Construction Contracts Contents

1 accounting Standard(AS)765 Construction ContractsContents OBJECTIVE SCOPE Paragraph 1 DEFINITIONS 2-5 COMBINING AND SEGMENTING Construction Contracts 6-9 contract REVENUE 10-14 contract COSTS 15-20 RECOGNITION OF contract REVENUE AND EXPENSES 21-34 RECOGNITION OF EXPECTED LOSSES 35-36 CHANGES IN ESTIMATES 3 7 DISCLOSURE 38-44 ILLUSTRATION accounting Standard (AS) 7 Construction Contracts *(This accounting Standard includesparagraphsset inbolditalic type and plain type, which have equal authority.)

2 Paragraphs in bold italic type indicate the main principles. This accounting Standard should beread in the context of its objective and the General Instructionscontained in part A of the Annexure to the Notification.) Objective The objective of this Standard is to prescribe the accounting treatment ofrevenue and costs associated with Construction Contracts . Because of thenature of the activity undertaken in Construction Contracts , the date at whichthe contract activity is entered into and the date when the activity is completedusually fall into different accounting periods. Therefore, the primary issue inaccounting for Construction Contracts is the allocation of contract revenueand contract costs to the accounting periods in which Construction work isperformed. This Standard uses the recognition criteria established in theFramework for the Preparation and Presentation of Financial Statements todetermine when contract revenue and contract costs should be recognisedas revenue and expenses in the statement of profit and loss.

3 It also providespractical 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: * In respect of Contracts entered into prior to the effective date of the notificationprescribing this accounting Standard under Section 211 of the Companies Act,1956, the applicability of this Standard would be determined on the basis of the accounting Standard (AS) 7, revised by the ICAI in 2002. Construction Contracts 67 A Construction contractis a contract specifically negotiated for the Construction of an asset or a combination of assets that areclosely interrelated or interdependent in terms of their design,technology and function or their ultimate purpose or use.

4 A fixed price contractis a Construction contract in which thecontractor agrees to a fixed contract price, or a fixed rate per unitof output, which in some cases is subject to cost escalation A cost plus contractis a Construction contractin which the contractor is reimbursed for allowable or otherwise defined costs, plus percentage of these A Construction contract may be negotiated for the Construction of asingle asset such as a bridge, building, dam, pipeline, road, ship or tunnel. Aconstruction contract may also deal with the Construction of a number ofassets which are closely interrelated or interdependent in terms of their design,technology and function or their ultimate purpose or use; examples of suchcontracts include those for the Construction of refineries and other complexpieces of plant or equipment. 4. For the purposes of this Standard, Construction Contracts include:(a) Contracts for the rendering of services which are directly relatedto the Construction of the asset, for example, those for the servicesof project managers and architects; and (b) Contracts for destruction orrestoration of assets, and the restoration of the environment following the demolition of assets.

5 5. Construction Contracts are formulatedin a numberof ways which, forthe purposes of this Standard, are classified as fixed price Contracts and costplus Contracts . Some Construction Contracts may contain characteristics ofboth a fixed price contract and a cost plus contract , for example, in the caseof a cost plus contract with an agreed maximum price. In such circumstances,a contractor needs to consider all the conditions in paragraphs 22 and 23 inorder to determine when to recognise contract revenue and expenses. Combining and Segmenting Construction Contracts 6. The requirements of this Standard are usually applied separately to each 68 AS7construction contract . However,incertaincircumstances,itisneces sary toapply the Standard to the separately identifiable components of a singlecontract or to a group of Contracts together in order to reflect the substanceof a contract or a group of Contracts . 7. When a contract covers a number of assets, the Construction of each asset should be treated as a separate Construction contract when:(a) separate proposals have been submitted for each asset; (b) each asset has been subject to separate negotiation and thecontractor and customer have been able to accept or rejectthat part of the contract relating to each asset; and (c) the costs and revenues of each asset can be identified.

6 8. A group of Contracts , whether with a single customer or with severalcustomers, should be treated as a single Construction contract when: (a) the group of Contracts is negotiated as a single package; (b) the contractsaresocloselyinterrelated thattheyare,in effect,part of a single project with an overall profit margin; and (c) the Contracts are performed concurrently or in a continuoussequence. 9. A contract may provideforthe Construction ofan additional asset at the option of the customer or may be amended to include theconstruction of an additional asset. The Construction of the additionalasset should be treated as a separate Construction contract when: (a) the asset differssignificantlyindesign,technologyo rfunction from the assetorassetscoveredbythe originalcontract; or (b) the price of the assetisnegotiated withoutregardtotheoriginalcontract price.

7 contract Revenue 10. contract revenue should comprise: Construction Contracts 69 (a) the initial amountofrevenue agreedinthecontract;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 contract revenue is measured at the consideration received or receivable. The measurement of contract revenue is affected by a variety ofuncertainties that depend on the outcome of future events. The estimatesoften need to be revised as events occur and uncertainties are , the amount of contract revenue may increase or decrease fromone period to the next. For example: (a) a contractorandacustomermay agree to variations or claimsthat increase or decrease contract revenue in a period subsequentto that in which the contract was initially agreed; (b) the amount of revenue agreedin a fixedprice contract may increase as a result of cost escalation clauses; (c) the amount of contract revenue may decrease as a result ofpenalties arising from delays caused by the contractor in thecompletion of the contract ; or (d) when a fixed price contract involves a fixedprice per unit ofoutput, contract revenue increases as the number of units is increased.

8 12. A variation is an instructionbythecustomerfora change in the scope of the work to be performed under the contract . A variation may lead to anincrease or a decrease in contract revenue. Examples of variations arechanges in the specifications or design of the asset and changes in the duration of the contract . A variation is included in contract revenue when: (a) it is probable that the customerwill approve the variation and theamount of revenue arising from the variation; and (b) the amount of revenue canbe reliablymeasured. 70 AS713. A claim is an amount that the contractor seeks to collect from the customer or another party as reimbursement for costs not included in thecontract price. A claim may arise from, for example, customer caused delays,errors in specifications or design, and disputed variations in contract measurement of the amounts of revenue arising from claims is subjectto a high level of uncertainty and often depends on the outcome of negotiations.

9 Therefore, claims are only included in contract revenue when: (a) negotiations have reached an advanced stage such that it is probable that the customer will accept the claim; and (b) the amount that it is probable willbe acceptedbythecustomercan be measured reliably. 14. Incentive payments are additional amounts payable to the contractor if specified performance standards are met or exceeded. For example, acontract may allow for an incentive payment to the contractor for earlycompletion of the contract . Incentive payments are included in contractrevenue when: (a) the contract is sufficiently advancedthat it is probable that thespecified performance standards will be met or exceeded; and (b) the amount of the incentive payment can be measured Costs 15. contract costs should comprise:(a) costs that relatedirectlytothespecific contract ;(b) costs that are attributabletocontractactivityingeneral andcan be allocated to the contract ; and (c) such other costsasarespecificallychargeabletothecus tomerunder the terms of the Costs that relate directlyto a specific contract include:(a) site labour costs, includingsite supervision; Construction Contracts 71(b) costs of materials usedin Construction ;(c) depreciation ofplant andequipment usedon the contract ;(d) costs of moving plant, equipment andmaterials to andfrom thecontract site; (e) costs of hiringplant andequipment;(f)costs of design andtechnical assistance that is directly related to the contract ; (g) the estimated costs of rectification andguarantee work, including expected warranty costs.

10 And (h) claims from costs may be reducedby any incidental income that is not included incontract revenue, for example income from the sale of surplus materials andthe disposal of plant and equipment at the end of the contract . 17. Costs that may be attributable to contract activity in general and can be allocated to specific Contracts include: (a) insurance ;(b) costs of design and technical assistance that is not directly related to a specific contract ; and (c) Construction costs are allocatedusing methods that are systematic andrational andare applied consistently to all costs having similar characteristics. Theallocation is based on the normal level of Construction activity. Constructionoverheads include costs such as the preparation and processing of constructionpersonnel payroll. Costs that may be attributable to contract activity in generaland can be allocated to specific Contracts also include borrowing costs asper accounting Standard (AS) 16, Borrowing Costs.