Construction industry defines projects based on their physical purpose and contractual risk. They are summarised as follows:
Residential Construction:
Refers to projects involving the building of individual houses, apartments, or housing complexes designed exclusively for private living.Commercial Construction:
The development of civil structures intended for business operations and/or revenue generation, such as offices, retail malls, and warehouses.Infrastructure Projects Construction:
The planning, design, and building of large-scale physical structures essential for society's economic and functional operations (bridge, highway, roads etc)EPC (Engineering, Procurement, Construction):
Contract model where a single contractor is responsible for design, material procurement and final construction. Contractor handovers the completed physical asset to the client. Commissioning, testing, or making the facility operational may still involve the client or another party.Turnkey projects:
Contractor delivers dully completed ready-to-operate facility. Client just “turns the key” and starts operating. So, it includes commissioning, testing, and ensuring functionality as well.BOT (Build-Operate-Transfer):
Private Contractor builds a public project. Ownership is transferred once construction is complete. The private entity is granted a license or concession to use and operate the asset for a fixed period to recover its investment and earn a profitBOOT (Build-Own-Operate-Transfer):
Similar to BOT, but the private contractor retains legal ownership of the facility during the operation period before final transfer to Government.
Accounting Practices wrt construction industry
Accounting in construction industry is unique because revenue recognition and expense tracking for this industry must align with long project cycles. Hence there are specific standards and regulations to ensure transparency and compliance.
Regardless of the type of contract, the process flow for construction contracts is as follows:
Process flow is as follow: Contract signing → Client pays advance → Work Execution & Cost Tracking → Progress Measurement → Billing & Invoicing → Revenue Recognition → Payment Collection → Final Settlement.
Contractors issue progress bills based on milestones. Retention money (5–10%) is withheld by clients until project completion to ensure quality and compliance.
Types of Construction Contracts
As per Accounting Standard, the Construction contracts can be classified into different types. They are:
Fixed Price Contract → The contractor agrees to construct the project according to the client’s design/specifications for a lump sum. The scope usually covers construction and handover of the completed structure. Contractor bears cost overruns, if any.
Cost plus contract → Contract where the contractor is reimbursed for the actual costs incurred (materials, labor, overheads) and is additionally paid a fee or margin (either a fixed amount or a percentage of costs) as profit. Requires detailed cost records for reimbursement purposes.
Whatever be the method of accounting, Each project is treated as a separate cost/revenue center and books of accounts track project-specific inflows and outflows.
Methods of accounting:
Basically, there are two methods for accounting of revenue and cost of Construction Industry.
→ Percentage of Completion Method: Revenue and cost are recognized based on the stage of completion of a project.
→ Completed Contract Method : Revenue is recognized only when the project is completed.
Let's see what AS-7 and Ind AS 115 has got to say about the revenue recognition aspect and disclosures
AS-7 : Construction Contracts
For Non-Ind AS Entities, AS-7 is the applicable standard that deals with accounting for construction contracts.
- What is contract revenue?
Contract revenue (as per AS 7) is the total revenue expected from a construction contract, which includes = Initial amount of revenue agreed in the contract + Variations in contract work (approved changes in scope/price) + Claims (compensation for delays, extra costs, etc.) + Incentive payments (bonuses for early completion or performance targets)+ Retention money
- What is the Method of accounting prescribed in AS?
When the outcome can be reliably estimated, contract revenue is recognised using Percentage of Completion Method.
If the outcome cannot be reliably estimated, revenue is recognised only to the extent of costs incurred that are probable of recovery (Zero-margin method). - How is the progress of work / POC determined?
The percentage of completion is determined using either of the two options: Cost to cost method or technical assessment.
- What about recognition of expected loss?
If total contract costs are expected to exceed total revenue, the entire expected loss must be recognised as an expense immediately, regardless of the stage of completion.
- What is the accounting treatment of a) Variations, Claims, incentives b) Retention money.
[a] These are included in revenue only when negotiations have reached an advanced stage and the amount can be reliably measured and it is also probable of collection.
[b] Adopts a conservative approach. Retention money is recognized as revenue only when the work is finally certified by client/engineer.
| Method | Details |
|---|---|
| Cost to cost method | the proportion of costs incurred for work performed to date, as against the total estimated cost of the project. |
| Work surveys | Stage of completion may be determined by technical assessment surveys of work performed or by measuring the extent of physical completion of a proportion of the contract work. |
Ind AS 115: Revenue from Contracts with Customers
Ind AS applies for listed companies and those with net worth over ₹250 crore. Unlike AS-7, Ind AS 115 covers all sorts of contracts with customers, including construction contract business.- What is contract revenue?
Contract revenue is not defined in the same way as under AS 7. Instead, the standard uses broader concept of transaction price ie the amount of consideration a company expects to be entitled to in exchange for transferring goods/services.
- What is the Method of accounting prescribed in Ind AS 115?
The Standard does not prescribe either the POCM or CCM directly. Instead, it introduces a system built around transfer of control of goods or services to the customer.
Construction contracts involve multiple obligations (design, build, handover). Each must be assessed separately.
→ If control transfers over time (customer controls the asset as it is built), revenue is recognized progressively (similar to POCM) Eg Independent houses, Bridge for Govt etc
→ If control transfers at a point in time (like completed unit handed over), revenue is recognized only on completion. Eg: developer-built apartment complex and sold to individual buyers. - How is the progress of work / POC determined?
Ind AS 115 explicitly uses the terms input methods and output methods when describing how to measure progress for performance obligations satisfied over time.
The method chosen must faithfully depict the transfer of control. That’s the key point here.
→ Input methods: Measure progress based on the entity’s efforts or inputs (e.g costs incurred, labor hours, machine hours).
→ Output methods: Measure progress based on direct results (e.g units produced, milestones achieved, surveys of work performed). - What about recognition of expected loss?
Expected losses or gains from future events must be estimated and reflected immediately, as soon as they are foreseen.
- What is the accounting treatment of Variable considerations and retention money?
Unlike AS-7, Ind AS 115 Introduced the explicit concept of variable consideration.
Contract modifications, claims, incentives and retention money are all treated as forms of variable consideration. They are only recognised to the extent it is highly probable that a significant reversal will not occur.
Retention money: Adopts principle-based approach. Retention is recognized if the entity has enforceable right to payment for the performance completed, even if cash is withheld. The focus is on transfer of control and entitlement and not just certification