Module 5 (remaining notes)

CONTRACT COSTING:
Contract costing is a specialized form of costing used primarily in industries where work is done
on a contractual basis, such as construction, shipbuilding, and large-scale manufacturing.
The Institute of Cost and Management Accountants (ICMA) defines contract costing as a
method of costing used specifically for projects or contracts that are carried out over a period of
time. According to ICMA, contract costing involves accumulating costs for each contract
separately, enabling businesses to determine the profitability of individual contracts.
SPECIAL FEATURES:
➢ It is followed by the firms engaged in construction work.
➢ Work is undertaken as per the requirements of the customer or contractee.
➢ It involves huge cost.
➢ The work is executed at the customer’s site and not in the factory.
➢ A contract takes long time for completion. Hence contract account covers more than one
accounting year.
➢ A separate account is kept for each contract.
➢ Most of the costs incurred on the contract are direct.
➢ Profit upon the incomplete contract is called notional profit. Only a portion of the same
is credited to profit and loss a/c because it is not the actual profit.

COST PLUS CONTRACT: in this type of contract, the contractor is paid the actual cost
incurred plus a certain percentage of profit. The contractee will have the right to inspect the
books of accounts and documents relating to the cost actually incurred. Government contracts
are generally made on cost plus basis.

ADVANTAGES DISADVANTAGES
No risk of loss Contractor would’nt get extra profits arising
on favorable market conditions
Contractor knows the percentage of profit in Disputes regarding ascertainment of actual
advance cost.
Useful where probable cost cannot be Contractee has to pay more for inefficiency
predicted
Preparing tenders and quotation becomes Total cost cannot be ascertained in advance
simple
It provides escalation clause Chance of misuse of materials and labor by
the contractor
ESCALATION CLAUSE:
An escalation clause in a contract is a provision that allows for adjustments in the contract price
based on certain conditions, typically related to changes in costs over time. It’s commonly used
in construction contracts and long-term agreements where costs may fluctuate due to inflation,
changes in labor rates, or the price of materials.
An escalation clause is a part of a contract that allows the price to go up if certain costs increase
over time. It’s often used in construction or long-term projects where prices can change.
Why Use It?

• Protects Against Rising Costs: If the price of materials or labor goes up, the contractor
can adjust the contract price to cover those costs.
• Fairness: It ensures that the contractor isn’t stuck losing money if prices rise
unexpectedly.

SUB CONTRACT:
A subcontract is an agreement where a primary contractor hires another party, called a
subcontractor, to perform a specific part of the work or service outlined in a larger contract. This
is common in construction, but can also apply to various industries.
Example:
If a construction company is building a new office building, they might hire a subcontractor to
handle all the electrical work. The subcontractor would be responsible for completing that part
of the project while the main contractor oversees the overall construction.

RETENTION MONEY TREATMENT OF COST OF PLANT:

Retention money is a portion of a contractor's payment that is withheld by the client or project
owner until the project is completed satisfactorily. This practice is common in construction
contracts and serves several important purposes.
It is paid sometime after the completion of the contract.it is done to the protection of the
contractee in case the contractor does not fulfil the terms and conditions of the contract.

PROFIT ON INCOMPLETE CONTRACT:

Profit on an incomplete contract refers to the estimated profit a contractor expects to make
from a project that has not yet been fully completed. Recognizing profit from incomplete
contracts is a key aspect of accounting, particularly in the construction industry, where projects
can span several months or even years.
When a contractor is working on a project (like building a house or a bridge), they may not finish
the work right away. However, they can still recognize some profit while the work is ongoing.
The profit upon the incomplete contract is known as notional profit. It cannot be taken as actual
profit.
Only a reasonable portion of notional profit is taken on the basis of following principles:

• If the contract completed is ¼ or less than ¼ - full amount of notional profit should be
transferred to work in progress as reserve.
• If the contract completed is more than ¼ but less than ½ - then 1/3 of the notional profit
should be taken into profit and loss a/c. balance on notional profit is transferred to work
in progress a/c as reserve.
• If the contract completed is ½ and more than ½ - then 2/3 of the notional profit should
be credited to profit and loss a/c. balance should be transferred to work in progress as
reserve.
• The loss on incomplete contract is transferred to profit and loss a/c (debit)

TRANSPORT/SERVICE COSTING:
It involves determining the costs associated with providing transportation and related services,
which helps in pricing, budgeting, and decision-making. In the case of transport undertakings
the basic problem is the selection of cost unit. The factors to be considered while selecting the
cost unit are number of passengers, tonnage carried, distance covered, capacity etc.
CALCULATION OF RATE PER PASSENGER KILOMETER:
The rate per passenger kilometer is a key metric in transportation costing, especially for airlines,
railways, and public transit. It represents the cost incurred to transport one passenger over one
kilometer.
To calculate this rate, you generally follow these steps:
• Total Operating Costs: Determine the total costs associated with running the service,
including fuel, maintenance, salaries, and overheads.
• Total Passenger Kilometers: Calculate the total passenger kilometers traveled, which is
the number of passengers multiplied by the distance traveled.
• Rate Calculation: Divide the total operating costs by the total passenger kilometers to
find the rate.
Formula:
Rate per Passenger Kilometer=Total Operating Costs/Total Passenger Kilometers