Accounting Standard – 7 Construction Contract

Today we have brought you good quick summary of accounting standard 7 or AS 7 in short, This indian Accounting Standard 7 is mandatory as of July 1 2017.
Construction Contract :- 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.

Accounting Standard 7 AS Construction

Recognition of contract revenue and contract cost
When the outcome of a construction contract can be estimated reliably, contract revenue and contract cost should be recognized as revenue and expenses by reference to the stage of construction.

(This accounting standard recommends the use of percentage of completion method)

When the outcome of a construction contract cannot be estimated reliably,
  • Revenue should be recognized only to the extent of contract costs incurred of which recovery is probable. (i.e. Revenue recognized = Costs Incurred )
  • Contract costs should be recognized as an expense in the period in which they are incurred.
The outcome of a construction contract can be estimated reliably when all the following conditions are satisfied:
  1. Total contract revenue can be measured reliably;
  2. The receipt of revenue is probable;
  3. The contract costs to complete the contract can be measured reliably;
  4. The stage of completion at the reporting date can be measured reliably;
  5. The contract costs attributable to the contract can be clearly identified.
Contract revenue should comprise:
  1. The initial amount of revenue agreed in the contract; and
  2. Variations in amount to be received
  • To the extent that it is probable that they will result in revenue; and
  • They are capable of being reliably measured.
(Contract can of two kinds: Fixed Price contract and Cost Plus 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.
At any stage of contract, 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 loss is determined irrespective of:
  • Whether or not work has commenced on the contract;
  • The stage of completion of contract activity; or
  • Whether outcome of contract is estimated or not
When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognized in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognized as an expense rather than an adjustment of the amount of contract revenue. Contract costs that relate to future activity, are recognized as an asset provided it is probable that they will be recovered. Such asset is classified as Contract WIP. The stage of completion of a contract may be determined by following ways;
  • Surveys of work done
  • Completion of physical proportion of the contract work
  • The proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs.
When a contract covers a number of assets, the construction of each asset should be treated as a separate construction of each asset should be treated as separate construction contract when :
  • Separate proposals have been submitted for each asset;
  • Each asset has been subject to separate negotiation
  • 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 very closely interrelated
  • The contracts are performed concurrently or in a continuous sequence.
The recognition of revenue and expenses in construction contract is based on reliable estimate. This estimate may vary from one accounting year to another accounting year. The effect of change in estimate should be treated as per AS-5. i.e. It should not be treated as prior period item or extraordinary item.

  • Contract Revenue recognized as revenue
  • Method used to determine the contract revenue
  • Method used to determine the stage of completion
  • Contract costs incurred + Recognised Profit – Recognised Loss
  • Amount of advances received
  • Amount due from customers
  • Amount due to customers
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