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Study Note 9.1, Page 647-672

Study Note 9.1, Page 647-672

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Financial Accounting
This study note includes
Accounts for Miscellaneous Services
Computer Software Accounting
Accounts of Insurance Companies
Accounts of Banking Companies
Accounts of Electric Supply Companies.
1.In addition to usual final accounts, contractors prepare different Contract Accounts tofind out cost of each contract, work-in-progress and profit to be considered in case of eachcontract.(1)Accounting ProcedureContract Accounts for different work site are maintained in the Contract Ledger. Materi-als sent to the work site, wages to labourers engaged in that work site and any specialplant purchased for that particular work site are debited to the specific Contract Accountidentified by number or name. Materials may be sent to site by suppliers, or from themain stores or supplied by the Contractee. The overheads are charged to different Con-tract Accounts on the basis of some estimate. When the same plant is used at differentworksites appropriate depreciation on the basis of the period for which it is used in aparticular worksite is debited to that Contract Account.(II) 1.Contract Account should get the credit. On the other hand, if materials are sold out froma worksite, in addition to the credit to that Contract Account, profit or loss on sale of materials is to be transferred from that Contract Account, as this profit or loss should beshared by all contracts i.e., the amount is adjusted with Profit and Loss Account. Simi-larly, for accidental loss the Contract Account is credited as against Loss by AccidentAccount, which is cleared by transfer to Profit and Loss Account to the extent not cov-ered by Insurance Claim.2.At the end of the year the special plant, if any, is carried down at the estimated value, sothat difference between charging price and the price atwhich it is carried down remainscharged in that particular account. Similarly, the materials remaining at site are carrieddown. In addition to these, work certified and the work completed but not certified arecarried down. In the alternative, all these may be transferred to Work-in-Progress Ac-count. Some accountants, however, prefer to carry down materials and plant at site inthe Contract Account itself and to transfer work certified and work not certified to Work-in Progress Account. If Contract Account is given a break before considering certified oruncertified work, upto date cost of contract comes out.
Financial Accounting
3.Contractee usually makes payment upto a percentage of the work certified. The percent-age of certified work retained is know as retention of security 10% is usual security. If 2%earnest money was paid at the time of tender, 8% is deducted from Running Bills. Inaddition to 10% 2% 1. T. is also deducted.4.The amount received is credited to the Contractees Account. The amount certified, asalready noted, may be carried down in the Contract Account or may be transferred toWork-in-Progress Account. In the alternative, contractee may be debited as against Con-tract Account or Work-in-Progress Account with the certified work. When the contracteeis debited with certified work from the time to time the balance in the acccount representtotal retention amount. On the other hand, if the contractee is not so debited, then thecredit in his account represents advance payment to be adjusted by debit with contractvalue against the Contract Account on completion of the work.5.For valuation of uncertified work the materials used, wages and proportionate overheadsfor the work completed but not yet certified are considered.5.1Profit on Uncompleted ContractWhen the contract is not yet complete it is not proper to consider profit therein as earnedprofit, as nobody knows as to what will happen ultimately. It should be appreciated thatthe payments are in the nature of advance payments, and hence the contract is for theentire work and not for the part as such. However, if no profit is taken into considerationwhen the contract is for a lengthened period there is no profit for a number of years, andthere is a huge profit in the year of completion. To aviod this, an amount of profit esti-mated on a very conservative basis to have been earned in the current year is credited toP. & L. Account, the balance being carried forward or credited to WIP Account. No profitis considered if less than one-third is complete. But loss is always taken into consider-ation.5.IIThe estimate of profit in the current year may be either on (a) retrospective basis or on (b)prospective basis. The systems may be compared with the systems of valuation ~f liabili-ties under Life Insurance Policies. In any case the Contract Account may be balanced off after the items discussed above have been considered, the balance (say, Accounting Profit)being carried down. If there is loss at this stage, it is written off to Profit and Loss Ac-count.5.III.Under retrospective method the accounting profit as disclosed above is the basis of de-termination of profit in the current year. The percentage of payment is applied to theaccounting profit to convert it to cash or realised basis, as the profit is deemed to havebeen earned on the work certified. Usually one-third ( when half or more than one-third)or two-thirds (when more than half is complete) thereof is considered as profit to becredited to the Profit and Loss Account. Sometimes, an approximate reasonable ratiohaving regard to the extent of completion (certified value compared to contract value, orsometime, time spent compared to total time) is taken instead of the above one-third ortwo-thirds basis. The difference between accounting profit and profit credited to Profitand Loss Account is either carried down to Contract Account or is credited to WIP Ac-count. This method is most commonly used.
Financial Accounting
5.IV.Prospective method is applied when the work is going to be completed shortly. if theContract Account is balanced without considering certified work or uncertified work,the balance indicates cost incurred upto-date for certified and uncertified work. An esti-mate for further expenditure on materials, wages etc. for completion of the contract ismade. The amount of opening balances at site and the estimated sale or balance at site oncompletion must be considered for finding out estimated further cost for completion of the work. Net cost already incurred plus estimated future net cost will a mount to esti-mated total cost for completion of the work. Sometimes a contingency provision is madeto have estimated total cost ultimately. The contingency provision may be in terms of apercentage on the estimated total cost or on the estimated ultimate total cost.6The excess of the contract value over the estimated ultimate total cost is the estimatedtotal profit on the contract. A reasonable proportion thereof ( according to the extent of as discussed under prospective system above) is considered to be profit earned uptodate.If some profits have already been credited to Profit and Loss Account in earlier years, theexcess of estimated uptodate profit over the profits already considered is credited toProfIt and Loss Account in the current year. Sometimes, to be more conservative, theuptodate estimated profit is converted to realised profit on the basis of percentage of payment.(Ill) W. I. P. and Completion of Contract1..In valuation of Work-in Progress the certified work, uncertified work, materials and plantsat site are added and provision for unrealised profit is deducted. The valuation may beavailable from the Contract Account itself, from Work-in-Progress Account or from boththese accounts according to the nature of entries passed for considering the balances etc.In the alternative, uptodate net cost may be found as discussed under prospective sys-tem, and the profit considered in accounts is added up with net cost together with bal-ances at site to get the value of Work-in-Progress. If receipts are lying as advances inContractee’s Account the balance in Contractee’s Account is deducted from the Work-in-Progress Account. However, if the contractee’s balance is in excess of the value of Work-in-Progress, the accounts are shown on both the sides. At the beginning of thenext year Work-in-Progress Account is closed by transfer to particular Contract Accountfrom both sides separately.In the year of completion the accounting profit (or loss) as disclosed by the ContractAccount is transferred to Profit and Loss Account without any further calculation eitherby retrospective or by Prospective methods. The Contract Account is closed by credit toContract Account and debit to Contractee’s Account either with full value of contract orwith certified value of contract in that year according to the system followed so far.

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