Contract Costing - Methods of Cost Determination, Cost Management | Cost Management - B Com PDF Download

What is a Contract Costing?

Contract Costing is otherwise called as terminal costing. It is one of the methods of Job Costing. Contract costing is also prospered just like job costing. A separate number is allotted to each contract and records are also maintained for each contract separately. The cost unit is each contract account.

Where is contract costing method used?

The contract costing method is used mostly by builders, civil contractors, ship builders, and construction and mechanical engineering firms. Generally, the contract is undertaken at the site of contract i.e. customer and according to the specifications of customer. More over, the period inquired to complete a contract is fairly long time or usually more than one year.

The main purpose of preparing contract account is the ascertainment of cost of each contract separately and profit on each contract.

Definition of Contract Costing

CIMA defines contract cost as

" the aggregated costs relative to a single contract designated a cost unit."

CIMA defines contract costing as

" that form of specific order costing which applies where work is undertaken to special requirements of customers and each order is of long term duration."

Types of Contract

The following are the types of contract.

1. Fisted price contract

2. Fisted price contract subject to Escalation Clause.

3. Cost plus contract.

Features of Contract Costing

The following are the features of contract costing.

1. A contract is undertaken according to the specific requirements of customers.

2. Generally, the duration of a contract is long period.

3. The contract is undertaken only at the site of the customer.

4. Contract work mainly consists of construction activities.

5. The specific order costing principles are applied in contract costing.

6. The size of a contract is usually large or bigger than jobs.

7. It requires a long time to complete a contract.

8. Each contract is an independent one, quite distinct from another.

9. A distinctive number is assigned to each contract to differentiate the contract from one another.

10. A separate account is maintained and prepared for each contract to find out the profit earned from each contract separately.

11. If a contract is not completed at the end of the accounting period, only a portion of profit is transferred to profit and loss account on the basis of stage of completion of a contract.

12. There is no problem of under absorption and over absorption of overheads.

13. Every conceivable expenditure is charged to the concerned contract.

14. If the materials, plants and other inputs are transferred from one contract to another, the transfer may be affected by giving debit and credit to the respective contracts.

15. The proportion of indecent costs to total cost of a contract is very small.

16. A contractor may appoint a sub — contractor(s) for the execution of the work of the main contract.

17. The contractee i.e. the customer pays money only on the basis of the work certified by the architect, engineer or surveyor.

18. Escalation clause may be incorporated in the agreement of the contract. It so, the contractor is protected from any rises in the prices of materials, labour and other inputs.

Procedure of Contract Costing

In contract costing, most of the expenses are direct in nature as in the form of materials, labour, expenses, plant, sub-contract charges and the like. Only a small portion of amount is charged as overheads which are apportioned on suitable basis. Accounting treatment of costs of contract costing is briefly explained below.

1. Materials

The value of materials used is debited in the concerned contract account. Materials may be specifically purchased from the open market, issued from the stores, transfer from other contracts or supplied by the contractee himself. If materials are returned to stores, the value of materials is credited in the concerned contract account.

Sometimes, materials may be transferred from one contract to another. If so, the value of materials is debited in the receiving contract account and credited in the transferring contract account. Whenever the materials are purchased from the open market, the values of materials are debited in the concerned contract account.

Similarly, if materials are issued from stores, the concerned contract account is debited and the stores control account is credited. Sometimes, some materials may be stolen or destroyed by fire, the value of materials is credited in the concerned contract as stores account and the same is transferred to profit and loss Account.

2. Labour

Generally, the contract is carried on only at the site of the contractee i.e., customer not within the company premises. Hence, labour is engaged at site to work on the contract. The amount paid to workers is wages which is directly debited in the concerned contract account. The details of information regarding wages are obtained from the records of time sheet and wages sheet. Equitable base method is usually adopted to apportion the wages of supervisors working on two or more contracts.

Likewise, the overheads are also apportioned on suitable basis. The accrued wages and outstanding expenses are calculated at the end of the accounting period and debited in the concerned contract account.

3. Direct Expenses

The direct expenses are debited in the concerned contract account as and when they are incurred. Examples of direct expenses are hire charges paid for the plant procured from outside, sub-contractor’s charges, architect’s fees, electricity, insurance and the like.

4. Plant and Machinery

The plant and machinery is treated in two ways. Under first method, the full value of plant and machinery is debited in the concerned contract account if the plant and machinery is specifically purchased for the contract. At the end of contract, the plant and machinery may be sold out in the market if it is not required further. If so, the sale proceeds are credited in the concerned contract account.

Sometimes, the plant and machinery may be required further, if so, the depreciated value or revalued amount of plant and machinery is credited in the concerned contract account. The net effect is that the contract account is debited with the amount of depreciation.

Under second method, the contract account is debited with the amount of depreciation of plant and machinery. The plant and machinery may be purchased specifically from the open market or issued from the stores. The amount of depreciation is calculated on the basis of daily use or hourly basis. Sometimes, a plant is procured on hire basis, if so, only hourly charges are debited in the contract account.

5. Overheads

Indirect costs cannot be directly charged to any contract account. These costs are apportioned to all the contract accounts only on the suitable basis. These are called as overheads. The term overheads includes payment made to engineers, supervisors, architects, managers, store keeper, central office, administrative expenses like staff salaries, telephone expenses, postage, rent, stationery, advertisement expenses etc.