Accounting Standard (AS) 7, Accounting for Construction Contracts
The statement applies to accounting for construction contracts, in the financial statements of contractors.
A construction contract may be related to the construction of single asset or a number of assets closely, interrelated or interdependent in terms of the scope of the contract.
For the purpose of this statement construction contract covers:
(a) Contracts for rendering of services directly related to the construction of the asset e.g. service of project-managers, architects etc.
(b) Contracts for destruction/restoration of assets and restoration of environments following demolition.
(c) Consultancy contracts in project management, designing, computers where such contracts are related to the construction of the asset.
(d) Those long-term contracts not relating to construction of an asset.
A construction contract may be
(a) a fixed-price contract with/without escalation
(b) a cost-plus contract (provision for reimbursement of overhead on agreed basis in addition to fixed price/fees)
(c) a mix of both (a cost-plus contract with a minimum agreed price)
The statement usually apply to each contract separately, however, sometimes it is necessary to apply the statement to the separately identifiable components of a single contract or to a group of contracts together in order to reflect the substance. When a contract covers —
(a) Number of assets: each asset treated as separate contract when the proposal, negotiation and cost/revenue can be identified distinctly.
(b) Negotiated single package of interrelated identifiable with an overall profit margin performed concurrently or continuous sequence: treated as a single contract whether a single customer or a group of customers.
(c) Construction of an additional asset as the provision of the contract: treated as separate contract if there is significant change in design, technology or transaction from original contract in terms of the scope and/or price.
Additional asset should be treated as a separate construction contract if there is significant change in design, technology or function from the assets covered in the original contract price.
Contract revenue comprises of
(a) revenue agreed in the contract
(b) variations in the scope of contract, adverse/favourable
(c) incentive payment (degree of certainty and reliability)
(d) penalties due to delay in execution
Contract costs comprise of
(a) directly related to specific contract
(b) attributable cost relating to contract activity in general and precisely allocable to the contract as reduced by incidental income not included in contract revenue (sale of surplus material, disposal of contract specific plants etc).
Contract cost and revenue are recognized for accounting only when the outcome of the construction contract can be measured reliably with regard to the stage of completion of the contracts activity at its B/S date. All expected losses should recognized as an expense for the contract.
Under the percentage completion method, contract revenue is recognized in the P/L in the accounting period in which the work is performed and the related contract cost is shown as an expense. However, expected excess of total contract is recognized as an expense immediately. Revenue earlier recognized or becoming doubtful/uncollectable should be treated as an expense.
A long-term contract is subject to fluctuation for various reasons in the original estimation thus likely to affect the determination of contract results. It is necessary that an annual review of the cost already incurred and future cost required to complete the project on schedule. While estimating the future cost care should be taken for foreign exchange rate fluctuation, labour problem, changes in material price etc.
Disclosure under AS -7 (on reporting date by an enterprise)
A) An enterprise should enclose
(a) The amount of contract revenue recognized as revenue in the period
(b) The methods used to determine the contract revenue recognized in the period
(c) Method used to determine the stage of completion of contract in progress
B) An enterprise should disclose the following for contracts in progress at the reporting date
1. The aggregate amount of costs incurred and recognized profit less recognized losses upto reporting date.
2. The amount of advance received and amount retained
C) An enterprise should present
(a) Gross amount due from customer is an asset
(b) Gross amount due to customer is a liability
(c) Contingencies as per AS-4 (warranty cost, penalties, guarantee issued by banks against counter indemnity of contractor)