AS 7, Construction Contracts deals with a timing problem that ordinary invoicing cannot solve: construction work often begins in one accounting period and finishes in another. For contractors applying the Accounting Standards framework, the accounting question is how much contract revenue, cost and profit or loss belongs in each reporting period. The answer depends on reliable estimation of the contract outcome, the stage of completion, recoverability of costs and whether the contract is expected to make an overall loss.
The primary reference is ICAI's official AS 7 text. ICAI also maintains a reader-facing AS 7 publication page. This guide explains the standard as a practical year-end workflow; entity-level framework applicability should be confirmed before applying it to live financial statements.
What AS 7 covers
AS 7 applies to construction contracts in the financial statements of contractors. A construction contract is one specifically negotiated for constructing an asset, or a group of closely interrelated or interdependent assets. The standard also includes services directly related to construction, such as certain project-management or architectural services, and contracts for destruction or restoration of assets and related environmental restoration.
Contracts may be fixed price, cost plus, or contain characteristics of both. AS 7 also contains rules for when separate components of one arrangement should be treated separately and when multiple contracts should be combined so that accounting reflects the commercial substance rather than the number of legal documents.
Build contract revenue carefully
Contract revenue starts with the amount agreed in the contract. Variations, claims and incentive payments are added only when the conditions in the standard are met. In broad terms, the additional amount must be sufficiently probable and capable of reliable measurement. A disputed claim should therefore not be converted into revenue merely because it appears in an internal project forecast.
Contract revenue can also move down. Penalties caused by contractor delays can reduce revenue, while an approved variation or a qualifying incentive can increase it. The contract-revenue schedule should therefore be reconciled to the latest approved commercial terms rather than copied from the original contract value every year.
Identify contract costs before calculating profit
Contract costs include costs directly related to the specific contract, costs attributable to construction activity generally that can be allocated to the contract on a systematic and rational basis, and other costs specifically chargeable to the customer under the contract. Direct examples in AS 7 include site labour, construction materials, depreciation of plant used on the contract, equipment hire, directly related design or technical assistance, rectification and guarantee costs, and certain third-party claims.
Not every project-related expense belongs in contract cost. General administration costs for which reimbursement is not specified, selling costs, non-reimbursable research and development costs, and depreciation of idle plant not used on a particular contract are examples the standard excludes. This distinction matters because an inflated cost pool can distort both the stage of completion and reported margin.
When the outcome can be estimated reliably
When the outcome can be estimated reliably, AS 7 requires contract revenue and contract costs to be recognised by reference to the stage of completion at the reporting date. This is commonly called the percentage of completion method. For a fixed-price contract, reliable estimation requires, among other things, reliable measurement of total contract revenue, probable economic benefits, reliable measurement of costs to complete and stage of completion, and clearly identifiable and measurable contract costs that can be compared with prior estimates.
For a cost-plus contract, the standard focuses on probable economic benefits and the ability to identify and measure attributable contract costs reliably. The practical lesson is that percentage of completion is not an automatic formula applied to every long-running project; the reliability conditions have to be supported by project budgets, cost records and enforceable commercial terms.
How to measure the stage of completion
AS 7 permits the method that reliably measures work performed. Depending on the contract, this may include:
- the proportion of contract costs incurred for work performed to estimated total contract costs;
- surveys of work performed; or
- completion of a physical proportion of the contract work.
Progress billings and customer advances do not necessarily measure work performed. A contractor may bill ahead of physical progress, or receive an advance before related work begins. Revenue recognition should therefore not be driven simply by invoice value or cash collection.
Cost-to-cost method: remove costs that do not represent work performed
When completion is measured using costs incurred, only costs reflecting work performed up to the reporting date belong in the numerator. AS 7 specifically identifies examples that may need exclusion, such as standard materials delivered to site but not yet installed, used or applied, and advance payments to subcontractors for work not yet performed. Specially made materials can require different consideration under the standard.
Worked example: percentage of completion
Assume a contractor has a fixed-price contract of Rs 10 crore and the latest reliable estimate of total contract cost is Rs 8 crore. At year-end, costs that genuinely represent work performed are Rs 3.2 crore, with no relevant future-activity costs included in that amount. Using a cost-to-cost measure, the stage of completion is 40%.
On these simplified facts, cumulative contract revenue recognised is Rs 4 crore, cumulative contract cost recognised is Rs 3.2 crore and cumulative profit is Rs 0.8 crore. If progress billings happen to be Rs 5 crore, that does not by itself increase the stage of completion to 50%. Billing and revenue recognition answer different questions under AS 7.
When the outcome cannot be estimated reliably
If the outcome cannot be estimated reliably, AS 7 takes a more cautious approach. Revenue is recognised only to the extent of contract costs incurred whose recovery is probable, while contract costs are recognised as expense in the period incurred. In that situation, no profit is recognised merely because some recoverable work has been performed.
Once the uncertainties preventing reliable estimation no longer exist, the contract moves to the normal stage-of-completion requirements. Finance teams should document what changed: for example, whether cost forecasts became reliable, a major contractual uncertainty was resolved, or enforceable commercial terms became clear.
Expected loss is recognised immediately
One of the most important AS 7 rules is independent of the percentage completed. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately. The standard says this is determined regardless of whether work has commenced, the stage of completion, or profits expected on other contracts that are not combined with the loss-making contract under AS 7.
Short loss example
Suppose a newly secured contract has total expected revenue of Rs 10 crore but, before meaningful work starts, the latest supportable estimate shows total contract cost of Rs 10.6 crore. The expected Rs 0.6 crore loss cannot be deferred until construction progresses. Subject to the contract-specific accounting entries and any amounts already recognised, the expected total loss must be reflected immediately under AS 7.
Changes in estimates are handled cumulatively
Construction budgets change. AS 7 applies percentage of completion on a cumulative basis using current estimates of contract revenue and contract costs. A change in those estimates, or in the estimated outcome of a contract, is accounted for as a change in accounting estimate under AS 5. The updated estimates affect the period of change and, where relevant, subsequent periods rather than being treated automatically as a prior-period error.
Year-end disclosure and presentation checklist
- Reconcile contract revenue recognised during the period and document the method used to determine it.
- Document the method used to determine the stage of completion for contracts in progress.
- For contracts in progress, compile costs incurred plus recognised profits less recognised losses, advances received and retentions.
- Present the gross amount due from customers for contract work as an asset where the AS 7 formula produces a receivable position.
- Present the gross amount due to customers for contract work as a liability where progress billings and recognised losses exceed costs incurred plus recognised profits under the standard's formula.
- Update estimates of revenue, cost to complete, claims, variations, incentives, penalties and expected losses using support available at the reporting date.
- Keep progress billings, advances and physical or cost-based progress separately identifiable so billing does not become a substitute for performance measurement.
Common mistakes
- Recognising revenue based on invoices raised instead of the stage of completion.
- Including uninstalled standard materials or subcontractor advances in a cost-to-cost progress numerator without analysing whether they represent work performed.
- Recognising disputed claims or incentives before probability and reliable-measurement conditions are met.
- Waiting for a loss-making contract to reach a particular completion percentage before recognising the expected overall loss.
- Using an outdated total-cost estimate even after significant project information has changed.
- Netting profitable and loss-making contracts merely because they involve the same customer when the AS 7 combination criteria are not met.
Practical takeaway
AS 7 is best applied through a contract-by-contract control sheet that separates commercial value, recognised revenue, costs representing work performed, future-activity costs, billing, cash receipts, cost to complete and expected loss. First establish whether the outcome can be estimated reliably. Then use a method that genuinely measures work performed, not invoices raised. Reforecast the contract at every reporting date, and recognise an expected overall loss immediately when the standard's condition is met. That discipline makes construction-contract accounting far more defensible for both finance teams and auditors.
