Understanding Contract Costing in Management Accounting
Contract costing in management accounting refers to a specific type of job costing applied to long-term projects like construction. Contracts serve as cost centers executed under customer specifications, involving materials, wages, direct charges, sub-contracts, and completion certificates. Contract costing aims to calculate total contract costs and determine profits or losses. Different types include fixed price contracts, escalation clauses, and a combination of cost-plus and fixed price models.
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Cost Cost & Management Accounting & Management Accounting Coordinator Dr. D. Heena Cowsar Assistant Professor of Commerce Bon Secours College for Women (Affiliated to Bharathidasan University) Thanjavur Coordinator Dr. D. Heena Cowsar Assistant Professor of Commerce Bon Secours College for Women (Affiliated to Bharathidasan University) Thanjavur
Contract Contractor & Contractee to accomplish the job agreed between them for profit within the stipulated period of time. Contract of cost is a single contract. The contract itself is a cost center and is executed under the customer s specifications. particularly in case of the organization s doing construction work. It is also known as terminal costing. Each contract, short term or long term is treated as a job. construction and engineering projects, ship building, road and railway line contracts, construction of bridges etc. customer s site. As it takes number of years to complete a job, the problem of profit taking arises. Contract It is an agreement signed between two parties namely Contract Costing Contract Costing is a special type of job costing where the unit Costing Contract costing is a variant of job costing system applicable It is one of the method of Costing and mainly applied in civil It is a long time process, Where the work is executed at the
CIMA defines Contract costing as follows Contract costing is that form of specific order costing which applies where work is undertaken to customers special requirements and each order is of long-term duration . Features 1. Materials 2. Wages 3. Direct Charges 4. Bill of Sub Contract 5. Certificate of Completion CIMA defines Contract costing as follows Features of of Contract Contract costing costing The work being of a constructional nature, the same is executed at the customer s site, as per his specifications. Materials The bulk of the materials purchased and delivered direct to the contract site or obtained from the central stores through the requisition slips. Wages The wages which cannot be charged directly to any contract are treated as indirect wages that require apportionment. Direct Charges Most of the costs which are normally treated as indirect can be identified specifically with a particular contract and are charged to it as direct costs. Materials Wages Direct Charges
Bill of sub Parts of large contracts are often done by third parties under sub-contracts. Sub- contracts is a practice normally followed on the region of economy, specialized nature of work, want of capacity, etc. Certificate of completion The contracts do not pay the full value of the work certified as completed but retain a certain percent under the terms of the agreement. Objects Of Contract Costing The main objects of Contract Costing are: ( (i i) ) to ascertain the total cost of a contract, and (ii) Types of Contract Costing Bill of sub- -contractors contractors Certificate of completion Objects Of Contract Costing (ii) to ascertain the profit or loss on the contract. Types of Contract Costing Price of of Contract margin of of profit Price margin Contract is is ascertained profit to to the ascertained by the total by adding cost of of Contract adding a a fixed Contract fixed amount amount of of Cost plus Contract Cost plus Contract total cost Types of Contract Costing Both Contractor Contract Both Contract Contractor and and Contractee Contractee agrees agrees to to the the fixed fixed price price of of Fixed Price Contract Contract Costing Escalation Clause Escalation Clause Mixture of Both Cost plus & Fixed Price Contract Mixture of Both Cost plus & Fixed Price Contract
1. Cost ascertained by adding a fixed margin of profit to the total cost of the contract. In this case, the manufacturer is assured of a certain percentage of profit in advance and is protected against any fluctuations in the market prices of the various cost elements involved in the production. As a result of the viewpoint of the manufacturer, the possibility of incurring any loss is eliminated. 1. Cost- -plus contract Cost Plus Contract is a contract in which the value-of-the contract is plus contract 2 2. . Fixed agree to a fixed contract price. In this case, the manufacturer is not assured of a certain percentage of profit in advance and is not protected against any fluctuations in the market prices of the various cost elements involved in the production. Fixed Price Price Contract Under Fixed-Price Contract the contractor and the contractee both parties Contract 3 3. . Contract method the fixed price increase with the increase in the cost of materials, labour Contract with It is a combination of both Cost plus and Fixed price contract. Under this with Escalation Escalation Cost Cost
Terminology of Contract Costing Terminology of Contract Costing 1 .Sub entered into) may entrust some portion of the work to be done by one or more than one sub-contractor. The cost in this connection is the direct charge on the contract and is treated as such in the contract costing. 1 .Sub- -contracts. contracts. The contractor (if thinks proper and allowed to do so by the agreement 2. Escalation Clause. provision for the escalation clause the contractor is interested in safeguarding himself against any charge in the price level. The agreement itself specifies the procedure for the calculation of adjustment in order to avoid all disputes etc. 2. Escalation Clause. In a contract agreement, there is a usual practice of making a 3. Surveyor s Certificate and Retention Money: more than a year it is normal practice to make payment against the portion of the contract completed on the basis of work certified by the contractee s surveyor. The certificate issued by the surveyor (or technical assessor) in this respect is known as Surveyor s Certificate. contractor. A certain percentage (say 10% to 20%) of the amount is retained by the contractee and is paid sometime after the completion of the contract. The sum of money thus retained is known as Retention Money. This is done to give protection to the contractee in case the contractor does not fulfill the terms and conditions of the contract. 3. Surveyor s Certificate and Retention Money: In case of large contract which extends for As per terms of the contract, full amount of the work certified is not paid to the
4 4. . Uncertified The work which has been done by the contractor but not certified by the architect on the date of accounting due to insufficient progress is known as Uncertified Work. In case of incomplete contract for which profit is required to be calculated, the value of uncertified work should be taken into account and it is justifiable to evaluate such work at cost. Because, it is not logical to calculate profit on the work which is not complete. Thus the Contract A/c is credited with this cost of uncertified work and Work-in-progresses debited with the same. This entry is reversed at the beginning of the next year. Uncertified Work Work: : 5 5. . Work Work-in-progress means incomplete contract which is in progress. The contractor may prepare a Work-in-progress A/c by debiting the account with the value of work certified and cost of uncertified work and by crediting the profit not transferred to Profit & Loss A/c (i.e. reserve profit). The difference between the two sides of the account less cash received is the work-in-progress, which is shown in the Balance Sheet. Work- -in in- -Progress Progress Contract Contract: : 6 6. . Notional years, wide fluctuations may be noted in the profit figures of contractors from year to year. Notional Profit Profit: : Notional means estimate. As completion of contracts take several Notional Profit=value of work certified-cost of work certified
Profit of Incomplete Contract considered in in respect Profit of Incomplete Contract respect of of work 1 1. . Profit cost Profit should cost. . should be be considered work certified certified only only; ; work work uncertified uncertified should should always always be be valued valued at at 2 2. . Recently Recently Stated Stated 3 3. . More More than than 25 25% % completed completed 4 4. . More More than than 50 50% % completed completed If If the if if the certifies more one should PROFIT received/work NOTIONAL work date the contract the architect certifies that more than one- -third should be PROFIT received/work NOTIONAL PROFIT work certified date- -uncertified contract has architect of of the that the than 25 third of of notional be recognized = = has advanced the contractee the work 25% %, , in in that notional profit recognized as as profit 1 1/ /3 3 advanced and contractee work completed that case, and If If the more than situation notional be Profit * *2 2/ /3 3*cash /work the contract more than than situation two notional profit be recognized Profit = = Notional *cash /work certified contract is is done than 50 90 two- -third profit should recognized as as profit Notional profit done but less in in third of of should profit. . profit received If If the recently fourth no transferred and the work recently fourth or or less no profit transferred to to profit and loss work started and less is is done profit should started one done 50% % but 90% % less that and one- - completed that case, profit profit. . *cash certified Value of of work to to should be profit account. . be loss account *cash certified. . received PROFIT = = Value certified- -(cost uncertified amount) certified. . (cost of of work amount) 5. If the contract is done 90% or more in that situation total profit may be recognized. 5. If the contract is done 90% or more in that situation total profit may be recognized.
Format of Contract Account Format of Contract Account Contract Account Contract Account Particulars Particulars Amount Amount Particulars Particulars Amount Amount To Materials To Materials By Materials By Materials (i) Direct Purchases xxx (i) Returned to Suppliers or Returned to Stores xxx (ii) Issued from Stores xxx (ii) Transferred to other Contracts or In Hand xxx (iii) Transferred from other Contracts xxx (iii) Sold xxx To Wages To Wages xxx By Plant : By Plant : Returned to Stores To Plant To Plant (ii) Transferred to other Contracts or In Hand xxx (i) Cost of Special Plant xxx (iii) Sold xxx (ii) Depreciation of General Plant xxx By Profit and Loss Account By Profit and Loss Account To Direct Expenses To Direct Expenses xxx (i) Materials or Plants Lost, Stolen or Destroyed xxx To Cost of Sub To Cost of Sub- -contracts contracts xxx By Contractee s By completed contract) OR Contractee s A/c A/c (Contract Price in case of a OR xxx To Cost of Extra Work To Cost of Extra Work By WIP By WIP (In case of an incomplete contract) xxx To indirect Expenses To indirect Expenses xxx (i) Value of Certified Work xxx To Expenses Accrued To Expenses Accrued xxx (ii) Cost of Uncertified Work xxx
Contractees Contractee s Account for Contract Costing Account for Contract Costing Particulars Contract account (value of work certified) Particulars Amount xxx Amount Particulars Bank A/C (cash received) Particulars Amount xxx Amount Balance c/d xxx xxx xxx
Balance Sheet for Contract Costing Balance Sheet for Contract Costing Liabilities Liabilities Amount Amount Assets Assets Amount Amount Profit & loss: Profit & loss: Fixed asset: Fixed asset: Profit on contract xxx Plant xxx (-) Less: loss on fire xxx xxx (-) depreciation xxx xxx Outstanding Liabilities: Outstanding Liabilities: Other fixed assets xxx Accrued wages xxx (-) depreciation xxx xxx Accrued direct expense xxx Current assets: Current assets: Other accrued expenses xxx xxx Material at site xxx Work-in-progress xxx Cash in hand xxx xxx xxx xxx xxx xxx
Valuation of closing stock in Balance sheet 1. If Notional Profit determined Valuation of closing stock in Balance sheet 1. If Notional Profit determined Asset side Asset side Amount Amount Work in Progress: Cost of work certified (+) Cost of work Uncertified (-) cash received (-) provision for unrealized profit work-in- progress Work in progress xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx 2. If notional profit cannot be determined Asset side Cost of contract (-) cash received Work in progress 2. If notional profit cannot be determined Asset side Amount xxx xxx xxx Amount
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