CONTRACT COSTING Contract costing is that form specific order costing which applies where the work is undertaken according to customer’s requirements and each order is of long duration as compared to job costing. The work is generally of constructional and repairs nature. A construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single substantial project. This covers various activities such as construction of plants (including site preparation), bridges, roads, dams, ships , buildings, complex pieces of equipment, production of motion pictures etc .that is why this method is used by builders , civil engineering contractors, constructional and mechanical engineering firms etc. These contracts are negotiated in a numbers of ways.
Distinguishing features of contract account The work to be executed depends upon customer’s specification and is generally done at site. Each contract is treated as cost unit and is generally of long duration for completion. Most of the expenses are direct in nature and payment is received depending on the stage of the completion of work. The following are the main distinguishing features of contract accounts : 1.Higher proportion of direct costs :As most of the items of expenses can be directly identified with a contract ,though indirect ,are treated as direct expenses. Expenses on telephone installed at site ,site power usage ,site vehicles ,transportation are treated as direct expenses. 2.low indirect cost: The only item of indirect cost may be head office expenses. Such cost represents only a small proportion of the contract cost and is absorbed usually on some overall basis such as percentage of total contract cost. 3.Difficulties of cost control: The large scale of contracts and the size of the site may create some major problems of cost control relating to material usage and losses ,pilferage , labour supervision and utilisation, damage to and loss of plant and tools etc. 4.Surplus materials :Surplus material, if any, will be either credited to the contract account with the cost of material at the end of the contract or will be debited to the new contract account, if directly transferred to another contract. If the material is not required immediately, it will be stored at the cost debited to a stock account.
Comparison between job and contact costing There are certain similarities in job and contract costing. Both the methods belong to the category of specific order costing in which work is executed according to the specification of customers. As every job and contract is dissimilar in nature and is Identified by a separate number and is known by that number until it is completed. Profit is also determined in respect of each job and contract separately. Inspite of the above similarities there are certain differences between job and contract costing. These are given as under: 1.Size: A job is small in size but the contract is big in size. 2.Place of work: Work under job costing is performed in the workshop but the contract is executed mostly at site. 3.Time for completion: A job usually takes less time for completion whereas a contract takes more time to complete the work. 4.Payment of price: The selling price of a job is paid in full after completing the job But incase of contract, the price is paid in various instalments depending upon the progress of the work. 5.Investment : There is heavy investment on assets incase of job costing as compared to contract costing.
Types of contract There are two types of contracts: 1.Fixed price contracts: Under this contracts both parties agree to a fixed contract price. 2.Cost plus contracts: Under this contracts no fixed price could be settled. The contractor reimbursed for allowable or otherwise define Cost plus a percentage of this cost or a fixed fee towards profit. Each contract is considered as a separate unit of cost and is Allotted a distinguishing number. A separate account is kept for each Individual contract; usually a greater part of the work is carried out at the contract site itself, so whole of the expenditure can be charged Direct to the contract. However, the overhead relating to the office, central store etc. Require apportionment among the various contracts on some arbitrary basis such as percentages of wages , materials or prime cost.
ILLUSTRATION: The following was the expenditure on a contract for Rs.6,00,000 commenced in January 2011: Materials Rs. 1,20,000; wages Rs. 1,64,400; plant Rs. 20,000; Business charges Rs. 8,60. Cash received on account to 31 dec, 2011 amounted to Rs. 2,40,000 being 80% of work certified; the value of materials in hand on 31 dec 2011 was Rs. 10,000. Prepare the contract account for 2011 showing the profit to be credited to the year’s profit and loss account. Plant is to be depreciated at 10%. SOLUTION: CONTRACT ACCOUNT
Profit on uncompleted contracts(modern approach) According to this approach there are two methods of calculating the profits on uncompleted contracts: 1.Percentage of completion method .Under this method the profit is determined at the end of each accounting period before the completion of the entire contract. 2.Completion contract method. Under this method, the profit is recognized only when the contract is completed or substantially completed. Method (1) may be adopted only if the following conditions are satisfied: (a)The cost attributable to the different stages of completion of the contract activity can be clearly identified. This is necessary to match the cost with the revenue till the stage of completion and to find out the resultant profit attributable to the proportion of work completed. (b)There must exist adequate estimating process so that both cost to complete the contract and the percentage of contract performance completed at the end of accounting period can be reliably estimated.
(c) The cost attributable to the contract generally start with the signing of the contract and end when the contract is nearing completion. Cost incurred before signing a contract is applicable if such cost can be directly associated with a specific contract and there is vary probability that the contract will be obtained. Work-in-progress The total expenditure cumulative to the year is treated as work in progress, if no profit is taken in accounts. The amount of the profit is to be added to the progress cost, if the profit is included for the adoption of the percentage of completion method. For balance sheet purposes, payments received from the contractee from time to time are normally taken separately as advance and shown on the liabilities site of the balance sheet. Alternatively, the advance may be deducted from the cost(and profit) and only one figure kept on the assets side.