AS 7 Construction Contracts: Expected Losses, Changes in Estimates and Disclosures

Understand Expected Losses, Changes in Estimates and Disclosures

Key rules to remember

Expected loss test

Total estimated contract costs > Total contract revenue → recognise the entire loss at once

Apply when the excess is probable. Recognise the loss in full in the period it becomes probable.

Stage of completion (cost proportion)

Stage of completion = Contract costs incurred to date ÷ Total estimated contract costs

Costs for future work, such as materials not yet used, are excluded from costs incurred. Use this method only if the question does not give another basis.

Cumulative revenue to date

Cumulative revenue = Contract price × Stage of completion

Revenue for the year = cumulative revenue − revenue recognised in earlier years. Use the latest estimate of contract price.

Provision for foreseeable loss

Provision = Total expected loss − Loss already shown through revenue less costs to date

Make sure the cumulative loss shown in the books equals the total expected loss.

Uncertain outcome

Revenue = Recoverable costs incurred; Expense = Costs incurred; Profit = 0

Applies when outcome cannot be estimated reliably, as long as costs are probable of recovery.

Gross amount due from customers

Costs incurred + Recognised profits − Recognised losses − Progress billings (if positive)

Shown as an asset. If negative, it is shown as gross amount due to customers, a liability.

Uncollectable revenue

Uncollectable amount → expense, not a reduction of revenue

AS 7 treats it as an expense when uncertainty arises about collecting an amount already in revenue.

How to solve Expected Losses, Changes in Estimates and Disclosures questions

1. 1Write down the contract price, costs incurred to date, and estimated costs to complete. Adjust for any cost that relates to future work.
2. 2Add costs incurred and costs to complete to get total estimated cost. Compare with the contract price. If cost is higher, the contract is loss-making.
3. 3Decide whether the outcome can be estimated reliably. If not, take revenue as recoverable costs incurred and show zero profit, or the full loss if one is expected.
4. 4If outcome is reliable, compute stage of completion and cumulative revenue. Deduct revenue of earlier years to get revenue for the year.
5. 5For a loss-making contract, recognise the full expected loss. Charge costs incurred for the year, then add the provision needed so that the cumulative loss equals the total expected loss.
6. 6For changed estimates, recompute everything on the new figures from the start. The difference from earlier recognised amounts goes through the current year only.
7. 7Treat uncollectable amounts as a separate expense. Then prepare the disclosure figures: costs plus recognised profits less losses, advances, retentions, and amounts due from or to customers.
8. 8Show the year-wise statement clearly, with cumulative columns. This earns step marks even if one figure is wrong.

Quickest way: Cumulative-table method

Common mistakes in Expected Losses, Changes in Estimates and Disclosures

• Recognising only the percentage-of-completion share of the expected loss.

  Students apply the stage of completion to the loss the same way they do for profit.

  Fix: Recognise the entire expected loss immediately. Show the portion not yet reflected in revenue less costs as a provision.

• Reducing contract revenue for an uncollectable amount.

  It feels natural to cut revenue when the customer will not pay.

  Fix: AS 7 says to recognise the uncollectable amount as an expense. Revenue stays as computed.

• Restating earlier years when estimates change.

  Students think a revised total cost means earlier profit was wrong.

  Fix: A change in estimate is accounted for under AS 5 in the current period. Compute cumulative figures and subtract amounts already recognised.

• Using costs incurred including unused materials to find the stage of completion.

  Students take the total cost figure given without reading its description.

  Fix: Exclude materials delivered to site but not yet used from costs incurred when computing the stage of completion. Carry them forward as an asset, not an expense, until they are used.

• Showing a profit when the outcome is uncertain.

  Students apply the percentage of completion method out of habit.

  Fix: If the outcome cannot be estimated reliably, revenue equals recoverable costs incurred and profit is zero.

• Leaving out disclosure items such as advances and retentions.

  Students focus on the calculation and treat disclosure as an afterthought.

  Fix: Learn the disclosure list as a set: revenue, methods, stage-of-completion method, costs plus profits less losses, advances, retentions, and amounts due from or to customers.

Worked examples