Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Cost Accounting

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B Com : Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

The document Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev is a part of the B Com Course Cost Accounting.
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Contract Costing
Meaning
It is a special form of job costing and it is the most appropriate method to be adopted in such industries as building and construction work, civil engineering, mechanical fabrication and ship building. In other words, it is a form of specific order costing which applies where the work is undertaken to customer’s requirements and each order of long duration as compared to job costing. It is also known as terminal costing.
The official CIMA terminology defines contract costing as “ a form of specific order costing in which costs are attributed to individual contracts.”

Basic features:

  1. Each contract itself a cost unit.
  2. Work is executed at customers site
  3. The existence of sub contract
  4. Most of the expenses incurred upon the contracts are direct.
  5. Cost control is very difficult in contract costing.

Types of contracts 
Generally there are three types of contracts:
1. Fixed price contracts: Under these contracts both parties agree to a fixed contract price.
2. Fixed price contract with Escalation clause
3. Cost plus contract: Under this contract no fixed price could be settled for a contract.

Contract Account
A contract account is a nominal account in nature. It is prepared to find out the cost of contract and to know profit or loss made on the contract. A contractor may undertake a number of contracts at a time. For each contract a separate account is opened. In the contract account all direct cost such as material, labour and other direct expenses incurred during an accounting period are debited and the indirect expenses are apportioned on an equitable basis. The differences between the two sides are known as Notional profit or notional loss.

Special Terms in Contract Account
1. Work in Progress: It is the unfinished contract at the end of the accounting period and it includes amount of work certified and amount of work uncertified. Work in progress is an asset, shown in the balance sheet by deducting there from any advance received from the contractee.

2. Work certified: The sales value of work completed as certified by the architect is known as ‘work certified’. In the case of contracts of long duration, the amount payable by the customer to the contractor is based on the sales value of work done as certified by the architect. At the end of the financial year, the total sales value of work done and certified by the architect is credited to the contract account.

3. Work Uncertified: It means work which has been carried out by the contractor but has not been certified by the architect. Sometimes, work which is complete remains uncertified at the end of the financial year. The reasons for the same may be a. Work not sufficient enough to be certified b. Work has not reached the stipulated stage to qualify for certification It is always valued at cost and credited to the contract account.

4. Retention money: - Regardless of the amount of work certified, the contractor is paid a specified percentage of the same and the balance is held or retained by the contractee. This is because of the fact that the contractee has to safe guard himself against any contingency arising from the non fulfillment of the terms of the contract by the contractor. The unpaid balance of work certified or the amount held back or retained by the contractee is known as ‘retention money’.

5. Sub contract: Sometimes the contractor enters into contracts with another contractor to give a portion of work undertaken by him. In such cases the work performed by the subcontractor s forms a direct charge to the contract concerned. Sub contract cost will be shown on the debit side of the contract account.

6. Escalation clause: This is clause which is provided in the contract to cover up any increase in the price of the contract due to increase in the prices of raw material or labour or in the utilization of any other factors of production. If material and labour utilization exceeds a particular limit, the customer agrees to bear the additional cost occasioned by excessive utilization. Here, the contractor has to satisfy the customer that excessive utilization is not the result of decreased efficiency.

Specimen Form of Contract Account (Unfinished Contract)
Contract A/C

To materials

To Labour

Xxx

Xxx

By work in progress: Work

certified

 

To Plant

Xxx

xxx

 

Xxx

To Overheads

Xxx

Work

uncertified

Xxx

To cost of sub contracts

Xxx

xxx

 

 

To Notional Profit c/d(B/F)

Xxx

By material returned

 

Xxx

 

 

By

plant

Xxx

 

Xxx

xxx

Less:Depreciation

By material lying at site

Xxx

To Profit and Loss A/C

Xxx

xx

Xxx

To WIP (B/F)

Xxx

 

 

 

 

Xxx

By Notional profit B/d

 

Xxx

Treatment of Plant and Machinery: 
One of the distinguishing features of a contract is the use of special plant and machinery. The cost of these is capital expenditure, but yet, the usage of these should be reflected in the form of depreciation. There are two distinct methods of charging depreciation.

  1. At the time of issue of plant to contract the contract account is debited with the full value of the plant. At the end of the period contract account is credited with the depreciated value. This method is used when plant and machinery is used at the contract site for a long period.
  2. In the second method, contract account is debited with an hourly rate of depreciation for the number of hours the plant is used on the contract. A cost centre is set up for each machine. An estimate is made is made of the cost such as maintenance, depreciation, driver’s wage etc to be incurred. The total of this cost is divided by the number of hours that the machine is expected to be used.

Profit on Incomplete Contract: 
In the case of a small contract extending over the financial period, profit or loss on the same may be ascertained by crediting it with the contract price due by the contractee. This procedure cannot be adopted in the case of contracts extending beyond the accounting period, and taking a long time for completion. If there is any profit upon the incomplete contract, it cannot be taken as actual profit. The profit upon the incomplete contract is called notional profit.
For the purpose of determining the amount of profit to be transferred to profit and loss account and making provision for future contingencies, the following guidelines may be kept in mind.
1. When the work has not reasonably advanced (1/4 or less than ¼) : - No profit should be taken to the credit of p/L account in the case of contracts which have just commenced and a small portion of the work is complete.
2. Where the work is complete more than ¼ but less than ½ of contract price: In this case 1/3 of the notional profit as reduced by the percentage of cash received may be credited to profit and loss account. The usual formula is

Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

The balance of notional profit shall be kept as reserve till the completion
3. If the contract completed is more than 1/2 but less than 90%: Here 2/3 rd of the notional profit should be taken to profit and loss account.

Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

The balance of notional profit shall be transferred to work in progress as reserve. It is to be noted that in order to find out how much portion of contract is completed, work certified should be compared with contract price.
4. If the contract is nearing completion: Here, estimated profit may be ascertained by deducting the total cost of contract to date plus estimated additional expenses to complete the contract , from the contract price. It is calculated by using the following formula

Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

The loss on incomplete contract should be fully transferred to profit and loss account

Accounting Problems on Contract Accounts
Problem 1.
The following sums have been spent on a contract still unfinished on the day the books of accounts are being closed for the year:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Rs 2,00,000 have been received from the contractee, being 80% of the work certified. Find out the profit to be credited to Profit and Loss Account, if the value of work in progress uncertified is Rs 10,000.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 2.
T. Thekedar started work on 1st January, 2012 on a contract for Rs 5,00,000. On 31st March, 2012 when he prepared his final accounts, the following information relating to the contract was extracted from his books of account:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
On 31st March, 2012 materials lying unused at site were valued at Rs 21,620. Machines were depreciated @ 20% per annum. Value of work certified by 31st March, 2010 was Rs 3,50,000 while the cost of work done but not yet certified as on that date was Rs 18,000. On the basis of architect’s certificate T. Thekedar had received a total sum of Rs 2,80,000 from the contractee till 31st March, 2012.
Prepare Contract Account in T. Thekedar’s ledger. Also show the relevant portions of the contractor’s balance sheet as at 31st March, 2012.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Working Notes : 
(i) Calculation of written down value of machines on 31st March. 2012:—
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

(ii) Calculation of amount to be transferred from Contract Account to Profit & Loss Account :—
Total surplus in Contract Account as on 31st March, 2012
= ₹ 21,620 + ₹ 1,40,600 + ₹ 3,68,000 - ₹ 1,60,000 - ₹ 1,38,720 - ₹ 1,48,000 - ₹ 8,100 - ₹ 6,400
= ₹ 69,000
Profit to be credited to Profit & Loss Account
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 3.
The following information relates to a contract for Rs 75,00,000 (the contractee paying 90% of the value of work done as certified by the architect:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Plant was valued at the end of the first year, the second year and the third year at Rs 80,000, Rs 50,000 and Rs 20,000 respectively. Prepare the contract account for all the three years and show the relevant figures in the balance sheets.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Note.- Alternate ways of presenting Contract Account when the contract is incomplete arc as follows (Figures for the second year):—
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
This figure is ascertained by deducting from the value of work certified, the reserve to be carried forward. In this case. the figure represents ₹ 56,50,000 minus ₹ 6,30,000—the reserve already calculated. Method (2) cannot be adopted unless calculations are first made in the ordinary way.  
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 4.
The following particulars are drawn from the costing books of a contractor for the month of March, 2011:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
A certificate of completion was obtained for Job 751; of the balance in this account standing on 28th February, Rs 61,500 was in respect of Plant and Machinery, the remainder consisting of Wages and Materials. A machine costing Rs 5,500, specially bought for this contract, was sold during March for Rs 2,000.
Of the remainder of the balance on Plant and Machinery, Rs 40,000 worth had been utilised on the Job for eight months and the rest for six months. Of the former, half was transferred to Job 755, and the balance thereof returned to Stores. The contract price of Job 751 was fixed at Rs 3,75,000.
Prepare Contract Account and state the profit made on the job certified as completed, allowing depreciation on machinery at 15% per annum. Assume 10% for establishment charges on wages and materials.

Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 5.
A and B, contractors, obtained a contract to build houses, the contract price being Rs 4,00,000.
Work commenced on 1st April, 2010 and upon it the following expenditure was incurred during the year:
Plant and Tools, Rs 20,000, Stores and Materials, Rs 72,000, Wages, Rs 65,000, Sundry Expenses, Rs 5,300 and Establishment Charges Rs 11,700.
Certain materials costing Rs 12.000 were unsuited to the contract and were sold for Rs 14,500. A portion of the plant was scrapped and sold for Rs 2,300.
The value of the plan) and tools on site on 31st March, 2011 was Rs 6,200 and the value of the stores and materials on hand Rs 3,400. Cash received on account was Rs 1,40,000 representing 80% of the work certified. The cost of the work done, but not certified, was Rs 21,900; this was certified later for Rs 25,000.
A and B decided to estimate what further expenditure would be incurred in completing the contract, to compute from this estimate and the expenditure already incurred the total profit that would be made on the contract and to the take to credit of Profit and Loss Account for the year ended 31.3.2011 that proportion of the total which corresponded to the work certified by 31st March, 2011.
The estimate was as follows:
(а) That the contract would be completed by 31st December, 2011.
(b) That the wages on the contract from 1st April, 2011 to 31st December, 2011 would amount to Rs 71,500.
(c) That the cost of stores and materials required in addition to those in stock on 31st March, 2011 would be Rs 68,600 and that further contract expenses would amount to Rs 6,000.
(d) That a further Rs 25,000 would have to be laid out on plant and tools and that a residual value of the plant and tools on 31st December, 2011 would be Rs 3,000.
(e) That the establishment charges would cost the same per month as in the year ended 31st March, 2011.
(f) That 2 1/2 per cent of the total cost of the contract would be due to defects, temporary maintenance and contingencies.
Prepare Contract, Stores and Materials and Plant accounts for the year ended 31st March, 2011 and show your calculation of the amount credited to Profit and Loss Account for that year.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Profit on the entire contract is likely to be Rs 54,795 and hence the credit to be given to Profit and Loss Account is Rs 23,973, that is, Rs 54,795 x 1,75,000/4,00,000.
The estimated profit on the entire contract will be found as follows:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 6.
Brick and Tile Ltd., building contractors, commenced to trade on 1st April, 2011. The books and records are well kept but neither staff nor directors have any knowledge of the preparation of final accounts.
The summarised trial balance of the company at 31st March, 2012 was:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
You ascertain that:
(1) On 31st March, 2012, there were three contracts Nos. 15,16, and 18, incomplete, ail other contracts and jobs having been completed within the year, each showing a profit and none having any retentions against it.
(2) The quantity surveyor gives you the following details from his records of the incomplete contracts which were measured on 31st March, 2012:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
All materials are purchased for specific contracts and any unused on site are included in the measure.
(3) Vehicles, plant and machinery are to be depreciated by 25% and office furnishings and equipment are to be depreciated by 10%.
You are required:
(a) To prepare a statement showing the amounts to be included in the Trading Account for the year ended 31st March, 2012 in respect of Sales and Work in Progress, and
(b) To show how Work in Progress would appear in the Balance Sheet as on 31st March, 2012 including any notes thereon you consider necessary.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 7.
A firm of contractors obtained a contract for construction of bridges across river Revathi. The following details are available in the records kept for the year ended 31st March, 2012:
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
The firm seeks your advice and assistance in the presentation of accounts keeping in view the requirements of AS-7 “Accounting for Construction Contracts” issued by the Institute of Chartered Accountants of India.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Since this contract is in its initial stages, the future costs and sale value to be created have not been taken into account; also the whole of the profit is carried forward as reserve.
Percentage of cost incurred to total cost = 605/1101 x 100 = 55%
Proportion of total contract value recognised as revenue as per para 7.2 of Accounting Standard – 7 = 55% of Rs 1000 lakh = Rs 550 lakh.
Loss, being the excess of cost incurred over revenue recognised = Rs (605 – 550) lakh = Rs 55 lakh.
Thus, in the profit and loss account for the year ended 31st March, 2012, a loss of Rs 55 lakh will be recognised.
Paras 35 and 36 of AS-7 state that a foreseeable loss on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed. Since the total foreseeable loss is Rs 100 lakh, a provision of Rs 45 lakh is required to be made.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

Problem 8.
Media Advertisers obtained advertisement rights for One Day World Cup Cricket Tournament to be held in June, 2011 for Rs 250 lakhs.
By 31st March, 2011 they have paid Rs 150 lakhs to secure these advertisement rights. The balance Rs 100 lakhs way paid in April, 2011.
By 31st March, 2011 they procured advertisement for 70% of the available time for Rs 350 lakhs. The advertisers paid 60% of the amount by that date. The balance 40% was received in April, 2011.
Advertisements for the balance 30% time were procured in April, 2011 for Rs 150 lakhs. The advertisers paid the full amount while booking the advertisement.
25% of the advertisement time is expected to be available in May, 2011 and the balance 75% in June, 2011.
You are asked to:
(i) Pass journal entries in relation to the above.
(ii) Show in columnar form as to how the items will, appear in the monthly financial statements for March, April, May and June, 2011
Give reasons for your treatment.
Solution.
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev
Contract Costing - Methods of Costing, Cost Accounting B Com Notes | EduRev

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