26 January 2024
As per AS7 of ICAI: When an uncertainty arises about the collectability of an amount already included in contract revenue, and already recognised in the statement of profit and loss, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense rather than as an adjustment of the amount of contract revenue.
Now my questions are: 1. how should i classify(group) this expense? does it fall under direct or indirect expense. please note that the uncollectability arises due to final measurement and not a bad debt situation. 2. Incase the revenue is recognised during mid year reconstiution of firm should i follow the above guidelines if the adjustment is to be done in the same accounting year? Example: the construction contract was taken up during april 2023. Reconstitution of firm happens on Dec,2023 and at that time the initial contract amount was recognised as revenue, now the work finished on Jan., 2024 itself and during final measurement slight variation in amount is noticed and that necessitate an adjustment of recognised revenue. Now given that this whole thing is happening in the same accounting year and year end profit and loss is not prepared yet, but mid year p&l due to reconstitution was prepared, shouldi i follow the Accounting guideline qouted above and recognise the uncollectable amount as expense or adjustment of revenue is permitted? if expense need to be recognised, will it be a direct expense or indirect?
06 July 2024
Let's address your questions based on the principles outlined in AS 7 (Construction Contracts) issued by ICAI:
1. **Classification of Expense**: - The expense arising from uncertainty about the collectability of an amount already included in contract revenue is typically classified as an indirect expense. This is because it represents a cost incurred due to operational activities or adjustments that affect the overall profitability of the contract or business. - In your case, where the uncollectability arises due to final measurement adjustments and not due to a straightforward bad debt scenario, it still falls under the category of an indirect expense. The expense is incurred in the course of executing the contract or finalizing contract revenue, impacting profitability indirectly.
2. **Timing and Recognition in Mid-Year Reconstitution**: - When a contract is reconstituted mid-year (in your example, due to firm reconstitution in December 2023), and adjustments to contract revenue are necessary (such as due to final measurement differences), AS 7 guidelines apply. - According to AS 7, if there is uncertainty about collecting an amount already recognized as revenue and included in the statement of profit and loss, the uncollectable portion should be recognized as an expense rather than adjusting the amount of contract revenue. - Since the adjustments are occurring within the same accounting year, and a mid-year profit and loss statement has already been prepared due to reconstitution, you should follow the guidelines of AS 7. This means recognizing any uncollectable amount as an expense in the profit and loss statement for the period where the adjustment is identified.
3. **Expense Recognition**: - The expense related to the uncollectable amount should be recognized in the profit and loss statement for the accounting period where the adjustment is made. This ensures that the financial statements accurately reflect the impact on profitability for that period. - Whether the expense is classified as direct or indirect depends on its nature and relation to the contract activities. Typically, expenses related to contract adjustments, including uncollectable amounts arising from final measurement adjustments, are treated as indirect expenses.
In conclusion, for your construction contract scenario: - If there is uncertainty about collecting an amount already recognized as revenue and included in the profit and loss statement, recognize the uncollectable portion as an expense according to AS 7. - Follow these guidelines even if adjustments occur mid-year due to reconstitution, ensuring that the financial statements reflect the correct profitability impact for the period involved.
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