A Study On Contract Costing: Project Report

A STUDY ON CONTRACT COSTING
PROJECT REPORT
Submitted by
BENI BERSILLAI
MZC18MBA11
Under the guidance of
ASST. PROF : VISHNU PANKAJAKSHAN
In partial fulfillment of the requirements
for the award of the Degree of
MASTER OF BUSINESS ADMINISTRATION

of
A P J Abdul Kalam Technological University
MOUNT ZION SCHOOL OF BUSINESS MANAGEMENT
2020 JANUARY
CONTRACT COSTING
Contract costing is the tracking of costs associated with a specific contract with a
customer. For example, a company bids for a large construction project with a
prospective customer, and the two parties agree in a contract for a certain type of
reimbursement to the company. This reimbursement is based, at least in part, on
the costs incurred by the company in order to fulfill the terms of the contract. The
company must then track the costs associated with that contract so that it can
justify its billings to the customer. The most typical types of cost reimbursement
are:
 Fixed price. The company is paid a fixed total amount for completing the
project, possibly including progress payments. Under this arrangement, the
company will want to engage in contract costing to compile all of the costs
relevant to the construction project, just to see if the company earned a profit on
the deal.
 Cost plus. The company is reimbursed for the costs it incurred, plus a
percentage profit or fixed profit. Under this arrangement, the company will be
forced under the terms of the contract to track the costs related to the project, so
that it can apply to the customer for reimbursement. Depending on the size of the
project, the customer may send an auditor to examine the company's contract
costs, and may disallow some of them.
 Time and materials. This approach is similar to the cost plus arrangement,
except that the company builds a profit into its billings, rather than being awarded
a specific profit. Again, the company must track all contract costs carefully, since
the customer may review them in some detail.
Contract costing can involve a considerable amount of overhead allocation work.

Customer contracts typically specify exactly which overhead costs can be
allocated to their projects, and this calculation may vary by contract.
FORMAT OF CONTRACT COSTING
Profit or Loss Account:
The balance of Contract Account represents profit or loss which is transferred to Profit and Loss
Account. However, when contract is not completed within the financial year, only the part of the
profit arrived is taken into account and the remaining profit is kept as reserve to meet any
contingent loss on the complete portion of the contract.
Computation of Profit or Loss on Contract:

There may be three situations in the computation of profit or loss on contracts.
They are:
(I) Profit on completed contracts,
(II) Profit on uncompleted contracts,
(III) Profit on likely to be completed contracts.
I. Profit on Completed Contracts:
If a contract is begun and completed in the same financial year, then, the entire profit or loss
made on such a contract should be transferred to the Profit and Loss Account. If there is profit,
the same should be credited to the Profit and Loss Account and debit should be given to Contract
Account. On the other hand, if there is loss, the same should be debited to the Profit and Loss
Account and credit being given to the Contract Account.
II. Profit on Uncompleted Contracts:
Contracts which are started and finished during the same financial year create no accounting
problems. But in case of those contracts which take more than one year to complete, a problem
arises whether profit on such contracts should be worked out only on the completion of the
contract or at the end of each financial year on the partly completed work. If profit is computed
only on the completion of the contract, profit will be high in the year of completion of the
contract, where as in other years of working on contract, profit will be nil.
This would result not only distorted profit pattern but also higher tax liability because income-tax
at higher rates may have to be paid. Therefore, when contracts extend beyond a year, it becomes
necessary to take into account the profit earned or loss incurred oh the work performed during
each year. This helps in avoiding distortion of the year-to-year profit trend of the business.
There are two aspects of the profit computation:
(1) Computation of notional profit or estimated profit, and
(2) Computation of the portion of such profit to be transferred to Profit and Loss Account.
The portion of the notional or estimated profit to be transferred to Profit and Loss Account
depends upon the stage of completion of the contract. Prudence requires that the total notional
profit should not be transferred to Profit and Loss Account but a portion of it should be withheld
as a reserve to meet any unforeseen future expenses or contingencies.
However, the following general rules may be followed in this context:
1. First Rule:
When work certified is less than 1/4 of the contract price, no profit is transferred to Profit and
Loss Account. This is based on the principle that no profit should be taken into account unless
the contract has reasonably advanced.
2. Second Rule:
When work certified is 1/4 or more but less than 1/2 of the contract price, then generally 1/3 of
the profit is transferred to Profit and Loss Account. The balance amount is treated as reserve.
Thus, profit to be transferred to Profit and Loss Account is computed by the following formula –
3. Third Rule:
When work certified is 1/2 (i.e. 50%) or more but less than 9/10 (i.e. 90%) of the contract price,
then the profit to be transferred to Profit and Loss Account is computed by the following formula
–
4. Fourth Rule:
When contract is near completion then the estimated profit should be calculated on the whole
contract. The proportion of estimated profit to be transferred to Profit and Loss Account is
computed by any one of the following formulas:
5. Fifth Rule – Loss on Uncompleted Contracts:

In the event of a loss on uncompleted contracts, this should be transferred in full to the Profit and
Loss Account. Whatever be the stage of completion of the contract.
6. Cost Plus Method of Contract:
Cost plus method of contract is that where contract price is not settled between contractor and
contractee, but it is agreed that contractor will be paid a fixed percentage of profit on the total
cost incurred by contractor on and above the total cost of the work done. Such type of contract is
entered into in war time or time of economic fluctuation or where contract is to be executed in
urgency and it is difficult to quote the price of the contract.
ILLUSTRATION
Calcutta Construction Ltd. undertook a contract for construction of a bridge on 1st July, 1991. The
contract price was Rs.5,00,000. The Company incurred the following expenses up to December, 1991:
Depreciation 10% p.a. on plantCharge other works expenses @ 20% of wages and office
expenses @ 10% of works cost. The
amount certified by the engineer was
Rs.3,00,000, retention
money being 20% of the certified
value. Prepare the Contract
Account showing therein the amount
of profit that the company can
reasonably take to its Profit and Loss Account.

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A STUDY ON CONTRACT COSTING

Under the guidance of

ASST. PROF : VISHNU PANKAJAKSHAN

In partial fulfillment of the requirements

for the award of the Degree of

MASTER OF BUSINESS ADMINISTRATION

A P J Abdul Kalam Technological University

MOUNT ZION SCHOOL OF BUSINESS MANAGEMENT

Contract costing can involve a considerable amount of overhead allocation work.

Computation of Profit or Loss on Contract:

5. Fifth Rule – Loss on Uncompleted Contracts:

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