AS 7 prescribes the accounting for construction contracts in the financial statements of contractors. Construction contracts pose a particular accounting challenge: a single contract may span several accounting periods, so the question of *when* to recognise revenue and profit — spread across the build, or only on completion — has a major effect on the reported results of each year. AS 7 answers this with the percentage of completion method.
Objective and scope
The objective is to prescribe the accounting treatment of revenue and costs associated with construction contracts. 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. The standard applies in the accounts of contractors. Because the contract activity typically straddles period-ends, the central issue is the allocation of contract revenue and contract costs to the accounting periods in which the construction work is performed.
Contracts may be fixed price (a set contract price, sometimes subject to escalation clauses) or cost plus (the contractor is reimbursed allowable costs plus a percentage or fixed fee), and AS 7 covers both.
Contract revenue and contract costs
Contract revenue comprises the initial amount of revenue agreed in the contract, plus variations in contract work, claims, and incentive payments to the extent that it is probable they will result in revenue and they are capable of being reliably measured. Contract revenue is measured at the consideration received or receivable, and it can increase or decrease from one period to the next as variations, claims, and incentives are agreed.
Contract costs comprise costs that relate directly to the specific contract (such as site labour, materials used, depreciation of plant used on the contract, and costs of moving plant and materials to and from the site); costs that are attributable to contract activity in general and can be allocated to the contract (such as insurance and some design and technical assistance, allocated systematically); and such other costs as are specifically chargeable to the customer under the terms of the contract. General administration and selling costs, research and development not reimbursable, and depreciation of idle plant not used on the contract are excluded.
The percentage of completion method
The core of AS 7 is the percentage of completion method. When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. In other words, profit is recognised gradually as the work progresses, in proportion to how much of the contract has been completed, rather than being deferred entirely to the end.
The stage of completion may be determined in various ways — for example, the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs; surveys of work performed; or completion of a physical proportion of the contract work. Whichever method is used, it should measure reliably the work performed.
For the outcome to be estimated reliably, certain conditions must be met — broadly, that total contract revenue can be measured reliably, it is probable that the economic benefits will flow to the enterprise, and both the contract costs to complete and the stage of completion can be measured reliably. (For cost-plus contracts the conditions are framed around the probability of economic benefits and the costs being clearly identifiable and reliably measurable.)
When the outcome cannot be estimated reliably, revenue should be recognised only to the extent of contract costs incurred that it is probable will be recoverable, and contract costs should be recognised as an expense in the period incurred. No profit is recognised in this situation — only cost recovery — because the outcome is too uncertain to recognise profit prudently.
Expected losses
A particularly important rule: when it is probable that total contract costs will exceed total contract revenue — that is, the contract is expected to make a loss — the expected loss should be recognised as an expense immediately, regardless of the stage of completion. This is an application of prudence: an anticipated loss is recognised as soon as it is foreseen, not spread over the remaining life of the contract. So while profit is recognised gradually, an expected overall loss is recognised at once and in full.
Disclosure requirements
An enterprise should disclose the amount of contract revenue recognised in the period; the methods used to determine contract revenue recognised; and the methods used to determine the stage of completion of contracts in progress. For contracts in progress at the reporting date, disclosures include the aggregate amount of costs incurred and recognised profits (less recognised losses) to date, the amount of advances received, and the amount of retentions. These disclosures help users understand how much revenue and profit have been taken to date and the financial position of ongoing contracts.
A brief illustration
A contractor takes on a fixed-price contract for ₹100 lakh, with estimated total costs of ₹80 lakh (expected profit ₹20 lakh). By the end of year one, costs of ₹40 lakh have been incurred — 50% of total estimated costs. Under the percentage of completion method, the contract is 50% complete, so the contractor recognises ₹50 lakh of revenue and ₹40 lakh of cost, giving ₹10 lakh of profit in year one — half the total expected profit, matching the half of the work done. If, however, midway the contractor realised total costs would actually be ₹110 lakh against revenue of ₹100 lakh, the entire expected loss of ₹10 lakh would be recognised immediately, not spread over the remaining work.
How AS 7 relates to Ind AS 115
There is an important framework difference here. Under the AS framework, construction contracts are governed by AS 7 with its percentage of completion method. Under the Ind AS framework, there is no separate construction-contracts standard — construction contract revenue is dealt with under Ind AS 115, Revenue from Contracts with Customers, which applies a single five-step model to all revenue, including construction. Ind AS 115 recognises revenue as performance obligations are satisfied, which may be *over time* (similar in effect to percentage of completion, where the criteria for recognising over time are met) or *at a point in time*. So the AS framework keeps a dedicated construction standard, while Ind AS folds construction into its general revenue standard. The recognition-over-time concept in Ind AS 115 produces results broadly comparable to percentage of completion in many construction situations, but the analysis and criteria are framed differently.
Common pitfalls
Recurring issues include recognising revenue without a reliable basis for the stage of completion; failing to recognise an expected overall loss immediately (instead spreading it); including general administration or selling costs in contract costs; and not revisiting estimates of total contract cost as the contract progresses, so that the percentage of completion is based on outdated figures.
Why this is cleaner on a unified system
Construction-contract accounting depends on tracking contract costs accurately and relating them to estimated total costs and revenue — which is far more reliable when project costs, purchasing, payroll for site labour, and the ledger all sit in one connected system. When cost data flows directly from source into the contract records and the accounts, calculating the stage of completion and recognising revenue and any expected losses is based on a single, consistent set of figures rather than reconciled across separate tools.
This article is a detailed educational summary of AS 7 in plain language. It is not a substitute for the full text of the standard. Accounting standards are amended from time to time; always verify the current, authoritative text of AS 7 as issued by the ICAI before relying on it, and consult a qualified chartered accountant for application to your specific circumstances.