G9.

5 CONTRACT coSTING
Contract costing is a form of specific order costing where job undertaken is
relatively large and normally takes period longer than a year to complete.
Contract costing is usually adopted by the contractors engaged in any type of
contracts like construction of building, road, bridge, erection of tower, setting up
of plant etc. Contract costing have the following distinct features:
. The major part of the work in connection with each contract is ordinarily
carried out at the site of the contract.
2. The bulk of the expenses incurred by the contractor are considered as
direct.
3. The indirect expenses mostly consist of office expenses, stores and works.
4. A separate account is usually maintained for each contract.
5 The number of contracts undertaken by a contractor at a time is usually few.
6. The cost unit in contract costing is the contract itself.
A contract takes longer period to complete and the result of the contract can
be known only after the completion of the contract. To have a better control
over the contract and cost, it is necessary to have an idea of profitability of
contracts at regular intervals or atleast in a year. For this purpose, a contractor
needs to calculate expected profit or notional profit for a contract. It also helps in
profit comparison for a period and provide a good basis for performance
measurement and evaluation of those who are engaged in the contract. The
expected or notional profit in respect of each contract in progress (i.e. incomplete
contracts) is transferred to the costing profit and loss account (consolidated) for
the year to determine overall profitability of the contractor.
G9.6 RECORDING OF CONTRACT COSTS
(i) Material Cost
All materials supplied from the stores or purchased directly for the contract are
debited to the concerned contract account.
Contract Account (Contract No)... . or.
DI.

To Stores Ledger Control A/c (Issued from stores) or

To Cost Ledger Control A/e (Direct purchase)
In the case of transfer of excess material from one contract to another, cost of
these excess materials are adjusted on the basis of Material Transfer Note.
Contract Account (Contract No. XYz) ********.
. Dr.
Dr

To Contract Account (Contract No. ABC)

In case the return of surplus material appears uneconomical on account of high
cost of transportation, the same is sold and the concerned contract account is
credited with the price realised. Any loss or profit arising therefrom is transferred
to the Costing Profit and Loss Account.
Cost Ledger Control Ae. Dr.

Costing Profit & Loss A/c (Loss).. Dr

To Contract A/c
To Costing Profit & Loss A/c (Profit)
Any loss of material due to theft or destruction etc. is transferred to the Costing
Profit and Loss Account.
Costing Profit & Loss A/c.. Dr.

To Contract A/c
If any stores items are used for manufacturing tools, the cost of such stores items
are charged to the work expenses account.
Works expenses A/c...**..... D.
To Stores Ledger Control A/c
(With amount of stores used for works)
Contract A/.************************************* Dr.
To Works expenses
(With amount of works used in the contract)
If the contractee has supplied some materials without affecting the contract price,
no accounting entries will be made in the contract account, only a note may be
given about it.
(1i) Employee Labour Cost
Workers employed on the site of the contract is regarded as direct employees
irrespective of the nature of the task performed) and the wages paid to them are
charged to the concerned contract directly. If an employee is engaged
concurrently in other contract also then the total wages paid is apportioned to
the contacts on some reasonable basis, usually on time basis.
Contract A/C..
******************************** Dr.
To Wages Control A/c
(ii) Direct Expenses
Direct expenses (if any) are directly charged to the concerned contract account.
Contract A/C.. ************************ Dr.
To Direct Expenses A/c
(iv) Indirect Expenses

Indirect expenses (such as expenses of engineers, surveyors, supervisors,

corporate office etc.) may be distributed over several contracts on certain
reasonable basis as overheads.
Contract A/c. ******************************* Dr.

To Overheads A/c
(v) Plant and Machinery
The value of the plant in a contract may be either debited to contract account 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 (depreciation) for use of the
plant may be debited to the contract account.
ContractA/C.. ************************** Dr.

To Plant and Machinery A/c (with cost)

Plant and Machinery A/c (with WDV).. Dr.
To Contract A/c
or

Contract A/c.. ....UDr.

*******************************

To Depreciation on Plant and Machinery A/c

(vi) Sub-Contract

Sub-contract costs are also debited to the Contract Account.

Contract A/C. *********************** Dr.

To Cost of Sub-Contract A/c

Extra work: The extra work amount payable by the contractee should be added
to the contract price. If extra work is substantial, it is better to treat it asa
separate contract. If it is not substantial, expenses incurred should be debited to
the contract account as "Cost of Extra work".

9.79.7 MEANING OF THE TERMS USED IN

CONTRACT COSTING
Work-in-Progress: Work-in-progress in contract costing refers to the
contract which is not complete at the reporting date. In Contract Accounts,
the value of the work-in-progress consists of
the cost of work completed, both certified and uncertified:

(i) the cost of work not yet completed; and

Cii) the amount of estimated/ notional profit.
In the Balance Sheet (prepared for management), the work-in-progressis
usually shown under two heads, viz., certified and uncertified. The cost of work
completed and certified and the profit credited will appear under the head
'certified' work-in-progress, while the completed work not yet certified, cost of
material, employee and other expenses which has not yet reached the stage of
completion are shown under the head "uncertified" work-in-progress.
(i) Cost of Work Certified or Value of Work Certified: A contract is a
continuous process and to know the cost or value of the work completed as on
a particular date; assessment of the completion of work is carried out by an
expert (it may be any professional like surveyor, architect, engineer etc.). The
expert, based on his assessment, certifies the work completion in terms of
percentage of total work. The cost or value of certified portion is calculated
and is known as Cost of work certified or Value of work certified respectively.

Mathematically:

(a) Value of Work Certified = Value of Contract x Work certified (%)

(b) Cost of Work Certified = Cost of work to date - (Cost of work uncertified

+Material in hand + Plant at site)

(ii) Cost of Work Uncertified: It represents the cost of the work which has
been carried out by the contractor but has not been certified by the expert. It is
always shown at cost price. The cost of uncertified work may be ascertained as
follows:

) )
Total cost to date XXX

Less: Cost of work certified XXX

Material in hand XXX

Plant at site XXX XXX

Cost of work uncertified XXX

(iv) Progress Payment: A Contractor gets payments for work done on a

contract based on work completion. Since, a contract takes longer period to
complete and requires large investment in working capital to progress the
contract work, hence, it is desirable by the contractor to have periodic payments
from the contractee against the work done to avoid working capital shortage. For
this a contactor enters into an agreement with the contractee and agrees on
payment on some reasonable basis, which generally. includes percentage of work
completion as certified by an expert.

Mathematically:
Progress payment Value of work certified - Retention money - Payment to date

(v Retention Money: In a contract, a contractee generally keeps some

amount payable to contractor with himself as security deposit. In a contract, a
contractor undertakes to completed a job work on the basis of pre- determined
terms and conditions and work specifications. To ensure that the work carried out
by the contractor is as per the plan and specifications, it is monitored periodically
by the contractee. To have a cushion against any defect or undesirable work,
the contractee upholds some money payable to contractor. This security
money upheld by the contractee is known as retention money. In some
contracts the contractor has to deposit some security money before staring of the
contract as a term of contract. This is known as Earnest money. If any deficiency
or defect is noticed in the work, it is to be rectified by the contractor before the
release of the retention money. Retention money provides a safeguard against
the risk of loss due to faulty workmanship.

Mathematically:
Retention Money = Value of work certified- Payment actually made/ cash paid

(vi) Cash Received: It is ascertained by deducting the retention money from the
value of work certified ie.

Cash received = Value of work certified - Retention money

(vii) Notional Profit: It represents the difference between the value of work
certified and cost of work certified. It is determined:
Notional profit Value of work certified- (Cost of work to date - Cost of work not
yet certified)

(vii) Estimated Profit: It is the excess of the contract price over the estimated
total cost of the contract.
ILLUSTRATION 3:
COMPUTE estimated profit on a contract (which has been 90% complete) from the
following particulars:

Total expenditure to date 22,50,000

Estimated further expenditure to complete the contract (including 2,50,000
contingencies)
Contract price 32,50,000
Work certified 27,50,000
 Work uncetified 1,75,000
Cash received 21,25,000
sOLUTION
Calculation of Estimated Profit:

Total expenditure to date 22,50,000

Estimated further expenditure to complete the contract
(including contingencies)
2.50.000
25,00,000
Estimated profit on contract (Balancing figure) Z.50.000
Contract price | 32.50.000
G9.8 coST PLUS cONTRACT
Cost- plus contract is a contract where the value of the contract is determined
by adding an agreed percentage of profit to the total cost. These types of
contracts are entered into when it is not possible to estimate the contract cost
with reasonable accuracy due to unstable condition of factors that affect the cost
of material, employees, etc.
Cost plus contracts have the following advantages and disadvantages:

Advantages
() The Contractor is assured of a fixed percentage of profit. There is no risk
of incurring any loss on the contract.
i) It is useful specially when the work to be done is not definitely fixed at
the time of making the estimate.
(ii) Contractee can ensure himself about 'the cost of the contract, as he is
empowered to examine the books and documents of the contractor to
ascertain the veracity of the cost of the contract.
Disadvantages The contractor may not have any inducement to avoid wastages
and effect economy in production to reduce cost.
9.8.1 Escalation Clause in a Contract
Escalation clause in a contract empowers a contractor to revise the price of
the contract in case of increase in the prices of inputs due to some macro-
economic or other agreed reasons. A contract takes longer period to complete
and the factors based on which price negotiation is done at the time of entering
into the contract may change till the contract completes. This protect the
contractor from adverse financial impacts and empowers the contractor to
recover the increased prices. As per this clause, the contractor increases the
contract price if the cost of materials, employees and other expenses
increase beyond a certain limit. Inclusion of such a clause in a contract deed is
called an "Escalation Clause"
ILLUSTRATION 4

The following expenses were incurred on a contract: (

Materials purchased 6,00,000
Material drawn from stores 1,00,000
Wages 2,25,000
Plant issued 75,000
Chargeable expenses 75,000
Apportioned indirect expenses 25,000
The contract was for ? 20,00,000 and it commenced on January 1, 2020. The value of
the work completed and certified upto 30th November, 2020 was 13,00,000 of which
1040,000 was received in cash, the balance being held back as retention money by
the contractee. The value of work completed subsequent to the architect's certificate
but before 31st December, 2020 was 60,000. There were also lying on the site
materials of the value of 740,000. It was estimated that the value of plant as at 31st
December, 2020 was F30,000.

You are required to COMPUTE value of work certified, cost of work not certified and
notional profit on the contract til the year ended 31 December, 2020.
sOLUTION
Contract Account

Particulars
L Particulars

To Material purchased 6,00,000By Work-in-progress:

Stores issued 1,00,000 Value of
work 13,00,000
 certified

Wages 2,25,000 Cost of work 60,000

uncertified

Plant 75,000 Material unused 40,000

Chargeable expensesS 75,000 Plant less 30,000
depreciation
Indirect expenses 25,000
Costing P8L A/C 3,30,000
(Notional profit) (bal.
figure)
14,30,000 14,30,000

ILLUSTRATION 5

A contractor prepares his accounts for the year ending 31st December each year.
He commenced a contract on 1st April, 2020.
The fotlowing information relates to the contract as on 31st December, 2020:

(
Material issued 2,51,000

Wages 5,65,600

Salary to Foreman 81,300

A machine costing 2,60,000 has been on the site for 146 days, its working life is
estimated at 7 years and its final scrap value at 715,000.
A supervisor, who is paid 8,000 p.m. has devoted one-half of his time to this
Contract.

All other expenses and administration charges amount to 1,36,500.

Material in hand at site costs 35,400 on 31st December, 2020.
The contract price is 20,00.000. On 31st December, 2020 two-third of the contract
was completed. The architect issued certificates covering 50% of the contract price,
and the contractor had been paid ?7,50,000 on account.

PREPARE Contract A/c and show the notional profit or loss as on 31st December,
2020.
SOLUTION
Contract Account
Particulars ) Particulars
To Material issued 2,51,000 By Machine (Working 2,46,000
note 1)

Wages 5,65,600 Material (in hand) 35,400

Foreman's salary 81,300 Works cost 10,49,000
(balancing figure)
Machine 2,60,000
Supervisor's salary 36,000
8,000x 9)/2
Administrative 1,36,500
charges
13,30,400 13,30,400
Works cost 10,49,000 Value of work 10,00,000
certified
Costing P&L A/C 2,13,250" Cost of work 2,62,250
(Notional profit) uncertified
(Working Note 2)
12,62,2500 12,62,250

Working notes:
1. Written down value of Machine:

-72,60,000-15,000,146days=
7 years 365 days
7 14,000
Hence the value of machine after the period of 146 days = 2,60,000
14,000 = ?2,46,000
2. The cost of 2/3d of the contract is 10,49,000
Cost of 100% 10,49,000x3
2
=715,73,500
Cost of 50% of the contract which has been certified by the architect is
7,86,750. Also the cost of 1/3d of the contract, which has been completed
but not certified by the architect is 2,62,250.
ILLUSTRATION 6
M/s. Bansals Construction Company Ltd. took a contract for ?60,00,000 expected to
be completed in three years. The following particulars relating to the contract are
available:

2018 ( 2019 ( 2020(

Materials 6,75,000 10,50,000 9,00,000
Wages 6,20,000 9,00,000 7,50,000
Transportation cost 30,000 90,000 75,000
Other expenses 30,000 75,000 24,000
Cumulative work certified 13,50,000 45,00,000 60,00,000
Cumulative work uncertified 15,000 75,000
Plant costing 3,00,000 was bought at the commencement of the contract.
Depreciation was to be charged at 25% per annum, on the written down value
method. The contractee pays 75% of the value of work certified as and when
certified, and makes the final payment on completion of the contract
You are required to PREPARE a contract account for three years and total estimated
profit/ loss from the contract.
sOLUTION
Contract Account (For the year ended 2018)

Particulars Particulars
To Materials 6,75,000 By Plant at site c/d 2,25,000
(75% of 3,00,000)
Wages 6,20,000 Work-in-progress c/d:
Transportation 30,000 - Work certified 13,50,000
cost
Other expenses - Work uncertified
30,000 15,000
Plant 3,00,000 Costing P&L A/e 65,000
(Loss for the year)
16,55,000 |16,55,000
 Costing Profit & Loss A/c for the year ended 2018
Particulars
Partic Particulars
To Contract A/c 65,000 By Balance c/d (Loss) 65,000
(Notional Loss on
contract)
65,000 65,000
Contract Account (For the year ended 2019)

Particulars Particulars
To Plant at site b/d 2,25,000 By Plant at site c/d 1,68,750
(75% of R2,25,000)

Work-in-progress b/d: "Work-in-progressc/d:

Work certified 13,50,000 Work certified 45,00,000
-Work uncertified 15.000 13,65,000 -

Work uncertified 75,000 45,75,000

Materials 10,50,000

Wages 9,00,000
Transportation cost 90,000
Other expenses 75,000
Costing P&L A/c 10,38,750
(Notional Profit for the
year)
47,43,750 47,43,750
Costing Profit & Loss A/c for the year ended 2019

Particulars Particulars R)
To Balance b/d 65,000 By Contract A/c 10,38,750
(Notional profit on
contract)
To Balance c/d (Profit) 9,73,750
10,38,750 10,38,750
 Contract Account (For the year ended 2020)

Particulars Particulars (
To Plant at site b/d 1,68,750 By Plant at site c/d 1,26,563
(75% of 1,68,750)
Work-in-progress b/d: Contractee A/c 60,00,000
- Work certified 45,00,000 Costing P&L A/¢ 3,66,187
(Notional Loss for the
year)
-Work uncertified 75.000 45,75,000
Materials 9,00.000
Wages 7,50,000|
Transportation cost 75,000
Other expenses 24,000
64,92,750 64,92,750

Costing Profit & Loss A/c for the year ended 2020

Particulars Particulars
To Contract A/c (Notional 3,66,187 By Balance b/d 9,73,750
loss on contract)
Estimated profit on 6,07,563
Contract

9,73,750 9,73,750
ILLUSTRATION 7:
A contractor has entered into a long term contract at an agreed price of 7 17,50,000
subject to an escalation clause for materials and wages as spelt out in the contract
and corresponding actual are as follows:
Standard Actual
Materials Qty (tons)D Rate ( Qty (tons) Rate ()
A 5,000 50.00 5,050 48.00
3,500 80.00 3,450 79.00

2,500 60.00 2,600 66.00

 Wages Hours Hourly Rate ( Hours Hourly Rate ()
X 2,000 70.00 2,100 72.00

2,500 5.00 2,450 75.00

3,000 65.00 3,,100 66.00

Reckoning the full actual consumption of material and wages, the company has
claimed a final price of 7 17,73,600. Give your ANALYSIS of admissible escalotion
claim and indicate the final price payable.
sOLUTION

Statement showing final claim

Standard Standard Actual Variation in Escalation

Qty/Hrs. Rate() Rate () Rate () Claim ()
(a) (b) (c) (d) =(c)-(b)|(e) =(a) x(d)
Materials
5,000 50.00 48.00 (2.00 10,000

B 3,500 80.00 79.00 1.00 3,500

C 2,500 60.00 66.00 (+) 6.00 15,,000
Materials escalation claim: (A) 1,500
Wages
2,000 70.00 72.00 (+) 2.00 4,000
2,500 75.00 75.00
Z 3,000 65.00 66.00 (+) 1.00 3,000
Wages escalation claim: (B) 7,000
Finalclaim: (A +B) 8,500

Statement showing final price payable

Agreed price 17,50,000
Agreed escalation:
Material cost 1,500

Labour cost 7,000 8,500

Final price payable 17,58,500

The claim of 17,73,600 is based on the total increase in cost. This can be verified
as shown below
Statement showing total increase in cost

Standard Cost Actual Cost Increase/

Qty/hrs Rate Amount Qty/hrs Rate Amount (ecreas
) e)
(a) (b) ()= (d) (e)(f) =(d)| g =(f)-
(a)x (b) x
(e) (c)
I. Materials
A 5,000 50.00 2,50,000 5,050 48.00 2,42,400 (7,600)
B 3,500 80.00 2,80,000 3,450 79.00 2,72,550 (7,450)
C 2,500 60.00 1,50,000 2,600 66.00 1,71,600| 21,600
6,80,000 6,86,550 6,550
I1. Wages

2,000 70.00 1,40,000 2,100 72.00 1,51,200

2,500 75.00 1,87,500 2,450 75.00 1,83,750
3,000 65.00 1,95,000 3,100 66.00 2,04,600
5,22,500 5,39,550 17,050
23.600
Contract price 7 17,50,000

Add: Increase in cost 23.600

The final price claimed by the company 1773.600
This claim is not admissible because escalation clause covers only that part of
increase in cost, which has been caused by inflation.
Note: It is fundamental principle that the contractee would compensate the
contractor for the increase in costs which are caused by factors beyond the
control of contractor and not for increase in costs which are caused due to
inefficiency or wrong estimation.