Variable consideration, uninstalled materials and a discounted contract variation
Nirmal Solar EPC Ltd has a single contract to design, build and commission a 250 MW solar plant for a state utility for ₹480 crore over 30 months from 1 April 20X4. The contract gives a bonus of ₹1.50 crore for each month of early completion, capped at ₹12 crore, and imposes liquidated damages of ₹2 crore per month of delay, capped at ₹18 crore. At 31 March 20X5 the project is five weeks behind programme because of a subcontractor's foundation work; engineers expect to recover most of the delay, but a one-month delay to completion is now the most likely outcome. Costs incurred to date are ₹156 crore, of which ₹52 crore relates to solar modules delivered to site and not yet installed. Total estimated costs to complete the contract are ₹390 crore. On 31 March 20X5 the utility signed a variation adding a 60 MWh battery storage system for ₹64 crore, a scope the company would normally sell for ₹78 crore; the battery system is distinct from the plant already built and will cost ₹58 crore to procure and install. The company has a long record of completing such contracts on time.
1. Determine the transaction price at 31 March 20X5, explaining the treatment of the bonus and the liquidated damages.
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Starting point: ₹480 crore of fixed consideration.
Completion bonus The bonus is variable consideration. It is included only to the extent that it is highly probable that a significant reversal will not occur when the uncertainty resolves. The project is already five weeks late and a one-month overrun is the most likely outcome, so the bonus is not highly probable - indeed it is improbable. The company's historical record does not cure the current, contract-specific evidence. Include nil.
Liquidated damages The LD clause is a price concession embedded in the contract, so it is variable consideration that reduces the transaction price, not a separate penalty expense. Estimate it using the expected value, which is appropriate for a portfolio of similar outcomes:
- 60% chance of one month: 0.60 × ₹2 crore = ₹1.20 crore
- 30% chance of two months: 0.30 × ₹4 crore = ₹1.20 crore
- 10% chance of no delay: nil
- Expected value = ₹2.40 crore The cap of ₹18 crore is not reached; the estimate is reasonably assured because the damages are contractual. Include ₹2.40 crore as a reduction.
Transaction price = ₹480 − ₹2.40 = ₹477.60 crore
Two cautions. If the delay were caused by the customer's land handover, relief or compensation could change the estimate. Any recovery from the subcontractor is a separate reimbursement right recognised against cost, never as revenue. Reassess both estimates at every reporting date.
2. Measure progress and compute revenue, cost and gross profit for the year to 31 March 20X5, explaining the treatment of the uninstalled modules.
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Why the modules are excluded from progress The 250 MW plant is a single performance obligation satisfied over time, measured cost-to-cost. Modules delivered to site but not installed do not depict the transfer of control or the entity's performance: the customer does not control them, they have not been incorporated into the plant, and no installation effort has been applied. Including them would inflate progress and pull forward margin that has not been earned.
Adjusted progress
- Costs incurred excluding uninstalled modules = ₹156 − ₹52 = ₹104 crore
- Total expected costs excluding those modules = ₹390 − ₹52 = ₹338 crore
- Progress = 104 ÷ 338 = 30.77%
Computation
- Revenue on installed work = 30.77% × ₹477.60 = ₹147.00 crore
- Add pass-through of the uninstalled modules at zero margin = ₹52.00 crore (the entity acts as principal and is exposed to the modules' price risk, so revenue equal to cost is recognised)
- Revenue = ₹199.00 crore; cost = ₹156.00 crore; gross profit = ₹43.00 crore
Check: 30.77% × (₹477.60 − ₹338) = ₹42.96 crore, the same margin.
Other points Only costs that contribute to progress enter the numerator; abnormal rework is excluded from the measure but still enters total expected cost. The net contract position (revenue recognised less amounts billed) is presented as a contract asset or contract liability, not netted against inventory.
3. Account for the battery storage variation and state the amounts to be recognised in future periods.
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Step 1 - Is it a separate contract? The battery system is distinct, but the additional consideration of ₹64 crore is not the stand-alone selling price of ₹78 crore, and the discount is not a price adjustment for unsatisfied original scope. It therefore cannot be accounted for as a separate contract.
Step 2 - Which modification route? The battery is distinct from the plant already transferred, so the existing contract is treated as terminated and a new contract created for the remaining work. (If the remaining work were not distinct, a cumulative catch-up would be required instead.)
Step 3 - New contract price and margin
- Unrecognised consideration on the original contract = ₹477.60 − ₹199.00 = ₹278.60 crore
- Add the variation consideration = ₹64.00 crore
- New contract price = ₹342.60 crore
- Remaining cost = (₹390 − ₹156) + ₹58 = ₹292.00 crore
- Expected margin = ₹50.60 crore (14.8%)
Step 4 - Recognition There is no immediate loss and no catch-up on the modification date. The ₹14 crore discount (₹78 − ₹64) is recognised over the remaining period as a thinner margin - 14.8% against the 19.1% that would have been earned on the balance of the original work. Had the battery been priced at stand-alone selling price, the new contract price would have been ₹356.60 crore and the margin ₹64.60 crore; the ₹14 crore difference is precisely the discount given. Continue to reassess the completion bonus and LD at each reporting date.