1.29 Query
Valuation of work-in-process of long term construction contracts.
1 A government company is primarily engaged in the design and development, manufacture, repair and maintenance and overhaul of aircrafts, engines, related avionics and accessories and supply of spare parts mainly to Indian Air Force and other defence establishments on contract basis. The contract is entered into with Indian Air Force for each project. The normal duration of each project is around 10 years. The cycle time of manufacture for aircraft is 24 to 30 months. Substantial expenditure, including hundred percent towards material, is reimbursed by the customer as and when incurred. An account of material used projectwise is maintained and at the end of each project, the unused balance material, if any, being IAF’s property is surrendered to IAF. The company, is thus, mainly engaged in the execution of long-term projects.
2. As per the accounting policy of the company, which is, in the view of the querist, in accordance with Accounting Standard 2 (AS-2), issued by the Institute of Chartered Accountants of India, raw materials, components, stores and spare parts are valued at the “weighted average cost”, stock-in-trade is valued at “lower of cost or realizable value” and work-in-progress is shown at “cost or realizable cost or the evaluated value, whichever is less”.
3.The material content of the work-in-progress is shown at cost or realizable cost, whichever is lower. The overheads are loaded on the basis of absorption costing method. Under this method, work orders are loaded with cost on the basis of a composite man-hour rate of the factory which takes into account all overheads including general administration overhead, financing charges and other non-manufacturing overheads like head office expenses, R&D expenditure, indirect department expenses etc. In the considered opinion of the company, this method of valuation of work-in-progress could be continued as the company appears to fall in the category mentioned in para 5(iii) of Accounting Standard 2, which provides for exclusion of certain type of industries having long-term engineering projects/contracts.
4.The querist has requested the Expert Advisory Committee to confirm aforesaid understanding of the Accounting Standard 2 by the company with regard to inclusion of non-production overheads in the closing value of work-in-progress of long-term aircraft projects/contracts undertaken by the company.
Opinion May 23, 1989
1.The Committee notes that according to para 5(iii) of Accounting Standard 2 (AS) 2 on ‘Valuation of Inventories’, in respect of “Work-in-progress under long-term contracts, such as engineering, real estate development and construction projects”, AS 2 does not apply.
2.The Committee notes that para 2 and 3 of Accounting Standard (AS) 7on ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India, state as below:
2.The feature which characterises a construction contract dealt with in this Statement is the fact that the date at which the contract is secured and the date when the contract activity is completed fall into different accounting periods. The specific duration of the contract performance is not used as a distinguishing feature of a construction contract. Accounting for such contracts is essentially a process of measuring the results of relatively long-term events and allocating those results to relatively short-term accounting periods.
3. For the purposes 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.”
3.On the basis of the above, the Committee is of the view that for the purpose of valuation of work-in-progress of the company in question, AS-7 would be applicable.
4.The Committee notes that paras 8.7 and 8.8 of AS-7, recommend as below:
“8.7 Examples of costs that can be attributed to the contract generally, or that relate to contract activity but cannot be related to specific contracts, include;
(i) general administration and selling costs;
(ii) finance costs;
(iii) research and development costs;
(iv) depreciation of plant and equipment that cannot be allocated to a particular contract.
8.8 Costs referred to in paragraph 8.7 are usually excluding from the accumulated contract costs because they do not relate to reaching the present stage of completion of a specific contract. However, in some circumstances general administrative expenses, development costs and finance costs are specifically attributable to a particular contract and are sometimes included as part of accumulated contract costs.”
5.On the basis of the above, the Committee is of the opinion that although AS 2 is not applicable to the company, yet non-production overheads which are not specifically attributable to a particular contract should not be included in the valuation of work-in-progress. However, such overheads can be included in the valuation of work-in-progress where these are specifically attributable to the particular contract. ________________________
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