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Quick Reference on Accounting Standard (AS) 7

Download Quick Reference on Accounting Standard (AS) 7 Construction Contracts

This Standard prescribes the accounting for construction contracts in the financial statements of contractors.

A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

Contract revenue – Contract revenue should comprise:

  • the initial amount of revenue agreed in the contract; and
  • variations in contract work, claims and incentive payments:
    • to the extent that it is probable that they will result in revenue; and
    • they are capable of being reliably measured.

Contract costs – Contract costs should comprise:

  • costs that relate directly to the specific contract, e.g., site labour costs, cost of materials used in construction, etc.;
  • costs that are attributable to contract activity in general and can be allocated to the contract, e.g., insurance, construction overheads, borrowing costs as per AS 16, Borrowing Costs, etc.; and
  • such other costs as are specifically chargeable to the customer under the terms of the contract, e.g., general administration costs and development costs for which reimbursement is specified in the terms of contract.

Exclusions- Costs of a construction contract exclude costs that cannot be attributed to contract activity or cannot be allocated to a contract, e.g.,

  • general administration costs for which reimbursement is not specified in the contract;
  • selling costs;
  • depreciation of idle plant and equipment that is not used on a particular contract;
  • research and development costs for which reimbursement is not specified in the contract.

Recognition of Contract Revenue and Expenses – Outcome of the contract estimated reliably

  • Yes – Apply percentage completion method, ie, recognise the revenue and expenses having regard to the stage of completion of the contract activity at the reporting date
  • No – Recognise the revenue only to the extent of such contract costs incurred, the recovery of which is probable. Further, contract costs are to be treated as period expense

Determination of stage of completion- Examples of methods (depends on nature of the contract)

  • Costs incurred to estimated total contract costs method
  • Survey method
  • Physical evaluation method

Treatment of contract costs relating to future activity – Recognised as an asset provided it is probable that they will be recovered. Such costs represent an amount due from the customer and are often classified as contract work-in-progress. Example: uninstalled material, etc.

Treatment of expected loss on the contract – When it is probable that total contract costs will exceed total contract revenue, the expected loss on the contract should be immediately recognised as an expense.

Uncertainty regarding collectability of an amount – When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognised in the Statement of Profit and Loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment to the amount of contract revenue.

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