An infrastructure contractor raises its cost estimate on a contract that is 60% complete. How much profit is reversed this year, and what changes if the contract turns loss-making?

At a Rs 900 crore estimate, this year reverses Rs 60 crore: expected profit falls to Rs 100 crore, 60% of it is Rs 60 crore, and Rs 120 crore was already booked. At Rs 1,050 crore the contract loses Rs 50 crore, and the full loss is recognised immediately, so cumulative profit swings from plus Rs 120 crore to minus Rs 50 crore, a Rs 170 crore hit this year.

Under cost-to-costA way to measure progress on a long contract: cost incurred so far divided by estimated total cost gives the share of revenue to recognise. accounting, every year's revenue depends on the latest estimate of total cost. When the estimate changes, the method does not restate past years; it recalculates cumulative profit on the new estimate and puts the whole difference in the current year. A change in estimate is caught up in one year, so a small revision late in a contract can wipe out years of booked profit. Picture a tailor who charged for three quarters of a suit, then finds the cloth costs more; the correction lands on the day he notices.

Recompute from scratch. Rs 540 crore spent against Rs 900 crore expected is still 60% complete, so cumulative revenue stays at Rs 600 crore and cumulative profit is Rs 600 crore less Rs 540 crore of cost, Rs 60 crore. Rs 120 crore was booked last year, so this year shows nil revenue on the contract, Rs 60 crore of cost and a Rs 60 crore loss.

At Rs 1,050 crore the contract will lose Rs 50 crore in total. Progress falls to 51.4%, revenue to date to Rs 514.3 crore, and the work done shows a loss of Rs 25.7 crore. Accounting does not let the company spread the rest of the loss over future work: the remaining Rs 24.3 crore is provided now, as an onerous contractA contract whose unavoidable costs exceed the benefits expected from it. The expected loss is recognised as soon as it is foreseen.. Profits are recognised as earned; losses are recognised as soon as they are expected. That asymmetry is deliberate.

Look for the pressure before the revision. Contract assets, revenue recognised but not yet billed, growing faster than revenue is the classic warning: management has been booking progress the client has not agreed to pay for. A cost estimate that never moves on a three-year project is another; real projects drift. When a contractor's margins are suspiciously smooth across many contracts, the estimates are doing the smoothing. Ask how many contracts had estimate revisions this year and their total effect; well-run contractors disclose it.