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Accounting
Standards Summary
Accounting Standard 7 7 (REVISED)
Construction
Contracts
| Issuing
Authority : |
The
Institute of Chartered Accountants of India |
| Status
: |
Mandatory |
| Effective
Date : |
Contracts
entered into accounting periods commencing on or
after 1-4-2003. (Accordingly earlier Accounting
Standard AS-7, Accounting for Construction Contracts
is not applicable in respect of such contracts) |
| Scope
: |
To
be applied for construction contracts in the financial
statements of the Contractors. |
Definitions
:
Construction Contract: 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 construction contract
can be a fixed price contract or a cost plus contract.
Combining
and Segmenting Construction Contracts
Though the requirements of this statement are usually
applied separately to each construction contract,it
may be necessary in some cases, to apply the statement
to the separately identifiable components of a single
contract or to a group of contracts together to reflect
the essence of a contract or a group of contracts
In case of a contract covering a number of assets,construction
of each asset should be treated as a separate construction
contract when:
- separate
proposals have been submitted for each asset;
- each
asset has been separately negotiated and the contractor
and customer have been able to accept or reject that
part of the contract relating to each asset;and
- the
costs and revenues of each asset can be identified.
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;
- the
contracts are so closely interrelated as to form in
effect,part of a single project with an overall profit
margin;and
- the
contracts are performed concurrently or in a continuous
sequence.
A contract
for the additional asset should be treated as a separate
contract when:
- the
new asset differs significantly in design,technology
or function from the existing asset or assets;or
- the
price of the asset is negotiated without regard to
the original contract price.
Contract
Revenue
Contract revenue should comprise:
- the
initial amount of revenue agreed in the contract;
and
- variations
in contract work,claims and incentive payments:
-
to the extent that it is probable that they will
result in revenue; and
-
they are capable of being reliably measured.
Contract
Costs
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.
Recognition
of Contract Revenue and Expenses
When the outcome of a construction contract can
be estimated reliably,contract revenue and contract
costs associated with the construction contract should
be recognised as revenue and expenses respectively by
reference to the stage of completion of contract activity
at the reporting date.When it is probable that total
contract costs will exceed total contract revenue,the
expected
loss should be recognised as an expense immediately.
In case
of fixed price contracts, the outcome can be estimated
reliably when the following conditions are satisfied:
- total
contract revenue can be measured reliably;
- it is
probable that the economic benefits associated with
the contract will flow to the enterprise;
- both
the contract costs to complete the contract and the
stage of contract completion at the reporting date
can be measured reliably;and
- the
contract costs attributable to the contract can be
clearly identified and measured reliably so
that actual contract costs incurred can be compared
with prior estimates.
In case
of cost plus contracts,the outcome can be estimated
reliably when all the following conditions are satisfied:
- it
is probable that the economic benefits associated
with the contract will flow to the enterprise; and
- the
contract costs attributable to the contract, whether
or not specifically reimbursable,can be clearly identified
and measured reliably.
When the
outcome cannot be estimated reliably:
- revenue
should be recognised only to the extent of contract
costs incurred of which recovery is probable;and
- contract
costs should be recognised as an expense in the period
in which they are incurred.
An expected
loss on the construction contract should be recognised
as an expense immediately.
When
the uncertainities preventing estimating the outcome
of the contract reliably no longer exist, revenue and
expenses should be recognised by reference to the stage
of completion of the contract activity at the reporting
date.
When
it is probable that total contract costs will exceed
total contract revenue,the expected loss should be recognised
as an expense immediately.The amount of such a loss
is determined irrespective of:
-
whether or not work has commenced on the contract;
- the
stage of completion of contract activity;or
- the
amount of profits expected to arise on other contracts
which are not treated as a single
construction contract
Changes
in Estimates
Since
the percentage of completion method is applied on a
cumulative basis in each accounting period, the effect
of a change in the estimate of contract revenue or contract
costs,or the effect of a change in the estimate of the
outcome of a contract , is accounted for as a change
in accounting estimate in accordance with AS-5, Net
Profit or Loss for the Period,Prior Period Items and
Changes
in Accounting Policies.
Disclosure
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 stage of completion
of contracts in progress.
An
enterprise should disclose the following for contracts
in progress at the reporting date:
-
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.
An enterprise
should present:
-
the gross amount due from customers for contract work
as an asset;and
-
the gross amount due to customers for contract work
as a liability.
Contingencies
arising from such items as warranty costs, penalties,
or possible losses are disclosed in accordance with
AS-4,Contingencies and Events Occurring After the Balance
Sheet Date.
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