1.24 Query
Exhibition of work-in-progress in accounts
1.A Government of India undertaking, is a contracting organisation which undertakes fabrication of tanks and vessels in its workshop apart from undertaking contract jobs at site for fabrication and erection of tanks and vessels, gas holders, structural works, fabrication and laying of transmission lines etc. The contracts involve a period of completion of more than one year in most cases and the cost incurred in incomplete contracts is carried forward to the next accounting year as work-in-process.
2.The accounting method followed for such contract jobs is the percentage of completion method. The company has adopted the policy of recognising only 50% of the proportionate profit to the stage of completion (if the progress is above 75%) out of the total estimated profit expected to be realised. However, losses anticipated at the end of the completion of the contract are recognised and provided for in proportion to the stage of completion.
3.According to the querist, the work-in-progress is valued on the basis of accepted accounting principles. Even in the case of contracts which are mechanically completed 100% and expenses relating to the contract have been incurred in full and no further expenditure is envisaged, for want of completion of formalities of like handing’ over and acceptance of the equipment/contract works, acceptance by the client of rates for items not covered in the agreement (extra items), acceptance of rates for excess quantities (quantities in excess of agreed variation) for which rates have to be finalised by mutual discussion etc., the company is unable to bill the clients for the work completed. In such cases though the work is 100% complete, the company is carrying the unbilled portion (at cost or realisable value, whichever is lower) as work-in-progress.
4. Typical cases of contract conditions which prevent the company from billing the client immediately on completion of the work are as under:
“(a) Contract for laying water mains
Method of fixing rates for extra items and additional quantities and payment thereof
If the additional or altered work includes any class of work for which no rate is specified in the contract then such work shall be carried out at the rates specified for similar items of work in the agreement. In the absence of similar items in the agreement, rate shall be as specified for similar items in the schedule of rates of the Board prevalent at the time of making such additions and alterations, plus or minus the overall percentage of original tendered rates over the current schedule of rates of the year in which the tender is accepted as mentioned in sub-clause (ii) above. With regard to item/items of work which is/are similar or not, in agreement/in the S.R. of the Board, the decision of the project engineer shall be final and binding on the contractor.
In case when such items of work are not to be found in the schedule of rates as approved by the Board, the rates payable shall be worked out with reference to the data of costs of all materials and labour as reflected by the current market conditions in the opinion of the Chief Engineer with due provision for 25% overheads including all profits. This clause is not negotiable.
(b) Contract for Fabrication of Storage Tanks
Terms of Payment Schedule
(a) Plate Work
(i) 10% on approval of drawings (ii) 25% against fabrication (iii) 20% against erection (iv) 25% against welding (v) 5% against radiography clearance (vi) 5% against successful completion of hydrotest (vii) 10% against final acceptance.
(b) Structurals
(i) 10% against approval of drawings (ii) 50% against supply of raw materials (iii) 15% against fabrication (iv) 15% against erection, alignment and welding (v) 10% after final acceptance.
(c) Calibration
(i) 90% on completion of calibration (ii) Balance 10% on presentation of calibration charts”
In the case of category (a) above, though the company had completed the work of fabricating and laying transmission lines and handed over the same to the client and transmission lines are now in use, the company could not bill the client for want of completion of formalities with regard to the fixing of rates for extra items and additional quantities as well as ascertaining the price escalation allowable to it as per the contract. Because of this the company could not treat the contract as completed and had to carry an amount of about Rs. 63 lakhs as work-in-progress as on 31.3.1985 despite the fact that the work was complete in all respects and the Project Managers had certified it as 100% complete.
As regards the category (b), as per the terms of the contract, the company could bill the customers for the balance 10% of the contract value only after final acceptance and presentation of calibration chart. Though physically and from the financial point of view, the work was complete 100% by 31st March, 1985, the company could bill the client for the final 10% only in May, 1985 on presentation of the calibration chart which had to be arranged through the good offices of the client with Central Public Works Department as per statutory requirements. In the circumstances, the value of unbilled contract work was carried forward as work-in-progress as on 31.3.1985.
5.The querist has expressed his view that in the above two cases as well as in other similar cases, it will not be correct to debit the client with unbilled portion of the total contract value until such time the company is in a position to bill them as per the contractual terms and completion of the formalities listed therein. This has created a peculiar situation where, even though the work with regard to these contracts have been completed 100% and no additional financial commitment is involved, the company was left with no alternative but to carry forward the unbilled portion as work-in-progress.
6.The company has now been advised that a work which has been completed 100% cannot be carried as work-in-progress, even if the company is not in a position to bill the party for want of completion of certain formalities as above, as per contractual obligations. At the same time, it would not be correct to debit the unbilled portion also to the client’s account and remove the same from contract work-in-progress so long as the company is not in a position to bill the client.
7.The querist has expressed his view that it would appear that the practice adopted by the company in carrying the unbilled portion as work-in-progress despite the fact that the contract is 100% complete may not be strictly correct. It would also be incorrect to debit the client’s account and exhibit such unbilled portion also as ‘Sundry Debtors’ in the final accounts. In this context the querist has informed that Engineers India Ltd., is exhibiting such unbilled amounts under ‘other current assets’, as a separate item “Income due but not billed (as per contracts)” under the main head ‘Current Assets, Loans and Advances’. This practice, according to the querist, appears to be more appropriate in the circumstances.
8.The opinion of the Expert Advisory Committee has been sought as to the most appropriate method of exhibition of such unbilled amounts in the balance sheet. Opinion July 23,1986
1.The Committee notes from the facts of the query that there are two typical types of contracts, the performance of which is fully completed viz.,
(i) Contracts in respect of which certain amounts could not be billed because of finalisation of rates of (a) items not covered in the agreement, (b) excess items supplied to the customers etc. The method of determination of rates in respect of such items has been laid down in the terms and conditions of the contract, which is not negotiable. The unbilled amounts on such contracts apparently represent the amounts pertaining to the said items.
(ii) Contracts in respect of which 10% of the contract value could not be billed pending completion of certain formalities, e.g. handing over and acceptance of equipment, presentation of calibration charts etc.
2.The Committee notes that the principles of revenue recognition on construction/service contracts are laid down in Accounting Standard 7 (AS-7) on ‘Accounting for Construction Contracts’ and Accounting Standard 9 (AS-9) on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India.
3.According to AS-7, “under the percentage of completion method, the amount of revenue recognised is determined by reference to stage of completion of the contract activity at the end of each accounting period (para 9.1)…… The stage of completion used to determine revenue to be recognised in the financial statements is measured in an appropriate manner. For this purpose no special weightage should be given to a single factor; instead, all relevant factors should be taken into consideration; for example, the proportion that costs incurred to date bear to the estimated total costs of the contract, by surveys which measure work performed and completion of physical proportion of the contract work (para 9.2)…… progress payments and advances received from customers may not necessarily reflect the state of completion………(Para 9.3)”.
4. According to AS-9, “In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.”
5.In brief, revenue can be recognised on construction contracts, which are accounted for under percentage of completion method, on the following basis:
(i) the stage of completion of contract activity; and
(ii)no significant uncertainly exists regarding the amount of the consideration that will be derived from the contract.
6.From the facts of the query the Committee notes that the contract activity is physically hundred percent complete on both types of contracts mentioned in para 1 above, particularly, in cases where the equipment under contract has been handed over to the customer and is being used by him. Also, as mentioned in the query, no additional costs have to be incurred on such contracts. In view of this the Committee is of the view that such contract can be considered to be fully complete for the purpose of the consideration at para 5 (i) above. However, with regard to the consideration at para 5 (ii), significant uncertainty may exist in respect of payment of liquidated damages, performance guarantees, price escalations etc. this is a matter of fact to be determined in the actual circumstances of a case.
7.On the basis of the above, the Committee is of the opinion that in respect of contracts which are fully completed in physical as well as economic sense but which are not handed over to the customers and/or significant uncertainty exists regarding the amount of consideration including the unbilled amounts, revenue related to unbilled amount should not be recognised and that such contracts should be shown as “Finished contracts not yet handed over/billed” under current assets in the balance sheet. However, with regard to the contracts which are fully completed in physical as well as economic sense and are handed over to customer for use and no significant uncertainty exists regarding the amounts of consideration including the unbilled amounts, revenue can be recognised and the unbilled amount can be shown as “Revenue due on contracts but not billed”, under the head. ‘Other Current Assets’ in the balance sheet. _________________________
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