Think of a builder who signs a ₹5 crore contract to build a commercial complex over 3 years. The big question in accounting: when does he recognise the ₹5 crore revenue — only when he hands over the keys, or a little each year as work progresses? AS 7 Construction Contracts answers exactly this. It mandates the Percentage of Completion Method (PCM) — you recognise revenue and costs proportionally as the contract progresses, not in a lump sum at the end.
Here's the core logic. Contract revenue includes the original contract price, variations (changes in scope approved by the customer), claims (extra amounts you expect to recover for unforeseen costs), and incentive payments (bonuses for finishing early). Contract costs include direct materials, labour, subcontractor charges, and attributable overheads. The stage of completion is usually measured as: Costs incurred to date ÷ Total estimated costs × 100. Multiply this % by total contract revenue, subtract revenue already recognised in prior periods — that's your revenue for the current year. Simple enough once you see it worked out.
Now, two critical special cases to know cold. First, foreseeable loss: if at any point you estimate the contract will result in a net loss (total costs > total revenue), you must recognise the entire expected loss immediately — no deferral allowed. This is the prudence concept in action. Second, uncertain outcome: when you genuinely cannot estimate the contract outcome reliably (often in early stages), recognise revenue only to the extent of costs recoverable (i.e., profit = zero), but keep expensing costs. This is different from a loss situation — you're not booking a loss, just being conservative. AS 7 does not permit the Completed Contract Method, which was the old approach. The ICAI has been very clear on this, and exam questions will test whether you apply PCM correctly even when the question tempts you toward a year-end recognition approach.