Advanced Accounting · AS 7 Construction Contracts

AS 7 Contract Revenue and Contract Costs

Updated 4 October 2026 · Fact-checked

Under AS 7, contract revenue is the agreed contract amount plus variations, claims and incentive payments, if probable and reliably measurable. Contract costs are costs that relate directly to the contract, a share of general contract costs, and costs chargeable to the customer. Add these up, then exclude non-allowable items.

Understand Contract Revenue and Contract Costs

A construction contract runs for months or years. To report profit each year, you need two numbers: total contract revenue and total contract cost. AS 7 tells you what goes into each.

Contract revenue starts with the initial amount agreed in the contract. It then changes as the work changes. It includes three additions: variations (a change in the scope of work), claims (amounts the contractor seeks from the customer for costs not in the price) and incentive payments (extra amounts for meeting or beating performance standards).

These additions are not automatic. A variation counts only if it is probable that the customer will approve it and the amount can be measured reliably. A claim counts only if negotiations are advanced enough that the customer will probably accept it, and the amount can be measured reliably. An incentive counts only if the contract is sufficiently advanced that the target will probably be met or exceeded, and the amount is reliably measurable. Revenue is measured at the fair value of the consideration received or receivable.

Contract costs have three groups. First, costs that relate directly to the specific contract: site labour, materials used, depreciation of plant used on the contract, cost of moving plant and materials to and from the site, hire of plant, design and technical help directly linked to the contract, estimated rectification and guarantee costs, and claims from third parties. Second, costs attributable to contract activity in general that can be allocated to the contract: insurance, design and technical help not directly linked to a specific contract, and construction overheads. These are allocated on a systematic, rational basis, applied consistently to all costs with similar characteristics. Third, other costs specifically chargeable to the customer under the contract, which may include general administration and development costs if the contract allows reimbursement.

Borrowing costs can be part of contract cost, but only as AS 16 allows. Costs that cannot be attributed to contract activity or allocated to a contract are excluded. Examples are general administration costs with no reimbursement under the contract, selling costs, research and development costs not reimbursable, and depreciation of idle plant not used on the contract.

Contract cost can also be reduced by incidental income that is related to the contract and is not included in contract revenue. Examples are income from the sale of surplus materials and from the disposal of plant and equipment at the end of the contract. Income that is not related to the contract, such as interest on surplus funds, is not deducted from contract cost.

Key rules to remember

Contract revenue: Contract revenue = Initial agreed amount ± Variations + Claims + Incentives; Include variations, claims and incentives only when the AS 7 conditions of probability and reliable measurement are met. A variation can also reduce revenue.
Contract cost: Contract cost = Direct costs + Allocated contract-activity costs + Costs specifically chargeable to customer; Allocate shared costs on a systematic, rational and consistently applied basis.
Incidental income: Contract cost = Costs above − Incidental income related to the contract and not in revenue; Only incidental income related to the contract is deducted, for example income from the sale of surplus materials or the disposal of plant and equipment at the end of the contract. Do not deduct income unrelated to the contract, such as interest on surplus funds. Deduct only if the income is not included in revenue.
Exclusions: Exclude: non-reimbursable general administration, selling, non-reimbursable R&D, depreciation of idle plant; These cannot be attributed to contract activity, so they never enter contract cost.

How to solve Contract Revenue and Contract Costs questions

Use this method for any question that asks for contract revenue, contract cost, or which items to include.

1List every figure given and tag each as revenue item or cost item.
2For revenue, start with the agreed contract price.
3Test each variation, claim and incentive against the AS 7 conditions. Include only if probable and reliably measurable. Add or subtract as the case requires.
4For cost, put direct costs first: labour, materials, plant depreciation and hire, moving costs, design, rectification and guarantee estimates.
5Add allocable costs (insurance, design not linked to one contract, construction overheads) using the allocation basis given, such as share of direct labour or contract value.
6Remove excluded items: non-reimbursable administration, selling, R&D, idle plant depreciation. Deduct incidental income only if it is related to the contract (such as sale of surplus materials or disposal of plant at contract end) and is not in revenue.
7Add borrowing cost only if it meets AS 16 capitalisation rules, then total and state each inclusion or exclusion with a one-line reason.

Quickest way: Include-or-exclude scan

When to use it: Use this for MCQs and for the first pass in written questions with many cost items.

Ask of each cost item: is it linked to this contract, allocable to it, or chargeable to the customer? If none, exclude it.
Mark selling, general administration (unless reimbursable), R&D (unless reimbursable) and idle plant depreciation as out.
For claims, variations and incentives, look for words like approved, probable, negotiations advanced. If absent or doubtful, leave them out.
In MCQs, the wrong options usually add an excluded item or a doubtful claim. Eliminate these first.
In written answers, show a two-column working (revenue, cost), give a reason for each excluded item, and write the total clearly to earn step marks.

Common mistakes in Contract Revenue and Contract Costs

Including every claim the contractor makes in revenue.
Students treat a claim as a right to money.
Fix: Include only if negotiations are advanced and acceptance is probable, and the amount is reliably measurable.
Adding general administration and selling costs to contract cost.
They look like business expenses of the contractor, so they seem to belong.
Fix: Exclude them unless the contract specifically allows reimbursement. Selling costs are always excluded.
Charging depreciation on all plant to the contract.
Students see 'depreciation' and treat it as a direct cost.
Fix: Include only depreciation of plant used on the contract. Idle plant depreciation is excluded.
Ignoring incidental income when computing cost, or deducting income that is not related to the contract.
Students focus on additions and forget deductions. Others deduct every income item in the question, such as interest on surplus funds.
Fix: If incidental income is related to the contract (for example sale of surplus materials or disposal of plant at the end of the contract) and is not included in revenue, deduct it from contract cost. Do not deduct income unrelated to the contract.
Capitalising all borrowing costs into contract cost.
Students forget that AS 7 refers to AS 16 for this.
Fix: Include borrowing cost only if it meets the AS 16 criteria. Otherwise charge it to the profit and loss statement.
Treating a negative variation as zero.
Variations are usually seen as additions.
Fix: A reduction in scope reduces contract revenue. Adjust the price in both directions.

Worked examples

Example 1

A contractor has a fixed-price contract of ₹80,00,000. Approved variation for extra work: ₹4,00,000. A claim for customer-caused delay of ₹3,00,000 is under early discussion and acceptance is uncertain. An incentive of ₹2,00,000 is payable if the contract is completed early; the contract is well advanced and early completion is probable and reliably measurable. Compute contract revenue.

Show the solution

Start with initial amount: ₹80,00,000.
Variation is approved, so it is probable and measurable. Add ₹4,00,000.
Claim is under early discussion and acceptance is uncertain. Do not include it.
Incentive is probable and measurable. Add ₹2,00,000.
Total = 80,00,000 + 4,00,000 + 2,00,000 = ₹86,00,000.

Answer: Contract revenue is ₹86,00,000. The ₹3,00,000 claim is excluded until acceptance becomes probable.

Example 2

For a construction contract, the following costs were incurred: site labour ₹12,00,000; materials used ₹20,00,000; depreciation of plant used on this contract ₹1,50,000; depreciation of idle plant ₹60,000; design cost directly linked to the contract ₹1,00,000; allocable insurance ₹40,000; allocable construction overheads ₹1,10,000; general administration (not reimbursable) ₹90,000; selling costs ₹30,000. At the end of the contract, the contractor also earned ₹25,000 from the sale of surplus materials, which is not included in contract revenue. Compute contract cost.

Show the solution

Direct costs: labour 12,00,000 + materials 20,00,000 + plant depreciation 1,50,000 + design 1,00,000 = ₹34,50,000.
Allocable costs: insurance 40,000 + construction overheads 1,10,000 = ₹1,50,000.
Sub-total = 34,50,000 + 1,50,000 = ₹36,00,000.
Exclude idle plant depreciation (₹60,000), non-reimbursable administration (₹90,000) and selling costs (₹30,000). They cannot be attributed to the contract.
The ₹25,000 from sale of surplus materials is incidental income related to the contract. It is not a cost incurred, and because it is not in revenue, deduct it from contract cost: 36,00,000 − 25,000 = ₹35,75,000.

Answer: Contract cost is ₹35,75,000.

Exam tips

Write a reason beside every item you exclude. Examiners award marks for the reasoning, not just the total.
When a question gives allocation bases, show the allocation working in a separate line before adding it to cost.
Read claim and incentive wording carefully. Words like 'approved' or 'probable' decide inclusion; 'under discussion' or 'uncertain' usually mean exclusion.
In theory questions, list the three groups of contract cost in order and give two examples of each.
Expect MCQs asking which item is not part of contract cost. Selling cost and idle plant depreciation are the usual answers.

Practice questions from AS 7 Construction Contracts

Contract Revenue and Contract Costs in other exams

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

Contract Revenue and Contract Costs: frequently asked questions

What costs cannot be included in contract cost under AS 7?

Costs that cannot be attributed to contract activity or allocated to the contract are excluded. Examples are selling costs, non-reimbursable general administration, non-reimbursable research and development, and depreciation of idle plant.

When can a claim be included in contract revenue?

Only when negotiations have reached an advanced stage and it is probable the customer will accept the claim. The amount must also be reliably measurable.

Can borrowing costs be part of contract cost?

Yes, but only to the extent AS 16 permits capitalisation. If they do not meet the AS 16 criteria, they are expensed.

Is a variation always added to contract revenue?

No. It is included only if it is probable that the customer will approve it and the amount can be measured reliably. A variation can also reduce revenue.