Contract and Operating Costing

Gourav Vallabh XLRI Jamshedpur

Features of Contract Costing

Contract Costing is a variation of job costing applied in those undertakings which are engaged in constructional and repair works. The difference between these two methods of costing lies in the size of order received. Expenses chargeable to contracts are direct in nature. Each contract is treated as cost unit, i.e., the cost of construction of is ascertained in respect of each and every contract separately.

Similarities and Dissimilarities between job and contract costing

Similarities
Production starts on received orders from customers. Quotation price is asked before giving orders. Every job and contract is dissimilar in nature. Profit is determined in respect of each job and contract separately. They belong to category of specific order costing.

Contd.

Dissimilarities
A job is small in size, contract is big in size. A job usually takes less time to complete. The selling price of a job is paid after completing the job in full. Expenses under job costing takes the form of both direct and indirect, whereas under contract costing most of the expenses are direct in nature. Profit earned on job is entirely taken to P & L A/c. In case of incomplete contract only proportionate profit is taken to P & L A/c.

Procedure of Contract Costing

The preparation of contract account is the essence of contract costing: 1. Materials
When materials are purchased When materials are sent to site When material is transferred from one contract to another When material is supplied by the contractee When material are sold at work site For recording accidental loss of material For recording material remaining at site at the end of the year

Contd.

2. Labour Cost: All labour engaged at the contract site is regarded as direct irrespective of the nature of the job performed by the employee. 3. Direct Expenses: Some examples of direct expenses are Architects and consultants fees, the hire of plant from outside firms, electricity charges, insurance charges, etc. 4. Plant and Machinery:

Where plant is specifically purchased for a particular contract to be used for longer duration. When the plant is used relatively for a shorter duration on a contract.

Contd.

5.

6. 7.

8.

9.

Indirect Expenses: The administration expenses incurred and the supervisors salary is apportioned among the contracts on some suitable basis. Sub Contract: The cost of sub contract is debited to contract account. Retention Money: Usually the contractee stipulates in the contract deed that he withhold a part of the contract price to be paid at later stage after completion of the contract. Progress Payment: If every installment of money paid by the contractee to the contractor depends upon the progress of work is known as progress payment. Escalation Clause: Sometimes, owing to fluctuation in the prices of materials and labour costs the contract price is altered so that neither party suffers the loss arising out of the change in price level.

Contd.

10. Cost plus contract: Under such circumstance, the contractee agrees to pay to the contractor, the actual cost incurred together with an agreed amount of profit which the contractor earns in the usual course of business. 11. Work Certified and Work Uncertified 12. Work in Progress 13. Profit on Uncompleted Contract 14. Loss on uncompleted contract 15. Balance Sheet 16. Target Costing

Problem (On Escalation Clause) The escalation clause of a long term contract stipulates the following quantities and rates of materials of A,B and C and the following number of labour hours of X,Y and Z and their rates of pay. The actuals are shown below:
Materials Qty (Tons) Rate (Rs) Actual Qty (Tons) Actual Rate (Rs)

A
B C

500
1000 20

50
30 1000

500
1000 20

45
35 1010

Labour
X Y

Hours
4800 2400

Hourly Rate
2 1

Actual Hours
4800 2400

Actual Hourly Rate

2.25 1.5

9600

1.5

9600

1.5

Compute the amount of final claim so far as the rate is concerned.

Operating Costing
This method of costing is adopted by those business organization which are engaged in providing service such as transportation, Generation & Distribution of electricity, Hotels, Hospitals, Theaters etc. Normally double units of management are used such as Ton Kilometers, passenger Kilometer, room days, patient days, Kilowatt hrs. etc.

Commercial and Absolute Ton Kilometers

It is obtained by multiplying the total tonnage carried by the kms. traveled and dividing the product by two. This is normally done where the vehicles return empty. In the case of absolute ton kilometers every distance is calculated separately and added to find the final absolute ton kilometer.

Problem
A truck starts with a load of 10 tons of goods from station P. It unloads 4 tons at station Q and rest of the goods at station R. It reaches back directly to station P after getting reloaded with 8 tons of goods at station R. The distance between P to Q, Q to R and then from R to P are 40 Kms. 60 Kms, and 80 Kms respectively. Compute Absolute ton-kms and Commercial ton kms.

Problem
Global Transport Ltd. charges Rs 90 per ton for its 6 ton truck lorry load from city A to city B. The charges for the return journey are Rs 84 per ton. No concessions or reductions in these rates is made for any delivery of goods at intermediate station C. In January 1997 the truck made 12 outward journeys for city B with full load out of which 2 tons were unloaded twice in the way at city C. The truck carried a load of 8 tons in its return journey for 5 times but once caught by police and Rs 1200 was paid as fine. For the remaining trips the truck carried full load out of which all the goods on load were unloaded once at city C. The distance from city A to city C and city B are 140 and 300 kms respectively. Annual fixed costs and maintenance charges are Rs 60000 and Rs 12000 respectively. Running charges spent during January 1997 are Rs 2944. You are required to find out cost per absolute tonkilometers and the profit for January 1997.
Answer: Net Revenue Received 12,168, Total Absolute Ton Kms 44,720, Cost per absolute ton kms Rs .2 and Profit is Rs 3224