AS 7 Accounting For Construction Contracts Revised Notes. In the previous articles, we have given AS 9 Revenue Recognition and AS 14 Accounting For Amalgamation. Today we are providing complete details of accounting standard – 7 construction contracts I;e definitions, types of construction contracts, accounting treatment, provision for Foreseeable Losses and disclosure. You can also download AS 7 accounting for construction contracts notes by ICAI at the end of this article. This notes is also useful for IPCC students.
AS 7 Accounting For Construction Contracts Summary Notes
This Statement deals with accounting for construction contracts in the financial statements of enterprises undertaking such contracts (hereafter referred to as ‘contractors’). The Statement also applies to enterprises undertaking construction activities of the type dealt with in this Statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale.
The feature which characterizes a construction contract dealt with in this Statement is the fact that the date at which the contract is secured and the date when the contract activity is completed fall into different accounting periods. The specific duration of the contract performance is not used as a distinguishing feature of a construction contract. Accounting for such contracts is essentially a process of measuring the results of relatively long-term events and allocating those results to relatively short-term accounting periods.
For the purposes of this Statement, a construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single project. Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment. Contracts for the provision of services come within the scope of this Statement to the extent that they are directly related to a contract for the construction of an asset. Examples of such service contracts are contracts for the services of project managers and architects and for technical engineering services related to the construction of an asset.
The objective of this Statement is to prescribe the accounting treatment of revenue and costs associated with construction contracts. Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is completed usually fall into different accounting periods. Therefore, the primary issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction work is performed. 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 also provides practical guidance on the application of these criteria.
The following terms are used in this Statement with the meanings specified:
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.
A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses.
A 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 fee.
Types of Construction Contracts
Construction contracts are formulated in a variety of ways but generally fall into two basic types:
(i) fixed price contracts—the contractor agrees to a fixed contract price, or rate, in some cases subject to cost escalation clauses;
(ii) cost plus contracts—the contractor is reimbursed for allowable or otherwise defined costs, and is also allowed a percentage of these costs or a fixed fee.
Both types of contracts are within the scope of this Statement
Selection of Method
1) The selection of a method of accounting for a construction contract depends on considerations discussed earlier. The contractor may use both methods simultaneously for different contracts depending upon circumstances.
2) When a contractor uses a particular method of accounting for a contract, then in respect of all other contracts that meet similar criteria, the same method is used.
3) The methods of accounting used by the contractor and the criteria adopted in selecting the method/s represent an accounting policy.
Accounting Treatment of Construction Contract Costs and Revenues
Two methods of accounting for contracts commonly followed by contractors are the percentage of completion method and the completed contract method.
a) Under the percentage of completion method, revenue is recognized as the contract activity progresses based on the stage of completion reached. The costs incurred in reaching the stage of completion are matched with this revenue, resulting in the reporting of results which can be attributed to the proportion of work completed. Although (as per the principle of ‘prudence’) revenue is recognized only when realized, under this method, the revenue is recognized as the activity progresses even though in certain circumstances it may not be realized.
b) Under the completed contract method, revenue is recognized only when the contract is completed or substantially completed; that is when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognized until the contract activity is substantially completed.
Under both methods, provision is made for losses for the stage of completion reached on the contract. In addition, provision is usually made for losses on the remainder of the contract.
Contract costs should comprise:
- costs that relate directly to the specific contract;
- costs that are attributable to contract activity in general and can be allocated to the contract; and
- such other costs as are specifically chargeable to the customer under the terms of the contract.
Costs that relate directly to a specific contract include:
- site labour costs, including site supervision;
- costs of materials used in construction;
- depreciation of plant and equipment used on the contract;
- costs of moving plant, equipment and materials to and from the contract site;
- costs of hiring plant and equipment;
- costs of design and technical assistance that is directly related to the contract;
- the estimated costs of rectification and guarantee work, including expected warranty costs; and
- claims from third parties.
Provision for Foreseeable Losses
1) When current estimates of total contract costs and revenues indicate a loss, provision is made for the entire loss on the contract irrespective of the amount of work done and the method of accounting followed. In some circumstances, the foreseeable losses may exceed the costs of work done to date. Provision is nevertheless made for the entire loss on the contract.
2) When a contract is of such magnitude that it can be expected to absorb a considerable part of the capacity of the enterprise for a substantial period, indirect costs to be incurred during the period of the completion of the contract are sometimes considered to be directly attributable to the contract and included in the calculation of the provision for loss on the contract.
3) If a provision for loss is required, the amount of such provision is usually determined irrespective of:
- whether or not work has commenced on the contract, and
- the stage of completion of contract activity; and
- the amount of profits expected to arise on other unrelated contracts.
4) The determination of a future loss on a contract may be subject to a high degree of uncertainty. In some of these cases, it is possible to provide for the future loss, and in other cases, only the existence of a contingent loss is disclosed.
When the outcome of a construction contract cannot be estimated reliably:
(a) revenue should be recognized only to the extent of contract costs incurred of which recovery is probable; and
(b) contract costs should be recognized as an expense in the period in which they are incurred.
An expected loss on the construction contract should be recognized as an expense immediately.
Recognition of Expected Losses
When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately.
The amount of such a loss is determined irrespective of:
(a) whether or not work has commenced on the contract
(b) the stage of completion of contract activity; or
(c) the amount of profits expected to arise on other contracts which are not treated as a single construction contract.
An enterprise should disclose:
(a) the amount of contract revenue recognized as revenue in the period;
(b) the methods used to determine the contract revenue recognized in the period; and
(c) the methods used to determine the stage of completion of contracts in progress.
An enterprise should disclose the following for contracts in progress at the reporting date:
(a) the aggregate amount of costs incurred and recognized profits (less recognized losses) up to the reporting date;
(b) the amount of advances received; and
(c) the amount of retentions.
Click Here to download AS 7 accounting for construction contracts notes by ICAI.
Suggested Articles :
- AS 10 Property, Plant and Equipment | Accounting Standard
- What is Partnership Deed and What are its Main Contents?
- What is IRR (Internal Rate of Return) | Formula, Examples
- What is Ratio Analysis : Meaning, Types of Ratios & their Formulas
- Partnership Firm Registration Procedure in India | Partnership Deed
- Accounting Standard (AS) – 14 Accounting for Amalgamation
- AS 6 Depreciation Accounting Revised Notes | Applicability
- AS 2 Valuation of Inventory Revised Notes and Applicability
- AS 10 Accounting For Fixed Assets Revised Notes
- Accounting Standard 15 Employee Benefits Summary Notes PDF
Hope this article will help you to check the details of AS 7 Accounting For Construction Contracts Revised Notes. Share this article ” AS 7 Accounting For Construction Contracts Revised Notes ” to your friends who are studying CA, CMA and CS courses.