Contract Costing Intro

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 centre 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.”

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.

It is a method of costing in which each contract is taken as a separate costing unit for the purpose of cost ascertainment and control. The objective is find out the Profit or loss on each contract separately. Contract costing is employed in business undertakings engaged in building construction, road construction, bridge construction, dam construction and other civil engineering works, ship building etc.

Contracts are generally of large size. A contract generally takes more than one year to complete. Work on contract is carried out at the site of the contracts and not in factory premises. Payments by the customer (contractee) are made at various stages of completion of the contract based on architects certificate for the completed stage.

 

Contract Costing is a special type of job c.osting where the unit of cost is a single contract. Contract itself is a cost centre 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.”

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.

 

SPECIAL FEATURES OF CONTRACT COSTING

The following are the special features of Contract Costing:

(1) The cost unit is a specific contract.

(2) Each contract takes a long time to complete.

(3) The work being of a constructional nature, the same is executed at customer’s site, as per his specifications.

(4) Bulk of the materials purchased and delivered direct to the contract site or obtained from the central stores through the requisition slips.

(5) Generally specific portions of the contract are given to sub-contractors.

(6) 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.

(7) 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.

(8) Scale of operations and cost control becomes difficult due to theft of materials, labor time utilization, pilferages etc.

(9) The pay roll is prepared either at the site or at a central administrative office.

 

Recording Cost on Contract or Costing Procedure

In contract costing, costs are allocated, collected and accumulated according to the contract works. Each contract is treated as a separate entity in which each contract account may be maintained separately or in general ledger itself for the purpose of costing and cost control. The following are the costing procedure for different costs relating to the important expenses :

Labor : In the case of contract costing, all labors engaged at site and the salaries and wages paid to the labor and workers are treated as direct labor cost is debited to Contract Account.

Direct Expenses: Most of the expenses like electricity, insurance telephone, postage, sub-contracts, Architect’s fees etc. can also be treated as direct cost is debited to Contract Account.

Overhead Cost: In the case of contract costing overheads incurred only an insignificant part of the total cost of contract account. The nature office and administrative expenses of a particular contract may be apportioned on suitable basis.

Plant and Machinery: For use of plant and machinery in a particular contract, the treatment of plant costs in any of the two ways:

(a) Where a plant has been specially purchased for a particular contract and will be exhausted at site Contract Account should be debited with the cost of the plant. On completion of the contract the residual or written down value as shown by the Plant Ledger will be credited “to the Contract Account.

(b) When the plant and machinery are required to the contract site only for a shorter period, the contract account should be debited with the notional amount of depreciation based on some estimates be charged to Contract Account.

Sub-Contracts: Sub-Contracts refer to some portions of the specified work connected with the main contract, to be done by the sub-contractor. For example, the work of painting, special flooring, steel work etc. may be given to the sub-contractors. Usually sub-contract has been undertaken on cost-plus basis and the cost of such sub-contract should be treated as a direct charge and is debited to Contract Account.

 

Work Certified: In the case of the small contracts which are completed within the shorter period, the contractor pays the contract price on the completion of the contract. In the case of contracts of long duration. the contract agreement provides interim payment to the contractor. It is done on the basis of certificates issued by the contractee’s Surveyor, Architect or Engineer. At the same time Contractee usually does not pay to the full value of the work certified. A portion of amount say 20% or 30% thereof shall be retained by the Contractee. The money so retained is called as “Retention Money.” This retention money is indented to ensure that the contractor to complete the work as scheduled and according to specifications. Money retained could also be used for imposing penalties for faulty or delayed work. This amount will be settled on completion of the contract.

 

 Work Uncertified : If the progress of a work is unsatisfactory or the work has not reached the stipulated stage, though certain work is completed, such work does not qualify for a certificate by the Contractee’s Architect or Surveyor is termed as “Work Uncertified.” It is valued at cost and credited to Contract Account and debited to Work in Progress Account.

 

 Work in Progress: Work in progress includes the amount of work .certified and the amount of work uncertified. The work in progress account will appear on the asset side of the balance sheet. The amount of cash received from the contractee and reserve for contingencies will be deducted out of this amount.

Treatment of Profits or Loss on Contracts Alc.

The accounting treatment of profits or loss of contracts in the following stages :

(A) Profit or Loss on incomplete contracts

(B) Profits or Loss on completed contracts

 

(A) Profit or Loss on Incomplete Contracts

To determine the profits to be taken to Profit and Loss Account. in the case of incomplete contracts, the following situations may arise :

(i) Completion of Contract is Less than 25% : In this case no profit should be taken to Profit and Loss Account.

(ii) Completion of Contract is upto 25% or more but Less than 50% : In this case one-third of the notional profit, reduced in the ratio of cash received to work certified, should be transferred to Profit and Loss Account. It can be expressed as :

 

contract costing 001 2nd year bcca

 

(iii) Completion of Contract is upto 50% or more but Less than 90% : In this case two-third of the notional profit reduced by proportion of cash received to work certified is transferred to Profit and Loss Account. The equation is

contract costing 002 2nd year bcca

 

(iv) Completion of Contract is upto 90% or more than 90%, i.e., it is nearing completion: In this case the profit to be taken to Profit and Loss Account is determined by determining the estimated profit and using anyone of the following formula :

contract costing 003 2nd year bcca

Escalation Clause: This clause is often provided in contracts as safeguard against any likely changes in price or utilization of material and labor. Such a clause in a contract would provide that in the event of a specified contingency happening, the contract price would be suitably enhanced by an agreed formula or factor.

This clause is particularly necessary where the prices of a certain raw material are likely to rise. where labor rates are anticipated to increase, or where the quantity of material and labor hours cannot be assessed properly or estimated unless the job has progressed sufficiently.

 

Cost-Plus Contract: These contracts provide for the payment by the contractee of the actual cost of manufacturing plus a stipulated profit. The profit to be added to the cost may be a fixed amount or it may be a stipulated percentage of cost. These contracts are generally entered into when at the time of undertaking of a work, it is not possible to estimate it’s cost with reasonable accuracy due to unstable condition of material. labor etc. or when the work is spread over a long period of time and prices of materials. rates of labor etc. are liable to fluctuate.

(B) Profits or Loss on Completed Contracts

When a contract is completed, the overall profit or loss on the contract is transferred to the Profit and Loss Account.

 

 

 

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