specifically negotiated for the construction of an Asset or combination of Assets closely interrelated or interdependent. This Accounting Standard (AS) further mentions that the following
are also included in construction contracts.
• Contracts for rendering of services which are directly related to the construction of Assets
• Contract for destruction or restoration of Asset and the restoration of the environment following the demolition of Asset.
Fixed Price Contracts: In these contracts, contractor agrees for fixed price of the contract or fixed rate per unit.
Cost plus Contracts: In these contracts, contractor is reimbursed the cost is defined plus fixed percentage of fee/
profit.
Some construction contracts may be a mix of the both.
Types
The primary objective of this AS is the allocation of ‘contract revenue’ and ‘contract cost’ to the accounting period in which construction work is performed.
Objective
AS 7 does not apply to customer (Contractee). This would not be applicable for the construction projects undertaken by the enterprise on its own account as a commercial venture in the nature of production
activities.
Applicability
Profit/loss = (Contract Revenue – Contract Cost)
contract revenue and contract cost associated
with the construction contract should recognize revenue and expenses respectively with reference to stage of completion of the contract activity at the reporting date.
Calculation of profit or loss
• Cost to cost method: the percentage of completion would be estimated by comparing total cost incurred
to date with total cost expected for the entire contract:—
Percentage of Completion = (Cost to Date × 100) / (Cumulative Cost Incurred + Estimated Cost to Complete)
Current revenue from contract = Contract price × Percentage of completion – Revenue previously recognized
• By survey of work performed
• Completion of physical proportion of the contract work
following contract cost should be excluded.
• Contract cost that relates to future activity on the contract such as cost of material that have been delivered
to a contract site or set aside for use of a contract but not used and applied.
• Payment made to sub-contractors in advance of work performed under the sub-contract.
stage of completion
• Revenue recognized in the period in which work is performed;
• Expenses recognized in the period in which the work to which expenses relate is performed.
Conditions for recognizing the contract revenue -
• Total contract revenue can be measured reliably
• It is probable that economic benefits associated with contract will flow to the enterprise / contractor
• Total contract cost and cost up to the stage of completion is measured reliably
• Contract cost attributable to contract can be clearly identified.
Uncertainty in collection amounts to expenses - When an uncertainty arises about the collectability of an amount already included in contract revenue and already recognized in profit and loss statement, it amounts to expense. This uncollectable amount of which recovery has ceased to be probable is recognized as an expense rather than as an adjustments to contract revenue.
Principles of recognition of revenue and expenses
1.Specific costs to contract
2.Cost attributable to contract
3.Cost specifically chargeable to customers
under the terms of contract
4.Cost excluded
5.Contract revenue
6.Provision for expected losses
Contract costs
1
• Site labour cost including supervision
• Cost of material used in construction
• Depreciation of plant and equipments used on the contract
• Cost of moving plant, equipments and materials from contract site
• Cost of hiring plant
• Cost of design and technical assistance
• Estimated cost of rectification and guarantee work including expected warranty cost
• Claim from third parties
• Pre-contract cost. If it is probable that contact will be obtained
These costs should be reduced by incidental income if any not included in contract revenue, for example, sale of
surplus/scrap material, disposal of plant and equipment at the end of contract.
• Insurance.
• Cost of design and technical assistance that is not directly related to a specific contract.
• Construction overheads.
2
.Some general administration cost/for which reimbursement is specified.
• Development cost.
• Reimbursement of any other cost.
3
• General administration cost
• Selling cost
• Research and development
• Depreciation cost of idle plant and equipment
• Cost incurred in securing the contract. Pre-contract cost
4
• Revenue/price agreed as per Contract.
• Revenue arising due to escalation clause.
• Claims - Claims is the amount that contractors seek to collect from the customer as reimbursement of cost not included in contract price.
• Increase in revenue due to increase in units of output.
• Increase or decrease in revenue due to change or variation in scope of work to be performed.
• Incentive payments to the contractors.
• Decrease in contract revenue due to penalties.
5
When it is probable that total contract cost will exceed total contract revenue, the expected losses should be recognized as an expense irrespective of —
• Whether or not work has been commenced
• Stage of completion of contract
• The amount of profit on other contracts which are not treated as a single contract.
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• The method used to determine the stage of completion of contract in progress
• The method used to determine the contract revenue recognized in the period. In addition to policy disclosure following disclosures is also required to be made by the enterprise (contractor):
• The amount of contract revenue recognized in the period
• Contract cost incurred and recognized profit (less recognized losses) upto the reporting period
• Advance received
• Gross amount due from customers for contract work [(cost incurred + recognised profit) – (recognized losses
+ progress billing)]
• Gross amount due to customer for contract work [(recognized losses + progress billing) – (cost incurred +
recognized profit)].