CA Intermediate · Advanced Accounting

AS 7 Construction Contracts: CA Intermediate Advanced Accounting Study Guide

AS 7 sets how a contractor accounts for construction contracts. You recognise contract revenue and costs by the percentage of completion method when the outcome can be estimated reliably. You compute the stage of completion, revenue to date, less earlier revenue, and book any expected loss at once.

What this chapter covers

AS 7 deals with the accounting of a contractor for construction contracts in the contractor's own books. It covers what counts as a construction contract, when contracts are combined or split, what goes into contract revenue and contract cost, and how revenue and expenses are recognised across accounting periods. It also covers expected losses, changes in estimates and disclosures.

The core idea is simple. A contract runs over more than one period. If you waited for completion to book profit, early years would show nothing and the last year would show everything. AS 7 spreads revenue and cost by the stage of completion, so each period reports its fair share.

This chapter links to other parts of Advanced Accounting. It sits with the revenue and standards-based chapters, so the habit of reading a standard's conditions carefully carries over. It also uses basic ledger and journal skills, such as contract account, work-in-progress, advances and retention money. In Cost and Management Accounting, contract costing uses similar ideas, so effort here helps there too.

AS 7 is a compact, numerical chapter with a fixed method, so it rewards practice more than memory. Once you can run the percentage of completion steps and handle a loss-making contract, most questions follow the same pattern. It suits both MCQs, which test definitions, cost inclusion and quick calculations, and written answers, where a clean working earns step marks even if one figure goes wrong. Few chapters give such reliable marks for the time spent.

AS 7 Construction Contracts: topics in the order to study them

1AS 7 Scope, Definitions and Types of ContractsStart here because every later calculation depends on knowing what a construction contract is and whether it is fixed price or cost plus.
2Combining and Segmenting Construction ContractsNext, because you must decide the unit of account (one contract or several) before you measure revenue and cost.
3Contract Revenue and Contract CostsThen learn what goes into revenue and cost, since the percentage of completion needs correct totals and the right exclusions.
4Recognition of Contract Revenue and Expenses (Percentage of Completion)This is the core method and the main source of numerical questions, so study it once revenue and costs are clear.
5Expected Losses, Changes in Estimates and DisclosuresFinish with loss provisions, revised estimates and disclosures, which build on the recognition method and complete the chapter.

How to prepare AS 7 Construction Contracts

Treat this chapter as one method with a few rules around it. Learn the rules first, then drill the method until the steps are automatic.

Read the definitions and write a one-line test for each: fixed price contract, cost plus contract, and what a construction contract covers.
Learn when contracts are combined and when they are segmented. Keep the conditions in short bullet form so you can state them in a written answer.
Learn the conditions for a reliable estimate of the outcome, one list for each contract type. Fixed price: total contract revenue can be measured reliably; it is probable that economic benefits will flow to the contractor; the costs to complete and the stage of completion can be measured reliably; and the costs attributable to the contract can be clearly identified and measured reliably. Cost plus: it is probable that economic benefits will flow to the contractor, and the costs attributable to the contract can be clearly identified and measured reliably.
List what is included in contract cost and what is excluded, such as costs that cannot be attributed to the contract. Do the same for contract revenue items like variations, claims and incentives.
Practise the percentage of completion steps in a fixed order: stage of completion, revenue to date, less revenue of earlier years, then cost and profit for the year. Write each step as a separate line.
Solve loss-making contract questions. Recognise the full expected loss immediately, and check how it splits between the loss already reflected and the provision for the balance.
Practise questions with revised estimates. Recompute cumulative figures at the new estimate and take the difference as the current year effect.
Finish with a timed set: 10 MCQs on definitions and inclusion, then 2 full written problems. Check that each answer has working notes and the disclosure points required.

Common mistakes in AS 7 Construction Contracts

Including costs of materials not yet used in the stage of completion
Fix: Remove costs for materials bought but not yet used, unless they were specially made for the contract, and remove payments in advance to subcontractors for future work, before computing the percentage.
Booking the whole year's revenue as cumulative revenue
Fix: Always compute revenue to date first, then subtract revenue of earlier years to get the current year's figure.
Spreading an expected loss over the contract life
Fix: Find the expected loss as total expected contract cost minus total contract revenue. Recognise that whole loss immediately as an expense. The provision is the full expected loss less any loss already recognised.
Confusing fixed price and cost plus contracts when judging reliable estimates
Fix: Keep two short condition lists and revise them side by side. Fixed price: total contract revenue can be measured reliably; it is probable that economic benefits will flow; the costs to complete and the stage of completion can be measured reliably; and the costs attributable to the contract can be clearly identified and measured reliably. Cost plus: it is probable that economic benefits will flow, and the costs attributable to the contract can be clearly identified and measured reliably.
Applying a revised estimate to past years
Fix: Recompute cumulative figures using the new estimate and take only the difference in the current year.
Skipping working notes and disclosures in written answers
Fix: Show stage of completion, revenue, cost and profit as separate lines, and add the required disclosure points to earn step marks.

Last-day revision: AS 7 Construction Contracts

AS 7 applies to the contractor's accounts for construction contracts, including related service contracts directly tied to the construction.
A fixed price contract has an agreed price, possibly with escalation clauses; a cost plus contract pays cost plus a percentage or fixed fee.
Segment a contract covering several assets when separate proposals were submitted for each asset, each asset was separately negotiated so the contractor and customer could accept or reject it, and the cost and revenue of each asset can be identified. Combine a group of contracts when the group is negotiated as a single package, the contracts are so closely interrelated that they are in effect part of a single project with an overall profit margin, and they are performed concurrently or in a continuous sequence.
Contract revenue includes the agreed amount plus variations, claims and incentive payments, subject to the standard's conditions.
Contract costs have three components: (a) costs that relate directly to the specific contract; (b) costs attributable to contract activity in general that can be allocated to the contract, such as insurance, design and technical assistance not directly related to a specific contract, and construction overheads; and (c) other costs specifically chargeable to the customer under the terms of the contract. Excluded costs are: general administration costs, selling costs and research and development costs, unless the contract provides for their reimbursement, and depreciation of idle plant and equipment not used on the contract.
Use the percentage of completion method when the outcome can be estimated reliably.
Reliable estimate for a fixed price contract: total contract revenue can be measured reliably; it is probable that economic benefits will flow; the costs to complete and the stage of completion can be measured reliably; and the costs attributable to the contract can be clearly identified and measured reliably.
Reliable estimate for a cost plus contract: it is probable that economic benefits will flow, and the costs attributable to the contract can be clearly identified and measured reliably.
Stage of completion may be determined by (a) the proportion of contract costs incurred for work performed to date to the estimated total contract costs, (b) surveys of work performed, or (c) completion of a physical proportion of the contract work. Under the cost method, only costs reflecting work done count. Costs of materials not yet used in contract performance are excluded, unless the materials were specially made for the contract. Payments in advance to subcontractors for work to be performed in future are also excluded.
Revenue for the year = revenue to date − revenue recognised in earlier years.
Expected loss = total expected contract cost − total contract revenue, when cost is higher. Recognise it as an expense in full immediately when it is probable that total contract costs will exceed total contract revenue, whatever the stage of completion. The provision is the full expected loss less any loss already recognised.
If the outcome cannot be estimated reliably, the percentage of completion method does not apply. Recognise revenue only to the extent of contract costs incurred that are probable of recovery, and recognise contract costs as an expense in the period they are incurred. So no profit is recognised. Any expected loss on the contract is still recognised immediately as an expense.
A change in estimate is applied in the period of change, not by restating earlier years.
Write disclosures in answers: contract revenue recognised in the period, the method used to determine it and the stage of completion, and for contracts in progress at the reporting date, the aggregate of costs incurred and recognised profits (less recognised losses) up to that date, the advances received and the retentions.

AS 7 Construction Contracts practice questions

AS 7 Construction Contracts in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

AS 7 Construction Contracts: frequently asked questions

Is AS 7 mostly theory or numerical?

It is mostly numerical, with a small theory base. You need the definitions and inclusion rules to get the numbers right. Expect MCQs on concepts and written problems on percentage of completion and losses.

Which method does AS 7 use to recognise revenue?

AS 7 uses the percentage of completion method when the outcome of the contract can be estimated reliably. Revenue and costs are recognised in line with the stage of completion at the reporting date.

How do I handle a loss-making contract in the exam?

Recognise the expected loss as an expense immediately when it is probable that total contract costs will exceed total contract revenue. Do this irrespective of the stage of completion and the profit expected on other contracts. Show the working clearly so that the loss already recognised and the balance provision are visible.

How long should I give this chapter?

It is short, so a few focused sessions are enough if you practise the numerical steps. Spend most of the time on solved questions and a final timed set rather than rereading the standard.