A road and bridges contractor publishes its third-quarter result. Revenue is up 18%, the operating margin is up ninety basis points, and the concall opens with a paragraph about execution discipline. An analyst who has been following the company checks the obvious sources of the improvement and finds none of them: no new project reached the revenue stage, no rate was renegotiated, no order was added, the physical progress reported to the client is in line with the previous quarter, and the cost incurred in the quarter is almost identical to the cost incurred in the one before. Then a line in the notes explains it. The company has revised its estimate of the total cost required to complete two large contracts. Nothing about the work changed. What changed is a forecast of money that has not yet been spent — and on a contract accounted for over time, that forecast is the divisor of the fraction that decides how much revenue exists.
A mason is building a wall for a fixed ₹1,200. He said it would take a thousand bricks, and he has laid six hundred, so he is 60% done and has earned ₹720 of the price. Now he decides the wall actually needs only nine hundred and fifty bricks — better bonding, less waste. He has laid no additional bricks. But six hundred out of nine hundred and fifty is 63%, so on his own way of keeping score he has now earned ₹758. The customer has not paid a rupee more and the wall is exactly as tall as it was.
This is not a trick; it is the only workable way to report a job that spans several reporting dates. Progress on a long contract is measured by inputs consumed against inputs expected, and revenue is the contract price multiplied by that fraction. Which means the estimate of total expected cost is not a footnote about the future. It is a live input into the current period's revenue and profit.
How revenue on an unfinished contract is computed
Since accounting periods beginning on 1 April 2018, revenue in India has been governed by Ind AS 115, which replaced the separate older standards for construction contracts and for revenue generally. Its central question for a contractor is whether the customer obtains control of the work as it is performed. For most construction, engineering and long-cycle manufacturing under a customer's specification, the answer is yes — the asset is being built on the customer's land or to a design the customer alone can use — so revenue is recognised over time rather than at delivery. The standard then requires the company to choose a method of measuring progress towards completion and to apply it consistently.
- An output method measures what has been produced — kilometres surfaced, units certified, milestones signed off by an engineer. It is the more objective of the two and it is the less common, because on a complex project the outputs are not reliably measurable until late.
- An input method measures what has been consumed — costs incurred, labour hours, machine hours. The overwhelmingly common version in Indian contracting is the cost-to-cost method: progress equals costs incurred to date divided by the total costs expected at completion.
- Both are estimates, and one of them has a management-controlled denominator. Under the cost-to-cost method, revenue to date is the contract price multiplied by a fraction whose bottom half is a forecast. Nothing improper follows from that. What follows is that the forecast has to be read as part of the profit, because arithmetically it is.
- Contract price
- The transaction price, including any variable consideration that meets the recognition test — the subject of the fifth lesson in this module
- Cost incurred to date
- Actual, recorded, auditable. The reliable half of the fraction
- Total estimated cost at completion
- Cost incurred to date plus the estimated cost to complete. A forecast, revised at every reporting date
Example: Revenue for the period is revenue to date less revenue already recognised. So a revision to the denominator changes revenue to date immediately, and the whole of that change lands in the period the revision is made.
Why the correction is invisible, and where to look instead
A revised forecast of cost is a change in accounting estimate, not the correction of an error, and the two are treated in opposite ways. An error is corrected retrospectively — prior periods are restated and the reader can see what happened. An estimate is revised prospectively: earlier periods stand as reported, and the entire cumulative effect of the new estimate is absorbed by the current period. That is the correct treatment and it is also why an optimistic estimate never announces its own reversal. The gain arrives as a good quarter and the reversal arrives, if it arrives, as a bad margin in a period nobody connects to it.
- 1Compare margin against physical progress, not against revenue
Most contractors disclose physical or financial progress on major projects somewhere — the presentation, the management discussion, the concall. A quarter in which reported revenue growth outruns reported physical progress is the pattern this lesson describes, and it is the only external check that does not depend on the company's own estimate.
- 2Read the note on significant estimates and judgements
Every set of Ind AS accounts carries one, and for a contractor the cost to complete long-term contracts is almost always in it. The note will not give you the numbers, but it will tell you whether a revision was made in the year, and companies that revise regularly tend to say so in comparable language each time.
- 3Read the key audit matters
Estimation of costs to complete is one of the most frequently reported Key Audit Matters for Indian contractors, precisely because the auditor cannot verify a forecast. What the auditor describes as the procedures performed tells you how much of the estimate rests on management representations.
- 4Watch the tail of finished projects
A company whose estimates run optimistic produces a recognisable signature over time: strong margins in the middle of large projects and weak margins in the closing stages of them. Aggregate margins can look stable while this happens, because a new project in its middle years offsets an old one in its tail. It stops working when the new projects stop arriving.
A contractor lowers its estimate of the total cost to complete a fixed-price contract. The cost actually incurred during the quarter is unchanged. What happens to the quarter's reported revenue and margin on that contract?
₹1,200 crore ka fix daam ka kaam, cost ka andaza ₹1,000 crore — yaani ₹200 crore profit. ₹600 crore kharch ho gaya, toh 600÷1,000 = 60% kaam, revenue ₹720 crore, profit ₹120 crore. Ab company kehti hai design badal gaya, total cost ₹950 crore hogi. Is saal ₹160 crore kharch hua, kul ₹760 crore. Ab 760÷950 = 80% → revenue ₹960 crore tak, yaani is saal ₹240 crore aur profit ₹80 crore (33.3%). Purane andaze pe 760÷1,000 = 76% → is saal ₹192 crore aur profit ₹32 crore (16.67%). Ek eent zyada nahi lagi, aur ₹48 crore profit aa gaya. Aur agar andaza galat nikla aur cost phir ₹1,000 crore hui? Bacha hua kaam zero margin pe hoga — kyunki poora ₹200 crore pehle hi gin liya gaya.
- For work the customer controls as it is performed, revenue is recognised over time, not on delivery.
- The common Indian method measures progress as cost incurred over total estimated cost at completion.
- The denominator is a forecast, so revising it changes this period's revenue and margin with no change in work done.
- A change in estimate is prospective: no restatement, and the whole cumulative effect lands in the current period.
- An optimistic estimate reverses as a zero-margin tail on the finished contract, years later and under another explanation.
Mark it done to track your progress through the curriculum.