Contract Costing | CMA Inter Syllabus

---

Contract Costing

Contract Costing is a method used in construction industry to find out the cost and profit of a particular construction assignment. The principles of job costing are also applicable in contract costing. In fact, Contract Costing can be termed as an extension of Job Costing as each contract is nothing but a job completed. Contract Costing is used by concerns like construction firms, civil engineering contractors, and engineering firms. One of the important features of contract costing is that most of the expenses can be traced to a particular contract. Those expenses that cannot be traced to a particular contract are apportioned to the contract on some suitable basis.

Contract Costing is a ‘form of specific order costing where costs are attributed to contracts’.     -CIMA Official Terminology

 

Essential features of contract costing

• A formal contract is made between customer and supplier.
• Work is undertaken to customers’ special requirements.
• The work is for a relatively long duration.
• The work is frequently constructional in nature.
• The method of costing is similar to job costing.
• The work is frequently based on site.
• It is not unusual for a site to have its own cashier and time-keeper

 

Types of Contracts

1. Cost-Plus Contracts: Cost-plus contract is a contract where the value of the contract is determined by adding an agreed percentage of profit to the total cost. These types of contracts are entered into when it is not possible to estimate the contract cost with reasonable accuracy due to unstable condition of factors that affect the cost of material, employees, etc. This type of contract is generally adopted when the probable cost of contract cannot be ascertained in advance with reasonable accuracy. In this type of contract, the contractor receives his total cost plus a profit, which may be a percentage of cost. These types of contracts give protection to the contractor against fluctuations in profits as he is guaranteed about his profit irrespective of the actual costs. However, in order to avoid any dispute in future, it is always advisable to specify the admissible costs in advance. Similarly, the customer may also reserve the right of demanding ‘cost audit’ in order to check the reliability of the claim of the contractor regarding increase in the costs.
2. Target-price contracts: In such cases, the contractor receives an agreed sum of profit over his pre-determined costs. In addition, a figure is agreed as the target figure and if actual costs are below this target, the contractor is eligible for bonus for the savings.

 

Accounting of Cost for Contract

The cost computation in case of a contract is done on the following basis.

(i) Material Cost: Direct Material required for a particular contract is debited to the Contract Account. There may be some quantity of material which is returned back to the store. In such cases, material returned note is prepared and is either credited to the Contract Account or deducted from the material debited to the Contract Account. Similar treatment is given to the material transferred from one contract to another one.

● All materials supplied from the stores or purchased directly for the contract are debited to the concerned contract account.

Contract A/c (Contract No:)

To Stores Ledger Control A/c (issued from stores) or

To Cost Ledger Control A/c (direct purchase)

● In the case of transfer of excess material from one contract to another, costs of these excess materials are adjusted on the basis of Material Transfer Note.

Contract A/c (transferee contract no:)

To Contract A/c(transferor contract no:)

● In case the return of surplus materials appears uneconomical on account of high cost of transportation, the same is sold and the concerned contract account is credited with the price realized. Any loss or profit arising therefrom is transferred to the Costing Profit & Loss A/c

Cost Ledger Control A/c

Costing Profit & Loss A/c (loss)

To Contract A/c (cost of material)

To Costing Profit & Loss A/c (profit)

● Any loss of materials due to theft or destruction etc. is transferred to the Costing Profit & Loss A/c.

Costing Profit & Loss A/c

To ContractA/c

● If any stores items are used for manufacturing tools, the cost of such store items are charged to the Works Expenses A/c.

Works Expenses A/c

To Stores Ledger Control A/c (with amount of stores used for works)

● If the contractee has supplied some materials without affecting the contract price, no accounting entries will be made in the contract account, only a note may be given about it.

(ii) Employee (Labour) Cost: It is usual for direct labour on a contract site to be paid on an hourly basis. Employees who work on several contracts at the same time will have to record the time spent on each contract on time sheets. Each contract will then be charged with the cost of these recorded hours.

Contract A/c

To Wages A/c

To Outstanding Wages A/c

(iii) Expenses: All expenses incurred for a particular contract should be charged to that contract. In case of any indirect expenses incurred for the organization as a whole, they should be charged to the contract on some suitable basis. Direct expenses can be charged directly to the contract. 

● Direct expenses (such as architect’s fees, hire charges of concrete mixer, electricity charges, cost of special tools etc) incurred and / or outstanding.

Contract A/c

To Direct Expenses A/c

To Outstanding Direct Expenses A/c (direct purchase)

● Indirect expenses (such as expenses of engineers, surveyors, supervisors, corporate office etc.) may be distributed over several contracts on certain reasonable basis as overheads.

Contract A/c

To Overheads A/c

(iv) Cost of Plant: A feature of most contract work is the amount of plant used. Plant used on a contract may be owned by the company, or hired from a plant hire firm.

1. If the plant is hired, the cost will be a direct expense of the contract.
2. If the plant is owned, a variety of accounting methods may be employed. 
   
   

   ● The value of the plant may be either debited to contract account and the written down value thereof at the end of the year entered on the credit side for closing the contract account.

   Contract A/c

   To Plant and Machinery A/c

   Plant and MachineryPlant and Machinery A/c (with WDV)

   To Contract A/c

   Or

   ● Only a charge (depreciation) for use of the plant may be debited to the contract account.

   Contract A/c

   To Depreciation on Plant and Machinery A/c

    

(v) Cost of supervision and sub-contractors: The cost of supervision, which is usually a production overhead in unit costing, job costing and so on, will be a direct cost of a contract. On large contracts, much work may be done by sub-contractors. The invoices of sub-contractors will be treated as a direct expense to the contract.

● Sub-contract costs are also debited to the Contract Account

Contract A/c

To Cost of Sub-Contract A/c

In contract costing, as each contract may take a long period for completion, the question of computing of profit is to be solved with the help of a well defined and accepted method.

(vi) Extra Work: The extra work amount payable by the contractee should be added to the contract price. If extra work is substantial, it is better to treat it as a separate contract. If it is not substantial, then the amount should be debited to the contract account as “Cost of Extra Work” 

Some Important Terminologies

1. Cost of Work Certified or Value of Work Certified: A contract is a continuous process and to know the cost or value of the work completed as on a particular date; assessment of the completion of work is carried out by an expert (it may be any professional like surveyor, architect, engineer etc.). The expert, based on his assessment, certifies the work completion in terms of percentage of total work. The cost or value of certified portion is calculated and is known as Cost of work certified or Value of work certified respectively. Payment is made on the basis of work certified.
2. Cost of Work Uncertified: It represents the cost of the work which has been carried out by the contractor but has not been certified by the expert. It is always shown at cost price. There is no role of work uncertified in payment.
   Example
   
3. Work-in-Progress: It costing refers to the work which is not complete on the reporting date.
   
   Value of the work-in-progress = the cost of work completed, both certified and uncertified + the cost of work not yet completed + amount of estimated/ notional profit (reserve for contingencies).
   
   [amount received from the contractee is subtracted from the WIP in the Balance Sheet]
   
   In the Balance Sheet (prepared for management), the work-in-progress is usually shown under two heads, viz., certified and uncertified. The cost of work completed and certified and the profit credited will appear under the head ‘certified’ work-in-progress, while the completed work not yet certified, cost of material, employee and other expenses which has not yet reached the stage of completion are shown under the head ‘uncertified’work-in-progress.
4. Retention Money: In a contract, a contractee generally keeps some amount payable to contractor with himself as security deposit. To ensure that the work carried out by the contractor is as per the plan and specifications, it is monitored periodically by the contractee. To have a cushion against any defect or undesirable work, the contractee upholds some money payable to the contractor. This security money upheld by the contractee is known as retention money.
   
   Retention money = Value of work certified- Payment made to contractor
5. Notional Profit: It represents the difference between the value of work certified and cost of work certified.
   Value of Work Certified  -  ×××
   
   Add Cost of Work not yet Certified  -  ××× 
   
   Total  -  ××××××
   
   Less Total cost of contract to date  -  ×××
   
   Notional Profit -  ×××
6. Estimated Profit: It is the excess of the contract price over the estimated total cost of the contract. [can be calculated and feasible to calculate only in case of contracts whose end is near].
7. Escalation Clause: In order to protect the contractor from the rise in the price, an escalation clause may be inserted in the contract. Escalation clause in a contract empowers a contractor to revise the price of the contract in case of increase in the prices of inputs due to some macro-economic or other agreed reasons.As per this clause, the contract price is increased proportionately if there is a rise in input costs like material, labour or overheads. The condition that may be laid down is that the contractor will have to produce a proof regarding the rise in the price

Profit on Incomplete Contract

The long duration of a contract usually means that an estimate must be made of the profit earned on each incomplete contract at the end of an accounting period. This avoids excessive fluctuations in reported profits. A more difficult problem emerges when a contract is incomplete at the end of an accounting period. The contractor may have spent considerable sums of money on the work, and received substantial progress payments (payments received by the contractee with the progress of the contract), and even if the work is not finished, the contractor will want to claim some profit on the work done so far.

There are several different ways of calculating contract profits, but the overriding consideration must be the application of the prudence concept. If a loss is expected on a contract, the total expected loss should be taken into account as soon as it is recognised, even if the contract is not complete. While estimating the size of the profit on an incomplete contract the guidelines in the following paragraphs should be noted.

• If the contract is in its early stages: No profit should be credited to Profit and Loss Account. Profit should only be taken when the outcome of the contract can be assessed with reasonable accuracy. As a general rule, no profit should be recognised unless a contract is at least 25% complete.
• If the contract is reasonably advanced: In this case the portion of notional profit to be transferred to Profit & Loss Account is based on the degree of completion of the contract. The degree of completion of the contract can be found out by comparing work certified and the contract price (Cash received/Work Certified).
  1. If the degree of completion of work is above 25% but less than 50% of total work, 1/3 × Notional Profit × Cash Received/Work Certified will be transferred to Profit & Loss Account and the remaining amount would be kept as 
     reserve.
  2. If the degree of completion of work is more than or equal to 50% of the total work but less than 90%, 2/3 × Notional Profit × Cash Received Work Certified will be transferred to Profit & Loss Account and the remaining amount would be kept as reserve.
• If the contract is almost complete (Degree of composition is 90% or more)
  In this case, the portion of the profit to be transferred to Profit & Loss Account is calculated by using the estimated total profit which is ascertained by subtracting the total cost to date and the additional cost to complete the contract from the contract price. The different formulas for such computations of profit are as follows:
  1. Estimated Profit × Work Certified /ontract Price or,
  2. Estimated Profit × Work Certified/Contract Price × Cash Received/Work Certified or,
  3. Estimated Profit × Total Cost to date/Estimated Total Cost or,
  4. Estimated Profit × Total Cost to date/Estimated Total Cost × Cash Received/Work Certified
• When an incomplete contract reveals a loss, the whole amount of the loss must be charged to the profit and loss account of the accounting year.
  Following is a pictorial representation of the above principles.
  

Illustration 11

A firm of Builders, carrying out large contracts kept in contract ledger, separate accounts for each contract on 30th June, 20X1, the following were shown as being the expenditure in connection with Contract No. 555.

	Amount (₹)
Materials purchased	1,16,126
Materials issued from stores	19,570
Plant, which has been used on other contracts	25,046
Additional plant	7,220
Wages	1,47,268
Direct expenses	4,052
Proportionate establishment expenses	17,440

The contract which had commenced on 1st February, 20X1 was for ₹ 6,00,000 and the amount certified by the Architect, after deduction of 20% retention money, was ₹ 2,41,600 the work being certified on 30th June, 20X1. The materials on site were ₹ 19,716. A contract plant ledger was also kept in which depreciation was dealt with monthly the amount debited in respect of that account is ₹ 2260. Prepare Contract Account showing profit on the contract.

Solution:

View solution in koncept education app - Download App 

Illustration 12

A contractor has undertaken a construction work at a price of ₹ 5,00,000 and begun the execution of work on 1st January, 20X1. The following are the particulars of the contract up to 31st December, 20X1. 

Particulars	Amount (₹)	Particulars	Amount (₹)
Machinery	30,000	Overheads	8,252
Materials	1,70,698	Materials returned	1,098
Wages	1,48,750	Work certified	3,90,000
Direct expenses	6,334	Cash received	3,60,000
Uncertified work	9,000	Materials on 31.12.20X1	3,766
Wages outstanding	5,380
Value of plant on 31.12. 20X1	22,000

It was decided that the profit made on the contract in the year should be arrived at by deducting the cost of work certified from the total value of the architects certificate, that 1/3 of the profit so arrived at should be regarded as a provision against contingencies and that such provision should be increased by taking to the credit of Profit and Loss Account only such portion of the 2/3rd profit, as the cash received to the work certified.

Solution:

View solution in koncept education app - Download App

 

Illustration 13

A contractor commenced the work on a particular contract on 1st April, 20X1 he usually closes his books of accounts for the year on 31st December of each year. The following information is revealed from his costing records on 31st December, 20X1.

	Amount (₹)
Materials sent to site	43,000
Jr. Engineer	12,620
Labour	1,00,220

A machine costing ₹ 30,000 remained in use on site for 1/5th of year. Its working life was estimated at 5 years and scrap value at ₹ 2,000

A supervisor is paid ₹ 2,000 per month and had devoted one half of his time on the contract.

All other expenses were ₹14,000 the materials on site were ₹ 2,500.

The contract price was ₹ 4,00,000. On 31st December, 20X1  2/3rd of the contract was completed however, the architect gave certificate only for ₹ 2,00,000. On which 80% was paid. Prepare Contract Account.

Soluton:

View solution in koncept education app - Download App

 Illustration 14

The following figures are supplied to you by contractor for the year ending 31st December, 20X2. 

Particulars	Amount (₹)
Work-in-Progress on 31-12-20X1      ₹ 85,000
Less: Cash received from contractee   ₹ 55,000	30,000
During the year:
Wages	8,500
Materials bought	6,000
Working expenses	1,500
Materials issued from stores	10,500
Administrative expenses (₹250 are chargeable to Profit and Loss Account)	1,250
Plant	2,500
Material returned to supplier	450
Material returned to stores	550
Work certified	15,000
Contracts finished	22,500
Profits taken upon contracts	11,500
Advances from contractee	40,000

Prepare Contract Ledger Accounts, and the total contractee’s and show the work-in-progress as it would appear in the Balance sheet.

Solution:

View solution in koncept education app - Download App

 

Illustration 15

The information given under has been extracted from the books of a contractor relating to contract for ₹3,75,000.

	I YEAR	II YEAR	III YEAR
	Amount (₹)	Amount (₹)	Amount (₹)
Materials	45,000	55,000	31,500
Direct Expenses	1,750	6,250	2,250
Indirect expenses	750	1,000	---
Wages	42,500	57,500	42,500
Total work certified	87,500	2,82,500	3,75,000
Uncertified work	---	5,000	---
Plant	5,000	---	---

The value of plant at the end of I year was ₹4,000 at the end of II year ₹2,500 and at the end of III year it was ₹1,000. It is customary to pay 90% in cash of the amount of work certified. Prepare the contract Account and show how the figures would appear in the balance sheet.

Solution:

View solution in koncept education app - Download App

 Illustration 16

A firm of engineers undertook three contracts beginning on 1st Jan, 1st May and 1st August 20X1. Their accounts on 30th November, 20X1 showed the following position:

Particulars	Contract I	Contract II	Contract III
	Amount (₹)	Amount (₹)	Amount (₹)
Contract price	80,000	54,000	60,000
Materials	14,400	11,600	4,000
Wages	22,000	22,500	2,800
General expenses	800	550	200
Cash received for
work certified	30,000	24,000	5,400
Work certified	40,000	32,000	7,200
Work uncertified	1,200	1,600	400
Wages outstanding	700	750	350
General expenses
outstanding	150	100	50
Plant installed	4,000	3,200	2,400
Materials on hand	800	800	400

On the respective dates of the contracts, the plant was installed depreciation thereon being taken at 15% p.a. You are required to prepare accounts in the Contract Ledger.

Soluiton:

View solution in koncept education app - Download App

 

Illustration 17

The following is the Trial Balance of Premier Construction Company, engaged on the execution of contract No.747, for the year ended 31st December, 20X2.

Contractee’s Account	Amount (₹)	Amount (₹)
Amount received		3,00,000
Buildings	1,60,000
Creditors		72,000
Bank Balance	35,000
Capital Account		5,00,000
Materials	2,00,000
Wages	1,80,000
Expenses	47,000
Plant	2,50,000
	8,72,000	8,72,000

The work on Contract No. 747 was commenced on 1st January, 2022. Materials costing ₹ 1,70,000 were sent to the site of the contract but those of ₹ 6,000 were destroyed in an accident. Wages of ₹ 1,80,000 were paid during the year. Plant costing ₹ 50,000 was used on the contract all through the year. Plant with a cost of ₹ 2 lakhs was used from 1st January to 30th September and was then returned to the stores. Materials of the cost of ₹ 4,000 were at site on 31st December, 2022.

The contract was for ₹ 6,00,000 and the contractee pays 75% of the work certified. Work certified was 80% of the total contract work at the end of 2022. Uncertified work was estimated at ₹ 15,000 on 31st December, 2022.

Expenses are charged to the contract at 25% of wages. Plant is to be depreciation at 10% for the entire year.

Prepare Contract Account for the year 2022 and Balance Sheet as on 31st December, 2022 in the books of Premier Construction Company.

Solution:

View solution in koncept education app - Download App

 Illustration 18

A company of builders took to a multi-storied structure for ₹ 40,00,000 estimating the cost to be ₹ 36,80,000. At the end of the year, the company had received ₹ 14,40,000 being 90% of the work certified; work done but not certified was ₹ 40,000. Following expenditures were incurred.

	₹
Materials	4,00,000
Labour	10,00,000
Plant	80,000

Materials costing ₹ 20,000 were damaged. Plant is considered as having depreciated at 25%.

Prepare Contract Account and show all the possible figures that can reasonably be credited to Profit and Loss Account.

Solution:

View solution in koncept education app - Download App

 

Illustration 19

The following Trial Balance was extracted on 31st December, 20X1 from the books of Swastik Co. Ltd contractors:

	Dr.	Cr.
Share Capital:
Shares of  ₹10 each		3,51,800
P&L A/c on 1.1. 20X1		25,000
Provision for Dep. on Machinery		63,000
Cash received on account Contract - 7		12,80,000
Creditors		81,200
Land and Buildings (Cost)	74,000
Machinery (Cost)	52,000
Bank	45,000
Contract 7:
Materials	6,00,000
Direct Labour	8,30,000
Expenses	40,000
Machinery on site (Cost)	1,60,000
	18,01,000	18,01,000

Contract 7 was begun on 1st Jan 20X1. The contract price is ₹ 24,00,000 and the customer has so far paid ₹ 12,80,000 being 80% of the work certified.The cost of the work done since certification is estimated at ₹ 16,000. On 31st December, 20X1, after the above Trial Balance was extracted machinery costing ₹ 32,000 was returned to stores, and materials then on site were value at ₹27,000.

Provision is to be made for direct labour due ₹6,000 and for depreciation of all machinery at 12 1/2 % on cost.

You are required to prepare:

(a) The Contract Account;

(b) A Statement of Profit, if any, to be properly credited to profit and loss account for 20X1 and 

(c) The Balance Sheet of Swastik Co. Ltd as on 31st December.

Solution:

View solution in koncept education app - Download App

 Illustration 20

Kapur Engineering Company undertakes long term contract which involves the fabrication of pre stressed concrete block and the reaction of the same on consumer’s life.

The following information is supplied regarding the contract which is incomplete on 31st March, 20X1.

Cost Incurred:	Amount (₹)
Fabrication cost to date:
Direct materials	2,80,000
Direct Labour	90,000
Overheads	75,000
	4,45,000
Erection cost to date	15,000
Total	4,60,000
Contract price	8,19,000
Cash received on account	6,00,000
Technical estimate of work completed to date:
Fabrication: Direct materials	80%
Direct labour and overheads	75%
Erection	25%

You are required to prepare a statement for submission to the management indicating

(a) The estimated profit on the completion of the contract;

(b) The estimated profit to date on the contract.

Solution:

View solution in koncept education app - Download App

 

Illustration 21

The following particulars are obtained from the books of Vinay Construction Ltd. as on March, 20X1. 

	₹
Plant and equipment at cost	4,90,000
Vehicles at cost	2,00,000

Details of contract with remain uncompleted as on 31-3-20X1.

	Contract nos.
Particulars	V.29	V.24	V.25
	(₹lacs)	(₹lacs)	(₹lacs)
Estimated final sales value	8.00	5.60	16.00
Estimated cost	6.40	7.00	12.00
Wages	2.40	2.00	1.20
Materials	1.00	1.10	0.44
Overheads (excluding dep.)	1.44	1.46	0.58
	4.84	4.56	2.22
Value certified by architects	7.20	4.20	2.40
Progress payments received	5.00	3.20	2.00

Depreciation of plant and Equipment and Vehicle should be charged at 20% to the three contracts in proportion to work certified. You are required to prepare statements showing contract-wise and total.

(a) Profit/loss to be taken to the P & L A/c for the year ended 31st March, 20X1.

(b) Work-in-progress as would appear in the Balance Sheet as at 31-03-20X1.

Solution:

View solution in koncept education app - Download App

 Illustration 22

A company is manufacturing building bricks and fire bricks. Both the products require two processes. Brick forming and Heat treatment. The requirements for the two bricks are:

	BUILDING BRICKS	FIRE BRICKS
Forming per 100 bricks	3 hrs.	2 hrs.
Heat treatment per 100 bricks	2 hrs.	5 hrs.

 Total costs of the two departments in one month were:

Forming	₹ 21,200
Heat Treatment	₹ 48,800

 Production during the month was:

Building Bricks	1,30,000 Nos.
Fire Bricks	70,000 Nos.

Prepare statement of manufacturing costs for the two varieties of bricks.

Solution:

View solution in koncept education app - Download App

 Illustration 23

Deluxe limited undertook a contract for ₹5,00,000 on 1st July, 20X1. On 30th June 20X2 when the accounts were closed, the following details about the contract were gathered:

Particulars	Amount (₹)
Materials purchased	1,00,000
Wages paid	45,000
General expenses	10,000
Plant Purchased	50,000
Materials on hand 30-6-20X2	25,000
Wages accrued 30-6-20X2	5,000
Work certified	2,00,000
Cash received	1,50,000
Depreciation of Plant	5,000
Work uncertified	15,000

The above contract contained an escalator clause which read as follows:

“In the event of prices of materials and rates of wages increase by more than 5% the contract price would be increased accordingly by 25% of the rise in the cost of materials and wages beyond 5% in each case”.

It was found that since the date of signing the agreement the prices of materials and wage rates increased by 25% the value of the work certify does not take into account the effect of the above clause.

Prepare the contract account. Working should form part of the answer.

Solution:

View solution in koncept education app - Download App

 

 

Exercise

 Multiple Choice Questions

1. Cost Price is not fixed in case of _________.

1. Cost plus contracts
2. Escalation clause
3. De-escalation clause
4. All of the above

Answer : a

2. Most of the expenses are direct in ________.

1. Job Costing
2. Batch Costing
3. Contract Costing
4. None of the above

Answer : c

4. Cost plus contract is usually entered into those cases where ________.

1. Cost can be easily estimated
2. Cost of certified and uncertified work
3. Cost of certified work, cost of uncertified work and amount of profit transferred to Profit and Loss Account
4. Determination of contract cost with reasonable accuracy is not possible

Answer : d

3. In order to determine cost of the products or services, different business firms follow:

1. Different techniques of costing
2. Uniform costing
3. Different methods of costing
4. None of the above

Answer : c