CONTRACT COSTING
Definition:
Contract costing is that method of costing in cost accounting which is used to collect and identify all the
expenses relating to a specific contract.
It is a way of providing a quotation for especially large and long term projects that will usually be
performed over a number of accounting periods.
The principles of job costing are applicable to contract costing and is used by such concerns of builders,
constructional, ship builders etc. who undertake work on a contract basis.
Types of Contracts.
Fixed Price Contract.
Cost Plus Contract.
Note: We will be doing accounting for Fixed Price contract only.
Fixed Price Contract:
Contracts given on lump sum fixed price is fixed price contract.
It generally includes an escalation clause
Cost Plus Contract:
All the cost incurred will be reimbursed by the contractee together with certain percentage or fixed
amount as commission.
Important Terms in Contract Costing
CONTRACTOR:
One who takes the Contract.
CONTRACTEE:
One who gives the Contract.
CONTRACT PRICE:
Fixed Price agreed by the parties as Consideration for the contract.
Work Certified
Value of work done by the contractor and accepted or certified by the contractee.
Work Certified will be on the basis of Contract price, and it will include profit element.
Work Un-certified
Cost of work done by the contractor but not certified by the contractee.
Work Uncertified will not include profit element.
Accounting for Fixed Price Contract
5 Steps to do Contract Costing.
i. Calculate Cost incurred.
ii. Calculate Notional Profit.
iii. Calculate Profit to be transferred to P/L & Reserves.
iv. Valuation of WIP.
v. Contractee Account.
Profit to be transferred to P/L will depend on Degree of Completion of contract.
Degree of Completion depends on Work Certified by the contractee.
Degree of Completion= (Work Certified ÷ Contract Price )× 100
Calculation of Profit to be transferred to P/L.
Degree of Completion Profit to be transferred to P/L Account
Less than 25% NIL
1/3× Notional Profit× (Cash Received÷ Work
25% or More but Less than 50% Certified)
Cash Basis
2/3× Notional Profit× (Cash Received÷ Work
50% or More Certified)
Cash Basis
Notional Loss :
At any time if there is Notional Loss instead of Notional Profit then full amount of loss will be
transferred to P/L irrespective of Degree of Completion.
Some Important Treatments.
Normal Loss of materials => NO ENTRY.
Abnormal Loss of Materials =>
Abnormal loss A/c …… Dr.
To Contract A/c
Insurance Co./ Bank A/c ……Dr.
P/L A/c ………………… Dr.
To Abnormal Loss A/c
Some other Important Treatments.
Loss related to plant will not be treated in Contract A/c.
It will be directly charged to Profit and Loss A/c.
If plant is specifically purchased for contract then its Profit & Loss on sale will be transfer to
Contract A/c.
Retention Money
A contractor does not receive the full payment of the work certified by the surveyor. Contractee retains
some amount to be paid, after some time, when it is ensured that there is no default in the work done
by the contractor.
If any deficiency or defect is noticed, it is to be rectified by the contractor before the release of the
retention money. Thus, the retention money provides a safeguard against the default risk in the
contracts.
Progress Payments
Payments received by the contractors when the contract is ‘in progress’ are called Progress Payments or
Running Payments.
It is released by the Contractee on the basis of Architect’s certificate and as per the terms of the
contract.
Valuation of WIP :
xxx
Work Certified
xxx
Work Uncertified
Less: Reserves (xxx)
WIP = xxx
WIP will be shown in the ‘Assets’ side of Balance Sheet & Contractee on the ‘Liability’ side.
Cash received from the Contractee is like advance and will be treated as ‘Liability’ till the
contract is handed over to Contractee.
Alternative way of calculating WIP
Cost of Work done xxx
Add: Profit transferred to P/L A/c xxx
WIP xxx
Accounting when contract is near to Completion.
When degree of completion is around 90% , we say that contract is near to completion.
Treatment :
1st and 2nd stage will be same as before.
There will be change only in calculation of profit to be transferred to P/L.
Profit to be transferred will depend on estimated profit on completion of contract.
Calculation of Estimated Profit on completion
Contract price ****
Less: Cost incurred till date (****)
Less: Estimated further cost (****)
Estimated Profit on completion
(EP) ****
Methods of calculation of Profit in case of Contract is near to Completion
1. Estimated Profit × (Work Certified÷ Contract Price)× (Cash Received÷ Work Certified)
D.O.C % of Cash Rcvd
2. Estimated Profit× (Work Certified÷ Contract Price) D.O.C
3. EP× (Cost incurred till date÷ Total Estimated Cost)× (Cash Received÷ Work Certified )
D.O.C % of Cash Rcvd
4. EP× (Cost incurred till date÷ Total Estimated Cost)
D.O.C
Escalation Clause
This clause is usually provided in the contracts as a safeguard against any likely changes in the price or
utilization of material and labour.
If during the period of execution of a contract, the prices of materials or labour rise beyond a certain
limit, the contract price will be increased by an agreed amount.
Important points of Escalation Clause
i. Escalation claim is for rise in price level & not for increase in quantity.
ii. Claim is to be calculated on material consumed & not on material purchased.
iii. Expenses should be considered on accrual basis.
(i.e. after adjusting O/S and prepaid.)
iv. Escalation claim should not be included in work certified & contract price.
Some Important theory questions:
What is Contract Costing ?
What is Cost Plus Contract ? Its Advantages.
What do you mean by “Escalation Clause” ?
What do you mean by ‘Retention money ’ ?
State the differences between Contract costing and Job costing.
