ICDS IIIConstructio

n Contracts

BY Y.MADHURI DEVI Brahmayya & Co Chartered Accountants Vijayawada

1. Preamble

2. Construction contract

3. Contract revenue

4. Degree of completion

5. Contract cost

6. Exclusions of contract cost

7. Combining & Segmenting8. Act vs. ICDS9. Transitional provisions

10. Difference btw ICDS & AS-7

AGENDA

PreambleICDS III Applicability: With effect from 01/04/2015 and accordingly apply to

A.Y.2016-17 and subsequent years.

Purpose : This ICDS is applicable for computation of income chargeable under the heads “PGBP” and “IOS” and not for purpose of maintenance of books of accounts.

Retrospective or Prospective: ICDS III applies prospectively not retrospectively

ACT VS ICDS:When there was a conflict between Act and ICDS, Act will prevail over the standard.Scope of ICDS III:This standard is applied in determination of income for a construction contract of a contractor.

WHAT IS CONSTRUCTION CONTRACT ? It is a contract a) specially negotiated for the construction of assets or b) combination of assets that are closely interrelated in terms of design ,

technology and function or use and includes the following: i) Contract for rendering the services directly related to construction of asset ii)Contract for destruction (or )restoration of assets

TYPES OF CONTRACTS: For the purpose of ICDS there are two types of contracts. They are as follow:

TYPES

FIXED PRICE COST PLUS

Contractor agrees at a fixed contract price or fixed rate per unit of

output

Contract price=Cost + Markup

CALCULATION OF PROFIT/LOSS UNDER PERCENTAGE OF COMPLETION METHOD: REVENUE: Contract Revenue x Degree of completion

xxx Less: Contract Cost Incurred

(xxx) Cumulative Profits / Loss

xxx Less: Profit or loss of previous year

(xxx) Profit/loss of the year

xxx Contract Revenue: a) The initial amount of revenue agreed in the contracts including

retentions. b) Variations in contract work, claims and incentive payments:

(i) To the ex tent that is probable that they will result in revenue; and

(ii) They are capable of being reliably measured.

a) b)Probable outcome X Certainty

X Measurability X

Retention Money:“ Retentions “ are amounts of progress billings which are not paid until the

satisfaction of conditions specified in the contract for the payment of such amount or until the defects have been rectified.

“ Progress billings “ are amounts billed for work performed on a contract whether (or) not they have been paid by the customer.

CASE LAWS In CIT v. P&C Constructions' (P.) Ltd ( 2009) 318 ITR 113(Mad.) CIT v. Simplex Concrete Piles India (P.) Ltd.(1989) 45 Taxman 37 (Cal.)

judgments retention money is not taxable due to following reasons As retention money is repayable only after the satisfaction of conditions so it

could not be said that said amount had accrued to assesse at he time of contract and could not be taxed in assessee ‘s hand.

Moreover the right to receive retention money will not arises at the time of submission of bills.

In order to nullify the above judgments ICDS explicitly stated that

retention monies are part of contract and they are to be recognized as revenue on percentage of completion method.

What happens if Contract revenue recognized is subsequently unrealized?The unrealized amount should be recognized as expense and not as an adjustment of the amount of contract revenue. But practically it is not possible to follow, as books of accounts are prepared in accordance with standard and for the computation of income we are considering ICDS so in order to solve the situation Finance Act 2015 has amended the section 36(1)(vii) by inserting a new second proviso w.e.f A.Y 2016-17 the said new second proviso provides that:

or

and

ILLUSTRATION

Contract Price as per agreement is 10,00,000

Contract revenue recognized in books is 9,00,000 ( Due to non recoverability from the party)

For the purpose of computing income of the assessee in accordance with ICDS, income is

considered as 10,00,000 based on the contract price and accordingly assessee had paid tax on it.

In subsequent years it is very clear that amount of 1,00,000 is not recoverable from party.

Based on the non recoverability the assessee can claim 1,00,000 as an irrecoverable bad debt as

per provisions of section 36(1)(vii) in computation of total income.

Degree of completion: Cost incurred x 100 Total estimated contract cost (or) Surveyors of work performed. (or) Completion of physical portion of contract work. Note: Progress payments and advances received from customers are not

determinative of the stage of completion of contract.

Contract cost:

CONTRACT COST

Indirect

expenses

Direct

expenses

Borrowing cost

Cost to specifica

lly charged

to custome

r

Borrowing Cost: It was newly inserted by ICDS where the borrowing Costs for inventories that require a period of 12 months or more to bring them in to a saleable condition should be allocated as per ICDS 9 “Borrowing Cost”

Exclusions from contract costs: Incidental income: Any incidental income not being in the nature of : 1) interest 2) dividends 3) capital gains shall be deducted from contract costs. Costs that cannot be attributed to any contract activity shall be excluded. When costs incurred in securing a contract are recognized as an expense in the

period in which they are incurred they are not included in cost for subsequent years. Contract cost that relate to future activity are recognized as an asset and are

classified as contract work in progress. Payments made to subcontractors in advance of work performed under the sub-

contract.IllustrationContract cost incurred 9500Less: Contract cost recognized as contract expense as per ICDS III

9000( Estimated cost x DOC) Work in progress 500

EARLY STAGES OF CONSTRUCTION

During the early stages of a contract where the outcome of a contract cannot be estimated reliably,

Contract revenue is recognized only to the extent of the cost incurredThe early stage of a contract shall not extend beyond 25% of the stage of completion

RECOGNISATION METHODPercentage of completion method is applied on a “Cumulative basis” in each previous year to

the current estimates of contract revenue and contract costs.

Change in Estimates: Where there is change in estimate s, the changed estimates shall be used in determination of the amount of revenue and expenses in the period in which the change is made and in subsequent periods.

Prospective

Retrospective X

Combining and segmenting of construction contracts

ICDS III should be applied to the Separately identifiable components of a single contract ( Segmenting of contracts) (or) To a group of contracts together ( Combining of contracts)

Segmenting of contract:

Where a single contract covers a number of assets, the construction of each asset should be treated as a

separate construction contract when:

Separate proposals have been submitted for each asset

Each asset has been subject to

separate negotiation

The costs and revenues of

each asset can be identified.

A group of contracts , whether with a single customer or with several customers , should be treated as a single construction contract when:

The group of contracts is negotiated as a single package

The contracts are so closely interrelated that they are in

effect part of a single project with an overall profit margin

The contracts are performed concurrently or in a continuous

sequence.

Combining of contracts:

Creation of additional asset

Asset differs significantly in design technology from the asset or assets covered function the original contract ( or) The price of the asset is negotiated without having regard to the original contract price.

Treated as a single construction contract when

ACT VS ICDSWhen there was a conflict between Act and ICDS then “Act will prevails over standard”

43 CA vs ICDS IIIThe Finance Act, 2013 inserted section 43CA of the Act applicable from A.Y. 2014-15 which deals with the taxability of transfer of immovable properties, i.e., land or building or both in the nature of stock-in-trade. The primary intention of this provision is that sale value of a property held as stock in-trade should not be less than the value adopted for stamp duty purposes. These newly introduced provisions are identical to the provisions of section 50 cIllustration

Then contract price will be 10,50,000 not 10,00,000

ICDS III • Contract price in agreement including retentions is 10,00,000

43CA •Stamp value at the time of sale is 10,50,000

Transitional ProvisionContract revenue and contract costs associated with the construction contract, which

commenced on or before the 31 st day of March 2015 but not completed by the said date , shall be recognised as revenue and costs respectively in accordance with the provisions of the standard .

The amount of contract revenue , contract costs or expected loss, if any , recognised for the said contract for any previous year commencing on or before the 01/04/2014 shall be taken in to account for recognizing revenue and costs of the said contract for the previous year commencing on the 1/04/2015 and subsequent previous years.

Commenced on or before 31/03/2015 but not completed

F.Y 2011-12 F.Y.2012-13 F.Y. 2013-14 F.Y 2014-15

31/03/2015 Transitional Provision will apply

Contract commenced

on (or)before 31/03/2015

Contract cost and revenue

not recognis

ed

Contract cost and revenue recognis

ed

Recognize in accordance with the provisions of

this standard

Taken in to account in recognizing the

revenue and cost of the P.Y.2015-16 and subsequent years

Transitional Provision

Example 1:If contract started on 01/4/2013 and it was to complete with in 4 years . The contractor want

to follow completed contract method and does not recognize any revenue and costs. Contract price 10,00,000 Estimated contract cost 8,00,000 Surveyor has given degree of completion for 3 years i.e. from 01/04/2013-31/03/2016 as

30%,60%,80%. If transitional provision apply how to consider the costs and revenue in

F.Y.2015-16?Solution: If contract cost and revenue not recognised in earlier years recognize in

accordance with the provisions of this standard. Earlier year Current year Completed contract method Percentage of completion

methodMoreover ICDS III is applied prospectively and not retrospectively hence

the provisions of the standard is applicable to current year.By applying the provisions of standard current year income is calculated

as follows

Impact: Due to absence of prudence concept more revenue is recognised

although it relates to previous year. As per the accrual concept revenue and expenses is to be

recognised when it is occurred but recognizing earlier years income and expenses although it is not accrued questions the applicability of accrual concept.

2013-14 2014-15 2015-16Degree of completion 30% 60% 80%A. Contract revenue (10,00,000) Recognized = contract price x DOC

- - 8,00,000

B. Contract cost Estimated total cost x DOC(8,00,000)

- - 6,40,000

C. Cumulative profit (A-B) - - 1,60,000D. Profit of the year Cumulative profit – Profit of previous years

- - 160000

Example 2: If contract started on 01/4/2013 and it was to complete with in 4 years . The contractor want to follow percentage of completion method and recognizes corresponding revenue and costs. Contract price 10,00,000Estimated contract cost 8,00,000Surveyor has given degree of completion for 3 years i.e. from 01/04/2013-31/03/2016 as 30%,60%,80%. If transitional provision apply how to consider the costs and revenue in F.Y.2015-16?Solution: If contract cost and revenue are recognised in earlier years then Contract cost and revenue recognised should be taken in to account in recognizing the revenue and cost of the P.Y.2015-16 and subsequent years. Hence the solution is as follows.

2013-14 2014-15

2015-16

Degree of completion ` 30% 60% 80%A. Contract revenue Recognized = contract price x DOC

3,00,000 6,00,000

8,00,000

B. Contract cost Estimated total cost x DOC 2,40,000 4,80,00

06,40,000

C. Cumulative profit (A-B) 60,000 1,20,000

1,60,000

D. Profit of the year Cumulative profit – Profit of previous years

60,000 60,000 40,000

ICDS VS AS 7S.No Points for Comparison ICDS-III AS-71. Applicability This ICDS is

applicable for computation of income chargeable under the heads “PGBP” (or) “IOS” and not for purpose of maintenance of books of accounts.

This AS-7 is applicable for purpose of preparation of Financial statements.

2. Criteria for recognition of variations in contract work claims incentive payments

Not specified in ICDS III

Recognition criteria specified in AS 7

3. Contract cost which relate to future activity

Recognized as asset . If such costs are not realizable then it will be allowable under I.T.Act.

Recognized as an asset when it is probable that such costs are recoverable.

4. Retentions Retentions shall include in contract revenue

AS-7 is silent on retentions

ICDS VS AS 7

S.No Points for Comparison

ICDS-III AS-7

5. Recognition of contract costs and contract revenues with reference to percentage completion method

Contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date.

When the outcome of the construction contract can be estimated reliably, Contract revenue and contract costs associated with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date.AS7 specifies criteria as to when the outcome of the construction contract can be estimated reliably for fixed price contracts and cost

6. Reversal of contract revenue recognized

Before reversal of revenue ,the sum shall be written off in the books of accounts in

line with provisions of 36(1)(vii)

No such reversal is possible

ICDS VS AS 7S.No

Points for Comparison

ICDS-III AS-7

7. Borrowing costs Allocated Borrowing costs in accordance with ICDS 9 on Borrowing Costs

Shall not be included in contract costs

8. Netting of costs by incidental income.

All types of incidental incomes except in the nature of interest, dividend and capital gains are reduced from the contract costs.

All types of incidental incomes are reduced from contract costs.

9. Early stages of completion of contract .

During the early stages of contract where the outcome of the contract cannot be estimated reliably.Contract revenue is recognized only to the extent of costs incurred.The early stage of a contract shall not extend beyond 25% of the stage of completion.

During the early stages of contract where the outcome of the contract cannot be estimated reliably.Contract revenue is recognized only to the extent of costs incurred.No such percentage is mentioned.

10. Recognition of expected losses from contract

In proportion to percentage of completion.

To be recognized in full.

Illustration : Disallowance of expected losses There was a proposal to construct a residential

building which takes 2 years to complete , the particulars of contract was as follows ( In Lakhs)

• Contract Revenue – 100• Cost incurred during year 1 – 60• Estimated Total cost - 120• Degree of Completion at the end of year 1

– 50 % ( 60/120)• Cost incurred during 2nd year – 60• Degree of Completion at the end

of 2nd year – 100 % ( 120/120)

Note : Calculation of provision Year 1 Year 2Total estimated cost 120 120 (-) Total revenue ( 100) ( 100) Total loss 20 20(-)loss recognized (10) (20) Provision to made 10 _

Year 1 Books

ICDS

REVENUE: Contract Revenue x Degree of completion ( 100 X 50 %) 50 50

Less: Contract Cost Incurred till reporting date

60 60

Loss for the year ( 10) (10)Less : Provision for expected losses

( 10) -

Net loss for the year (20) (10) Year 2 Books ICDSREVENUE: Contract Revenue x Degree of completion ( 100 X 100 %)

100 100

Less: Contract Cost Incurred till reporting date (60+60)

120 120

Cumulative loss (20) (20)Less: loss of earlier years 20 10 Net loss for the year - ( 10)

Disclosure

1 •Amount of contract revenue recognized

2 •Method used to determine stage of completion

3 •Amount of cost incurred

4 •Recognized profits and losses up to reporting date

5 •Amount of advances received

6 •Amount of retentions

madhuridv77@gmail.com

Thank

you

By Y.Madhuri D

evi