[Opinion] Revenue Recognition as per Percentage Completion Method | Key Aspects to Consider Under Accounting Standard-7

CA Nitin Sharma & Rituraj Jain – [2024] 169 taxmann.com 656 (Article)

“You Can’t Build a Bridge and Count the Revenue at the Same Time!”

1. Introduction

• The Percentage Completion Method (PCM) is used for long-term construction contracts that take more than one year to finish. Instead of waiting until the project is complete, this method lets companies recognize revenue and costs as the work progresses.
• Each year, the company records the revenue based on how much of the project is completed, matching it with the costs incurred. In this way, the financial records reflects a clearer picture of the progress of the project over time.
• AS 7 states that the percentage completion method can only be used if it is possible to reasonably ascertain the cost of the contract as well as the amount of revenue it will generate.
• It also states that if the total costs of a contract are expected to be higher than the total revenue, the loss should be recognized and recorded as an expense immediately.

2. Glossary

• Construction Contract: A construction contract is an agreement specifically made for building an asset or multiple assets that are closely related in design, function, or purpose. It covers projects where the parts work together as a whole.
• Fixed Price Contract: In a fixed price contract, the price is agreed as fixed sum or a fixed rate per unit of output. In some cases, the contract may require the customer to pay additional sums to compensate the contractor against cost escalations.
• Cost Plus Contract: A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus percentage of these costs or a fixed fee.

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