For capital goods companies, the accounting implications of disruption are closely tied to long-cycle contracts, cost estimation, and project execution timelines. Changes in input costs and execution timelines may not immediately reflect in cash flows, but they can materially affect revenue recognition and provisioning.
Set out below are the key accounting areas requiring focused attention, followed by additional aspects that should be considered during the financial close.
Stage of Completion and Revenue Recognition (Ind AS 115)
For EPC companies and long-cycle manufacturing businesses, revenue is often recognised over time based on the percentage of completion.
Under Ind AS 115 (Revenue from Contracts with Customers), the method used to measure progress must faithfully depict the transfer of control. In an environment of cost escalation and execution uncertainty, the relationship between cost incurred and actual work performed may become distorted.
If higher input costs increase the cost base without corresponding physical progress, a cost-to-cost method may overstate revenue. Management may therefore need to reassess both the method of measuring progress and the assumptions underlying estimated total contract costs.
Onerous Contracts and Provisioning (Ind AS 37)
Fixed-price contracts are particularly exposed to cost escalation. Where the cost of fulfilling a contract exceeds the expected economic benefits, the contract becomes onerous under Ind AS 37.
A provision must be recognised for the expected loss, measured at the lower of the cost of fulfilment and the penalties for non-fulfilment. This assessment should be performed contract by contract.
Liquidated damages exposure should also be considered. Where delays in execution lead to contractual penalties, these form part of the unavoidable cost of the contract and should be included in the measurement of the provision.
Contract Escalation and Modification (Ind AS 115)
In response to rising input costs, companies may seek to renegotiate contract terms with customers. This may include price escalation clauses, revised timelines, or scope changes.
Under Ind AS 115, such changes must be evaluated to determine whether they constitute a contract modification and how they should be accounted for. Recognition of additional revenue based on expected renegotiation outcomes should be approached cautiously unless supported by enforceable contractual terms.
Borrowing Cost Capitalisation (Ind AS 23)
For projects involving qualifying assets, borrowing costs are capitalised under Ind AS 23. However, capitalisation should be suspended during extended periods in which active development is interrupted.
Where construction activity is materially slowed due to delays in components, logistics constraints, or execution challenges, management must assess whether the interruption is temporary or whether capitalisation should be paused for the affected period.
Other Aspects to Consider
In addition to the above, finance teams and auditors should also consider the following:
• Impairment indicators (Ind AS 36): Reduced order inflows or stressed project economics may indicate impairment of capitalised assets or project-related investments.
• Claims and variable consideration: Recovery claims for cost escalation or delay should be recognised only where it is highly probable that there will be no significant reversal.
• Cut-off for milestone billing: Delays in installation, commissioning, or customer acceptance may affect revenue recognition at the reporting date.
• Foreign exchange exposure (Ind AS 21): Import payables and export receivables should be remeasured at closing exchange rates.
• Going concern and liquidity: Companies with multiple stressed contracts may need to reassess cash flow forecasts and covenant compliance.
• SEBI LODR disclosures: For listed entities, material impacts on project execution or profitability must be disclosed in accordance with Regulations 30 and 33.
Closing Observation
For capital goods companies, the current reporting period requires careful reassessment of contract assumptions, cost estimates, and execution timelines. Revenue recognition and provisioning decisions are closely linked to judgments about how changing conditions affect future performance.
In this environment, early identification of stressed contracts and disciplined documentation of estimates will be critical. It would be useful to understand how others in the sector are approaching these assessments in practice.
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