ACCOUNTING STANDARD-7

CONSTRUCTION CONTRACTS

INTRODUCTION

ACCOUNTING - It is the process of:

Identifying Measuring Communicating economic information

ACCOUNTING STANDARD

The primary objective of accounting standards is to standardize the diverse

accounting policies and practices.

Accounting standards are mandatory for: Enterprises whose equity or debt securities are

listed on a recognized stock exchange in India. Or enterprises whose securities are in the

process of being issued and will be listed on a recognized stock exchange in India.

And for all other enterprises whose turnover for the accounting year is more than Rs 50 cr.

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

It 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.

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 recognized as revenue and expenses in the statement of profit and loss.

It applies to the accounting for construction contracts.

Combining and Segmenting

If the contract covers number of assets, construction of each asset will 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.

When the outcome of the contract can be estimated reliably, only then contract revenues and contract costs associated with the construction contract should be recognized as revenue and expenses.

Recognition of contract Revenue & expenses

But when the outcome of a construction contract can not be be estimated reliably, contract revenues and contract costs associated with the construction contract should be recognized as revenue and expenses respectively, by taking a base to the stage of completion of the contract activity at the reporting date.

Recognition of contract revenue & expenses

The outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:

a) The Total contract revenue can be measured reliably.

b) It is probable that the economic benefits associated with the contract will flow to the enterprise.

c) Both the contract costs can be measured reliably at the reporting date.

The Case of Fixed Price Contract

An outcome can be estimated reliably only when all the following conditions are satisfied:

a) It is probable that the economic benefits associated with the contract will flow to the enterprise.

b) The contract costs attributable to the contract, whether or not specifically reimbursable, can be clearly identified and measured re

In the case of a cost plus contract

The recognition of revenue and expenses by reference to the stage of completion of a contract is often referred to as the percentage of completion method.

Percentage of Completion Method

a) Contract revenue is recognized as a revenue in the statement of profit and loss in the accounting periods in which the work is performed. Contract costs are usually recognized as an expense in the statement of profit and loss in the accounting periods in which the work to which they relate is performed.

b) Any expected excess of total contract costs over total contract revenue for the contract is recognized as an expense.

Some Guidelines of the Method

Some Guidelines of the Method…(cOntd.)

c) If a contractor may have incurred contract costs that relate to future activity on the contract, such contract costs are recognized as an asset provided it is probable that they will be recovered. Such costs are often classified as contract works in progress.

Conclusion

As we know this is a revised accounting standard, earlier there were few limitations in the AS-7.So to overcome those limitations, AS-7 was revised. One of the limitation was that it did not have percentage of completion method, so the revenues and expenses could only have been calculated at the completion of the work.

AS-7 considers all the construction contract and also lays down norms on how to calculate revenue and expenses.

Thank You