Introduction to Cost Costing: A Contract Accounting Approach

Contract costing is a specialized method of job costing used primarily in industries where work is undertaken on a large-scale, often long-term basis and specifically for a customer. It is commonly applied in sectors such as construction, civil engineering, shipbuilding, and infrastructure projects.

1. Contract Costing

2. Dr. Emon Kalyan Chowdhury Professor & Head Department of Accounting CIU Business School Director Institutional Quality Assurance Cell (IQAC) Chittagong Independent University Email: [email protected] Phone: [phone]

3. Contract costing Contract Costing is a special type of job costing where the unit of cost is a single contract. Contract itself is a cost center and is executed under the customer's specifications. Contract Costing is defined by the I C M A Terminology as "that form of specific order costing which applies where work is undertaken to customer's special requirements and each order is of long duration. The work is usually of constructional nature."

4. Contract costing Contract Costing is also termed as ''Terminal Costing." The principles of job costing are applicable to contract costing and is used by such concerns of builders, public works contractors, constructional and mechanical engineering firms and ship builders etc. who undertake work on a contract basis.

5. Features of Contract Costing The cost unit is a specific contract. Each contract takes a long time to complete. The work being of a constructional nature, the same is executed at customer's site, as per his specifications. Bulk of the materials purchased and delivered direct to the contract site or obtained from the central stores through the requisition slips. Generally specific portions of the contract are given to sub-contractors.

6. Features of Contract Costing Most of costs which are normally treated as indirect can be identified specifically with a particular contract and are charged to it as direct costs. Overheads constitute only a very small proportion of the cost of the contract. However, indirect costs consist mainly of administrative cost of the central office. Scale of operations and cost control becomes difficult due to theft of materials, labour time utilization, pilferages etc. The pay roll is prepared either at the site or at a central administrative office.

7. Recording Cost Contract/Costing Procedure Each contract has a separate contract account . Contract costs include: Direct materials Direct labor Direct expenses Overheads Plant & Machinery Sub-contracts Used to monitor Work in Progress and Profit/Loss .

8. Recording Cost Contract or Costing Procedure Contract Account is debited for: Materials purchased directly for the contract. Materials issued from central stores via requisition. Materials transferred from another contract. Value of unused materials at site (closing inventory). Contract Account is credited for: Materials returned to stores. Materials sold at site. Materials transferred to other contracts. Materials lost (e.g., fire, theft). Return of unused materials after contract completion.

9. Recording Cost Contract or Costing Procedure Material Costs – Profit/Loss Adjustments Differences between sale price and cost → Profit or Loss . Losses due to fire/theft → charged to P&L. Such gains/losses transferred to Profit & Loss Account . Labour Costs Labour engaged directly at contract site. Wages and salaries for site workers. Treated as Direct Labour Costs . Debited to Contract Account.

10. Recording Cost Contract or Costing Procedure Direct Expenses Examples: Electricity, telephone, insurance at site. Architect’s or consultant’s fees. Sub-contracting charges. → Debited to Contract Account as Direct Expenses . Overhead Costs Usually a small portion of total contract cost. Office/admin overheads apportioned using: Labour hours Machine hours Percentage basis → Included in the Contract Account.

11. Recording Cost Contract or Costing Procedure Plant & Machinery Costs If plant purchased solely for contract → full cost debited; residual value credited after completion. If used temporarily → depreciation charged to Contract Account. Sub-Contracts Specialized work (e.g., painting, steel work) is outsourced. Usually on a cost-plus basis . → Debited to Contract Account as Direct Cost .

12. Recording Cost Contract or Costing Procedure Work Certified Verified by Surveyor/Architect. Payment made partially; balance retained as Retention Money (20%-30%). Ensures work is done per contract terms. Work Uncertified Completed work not approved for certification. Valued at cost . → Debited to WIP Account → Credited to Contract Account.

13. Recording Cost Contract or Costing Procedure Work in Progress (WIP) Includes: Work Certified Work Uncertified WIP = Asset on Balance Sheet. Deduct: Cash received Retention money Reserve for contingencies

14. Recording Cost Contract or Costing Procedure Treatment of Profit or Loss Incomplete Contracts: <25% Complete → No profit taken. 25–50% Complete → 50–90% Complete →  

15. Recording Cost Contract or Costing Procedure Profit on Near-Completion Contracts Use one of these formulas: Normal Profit =  

16. Recording Cost Contract or Costing Procedure Escalation Clause Protects against material/ labour price fluctuations. If prices rise, contract price adjusted as per pre-agreed formula. Helps maintain contractor’s profitability .

17. Recording Cost Contract or Costing Procedure Cost-Plus Contracts Contractee pays: Actual Cost + Stipulated Profit . Profit can be: Fixed amount, or Percentage of cost. Used when cost is unpredictable or long-term .

18. Recording Cost Contract or Costing Procedure Profits or Loss on Completed Contracts Upon completion: Total cost vs. contract price compared. Net profit/loss is calculated and transferred to P&L Account .

19. Conclusion Contract costing ensures: Accurate cost tracking Efficient cost control Reliable profit estimation It is crucial for businesses involved in large-scale, long-term projects .