CBDT’s Revised “Income Computation and Disclosure Standard III (ICDS 3)” relating to Construction Contracts applicable from the AY 2017-18 (corresponding to AS-7 issued by the ICAI)
This Income Computation and Disclosure Standard is applicable for computation of income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” and not for the purpose of maintenance of books of accounts.
In the case of conflict between the provisions of the Income-tax Act, 1961(‘the Act’) and this Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.
1. This Income Computation and Disclosure Standard should be applied in determination of income for a construction contract of a contractor.
2(1) The following terms are used in this Income Computation and Disclosure Standard with the meanings specified:
(a) “Construction contract” is a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and includes :
(i) contract for the rendering of services which are directly related to the construction of the asset, for example, those for the services of project managers and architects;
(ii) contract for destruction or restoration of assets, and the restoration of the environment following the demolition of assets.
(b) “Fixed price contract” is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which may be subject to cost escalation clauses.
(c) “Cost plus contract” is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a mark up on these costs or a fixed fee.
(d) “Retentions” are amounts of progress billings which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified.
(e) “Progress billings” are amounts billed for work performed on a contract whether or not they have been paid by the customer.
(f) “Advances” are amounts received by the contractor before the related work is performed.
2(2) Words and expressions used and not defined in this Income Computation and Disclosure Standard but defined in the Act shall have the meaning respectively assigned to them in the Act.
3. A construction contract may be negotiated for the construction of a single asset. A construction contract may also deal with the construction of a number of assets which are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.
4. Construction contracts are formulated in a number of ways which, for the purposes of this Income Computation and Disclosure Standard, are classified as fixed price contracts and cost plus contracts. Some construction contracts may contain characteristics of both a fixed price contract and a cost plus contract, for example, in the case of a cost plus contract with an agreed maximum price.
Combining and Segmenting Construction Contracts
5. The requirements of this Income Computation and Disclosure Standard shall be applied separately to each construction contract except as provided for in paragraphs 6, 7 and 8 herein. For reflecting the substance of a contract or a group of contracts, where it is necessary, the Income Computation and Disclosure Standard should be applied to the separately identifiable components of a single contract or to a group of contracts together.
6. Where a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when:
(a) separate proposals have been submitted for each asset;
(b) each asset has been subject to separate negotiation and the contractor and customer have been able to accept or reject that part of the contract relating to each asset; and
(c) the costs and revenues of each asset can be identified.
7. A group of contracts, whether with a single customer or with several customers, should be treated as a single construction contract when:
(a) the group of contracts is negotiated as a single package;
(b) the contracts are so closely interrelated that they are, in effect, part of a single project with an overall profit margin; and
(c) the contracts are performed concurrently or in a continuous sequence.
8. Where a contract provides for the construction of an additional asset at the option of the customer or is amended to include the construction of an additional asset, the construction of the additional asset should be treated as a separate construction contract when:
(a) the asset differs significantly in design, technology or function from the asset or assets covered by the original contract; or
(b) the price of the asset is negotiated without having regard to the original contract price.
9. Contract revenue shall be recognised when there is reasonable certainty of its ultimate collection.
10. Contract revenue shall comprise of:
(a) the initial amount of revenue agreed in the contract, including retentions; and
(b) variations in contract work, claims and incentive payments:
(i) to the extent that it is probable that they will result in revenue; and
(ii) they are capable of being reliably measured.
11. Where contract revenue already recognised as income is subsequently written off in the books of accounts as uncollectible, the same shall be recognised as an expense and not as an adjustment of the amount of contract revenue.
12. Contract costs shall comprise of :
(a) costs that relate directly to the specific contract;
(b) costs that are attributable to contract activity in general and can be allocated to the contract;
(c) such other costs as are specifically chargeable to the customer under the terms of the contract; and
(d) allocated borrowing costs in accordance with the Income Computation and Disclosure Standard on Borrowing Costs.
These costs shall be reduced by any incidental income, not being in the nature of interest, dividends or capital gains, that is not included in contract revenue.
13. Costs that cannot be attributed to any contract activity or cannot be allocated to a contract shall be excluded from the costs of a construction contract.
14. Contract costs include the costs attributable to a contract for the period from the date of securing the contract to the final completion of the contract. Costs that are incurred in securing the contract are also included as part of the contract costs, provided
(a) they can be separately identified; and
(b) it is probable that the contract shall be obtained.
When costs incurred in securing a contract are recognised as an expense in the period in which they are incurred, they are not included in contract costs when the contract is obtained in a subsequent period.
15. Contract costs that relate to future activity on the contract are recognised as an asset. Such costs represent an amount due from the customer and are classified as contract work in progress.
Recognition of Contract Revenue and Expenses
16. Contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date.
17. The recognition of revenue and expenses by reference to the stage of completion of a contract is referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed.
18. The stage of completion of a contract shall be determined with reference to:
(a) the proportion that contract costs incurred for work performed upto the reporting date bear to the estimated total contract costs; or
(b) surveys of work performed; or
(c) completion of a physical proportion of the contract work.
Progress payments and advances received from customers are not determinative of the stage of completion of a contract.
19. When the stage of completion is determined by reference to the contract costs incurred upto the reporting date, only those contract costs that reflect work performed are included in costs incurred upto the reporting date. Contract costs which are excluded are:
(a) contract costs that relate to future activity on the contract; and
(b) payments made to subcontractors in advance of work performed under the subcontract.
20. During the early stages of a contract, where the outcome of the contract cannot be estimated reliably contract revenue is recognised only to the extent of costs incurred. The early stage of a contract shall not extend beyond 25 % of the stage of completion.
Changes in Estimates
21. The percentage of completion method is applied on a cumulative basis in each previous year to the current estimates of contract revenue and contract costs. Where there is change in estimates, the changed estimates shall be used in determination of the amount of revenue and expenses in the period in which the change is made and in subsequent periods.
22.1 Contract revenue and contract costs associated with the construction contract, which commenced on or after 1st day of April, 2016 shall be recognised in accordance with the provisions of this standard.
22.2 Contract revenue and contract costs associated with the construction contract, which commenced on or before the 31st day of March, 2016 but not completed by the said date, shall be recognised based on the method regularly followed by the person prior to the previous year beginning on the 1st day of April, 2016.
23. A person shall disclose:
(a) the amount of contract revenue recognised as revenue in the period; and
(b) the methods used to determine the stage of completion of contracts in progress.
24. A person shall disclose the following for contracts in progress at the reporting date, namely:—
(a) amount of costs incurred and recognised profits (less recognised losses) upto the reporting date;
(b) the amount of advances received; and
(c) the amount of retentions.