terminal costing, is a variant ofjob costing.

In this
Contract costing, also known as isa cost unit and an
account is opened for each
method of costing, each contract to ascertain profit/loss thereon.
contract in the books of the contractor
Costing-Distinction
Contract Costing and Job
points of distinction between contract and job costing are as follows:
Main
time are usually large as compared to
1. The number of jobs undertaken at a much bigger in size.
number of contracts because contracts are generally
2. In contract costing, most of the costs
Contract Costing is used in:
are chargeable direct to contract Building construction
accounts. Under job costing, direct Road construction
allocation to suh an extent is not
Bridge construction
possible.
Other civil engineering works
3. Allocation and apportionment of Ship building, etc.
overhead costs is simpler in contract
costing as compared to job costing.
is a small
4. Contract is generally big while job is small. It is well said, 'a job
contract and a contract is a big job.?
5. Jobs are usually carried out in factory premises whËle contract work is done at
site.
8.2 Contract Costing

Features of Contract Costing

Contractcosting usually shows the following features:
1. Contracts are generally of large size and, therefore, a contractor
out a smallnumber of contracts in thecourse of one year. usually carries
2 A contract generally takes more than one year to complete.
3. Work on contracts is carried out at the site of contracts and not in
premises. factory
4. Each contract undertaken is treated as a cost unit.
5. Aseparate contract account is prepared for each contract in the
contractor to ascertain profit or loss on each contract.
books of the
Most of the materials are specially purchased for each Contract.
6. These
therefore, be charged direct fromn the supplier 's invoices. Any materials wil ,
from the store is charged to contract on the basis of material requisition drawn
7. Nearly all labour is direct. notes.
8. Most expenses (e.g.. electricity, telephone, insurance, etc.) are also dire
9. Specialist sub-contractors may be employed for say, electrical fittings, welding
work, glass work, etc.
10. Plant and equipment may be purchased for the contract or may be hired
the duration of the contract.
11. Payments by the customer (contractee) are made at various stages of completion
of the contract based on architect's certificate for the completed stage
amount, known as retention money, is withheld by the contractee as per agreed
terms.
12. Penalties may be incurred by the contractor for failing to complete the work
within the agreed period.
Contract Costing Procedure
The basic procedure for costing of contracts is as follows:
1. Contract account Each contract is allotted a distinct number and a separate
account is opened for each contract.
2. Direct costs Most of the costs of a contract can be allocated direct by to
the contract. All such direct costs are debited to the contract account. Direct
costs for contracts include: () Materials; (ii) Labour and supervision; ()
Direct expenses; (iv) Depreciation of plant and machinery; (v) Sub-contract
costs, etc.
3. Indirect costs Contract account is also debited with overheads which tend
to be small in relation to direct costs. Such costs are often absorbed on some
arbitrary basis as a percentage on prime cost, or materials, or wages, ett.
Overheads are normally restricted to head office and storage costs.
4. Transfer of materials or plant When materials, plant or other items are
transferred from the contract, the contract account is credited by that amounl.
5. Contract price The contract account is also credited with the contractprice.
However, when a contract is not complete at the end of the financial year, the
contract account is credited with the value of work-in-progress as on that dat.
6. Profit or loss on contract The balance of contract account represents prout
or loss which is transferred to Profit and Loss Account. However, whcn
 Contract Costing 8.3
contract is not completed within the financial year, onty apart of the profit
arrived is taken into account and the remaining profit is kept as reserve to
meet any
discussed incontingent loss on the
detail Jater in this incomplete
portion of the contract. This is
chapter.
Some of the SPECIAL POINTS IN CONTRACT COSTING
cost of Materials
important points to he considered in contract costing are now discussed:
Materials
include: materials
issuedfrom store ()
materials against
debited to the
specifically
material
purchased for the contract: (i) materials
requisition notes. The cost of both these types of
Materials
requirements, for Returned contract account.
to Store
Whenever materials are issued in excess of
store instance,cement, sand, pipes and bricks, these are later returned to
the
accompanied
materials returned.
by a Material
Such returned Return Note which gives the details of the
Materials at Site At the materials are credited to contract account.
end of each
unused at site is
credited
againstthe next period.
to contract accounting
period, value of materials lying
account and is carried forward for charging
Cost of Labour
All wages of workers engaged on a
particular contract are charged direct to the
contract, irespective of the type of work they perform. When several contracts are
runningat different locations, payroll is normally
payTollfor each contract. Difficulties in costing sectionalized
so as to have separate
may be encountered when some
workers may have to move from one site to another if a number of small
contracts are
undertaken. In such situations, it becomes necessary to provide time sheets from
which allocations can be made. In order to control labour utilization and prevent fraud
in the payment of wages, Surprise visits by head-office personnel will be necessary.
Plant
There are two different methods of dealing with depreciation of plant in contract
account:
(a) Contract account is debited with the cost of the plant installed. When the
contract is completed or the plant is no longer required, the plant is revalued and
contract account is credited with this revalued or depreciated figure. In case plantsaleis
account is credited with its
sold on the completion of the contract, the contract
be that the contract account
proceeds. The net effect of the above debit and credit will between
which is the difference
Will stand debited with the amount of depreciation,
plant debited and value of plant credited. The method is generally used
he value of
contracts which extend over more than one year because depreciated value
OlOng account and brought down as an opening
credited to the contract
die plant is
balance in the next period. is simply debited with the amountfor a
of
contract account
) Alternatively. when plant is sent to contract
only
method
depreciation. It is usual to use this
short period. For Cxample, mobile crane or bulldozer used in a contract may becharged
on this basis.
 Contract Account.

WorkCertified and Work Uncertified

When the contract is not completed till the end of the accounting year, the architect
IS required to value the work-in-progress, Such work-in-progress is classified into work
certified and work uncertified.
Work Certified This is that part of the work-in-progress which has been
approved by the contractee's architect or engineer for payment. Work certified is
valued at contract price (i.e., selling price), and includes an element of profit.
Work Uncertified This is that part of the work-in-progress which is not approved
by the architect or engineer. This is valued at cost and thus does not include an element
of profit.
Both work certified and uncertified appear on the credit side of the contract
account and also on the assets side of the balance sheet.

Retention Money and Cash Ratio

It is ausual praçtice not to pay the full amount of work certified. The contractee may
pay a fixed percentage, say 80% or 90% of the work certified, depending upon the
terms of the contract. This is known as Cash Ratio. The balance amount not paid is
known as Retention Money. For example, if cash ratio is 75%, the retention money
willbe the remaining 25%. This retention money is atypeof security for any defective
work which may be found in the contract later on. This also.works as a deterrent for
the contractor to leave the contract incomplete, if he finds the contract unprofitable.
The retention money may also be adjusted against penalties that become due if the
contract is not completed within the stipulated time as per the terms of the agreement.
 Contract Costing 8.5
ExtraWork
somet
the inwork
mes the contractor iS required to do some extra work like additions or alterations
for
such extraoriginally
work. done as per agreement. The contractor will charge extra money
and extra price The cost of such extra work is dehited to the contract account
realized credited teo the
is
Contract account.
orofit on
Contracts Uncompl
accounting which
eted and
are started Contracts
fo complete, a problenms. But in case finished during the same financial year create no
of those contracts which take
only on the problem arises whether profit on such more than one year
partlycompleted completion
work.
of the
1f contract contracts should be worked out
or at the end of each
protit will be
high in the profit is computed only on the financial year on the
year of completion of the contract.
working on
contract,
patternbut also
completion
profit will be nil. This of the contract, whereas in other years of
higher tax liability would result not only in distorted profit
paid.
Therefore,
account the when because
contracts extend beyond incomea tax atit higher rates may have to be
into profit carned (or loss year, becomes necessary to take
vear. This helps in incurred)
There are two
avoiding distortion of the on the work performed during each
aspects of profit year-t o -year profit trend of the business.
(a) Computation
(b) Computation of
of
notional profitcomput
or ation:
estimated
Loss Account.
the portion of such profit thatprofit.
is to be
transferred to Profit and
Notional Profit
Notional profit is the
the cost of
difference between the value of
work-in-progress certified. It is
computed as work-i
followsn-progress are
certified and
(Figures assumed):
Value of work certified
Jdd: Cost of work not yet certified 20,00,000
1,50,000
Less: Cost of work to date 21,50,000
19,00,000
Notional Profit 2,50,000
Ifin any year, cost of work done
exceeds the value of work certified and
the result willbe a notional loss. uncertified,
Estimated Profit
Estimated profit represents the excess of the
oost of the contract. It is computed as contract price over the estimated total
follows (Figures are assumed):
Contract price 30,00,000
Less: Total cost already incurred
21,00,000

Less: 9,00,000
Estimated additional costs to complete the contract 3,50,000
Estimated Profit 5,50,000
8.6 Contract Costing
Portion of Notional Profit or Estimated Profit to be
Profit and Loss Account Transferred to
The portion of the notional or estimated profit to be transferred to P&L
work-in-progress uncertifiedAccount
depends upon the stage of completion of the contract, i.e., ratio of
considered. Prudence requires that the total notional profit should notworkbe-in-progisres
certified to total contract work. For this purpose
no
totranstfer ed
to P&L Account but a
portion of it should be withheld as a reserve
unforeseen future expenses contingencies.
or meet any
Rules There are no hard and fast rules in this regard. However, the
generalrules may be followed in this context.
1. When work certified is less than 1/4 ofthe contract price, no profit is fol owing
to Profit and Loss Account. This is basedon the principle that no profit shoula
taken into account unless the contract has advanced reasonably.
transfer ed
2. When work-in-progresscertified is 1/4 or more but less than 1/2 of the
price, then generally 1/3 of the profit is transferred to Profit and Loss
balance amount is treated as reserve. Thus, profit to be transferred to Profit Accountandcont. rTheact
Account is computed by the following formula: Loss
Transfer to P&L A/c = Notional profit x
Alternatively, a more common practice is to further reduce this amount by he
cash ratio.
1 Cash received
Thus:Transfer to P&L Alc=Notional profit x 3 X
Work certified
3. When work certified is 1/2 or more but less than 9/10 of the contract price, (Le.
50% to 90%), then the profit to be transferred to P & L Account is computed as
follows:
2
Transfer to P&L A/c = Notional profit x 3
Here also a more common practice is to further reduce this amount by cash ratio.
This is shown below:
2 Cash received
Transfer toP&L A/c = Notional profit x Work certified
profit should be
4. When contract is near completion, then the estimated
transferred
calculated on the whole contract. The proportion of estimated profit to be
following formulas:
to Profit and Loss Account is computed by any one of the
Work certified
(a) Estimated profit x Contract price

Work certified Cash received

(b) Estimated profit x Contract price Work certified
Cost of work to date
(c) Estimated profit X
Estimated total cost of work
 Contract Costing 8.7

Cost of work to date Cash received

(d) Estimated profit x Estimated total cost of work Work certified
contracts,
s Loss on Uncompleted Contracts Inthe event of a loss on uncompleted
should be transferred in full to the Profit and Loss Account, whatever be the stage
this
of the contract.
of completion practice may
Itwas stated earlier also that these are not hard and fast rules. The
.ary from firm-to-firm depending upon the nature of work involved, degree of risk in
vary
work completed, etc. But whatever method is adopted, it should
the business, extent of
applied con_jstently from year-to-year so as not to disturb the trend of profits.
he
contract for 12,00,000 commenced
llustratin1 The following was the expenditure on a
in January 2020.
2,40,000
Materials 3,28,000
Wages 40.000
Plant
17,200
Overheads 8.000
Work uncertified
of the contract on 31 December 2020 was 4,80,000, being
Cash received on account
value of materials in hand was 12,000. The plant had undergone
80% of the work certified. The
20% depreciation.
Prepare Contract Account.