CONTRACT COSTING

Contract costing is one of the method

of job costing.
Contract costing is a form of specific
order costing which applies where
work is undertaken according to
special requirements of customers
and each order is of long duration.
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• It is also known as “terminal costing” as the
preparation of contract account is terminated
or closed after the completion of the contract.
• The contract costing is used when the job is
big & spread over long period of time.
• This method of costing is used by builders, civil
engineering contractors, ship building,
construction & mechanical engineering firms.
 Features of contract costing
• A contract mainly consists of construction
activities.
• A contract work generally is of long duration
extending beyond a financial period.
• The work of contract is carried at the customer’s
site, away from the factory premises.
• A contract is undertaken as per the customer’s
special requirements.
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• Each contract is independent & quite different
from another. A distinct number is assigned to
each contract like job to differentiate from one
another.
• Plants , machineries & equipment may be
specifically purchased for a contract or hired for
the duration of the contract.
• To find out the profit earned from each contract
a separate contract account is prepared &
maintained.
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• The completion date is pre-fixed & penalties
follow delays.
• If a contract is not completed at the end of the
accounting period, only a portion of profit is
transferred to the profit & loss account on the
basis of the stage of completion of the contract.
• Certain aspects of the work may be assigned to
sub – contractors.
 Difference between job costing & contract
costing
• Site for work:- job costing work is carried out in
the premises whereas the contract is carried
out at the site.
• Duration:- the duration of job costing is smaller
than that of contract work
• Payment of price:- the price under job costing
is paid only after the completion of the job
whereas in contract costing it is paid in different
instalments on certain basis before the
completion of work
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• Investment :- initial investment in assets is low in the
case of job costing as compared to contract costing
where the preliminary investment in assets is very high.
• Allocation & apportionment :- the allocation &
apportionment of overheads cost is simpler in contract
costing as compared to job costing.
• Transfer of profits:- the entire amount of profit earned
is transferred to profit & loss account in case of job
costing whereas on the basis of degree of work
completed, a part of profit earned is transferred to P&L
a/c & remaining will be kept as reserves in contract
account
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• Cost unit:- in case of job costing an order or
batch of products may be treated as cost unit
whereas each contract is a cost unit in contract
costing.
• In job costing, a cost if first allocated cost
centre & then charged to individual jobs
whereas in contract costing most of the
expenses are of direct nature & hence directly
charged to the respective contract account.
 The contract costing procedure
• A contract involves 2 parties:-
• Contractor:- is a person or an organisation
who undertakes to perform the contract
• Contractee :- Is a person / organisation who
assigns the contract work to the contractor.
• The contractor usually maintain a contract
ledger in which a separate contract is opened
for each contract.
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• The following steps are involved in the contract
costing procedure:-
a) Separate number:- each contract is allotted a distinct
number
b) Charging costs:- all costs relating to a particular
contract are charged to the respective contract
account.
c) Collection of costs:- most of the costs of contract can
be allocated directly. All such costs are debited to
the contract account. Indirect cost can also be
absorbed on some arbitrary basis
 Accounting treatment
• 1. Material cost:-
• Direct material :- most of the materials like
bricks, cement, steel etc are sent to the site.
Their cost are identified & debited to the
contract account.
• Store material:- store materials are received
through material requisition from the central
store. The cost of same should also be debited
to the respective contract account.
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• Material on site:- the cost of material on site is
estimated & credited to the contract account.
It is carried forward to the next year by
debiting to the contract account as an opening
balance.
• Material returned to the stores :- cost of
material so returned should be either
deducted from material issued or credited to
the contract account
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• Normal loss of material:- cost of material loss
gets included in the cost of contract
• Abnormal loss of material:- transferred to the
profit & loss a/c & credited to contract a/c
• 2. Labour cost:- the labour cost is debited to
the contract account. The contract account is
prepared on accrual basis, therefore all the
wages paid as well as outstanding for the
current period are charged to the contract a/c
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• 3. Overhead cost:-
• A) Direct allocation :- most of the expenses
incurred in connection with a contract can be
directly identified with each contract.
• B) Apportionment :- head office expenses will
require an apportionment to various contracts
on some equitable basis
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• 4. Treatment of plant & machinery:-
• When the plant is taken on hire, the hiring charges
are debited to the contract account.
• If the plant is specifically purchased for a contract,
the cost of plant & machinery is debited & written
down value at the end is credited to the contract
account
• If a part of the plant is damages / lost the cost of
such part should be credited to the contract account
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• If part of plant is lost after using it for the current
period, the written down value of the plant should
be credited to the contract a/c
• If plant /equipment has been purchased or sent
from central store for a particular contract there
are 2 ways of treatment:-
• 1. contract a/c may be debited with the cost of
plant sent to the site & then credited with it’s
depreciated value at the end of accounting period
or when it is moved back to store after its use
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• 2. depreciation may be calculated based on
the period for which the plant has been used
at the contract site during the accounting year
& debited to contract account.
• 5. sub contracting :- the price paid for sub
contracting should be charged to main
contract
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• 6. Work certified & work uncertified:-
• In contract work , a surveyor or an architect is
appointed to inspect & monitor the work. At the
end of the period, the surveyor verifies the value
of the work completed till the end of the period.
• Value of work certified:- it is the value of that
portion of the work in progress that has been
certified or approved by contractee’s architect.
The amount of work certified is valued at contract
price & hence include an element of profit
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• Cost of work uncertified:- this is that portion
of work in progress which is not certified by
the architect. It is valued at cost & thus
doesn’t include an element of profit in it.
• 7. contract price:- It is the price agreed
between the contractor & contractee for the
completion of contract. It is credited to the
contract account, if contract is completed.
 Continuation..
• 8. Progress payment:- A contract involves
large amount of expenditure & require long
period for it’s completion, hence payment by
the contractee are made at various stages of
completion based on the architects certificate.
• The payment received by the contractor are
credited to the personal account of the
contractee, such payment are not suppose to
be entered in the contract account.
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• 9. Retention money:- retention money is like
security against defective work in future. It is
usually a certain % of amount certified for
payment by the architect.
• 10. Treatment of expected loss:- whenever
certain future losses can be foreseen on a
particular contract then a provision should be
made in the year of such estimation.
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• 11. Profit/ Loss on contract:- the balance of
contract account represents profit / loss which
is transferred to profit & loss account. But if
the contract is not completed within the
accounting year, only a part of the profit is
transferred & the remaining profit is kept as
reserve to meet any contingent loss which
may arise on the completion of the remaining
contract.
Calculation of profit on incomplete contract

• 1. Calculation of notional or total estimated

profit = Value of work certified + cost of work
uncertified – cost of work done till date
(hence notional profit is ascertained out of the
value or work certified)
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• After ascertaining notional profit, a portion of such
profit can be transferred to the profit / loss account
of the year
• The portion of the notional or total estimated profit
to be transferred to profit/ loss account can be
calculated on the basis of the following rules:-
a) When an incomplete contract (whatever is the stage
of completion) is disclosing a loss in an accounting
year: in this case entire amount of loss is to be
transferred to P&L account
 Continuation..
• b) When the work on the contract has not
reasonably advanced, i.e the value of work
certified is less than ¼ th of the contract
price:- the whole amount of notional profit is
kept in work in progress reserve account , in
other words no profit should be taken to the
credit side of P&L account
 Continuation...
• c) When the work on the contract has reasonably
advanced:- there can be 2 cases
• If the value of work certified is ¼ or more but less
than ½ of the contract price, the amount of profit
to be taken to P&L account is determined by using
either of the following formula:-
1/3 x notional profit
OR
1/3 x Notional profit x cash received/ work certified
 Continuation..
• If the value of work certified is ½ or more than
½ of the contract price, the amount of profit to
be taken to profit & loss account is determined
by using either of following formula:-
1) 2/3 x Notional profit
OR
2) 2/3 x Notional profit x Cash received/ Work
certified
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• For the contracts which are almost complete, a
proportion of the estimated total profit is credited to
P&L account. This proportion is estimated by
adopting any one of the following formulas:-
1. Estimated profit x Work certified/ Contract price
2. Estimated profit x Work certified/ Contract price x
Cash received / work certified
• When the contract is fully complete the entire profit
or loss can be transferred to P&L account.
 Format of contract account
Particulars Amount Particulars Amount
To materials - By work in progress -
Work certified
Cost of work
uncertified
To wages - By cost of material -
damages
To plant - By material in hand -
To overheads - By plant in hand -
To profit transferred -
to P/L account

Reserve - -
 Format of balance sheet
Liabilities Amount
P&L Account profit
(- ) abnormal loss
(+) abnormal gain
Wages outstanding
Assets Amount
Building
Material
Work in progress
Work certified
(+) work uncertified
(-) reserve for
unrealized profit
(-) cash reserve
form contractee