Presentation on theme: "AS-7 Construction Contracts"— Presentation transcript:
1AS-7 Construction Contracts Book on how to play bridge1. VSNL2. Tough job done by ICAI for this AS.3. For a specific unit or company but to come up with a complete code on treatment, etc.Paragraph with 2 appendices to explain.5. In detail even whole day would be insufficient to discuss.Sunil AroraM.Com, FCA
2Construction contracts X & Co receives a contract for construction of a Fly Over in 2007Work of the contract is being carried on during the FY ending 31/03/2007, 08 & 09The contract is likely to be completed in the FYShould the profit be booked on completion of the contract in FY
3Taxability of income Two options: Cases pertain to contractors Project completion method% completion method from year to yearCases pertain to contractorsHeld: Income assessable on yearly basisSri Sukhdeodas Jalan v. CIT 26 ITR 617 (Patna)Tirath Ram Ahuja Pvt Ltd v. CIT 186 ITR 428 (SC)CIT v. NM Associates 256 ITR 141 (Mad)
4Accounting of contractor Whether appropriate to wait till completion of the project?AS 7 : Construction Contracts prescribes treatment of revenue and costs associated therewith in the financials of the contractorAS 7 revised in 2002 and applicable for accounting periods commencing on or after 01/04/2003
5OBJECTIVE Accounting treatment in the books of contractor. Contracts span over a number of financial years.Allocation of contract revenue and contract costs to various accounting periodsUncertainty attached with the total contract
6Recognition of Contract Revenue & Expenses If outcome of Construction contract can be reliably estimatedRevenue & Costs pertaining to the contract should be recognized by the stage of completion or % completion methodImplicationTotal RevenueTotal Costs -Profit ?Based on % of work completedRevenue, Cost, Profits, etc.up to the reporting date to be treated in F.S.
7Stage of completionAdvance / progressive payments received may not reflect the work performedHow to ascertain stage of completion?
8Issues Revenue from contract how ascertained? How to ascertain cost of the contract ?Stage of completion of contract?How to deal with expected losses ?Various types of contracts?What is a reliable estimate of outcome of contract ?If reliable estimates not possible ?
9Year wise allocation Contract revenue Contract cost Stage of completion
10Contract Revenue Consideration received or receivable Due to uncertainties and events which occur during the contract; The estimates need to be revisedThe amount of revenue from a contract may increase or decrease from one period to the next
11Contract Revenue Initial amount of revenue agreed Variations in the contractClaimsIncentive paymentsCost escalationsPenalties
12VariationsInstruction by the customer for a change in the scope of workVariation may increase or decrease the contract revenueVariation to be considered:It is probable that the costumer will approve the effect on revenue; andthe amount of revenue can be reliably measured
13ClaimsAmount which the contractor seeks to collect from the customer on account of changes, delays, errors, etcRevenue from claim is uncertain and depends on negotiationsTo be included:Negotiations have reached advanced stageIt is probable that customer will accept the claimAmount can be reliably measured
14Incentive paymentsAdditional amounts if specified performance standards met or exceededTo be included:The contract is sufficiently advancedIt is probable that the specified standard will be met or exceededIncentive payment can be reliably measured
15Cost escalationsWhether escalation clause in the agreement legally enforceable against the customerEscalations can be related to the customerEscalations due to delay by the contractorIt is probable that the escalation in cost will be realised from the customerWhether cost escalation can be reliably measured
16Penalties Cause for the levy of penalty or deduction from the revenue Status of penalty clause in the agreementIt is probable that the penalty may be waivedPenalty can be reliably measured
17Contract Costs Costs that relate directly to the specific contract Costs that are attributable to contract activity in general and can be allocated to the contractOther costs chargeable to the customer
18Direct contract costs Site labour, supervision, etc Costs of material Design & technical assistanceCost of moving plant, equipment, etc to & from the contract siteCosts of hiring plant & equipmentDepreciation?Cost of rectifications including expected warranty costs.
19Allocation of general costs InsuranceCost of design and technical assistance not directly related to a specific contractConstruction overheadsBorrowing costs as per AS 16Allocation to be systematic & rationalBasis of allocation to be consistent for all costs having similar characteristics
20Contract costsContract costs include costs for the period from securing the contract to the final completionCosts incurred for securing a contract are also included as a part of the contract costs;if they can be separately identified &reliably measured
21Recognition of Contract Revenue & Expenses If outcome of Construction contract can be reliably estimatedRevenue & Costs pertaining to the contract should be recognized by the stage of completion or % completion methodImplicationTotal RevenueTotal Costs -Profit ?Based on % of work completedRevenue, Cost, Profits, etc.up to the reporting date to be treated in F.S.
22Stage of completionAdvance / progressive payments received may not reflect the work performedProportion of costs incurred vis-à-vis total contract costsSurveys of work performedCompletion of physical proportion of work
23Costs incurred Only those costs which reflect the work performed Advances to suppliers, sub contractors, etcMaterials delivered not yet installedGeneral procurementSpecifically manufacturedWhether vendor selection and issue of purchase order can be taken as stage of contract?
24% completion methodContract costs are recognised as an expense in the period in which work is performedCosts which relate to future activity is recognised as an asset and classified as contract work in progressRevenue upto the stage of completion at the reporting date is recognisedThe estimates are revised, when necessaryNeed for revision does not indicate reliability of measurement
25Stage of completion 31-03-07 31-03-08 31-03-09 Total revenue 250 300 400Total cost200360Cost incurred80125288Stage of completion40%50%80%Revenue recognised10050170
26Reliable estimate of outcome Fixed Price ContractsCost Plus Contracts
27Reliable estimates possible Fixed Price ContractsContract Revenue can be reliably measuredContract costs to complete the contract can be measured reliablyContract cost attributable to the contract can be clearly identified and reliably measuredStage of completion can be reliably measuredEconomic benefits will flow to the enterprise
28Cost plus contractContractor is reimbursed for defined costs plus % of these costs or a fixed feeOutcome can be reliably measured:Contract costs attributable to the contract clearly identified & measuredEconomic benefit associated with the contract will flow to the enterprise
29Changes in EstimatesWith the progress of the contract, the estimates of costs & revenues to be revisedNeed for revision does not indicate that the outcome cannot be reliably measuredConsolidated review on each reporting dateBalance after deducting amounts recognised in the previous years to be treated in the FS
30Outcome cannot be reliably estimated Revenue to be recognized only to the extent of costs of which recovery is possibleCosts to be recognized as an expense in the period in which incurredApplicable more in the early stages of contract.
31Recognition of expected losses Contract Costs > Total Contract RevenueExpected Loss ?Work commenced or not ?Stage of completion of Contract ?Profit from other contract not treated as single contract ?
32Disclosure requirements Contract revenue:Revenue recognisedMethod usedBasis to determine stage of completionContracts in progress:Aggregate amount incurred and recognisedAdvances receivedRetentionsAmounts due from or to the customers