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.
Recognition of contract
Revenue & expenses

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.
The Case of Fixed Price Contract

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.
In the case of a cost plus 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
Percentage of Completion Method

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.
 Some Guidelines of the 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…
(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