1.17  Query:    

Applicability of Accounting Standard (AS) 7 to dredging contracts.

1. A company in the course of its business activities also undertakes land reclamation work involving, inter alia, filling the area with material dredged from sea/river beds. The construction of reclamation walls/bunds to contain the material dumped into the area to be reclaimed, as per the querist, is only incidental to dredging work. The work of construction of bunds to retain the dredged material being incidental to the company’s activity, i.e., dredging, which mainly involves civil works is offloaded to sub-contractors.

2. During the year 1992-93, the company undertook two reclamation contracts. In one case the construction of bund was the responsibility of the customer of the company and in the other case the construction of bunds was the responsibility of the company. The contract provided rates for dredging, and construction of bunds separately. In view of the volume of construction of bunds, this work was offloaded to sub-contactors. These two works were still in progress by the time the accounts for the year 1992-93 were closed, i.e., on 31.3.1993.

3. As per the querist, the government auditors during their audit of the accounts for the year 1992-93, observed that ‘future loss on construction contracts’ has not been provided for on these two contracts. However, the company is of the view that (i) dredging activities of the company do not fall under ‘construction contracts’, but fall under ‘service contracts’, (ii) in both the cases, the main work was dredging and bunds were only incidental to dredging, and (iii) in one case the construction of bunds was the responsibility of the customer and in the other the work relating to the bunds was ‘sub-contracted’ and therefore in both the cases, the question of loss to the company did not arise.

4. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)        Whether Accounting Standard (AS) 7, issued by the Institute of Chartered Accountants of India, is applicable to dredging contracts undertaken/dredging services provided by the company? Also, whether it is necessary to provide for foreseeable future losses on such contracts.

(b)        In case AS 7 is applicable whether it is applicable to the entire contract or limited only to portion of the activity relating to construction of bunds.

                                                                            Opinion                                      June 14, 1994

1. The Committee notes paras 3 and 4 of Accounting Standard (AS) 7 ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India, which read as follows:

“3.  For the purpose of this Statement a construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single project.  Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment.

4.  Contracts for the provision of services come within the scope of this Statement to the extent that they are directly related to a contract for the construction of an asset. Examples of such service contracts are contracts for the services of project managers and architects and for technical engineering services related to the construction of an asset.”

2.The Committee is of the view that contracts for undertaking land reclamation by performing dredging activities and/or construction of reclamation walls/bunds etc., come within the scope of Accounting Standard (AS) 7, as it result into construction of an asset, viz., reclaimed land, apart from walls/bunds.

3.  The Committee notes paras 17.4 and 19 of Accounting Standard (AS) 7, which require as follows:

“17.4    While recognising the profit under percentage of completion method, an appropriate allowance for future unforeseeable factors should be made on either a specific or a percentage basis.”

“19.  A foreseeable loss on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed.”

4.  On the basis of the above, the Committee is of the following opinion, in respect of the issues raised by the querist in para 4 of the query:

(a)        Accounting Standard (AS) 7, issued by the Institute of Chartered Accountants of India, is applicable to land reclamation contracts involving performance of dredging activities by the company. Accordingly, it would be necessary to provide for all foreseeable losses irrespective of the amount of work done and the method of accounting followed. Appropriate allowance for future unforeseeable factors, in case profit on such contracts is recognised as per percentage of completion method, should also be made as required under para 17.4 of Accounting Standard (AS) 7.

(b)        Accounting Standard (AS) 7 is applicable to entire land reclamation contract comprising dredging services and construction of reclamation walls/bunds etc.

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