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TMI BlogConstruction ContractsX X X X Extracts X X X X X X X X Extracts X X X X ..... nancial Statements to determine when contract revenue and contract costs should be recognised as revenue and expenses in the statement of profit and loss. It also provides practical guidance on the application of these criteria. Scope 1. This Standard should be applied in accounting for construction contracts in the financial statements of contractors. Definitions 2. The following terms are used in this Standard with the meanings specified: 2.1 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. 2.2 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. 2.3 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. 3. A construction contract may be negotiated for the construction of a single asset such as a bridge, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, in effect, part of a single project with an overall profit margin; and (c) the contracts are performed concurrently or in a continuous sequence. 9. A contract may provide for the construction of an additional asset at the option of the customer or may be amended to include the construction of an additional asset. The construction of the additional asset should be treated as a separate construction contract when: (a) the asset differs significantly in design, technology or function from the asset or assets covered by the original contract; or (b) the price of the asset is negotiated without regard to the original contract price. Contract Revenue 10. Contract revenue should comprise: (a) the initial amount of revenue agreed in the contract; and (b) variations in contract work, claims and incentive payments: (i) to the extent that it is probable that they will result in revenue; and (ii) they are capable of being reliably measured. 11. Contract revenue is measured at the consideration received or receivable. The measurement of contract revenue is affected by a variety of uncertainties that depend on the outcome of future events. The estimates often need to be revi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... probable that the specified performance standards will be met or exceeded; and (b) the amount of the incentive payment can be measured reliably. Contract Costs 15. Contract costs should comprise : (a) costs that relate directly to the specific contract; (b) costs that are attributable to contract activity in general and can be allocated to the contract; and (c) such other costs as are specifically chargeable to the customer under the terms of the contract. 16. Costs that relate directly to a specific contract include: (a) site labour costs, including site supervision; (b) costs of materials used in construction; (c) depreciation of plant and equipment used on the contract; (d) costs of moving plant, equipment and materials to and from the contract site; (e) costs of hiring plant and equipment; (f) costs of design and technical assistance that is directly related to the contract; (g) the estimated costs of rectification and guarantee work, including expected warranty costs; and (h) claims from third parties. These costs may be reduced by any incidental income that is not included in contract revenue, for example income from the sale of surplus materials ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. An expected loss on the construction contract should be recognised as an expense immediately in accordance with paragraph 35. 22. In the case of a fixed price contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied: (a) total contract revenue can be measured reliably; (b) it is probable that the economic benefits associated with the contract will flow to the enterprise; (c) both the contract costs to complete the contract and the stage of contract completion at the reporting date can be measured reliably; and (d) 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. 23. In the case of a cost plus contract, the outcome of a construction contract can be estimated reliably when all the following conditions are satisfied: (a) it is probable that the economic benefits associated with the contract will flow to the enterprise; and (b) the contract costs attributabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... outcome of the contract cannot be estimated reliably. 29. The stage of completion of a contract may be determined in a variety of ways. The enterprise uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include: (a) the proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs; or (b) surveys of work performed; or (c) completion of a physical proportion of the contract work. Progress payments and advances received from customers may not necessarily reflect the work performed. 30. When the stage of completion is determined by reference to the contract costs incurred upto the reporting date, only those contract costs that reflect work performed are included in costs incurred upto the reporting date. Examples of contract costs which are excluded are: (a) contract costs that relate to future activity on the contract, such as costs of materials that have been delivered to a contract site or set aside for use in a contract but not yet installed, used or applied during contract performance, unless the materials have been made specially for the cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otal contract revenue, the expected loss should be recognised as an expense immediately. 36. 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 in accordance with paragraph 8. Changes in Estimates 37. The percentage of completion method is applied on a cumulative basis in each accounting period to the current estimates of contract revenue and contract costs. Therefore, 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 (see Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies). The changed estimates are used in determination of the amount of revenue and expenses recognised in the statement of profit and loss in the period in which the change is made and in subsequent periods. Disclosure 38. An enterprise should disclose: (a) the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hod, measured by reference to the percentage of labour hours incurred upto the reporting date to estimated total labour hours for each contract. Revenue from cost plus contracts is recognised by reference to the recoverable costs incurred during the period plus the fee earned, measured by the proportion that costs incurred upto the reporting date bear to the estimated total costs of the contract. The Determination of Contract Revenue and Expenses The following illustration illustrates one method of determining the stage of completion of a contract and the timing of the recognition of contract revenue and expenses (see paragraphs 21 to 34 of the Standard). (Amounts shown hereinbelow are in Rs. lakhs) A construction contractor has a fixed price contract for ₹ 9,000 to build a bridge. The initial amount of revenue agreed in the contract is ₹ 9,000. The contractor's initial estimate of contract costs is ₹ 8,000. It will take 3 years to build the bridge. By the end of year 1, the contractor's estimate of contract costs has increased to ₹ 8,050. In year 2, the customer approves a variation resulting in an increase in contract revenue of ₹ 200 and estim ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with paragraph 21 145 520 380 200 55 1,300 Contract Expenses recognised in accordance with paragraph 21 110 450 350 250 55 1,215 Expected Losses recognised in accordance with paragraph 35 - - - 40 30 70 Recognised profits less recognised losses 35 70 30 (90) (30) 15 Contract Costs incurred in the period 110 510 450 250 100 1,420 Contract Costs incurred recognized as contract expenses in the period in accordance with paragraph 21 110 450 350 250 55 1,215 Contract Costs that relate to future activity recognised as an asset in accordance with paragraph 26 - 60 100 - 45 205 Contract Revenue (see above) 145 520 380 200 55 1,300 Progress Billings (paragraph 40) 100 520 380 180 55 1,235 Unbilled Contract Revenue 45 - - 20 - 65 Advances (paragraph 40) - 80 20 - 25 125 The amounts to be disclosed in accordance with the Standard are as follows : Contract revenue recognised as revenue in the period [paragraph 38(a)] 1,300 Contract costs incurred and recognized profits (less recognised losses) upto the reporting date [paragraph 39(a)] 1,435 Advances received [paragraph 39(b)] 125 Gross amount due from customers ..... 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