Contract costing

Contract costing
See also
Progress billings Freight out Compound entry Purchase account Purchase invoice Sub ledger Costs and expenses Prepaid rent Actual cost

Contract costing is also known as terminal costing. It is one of the methods of job costing. In this method, each contract is a cost unit and an account is opened for each contract in the books of the contractor to ascertain profit or loss thereon. In contract costing, most of the costs are chargeable direct to contract accounts. Contract costing involves a lot of expenditure. Contracts, which are involved in contract costing are, generally, construction works or repair works. Contract costing is applicable in: building construction, road and bridge construction and ship building (D. Davis, P. S. Anton 2016)

Features of contract costing

Contract costing usually shows the following features:

• Contract generally takes more than one year to complete.
• A contractor usually carries out a small number of contracts in the course of one year, because contracts are generally of large size.
• Nearly all labour is direct.
• It is carried out outside the factory of the concern undertaking the contract.
• Each contact undertaken is treated as a cost unit.
• In the books of the contractor there is a separate contract account, which is prepared for each contract to ascertain profit or loss on each contract ((M.N. Arora 2013, p. 8.0)
• For failing to complete the work within the agreed period penalties may be incurred by the contractor
• Each contract involves most of the materials, which are specially purchased for it. These will, therefore, be charged direct from the supplier's invoices. Any materials drawn from the store is charged to contract on the basis of material requisition notes.
• Most expenses (for example electricity, telephone, insurance) are direct.
• Specialist sub-contractors may be employed for say, electrical fittings, welding work, glass work
• Plant and equipment may be purchased for the contract or may be hired for the duration of the contract.
• Payments by the customer (contractee) are made at various stages of completion of the contract based on architect's certificate for the completed stage.
• An amount, known as retention money, is withheld by the contractee as per agreed terms (M.N. Arora 2013, p. 8.0).

Contract costing procedure

The basic procedure for costing of contracts is as follows:

• Contract account. Each contract is allotted a distinct number and a separate account is opened for each contract.
• Direct costs. Most of the costs of contract can be allocated direct by to the contract. All such direct costs are debited to the contract account. Direct costs for contracts include:

1. Deprecation of plant and machinery
2. Materials
3. Labour and supervision
4. Direct expenses
5. Sub-contract costs

• 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. Overheads are normally restricted to head office and storage costs (M.N. Arora 2013, p. 8.0)
• Transfer of material or plant. When materials, plant or other items are transferred from the contract, the contract account is credited by that amount.
• Contract price. The contract account is also credited with the contract price. 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 date.
• Profit or loss on contract. The balance of contract account represents profit or loss which is transferred to Profit and Loss Account. However, when contract is not completed within the financial year, only a part of the profit arrived is taken into account and the remaining profit is kept as reserve to meet any contingent loss on the incomplete portion of the contract. (M.N. Arora 2013)

References

• Abdel-Azim M.H., Ibrahim A. E. A., (2014) Investigating The Impact Of Historical Costing On Real Earnings Management: An Empirical Study, International Business & Economics Research Journal, Vol. 13, No. 2, page 387-400
• Arora M.N. (2013), Cost Accounting (For B. Com, Sem.4, Delhi University, Vikas Publishing House, page 8.0-8.3
• Davis D., Anton P. S. (2016), Annual Growth of Contract Costs for Major Programs in Development and Early Production, Acquisition Policy Analysis Center Performance Assessments and Root-Cause Analyses Office of the Under Secretary of Defense for Acquisition, Technology, and Logistics (AT&L) U.S. Department of Defense, page 1-15
• Ward G. S., Owren-Wiest N. J. (2016), Government Contract Costs, Pricing & Accounting Report, Thomson Reuters, Vol. 11, Issue 6, page 1-8

Author: Beata Franczyk