contract costing meaning definition features

2. Meaning of Contract
Costing
It is one of the methods of costing which is
applicable in where construction activities
takes place.
The duration of the contract work is
generally more than a year and much time
requires in completing the construction
work.
It involves more investment and labour for
construction work.

3. Definition of Contract
Costing
According to CIMA, Contract costing is
defined as, ”A form of specific order
costing: attribution of costs to individual
contracts”.

4. Application of contract Costing
This method is applicable in construction of
building, bridges, roads, dams and canals
etc.,
This method is also called as Terminal
costing.
Contractor: is one who accepts the
construction work from the party to complete
in a definite period of time.
Contractee: is the owner of construction work
and for whom the construction work is
assigned to the contractor to complete the
construction work

5. Features /Importance of Contract
costing
 A contract generally takes more than a year to complete
 Work on contract generally starts at the site of the
contract and not in factory premises.
 Each contract undertaken is treated as a cost unit.
 Separate contract account to prepared to ascertain
profit or loss on each contract.
 Most of the expenses are treated as direct expenses for
the construction work.
 If contract work is not completed in a particular year,
only proportionate of profit is transferred to profit and
loss account based on the work completion.

6.  Sub- contractors may be apportioned for
other than construction work, such as
electrical fittings, welding work, interior
decoration etc.,
 Plant & Machinery may be purchased
for the site or hired for the site
 Contractee will pay the money to the
contractor after holding certain
percentage of money which is called
retention money to safeguard the future
construction work.

7. Similarities between Job
Costing and Contract Costing
Job Costing Contract Costing
It is one of the method of costing It is one of the method of costing
Commitment to customer special
requirement
Commitment to customer special
requirement
Each job is treated as separate
entity for the purpose of costing
Each Contract is treated as
separate entity for the purpose of
costing

8. Dissimilarities between Job
Costing and Contract Costing
Job Costing Contract Costing
Jobs are performed inside the
factory
Contract work is performed outside
the factory such as construction of
bridges, roads and dams etc.
The cost of each job is less The cost of each contract is huge
or more
The period of completion of each
job is shorter duration
The period of completion of each
job is longer duration
While executing the job, each job
is given as separate job number
and is executed by the same group
of workers.
While executing a contract sub-
contract are given
Calculation of profit or loss on
each job is to be calculated for a
period.
If contract work is not completed
during the period, Profit on each
such contract shall be calculated
proportionately.

9. Terms used in Contract Costing
Retention Money: Certain percentage of
money hold by the contractee while
making the payment to the contractor is
called Retention Money.
The contractee may pay a fixed
percentage of work certified, depending
upon the terms of Contract.

10. Escalation Clause
Contract generally takes long time to
complete and in this period there may be
possibility of change in prices. Escalation
clause which protects the contractor
against raise in the prices of materials or
labour.
The contractor is entitled to enhance the
contract price if cost arises beyond a given
percentage.

11. Cost Plus Contracts
Cost plus contract is a contract in which
the contract price is ascertained by adding
a specified amount or percentage of profit
to the cost allowed in the contract.
Cost plus contract is usually entered into
for executing special type of work like
construction of dams buildings, power
house etc.,

12. Work Certified
As per the terms of the contract, the
contractee advances certain percentage of
amount or money to the contractor on the
basis of the percentage of work done by
the contractor and work certificate issued
by the contractee’s architect or engineer
periodically

13. Work Uncertified
A Work is completed by the contractor but
which remains to be certified by the
architect on the date of accounting is
known as ‘work done but not yet
certified’

14. Contract Price
It is the value of the contract agreed to be
paid to the contractor by the contractee for
completion of work according to the
satisfaction of the contractee

15. Treatment of profit on
incomplete contract
Work certified +Work uncertified/contract Price*100
1. When work certified is less than1/4
(25%) of the contract price no profit is to
transferred to the profit and loss account
and the whole amount of such profit is
treated as notional profit and is transferred
to the reserve account

16. 2. If work certified is ¼ (25%) or more than
¼(25%)of the contract price but less than
½ (50%) of the contract price then 1/3 of
the notional profit is transferred to the
profit and loss account and the balance is
to be transferred to the reserve account.
The profit to be transferred to the profit
and loss account is calculated as follows-
1/3 x notional profit x cash received / work certified

17. 3. If work certified is ½ (50%) or more than
½ (50%)of the contract price but near to
the completion of the contract then½
(50%) of the contract price then 2/3 of the
notional profit is transferred to the profit
and loss account and the balance is to be
transferred to the reserve account. The
profit to be transferred to the profit and
loss account is calculated as follows-
2/3 x notional profit x cash received / work certified

18. 4. When contract is near to the completion the
estimated profit is calculated on the contract
price. It is calculated as follows-
Estimated profit x work certified /contract price
OR
Estimated profit x cash received / contract price

19. Accounting Procedure
(Preparation of Contract Account)
Materials:
It includes the materials purchased directly from the
suppliers or materials issued from the stores against
materials requisition note.
The costs of both are debited to the contract account.
During the period if any materials found surplus and
are returned to the stores, they are credited to the
contract account.
In case any materials are transferred from the site to
other contracts, such materials also are credited to
the contract account, if any materials received from
other contracts are debited to the contract account.

20. Labour/Wages:
The wages payable to the workers engaged
on the contract are also debited
to the contract account. If any wages are
accrued or outstanding such outstanding
charges are added to the wages.
Plant and Machinery:
If any assets are purchased like plant and
machinery, tractors and any other assets are
debited to the contract account.
At the end of the year after depreciation the
net value of assets are credited to the
contract account. Alternatively only the
depreciation amount on the assets is debited
to the contract account.

21. Sub Contract:
Is to be debited to contract account
 Any Profit on the sale of assets or part of it is
debited to the contract account and credited
to profit and loss account.
 Any Loss or fire or destroyed of any
materials in transit or at the site are to be
debited to the profit and loss account and
credited to contract account.

22. Work in progress
 When contract work is not completed till the end of
accounting period then it is called work in progress.
 The contractor is required to value the work in
progress considering work certified and work
uncertified.
 Both work certified and work certified will appear on
the credit side of the contract account under the
heading Work in progress account.
a. Work certified: it is a part of work in progress
which refers to work has been completed and
approved and certified by an architect.
b. Work Uncertified: it is also a part of work in
progress , which refers to work on contract has
been completed but is not certified or not approved
by an architect.

23. Notional Profit
It is an estimate of earnings primarily used
in the building and the construction
industry. it is used to smooth out
fluctuation in reported revenue due to
contract that take a long time to complete.