1. AS-7 Construction Contracts
Book on how to play bridge
1. VSNL
2. Tough job done by ICAI for this AS.
3. For a specific unit or company but to come up with a complete code on treatment, etc.
Paragraph with 2 appendices to explain.
5. In detail even whole day would be insufficient to discuss.
Sunil Arora
M.Com, FCA

2. Construction contracts
X & Co receives a contract for construction of a Fly Over in 2007
Work of the contract is being carried on during the FY ending 31/03/2007, 08 & 09
The contract is likely to be completed in the FY
Should the profit be booked on completion of the contract in FY

3. Taxability of income Two options: Cases pertain to contractors
Project completion method
% completion method from year to year
Cases pertain to contractors
Held: Income assessable on yearly basis
Sri Sukhdeodas Jalan v. CIT 26 ITR 617 (Patna)
Tirath Ram Ahuja Pvt Ltd v. CIT 186 ITR 428 (SC)
CIT v. NM Associates 256 ITR 141 (Mad)

4. Accounting of contractor
Whether appropriate to wait till completion of the project?
AS 7 : Construction Contracts prescribes treatment of revenue and costs associated therewith in the financials of the contractor
AS 7 revised in 2002 and applicable for accounting periods commencing on or after 01/04/2003

5. OBJECTIVE Accounting treatment in the books of contractor.
Contracts span over a number of financial years.
Allocation of contract revenue and contract costs to various accounting periods
Uncertainty attached with the total contract

6. Recognition of Contract Revenue & Expenses
If outcome of Construction contract can be reliably estimated
Revenue & Costs pertaining to the contract should be recognized by the stage of completion or % completion method
Implication
Total Revenue
Total Costs -
Profit ?
Based on % of work completed
Revenue, Cost, Profits, etc.
up to the reporting date to be treated in F.S.

7. Stage of completion
Advance / progressive payments received may not reflect the work performed
How to ascertain stage of completion?

8. Issues Revenue from contract how ascertained?
How to ascertain cost of the contract ?
Stage of completion of contract?
How to deal with expected losses ?
Various types of contracts?
What is a reliable estimate of outcome of contract ?
If reliable estimates not possible ?

9. Year wise allocation Contract revenue Contract cost
Stage of completion

10. Contract Revenue Consideration received or receivable
Due to uncertainties and events which occur during the contract; The estimates need to be revised
The amount of revenue from a contract may increase or decrease from one period to the next

11. Contract Revenue Initial amount of revenue agreed
Variations in the contract
Claims
Incentive payments
Cost escalations
Penalties

12. Variations
Instruction by the customer for a change in the scope of work
Variation may increase or decrease the contract revenue
Variation to be considered:
It is probable that the costumer will approve the effect on revenue; and
the amount of revenue can be reliably measured

13. Claims
Amount which the contractor seeks to collect from the customer on account of changes, delays, errors, etc
Revenue from claim is uncertain and depends on negotiations
To be included:
Negotiations have reached advanced stage
It is probable that customer will accept the claim
Amount can be reliably measured

14. Incentive payments
Additional amounts if specified performance standards met or exceeded
To be included:
The contract is sufficiently advanced
It is probable that the specified standard will be met or exceeded
Incentive payment can be reliably measured

15. Cost escalations
Whether escalation clause in the agreement legally enforceable against the customer
Escalations can be related to the customer
Escalations due to delay by the contractor
It is probable that the escalation in cost will be realised from the customer
Whether cost escalation can be reliably measured

16. Penalties Cause for the levy of penalty or deduction from the revenue
Status of penalty clause in the agreement
It is probable that the penalty may be waived
Penalty can be reliably measured

17. Contract Costs Costs that relate directly to the specific contract
Costs that are attributable to contract activity in general and can be allocated to the contract
Other costs chargeable to the customer

18. Direct contract costs Site labour, supervision, etc Costs of material
Design & technical assistance
Cost of moving plant, equipment, etc to & from the contract site
Costs of hiring plant & equipment
Depreciation?
Cost of rectifications including expected warranty costs.

19. Allocation of general costs
Insurance
Cost of design and technical assistance not directly related to a specific contract
Construction overheads
Borrowing costs as per AS 16
Allocation to be systematic & rational
Basis of allocation to be consistent for all costs having similar characteristics

20. Contract costs
Contract costs include costs for the period from securing the contract to the final completion
Costs incurred for securing a contract are also included as a part of the contract costs;
if they can be separately identified &
reliably measured

21. Recognition of Contract Revenue & Expenses
If outcome of Construction contract can be reliably estimated
Revenue & Costs pertaining to the contract should be recognized by the stage of completion or % completion method
Implication
Total Revenue
Total Costs -
Profit ?
Based on % of work completed
Revenue, Cost, Profits, etc.
up to the reporting date to be treated in F.S.

22. Stage of completion
Advance / progressive payments received may not reflect the work performed
Proportion of costs incurred vis-à-vis total contract costs
Surveys of work performed
Completion of physical proportion of work

23. Costs incurred Only those costs which reflect the work performed
Advances to suppliers, sub contractors, etc
Materials delivered not yet installed
General procurement
Specifically manufactured
Whether vendor selection and issue of purchase order can be taken as stage of contract?

24. % completion method
Contract costs are recognised as an expense in the period in which work is performed
Costs which relate to future activity is recognised as an asset and classified as contract work in progress
Revenue upto the stage of completion at the reporting date is recognised
The estimates are revised, when necessary
Need for revision does not indicate reliability of measurement

25. Stage of completion 31-03-07 31-03-08 31-03-09 Total revenue 250 300
400
Total cost
200
360
Cost incurred 80
125
288
Stage of completion
40%
50%
80%
Revenue recognised
100 50
170

26. Reliable estimate of outcome
Fixed Price Contracts
Cost Plus Contracts

27. Reliable estimates possible
Fixed Price Contracts
Contract Revenue can be reliably measured
Contract costs to complete the contract can be measured reliably
Contract cost attributable to the contract can be clearly identified and reliably measured
Stage of completion can be reliably measured
Economic benefits will flow to the enterprise

28. Cost plus contract
Contractor is reimbursed for defined costs plus % of these costs or a fixed fee
Outcome can be reliably measured:
Contract costs attributable to the contract clearly identified & measured
Economic benefit associated with the contract will flow to the enterprise

29. Changes in Estimates
With the progress of the contract, the estimates of costs & revenues to be revised
Need for revision does not indicate that the outcome cannot be reliably measured
Consolidated review on each reporting date
Balance after deducting amounts recognised in the previous years to be treated in the FS

30. Outcome cannot be reliably estimated
Revenue to be recognized only to the extent of costs of which recovery is possible
Costs to be recognized as an expense in the period in which incurred
Applicable more in the early stages of contract.

31. Recognition of expected losses
Contract Costs > Total Contract Revenue
Expected Loss ?
Work commenced or not ?
Stage of completion of Contract ?
Profit from other contract not treated as single contract ?

32. Disclosure requirements
Contract revenue:
Revenue recognised
Method used
Basis to determine stage of completion
Contracts in progress:
Aggregate amount incurred and recognised
Advances received
Retentions
Amounts due from or to the customers

34. Other Issues
Unertainty about collectivity of revenue already recognized
Contact costs where recovery is improbable.