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CA Sandesh Mundra

Consult Us For Construction

Accounting for the Construction Sector

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a) Accounting Standard / Guidance Notes

The Accounting Sector applicable to this industry which works purely on contractual basis is AS-7 – Accounting for construction contracts. The standard emphasizes on Percentage completion Method Accounting (POCM).

Let us try and understand the accounting intricacies with a small example:-

 

Theoretical Scenario –

Factor 1 – Value of Work order is Rs.100 cr.

Factor 2 – Estimated Completion Cost is Rs.80 cr

Factor 3 – Cost Incurred till date is Rs. 20 cr

Solution  – Percentage Completion is 25% (20/80)

- Revenue to be booked is Rs. 25 cr. (Thus profit booked is Rs 5 cr).

The calculations as above look very simple.

Lets now come to a practical Scenario and see the kind of issues that are faced–

Factor 1 – Value of Work order is Rs.100 cr.

-         Value of Work order is tentative Rs. 100 cr in case of Hard rock / Rs.85 cr in case there is no hard rock.

-         All items are not released at a go / Work amendments are issued on a regular basis.

-         Value is Rs. 120 cr. in case work is completed in 18 months / 100 cr. if it is completed in 24 months. That is incentive given for earlier completion.

-         The client has informally accepted the escalation, but is willing to release the same only upon succesful completion of the job.

-         Even the calculations at the client level can go absolutely wrong at times in terms of engineering quanitites.

Factor 2 – Estimated Completion Cost is Rs.80 cr

-         Most of the times the contractor never has the data on expected costs. You have to go by the market and work at the prevailing market rates.

-         The expected costs fluctuate every moment. If the output in terms of concrete is 100 cum per day the cost would be 65 cr if it is 60 cum per day the same is 110 cr.

-         Situations like labour unrest, accidents at the site, equipment damage can change the whole scenario of the site.

-         At times confusion prevail with regard to the Indirect taxes, resulting into increase in the contract costs.

-         Several extra items are expected to be executed in the course of the job.

Factor 3 – Cost Incurred till date is Rs. 20 cr (25%)

-         Cost of Extra items at times is significant and needs to be excluded while calculating the cost incurred against the original work order.

-         Liability to pay the subcontractor has arose, but the bills have not been certified as the rates have not been finalized. Only after an overview of their work after some time that the actual rates are finalized

-         Free Issue Materials supplied by the client are reconciled / returned at the end of the project. Sometimes these may have an heavy impact. Online monitoring is thus required.

-         Certain costs were although necessary but were not anticipated at the start of the work.

-         Various sites are running. Capital goods and materials from one site are transferred to another site, and no financial effect is taken care of, hence the same are not considered while working out the cost.

-         Determining a base for allocation of common costs among the projects is very difficult and most of the times very subjective as we have to depend on the management for that.

-         Need to provide for Contingencies, like liquidated damages from the client / similar claims on the sub-contractors would reduce the cost.

How do we then recognize the revenue in such a scenario ?

 

Solution –

-          Contractors normally have the system of raising RA bills. Those bills which have been duly certified by the client need to be recognized as part of Contract revenues.

-         At times certain items are certified without execution to show the progress of the work, which should be suitably adjusted.

-         Field survey is required to be carried out with the billing engineer to ascertain the status of works carried out but not billed or if billed but lying uncertified. Care for extra works executed not forming part of the original order to be taken. A certificate needs to be taken with regard to the same backed by informal communication with the sub-contractors.

-         Stock of Unutilised material lying at the site and stock of scrap needs to be physically verified. Care should be taken to ensure that no Free Issue Material is taken into consideration.

-         All conservative stands need to be taken i.e. escalations need to be taken into account only after complete assurance from the client, time based incentives to be considered only after substantial completion.

-         Cross verification of findings with the technical auditor, if any.

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CA Sandesh Mundra, Consultant – Management Audit and Indirect Taxation - Chartered Accountant, Diploma in Information System Audit, Diploma in Insurance & Risk Management , Certificate from ICAI on International Financial Reporting Standards. Actively associated with clients in the industrial construction sector since last 9 years.He possesses special skills in structuring the indirect tax component of the works contracts and as management auditor, has visited several construction sites in various states like Orissa, Rajasthan, Gujarat, Maharasthra, Madhya Pradesh etc. During the course of said visits he has been to very large industrial complexes, refineries, power plants etc

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