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The Indian Accounting Standard 11 prescribes the accounting treatment of the revenues and costs associated with construction contracts. One of the primary assumptions of accounting is the matching concept. Under this concept, the revenues are matched with the costs in the period in which they are incurred. However, construction contracts are long-term in nature and hence, the revenue and costs are carried over from one accounting period to another. Hence, the need for this standard arose. This standard clearly explains the recognition of contract revenue and its expenses.
This standard shall be applied while accounting for construction contracts. Financial statements of contractors including the financial statements of real estate developers are usually aligned to this standard.
To understand this standard, we must first understand the meaning of the terms used in the standard, which are primary to the accounting treatment of construction contracts. The standard defines the following:
The other terms defined are the fixed-price contract, which means that the contractor agrees with a fixed price for the contract and cost-plus contract, which refers to a price for the defined costs plus a percentage of these costs or a fixed fee. The requirements of this standard are usually applied separately to each construction contract. However, in certain circumstances, 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 group of contracts.
To recognise the costs and revenues of the contract for the purpose of accounting, it must be ensured that the outcome of the construction contract can be estimated reliably. The outcome of a fixed price contract can be estimated reliably when:
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:
Once the outcome of the contract can be estimated reliably the contract costs and revenue will be recognised as revenue and expenses by reference to the stage of completion of the contracting activity at the end of the reporting period. This method is called the percentage of completion method. The stage of completion can be determined by either of the following:
When the outcome of a construction contract cannot be estimated reliably:
Another important aspect that the standard covers is the recognition of losses. When it is probable that the total contract costs will exceed the total revenue, then the loss must be expensed out (recorded) immediately.
The entity must disclose:
In case of contracts that are in progress at the end of the reporting period, an entity must disclose the aggregate amount of costs incurred and recognised profits or losses, the advances received so far and the number of retentions (if any).
Infrastructure such as roads, tunnels, flyovers, hospitals, and prisons are financed through the public budget by the public sector. However, off late, the government is encouraging private companies to undertake the task by constructing, operating and maintaining the same. This arrangement is referred to as the Service Concession Arrangement. Under this arrangement, there is a grantor (public sector company) and an operator (private company) entering into an arrangement for the construction, operation and maintenance of a public asset. Appendix A sets out general principles on recognising and measuring the obligations and related rights in these service concession arrangements. Requirements for disclosing information about service concession arrangements are in Appendix B of this Indian Accounting Standard. Here:
Construction contracts are long-term and also have a lot of contingencies attached to it. So an entity needs excellent tools for calculating estimates; following this standard for accounting them surely helps.