AS-7 Construction Contracts and AS-18 Related Party Transactions

A summarisation of the provisions of accounting standards 7 and 18 issued by ICAI.

1. CA PRAKHAR JAIN

2. BRIEF
OUTLINE
Types of Contracts
Combining and Segmenting
Contract Revenue
Contract Costs
Recognition of Revenue and Cost
Recognition of Expected Losses
Disclosures

3. TYPES OF
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.
Contractor agrees to a
fixed price, or a fixed
rate per unit
Re-imbursement of
allowable/ defined
costs + profit/ fees
Services directly related to construction
Contracts for destruction or restoration
of assets, and environment restoration
Construction Contract
Fixed price contract Cost plus contract Construction Contract Includes -

4. (a) separate proposals
have been submitted for
each asset;
(b) each asset been subject
to separate negotiation &
the contractor & customer
have been able to accept/
reject that part relating to
each asset; and
(a) the group of
contracts is negotiated
as a single package;
(b) the contracts are so
closely interrelated that
they are, in effect,
part of a single project
with an overall profit
margin; and
SEGMENTING
AND
COMBINING
CONTRACTS
When a contract covers a no. of assets,
construction of each asset to be
treated as a separate contract when:--
(c) the costs & revenues of
each asset can be identified.
A group of contracts, whether with a
single customer or with several, to be
treated as a single contract when:-
(c) the contracts are
performed concurrently/
in a continuous sequence.
Any additional asset should be treated as
a separate construction contract when:-
(a) asset differs significantly - design/tech/use
(b) price negotiated without regard to original

5. CONTRACT REVENUE
Variation
The Initial amount Variations in
contract work,
claims & incentive
payments
is an instruction by the
customer for a change
in the scope of work to
be performed
of revenue agreed
in the contract
Claim
is an amount contractor seeks to
collect from customer/ another
party as reimbursement for costs
not included in contract price
Incentive payments
are additional amounts
payable if specified
performance standards
are met or exceeded
(i) to the extent that it is probable
that they will result in revenue; and
(ii) they are capable of being
reliably measured
Examples - Cost escalation, penalties, changes
(i) Probable that the
customer will approve; and
(ii) Amount of revenue can
be reliably measured
(i) Probable that the customer will
accept the claim; and
(ii) Amount that is probable will be
accepted can be reliably measured
(i) Probable that the
standards will be met; and
(ii) Amount of incentive
can be reliably measured

6. CONTRACT COSTS
Directly related costs
Main Costs
costs that relate directly
to the specific contract,
(incl. cost of securing)
Allocated Costs
Costs that may be attributable to
contract activity in general and
can be allocated to specific
contracts include:
Unattributable Costs
excluded from the costs of
a construction contract
(i) Site labour costs, incl. supervision;
(ii) Costs of materials
(iii) Depriciation on P&M used
(iv) Costs of moving things to/ from
(v) Costs of hiring P&M
(vi) Costs of design & technicals
(vii) Rectification/ Guarantee and
expected warranty cost
(viii) Claims from 3rd parties
(i) Insurance;
(ii) Costs of design/ technical
assistance not of a specific contract;
(iii) Construction overheads; and
(iv) Borrowing Costs as per AS-16
(i) General administration
costs not re-imbursible as
per contract;
(ii) Selling costs;
(iii) R&D Costs not
reimbursible
(iv) Depriciation on idle P&M
Attributable
costs that are attributable to
contract activity in general and
can be allocated to the contract
Specific Costs
as are specifically
chargeable under
terms of contract
reduced by any incidental income allocated using systematic method Not Included in Contract cost

7. RECOGNITION OF
CONTRACT REVENUE
AND EXPENSES
When the outcome can be estimated reliably-
Revenue and Costs are Recognised by reference to
stage of completion (Percentage of Completion)
When the outcome cannot be estimated reliably-
(a) Revenue should be recognised only to extent of
contract costs incurred of which recovery probable
(no stage of completion relavant); and
(b) Contract costs to be recognised as an expense in
the period in which they are incurred (no WIP)
Therefore, No profit is recognised
Any Expected losses are recognised immediately.
[When uncertainties over, recognise as per PoC]

8. Which are not fully enforceable, that is, their validity is
seriously in question
The completion of which is subject to the outcome of
pending litigation or legislation
Relating to properties that are likely to be condemned
or expropriated
Where the customer is unable to meet its obligations
Where the contractor is unable to complete the
contract or otherwise meet its obligations under the
contract
Where outcome of a Contract cannot be estimated
reliably, and there are some Contract costs recovery of
which is not probable, then they are recognised as an
expense immediately (and Revenue against it is not
recognised).
Examples include contracts -
1.
2.
3.
4.
5.
COSTS OF
WHICH
RECOVERY
NOT
PROBABLE

9. WHEN
CAN WE
RELIABLY
ESTIMATE
An enterprise is generally able to make reliable estimates
after it has agreed to a contract which establishes:
(a) each party’s enforceable rights regarding the asset to be
constructed;
(b) the consideration to be exchanged; and
(c) the manner and terms of settlement.
Total contract revenue can be measured reliably
Both the contract costs and the stage of contract
completion can be measured reliably
Probable that the economic benefits will flow
Costs attributable to the contract can be clearly
identified and measured reliably
In the case of a fixed price contract, outcome can be
estimated reliably when all 4 below met -
1.
2.
3.
4.
In the case of a cost plus contract, outcome can be
estimated reliably when 3rd and 4th above met

10. OTHER
POINTS
Any expected excess of total contract costs over total contract
revenue (expected loss) for the contract is recognised as an
expense immediately in accordance with paragraph 35
Contract costs that relate to future activity on the contract are
often classified as contract work in progress
When an uncertainty arises about the collectability of an
already recognised contract revenue, it is recognised as an
expense rather than as an adjustment in revenue
The enterprise reviews and, when necessary, revises
estimates of contract revenue and contract costs as contract
progresses. The need for such revisions does not necessarily
indicate that the outcome cannot be estimated reliably.
STAGE OF
COMPLETION Proportion that 'Contract costs incurred' bear to the
'Estimated total contract costs'
Surveys of work performed
Completion of a physical proportion
Stage of completion may be determined in variety of ways.
Use method that measures reliably the work performed, incl. -
1.
2.
3.
[Progress payments and advances received from customers
may not necessarily reflect the work performed]

11. WHEN COST
METHOD
FOLLOWED
Only those contract costs that reflect
work performed are included in costs
incurred upto the reporting date.
Examples of costs which are excluded are:
Contract costs that relate to future
activity on the contract (such as closing
stock not yet used, unless specific)
Payments made to subcontractors in
advance

12. whether or not work has commenced on the contract
the stage of completion of contract activity
the amount of profits expected to arise on other
contracts which are not treated as a single
construction contract in accordance with paragraph 8
When it is probable that total contract costs will exceed
total contract revenue, the expected loss should be
recognised as an expense immediately
The amount of such a loss is determined irrespective of:-
1.
2.
3.
RECOGNITION
OF EXPECTED
LOSSES
CHANGES IN
ESTIMATES
The PoC method is applied on a cumulative basis in each
accounting period to the current estimates of contract
revenue and contract costs.
If changed, then chaged estimates are used to determine
revenue/ costs to be recognised for current & next periods.
Therefore, the effect of a change in the estimate of
revenue or costs or outcome of a contract, is accounted
for as a change in accounting estimate (AS-5)

13. (a) the amount of
contract revenue
recognised as
revenue in the period;
(b) the methods used
to determine the
contract revenue
recognised in the
period; and
(c) the methods used
to determine the
stage of completion
of contracts in
progress.
Costs incurred
(+) net
recognised
profits/ losses
(-) progress
billings
Disclose overall:-
Unbilled
Revenue =DISCLOSURE
(a) the aggregate
amount of costs
incurred and
recognised profits (less
recognised losses) upto
the reporting date;
(b) the amount of
advances received; and
(c) the amount of
retentions (amounts of
progress billings which
are not paid until
the satisfaction of
conditions specified)
Disclose for contracts
in progress (each) :-
(a) the gross amount
due from customers
for contract work as an
asset; and
(b) the gross amount
due to customers for
contract work as a
liability
Present for all
contracts in
progress:-
Billed but not
recognised =
Progress
billings (-)
costs
incurred (-)
net
recognised
profits/ losses
Like warranty costs,
penalties or possible
losses - As per AS-4
Disclose contingencies

14. CA PRAKHAR JAIN

15. RELATED PARTY
RELATIONSHIPS
Enterprises that directly, or indirectly through one or
more intermediaries, control, or are controlled by, or are
under common control with, the reporting enterprise
(including holding, subsidiaries, and fellow subsidiaries)
Associates and JVs, and the investing party or venturer
wrt which the reporting enterprise is an associate or JV
Individuals owning, directly or indirectly, an interest in
the voting power that gives them control or significant
influence, and their relatives
Key management personnels and their relatives
Enterprises over which person described in 3 and 4
above exercise significant influence
=
1.
2.
3.
4.
5.

16. Related party transactions - A transfer of resources or
obligations between related parties, regardless of
whether or not a price is charged
Control - Ownership (direcly/ indirectly) >50%, control
over composition of BoD/ governing body, a substantial
interest in voting power and power to direct policies.
Significant Influence - participation in the policy
decisions, but not control of those policies
Relative – wrt an individual, means the spouse, son,
daughter, brother, sister, father, mother who may be
expected to influence, or be influenced by, that
individual in dealings with the reporting enterprise
Key management personnel - who have the authority
and responsibility for planning, directing, controlling
FEW DEFINITIONS

17. DEEMED NOT
RELATED PARTIES
Two companies simply because they have a director in
common (unless the director is able to affect the
policies of both in mutual dealings)
A single customer, supplier, franchiser, distributor, or
general agent with whom an enterprise transacts a
significant volume of business
The parties below, in the course of normal dealings -
providers of finance
trade unions
public utilities
government departments, government agencies
including government sponsored bodies.
=
1.
2.
3.
a.
b.
c.
d.

18. EXCEPTIONS
Related party disclosure requirements as laid down in
this AS, do not apply in circumstances where providing
such disclosures would conflict with the reporting
enterprise’s duties of confidentiality as specifically
required in terms of a statute or by any regulator or
similar competent authority.
No disclosure is required in consolidated financial
statements in respect of intra-group transactions
No disclosure is required in the financial statements of
state-controlled enterprises as regards related party
relationships with other state-controlled enterprises
and transactions with such enterprises

19. (a) Name of the
related party;
(b) Nature of the
related party
relationship where
control exists
(should be disclosed
irrespective of
whether or not there
have been
transactions)
Disclose where
control exists (even
if no transaction) :-
DISCLOSURES
The name of the
related party
Description of the
relationship
Description of nature
of transactions
Volume of the
transactions either as
an amount or as a
proportion
Any other elements
necessary for an
understanding of FS
The amounts O/s with
them and any PFDD
Amounts w/off
1.
2.
3.
4.
5.
6.
7.
Disclose when
transactions exist :-
purchases or sales of goods/ services/
fixed assets; Lease or Hire Purchase
Agency arrangements
Transfer of R&D/ Licensing
Finance/ Guarantee/ Collateral
Management contracts incl.
deputation of employees
Examples of transactions:-
Example of "Any Other element" :-
transfer of a major asset taken place
at amount materially different from
that obtainable on commercial terms
Items of similar nature may be
aggregated by type of related party
Categorisation and Aggregation

20. THANK
YOU
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