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Liquidated Damages in case of construction contract be capitalized ?

Aurabinda Sil (Additional General Manager ( F&A) ) (53 Points)

13 January 2020

Liquidated Damages are deducted from construction contracts(New Electrical Sub station construction) from contractors bill for delayed construction / completion. Question is whether such LD deducted will be capitalized, i.e. LD be adjusted with CWIP (CWIP value being reduced by this LD amount ) or this LD amount be shown/treated as 'Other Income' in accounts ?

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yasaswi gomes (My grammar is 💯 good I) (7290 Points)
Replied 03 May 2020

My assumption about this is, this is an onerous contract and a loss will be expensed as the contract costs are exceeding revenues maybe. The borrowing costs will be capitalised only to the extent of the WIP irrespective of the delay. The liquidation damages are defined as, the damage charges which are set aside anticipating them. That means LD are provisions. It cannot be treated as other income. Finally, coming to the treatment of CWIP, please refer to the construction contracts standard. LD cannot be shown as other income because, this is a provision, meaning a liability, while CWIP is an asset.

Revenue under IND AS is defined as:

“Contract Revenue
Contract revenue comprises the initial amount of revenue agreed in the contract; and variations in contract work, claims, and incentive payments, to the extent that they may result in revenue. These need to be capable of being reliably measured.”

Similarly, LD can be setoff against CWIP in the form of contract costs if the standard permits. The meaning of contract costs is:

“Contract costs shall consist of:

Costs that relate directly to the specific contract.
Costs that are attributable to contract activity in general and can be allocated to the contract.
Such other costs as are specifically chargeable to the customer under the
terms of the contract.”