CHAPTER 3

3. Costing Methods: The Costing of Resource Outputs:

Job order, Batch and Contract Costing Methods
3.1 Job Order Costing Systems
Manufacturers can use two basic accounting systems; general accounting system, and cost accounting
system. A general accounting system is the logical extension of accounting for merchandising firms, and
uses the periodic inventory system. However, since managers require frequent accounting reports on
manufacturing costs for decision making purpose, the use of the general accounting system is very limited.
Cost accounting system uses the perpetual inventory system and it is most widely used, because it helps to
gather information that are needed in order to prepare periodic reports without physical counting and related
cumbersome tasks.
The cost accounting system uses the perpetual inventory system, and achieves greater accuracy in the
determination of product cost than is possible with the general accounting system. It also permits far more
effective control by supplying data on costs incurred by each manufacturing department or process and it
provides a fairly accurate unit cost of manufacturing each type of product that helps managers make good
decisions timely.

Companies frequently adopt one of the two costing systems to assign costs to products or services. These
are: Process costing system and Job order costing system
Process costing system is a costing system used for manufacturing processes which produce a single
product or single mix of products continuously for an extended period of time. In process costing, costs are
accumulated by departments, operations, or processes. The work performed on each unit is standardized or
uniform where a continuous mass production or assembly operation is involved. For example, process
costing is used by companies that produce appliances, alcoholic beverages, tires, sugar, breakfast cereals,
leather, paint, coal, textiles, lumber, candy, coke, plastics, rubber, cigarettes, shoes, typewriters, cement,
gasoline, steel, baby foods, flour, glass, men's suits, pharmaceuticals and automobiles. Process costing is
also used in meat packing and for public utility services such as water, gas and electricity.

A job order costing system provides a separate record of the cost of each particular batch of product that
passes through the factory. The system accumulates costs for a particular batch of production, commonly
referred to as a job. A job has a definite starting and completion time as would, for example, the production
of 10 pieces of windows, or 50 coffee tables. As the name implies, job order means, the units are produced
as per the order of a customer, each customer order is different in terms of specification. A difference in
specification means a difference in quantity of inputs used. An individual job does not mean a single output;
rather it means a single order which can be just for stock that can be sold later to ready-made buyers.
Whatever, whether for customer or stock, jobs are not similar, and their costs are also different. In job order
costing system, costs are accumulated by job. For each job, the firm maintains a separate job cost sheet,
which is a record on which manufacturing costs of the job are accumulated.

The objective of this method of costing is to work out the cost of each job by preparing the Job Cost Sheet.
A job may be a product, unit, batch, sales order, project, contract, service, specific program or any other
cost objective that is distinguishable clearly and unique in terms of materials and other services used. The
cost of completed job will be the materials used for the job, the direct labour employed for the same and
the production overheads and other overheads if any charged to the job.

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In job order costing, costs are accumulated by jobs, orders, contracts, or lots. The key is that, the work is
done to the customer's specifications. As a result, each job tends to be different. For example, job order
costing is used for construction projects, government contracts, shipbuilding, automobile repair, printing
jobs, wood furniture, office machines, machine tools, and luggage. Accumulating the cost of professional
services such as lawyers, doctors and CPA's also falls into this category.
The primary purpose of job costing is to bring together all the costs incurred for completing a job. The
system of job costing can be sub-divided into two categories viz. (a) Factory job costing and (b) Contract
costing. A variant of job costing system is batch costing in which costs are accumulated for specific
batches of products of a similar type ordered for manufacture.

As production in a job order system is not a continuous process, careful planning and strict control is
essential to avoid wastage of materials, man-power, machinery and other resources. On receipt of an order,
the production and planning department prepares a suitable design for the product or job. It also prepares
a bill of materials and an operation schedule. A production order is issued giving instructions to the shops
to proceed with the manufacture of the product. This production order (also known as work order or job
order record) constitutes the authority of the work. The production order usually lays down the quantity of
materials required, time allowed for the operations, sale price, customer’s name, shipping instructions, etc.
Sometimes the values of materials and labour are also indicated and then it serves the combined purpose
of an order for manufacture as well as the cost sheet on which the cost of the order is compiled. Every
production order is assigned a number called the job number, job-order number, work order number.

Most companies have costing system that are neither pure job costing nor pure process costing rather they
combine elements of both job costing and process costing. This is called hybrid costing system

Source of documents for job order costing

The key source document in job order costing system is job cost sheet (job cost record) this document
records and accumulates all the cost (direct material, direct labor and MOH cost) assigned to a specific job.
Source documents also exist for individual items in a job

1. Measuring Direct Materials Cost in Job Order Costing System:

At the beginning of production process, a document known as bill of materials is used for standard products.
"A bill of materials is a document that lists the type and quantity of each item of materials needed to
complete a unit of standard product". In case where it is not possible to use a bill of materials, the production
staff determines the material requirements from the blueprints submitted by the customer.

When an agreement is reached with the customer concerning the quantities, price and shipment date for
the order, a production order is issued. The production department then prepares a materials requisition
form. Materials requisition form is a detailed source document that specifies the type and quantity of
materials to be drawn from the storeroom, and identifies the job to which the costs of the materials are to
be charged. The form is used to control the flow of materials into production and also for making entries
in the accounting records. The completed form is presented to the storeroom clerk who then issues the
necessary raw materials. The storeroom clerk is not allowed to release materials without such a form
bearing an authorized signature. The following is a sample material requisition form for job 2B47.

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 Sample Materials Requisition Form:
Materials Requisition Number14873 Date March 2 ,2009
Job Number to Be Charged 2B47
Department Milling
Description Quantity Unit Cost Total Cost
M46 Housing 2 Br.124 Br.248
G7 Connector 4 103 412
Br.660
Authorized Signature __________________

After being notified that the production order has been issued, the accounting department prepares a job cost
sheet. A job cost sheet is a form prepared for each separate job that records the materials, labor and overhead
costs charged to the job. After direct materials are issued, the accounting department records their costs directly
on the job cost sheet. In addition to serving as a means for charging costs to jobs, the job cost sheet also serves
as a key part of a firm's accounting records. The job cost sheets form a subsidiary ledger to the work in process
(WIP) account. They are detailed records for the jobs in process that add up to the balance in the work in process
(WIP). The raw material cost Br.660 for job 2B47 is accumulated on a job cost sheet as follows:

JOB COST SHEET

Job Number 2B47 Date Initiated March 2 ,2009
Department Milling Date Completed
Item Units Completed
For Stock

Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660

2. Measuring Direct Labor Cost under Job Order Costing System:

Direct labor cost is handled in much the same way as direct materials cost. Direct labor consists of labor charges
that are easily traced to a particular job. Labor charges that cannot be easily traced directly to any job are treated
as part of manufacturing overhead. The later category of labor cost is known as indirect labor and includes tasks
such as maintenance, supervision, and cleanup. Workers use time tickets to record the time they spend on each
job and task. A completed labor time ticket is an hour by hour summary of the employees activities throughout
a specific job, the employee enters the job number on the time ticket and notes the amount of time spent on that
job. When not assigned to a particular job, the employee records the nature of the indirect labor task (such as
cleanup and maintenance) and the amount of time spent on the task. The daily time tickets are also used as the
basis for labor cost entries into the accounting records. Following is an example of employees’ time ticket.
Time Ticket No. 843 Date March 3 ,2009
Employee : Jaleta Bulli Station 4

Started Ended Time Completed Rate Amount Job Number

7:00 12:00 5.0 Br.9 Br.45 2B47
12:30 2:30 2.0 9 18 2B50
2:30 3:30 1.0 9 9 Maintenance

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At the end of the day, the time tickets are gathered and accounting department enters the direct labor
hours and costs on individual job cost sheets. The following is how to do that for job 2B47.
JOB COST SHEET
Job Number 2B47 Date Initiated March 2 ,2009
Department Milling Date Completed
Item Units Completed
For Stock

Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660 843 5 Br.45
3. Application of Manufacturing Overhead Cost in Job Order Costing:
Manufacturing overhead cost is incurred for the benefit of all jobs produced during a period and cannot be
related to any particular job. As manufacturing overhead costs are incurred, they are accumulated as
manufacturing overhead control account. Some manufacturing costs such as utility will not be known until
the end of the period. Hence, rather than holding a finished good job until all costs can be attributed to it,
it is necessary to develop a method of allocating manufacturing overhead cost to the job completed. This
is called normal costing. In normal costing direct material and direct labor costs are directly traced to the
job completed but MOH cost is allocated to it using budgeted rate and actual allocation base. To determine
budgeted rate:
 Estimate manufacturing overhead cost for the year.
 Choose allocation base such as labor hour, direct labor cost or machine hour.
 Estimate the allocation base for the year
 Calculate the budgeted rate using the formula.
Manufacturing-Overhead costs is not easily traced to jobs.
By definition, manufacturing overhead is a heterogeneous pool of indirect production costs, which bears
no obvious relationship to individual jobs or units of products, but must be incurred for production to take
place. Therefore, it is necessary to assign manufacturing-overhead costs to jobs in order to have a
complete picture of product costs. This process of assigning manufacturing overhead costs to production
jobs is called overhead application /or overhead allocation / or sometimes overhead absorption/
The following table shows: Summary of overhead concepts
Estimated overhead cost The amount of overhead cost that management estimate to be incurred.
This estimate is made Before the period or at the beginning of the period
in order to compute predetermined overhead rate.
Actual overhead cost The amount of overhead cost that is actually
incurred during a period (as shown by
payments for utilities, rents, and so on.)
Applied overhead The amount of overhead cost that is added The deference between
(applied) to work in process. This amount is these amounts represents
computed by applying under or over applied
actual activity during the period by the overhead
predetermined overhead rate
Actual costing- Allocate direct material and direct labor costs to cost objects on the bases of actual direct-
cost rate(s) and actual quantity of direct-cost input(s). Overhead costs are allocated to cost object on the
basis of actual overhead rate computed at the end of the period and actual amount of cost deriver used
Normal costing- allocate direct material and direct labor cost on the bases of actual direct cost rate(s) and
actual quantity of direct-cost input(s). Overhead costs are allocated to cost object on the basis of
predetermined /budgeted/ overhead rate computed at the beginning of the period and actual quantity of
cost-allocation base(s).The summary is given as follows.

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 Actual costing Normal costing
Direct costs Actual direct-cost rate(s) × Actual Actual direct-cost rate(s) × Actual
quantity of direct-cost Input(s) quantity of direct-cost input(s)
Indirect costs Actual indirect-cost rate(s) × Budgeted indirect-cost rate(s) × Actual
Actual quantity of cost-allocation base(s) quantity of cost-allocation base(s)
Allocation of overhead costs- for product costing to be useful, information must be provided to managers
on a timely basis. Suppose the cost-accounting department waited until the end of an accounting period so
that the actual costs of manufacturing overhead could be determined before applying overhead costs to the
firm’s products. The result would be very accurate overhead application and decision based in such
information could be better i.e. better pricing and control decisions may result from more accurate
product costs. However, the information might be useless because it was not available to managers for
planning, control, and decision making at the appropriate time. Do to this fact many opportunities may be
missed and late responses may be given to events. Thus, managers and management accountants must
weigh the costs and benefits of this information.
Actual overhead rate Predetermined overhead rate
- More accurate, but untimely information - Less accurate, but more timely information
Each entails costs and benefits that must be considered

With the consideration of all cost and benefits the only way to assign overhead costs to production is use
Predetermined overhead rate. As most management accountants recommend, and as most organizations
do, apply overhead to products on the basis of estimates made at the beginning of the accounting period.
The accounting department chooses some measure of productive activity to use as the basis for overhead
application this could be volume based cost drive (or activity base) which is common to all of the
company's products and services. An allocation base is a measure such as direct labor hours or machine
hours that is used to assign overhead costs to products and services. The most widely used allocation bases
are direct labor hours, direct labor cost, machine hours and even units of product can also be used to some
extent.

As estimate is made of (1) the amount of manufacturing overhead costs that will be incurred during a
specified period of time and (2) the amount of the cost driver that will be used or incurred during the same
time period, then a predetermined overhead rate is computed as follows:
Estimated Total Manufacturing Overhead Cost for the period
Predetermied Overhead rate =
Estimated Total Amout of Cost Driver (Allocation base)
For example, if a company has estimated that its total manufacturing overhead cost will be Br.320, 000 for
the year and its total direct labor hour will be Br.40, 000, its predetermined overhead rate (POR) for the
year will be Br.8 per direct labor hour, calculated as follows:
Br 320,000
Predetermied Overhead rate (POR) = = 𝐵𝑟 8 𝑝𝑒𝑟 𝐷𝐿 ℎ𝑜𝑢𝑟
40,000
Predetermined overhead rate is based on estimates rather than actual result. This is because the
predetermined overhead rate is computed before the period begins and is used to apply overhead cost
throughout the period. The process of assigning overhead costs to jobs is called overhead application. The
formula for determining the amount of overhead cost to apply to a particular job is:

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Overhead applied to a particular job = POR × Amount of allocation base
Note that the job cost sheet in the example below indicates that 27 labor hours have been worked. Therefore
a total of Br.216 of manufacturing overhead cost would be applied to the job.
Overhead applied to Job 2B47 = Predetermined overhead rate × Actual direct labor hours
= Br.8 per DLH × 27 DLHrs = Br.216
In addition to direct material and direct labor cost, the applied manufacturing overhead cost will be
entered in the job cost sheet and the total estimated cost to complete the job will be summarized as shown
below.
JOB COST SHEET

Job Number 2B47 Date Initiated March 2 ,2009

Department Milling Date Completed March 8 ,2009

Direct Materials Direct Labor Manufacturing Overhead

Req. No. Amount Ticket Hours Amount Hours Rate Amount
14873 Br.660 843 5 Br.45 27 Br.8/DLH Br.216
14875 506 846 8 60
14912 238 850 4 21
--------- 851 10 54
Br.1,404 -------- --------
===== 27 Br.180
===== =====
Cost Summary Units Shipped
Direct Materials Br.1,404 Date Number Balance
Direct Labor 180 March 8 -- 2
Manufacturing Overhead 216
Total Cost Br.1800
Unit Product Cost 900

The amount of overhead cost entered in the job cost sheet is not the actual amount of overhead caused by
the job. There is no attempt to trace actual overhead costs to jobs. If that could be done, the costs would be
direct costs, not overhead costs. Overhead assigned to the job is simply a share of the total overhead that
was estimated at the beginning of the year. When a company applies overhead cost to jobs as we have
done, it is called normal costing system. The overhead may be applied as direct labor-hours are charged to
jobs, or all of the overhead can be applied at once when the job is completed. The choice is up to the
company. If a job is not completed at the year-end, however, overhead should be applied to value the work
in process inventory.

Instead of using a predetermined overhead rate, a company could wait until the end of the accounting period
to compute an actual overhead rate based on actual total manufacturing costs and the actual total units in
the allocation base for the period. However, managers cite the following two reasons for using
predetermined overhead rates instead of actual overhead rates:

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1. Managers would like to know the accounting system's valuation of completed jobs before the end of
the accounting period. Suppose, for example a company waits until the end of the year to compute its
overhead rate. Then there would be no way for managers to know the cost of goods sold for a job until
the close of the year. The job may be completed and shipped before the end of the year. The seriousness
of this problem can be reduced to some extent by computing the actual overhead more frequently, but
that immediately leads to another problem as discussed below.
2. The use of predetermined overhead rate simplifies the record keeping. To determine the overhead cost
to apply to a job, the accounting staff simply multiplies the direct labor hours recorded for the job by
the predetermined overhead rate.

The Flow of Documents in a Job Order Costing System

The job
Materials
cost sheet
requisition
is used to
form
A These compute
production production unit
A sales Job
Sales Production order Direct labor costs are product
order is → → cost
Order Order initiates time ticket accumulated costs that in
prepared sheet
work on a on a form, turn are
as a basis →
job, prepared by used to
for
whereby the value
issuing
costs are accounting ending
a.....
charged Predetermined department inventories
through... overhead rates known as... and to
determine
cost of
goods sold

Some accounts which are important to record a particular job costs.

Work-in-process control-is the account used to record direct material and direct labor cost used / put/ in
to production. As direct materials are used, they are charged to individual job records, which are subsidiary
ledger accounts for the Work-in Process control account in the general ledger account. Its balance increases
when indirect costs are applied to production.
Manufacturing overhead control- is the account used to record the actual costs incurred during the period
in all the individual overhead categories such as indirect material, indirect labor, and other indirect costs.
It has a normal debit balance i.e. it increases when actual indirect costs are incurred and decreases when
indirect costs are applied to production process on the basis of the predetermined overhead rate.
Manufacturing overhead applied-is the account used to record the manufacturing overhead allocated
during the period to individual jobs on the bases of the budgeted rate multiplied by actual amount
/number/unit/ allocation base such as direct manufacturing labor-hours. It is a contra-account to
manufacturing overhead account.

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 Disposing of factory overhead balances-If the actual overhead had been less than or more than the applied
overhead, then, there will be overhead balances that should be disposed as of the end of the accounting
period.
If actual overhead is less than applied overhead, the difference would have been called over applied
overhead or over allocated overhead.
If the actual overhead is more than applied overhead, then, the difference is called under applied
Overhead or under allocated overhead.
In any ways, companies have three alternatives to dispose the overhead balances at the end of the period.
These are:
1. Adjusted allocation rate approach- this approach restate all entries in the general and subsidiary ledgers
by using actual cost rates than budgeted cost rates. First the indirect cost rate is computed at the end of
the year. Then, every job to which indirect costs were allocated during the year has its amounts
recomputed using the actual indirect-cost rate rather than the budgeted indirect cost rate. This will give
the best accuracy, and decisions based on accurate information could be sound and more important. But
unless computer system is applied, it will be complicated and costly.
2. Write-off to cost of Goods sold Approach-as in the case of most companies, the over or under applied
overhead costs may be closed into cost of goods sold.
a) For under applied overhead balance, by debiting Cost of Goods sold accounts and crediting
Manufacturing overhead account by the amount of the difference or by debiting cost of goods sold by
the amount of the difference and debiting Manufacturing overhead applied account by its balance and
crediting Manufacturing overhead control account by the total amount of its balance i.e.
Cost of goods sold----------------------------------x
Manufacturing overhead applied-----------------xx
Manufacturing overhead control--------------xxx
b) For over applied overhead balance, by crediting Cost of Goods sold account and debiting to
manufacturing overhead applied account by the amount of the difference or by crediting cost goods
sold by the amount of the difference, crediting manufacturing overhead control account by its balance
and debit manufacturing overhead applied account by its balance.
i.e. Manufacturing over head applied-------------------------xxx
Cost of goods sold------------------------------------------------x
Manufacturing overhead control-------------------------------xx
1. Proration Approach-is the distribution of overhead balances among ending work in process, finished
goods, and cost of goods sold accounts. Materials inventories are not allocated any manufacturing
overhead costs, so they are not included in this spreading of under-or over allocated overhead among
proration. To this effect, companies may use the amount of the current period’s applied overhead
remaining in each account as the base for the proration procedure.
Suppose that AB-Manufacturing company produces two products X and Y. Assume that the total actual
overhead costs incurred by the company and the total overhead costs applied by the company during the
year 2002 were $19,400 and $18,000 respectively. The current period before adjustment overhead balance
allocated to Work-in-Process, Finished Goods Inventory and Cost of Goods sold accounts are
$9,000,$3,000 and $6,000 respectively.
The under applied overhead balance = $19,400- $18,000 = $1,400
The company can prostate the balance of $400 among the three accounts as follows.
Total year end overhead balances of the three accounts (before adjustment) = $9,000 + $3,000 + $6,000 =
$18,000

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Thus, the amount allocated to each account should be:
Work-in process = $9,000 × $400 = $200
$18,000
Finished goods inventory = $3,000 × $400 = $66.67
$18,000
Cost of goods sold = $6,000 × $400 = $133.33
$18,000
The entry for this case should be:
Work-in process inventory------------------200
Finished goods inventory-----------------66.67
Cost of goods sold------------------------133.33
Manufacturing overhead control--------------400
This approach gives us a more accurate figure of work in process, finished goods, and cost of goods sold,
but it is still not as simple as write off to cost of goods sold methods.

NB-In all of the above cases /approaches/, the balances of manufacturing Overhead control and
Manufacturing Overhead applied accounts should be reduced to zero after the factory overhead balances
are removed through adjustment and ready to accumulate the overhead costs of the next accounting period.
 In choosing among the three approaches, managers should be guided by how the resulting information
will be used.
-If managers desire to develop the most accurate records of individual job costs for profitability analysis
purposes, the adjustment allocation-rate approach is preferred.
- If the purpose is confined to reporting the most accurate inventory and cost of goods sold figures,
proration approach on the manufacturing overhead-allocated component in the ending balances should be
used.

-If the amount of under or over allocated balances is small-in comparison to total operating income, or
some other measure of materiality, the write off to cost of goods sold method(the simples method) could
be used. This approach can be reliable in today’s business environment where the concept of JIT is
applicable.

ACCOUNTING PROCEDUER FOR JOB ORDER COSTING

Job order costing system requires a subsidiary ledger for each job order and general ledger (controlling
account) for the total amount. Entries in subsidiary ledger will be made frequently and summarized in
control account in weekly or monthly interval.
Major accounting procedures in job order costing system
 Receiving job order and purchase of raw materials
 Transferring raw material to work in process
 Recording labor to work in process
 Recording actual manufacturing overhead cost incurred
 Allocating manufacturing overhead cost work in process
 Transferring work in process to finished good
 Transferring finished goods to customers.

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Applying Accounting Procedures for Job order Costing System
To illustrate the procedures used in job-order costing, we will examine the accounting entries made by Alpha-
manufacturing co. during November 2003. The company uses machine hours to allocate overhead costs to the
individual jobs. It has worked on two production jobs during the month.
Job-1: 80 deluxe wooden canoes
Job-2: 80 deluxe aluminum fishing boats
The company undertaken the following activities/transaction during the month of November
Transaction-1: Acquisition of direct materials
4000-square feet of rolled aluminum sheet metal were purchased on account for $10,000. The purchase is
recorded with the following journal entry.
Raw-material Inventory----------------------10,000
Accounts payable------------------------------10,000
Transaction-2: Use of direct material
On November -1, the following material requisitions were filed.
Requisition number-001 (for job-1) ---------8,000 board feet of lumber, at $2 per
board foot, for a total of $16,000
Requisition number-002 (for job-2) --------7,200 square feet of aluminum sheet metal,
at $2.50 per square foot, for a total of $18,000
The following journal entry records the release of these raw materials to production.
Work-in-process inventory---------------34,000
Raw-material inventory--------------------34,000
Transaction-3: Use of indirect material
On November 15, the following material requisition was filed.
Requisition-003: 5-gallons of bonding glue, at $10 per gallon, for a total cost of $50
Manufacturing overhead-------------------50
Manufacturing supplies inventory----------50
Since only small amounts of bonding glue are used in the production of all classes of boats manufactured by
the company, the costs incurred is small, and no attempt is made to trace the cost of glue to specific jobs. Instead,
glue is considered an indirect material, and its cost is included in manufacturing overhead. The company
accumulates all manufacturing-overhead cost in Manufacturing Overhead account. All actual overhead cost
are recorded by debiting the account when indirect materials are requisitioned, when indirect-labor costs are
incurred , when utility bills are paid, when depreciation is recorded on manufacturing equipment, and so on.
Transaction-4: Use of direct labor
At the end of November, the cost-accounting department used the labor time tickets filed during the month to
determine the following direct-labor costs of each job.
Direct labor: Job-1------------------$9,000
Direct labor: Job-2--------------12,000
Total direct labor-----------------$21,000
The journal entry used to record these costs should be
Work-in-process Inventory---------------21,000
Wages payable--------------------------------21,000
Transaction-5: Use of indirect labor
The analysis of large time card undertaken on November-30 also revealed the following use of indirect labor
that is not charged to either of the products specifically, amounts to $14,000.
This cost is comprised of the production supervisor’s salary and the wages of various employees who spent
some of their time on maintenance, general cleanup duties and salary of guards and store keepers during
November.
Manufacturing overhead--------------------14,000
Wages Payable------------------------------------14,000

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No entry is made on any job cost sheet, since indirect-labor costs are not traceable to any particular job. In
practice, journal entries (4) and (5) are usually combined into one compound entry as follows:
Work in process inventory------------------21,000
Manufacturing overhead---------------------14,000
Wages payable------------------------------------35,000
Transaction-6: Other manufacturing over head costs
During November, the company incurred the following other manufacturing overhead cost besides the indirect
materials and indirect labors costs.
Rent on factory building (expired prepaid rent) ------------$3,000
Depreciation on equipment-------------------------------------5,000
Utilities (electricity, water, telephone) -----------------------4,000
Property taxes-----------------------------------------------------2,000
Insurance (amount expire during the month) -----------------1,000
Total --------------------------------------------------------------$15,000
The following compound entry is made on November-30, to record these costs.
Manufacturing overhead------------------------15,000
Prepaid Rent----------------------------------------------3,000
Accumulated depreciation-Equipment----------------5,000
Accounts Payable (utilities and property tax) --------6,000
Prepaid Insurance-----------------------------------------1,000
Application of manufacturing overhead
Various manufacturing-overhead costs were incurred during November, and these costs were accumulated by
debiting the Manufacturing-Overhead accounts. However, no manufacturing-overhead cost have yet been added
to Work- in-Process Inventory or recorded on the job-cost sheets. The application of overhead to the firm’s
products is based on a predetermined overhead rate. This rate computed by the accounting department at the
beginning of the period. (Refer to page-14 to 15)
Transaction-7: Allocation of overhead costs
Factory machine-usage records indicate the following usage of machine hours during November.
Machine hour used: Job-1 -----------------------------1, 200 hours
Machine hour used: Job-2-------------------------------2,000 hours
Total machine hours--------------------------------------3,200 hours
The total manufacturing overhead applied to Work-in-Process Inventory during November is calculated as
follows.
Machine hour x Predetermined Manufacturing
Overhead rate overhead applied
Job-1 1,200 × $9.00 = $10,800
Job-2 2,000 × $9.00 = $18,000
Total manufacturing overhead applied $28,800
The following journal entry is made to apply manufacturing overhead to Work-in-Process Inventory.
Work-in-Process Inventory ----------------------28,800
Manufacturing overhead---------------------------------28,800
NB. As the following time line shows, three concepts are used in accounting for overhead. Overhead is
budgeted at the beginning of the accounting period, it is applied during the period, and actual overhead is
measured at the end of the period.

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Beginning of End of
Accounting period accounting period
TIME

Budgeted overhead
(and calculation of Applied Actual
Predetermined overhead overhead
Overhead rate)

Transaction-8: Selling and administrative costs

During November, Alpha-manufacturing co. incurred the following selling and administrative costs.
Rental of sales and administrative offices--------------------------$1,500
Salaries of sales personnel---------------------------------------------4,500
Salaries of management------------------------------------------------8,000
Advertising---------------------------------------------------------------1,000
Office supplies used------------------------------------------------------ 300
Total---------------------------------------------------------------------$14,800
Since these are not manufacturing costs, they are not added to Work-in-Process Inventory. Selling and
administrative costs are period costs, not product costs. They are treated as expenses of the accounting period.
The following journal entry is made
Selling and Administrative Expenses---------------------14,800
Wages Payable---------------------------------------------------12,000
Accounts payable-------------------------------------------------1,000
Prepaid Rent-------------------------------------------------------1,500
Office Supplies inventory------------------------------------------300
Transaction-9: Completion of production job
Job-2 was completed during November, whereas job-1 remained in process. The job sheet indicates that the
total cost of job-2 was $48,000. The following journal entry records the transfer of these job costs from Work-
in-Process Inventory to finished goods inventory.
Finished goods inventory--------------------48,000
Work-in- Process inventory-------------------48,000
Transaction-10: Sales of goods
Sixty deluxe aluminum fishing boats manufactured in job-2 were sold for $900 each during November. The
cost of each unit sold was $600 as shown on the job cost sheet. The following journal entries were made
a) Accounts Receivable------------------54,000
Sales Revenue-----------------------------54,000

b) Cost of goods sold-----------------------36,000

Finished goods inventory-----------------36,000
The reminder of the manufacturing cost of job-2 remains in Finished –goods inventory until some subsequent
accounting period when the units are sold. Therefore the cost balance for job-2 remaining in inventory is
$12,000 (20 units remaining times $600 per unit.)

Transaction-11: Disposition of overhead balances

During November, Alpha-Manufacturing co. incurred total actual manufacturing-overhead costs of $29,050,
but only $28,800 of overhead was applied to Work-in-Process Inventory. The amount by which the company’s
actual overhead exceeds applied overhead, called under applied overhead, and is calculated below.
Actual manufacturing overhead*----------------------------------$29,050
Applied manufacturing overhead+-------------------------------- 28,800
Under applied overhead---------------------------------------------$ 250

Page 12 of 21
The company disposes its overhead balances at the end of the year by directly writing the amount to cost of
goods sold during the period. Accordingly, the following journal entry is made by the company. This entry
reduces the balance of Manufacturing Overhead accounts to zero and increase the balance of cost of goods sold
account by $250.
Cost of goods sold------------------------------250
Manufacturing Overhead control--------------250

Schedule of cost of goods sold

Schedule of cost of goods sold for Alpha-manufacturing Company is displayed in Exhibit 3-2 .This schedule
shows the November cost of goods sold and detailed the changes in Finished-Goods Inventory during the month.
Exhibit 3-2: Schedule of cost of goods manufactured
Alpha-Manufacturing company
Schedule of cost of Goods Manufactured
For the month of November, 2003
Direct material:
Raw-material inventory, November-1-----------------------$30,000
Add: November purchase of raw material-------------------10,000
Raw material available for use-------------------------------$40,000
Deduct: Raw-material inventory, November-30--------------6000
Raw material used--------------------------------------------------------------$34,000
Direct labor----------------------------------------------------------------------------------21,000
Manufacturing overhead:
Indirect material---------------------------------------------- $50
Indirect labor----------------------------------------------------14,000
Rent on factory building--------------------------------------- 3,000
Depreciation on equipment-------------------------------------5,000
Utilities------------------------------------------------------------4,000
Property taxes----------------------------------------------------2,000
Insurance----------------------------------------------------------1,000
Total actual manufacturing overhead--------------------$29,050
Deduct: Under applied overhead------------------------- 250*
Overhead applied to work in process--------------------------------------------28,800
Total manufacturing costs------------------------------------------------------ $83,800
Add: Work in process inventory, November-1-------------------------------- 4,000
Subtotal---------------------------------------------------------------------------- $87,800
Deduct: Work in process, November-30, ---------------------------------------39,800
Cost of goods manufactured---------------------------------------------------- $48,000
 The schedule of cost of goods manufactured lists the manufacturing costs applied to Work in Process.
Therefore, the under applied overhead of $250 must be deducted from total actual overhead to arrive at the
amount of overhead applied to work in process during November. If there had been over applied overhead,
the balance would have been added to total actual manufacturing overhead.
Exhibit 3-3: Schedule of cost of goods sold
Alpha-Manufacturing company
Schedule of cost of goods sold
For the Month of November, 2003
Finished goods inventory, November-1------------------------------------$12,000
Add: Cost of goods manufactured*-------------------------------------------48,000
Cost of goods available for sale--------------------------------------------- $60,000
Deduct: Finished-goods inventory, November-30------------------------ 24,000
Cost of goods sold (before adjustment) ------------------------------------$36,000
Add: Under applied overhead +--------------------------------------------- 250
Cost of goods sold (adjusted for under applied overhead) -------------$36,250
* The cost of goods manufactured is obtained from the schedule of cost goods manufactured in Exhibit 3-2.
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+ The company closes overhead balances to cost of goods sold account. Hence the $250 balance in under applied
overhead is added to cost of goods sold for the month.

Exhibit 3-4: Income statements

Alpha-Manufacturing company
Income statement
For the Month of November, 2003
Sales revenue----------------------------------------------------------------------$54,000
Less: Cost of goods sold*------------------------------------------------------- 36,250
Gross margin----------------------------------------------------------------------$17,750
Selling and administrative expenses---------------------------------------------14,800
Income before taxes---------------------------------------------------------------$ 2,950
Income tax expenses------------------------------------------------------------ 1,420
Net Income----------------------------------------------------------------------- $1,530
*The cost of goods sold is obtained from the schedule of cost of goods sold
in Exhibit 3-3.
Posting journal entries to the ledger
All of the journal entries in the Alpha-Manufacturing illustration are posted to the ledger in Exhibit 3-5 as
follows. An examination of these T-accounts provides a summary of the cost flows discussed throughout the
illustration.
Exhibit 3-5: Ledger accounts for Alpha-Manufacturing Company’s illustration.
Accounts Receivable Raw material Inventory Wages Payable
10,000 Bal.
Bal. 11,000 Bal. 30,000 34,000 (2) 21,000 (4)
(10a) 54,000 (1) 10,000 14,000 (5)
12,000 (8)

Prepaid Insurance Work-in-Process Inventory Office Supplies inventory

Bal. 4,000 48,000 (9) Bal. 900 300 (8)
Bal. 2,000 1,000 (6) (2) 34,000
(4) 21,000
(7) 28,800 Accumulated Depreciation-
Prepaid Rent equipment
Finished Goods inventory
Bal. 5,000 Bal. 12,000 36,000 (10b) 105,000 Bal.
3,000 (6) (9) 48,000 5,000 (6)
1,500 (8)

Accounts payable Manufacturing Overhead

Manufacturing supplies 3,000 Bal. (3) 50 28,000 (7)
Inventory 6,000 (6) (5) 14,000
10,000 (1) (6) 15,000
Bal. 750 50 (3) 1000 (8)
250 (11)
Selling and administrative
Cost of Goods sold Expenses Sales Revenues
(10b) 36,000 54,000 (10a)
(11) 250 (8) 14,800

* The number in parentheses relates T-account entries to the associated journal entries. The given balances are
the November-1 account balances.

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Exercise 3.1: the following budgeted data is given for XYZ textile factory for the year 2004
Estimated MOH cost-------------------------------$450,000
Estimated no of shirts produced--------------------200,000shirts
Estimated DM cost for the year---------------------$300,000
Estimated DL cost -----------------------------------$900,000
Estimated DL hours ---------------------------------300,000hrs
Estimated machine hours ----------------------------90,000hrs
Compute the predetermined MOH rate on the following allocation base
1. physical output method
2. direct material cost base
3. direct labor base
4. direct labor hours base
5. machine hours base
Assume all information in above and the following additional information
Actual data for job 201 is given below
Actual shirts completed for job 201 -----2,000 shirts
Actual DM used --------------------------$30,000
Actual DL cost ----------------------------$20,000
Actual DL hours---------------------------400hrs
Actual machine hours----------------------240hrs
Determine the total cost of job 201 under each of the five bases of allocation
Exercise 3.2: A corporation uses job order cost system. The factory overhead rate estimated for the year 2001
was $8 per DL hour; the inventory account had the following balances on Dec. 1
Raw material--------------------------$7,000
WIP (job210) ---------------------------$6,500
FG (job209) -----------------------------$7,000
During December, the following events occurred
1. material purchased on account $18,000
2. direct materials and factory supplies were issued as follows
 job 211---------------------$4,500
 job212----------------------$5,300
 job213-----------------------$6,200
 indirect material ------------$1,800
3. the December direct labor cost were
 job 210------------------------150 hrs@ $6per hour
 job 211------------------------400 hrs@ $6per hour
 job 212------------------------350 hrs@ $6per hour
 job 213------------------------100 hrs@ $6per hour
4. factory indirect labor for December was $2,400
5. other overhead cost incurred during December
 Utility paid in cash----------------------$2,500
 Factory deprecation---------------------$ 1,000
 Repair and maintenance ----------------$500
 Total $4,000
6. job 210,211and 212 &213 were completed and transferred to FG
7. job 209 and 211 were sold on account for120% of cost
Required:
1. Journalize the above transactions
2. determine the under or over applied overhead

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Exercise 3.3 Robinson manufacturing company uses a job order costing system. Its job order costing system
has two direct costs (DM and DL) and one indirect cost category on January 1, 2004, the following inventories
are available
 Raw material ------------------$10,000
 WIP----------------------------$5,000
 Finished goods ----------------$15,000
Robinson budgeted the 2004 manufacturing overhead to be $1,280,000 and the budget quantity of machine
hours (allocation base) are 16,000 machine hours.
The following transaction occurs during the month of January
1. Purchase of material (direct and indirect), $89,000on account
2. raw material sent to manufacturing plant floor is $85,000out of which $4,000 is indirect material
3. manufacturing labor wages liability incurred is $54,000out of which $15,000is indirect
4. The actual machine hours used in the period were 1,000 machine hours. The manufacturing over head
is allocated using this actual machine hour.
5. additional manufacturing over head cost incurred during the month is $75,000 this cost consists of utility
and repairs,$23,000 insurance expired $2,000, depreciation expense $50,000
6. cost of finished goods of eight individual jobs completed and transferred out is $188,800
7. finished goods costing $180,000 was sold for $300,000on cash
Required:
a) journalize the above tr5ansactions
b) post using t-account
c) compute the under or over applied MOH cost
d) close the amount using direct write-off to cost of good sold
Exercise 3.4 ABC Company uses normal costing with single manufacturing overhead cost pool and machine
hours as the cost allocation base. The followings data are for 2004.
 Budgeted manufacturing overhead ---------------------------$4,800,000
 Overhead allocation base ---------------------------------------machine hour
 Budgeted machine hour ----------------------------------------$80,000
 Actual manufacturing over head incurred----------------------$4,900,000
 Actual machine hour ---------------------------------------------$75,000
Machine hour’s data and the ending balance (before peroration of under or over applied MOH cost) are4 as
follows
Actual machine hours End of year balance
Cost of goods sold 60,000 8,000,000
Finished goods 11,000 1,250,000
Work in process 4,000 750,000
Required:
a) Compute the budgeted manufacturing overhead rate for 2004
b) Compute the under or over applied MOH cost
c) Close the amount using
I. Direct write of to cost of goods sold
II. Prorate based on ending balance of WIP,CGS and FG
III. Prorate based on the allocated MOH cost amount in the ending balance of WIP,CGS and
FG

Page 16 of 21
 BATCH COSTING

This is another form of job costing which is adopted in case of manufacturing of a large number of
components of machines or of other articles. Since a large number of them are manufactured together and
pass through the same process of manufacture, it is convenient to collect their cost of manufacture
together.

Separate job cost sheets are maintained for each batch of products. Each batch is allotted a
number.Material requisitions are prepared batchwise, the direct labour is engaged batchwise and the
overheads are also recovered batchwise. Cost of each component in the batch is then determined by
dividing the total cost by the number of articles manufactured.
FEATURE OF BATCH COSTING
Features of batch costing system are as under:
 Batch costing is applied in industries where identical products are produced.
 A batch is a cost unit which consists of a separate, readily identifiable group of product units which
maintains its separate identity throughout the production process.
 The output of batch consists of a number of units and it is not economical to ascertain cost of every
unit of output independently
 The procedure is very similar to job costing:
(a) Each batch is treated a job and costs are calculated for total batch.
(b) On completion of production cost per unit is found as

𝑇𝑜𝑡𝑎𝑙 𝐵𝑎𝑡𝑐ℎ 𝐶𝑜𝑠𝑡

𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 =
𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝑖𝑛 𝐵𝑎𝑡𝑐ℎ
Job Costing Batch Costing
It is carried out or a product is produced by The process of producing the product has a
specific orders. continuous flow and product is homogeneous.
It is determined for each job. It is compiled on time basis.
Each job is separate and independent of other Product lose their individuality as they are
jobs. manufactured in a continuous flow

APPLICATIONS OF BATCH COSTING

Batch costing is used for calculating total cost of each batch. Batch is small group of units which is
produced for production purposes. We also identify batch of units in our production. All raw material is
supplied on batch basis and other expenses are also paid on the basis of each batch.

For instance, in the drugs industry, producer will make the batch of tablets instead of producing single
tablet. This will be easy to sell that batch in market. So, calculating cost of each batch, we will calculate
material cost per batch, labour cost per batch and other expenses per batch. If we want to calculate cost
per unit, we have to divide total batch cost with total batch units.
It is used in following industries:
1. Manufacturing industry for readymade garment
2. Manufacturing industry for toys
3. Manufacturing industry for tire & tube

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 CONTRACT COSTING

Contract (or terminal) costing, is one form of application of the principles of job order costing. In contract
costing each contract is treated as a cost unit and costs are ascertained separately for each contract. It is
suitable for business concerned with building or engineering projects or structural or construction contracts.

Usually, there is a separate account for each contract. Also the number of contracts undertaken at a time,
generally, not being very large, the Contract Ledger can very well be operated as part of the financial books.
The contract account is debited with all direct and indirect expenditure incurred in relation to the contract.
It is credited with the amount of contract price on completion of the contract. The balance represents profit
or loss made on the contract and is transferred to the profit and loss account. In case, the contract is not
completed at the end of the accounting period, a reasonable amount of profit, out of the total profit made
so far on the incomplete contract, may be transferred to profit and loss account.

DISTINCTION BETWEEN JOB AND CONTRACT COSTING

Contract jobs, while they resemble jobs, have a few distinctive features:

(i) Under job costing, the cost is first allocated to cost centres and then to individual jobs. In contract
costing, most of the expenses are of direct nature, overhead forms only a small percentage of total
expenditure and it represents expenses like share of head office expenses, share of central storage cost
etc.
(ii) Under job costing pricing is influenced by individual conditions and general policy of the organisation.
Under contract costing, pricing is influenced by specific clauses of the contract.
(iii)Unlike job costing, each contract is a cost unit in contract costing.
(iv) Under contract costing, the work is usually carried out at a site other than contractee’s own premises.
Job costing is often applied where jobs are carried out at the contractee’s own premises.

SPECIFIC ASPECTS AND RECORDING OF TRANSACTIONS OF CONTRACT COSTING

The recording procedure of the following items may be noted carefully:

(1) Material: Materials may be purchased in bulk and kept in store for supply to the contract, as and when
required, or these may be purchased and directly supplied to the contract. In the latter case, the cost of
material would be debited directly to the contract. If any materials are transferred from one contract to
another, their costs would be adjusted on the basis of Material Transfer Note, signed both by the transferor
and transferee foreman. In case certain materials charged to contract are returned to stores, the same will
be credited to the contract account. Materials stolen or destroyed by fire will be transferred to profit and
loss account. Materials in hand at the end of the year will appear on the credit side of the contract account.

(2) Labour: All labour actually employed on the site is regarded as direct labour irrespective of the nature
of the task performed by the labour concerned. If it is desired to ascertain the labour cost for a particular
job or work, each person would be provided with a job card upon which he must record the nature of the
work performed by him. On the basis of the analysis of the job cards, labour analysis sheets are prepared
for ascertaining the actual cost of labour on different operations.

Page 18 of 21
If concurrently number of contracts are carried on and workmen are made to divide their time between two
or more contracts, it would be necessary to prepare analysis sheets of labour, for charging to each contract,
wages appropriate thereto.

(3) Direct expenses: The expenses which can be directly charged to different contracts will be posted
directly to the respective contracts. These include cost of special tools, cost of design, electric charge,
insurance etc.

(4) Plant used in a contract: The value of plant used on a contract may be either debited to the contract
and the written down value thereof at the end of the year entered on the credit side for closing the contract
account, or only a charge for use of the plant (depreciation) may be debited to the account.

(5) Overhead expenses: In contract, overhead expenses are few and relate only to works or administration
expenses which cannot be directly apportioned to individual contracts. These indirect expenses may be
distributed on several contracts as a percentage of cost of materials or wages paid or the prime cost. If,
however, the contracts are big, the labour hour method is often adopted for distribution of expenses since
it is more efficacious. In making the distribution, the location of the site of the contract is another important
factor to be considered, for contracts situated at a distance are not likely to receive the same supervision as
compared to those which are close. Where such factors are prominent, some sort of quota basis for
distribution of expenses may be followed.

(6) Extras: Where some additional work not stipulated in the contract is carried out, the expenditure on
this additional work should be separately analysed from that charged to the main contract. If the additional
work is quite substantial, it should be treated as a separate contract and a separate account should be opened
for it. If it is not very substantial, expenses incurred up on extra work should appear on the debit side of
the contract account as ‘cost of extra work’, and the extra amount which the contractee has agreed to pay
should be added to the contract price.

(7) Sub-contracts: Generally work of a specialised character e.g. the installation of lifts, special flooring
etc. is entrusted to other contractors by the main contractor. The cost of such sub-contracts is a direct charge
against the contract for which the work has been done.

(8) Escalation clause: Escalation clause is usually provided in the contract as a safeguard against any
likely changes in the price or utilisation of material and/labour. This clause provides that in case prices of
items of raw materials, labour etc. specified in the contract change during the execution of the contract,
beyond a specified limit over the prices prevailing at the time of signing the agreement, the contract price
will be suitably adjusted. The terms of the contract specify the procedure for calculating such adjustment
in order to avoid all future disputes. Thus this clause safeguards the interest of both the contractor and the
contractee in case of fluctuations in the prices of material, labour etc.
(9) Cost plus contract: Cost plus contract is a contract in which the value of the contract is ascertained by
adding a certain percentage of profit over the total cost of the work. This is used in case of those contracts
whose exact cost cannot be correctly estimated at the time of undertaking a work. The profit to be paid to
the contractor may be a fixed amount or it may be a particular percentage of cost or capital employed.
These type of contracts are undertaken for production of special articles not usually manufactured and is
generally employed, when Government happens to be a contractee. Generally, in such contract, contractor

Page 19 of 21
and contractee have clear agreement about the items of cost to be included, type of material to be used,
labour rates for different grades, normal wastages to be permitted and the rate or amount of profit.
Advantage of cost plus contract
(v) Cost plus contract ensures that a reasonable profit accrues to the contractor even in risky projects.
(vi) It simplifies the work offering tenders and quotations.
(vii) It provides escalation clauses and thus covers the contractor from fluctuations in price and
utilisation of elements of production.
(viii) The customer is assured of paying only reasonable amount of profit.
(ix) The customer has the right to conduct cost audit so that he can ensure that he is not being cheated
by the contractor.

Disadvantages of cost plus contract system

In spite of the advantages mentioned above cost plus contract system has the following disadvantages:

(i) Since the contractor is assured of profit margin, he may not take initiative for cost reduction by
affecting economies of production and reducing wastages.
(ii) The ultimate price to be paid by the customer cannot be exactly ascertained until the work is completed
and this creates delay in preparing purchase budget by the customer.
(iii) The customer has to pay not only the resultant high cost but also the resultant high profit. Thus,
customer have to pay substantially for lack of proper attitude (towards cost and efficiency) on the part
of contractor.

(10) Progress payment, Retention money and Architects’ certificate: When a contractor is engaged on
a contract for several years, he cannot afford to block a large amount of funds until the completion of the
contract. Therefore, in case of large contracts the system of progress payment is adopted. The contractee
agrees to pay a part of the contract price from time to time depending upon satisfactory progress of the
work.

The progress will be judged by the contractee’s architect, surveyor or engineer who will issue a certificate
stating the value of work so far done and approved by him. Such work is termed as work certified. The
terms of the contract provide that whole of the amount shown by the certificate shall not be paid
immediately but a percentage thereof shall be retained by the contractee until sometime after the contract
is completed. The sum retained is called retention money. Usually the contractor may be paid 75% or 80%
of the work certified depending upon the terms of the contract. The object of this retention is to place the
contractee in a favorable position in case the contractor does not fulfil some of the conditions laid down by
the contract or in case of faulty work.

It may quite possible that at the end of a period a part of the work done may remain unapproved because it
has not reached a stipulated stage. Such work which has not been so far approved by the contractee’s
architect or surveyor is termed as work uncertified. The full value of the work certified should be credited
to the contract account and debited to the account of the contractee. Whenever any amount is received from
the contractee cash account is debited and contractee’s account is credited. Until the contract is completed,
amount received from the contractee shows advance payments and is deducted from work in progress in
the balance sheet. When the contract is completed, contractee’s account is debited with the contract price
and the contract account is credited.
Page 20 of 21
(11) Profit on incomplete contracts: At the end of an accounting period it may be found that certain
contracts which have been completed while others are still in process and will be completed in the coming
years. The profit on completed contracts may be safely taken to the credit of the profit and loss account. In
the case of incompleted contracts there are unforeseen contingencies which may lead to heavy fluctuations
in costs and profit. At the same time it does not also seem desirable to consider the profits only on
completed contracts and ignore completely incomplete ones as this may result in heavy fluctuations in the
future for profit from year to year. If profit or loss is not shown in the intermittent years for the work in
progress, contract will show high figure of profit in the year of completion and reverse may be the case in
the year in which a large number of contracts remain incomplete. Therefore, profits on incomplete contracts
should be considered, of course, after providing adequate sums for meeting unknown contingencies. There
are no hard and fast rule regarding calculation of the figures for profit to be taken to the credit of profit and
loss account.

However, the following rules may be followed:

(i) Profit should be considered in respect of work certified only, work uncertified should always be valued
at cost.
(ii) No profit should be taken into consideration if the amount of work certified is less than 1/4th of the
contract price because in such a case it is not possible to foresee the future clearly.
(iii)If the amount of work certified is 1/4th or more but less than 1/2 of the contract price, 1/3rd of the
profit disclosed as reduced by the percentage of cash received from the contractee, should be taken to
the profit and loss account or Profit =1/3 x Notional Profit x {Cash received / Work certified}
The balance be allowed to remain as a reserve.

(iv) If the amount of work certified is 1/2 or more of the contract price, 2/3rd of the profit disclosed, as
reduced by the percentage of cash received from the contractee, should be taken to the profit and loss
account. Profit= 2/3 x Notional Profit x {Cash received / Work certified}
The balance should be treated as reserve.

(v) In case the contract is very much near to completion, if possible the total cost of completing the contract
should be estimated. The estimated total profit on the contract then can be calculated by deducting the
estimated cost from the contract price. The profit and loss account should be credited with that
proportion of total estimated profit on cash basis, which the work certified bears to the total contract
price. Profit=Estimated total profit x {Work certified / Contract price}
(vi) The whole of loss, if any, should be transferred to the profit and loss account.

That part of the profit which is not credited to the profit and loss account is treated as a reserve against
contingencies and is deducted from the amount of work-in-progress for balance sheet purpose. It is carried
down as a credit balance in the contract account itself, the work-in-progress being represented by the debit
balance in the contract account.

Note: The treatment of profit on incomplete contract will be computed as per specific instruction of
problem. If there is no specific instruction then above rules should be applied.

Page 21 of 21