CONTRACT COSTING M VIJAYASEKARAM Definition Contract Costing is

CONTRACT COSTING M. VIJAYASEKARAM

Definition Contract Costing is a special type of job costing where the unit of cost is a single contract. The contract itself is a cost center and is executed under the customer’s specifications. Contract costing is a variant of job costing system applicable particularly in case of the organization’s doing construction work. It is also known as terminal costing. Each contract, short term or long term is treated as a job. It is understood from common sense that construction work involves massive investment and labor employment. So no organization can undertake a large number of contracts at a time.

Difference between Job Costing and Contract Costing Size Job costing refers to very small work while contract costing refers to large work like building a bridge. Recording of expense All kinds of expenses are not charged to the job account. All kinds of expenses either direct or indirect are charged to the contract account. Profit Determination Under job order costing profit is determined after all cost related to the job is incurred. But under contract costing as it is operated for several years so each year-end an estimated profit is determined which is known as notional profit. Complexity in accounting Under job order costing Complexity in accounting is lower. But Under contract costing Complexity in accounting is high. Work Place Under job order costing work is done in the company’s factory. But Under contract costing work is done in the worksite.

Payroll The payroll is prepared either at the site or at a central administrative office. Control The scale of operations and cost control becomes difficult due to theft of materials, labor time utilization, pilferages, etc.

Why is the profit of incomplete contract ascertained Profit in respect of each contract during every financial year can be ascertained. While there is no controversy as to the treatment of loss incomplete contract there is a controversy as to the treatment of profit on the incomplete contract. The loss on incomplete contract in any year should, however, be transferred to the year’s Profit & Loss Account. So, on the conservative approach, the work-in-progress are valued at cost only. No portion of the profit, if any, is included in the value of work-in-progress. The arguments in favor of this approach are: • Until a contract is completed, nobody can say that ultimately there will be profit. So, profit it any year before completion is nothing but anticipated profit. • If profit is considered, income-tax shall be payable on that profit much earlier than the year of completion. • A contract may show a profit during earlier years of execution, but ultimately it may prove loss. Dividends paid on this basis of profit in earlier years shall be ultimately unjustified.

How the Profit of Incomplete Contract is Determined The treatment of profit on incomplete contracts is given below: Profit should be considered in respect of work certified only; work uncertified should always be valued at cost. If the work started recently and one-fourth or less is done no profit should be transferred to profit and loss account. If the contract has advanced and if the architect of the contractee certifies that the work completed more than 25%, in that case, one-third of notional profit should be recognized as profit. PROFIT = 1/3 *cash received/work certified. NOTIONAL PROFIT = Value of work certified-(cost of work to date-uncertified amount)

• If the contract is done more than 50% but less than 90% in that situation two-third of notional profit should be recognized as profit. Profit = Notional profit *2/3*cash received /work certified. If the contract is done 90% or more in that situation total profit may be recognized.