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Accounting Standard 7

Construction Contract

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AS

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Issued in• December• 1983

Titled as• Accounting

for Construction Contracts

Revised in• Year• 2002

Quick Facts

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Objectives

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Definition of Construction Contract

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Fixed Price Contract

Cost Plus Contract

Hybrid Contra

ct

Types of Contract

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Fixed Price Contract

• Contractor agrees to a fixed contract price, or a fixed rate per unit of output.• In some cases, subject to cost escalation clause.

Hybrid Contract

• Combination of fixed price & cost plus contract.• For eg: A cost plus contract with agreed maximum price.

Cost Plus Contract

• Contractor is reimbursed for allowable or defined costs.• Plus percentage of these costs or fixed fee.

Defining the terms

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Rendering of services

directly related to construction

of assets

Restoration or destruction of

assets

Restoration of environment following the demolition of

an asset

The 3 R’sConstruction contract includes:

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Combining•Separate proposal submitted for each asset.•Costs and revenues of each asset can be identified.•Each asset subject to separate negotiation and acceptance of terms laid in the contract.

Segmenting•Group of contracts negotiated as single package.•Contracts are closely interrelated.•Contracts performed concurrently or in a continuous sequence.

Combining & SegmentingWhen to combine or separate construction contracts:

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Additional assetWhether construction of additional asset be separate contract or part of existing?

A contract maybe amended to include construction of an additional asset or maybe constructed at the option of the customer.

The same should be considered as a separate contract when:

The asset differs significantly from the original asset.The price of asset is independent of original contract.

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Contract Revenue

Contract Revenue

Initial amount of revenue

agreed

Claims

Variations in contract

work

Escalation Clause

Incentive payments

Penalties

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Initial amount of revenue agreed

• It is the initially agreed amount between contractor & customer, specified in the contract.

Claims

• It is reimbursement of costs not included in contract price.• It may arise due to customer caused delays, errors in specification or design or disputed variations in contract

work.

Variations in contract work

• Instructions by customer for change in scope of work to be performed under the contract.• It may lead to increase or decrease in contract revenue.• Eg: Changes in specifications or design of an asset and duration of contract.

Defining the terms

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Escalation clause

• Increase in the amount of revenue due to inflation.• It is applicable to Fixed Price contract.

Incentive payments

• Additional amount payable to contractor, if specified standards are met or exceeded.• Eg: Incentive payment for an early completion of a contract.

Penalties

• Decrease in revenue due to delays caused by contractor in completion of contract.

Defining the terms Contd.

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Contract Cost

Directly related to specific

contract

Allocated to contract

Specifically chargeable to the customer

Contract Cost

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Cost ComponentsThe components of contract cost are mentioned below:

Directly related to specific contract

•Site labor cost•Cost of material•Depreciation of plant & equipment•Cost of hiring plant & equipment•Transportation charges•Expected warranty cost•Cost of design & technical assistance•Claims from third parties

Allocated to contract

•Insurance•Cost of design & technical assistance not directly related to the contract•Construction overheads

Specifically chargeable to the customer

•General administration and development costs for which reimbursement is stated in the contract

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Excluded from Contract CostFollowing costs are not attributable to a construction contract:

General administration cost for which reimbursement not specified

Depreciation of idle plant & machinery

Selling costs

Research & development

costs for which reimbursement not specified

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Recognition (Revenue & Expense)

When outcome of a construction contract can be estimated reliably

Contract Revenue & Contract Cost to be recognized

By reference to the degree of completion of the contract activity.

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Estimation of outcomeOutcome of construction contract can be estimated reliably on satisfaction of following conditions

Following conditions are to be satisfied, In case of Cost Plus Contract, to estimate outcome of construction contract reliably:

• Probable that economic benefit will flow to the enterprise.

• Contract cost can be identified, measured & analyzed.

Conditions to be satisfied in case of Fixed Price Contract apart from those mentioned in cost plus contract:

• Contract revenue can be measured reliably.

• Contract cost and stage of completion can be measured reliably, at reporting date.

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Degree of Completion

Methods of assessing degree of completion

Physical Proporti

on

Survey

Percentage

Completion

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Recognition (Expected losses)

Contract Revenue Contract Cost

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Disclosure

Contract revenue recognized in the period

Methods used to determine contract revenue

Methods used to determine degree of completion

An Enterprise should disclose the following:

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Disclosure Contd.

• Amount of advance received

• Amount of retentions

• Cost incurred and profits recognized upto reporting date

For contracts

in progress

• Amount due from customers as an Asset

• Amount due to customers as Liability

Present

An enterprise should also disclose and present the following in its financial statements:

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Thank You

Prepared• In the guidance of• CA Kapileshwar

Bhalla

By• Rohit Pandey