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Contract Costing

Sub-contract:
            The contractor may entrust certain types of specialized work such as electrical, plumbing, painting, carpentry, special flooring, etc. to a sub-contractor. The sub-contractor is responsible to the main contractor in terms of performing the work and he will get the payment from the main contractor. The cost of such sub-contract is debited to contract account.

Retention Money:
            Usually the contractee stipulates in the contract deed that he would withhold a part of the contract price to be paid at a later stage after completion of the contract. This is to make sure that the contractor has performed all work relating to contract on the most satisfactory manner and that no repair work arises within a prescribed time limit. The amount so withheld by the contractee is known as retention money. It safeguards the interest of the contractee against the contractor, who may at time perform sub-standard work and gain therefrom.

Escalation Clause:
            Sometimes, owing to fluctuation in the prices of materials and labour costs, the contract price is altered so that neither party suffers the loss arising out of the change in price level. To protect his interest against the rise in prices, the contractor inserts a clause known as the 'escalation clause', under which, the contractee will be obliged to pay the enhanced price of the contract because of increase in the  rates of materials, labour and other expenses. Similarly, to protect the interest of the contractee against the fall in the rates of materials, labour and overheads, a 'descalation clause' is inserted. However, it is to be noted that the terms and conditions under which the contract price is to be altered is to be specifically mentioned. The reasons which give rise to change in price level is to be stipulated. There should be no ambiguity in the wordings of this clause. The essentials of the escalation clause are as follows:
(a)   The elements of costs on the basis of which quotation price is submitted must be specified.
(b)   The elements in relation to which escalation clause applies should be specified.
(c)   The escalation clause should apply to only those factors which are beyond the control of contractor.
(d)   The escalation clause should mention the date from which the rise in price of the contract comes into effect.
(e)   The records of the contractor is to be made available to the contractee for inspection.
(f)     The provision for alteration of contract price must relate only to change in design, or any major alteration of the work but not on account of defective work.

Cost-plus Contract
            It is a modified method of contract costing. This method of costing is resorted to when it is not possible to determine the cost of the contract in advance with a reasonable degree of accuracy. Under such circumstance, the contractee agrees to pay to the contractor, the actual cost incurred together with an agreed amount of profit which the contractor earns in the usual course of business. This type of contract is mostly followed during the period of urgency when certain types of products are to be manufactured and supplied as in the case of defence products, component parts and so on.

Work Certified and Work Uncertified
            Work certified represents that portion of the contract that has been duly approved by the architect of the contractee. This is denoted in terms of money value in contract account and appears on the credit side of the contract account. Work uncertified refers to that portion of work completed by the contractor but disapproved by the architect on the ground that it has not reached a stipulated stage. The value of work uncertified also appears on the credit side of the contract account.

Profit on Uncompleted Contract
            As regards profit on a completed contract, it may be safely taken to profit and loss account. This is so because it is the actual profit earned on a contract which is taken for granted to be the profit earned on a completed contract. But in case of incomplete contract the profit made on it cannot be taken to be the actual profit. Since the completion of contract in the subsequent years may be subjected to risk of loss, a prudent contractor will not consider the profit on incomplete contract to be the actual profit. Instead, it is treated as notional profit and necessary provision is made in anticipation of probable losses. The question is what percentage of notional profit is to be transferred to profit and loss account on an incomplete contract in an accounting year. There are no hard and fast rules laid down to calculate a proportionate amount of profit to be taken into profit and loss account. However, the following rules are followed in practice as laid down by contractors of yester years.

(a)   When the work completed is less than 25 per cent of the contract : Under this situation no profit is transferred to profit and loss account. The entire amount of profit is carried forward in the form of reserve.

(b)   When the work completed is more than 25 per cent but less than 50 per cent : In this case ⅓ of the notional profit is transferred to profit and loss account and the balance is carried forward in the form of reserve. The following formula is used :

⅓ x Notional profit x Cash received/Work certified

(c)   When the amount of work completed is more than 50 per cent but not nearing a stage of completion : Under such situation ⅔ of notional profit is transferred to profit and loss account and the balance to work-in-progress account.

(d)   When the contract is nearing the stage of completion : In this case, the cost of completing the contract is estimated. Then the estimated profit is calculated by deducting the total estimated cost from the contract price. For calculating the profit to be taken to profit and loss account, the following formula is adopted :

Estimated profit x Work certified/Contract price

Contractee's Account
            The contractee's account is prepared by the contractor in his books. When the various instalments of contract price is received from the contractee, the following entry is passed :

                        Cash a/c                                                                     Dr.
                                    To contractee's a/c

            When the contract account is fully completed, the following entry is passed :
                        Contractee's a/c                                                        Dr.
                                    To contract a/c

            Thus it is clear that the contractee's account will show a debit balance indicating the amount due from him to the contractor till it is paid fully.

Target costing
            This is a variation of cost-plus contract. Under this method, the contractee agrees to pay the profit as per the agreement on the total contract price. In addition to the profit, sometimes, it is agreed upon by the contractor to complete the contract within a target price. In case, if he completes the contract within the target price, he is entitled to receive a bonus which is in proportion to the savings made, saving being difference between original contract price and target price.



1.      S.V. Construction Ltd. have obtained a contract for the construction of a bridge. The value of the contract is Rs. 12 lakhs and the work commenced on 1st October, 2000.  The following details are shown in their books for the year ended 30th September, 2001 :
            Plant purchases Rs. 60,000; Wages paid Rs. 3,40,000, Materials issued to site Rs. 3,36,000; Site expenses Rs. 8,000; General overheads apportioned Rs. 32,000; Wages accrued as on 30-9-2001 Rs. 2,800; Materials at site as on 30-9-2001 Rs. 4,000; Direct expenses accrued as on 30-9-2001 Rs. 1,200; Work not yet certified at cost Rs. 14,000; Cash received being 80% of work certified Rs. 6,00,000. Life of plant purchased is 5 years and scrap value is nil.
            (1) Prepare the contract account for the year ended 30th September, 2001; (2) Show the amount of profit which you consider might be fairly taken on the contract and how you have calculated it.



2.      A railway contractor makes up his accounts to 31st March. Contract No. SER/15 for the construction of a culvert between Bhilai and Rajpur commenced on 1st July, 2000. The costing records yield that following information at 31st March, 2001.

            A machine costing Rs. 25,000 has been on site for 73 days. Its working life is estimated at five years and its final scrap value at Rs. 1,000.
            A supervisor who is paid Rs. 18,000 per annum has spent approximately six months on the contract.
            All administration and other expenses amount to Rs. 17,000.
            Material in store at site at the end of the year cost Rs. 2,500.
            The contract price is Rs. 3,00,000. At the end of the year two-thirds of the contract was completed for which amount, the Architect's certificate has been issued and Rs. 1,60,000 has so far been received on account.
            It was decided that the profit made on the contract in the year should be arrived at by deducting the cost of work certified from the total value of the architect's certificate that ⅓ of the profit so arrived at should be regarded as a provision against contingencies and that such provision should be increased by taking to the credit of profit and loss account only such portion of the ⅔ profit as the cash received before to the work certified.
            Prepare a contract account showing profit or loss to be included in respect of this contract in the financial accounts to 31st March 2001.



3.      The following information relates to a building contract for Rs, 10,00,000 and for which 80% of the value of Work-in-Progress as certified by the architect is being paid by the contractee :

            The value of the plant at the end of 2000, 2001 and 2002 was Rs. 11,200, Rs. 7,000 and Rs. 3,000 respectively. Prepare Contract Account for the three years taking into account such profit as you think proper on incomplete contract.



4.      M/s Promising Company undertook a contract for erecting sewerage treatment plant for Prosperous Municipality for a total value of Rs. 24 lakhs.  It was estimated that the job would be completed by 31st January, 2001.
            You are asked to prepare the Contract Account for the year ending 31st January, 2001 from the following particulars :
a) Materials - Rs. 3,00,000
b) Wages - Rs. 6,00,000
c) Overhead charges - Rs. 1,20,000
d) Special Plant - Rs. 2,00,000
e) Work certified was for Rs. 16,00,000 and 80% of the same was received in cash.
f) Material lying on site as on 31-1-2001 - Rs. 40,000
g) Depreciate Plant by 10%.
h) 5% of the value of material issued and 6% of wages may be taken to have been incurred for the portion of the work completed, but not yet certified. Overhead are charged as a Percentage of Direct Wages.
i) Ignore depreciation of plant for use on uncertified portion of the work.
j) Ascertain the amount to be transferred to Profit and Loss A/c on the basis of realised profit.



5.      A Contract Account in the books of Contractors Ltd. appears as follows :
            June 30, 2001 Material issued to site Rs. 5,000; Plant issued to site Rs. 12,500; Direct Labour Rs. 4,600; Indirect Labour Rs. 640; Overhead Expenses Rs. 1,950.
            You are informed that it is the practice of the firm to take credit for two-thirds of the profit earned on the contracts in progress after taking into account the value of the work certified for payment by architects. You are required to :
a)     Complete the contract account to June 30.
b)     Show the amount which you would transfer to Profit and Loss Account along with necessary calculations.
c)      Show relevant entries in the Balance Sheet as on 30th June.
            For this purpose you are supplied with the following further information as at that date :

6.      A firm of building contractors began to trade on 1-1-2001.  The following was the expenditure on a contract for Rs. 6,00,000 :

            Out of the plant and material charged to the contract, plant which cost Rs. 5,000 and materials costing Rs. 4,000 were lost.  Some part of the materials costing Rs. 2,500 were sold at a profit of Rs. 500.  On 31st December, 2001 plant which cost Rs. 2,000 was returned to stores and plant which cost Rs. 3,000 was transferred to some other contract.
            The work certified was Rs. 4,80,000 and 80% of the same was received in cash.  The cost of work done but uncertified was Rs. 3,000. Charge depreciation on plant at 10% p.a. You are required to prepare the contract account for the year ended 31st December, 2001, by transferring to the profit or loss account the portion of profit, if any, which you consider reasonable.
           Also prepare the contractee’s account, work-in-progress account and the balance sheet in the books of the contractor.



7.      The following is the Trail Balance of Premier Construction Company, engaged on the execution of Contract No.747, for the year ended 31st December, 2001:

            The work on Contract No.747 was commenced on 1st January 2001.  Materials costing Rs. 1,70,000 were sent to the site of the contract but those of Rs. 6,000 were destroyed in an accident. Wages of Rs. 1,80,000 were paid during the year.  Plant costing Rs. 50,000 was used on the contract all through the year.  Plant with cost of Rs. 2 lakhs was used from 1st January to 30th September and was then returned to the stores.  Materials cost of Rs. 4,000 were at site on 31st December, 2001.
            The contract was for Rs. 6,00,000 and the contractee pays 75% of the work certified.  Work certified was 80% of the total contract work at the end of 2001. Uncertified work was estimated at Rs. 15,000 on 31st December, 2001.
            Expenses are charged to the contract at 25% of wages.  Plant is to be depreciated at 10% for the entire year.
            Prepare Contract No. 747 Account for the year 2001 and make out the Balance Sheet as on 31st December 2001 in the books of Premier Construction Co.



8.      Prepare Contract Account and Contractee’s Account assuming that the amount due from the contractee was duly received.

            The contract price was Rs. 90,000 and the contract took 13 weeks in its completion. The value of Loose Tools and Stores returned at the end of the period were Rs. 200 and Rs. 3,000 respectively. The plant was also returned at a value of Rs. 16,000 after charging depreciation at 20%. The value of tractor was Rs. 20,000 and the depreciation was to be charged to the contract @ 15% per annum. The administrative and office expenses are to be provided at 10% on works cost.



9.      The following figures are extracted from the books of Ram Dass, a contractor, for the year ending 31st December, 2001 :

            Prepare the Contract Ledger Control A/c as in General Ledger and Total Contractees' A/c. Show also how the Work-in-Progress would appear in the Balance Sheet as on 31st December, 2001.



10.      The following particulars relate to two houses which a firm of builders had in course of construction under contract :

            The total establishment expenses incurred during the year 2001 amounted to Rs. 12,240. These are to be charged to the two contracts in proportion to wages. Depreciation of plant is to be taken into account at the rate of 10% per annum.
            Prepare the two contracts accounts (in columnar form) showing the profit or loss on each house for the year 2001 and the sums which you consider appropriately transferable to the profit and loss account.



11.      Alcon Construction Company Ltd., commenced its business of construction on 1-4-2000. The trial balance as on 31-3-2001 showed the following balances :

            The contract price is Rs. 3,00,000 and work certified is Rs. 1,50,000. The work completed since certification is estimated at Rs. 1,000 (at cost). Machinery costing Rs. 2,000 was returned to stores at the end of the year. Stock of material at site on 31-3-2001 was of the value of Rs. 5,000. Wages outstanding were Rs. 200. Depreciation at 10% only on machinery used for the contract.
            You are required to calculate the profit from the contract and show how the work-in-progress will appear in the Balance Sheet as on 31-3-2001.



12.      A contractor, who prepares his account on 31st December each year, commenced a contract on 1st April, 2001. The costing records concerning the said contract reveal the following information on 31st December, 2001 :

            Plants costing Rs. 2,60,000 had been on site for 146 days. Their working life is estimated at 7 years and their final scrap value at Rs. 15,000. A supervisor, who is paid Rs. 4,000 p.m., has devoted approximately three-fourths of his time to this contract. The administrative and other expenses amount to Rs. 1,40,000. Materials in hand at site on 31st December, 2001 cost Rs. 25,400. Some of the material costing Rs. 4,500 was found unsuitable and was sold for Rs. 4,000 and a part of the plant costing Rs. 5,500 (on 31-12-2001) unsuited to the contract was sold at a profit of Rs. 1,000.
            The contract price was Rs. 22,00,000 but it was accepted by the contractor for Rs. 20,00,000. On 31st December, 2001, two-thirds of the contract price agreed to be paid was completed. Architect's certificate had been issued covering 50% of the cost of contract and Rs. 7,50,000 had so far been paid on account. Prepare contract account and state how much profit or loss should be included in the financial accounts to 31st December, 2001. Workings should be clearly given. Depreciation is charged on time basis.
            Also prepare the Contractee's account and show how these accounts would appear in the Balance Sheet as on 31st December, 2001.



13.      A contractor commenced a building contract on October 1, 1997. The contract price of Rs. 4,40,000. The following data pertaining to the contract for the year 1998-99 has been compiled from his books and is as under :

            The cash received represents 80% of work certified. It has been estimated that further costs to complete the contract will be Rs. 23,000 including the materials at site as on March 31, 1999.
            Required : Determine the profit on the contract for the year 1998-99 on prudent basis, which has to be credited to P/L A/c.



14.      X Ltd. closes its accounts on 31st December each year. The company commenced work on a contract on 1st January 1998. The following information relates to the contract as on 31st December 1998

            A machine costing Rs. 1,30,000 had been on the site for 146 days. Its working life is estimated at 7 years and its final scrap value at Rs. 7,500. A supervisor, who is paid Rs. 4,000 per month has devoted half of his time to this contract. Other expenses and administration charges amounted to Rs. 68,250. Materials at site at the end of the year cost Rs. 17,700. The contract price is Rs. 10 lakhs. On 31st December 1998, two-thirds of the contract was completed. The architect had issued certificate of approval covering 50% of the contract price and the contractor had been paid Rs. 3,75,000 on account.
            Prepare the contract account and work-in-progress account. Also show how the work-in-progress will appear in the balance sheet of the contractor as on 31st December 1998.



15.      The Maharashtra Construction Company undertook the construction of a building at a contract price of Rs. 12,00,000. The date of commencement of contract was 1st April 1998.
            The following cost information is given for the year ended 31st March 1999

            You are required to prepare a contract a/c for the year ended 31st March 1999.



16.      On 1.1.1999, Archana & Co., undertook one contract for a price of Rs. 25,00,000. Of the plant and materials sent to the contract, plant which cost Rs. 25,000 and materials worth Rs. 20,000 were lost in transit. On 31st December 1999, plant which originally cost Rs. 25,000 was returned to stores. The cost of work done but uncertified was Rs. 10,000 and materials costing Rs. 20,000 were at site. Charge depreciation at 10% p.a. on plant. Prepare contract account and balance sheet, from the following trial balance as on 31.12.99.           

17.      The following trial balance was extracted on 30th April 1998 from the books of General Contractors Ltd.

            Contract no. 15 was begun on May 1, 1997. The contract price is Rs. 4,80,000 and the customer has so far paid Rs. 2,56,000 being 80% of the work certified. The cost of work done since certification is estimated at Rs. 3,200 on April 30, 1998. After the above trial balance was extracted, plant costing Rs. 6,400 was returned to stores and materials then on site were valued at Rs. 5,400. Provision is to be made for labour accrued Rs. 1,200 and depreciation on plant at 12½%.
            You are required to (a) write up contract a/c (b) prepare balance sheet as on that date.



18.      Modern Construction Company with a paid up share capital of Rs. 50 lakhs undertook a contract to construct LIC houses. The contract was commercial on 1.1.1994 and the contract price was Rs. 50 lakhs. Cash received on account of contract on 31.12.94 was Rs. 18 lakhs (90% of the work certified). Work completed but not certified was estimated at Rs. 1,00,000. As on 31.12.94, materials at site was estimated at Rs. 30,000 and machinery at site costing Rs. 2,00,000 was returned to stores. Plant and machinery at site is to be depreciated at 5%. Wages outstanding on 31.12.94 was Rs. 5,000.
            The following trial balance was extracted as on 31.12.94.

Prepare the contract a/c to ascertain the profit from the contract and show the work-in-progress in the balance sheet.



19.      The following trial balance was extracted from the books of Gemini Contractor as on 31.12.89 :

            Contract no. 83 which was in progress on 1.1.89 was completed on 31.3.89. Contract no. 84 commenced on 1.1.89. Rs. 20,000 materials and Rs. 10,000 wages were paid for contract no. 83. Rs. 60,000 materials were sent to contract no. 84 but Rs. 3,000 worth was lost there by accident. Rs. 60,000 wages were paid for contract no. 84. Rs. 50,000 plant was used in contract no. 84 all through but plant costing Rs. 2,00,000 was used on contract no. 84 from 1st April 1989; prior to that, above machinery was used on contract no. 83. Rs. 4,000 materials were at site on contract no. 84 at the end of the year. Provide 10% depreciation on the plant and 2% on buildings.
            Contract no. 83 was Rs. 1,50,000 and certified work up to last year was Rs. 1,00,000. The work has been certified up to the full extent but payment has been received up to 80% of the certified amount. The balance has not been paid yet nor any entry has been passed on completion of the contract.
            Expenses are charged to contracts on the basis of 50% of direct wages. The new contract is for Rs. 4,00,000 and 90% is paid on certification. The uncertified work of contract as on 31st Dec. 1989 is estimated at Rs. 15,000.
            You are required to prepare : (a) Contract 83 a/c, (b) Contract no. 84 a/c, (c) P & L a/c for 1989, (d) Contract no. 83 contractee's a/c, (e) Contract no. 84 contractee's a/c, (f) Balance sheet as on 31.12.89.



20.      Rajesh contractor obtained a contract to build a house at a contract price of Rs. 15,00,000. The contractee agrees to pay 90% of the value of the work done as certified by the architect immediately on receipt of the certificate and to pay the balance after completion of the contract.
            The contractor commenced the work on 1st May 1999. A plant costing Rs. 20,000 was specially bought for the contract. The value of the plant at the end of 1996, 1997 and 1998 was Rs. 16,000, Rs. 10,000 and Rs. 4,000 respectively. The work done and certified by the architect as at the end of 1996 and 1997 was Rs. 3,50,000 and Rs. 11,50,000 respectively. Work costing Rs. 2,000 done as at the end of 1997 was not certified as on that date.
            Other details of the contract were as under :

            You are required to prepare contract a/c for the year ended 31st Dec. 1996, 1997 and 1998, considering that contract is fully completed in 1998.