Understanding Profit Calculation on Incomplete Contracts

Learn how to calculate profit on incomplete contracts in profit and loss accounts. Discover the rules determining when to credit profits on unfinished contracts, including provisions for potential losses. Follow a practical example to understand the application of these rules.

• Profit calculation
• Incomplete contracts
• Financial accounting
• Contract accounts
• Provision

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Uploaded on Jul 22, 2024 | 1 Views

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1. Calculating Profit on Incomplete Contracts in Profit and Loss Account M.VIAYASEKARAM

2. Read this article to learn about the calculation of profit on incomplete contracts in profit and loss account. In contract accounts there would be no difficulty in dealing with profits if the contracts were completed in the course of the financial year. Then the profit would be credited to the Profit and Loss Account. But difficulty arises when we have to deal with profits arising on contracts which are not complete at the end of the year. We cannot afford to credit the entire profit shown to the Profit and Loss Account. There is the possibility that next year due to rise in prices or wages or due to fines, there may be a loss. A provision has to be kept against such a contingency. Nor is it desirable that profit on a contract should be taken into account only when the contract is complete. In that case, the year in which the contract is completed, will show an abnormally high figure for profit.

3. The following rules may be followed for taking credit for profits earned on unfinished contracts: (a) If a contract has not advanced to a sufficiently high stage, no credit for profit should be taken. Generally, no credit is taken unless the contract is at least one-fourth complete. (b) In case the contract is 1/4 but less than 1/2 complete, one-third of the profit disclosed as reduced to the percentage of cash paid by the contractee should be transferred to the Profit and Loss Account, the balance being treated as a provision. (c) In case the contract is one-half or more complete, two-thirds of profit (disclosed by the Contract Account) as reduced to the percentages of cash paid by contractee should be transferred to the P&L A/c, the remaining profit being treated as a provision.

4. (d) The whole of the loss, if any, should be transferred to the P&L A/c. Suppose, a contract, not yet complete: (i) Discloses a profit of 54,000, (ii) Work-in- progress certified is Rs.2,00,000 (iii) Total value of contract is Rs. 5,00,000 and (iv) The contractee pays 90% of work certified.

5. Then, according to above rules, the transfer to Profit and Loss Account should be: P L A/c