Contract costing is a costing technique which is applied in accumulating the cost of large scale jobs. It is also called terminal costing.
Characteristics of Contract Costing
– There is a high proportion of direct cost since almost all the cost incurred arise due to the particular work being done.
– The contract may continue for more than one accounting period leading to technicalities in profit recognition.
– The contract price is normally estimated in advance of the work
– The work is executed in the premises of the contractee/ project client.
– The work to be executed depends upon customer specification. Hence very rarely two contracts resemble one another.
– Progress payments are made depending on the stage of completion of the work.
– Each contract is treated as a cost unit.
Similarities between Contract Costing and Job Costing
– Production starts on received orders from customers
– Every job and contract is dissimilar in nature
– There is no need to create demand since customers come on their own
– Profit is determined on each job or each contract separately
– Work is to be executed according to the customer’s specifications
– They belong to the category of specific order costing
Differences between Contract Costing and Job Costing
– A job is small in size whereas a contract is big in size.
– Work under job costing is performed in the premises of the manufacturer. In contract costing, the work is done in the premises of the customer.
– A job usually takes less time to complete compared to a contract
– The sales value of a job is paid after the job is completed fully. Under contract costing, progress payments are made depending on which stage the work has reached.
– Expenses under job costing take the form of direct and indirect whereas under contract costing, most of the expenses are direct in nature.
– Profit earned on a job is entirely taken to the profit and loss account whereas for incomplete contracts, only a portion of the profit is taken to the profit and loss account.
1. Retention Money
As the contract work progresses, the consultants (architect and quantity surveyor) appointed by the contractee issues certificates to indicate the portion of the work already completed. The contractor will be paid according to this certificate and a certain portion thereof will be retained by the contractee. This is called retention money.
2. Notional Profit
This is the difference between the value of work certified and the cost of work certified.
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 gets his payment from the main contractor. The cost of sub-contracts is debited to the contract account.
Profit on incomplete contracts
Many contracts take more than one accounting year. A problem arises as to whether profits on such contracts should be recognized only on their completion or whether some profits should be recognized every year.
The general position is that profit should be recognized in respect of work certified only.
The degree of completion
This is determined using any of the following formulae:
Degree of completion = Value of work certified / Contract price
Degree of completion= Cost to date / Estimated total cost