AS - 7
CONSTRUCTION CONTRACTS
THEORY QUESTIONS
Q.1. It is argued that profit on construction contracts should not be
recognised until the contract is completed. Please explain whether you
believe that this suggestion would improve the quality of financial
reporting for long-term construction contracts.
Ans. Usually, construction contracts are long term nature i.e., the contracts
are entered in one accounting period, however, the work performed will
flow into more than one accounting year. If the profit on construction
contracts is not recognised over the construction period, then the costs
incurred during the earlier years of the contract would be recognised
without any corresponding revenue.
This will result in losses for initial years followed high profits in future
years. The current treatment under AS 7 results in matching of revenue
and associated costs as they are recognised during the same period.
Also, the current accounting incorporates the prudence concept as any
foreseeable losses are accounted for immediately.
Therefore, AS 7 results in a fair representation of the underlying
financial substance of the transaction.
Q.2. Entity XY contracts with AB to construct 2 residential buildings in the
same premises. The construction of both buildings will begin
simultaneously. Building material, construction work, and other
related activities will go on in parallel to provide cost savings to entity
XY. This also helps AB achieve a timely completion of the two buildings
and negotiate a consolidated price for the two buildings. Explain
whether it is single contract?
Ans. In this Question, there is a single contract negotiated to construct two
buildings that are closely interrelated and interdependent in terms of
their ultimate purpose and use. Therefore, this represents a Single
Construction Contract.
Q.3. H, a sole-proprietor, contracts with M/s DM Construction, to dismantle
his office premises and construct it from scratch. Is it a Construction
contract?
Ans. In the given case, the construction contract includes both demolition as
well as construction of a new building.
AS - 7
Q.4. XYZ construction Ltd, a construction company undertakes the
construction of an industrial complex.
It has separate proposals raised for each unit to be constructed in the
industrial complex. Since each unit is subject to separate negotiation,
he is able to identify the costs and revenues attributable to each unit.
Should XYZ Ltd, treat construction of each unit as a separate
construction contract according to AS 7.
Ans. As per AS 7 ‘Construction Contracts’, 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 the
contractor and customer have been able to accept or reject that part
of the contract relating to each asset; and
(c) the costs and revenues of each asset can be identified.
Therefore, XYZ Ltd. is required to treat construction of each unit as a
separate construction contract.
Q.5. Describe, with reference to Accounting Standard 7 on accounting for
construction contracts, the methods which may be used for recognizing
revenue on construction contracts.
Ans. Accounting for Construction Contract is based on AS-7.
Completed Contract Method: - In this method, revenue is recognized only
when the work is completed or substantially completed. During the
course of the contract, costs and progress payments received are
accumulated but revenue will not be recognized until the contract
activity is substantially completed.
In both the methods, provisions are made for losses for the stage of
completion reached on the contract and provisions are also made for
losses on the remainder of the contract.
For the purpose of accounting, it is important to combine the contract
made with single customers or with several customers. If the contract
covers a number of projects and if the costs and revenues of such
individual projects can be known within the terms of the overall
contract each such project may be treated as equivalent to a separate
contract.
Q.6. Explain contract costs as per Accounting Standard-7 related to
'Construction Contracts'.
Ans. As per Para 15 of AS 7 “Constriction Contracts (revised 2002)”, contact
cost should comprise:
(a) cost that relates directly to the specific contact;
(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.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Q.7. Mr. 'X' as a contractor has just entered a contract with a local municipal
body for building a flyover. As per the contract terms, 'X' will receive an
additional ` 2 crore if the construction of the flyover were to be finished
within a period of two years of the commencement of the contract. Mr.
X wants to recognize this revenue since in the past he has been able to
meet similar targets very easily.
Is X correct in his proposal? Discuss.
Ans. According to para 14 of AS 7 (Revised) ‘Construction Contracts’,
incentive Payments are additional amounts Payable to the contractor if
specified performance standards are met or exceeded. For Example, a
contract may allow for an incentive Payment to the contractor for early
completion of the contract. Incentive payments included in contract
revenue when
(i) The contract is sufficiently advanced that it is probable that the
specified performance standards will be met or exceeded; and
(ii) The amount of the, incentive payment can be measured reliably.
In the given problem, the contract has not even begun and hence the
contractor (Mr. X should not recognize any revenue of this contract.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
PRACTICAL QUESTIONS
Q.1. X Ltd. commenced a construction contract on 01-04-2021. The fixed
contract price agreed was ₹2,00,000. The company incurred ₹81,000 in
2021-22 for 45% work and received ₹79,000 as progress payment from
the customer. The cost incurred in 2022-23 was ₹89,000 to complete
the rest of work. Show the extract of the Profit and Loss Account and
Customer’s Account for the related years.
Ans. Contract Profit – Y1 – ` 9000, Y2 ` 21,000
Q.2. XYZ Constructions has a contract to build an office building.
The terms and conditions are as under:
1. XYZ’s profit is agreed at:
▪ 25% on expected contract’s cost; For this purpose, the expected
cost cannot exceed ₹ 22 crores.
▪ The cost for fixation Price will be taken actual cost or ₹ 22 crores
whichever is less
2. The agreed price will be revised depending upon the actual cost
incurred.
Calculate Contract Revenue and Profit in the following cases:
Case I – when Estimated Contract cost is ` 18 Crores.
Case II – when Estimated Contract cost is ` 25 Crores.
Case III – when Estimated Contract cost is ` 30 Crores.
Ans. Contract Revenue Case I – ` 22.5 Cr. II – ` 27.5 Cr. III – ` 27.5 Crore
Q.3. AB contactors enters into a contract on 1st January 2021 with XY to
construct a 5- storied building. Under the contract, AB is required to
complete the construction in 3 years (i.e., by 31st December 2023). The
following information is relevant:
Fixed price (agreed) ₹ 5 crore
Material cost escalation (to the extent of 20% of increase in material
cost)
Labour cost escalation (up to 30% of increase in minimum wages)
In case AB is able to complete the construction in less than 2 years and
10 months, it will be entitled for an additional incentive of ₹ 50 lakh.
However, in case the construction is delayed beyond 3 years and 2
months, XY will charge a penalty of ₹ 20 lakh. At the start of the
contract, AB has a reason to believe that construction will be completed
in 2 years and 8 months. Assume that the construction was actually
completed in 2 years 9 months.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Labour cost was originally estimated to be ₹1.20 crore (based on initial
minimum wages). However, the costs have increased by 25% during the
construction period. Material costs have increased by 40% due to short-
supply. The total increase in material cost due to the 40% escalation is
₹ 80 lakh.
You are required to suggest what should be the contract revenue in
above case?
Assume that in year 2022, XY has requested AB to increase the scope
of the contract. An additional floor is required to be constructed and
there is an increase in contract fee by ₹1 crore.
AB has incurred a cost of ₹ 20 lakh for getting the local authority
approvals which it will be entitled to claim from XY in addition to the
increase in the fixed fee.
Also measure the total contract revenue in this case.
Ans. Total Contract Revenue ` 6.20 Cr. and 7.40 Cr.
Q.4. RT Enterprises has entered into a fixed price contract for construction
of a tower with its customer. Initial tender price agreed is ` 220 crore.
At the start of the contract, it is estimated that total costs to be incurred
will be ` 200 crore.
At the end of year 1, this estimate stands revised to ` 202 crore. Assume
that the construction is expected to be completed in 3 years.
During year 2, the customer has requested for a variation in the
contract. As a result of that, the total contract value will increase by `
5 crore and the costs will increase by ` 3 crore.
RT has decided to measure the stage of completion on the basis of the
proportion of contract costs incurred to the total estimated contract
costs.
Contract costs incurred at the end of each year is:
Year 1: ` 52.52 crore
Year 2: ` 154.20 crore (including unused material of 2.5 crore)
Year 3: ` 205 crore
You are required to calculate: (a) Stage of completion for each year. (b)
Profit to be recognised for each year.
Ans. (a) Stage of completion for each year 26%, 74%,100% (b) Profit – ` 4.68
Cr., ` 10.12 Cr., ` 5.2 Cr.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Q.5. H Ltd. Undertook a three-year contract for a total price of ` 57,50,000.
The contract cost are estimated to be ` 46,57,500. From the following
information, you are required to identify the revenue and cost in each
of the three years.
Particulars Year 1 Year 2 Year 3
Cumulative cost incurred to date 17,25,000 41,40,000 46,57,500
Estimated cost yet to be incurred 34,50,000 4,60,000 Nil
Progress Billing during the year 11,50,000 42,55,000 3,45,000
Collecting of Billing during the 8,62,500 34,50,000 14,37,500
year
Ans. Contract Profit- Year 1- ` 1,91,667, Year 2- ` 8,43,333, Year 3- `
57,500.
Q.6. The following Data is given for a financial period in respect of various
contracts undertaken by Malik Ltd (` in lakhs)
Contracts A B C D E F
Cost incurred 40.00 10.00 6.00 75.00 40.00 120.00
till date
Recognized 6.00 Nil Nil Nil Nil Nil
Profit
Recognized Nil 2.00 1.00 13.00 Nil Nil
Losses
Progress Billing 36.00 5.00 7.00 70.00 30.00 114.00
Determine the amount to be shown in the Balance Sheet for the above.
Q.7. PQ & Associates undertakes a construction contract the details of
which are provided below:
Total Contract Value ` 40 lakh
Costs incurred to date ` 3 lakh
Estimated future costs of completion ` 30 lakh
Work completed 10%
The work has started some time ago and there is an uncertainty with
respect to the outcome of the contract due to expected changes in
regulations.
PQ is certain that it would be able to recover the costs incurred to date.
Ans. In the given case, revenue and costs can only be recognised to the extent
of the costs incurred and those which are expected to be recovered.
Therefore, the profit & loss statement would appear as under:
Contract Revenue ` 3 lakh
Contract Costs ` 3 lakh
Contract Profit Nil
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
When the uncertainties that prevented the outcome of the contract
being estimated reliably cease to exist, revenue and expenses
associated with the construction contract should be recognised by the
percentage completion method.
LOSS MAKING CONCTRACTS
Q.8. X Ltd. commenced a construction contract on 01/04/21. The contract
price agreed was reimbursable cost plus 10%. The company incurred
₹1,00,000 in 2021-22, of which cost of ₹90,000 is reimbursable. The
further non-reimbursable costs to be incurred to complete the contract
are estimated at ₹ 5,000. The other costs to complete the contract could
not be estimated reliably. Prepare Profit or Loss A/c extract of X Ltd. for
2021-22
Ans. Net Loss ` 6,000
Q.9. Show Profit & Loss A/c (Extract) in books of a contractor in respect of
the following data for Year 1.
Contract price (Fixed) 6,00,000
Cost incurred to date 3,90,000
Estimated cost to complete 2,60,000
Assume that the contract period is 2 years. The contract is 100%
completed by Year 2. Actual costs incurred is the same as total
estimated costs to complete.
Ans. Provision in year 1 ` 20,000
Q.10. A company took a construction contract for ` 100 lakhs in January,
2006. It was found that 80% of the contract was completed at a cost of
` 92 lakhs on the closing date i.e. on 31.3.2007. The company estimates
further expenditure of ` 23 lakhs for completing the contract. The
expected loss would be `15 lakhs. Can the company recognize the loss
in the financial statements prepared for the year ended 31.3.2007?
Ans. According to AS - 7, 'Accounting for construction contract' an expected
loss on the construction contract should be recognized as an expense
immediately irrespective of:-
(i) The amount of profit expected to arise in other contracts; or
(ii) Whether or not the work has commenced on the contract; or
(iii) The stage of completion on the contract.
Provision Required for expected Loss ` 3,00,000
Q.11. Jain Construction Co. Ltd. Undertook a contract on 1st January, 2010
to construct a building for ` 80 Lakhs. The company found on 31st
March, 2010 that it had already spent ` 58,50,000 on the Construction.
Prudent estimate of additional cost for completion was ` 31,50,000.
What amount should be charged to revenue and what amount of
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
contract value to be recognized as turnover in the final accounts for the
year ended 31st March, 2010 as per provisions of AS-7 (revised)?
Ans. Provision Required for expected Loss ` 3,50,000
Q.12. On 1st December, 2002, Vishwakarma Construction Co. Ltd. Undertook
a tract to construct a building for ` 85 lakhs. On 31st March, 2003 the
company found that it had already spent ` 64,99,000 on the
construction. Prudent estimate of additional cost for completion was `
32,01,000. What is the additional provision for eseeable loss, which
must be made in the final accounts for the year ended 31st March, 2003
as per provisions of Accounting Standard 7 on “Accounting for
construction Contracts” and amount due to/ from customers if
progress billing received were `50,00,000.
Ans. Provision Required for expected Loss ` 3,96,000, Amount shown in
balance Sheet as Assets due from customer ` 2,99,000.
Q.13. S Ltd. Undertook a contract for building a crane for ` 10 lakhs. As on
31st March of a financial year, it incurred a cost of ` 1.50 lakhs and
expect that ` 9 lakh more will be required for completing the crane. It
has received so far ` 1.20 lakhs as progress payment. Discuss the
treatment of the above under AS- 7.
Ans. Provision required for expected Loss ` 0.43 lakhs, Amount shown in
balance Sheet as Liability ` 0.20 lakhs.
Q.14. Azad & co. a firm of contractors obtained a contract for construction of
bridge across the river jamuna. The following details are available in the
records kept for the year ending 31st March.
(in lakhs)
Total Contract price 1,000 Progress Billing Received 400
Cost incurred till Date 605 Progress payment to be 140
Received
Estimated further cost 495
The firm seeks your advice and assistance in the presentation of
accounts keeping in view the requirement of AS- 7.
Ans. Provision required for expected Loss ` 45 lakhs, Amount shown in
balance Sheet as Liability ` 35 lakhs.
Q.15. Modi Ltd. Undertook a contract to construct a building for ` 3 crores on
1st September, 2013. On 31st March 2014, it incurred a cost of ` 1.80
crores and expect that ` 1.40 crores more will be required for completing
the building. What amount should be charged to revenue in the final
accounts for the year ended 31st March, 2014 as per the provision of
AS- 7?
Ans. Provision required for expected Loss ` 8.75 crores.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Q.16.
Particulars ` in
Lakhs
Total Contract Price 960.00
Cost Incurred till Date 600.00
Estimated further Cost 400.00
Ans. Provision required for expected Loss ` 16 lakhs
Q.17. DAFALI BUILDCOM LTD. undertook a contract to construct a bridge
across river Pennar for ` 1500 Lakhs on 1st July, 2014. The following
details are available in the records kept for the year ended 31st March,
2015;
Particulars ` in
Lakhs
Work Certified 750
Work not Certified 207
Estimated further Cost 638
Progress Payment Received 600
Progress Payment to be Received 210
Required: what is the additional provision for foreseeable losses which
must be made int he final accounts for the year ended 31st March, 2015
as per provision of AS- 7.
Ans. Provision required for expected Loss ` 38 lakhs
Q.18. Akar Ltd. signed on 01/04/16, a construction contract for `
1,50,00,000. Following particulars are extracted in respect of contract,
for the period ending 31/03/17.
• Materials issued `75,00,000
• Labour charges paid `36,00,000
• Hire charges of plant `10,00,000
• Other contract cost incurred `15,00,000
• Out of material issued, material lying unused at the end of period is
`4,00,000
• Labour charges of `2,00,000 are still outstanding on 31.3.17.
• It is estimated that by spending further ` 33,50,000 the work can be
completed in all respect.
You are required to compute profit/loss to be taken to Profit & Loss
Account and additional provision for foreseeable loss as per AS – 7.
(May‟17)
Statement showing the amount of profit/loss to be taken to Profit and
Loss Account and additional provision for the foreseeable loss as per AS
7
Ans. Provision required for expected Loss ` 3,50,000.
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Q.19. A construction contractor has a fixed price contract for ` 9,000 lacs to
build a bridge in 3 years‟ time frame. A summary of some of the
financial data is as under:
Year 1 Year Year 3
2
Initial Amount for revenue agreed in 9,000 9,000 9,000
contract
Variation in Revenue (+) - 200 200
Contracts costs incurred up to the 2,093 6,168* 8,100**
reporting date
Estimated profit for whole contract 950 1,000 1,000
• *Includes ` 100 lacs for standard materials stored at the site to
be used in year 3 to complete the work.
• **Excludes ` 100 lacs for standard material brought forward from
year 2.
• The variation in cost and revenue in year 2 has been approved by
customer.
Compute year wise amount of revenue, expenses, contract cost to
complete and profit or loss to be recognized in the Statement of Profit
and Loss as per AS-7 (revised).
Q.20. M/s Action Construction Company Ltd. undertook a fixed price
construction contract to construct a building within 3 year‟s time for
`10,000 lakhs. A summary of the financial data during the construction
period is as follows:
Year 1 Year 2 Year 3
Initial Amount for revenue agreed in 10,000 10,000 10,000
contract
Variation in Revenue (+) - 500 1,000
Contracts costs incurred up to the 2,415 6,375 8,500
reporting date
Estimated profit for whole contract 1,950 2,000 2,500
The variation in cost and revenue in year 2 and 3 has been approved by
customer. Determine the stage of completion of contract and amount of
revenue, expenses and profit or loss to be recognized in the statement
of Profit and Loss for three years as per AS-7 (Revised).
Ans. ` 585, ` 915 and ` 1000
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
AS - 7
Q.21. The following data is provided for M/s. Raj Construction Co.
(i) Contract Price - ` 85 lakhs
(ii) Materials issued - ` 21 Lakhs out of which Materials costing ` 4
Lakhs is still lying unused at the end of the period.
(iii) Labour Expenses for workers engaged at site - ` 16 Lakhs (out of
which ` 1 Lakh is still unpaid)
(iv) Specific Contract Costs - ` 5 Lakhs
(v) Sub-Contract Costs for work executed - ` 7 Lakhs, Advances paid
to subcontractors - ` 4 Lakhs
(vi) Further Cost estimated to be incurred to complete the contract - `
35 Lakhs
You are required to compute the Percentage of Completion, the Contract
Revenue and Cost to be recognized as per AS-7.
Ans. Computation of contract cost
` lakh ` lakh
Material cost incurred on the contract (net of 21-4 17
closing stock)
Add: Labour cost incurred on the contract 16
(including outstanding amount)
Specified Contract cost Given 5
Sub-contract cost (advances should not be 7
considered)
Percentage of completion = Cost incurred till date/Estimated total cost
= ` 45,00,000/` 80,00,000
= 56.25%
Contract revenue and costs to be recognized Contract revenue
(` 85,00,000x56.25%) = ` 47,81,250
Contract costs = ` 45,00,000
“CA IQTIDAR MALIK” (B.COM (H), FCA, CS)
