material of as 7

8/9/2019 Material of as 7

1/29

1

AS 7AS 7: CONSTRUCTION CONTRACTS: CONSTRUCTION CONTRACTSan analysisan analysis


2/29


3/29

The present standard was introduced wef01.04.2003 as replacement to erstwhile AS

7 Accounting for Construction Contracts The erstwhile standard allowed completed

contract method for revenue recognition,which is now dispensed with

Presently, only percentage of completionmethod is allowed to be followed

3


4/29


5/29

The primary issue in this accounting standard isto match the contract revenues and costs thatoften fall in more than one accounting periods

This standard shall be applied in accounting forconstruction contracts in the financialstatements ofcontractors. The inference isthat the standard applies only with reference to

construction contracts and that too undertakenin the capacity as a contractor

5


6/29

Construction Contract A construction contract is a contract specifically

negotiated for the construction ofx an asset (e.g. building, dam, bridge etc.) orx a combination of assets that are closely interrelated or

interdependent in terms of their design, technology and

function or their ultimate purpose or use. (e.g. a plantcovering factory, township, logistics etc.)

For the purposes of this Statement, constructioncontracts include:x contracts for the rendering of services which are directly

related to the construction of the asset for example, those forthe services of project managers and architects; and

x contracts for destruction or restoration of assets, and therestoration of the environment following the demolition ofassets.

6


7/29

Fixed price contracts The contractor agrees to a fixed contract price for

completing the contract or for a fixed rate per unit ofoutput. The contract may or may not have anescalation clause

Cost plus contracts The contractor gets reimbursement of all allowable or

otherwise defined costs. Over and above he gets afixed percentage of costs or a fixed fees

Composite contracts These contracts possess the features of both the

above types. E.g. the contractor may get cost plus10% limited to Rs. 10 crores.

7


8/29

Splitting of a big contract When a contract covers a number of assets, the

construction of each asset should be treated as a

separate construction contract when: (conditions arecumulative)x separate proposals have been submitted for each asset;

x each asset has been subject to separate negotiation and thecontractor and customer have been able to accept or reject thatpart of the contract relating to each asset; and

x the costs and revenues of each asset can be identified.

E.g. Setting up a factory may be a single contract, butseparate negotiation would have taken place formachinery, civil works, furnishing, infrastructure etc.

8


9/29

Combining of small contracts A group of contracts, whether with a single customer

or with several customers, should be treated as a

single construction contract when: (conditions arecumulative)x The group of contracts is negotiated as a single package;

x The contracts are so closely interrelated that they are, ineffect, part of a single project with an overall profit margin;and

x The contracts are performed concurrently or in a continuoussequence

E.g. Installation of a machinery may involve manycontracts like design, lay out, purchase, installation,civil work, electrical work etc.

9


10/29

Treatment of additional work The construction of additional asset shall be

treated as a separate contract when: (conditionsnot cumulative)

x The asset differs significantly in design, technologyor function from asset or assets covered in theoriginal contract (or)

x The price of the asset is negotiated without regardto the original contract price

10


11/29

Contract revenue

Contract costsRecognition of contract

revenue and cost

11


12/29

Contract revenue shall comprise of: The initial amount of revenue agreed in the

contract (and)

Variations in contract work (e.g. additional work,escalation clause etc.), claims (e.g. reimbursementof costs) and incentive payments (e.g. completingwork ahead of deadline):

x To the extent that it is probable that they will result

in revenue (and) (CERTAINITY)x They are capable of being reliably measured(MEASURABILITY)

12


13/29

Contract costs should comprise: costs that relate directly to the specific contract (e.g.

Para. 16 of AS 7). These costs may be reduced byany incidental income that is not included in contractrevenue, for example income from the sale of surplusmaterials and the disposal of plant and equipment at the end ofthe contract.;

costs that are attributable to contract activity in

general and can be allocated to the contract. (e.g.Para. 17 of AS 7); and

such other costs as are specifically chargeable to thecustomer under the terms of the contract.

S. S. AYYAR AND CO. - AS 7 13


14/29

Examples of Costs that are not includible general administration costs for which reimbursement is not

specified in the contract;

selling costs;

research and development costs for which reimbursement is not

specified in the contract; and depreciation of idle plant and equipment that is not used on a

particular contract

Accounting treatment of costs incurred for securing a

contract

The same is included subject to the following points:x Costs are separately identified

x measured reliably and

x it is probable that the contract will be obtained

14


15/29

When to recognise revenue /costsWhen the outcome of a construction contract can be estimated

reliably, contract revenue and contract costs associated with theconstruction contract should be recognised as revenue andexpenses respectively . (See slides 16 and 17)

What is the criteria for recognising the same?The stage of completion of the contract activity at the reporting

date. (Refer slide 4) (refer the illustration circulated)

What is the rule for recognising loss arising from acontract?An expected loss on the construction contract should be

recognised as an expense immediately. The amount of such aloss is determined irrespective of:x whether or not work has commenced on the contract;x the stage of completion of contract activity; orx the amount of profits expected to arise on other contracts

15


16/29

Determining the outcome in the case of fixed pricecontract

In the case of a fixed price contract, the outcome of a

construction contract can be estimated reliably when all

the following conditions are satisfied:

x total contract revenue can be measured reliably;x it is probable that the economic benefits associated with the

contract will flow to the enterprise;

x both the contract costs to complete the contract and the stage of

contract completion at the reporting date can be measured

reliably; and

x the contract costs attributable to the contract can be clearlyidentified and measured reliably so that actual contract costs

incurred can be compared with prior estimates.

16


17/29

Determining the outcome in the case of costplus contract In the case of a cost plus contract, the outcome

of a construction contract can be estimated

reliably when all the following conditions aresatisfied:

x it is probable that the economic benefits associatedwith the contract will flow to the enterprise; and

x the contract costs attributable to the contract,

whether or not specifically reimbursable, can beclearly identified and measured reliably.

17


18/29

Treatment of costs incurred which pertains to future activities:

Such contract costs are 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

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 of the amount of contractrevenue (see examples in para. 33 of AS 7)

18


19/29


20/29

An enterprise should disclose:

the amount of contract revenue

recognised as revenue in the period;

the methods used to determine the

contract revenue recognised in the period;

and

the methods used to determine the stageof completion of contracts in progress.

20


21/29

An enterprise should disclose the

following for contracts in progress at the

reporting date: the aggregate amount of costs incurred and

recognised profits (less recognised losses)

upto the reporting date;

the amount of advances received; and the amount of retentions.

21


22/29


23/29

Applicability of AS 7 to enterprisesundertaking construction activities on their

own account (EAC vol. XXIII pg. 95)

According to Paragraph 1 of AS 7, This standard

should be applied in accounting forconstructioncontracts in the financial statements of

contractors. Therefore, AS 7 does not apply in

this case. They will have to follow AS 9 for

revenue recognition and AS 2 for inventory

valuation

23


24/29

Applicability of AS 7 to real estate developers (Referguidance note on recognition of revenue by Real Estate

Developers CA journal June 2006 page 1764)

For Services done till transfer of risks and rewards Developer

cannot be considered as a contractor and therefore AS 9 applies.

Here revenue recognition depends on paragraphs 10 and 11 of the

said standard:

x Paragraph 10 whether ultimate collection is assured (and)

x Paragraph 11 transfer of risks and rewards of ownership and no

ambiguity as to consideration Transfer of risks and rewards and

ownership take place depending on the terms of agreement

For Services done after transfer of risks and rewards Thedeveloper steps into the shoes of a contractor and hence AS 7

applies

24


25/29

Interpretation of the term turnover vis--visconstruction contracts (ASI 29)

The amount of contract revenue recognised as

revenue in the statement of profit and loss as per

the requirement of AS 7 shall be considered as

turnover

Turnover implies the incomings from the revenue

generating activities of an enterprise. Vis--vis a

contractor, revenue as per AS 7 is the incoming from

the revenue generating activities of the enterpriseand hence rightly treated as turnover

25


26/29

Applicability of AS 7 to turnkey projectsinvolving supply of goods and related

services: (EAC Vol. XX Pg. 156) E.g. Supply of machinery and related erection,

installation and commissioning

In such cases if the supply of machinery (i.e.contract of sale) is predominant then AS 9 shall

apply Alternatively if the works contract is predominant

then AS 7 shall apply

26


27/29

Applicability of AS 7 to engineering

consultancy services: (CA Journal

March 2006 Pg. 1350)

If consultancy is incidental to a

construction contract, AS 7 shall apply

In all other case, AS 9 shall apply

27


28/29

Applicability of AS 7 to entities not followingaccrual method of accounting (refercompendium of accounting standards 2005edition Page A-21) This generally applies in the case of non corporate

entities

Here the fact that accrual method of accounting is notfollowed shall be stated and compliance of AS shallbe viewed based on the method of accountingfollowed

Moreover, since CBDT has not issued anyaccounting standard on construction contracts, a noncorporate assessee can still follow completedcontract method. This view was upheld inMadhuvana House BuildingCo-operative society vs.

ACIT(2002) 76 TTJ 948(Bang)

28


29/29

THANK YOU

29

material of as 7

Documents