The order was won in a good year. Steel was cheap, the bid was aggressive because three competitors were bidding the same package, and the contract was lump sum turnkey — one price for the whole job, the contractor carrying the design and the input cost. Eighteen months in, structural steel is 40% dearer than it was on the bid date, the tonnage required has not changed, and the price in the contract has not moved by a rupee. The project is half built. What happens next in the accounts is the single most asymmetric piece of machinery in contract reporting: the entire expected loss on the contract, all of it, has to go into this period, even though half the work has not been done. The corresponding good news, when an estimate improves, is recognised only in proportion to the work completed.
You agree to supply lunch to an office for a year at ₹90 a box. Four months in, vegetables and oil have risen enough that each box costs you ₹104. You know, in month four, that the remaining eight months will lose money. Any sensible person accounts for the year, not for the month — the contract is a loser and pretending otherwise for eight more months does not make it one for less.
Accounting takes the same view and takes it immediately. Once total expected cost exceeds total expected revenue, the contract is onerous, and the whole of the expected shortfall is recognised at once rather than as it is suffered. It is prudence, it is correct, and it produces quarters where a single project detonates a whole year's profit.
Who carries the input cost, and how the contract says so
| Contract type | Who bears an input cost rise | What to look for |
|---|---|---|
| Fixed price, or lump sum turnkey | The contractor, entirely. One price for a defined scope, including design responsibility in a turnkey job | The margin is set at bid date, and every input movement after it belongs to the contractor — which runs both ways, since a fall in steel or fuel widens the same margin and is exactly the revision the previous lesson describes. Bids won in a cheap-input year are the ones to date |
| Cost-plus | The client. The contractor recovers allowable cost plus a fee or a percentage | A low but stable margin, and a business whose risk sits in the definition of allowable cost rather than in prices |
| Item rate with a price variation clause | Shared, on a formula. The rate is adjusted for movements in named indices from a stated base date | The formula, the indices used, and above all the portion of the contract value the formula does not apply to |
| Fixed price with a back-to-back supply contract | Passed to the supplier, if the terms genuinely match and the supplier survives | Whether the supply contract runs for the same period as the main contract. A two-year supply arrangement behind a four-year job is a hedge with a hole in it |
The asymmetry, in one contract
What this means when reading a contractor's year
- Date the order book against input prices. Orders won in a year when a major input was cheap carry the risk of the years that follow. A contractor whose book is dominated by fixed-price work bid two years ago is a different proposition from one bidding today, at today's prices, with today's knowledge.
- Find the provision line and read the movement, not the balance. Provisions for onerous or loss-making contracts are disclosed in the provisions note with a movement table — opening, created, used, reversed, closing. Provisions created tells you what management concluded this year; provisions used tells you what it is actually spending; provisions reversed tells you which earlier conclusions it has changed its mind about.
- A large reversal is not automatically good news. Reversing a provision credits the profit and loss account. If a company creates provisions generously in strong years, when it can afford the charge, and reverses them in weak ones, when the credit is needed, the earnings line has been smoothed by a judgement, and the pattern is visible only in the movement table across five years.
- Check whether the loss provision and the claim are the same story told twice. A contractor that provides for a loss and simultaneously recognises a claim against the client for the same cause has taken the charge and part of the recovery in one period. That can be right. It is also the arrangement most likely to require a second charge later, and the fifth lesson in this module is about the recovery half of it.
- Separate a bid problem from a cost problem. Input inflation hits everybody in a sector at once, so a contractor whose contracts turn onerous when its peers' do not has usually bid differently rather than bought differently. That is a pricing discipline question and it recurs, because the same people bid the next cycle.
A fixed-price contract is 50% complete when the contractor concludes that total costs will exceed the contract price by ₹60 crore. How much of that expected loss is recognised now, rather than as the remaining work is performed?
₹800 crore ka fix daam ka kaam, cost ka andaza ₹700 crore — ₹100 crore profit. Pehla saal: ₹280 crore kharch, 40% kaam, revenue ₹320 crore, profit ₹40 crore. Doosre saal steel 40% mehnga: naya andaza ₹860 crore, yaani poore contract mein ₹60 crore ka nuksaan. Kharch ₹430 crore, 50% kaam, revenue ₹400 crore tak — toh is saal revenue ₹80 crore par cost ₹150 crore, ₹70 crore ka nuksaan. Aur bacha hua ₹30 crore ka provision aaj hi — kul ₹100 crore ek saal mein. Aadha kaam bacha hai, par poora ₹60 crore ka nuksaan aaj likh diya (+40 −70 −30 = −60). Ulta case yaad rakho: andaza sudhre toh sirf jitna kaam hua utna hissa milta hai. Buri khabar poori, achhi khabar hisse mein.
- In a lump sum turnkey contract the contractor carries the input cost and the design, at a price set on the bid date.
- A price variation clause covers named components and weights, often excludes a portion of contract value, and tracks an index rather than your cost.
- Once total expected cost exceeds total expected revenue the contract is onerous and the whole expected loss is recognised at once.
- A favourable revision is recognised only in proportion to progress — the treatment is deliberately asymmetric.
- Read the provisions movement table, not the balance: created, used and reversed each answer a different question.
Mark it done to track your progress through the curriculum.