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Advanced Accounting · AS 7 Construction Contracts

AS 7 Scope, Definitions and Types of Construction Contracts

Updated 4 October 2026 · Fact-checked

AS 7 prescribes how contractors account for revenue and costs of construction contracts in their own financial statements. A construction contract is a contract specifically negotiated to build an asset or a combination of closely interrelated assets. It is either fixed price or cost plus. Classify the contract first, then apply the recognition rules.

Understand AS 7 Scope, Definitions and Types of Contracts

AS 7 (Construction Contracts) deals with accounting in the books of the contractor. The main issue is timing. A contract often starts in one year and ends in a later year. AS 7 tells you how to allocate contract revenue and contract costs to the accounting periods in which the work is done.

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. Examples are a bridge, a building, a dam, a pipeline, a road, a ship, a tunnel, and also the restoration of the environment. The word "specifically negotiated" matters. A standard flat sold off the shelf is not a construction contract in this sense.

AS 7 also covers contracts for services directly related to construction, such as services of project managers and architects. It covers contracts for the destruction or restoration of assets and the restoration of the environment following demolition of assets. The standard applies only to the contractor's accounts. It does not tell the customer how to account for the asset.

AS 7 recognises two types of contract. In a fixed price contract, the contractor agrees to a fixed contract price, or a fixed rate per unit of output. In some cases the price is subject to cost escalation clauses. In a cost plus contract, the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.

The real difference is who bears the risk. In a fixed price contract, the contractor bears the risk of cost overruns. In a cost plus contract, the customer bears most of that risk, but the contractor still faces the risk that some costs will not be allowed. Some contracts have features of both, for example a cost plus contract with an agreed maximum price. You must read the facts and decide which treatment fits.

Key rules to remember

Definition of construction contract
Construction contract = contract specifically negotiated to construct an asset or closely interrelated/interdependent assets
Interdependence is tested in terms of design, technology and function, or ultimate purpose or use.
Fixed price contract
Contractor receives a fixed contract price or fixed rate per unit of output (may have escalation clauses)
Contractor bears the risk of cost overruns unless an escalation clause covers them.
Cost plus contract
Contract revenue = allowable costs reimbursed + (percentage of costs or fixed fee)
Customer bears most cost risk. Only costs allowed under the contract are reimbursed.
Scope rule
AS 7 applies to the accounts of contractors only
It does not apply to the customer's books. It also does not cover other contracts, which are dealt with by other standards.

How to solve AS 7 Scope, Definitions and Types of Contracts questions

Use this method for any question that asks whether AS 7 applies, or asks you to classify or compare contracts.

  1. 1Read the facts and identify who is the contractor. AS 7 applies in the contractor's books only.
  2. 2Check whether the contract is specifically negotiated for an asset or a group of closely interrelated assets, or is a related service or restoration contract.
  3. 3If it is a standard product or general supply, state that it is outside the definition and another standard (such as AS 9) applies.
  4. 4Decide the type. Look for a fixed price or fixed rate per unit, versus reimbursement of costs plus a percentage or fixed fee.
  5. 5Check for hybrid features, such as escalation clauses or a cap on the price, and note them.
  6. 6State who bears the cost risk under the type you chose.
  7. 7Write the conclusion in one clear sentence linked to the definition, then move to the accounting treatment if the question asks for it.

Quickest way: Three-question test for MCQs and short answers

When to use it: Use it when the question gives a short fact pattern and asks you to classify the contract or decide whether AS 7 applies.

  1. Ask: is it specifically negotiated for an asset or related assets? If no, it is not AS 7.
  2. Ask: is the price fixed, or is it costs plus a margin? Fixed means fixed price. Reimbursement plus margin means cost plus.
  3. Ask: who bears the cost overrun? The contractor means fixed price. The customer means cost plus.
  4. For written answers, use the format: definition, application to facts, conclusion. Each part earns step marks.
  5. In MCQs, eliminate options that say AS 7 applies to the customer's books, or that cost plus means the contractor takes the cost risk.

Common mistakes in AS 7 Scope, Definitions and Types of Contracts

  • Treating any long-term supply or sale as a construction contract.

    Students focus on the long duration and ignore the words "specifically negotiated".

    Fix: Check for a negotiated asset or closely interrelated assets. Standard goods fall outside AS 7.

  • Applying AS 7 to the customer's accounts.

    The standard is about construction, so students assume it covers both parties.

    Fix: Remember that AS 7 deals only with the contractor's books.

  • Saying the contractor bears no risk in a cost plus contract.

    Students over-simplify that the customer pays the costs.

    Fix: The customer bears most cost risk, but only allowable costs are reimbursed, so the contractor can still lose on disallowed costs.

  • Ignoring escalation clauses in fixed price contracts.

    The words "fixed price" make students assume the price can never change.

    Fix: A fixed price contract may have cost escalation clauses. It is still fixed price.

  • Forgetting that related services and restoration contracts are covered.

    Students think only physical building work counts.

    Fix: Include project management, architect services, demolition and environmental restoration linked to construction.

Worked examples

Example 1

Sunrise Constructions agrees with a municipal body to build a flyover for a fixed sum of ₹40,00,00,000. The contract has a clause that raises the price if steel prices rise beyond an agreed level. Is this a construction contract under AS 7? Classify it.

Show the solution
  1. The contract is specifically negotiated for the construction of one asset, a flyover. So it is a construction contract.
  2. The price is a fixed sum of ₹40,00,00,000, which indicates a fixed price contract.
  3. The steel escalation clause allows a price change for a defined cost rise. AS 7 allows fixed price contracts to have escalation clauses, so the type does not change.
  4. The contractor bears the risk of cost overruns not covered by the escalation clause.

Answer: It is a construction contract and a fixed price contract. The escalation clause does not turn it into a cost plus contract.

Example 2

Delta Builders agrees to build a hospital for a customer. The customer will reimburse all allowable construction costs and pay Delta a fee of 10% of those costs. Delta also sells ready-made office furniture from stock to the same customer under a separate purchase order. Discuss the application of AS 7 to both.

Show the solution
  1. Hospital: it is specifically negotiated for an asset, so it is a construction contract.
  2. The contractor is reimbursed allowable costs plus 10% of costs, so it is a cost plus contract.
  3. Most of the cost risk lies with the customer, but Delta is paid only for allowable costs.
  4. Furniture: it is ready-made stock sold under a separate purchase order, not specifically negotiated for construction of an asset. It is outside the definition of a construction contract.
  5. The furniture sale is dealt with under the revenue recognition standard, AS 9, not AS 7.

Answer: The hospital contract is a cost plus construction contract under AS 7. The furniture sale is not a construction contract, and is accounted for under AS 9.

Exam tips

  • Start every answer with the definition of a construction contract, then apply it to the facts. This earns step marks.
  • In a compare-and-contrast question, write who bears the risk, how the price is set and what revenue is based on. Present these as separate points.
  • Expect MCQs that test the scope: contractor's books only, and which contracts count. Read each option for the word "customer".
  • Watch for hybrid contracts in case facts. Name the features of both types, then state which is dominant.
  • If the question asks for accounting treatment, first classify the contract in one line, then move on.

Practice questions from AS 7 Construction Contracts

AS 7 Scope, Definitions and Types of 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 Scope, Definitions and Types of Contracts: frequently asked questions

What is a construction contract as per AS 7?

It is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in design, technology and function, or ultimate purpose or use. It also includes related services and restoration contracts.

What is the difference between a fixed price and a cost plus contract?

In a fixed price contract, the contractor gets a fixed price or fixed rate per unit of output, so it bears the risk of cost overruns. In a cost plus contract, the contractor is reimbursed allowable costs plus a percentage of costs or a fixed fee, so the customer bears most of the cost risk.

Does AS 7 apply to the customer's books?

No. AS 7 deals with accounting by the contractor. It prescribes how the contractor recognises contract revenue and costs.

Can a contract have features of both types?

Yes. For example, a cost plus contract may have an agreed maximum price. You should read the terms, identify the features of both and then apply the treatment that fits the facts.