CONSTRUCTION CONTRACTS (revised 2002)

Accounting Standard AS 7 formerly named as Accounting for Construction Contracts is issued by ‘Institute of Chartered Accountant of India’ in December This covers the contracts that are formed before However AS 7 has been revised in 2002 which is named as Construction Contract (Revised 2002). This is applicable for contracts entered into during accounting periods on or after and is mandatory in nature from that date.

The primary objectives of this AS is the allocation of “ contract revenue ” and “ contract cost ” to the accounting period in which construction work is performed.

 The main question arising in Accounting for long term construction contracts is that when to recognize revenue and how to measure the revenue in the books of contractor and also how the profit or loss of construction contract by contractor. The following two ways may determine profit or loss:- ON YEAR TO YEAR BASIS BASED ON PERCENTAGE OF COMPLETION ON COMPLETION OF THE CONTRACT.

 However, after revision of this AS, it adopts only percentage of completion method for recognizing revenue & this method justifies the accrual system of accounting which is fundamental for accounting assumption.

 Contracts for rendering of services which are directly related to the construction of assets.. Ex: service of architect  Contract for destruction or restoration of asset and the restoration of the environment following the demolition of asset.

FIXED PRICE CONTRACTS COST PLUS CONTRACTS Some construction contracts may be a mix of the both.

This accounting standard is applied separately to each contract to calculate profit or loss from the contract but under some circumstances the profit/loss may be calculated in combination of two or more contracts or group of combined contracts.

A contract may provide for the construction of an additional asset at the option of the customer, such construction of additional asset should be treated as a separate construction contract if, ♦ Asset differs significantly as compared to original contract ♦ price of the additional asset is independent of original contract.

For calculating profit or loss we must determine the following:-

Initial amount of revenue agreed in 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. A variations is an instruction by the customer for a change in the scope of the work to be performed under the contract.

Revenue arises due to escalation clause. Increase in contract revenue is due to increase in units of output. Decrease in contract revenue is due to penalties Incentive payments to the contractor.

Recognition of revenue and expenses by reference to the stage of completion of a contract is generally referred as the percentage of completion method, under this method revenue is recognized as revenue in the statement of profit/loss in the accounting period in which work is performed.

 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  Survey of work performed.  Completion of physical proportion of the contract work.

Revenue recognized in the period in which work is performed. Expenses recognized in the period in which the work is performed.

Specific cost to contract Cost specifically chargeable to customers under the terms of contract. Cost allocatable to contract

If total contract cost exceeds, total contract revenue, the expected losses should be recognized as an expense irrespective of ▰ Whether or not work has commenced. ▰ Stage of completion of contract. ▰ The amount of profit on other contracts which are not treated as a single contract

The estimate is bound to vary from one accounting period to another accounting period of the construction contract; the effect of change in estimate of contract revenue or contract cost is accounted as change in accounting estimate as per AS-5

An enterprise(contractor) should disclose the following policy. ⋆ 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.

The amount of contract revenue recognized in the period. contract cost incurred and recognized profit(less recognized losses) up to the reporting period. Advance received Gross amount due from customers for contract work[(cost incurred + recognized profit) – (some of recognized losses + progress billing)] gross amount due to customer for contract work [(some of recognized losses + progress billing)-(cost incurred + recognized profit)].