Query No. 11

Subject:   

A. Facts of the Case

1. A company is setting up an integrated iron and steel plant.  The entire work for setting up the plant has been divided into several packages which have been awarded to different contractors for execution. 

2. The terms of payment in various contracts are as below:

      (i) For civil contracts

(a) 10% of total contract price as mobilisation advance shall be paid after signing of the contract, and subject to submission of pre-receipted invoice and bank guarantee.

(b) 80% of the total value of work executed shall be paid on monthly pro-rata basis subject to satisfactory progress of work and on certification of work by the purchaser (i.e., the company)/its consultants and on submission of certain documents.  Total value of works executed shall be arrived based on actual quantity of works executed as certified by the purchaser/consultant and unit rates applicable for such items of work.

(c) 10% of the contract price shall be paid on issue of completion certificate by the purchaser against submission of pre-receipted invoice and bank guarantee for equal amount valid till the expiry of maintenance and guarantee period.

      (ii) For supply contracts

(a) 10% of ex-works price towards supplies shall be paid as advance after signing of the contract.  Payment shall be released only after submission of a bank guarantee for equal amount valid till sixty days after the completion of supplies and having submitted the bank guarantee towards security deposit.

(b)75% of the ex-works price of the supplies and 100% of taxes, duties and freight on pro-rata basis subject to submission of requisite documents as per despatch instructions.

(c) 5% of the ex-works price after issue of preliminary acceptance certificate.

(d) 5% of the ex-works price after issue of commissioning certificate and submission of a fresh bank guarantee for 5% of total contract price towards guarantee/warranty valid till the expiry of guarantee/warranty period.

(e)  5% of the ex-works price after issue of final acceptance certificate.

      (iii) For erection and fabrication contracts

(a) 5% of the contract price as advance against submission of bank guarantee for equal amount and another bank guarantee towards security deposit for 10% of the total contract price.  Both the bank guarantees will be valid till sixty days after issue of commissioning certificate.

(b) 5% of the contract price after mobilisation of men and material handling equipment as approved by the purchaser/consultant to commence erection work at site and establishment of site office and stores.  The payment shall be released on receipt of a bank guarantee for equal value valid till sixty days after issue of commissioning certificate.

(c) 75% of the contract price on monthly pro-rata basis as per approved billing schedule subject to satisfactory progress of work as per milestones fixed and duly certified by purchaser/consultant on production of requisite documents.

(d)  5% of the contract price after issue of preliminary acceptance certificate.

(e)  5% of the contract price on issue of commissioning certificate and submission of a performance bank guarantee for 5% of the total contract price towards guarantee/warranty valid till the expiry of guarantee/warranty period.

(f)  5% of the contract price upon issue of final acceptance certificate.

3. The querist has reproduced the company’s accounting policy relating to capital work-in-progress which is as below:

“In accounting for the capital WIP, the portion that has been retained as per terms of contract is not accounted for till it becomes due for payment/release of amounts after completion of the job.”

4.  Keeping the above in view, the company accounts for capital work-in-progress in the following manner:

(a)   For civil works: 90% of the value of work completed and certified by the principal consultant is booked as capital WIP (being 10% towards adjustment of mobilisation advance and 80% towards progress payments).

(b)  For supply, and erection and fabrication contracts: 85% of the value of work completed or supply made as certified by the principal consultant is booked as capital WIP (being 10% towards adjustment of mobilisation advance and 75% towards progress payments).

(c)   The balance (10% or 15% of the contract price, as the case may be) is not accounted for till the issuance of preliminary acceptance certificate, commissioning certificate and final acceptance certificate as provided in the contract.

B. Queries

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

(a)   Whether the accounting policy followed by the company is correct.

(b)   Whether the method of accounting for capital work-in-progress is correct.

(c)   Whether the method of not accounting for 10% of the contract price in the case of civil contracts, and 15% of the contract price in the case of supply or erection or fabrication contracts, pending final certification is correct.

(d)   If the answer to (a) is in the negative, what should be the correct accounting policy and method of accounting to be followed by the company?

C. Points Considered by the Committee

6.  The Committee notes that Accounting Standard (AS) 7, ‘Accounting for Construction Contracts’, deals with accounting for construction contracts in the financial statements of contractors.  The present query, on the other hand, relates to certain issues relating to accounting for construction contracts from the view point of a contractee.  As such, AS 7 is not applicable to the present query.

7.  The Committee is of the view that the point of time when an enterprise should recognise an item as its asset is that when significant risks and rewards of ownership pass on to the enterprise.  In the present case, the company is accounting for capital work-in-progress in its books progressively over the period of the contracts without awaiting the completion of the construction work. The Committee presumes that as per the terms of the contracts, significant risks and rewards of ownership pass on to the company as the construction activity progresses and not at the time of completion of construction activities.

8.  The Committee is of the view that in the present case, the amount at which capital work-in-progress should be recognised by the company should reflect the stage of contract performance.  As the progress payments may not necessarily reflect the stage of contract performance, accounting for capital work-in-progress based on progress payments would not be appropriate.

9.  In order to recognise capital work-in-progress based on the stage of contract performance, it is essential that such stage should be capable of being reasonably estimated.  In this regard, the Committee notes that the stage of contract performance at a given point of time may comprise two elements: work certified by the company and work not yet so certified.  The Committee is of the view that as far as the work not certified is concerned, it should be included in capital work-in-progress only if a reliable estimate thereof can be made.  If such is not the case, the capital work-in-progress should be recognised based on the work certified only.

10.  The Committee notes that in respect of various kinds of contracts, the terms and conditions stipulate certain amount be given to the contractor after signing of the contracts as mobilisation advance.  The terms and conditions also provide for retention of certain amounts pending issuance of certain certificates.  Based on the facts available, the Committee is of the view that mobilisation advances to contractors and retention monies are not related to, and therefore do not reflect (except only incidentally), the stage of contract performance.

D. Opinion

11. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:

(a) The accounting policy followed by the company as described in paragraph 3 above is not correct.  The capital work-in-progress should reflect the stage of contract performance to the extent it can be measured reliably.

(b) Please see (a) above.

(c) Please see (a) above.

(d) Please see (a) above.

1 Opinion finalised by the Committee on 22.4.2000.