Contract costing

Calculation of cost of a contract and profit/loss incurred on it.

1. Contract Costing Mahesh Chandra Sharma Associate Professor, Department of Commerce Shaheed Bhagat Singh Evening College (University of Delhi) Delhi (India)

2. Contract A contract is usually assigned by a contractee to a contractor to  construct a building, Road, bridge, plant etc. for an agreed amount which is called contract price. Contractor: A person or a firm which has been awarded a contract for construction of a building/plant etc. Contractee: A contractee is a party who has given a contract to a contractor to complete a big job. Contract Price: The price agreed to be paid by a contractee to a contractor as a consideration for completion of a job.

3. Payment of Contract Price Lumpsum payment: Full payment of contract price is made in lumpsum either at the beginning or on completion of the contract as per terms. Progressive payment: It is made in instalments as a fixed percentage of the value of work certified by the architect/engineer/surveyor of the contractee. Certification is done at regular intervals. For example 80% of the work certified.

4. Contract Costing and Job Costing Contract costing : Contract costing is a special form of job costing. The main difference between a job and a contract are: Size : Contract is a big job. More time period is required to complete a contract than a job. Activities are performed within the factory area in a job while the same are performed outside factory area in case of a contract. Contract costing is used by building contractors, ship builders and others to ascertain cost of a contract and find profit earned or loss incurred in a contract. Job Costing is done by a manufacturing concern doing job work.

5. Contract Account Contract account is a nominal account, prepared to calculate profit or loss on a contract at the end of accounting year or on completion. A separate contract account is prepared each contract in the books of contractor in General Ledger or in the Contract Ledger (In case a large number of contracts are undertaken by a contractor.) Contract account is debited with all direct and indirect expenditure incurred in relation to the contract. Contract price is credited to the contract account on completion of the contract. The balance amount represents the profit earned or loss incurred on the contract and is transferred to Profit and Loss A/c.

6. Contract Costing – Some Terms Cost-plus Contract: Cost plus contract is a type of contract in which the contractee agrees to pay to the contractor the cost price (usually Prime cost) of the work done on the contract Plus an agreed percentage thereof by way of overhead expenses and profit. Sub-Contract: In certain cases the contractor may entrust some portion of the work to a sub contractor. For example: electricity fitting, wooden work, etc. Cost of sub contract is debited to the Contract A/c

7. Contract Costing – Some Terms Extras: In certain cases the contractee may require some additional work to be done or alterations to be made in the work originally agreed under the contract. These are called extras and the contractee is required to pay for them. If extra work is substantial , a separate account should be maintained for the same. If extra work is not substantial , the cost of such work may be debited to the contract a/c and the price charged for the same be credited to the contract a/c ( Contractee’s A/c)

8. Contract Costing – Some Terms Cost Escalation Clause: In certain cases there may be an escalation clause in the contract.  As per this clause, in case prices of items of raw materials, labour etc. specified in the contract increase during the execution of the contract, beyond a certain limit over the prevailing prices at the time of signing agreement, the contract price will be suitable adjusted as per terms. This amount is credited to the contract A/c (By Contractee’s A/c – Cost Escalation). Penalty: If a penalty is charged by the contractee from the contractor for defective work or delay in the execution, the amount may be deducted from the contract price.

9. Work-in-Progress I f the contract is incomplete, then the value of work done on the contract on a particular date is called ‘work-in-progress’. It includes: Work certified:   It is the value of work so far done and approved by the contractee’s architect/surveyor or engineer who issues a certificate stating the value of the work done so far. Work uncertified:   Work done after the date of certification up to the last day of the accounting year but not certified or approved by the contractee’s architect or serveyor is called as ‘work uncertified’. It is usually valued on the basis of prime cost or works cost.

10. Treatment of Materials and Plant Dr Contract Account Cr. Particulars Amt . Particulars Amt . Materials issued from store Materials purchased Materials transferred from other site Materials returned to store Materials sold (at cost) Materials transferred to other site Materials lost/destroyed (at cost) Materials at site Plant issued from store Plant purchased Plant transferred from other site Hire charges of plant Plant returned to store (Cost – Dep.) Plant sold(Cost – Dep.) Plant tfd . to other site (Cost – Dep.) Plant lost/destroyed (Cost – Dep.) Plant at site (Cost – Dep.)

11. Treatment of Labour /Expenses/Overheads and Contract Price Dr Contract Account Cr. Particulars Amt . Particulars Amt . Labour Paid + Outstanding Expenses Paid + Outstanding Overheads Paid + Outstanding Contractee’s A/c (Contract Price) Profit & Loss A/c (Profit) Profit & Loss A/c (Loss) Note: Balancing figure of the Contract account will be profit or loss.

12. Incomplete Contract Dr Contract Account Cr. Particulars Amt . Particulars Amt . Profit c/d (Estimated Profit or Notional Profit ) Work-in-Progress: Work Certified Work Uncertified Profit & Loss A/c (Profit transferred)* Work-in-Progress A/c (Reserve) Profit b/d XXX XXX

13. Incomplete Contract (calculation of Profit & Reserve) If there is a loss, then the whole amount of loss (irrespective of work certified) shall be transferred to Costing P & L A/c. If work certified is less than 1/4 th of the Contract Price – No profit shall be transferred to the P & L A/c

14. Incomplete Contract (calculation of Profit & Reserve) If work certified is 1/4 th or more but less than ½ of the Contract Price, 1/3 of the total estimated profit as reduced by the percentage of cash received shall be transferred to the P & L A/c * Profit = Total Estimated Profit If work certified is ½ or more of the Contract Price, 2/3 of the total estimated profit as reduced by the percentage of cash received shall be transferred to the P & L A/c * Profit = Total Estimated Profit  

15. If Contract is near Completion ( Calculation of Profit & Reserve) On the basis of Notional Profit (as disclosed by the Contract A/c) Profit to be transferred to P & L A/c = Notional Profit Profit to be transferred to P & L A/c = Notional Profit  

16. If Contract is near Completion ( Calculation of Profit & Reserve) If Contract is near Completion, then first find the total estimated cost = Cost incurred + estimated cost to be incurred to complete the contract. Then find Estimated Profit = Contract Price – T otal Estimated Cost On the basis of Total Estimated Profit (Contract Price – Total Estimated Cost) Profit to be tfd to P & L A/c = Estimated Profit Profit to be tfd to P & L A/c = Estimated Profit