Introduction to Contract Costing

1. UNIT-5
CONTRACT COSTING

2. INTRODUCTION TO CONTRACT COSTING
Contract costing is defined as that form of specific order costing
wherein work is carried out in accordance with the customer’s
special requirement and each order is of long duration. Contract
costing is also known as Terminal Costing because the work is
terminated once it is completed and contract A/c is closed.

3. FEATURES OF CONTRACT
• Pacta sunt Servanda – “agreement must be kept”
• Legally binding agreement
• Does not have to be in writing. One exceptions being contract to
sell land
• Can be in writing, oral or inferred by conduct
• Bi-lateral or lateral

4. CHARACTERISTIC FEATURES OF
CONTRACT COSTING
• Large in size and takes more than one year for completion
• Involves two parties viz. Contractor and Contractee
• Contract executed for a price termed as Contract price
• Expenses are chargeable directly to contract amount

5. TYPES OF CONTRACT COSTING
• Fixed price contracts
• Contracts with escalations
• Cost plus contracts

6. SYSTEM OF CONTRACT COSTING
• Contract costing is a form of particular order costing that contractors generally
apply for orders of a long duration. However, some prefer calling it "terminal
costing" because after completing the work, the account is closed immediately.
• As this name implies, contract costing is a process of tracking costs that are
associated with a specific contract. Hence, this can be a specialized form of job
costing. Nevertheless, this system only applies to jobs which include a contractual
bond. .

7. RECORDING OF COST OF A CONTRACT
• Materials
• Labour or Wages
• Site Expenses
• Indirect Expenses
• Plant and Machinery
• Sub-Contracts
• Extra Work

8. RECORDING THE VALUE AND PROFIT
ON CONTRACTS
• Certificate of Work Done
• Profit on Uncompleted Contract
• Valuation of Work-in-Progress

9. PROFIT OR LOSS ON CONTRACTS
In this case, the amount of profit to be transferred to the profit and
loss account is determined based on estimated profit. Estimated profit
for contracts nearing completion is the difference between the
contract price and the estimated cost of the contract on completion.

10. ESCALATION CLAUSE
An escalation clause is a section in a real estate contract that states
that a prospective buyer is willing to raise their offer on a home
should the seller receive a higher competing offer. The clause will
state how much more the buyer is willing to pay than the highest
offer and their spending limit.

11. COST PLUS CONTRACT
A cost-plus contract is an agreement to reimburse a company for
expenses incurred plus a specific amount of profit, usually stated as a
percentage of the contract's full price.

12. PROCESS COSTING
Process costing is an accounting method typically used by companies
that mass produce very similar or identical products or units of
output. It’s common in manufacturing industries where the costs of
producing each unit of output are very similar, and it doesn’t make
sense to try to track costs for each individual unit throughout the
production process.

13. TYPES OF INDUSTRIES USING
PROCESS COSTING
Process costing is widely used in industries such as:
• Oil refining
• Food production
• Chemical processing
• Textiles
• Paint manufacture

14. ADVANTAGES OF PROCESS COSTING
• Ease of use: For companies making many similar goods, process costing is more
practical and simpler to use than other cost accounting methods, such as job costing,
which involves tracking the cost of each item and component part, along with
managing payroll, other materials and overhead.
• Flexibility: Process costing can help companies improve their operations to reduce
costs, so they can offer products at more competitive prices. It highlights the cost of
each step in the manufacturing process, helping companies target redundant, outdated
or inefficient processes.
• Standardized: Process costing applies the same standardized costing method each
period, enabling companies to compare changes in costs over time. This helps
companies ensure that costs are in line with budgeted expenses and identify areas for
investigation.

15. DISADVANTAGES OF PROCESS
COSTING
• Errors: Process costing determines the cost of each unit based on the overall costs of
departments or stages involved in manufacturing. Errors can be caused by including non-
production costs in the calculation.
• Calculation difficulties (equivalent units): Process costing also relies on calculations of
equivalent units, which are determined by assigning costs to unfinished goods at the start or end
of an accounting period. Companies include the value of this work in process on balance sheets.
The real cost of these unfinished goods can vary, for example if the price of raw materials
fluctuates from month to month. If companies don’t accurately estimate the cost of work-in-
progress items, they’ll end up with inaccurate product costs.
• Time consuming: Calculating equivalent units can be time consuming. Management accountants
have to determine how far down the line in the production process these unfinished goods are and
assign costs accordingly.

16. COSTING PROCEDURE
• Analyse inventory flow.
• Convert in-process inventory to equivalent units.
• Compute all applicable costs.
• Calculate the cost per unit of finished and in-process inventory.
• Allocate costs to units of finished and in-process inventory.

17. IMPORTANT ASPECTS OF PROCESS
COSTING
• Process Losses
• Normal Process Loss
• Abnormal Process Loss

18. PROCESS GAINS
• New way to motivate workers
• New technologies
• Addition of information, ideas, direction and opinion
• Improved leadership

19. PROCESS LOSSES
• Coordination problems
• Communication problems
• Motivation problems
• Lack of information
• Problematic leadership

20. INTER PROCESS PROFIT
Inter process profit is a profit when the output of one process
transferred to the next process at an inflated price, there is a profit.
This profit is called “Inter process profit”. Since the value addition is
without incurring any cost, it would amount to or result in an amount
of profit equal to the value addition.

21. WORK IN PROGRESS
The term work-in-progress (WIP) is a production and supply-chain
management term describing partially finished goods awaiting
completion. WIP refers to the raw materials, labor, and overhead
costs incurred for products that are at various stages of the production
process.

22. EQUIVALENT PRODUCTION
An equivalent unit of production is an expression of the amount of
work done by a manufacturer on units of output that are partially
completed at the end of an accounting period. Basically the fully
completed units and the partially completed units are expressed in
terms of fully completed units.

23. JOINT PRODUCT COSTING
Joint products are those products which are produced simultaneously
in the production of the main product. They have high sales value.
Joint products are the major part of the production process. Joint
process may require further processing before they are sold.

24. BY PRODUCT COSTING
By products are those products which are procedure incidentally in
the production of the main product. It have low sales value. By
products are minor part of the production process. By products do not
require further processing.

25. FURTHER PROCESS DECISION
The sell or process further decision is the choise of selling a product
now or processing it further to earn additional revenue. The further
process decision most commonly arises when two or more products
are generated by a manufacturing process