ICAI Notes- Unit 1: Revenue Based Accounting Standards | Advanced Accounting for CA Intermediate PDF Download

 Page 1


? 
LEARNING OUTCOMES 
    
 
CHAPTER 
8 
 
*  
REVENUE BASED 
ACCOUNTING 
STANDARDS 
 
UNIT 1 : ACCOUNTING STANDARD 7 
CONSTRUCTION CONTRACTS 
After studying this unit, you will be able to comprehend the provisions 
of AS 7 related with: 
? Introduction and Scope of Construction Contract 
? Combining and Segmenting Construction Contracts  
? What is included in Contract Revenue  
? What is included and excluded in Contract Costs 
? Recognition of Contract Revenue and Expenses 
? Recognition of Expected Losses  
? Changes in Estimates  
? Disclosures. 
CHAPTER
© The Institute of Chartered Accountants of India
Page 2


? 
LEARNING OUTCOMES 
    
 
CHAPTER 
8 
 
*  
REVENUE BASED 
ACCOUNTING 
STANDARDS 
 
UNIT 1 : ACCOUNTING STANDARD 7 
CONSTRUCTION CONTRACTS 
After studying this unit, you will be able to comprehend the provisions 
of AS 7 related with: 
? Introduction and Scope of Construction Contract 
? Combining and Segmenting Construction Contracts  
? What is included in Contract Revenue  
? What is included and excluded in Contract Costs 
? Recognition of Contract Revenue and Expenses 
? Recognition of Expected Losses  
? Changes in Estimates  
? Disclosures. 
CHAPTER
© The Institute of Chartered Accountants of India
 
 
8.2 
 
ADVANCED ACCOUNTING 
1.1 SIGNIFICANCE OF THE STANDARD 
The need to have a standard for construction contracts and their accounting 
arises since the construction contracts generally cover more than one accounting 
period. Common examples of construction include construction of flyovers, dams, 
metro line, buildings etc. For example, if entity XY submits a tender to construct a 
flyover for a state government, the construction of that flyover might take 2 to 3 
years of time, depending on the scope of the contract. This standard addresses 
the requirements for recognition & measurement (i.e., the timing and amount) of 
construction revenue and construction costs. 
 
 
  
 
 
The entity that is required to complete the construction is referred to as 
Contractor and the customer who requires the construction to be completed is 
referred to as Contractee/Customer. 
 
 
Peculiar 
Features of 
Construction 
contracts 
Takes more than one 
accounting year to 
complete
Final outcome  
determined after  
no. of years from 
year of 
commencement of 
construction
Allocation of contract 
revenue and contract cost 
tothe accounting period in 
which construction work is 
performed
Long term
projects 
Start of construction 
(Year 1) 
End of construction 
(Year 3) 
Work in Progress 
© The Institute of Chartered Accountants of India
Page 3


? 
LEARNING OUTCOMES 
    
 
CHAPTER 
8 
 
*  
REVENUE BASED 
ACCOUNTING 
STANDARDS 
 
UNIT 1 : ACCOUNTING STANDARD 7 
CONSTRUCTION CONTRACTS 
After studying this unit, you will be able to comprehend the provisions 
of AS 7 related with: 
? Introduction and Scope of Construction Contract 
? Combining and Segmenting Construction Contracts  
? What is included in Contract Revenue  
? What is included and excluded in Contract Costs 
? Recognition of Contract Revenue and Expenses 
? Recognition of Expected Losses  
? Changes in Estimates  
? Disclosures. 
CHAPTER
© The Institute of Chartered Accountants of India
 
 
8.2 
 
ADVANCED ACCOUNTING 
1.1 SIGNIFICANCE OF THE STANDARD 
The need to have a standard for construction contracts and their accounting 
arises since the construction contracts generally cover more than one accounting 
period. Common examples of construction include construction of flyovers, dams, 
metro line, buildings etc. For example, if entity XY submits a tender to construct a 
flyover for a state government, the construction of that flyover might take 2 to 3 
years of time, depending on the scope of the contract. This standard addresses 
the requirements for recognition & measurement (i.e., the timing and amount) of 
construction revenue and construction costs. 
 
 
  
 
 
The entity that is required to complete the construction is referred to as 
Contractor and the customer who requires the construction to be completed is 
referred to as Contractee/Customer. 
 
 
Peculiar 
Features of 
Construction 
contracts 
Takes more than one 
accounting year to 
complete
Final outcome  
determined after  
no. of years from 
year of 
commencement of 
construction
Allocation of contract 
revenue and contract cost 
tothe accounting period in 
which construction work is 
performed
Long term
projects 
Start of construction 
(Year 1) 
End of construction 
(Year 3) 
Work in Progress 
© The Institute of Chartered Accountants of India
REVENUE BASED ACCOUNTING STANDARDS 
 
   
 
8.3 
 
The above discussion clearly indicates that there are two parties to the 
construction contract. Thus, if there is an entity which requires its engineering 
division to construct a machine for the production division, this would not meet 
the scope of AS 7. It will be addressed by AS 10 (Property, plant and equipment) 
and will be accounted as a case of self-constructed asset. 
1.2 INTRODUCTION  
Accounting Standard 7 prescribes the principles of accounting for construction 
contracts in the financial statements of contractors. The focus of the standard is 
to determine when the contractor should recognise contract revenue and contract 
costs in the statement of profit and loss.  
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. 
A construction contract may be negotiated for the construction of a single asset 
such as a bridge, building, dam, pipeline, road, ship or tunnel. A construction 
contract may also deal with the construction of a number of assets which are 
closely interrelated or interdependent in terms of their design, technology and 
function or their ultimate purpose or use; examples of such contracts include 
those for the construction of refineries and other complex pieces of plant or 
equipment. 
For the purposes of this Standard, construction contracts also include:  
(a)  contracts for the rendering of services which are directly related to the 
construction of the asset, for example, those for the services of project 
managers and architects; and  
(b)  contracts for destruction or restoration of assets, and the restoration of the 
environment following the demolition of assets. 
© The Institute of Chartered Accountants of India
Page 4


? 
LEARNING OUTCOMES 
    
 
CHAPTER 
8 
 
*  
REVENUE BASED 
ACCOUNTING 
STANDARDS 
 
UNIT 1 : ACCOUNTING STANDARD 7 
CONSTRUCTION CONTRACTS 
After studying this unit, you will be able to comprehend the provisions 
of AS 7 related with: 
? Introduction and Scope of Construction Contract 
? Combining and Segmenting Construction Contracts  
? What is included in Contract Revenue  
? What is included and excluded in Contract Costs 
? Recognition of Contract Revenue and Expenses 
? Recognition of Expected Losses  
? Changes in Estimates  
? Disclosures. 
CHAPTER
© The Institute of Chartered Accountants of India
 
 
8.2 
 
ADVANCED ACCOUNTING 
1.1 SIGNIFICANCE OF THE STANDARD 
The need to have a standard for construction contracts and their accounting 
arises since the construction contracts generally cover more than one accounting 
period. Common examples of construction include construction of flyovers, dams, 
metro line, buildings etc. For example, if entity XY submits a tender to construct a 
flyover for a state government, the construction of that flyover might take 2 to 3 
years of time, depending on the scope of the contract. This standard addresses 
the requirements for recognition & measurement (i.e., the timing and amount) of 
construction revenue and construction costs. 
 
 
  
 
 
The entity that is required to complete the construction is referred to as 
Contractor and the customer who requires the construction to be completed is 
referred to as Contractee/Customer. 
 
 
Peculiar 
Features of 
Construction 
contracts 
Takes more than one 
accounting year to 
complete
Final outcome  
determined after  
no. of years from 
year of 
commencement of 
construction
Allocation of contract 
revenue and contract cost 
tothe accounting period in 
which construction work is 
performed
Long term
projects 
Start of construction 
(Year 1) 
End of construction 
(Year 3) 
Work in Progress 
© The Institute of Chartered Accountants of India
REVENUE BASED ACCOUNTING STANDARDS 
 
   
 
8.3 
 
The above discussion clearly indicates that there are two parties to the 
construction contract. Thus, if there is an entity which requires its engineering 
division to construct a machine for the production division, this would not meet 
the scope of AS 7. It will be addressed by AS 10 (Property, plant and equipment) 
and will be accounted as a case of self-constructed asset. 
1.2 INTRODUCTION  
Accounting Standard 7 prescribes the principles of accounting for construction 
contracts in the financial statements of contractors. The focus of the standard is 
to determine when the contractor should recognise contract revenue and contract 
costs in the statement of profit and loss.  
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. 
A construction contract may be negotiated for the construction of a single asset 
such as a bridge, building, dam, pipeline, road, ship or tunnel. A construction 
contract may also deal with the construction of a number of assets which are 
closely interrelated or interdependent in terms of their design, technology and 
function or their ultimate purpose or use; examples of such contracts include 
those for the construction of refineries and other complex pieces of plant or 
equipment. 
For the purposes of this Standard, construction contracts also include:  
(a)  contracts for the rendering of services which are directly related to the 
construction of the asset, for example, those for the services of project 
managers and architects; and  
(b)  contracts for destruction or restoration of assets, and the restoration of the 
environment following the demolition of assets. 
© The Institute of Chartered Accountants of India
 
 
8.4 
 
ADVANCED ACCOUNTING 
 
Example 1 
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. 
The above example suggests that 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 Construction Contract. 
Example 2 
H, a sole-proprietor, contracts with M/s DM Construction, to dismantle his office 
premises and construct it from scratch. 
In the given case, the construction contract includes both demolition as well as   
construction of a new building.  
1.3  COMBINING AND SEGMENTING 
CONSTRUCTION CONTRACTS 
A contractor may undertake a number of contracts.  
The standard identifies certain cases where for the purposes of accounting, it is 
necessary to apply the Standard to the separately identifiable components of a 
single contract or to a group of contracts together in order to reflect the 
substance of a contract or a group of contracts. 
What are construction 
Contracts? 
Contracts specifically
negotiated for the
construction of an asset or
combination of assets that
are closely interrelated
Contracts for 
rendering of services 
related to 
construction of assets
Contracts for 
destruction  or 
restoration of assets. 
© The Institute of Chartered Accountants of India
Page 5


? 
LEARNING OUTCOMES 
    
 
CHAPTER 
8 
 
*  
REVENUE BASED 
ACCOUNTING 
STANDARDS 
 
UNIT 1 : ACCOUNTING STANDARD 7 
CONSTRUCTION CONTRACTS 
After studying this unit, you will be able to comprehend the provisions 
of AS 7 related with: 
? Introduction and Scope of Construction Contract 
? Combining and Segmenting Construction Contracts  
? What is included in Contract Revenue  
? What is included and excluded in Contract Costs 
? Recognition of Contract Revenue and Expenses 
? Recognition of Expected Losses  
? Changes in Estimates  
? Disclosures. 
CHAPTER
© The Institute of Chartered Accountants of India
 
 
8.2 
 
ADVANCED ACCOUNTING 
1.1 SIGNIFICANCE OF THE STANDARD 
The need to have a standard for construction contracts and their accounting 
arises since the construction contracts generally cover more than one accounting 
period. Common examples of construction include construction of flyovers, dams, 
metro line, buildings etc. For example, if entity XY submits a tender to construct a 
flyover for a state government, the construction of that flyover might take 2 to 3 
years of time, depending on the scope of the contract. This standard addresses 
the requirements for recognition & measurement (i.e., the timing and amount) of 
construction revenue and construction costs. 
 
 
  
 
 
The entity that is required to complete the construction is referred to as 
Contractor and the customer who requires the construction to be completed is 
referred to as Contractee/Customer. 
 
 
Peculiar 
Features of 
Construction 
contracts 
Takes more than one 
accounting year to 
complete
Final outcome  
determined after  
no. of years from 
year of 
commencement of 
construction
Allocation of contract 
revenue and contract cost 
tothe accounting period in 
which construction work is 
performed
Long term
projects 
Start of construction 
(Year 1) 
End of construction 
(Year 3) 
Work in Progress 
© The Institute of Chartered Accountants of India
REVENUE BASED ACCOUNTING STANDARDS 
 
   
 
8.3 
 
The above discussion clearly indicates that there are two parties to the 
construction contract. Thus, if there is an entity which requires its engineering 
division to construct a machine for the production division, this would not meet 
the scope of AS 7. It will be addressed by AS 10 (Property, plant and equipment) 
and will be accounted as a case of self-constructed asset. 
1.2 INTRODUCTION  
Accounting Standard 7 prescribes the principles of accounting for construction 
contracts in the financial statements of contractors. The focus of the standard is 
to determine when the contractor should recognise contract revenue and contract 
costs in the statement of profit and loss.  
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. 
A construction contract may be negotiated for the construction of a single asset 
such as a bridge, building, dam, pipeline, road, ship or tunnel. A construction 
contract may also deal with the construction of a number of assets which are 
closely interrelated or interdependent in terms of their design, technology and 
function or their ultimate purpose or use; examples of such contracts include 
those for the construction of refineries and other complex pieces of plant or 
equipment. 
For the purposes of this Standard, construction contracts also include:  
(a)  contracts for the rendering of services which are directly related to the 
construction of the asset, for example, those for the services of project 
managers and architects; and  
(b)  contracts for destruction or restoration of assets, and the restoration of the 
environment following the demolition of assets. 
© The Institute of Chartered Accountants of India
 
 
8.4 
 
ADVANCED ACCOUNTING 
 
Example 1 
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. 
The above example suggests that 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 Construction Contract. 
Example 2 
H, a sole-proprietor, contracts with M/s DM Construction, to dismantle his office 
premises and construct it from scratch. 
In the given case, the construction contract includes both demolition as well as   
construction of a new building.  
1.3  COMBINING AND SEGMENTING 
CONSTRUCTION CONTRACTS 
A contractor may undertake a number of contracts.  
The standard identifies certain cases where for the purposes of accounting, it is 
necessary to apply the Standard to the separately identifiable components of a 
single contract or to a group of contracts together in order to reflect the 
substance of a contract or a group of contracts. 
What are construction 
Contracts? 
Contracts specifically
negotiated for the
construction of an asset or
combination of assets that
are closely interrelated
Contracts for 
rendering of services 
related to 
construction of assets
Contracts for 
destruction  or 
restoration of assets. 
© The Institute of Chartered Accountants of India
REVENUE BASED ACCOUNTING STANDARDS 
 
   
 
8.5 
 
(a) When a contract covers a number of assets, the construction of each asset 
should be treated as a separate construction contract when:  
(i) separate proposals have been submitted for each asset; 
(ii) 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 
(iii) the costs and revenues of each asset can be identified.  
(b) A group of contracts, whether with a single customer or with several 
customers, should be treated as a single construction contract when:  
(i) the group of contracts is negotiated as a single package; 
(ii) the contracts are so closely interrelated that they are, in effect, part of 
a single project with an overall profit margin; and 
(iii) the contracts are performed concurrently or in a continuous sequence.  
(c) 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:  
(i) the asset differs significantly in design, technology or function from 
the asset or assets covered by the original contract; or 
(ii) the price of the asset is negotiated without regard to the original 
contract price.  
Illustration 1 
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?  
© The Institute of Chartered Accountants of India