Contractor Limited, an Indian company, has a reporting currency of Indian Rupee (INR). The company enters a long-term construction contract with a US company. The entire contract revenue is denominated in US$. The company will also need to incur approximately 25% of the contract cost in US$. The company determines the stage of completion on the contract as a proportion of the total costs incurred to date to the total estimated contract costs.
The management intends to use the forward exchange rates in arriving at INR amounts for foreign currency revenue and costs. Do you agree with the approach suggested by the management?
According to AS 7 Construction Contracts, contract revenues are measured at the consideration received or receivable. The standard recognizes that the measurement of contract revenue is affected by a variety of uncertainties that depend on the outcome of future events. In the case of foreign currency revenue, one of the uncertainties pertains to exchange rate that will apply at the revenue recognition date. Similarly, in the case of foreign currency contract costs, the estimate of costs to be incurred considers the future exchange rates.
Typically, a forward rate is considered to be an appropriate representative of the expected future exchange rate. Keeping this in view and in the absence of any specific guidance in AS 7, we believe that the approach suggested by the management is appropriate. However, if the reliable forward rates are not available at the reporting date, the company may consider using the spot exchange rates.