7
Contract Costing
BASIC CONCEPTS AND FORMULAE
Basic Concepts
1.
Contract costing:- Contract or terminal costing, as it is termed, is one form of
application of the principles of job costing. In fact a bigger job is referred to as a
contract. Contract costing is usually adopted by building contractors engaged in the
task of executing Civil Contracts.
2.
Sub-Contract : Sub-contract costs are also debited to the Contract Account.
3.
Extra work: The extra work amount payable by the contractee should be added to
the contract price. If extra work is substantial, it is better to treat it as a separate
contract. If it is not substantial, expenses incurred should be debited to the contract
account as “Cost of Extra work”.
4.
Cost of work certified: All building contractors received payments periodically
known as “running payment” on the basis of the architect’s or surveyor’s certificates.
But payments are not equal to the value of the work certified, a small percentage of
the amount due is retained as security for any defective work which may be
discovered later within the guarantee period.
5.
Work uncertified: It represents the cost of the work which has been carried out by
the contractor but has not been certified by the contractee’s architect. It is always
shown at cost price.
6.
Retention money: A contractor does not receive full payment of the work certified
by the surveyor. Contractee retains some amount (say 10% to 20%) to be paid, after
sometime, when it is ensured that there is no fault in the work carried out by contractor.
7.
Work-in-progress: In Contract Accounts, the value of the work-in-progress consists
of (i) the cost of work completed, both certified and uncertified; (ii) the cost of work
not yet completed; and (iii) the amount of profit taken as credit. In the Balance Sheet,
the work-in-progress is usually shown under two heads, viz., certified and uncertified.
8.
Notional profit : It represents the difference between the value of work certified and
cost of work certified.
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7.2
9.
Cost Accounting
Estimated profit : It is the excess of the contract price over the estimated total cost
of the contract.
10. Cost plus Contract : Under Cost plus Contract, the contract price is ascertained by
adding a percentage of profit to the total cost of the work. Such type of contracts are
entered into when it is not possible to estimate the Contract Cost with reasonable
accuracy due to unstable condition of material, labour services, etc.
14. Operating Costing: It is a method of ascertaining costs of providing or operating a
service. This method of costing is applied by those undertakings which provide
services rather than production of commodities.
15. Multiple Costing: It refers to the method of costing followed by a business wherein
a large variety of articles are produced, each differing from the other both in regard
to material required and process of manufacture. In such cases, cost of each article
is computed separately by using, generally, two or more methods of costing.
Basic Formulas
1.
When work on contract has not reasonably advanced, no profit is taken into account.
In practice, no profit is calculated when work certified is less than 1/4th but less than
½ of the contract price.
2.
When work certified is more than 1/4th but less than ½ of the contract price, following
formula is used to determine the figures of profit to be credited to profit and loss account:
1/3 × Notional profit ×
3.
When work certified is more than ½ of the contract price, but it is still not in the final
stage, following formula is used to determine the figure of profit to be credited to
profit and loss account:
2/3 × Notional profit ×
4.
Cash recieved
Work certified
Cash received
Work certified
When the contract is almost complete, an estimate total profit is determined by
deducting aggregate of cost to date and estimated additional expenditure from
contract price. A portion of this estimated total profit is credited to profit and loss
account. The figure to be credited to profit and loss account is ascertained by
adopting any of the following formulae:
4.1 Estimated total profit ×
Work certified
Contract price
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Contract Costing
4.2 Estimated total profit ×
Cash received
Contract price
4.3 Estimated total profit ×
Cost of Work to date
Estimated total cost
4.4 Estimated total profit ×
Cost of Work to date Cash received
×
Estimated total cos t
Work certified
7.3
5.
Profits on incomplete contracts: The overriding principle being that there can be
no attributable profit until the outcome of a contract can reasonably be foreseen. Of
the profit which in the light of all the circumstances can be foreseen with a
reasonable degree of certainty to arise on completion of the contract there should be
regarded as earned to date only that part which prudently reflects the amount of
work performed to date. The method used for taking up such profits needs to be
consistently applied.”
6.
The computation of escalation claim is based on wording of escalation clause.
Normally it is calculated on stipulated quantity of material and labour hours based on
price and rate differential.
7.
Work certified and consequent payment: Work certified and consequent payment m
7.1 The amount of work certified can be debited to contractee’s account. On receipt
of money from contractee, his personal account will be credited and cash or
bank account, as the cause may be will be debited.
7.2 At the time of balance sheet preparation, Contractee’s Account will be shown
on the ‘Assets side’ as debtors.
7.3 Under the second method (it is more common than the first, students are
advised to follow this method only) the amount of work certified is debited to
work-in-progress account and credited to contract account. The work-inprogress should be shown on the assets side after deduction of cash received.
Next year work-in-progress account will be debited to contract account.
Question 1
Write note on cost-plus-contracts.
Answer
These contracts provide for the payment by the contractee of the actual cost of manufacture
plus a stipulated profit, mutually decided between the two parties.
The main features of these contracts are as follows:
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7.4
Cost Accounting
1.
The practice of cost-plus contracts is adopted in the case of those contracts where the
probable cost of the contracts cannot be ascertained in advance with a reasonable accuracy.
2.
These contracts are preferred when the cost of material and labour is not steady and the
contract completion may take number of years.
3.
The different costs to be included in the execution of the contract are mutually agreed, so that
no dispute may arise in future in this respect. Under such type of contracts, contractee is
allowed to check or scrutinize the concerned books, documents and accounts.
4.
Such a contract offers a fair price to the contractee and also a reasonable profit to the
contractor.
5.
The contract price here is ascertained by adding a fixed and mutually pre-decided component
of profit to the total cost of the work.
Question 2
Write notes on Escalation Clause
Answer
Escalation Clause: This clause is usually provided in the contracts as a safeguard against
any likely changes in the price or utilization of material and labour. If during the period of
execution of a contract, the prices of materials or labour rise beyond a certain limit, the
contract price will be increased by an agreed amount. Inclusion of such a term in a contract
deed is known as an 'escalation clause'
An escalation clause usually relates to change in price of inputs, it may also be extended to
increased consumption or utilization of quantities of materials, labour etc. In such a situation
the contractor has to satisfy the contractee that the increased utilization is not due to his
inefficiency.
Question 3
Discuss briefly the principles to be followed while taking credit for profit on incomplete
contracts
Answer
Principles to be followed while taking credit for profit on incomplete contracts:
The portion of profit to be credited to, profit and loss account should depend on the stage of
completion of the contract. This stage of completion of the contract should refer to the certified
work only. For this purpose, uncertified work should not be considered as for as possible. For
determining the credit for profit, all the incomplete contracts should be classified into the
following four categories.
(i)
Contract less than 25% complete
(ii)
Contracts is upto 25% or more but less than 50% complete
© The Institute of Chartered Accountants of India
Contract Costing
7.5
(iii) Contracts is upto 50% or more but less than 90% complete
(iv) Contracts nearing completion, say between 90% and 100% complete.
The transfer of profit to the profit and loss account in each of the above cases is done as
under:
(i)
Contract less than 25% complete: if the contract has just started or it is less than 25%
complete, no profit should be taken into account.
(ii)
Contracts is upto 25% or more but less than 50% complete: In this case one third of the
notional profit reduced in the ratio of cash received to work certified, may be transferred
to the profit and loss account. The amount of profit to be transferred to the profit and loss
account may be determined by using the following formula:
Cash received
1
× Notional profit ×
Work certified
3
(iii) Contracts is upto 50% or more but less than 90% complete: In this case, two third of the
notional profit, reduced by the portion of cash received to work certified may be
transferred to the profit and loss account. In this case the formula to be used is as under:
Cash received
2
× Notional profit ×
Work certified
3
(iv) Contracts nearing completion, say between 90% and 100% complete: When a contract is
nearing completion or 90% or more work has been done on a contract. The amount of
profit to be credited to profit and loss account may be determined by using any one of the
following formula.
(a) Estimated profit ×
Work certified
Contract price
(b) Estimated profit ×
Work certified
Cash received
×
Contract price
Work certified
or Estimated profit ×
(c) Estimated Profit ×
(d) Estimated profit ×
(e) Notional profit ×
Work certified
Contract price
Cost of work to date
Estimated total cos t
Cost of work to date Cash received
×
Estimated total cost
Work certified
Work certified
Contract price
© The Institute of Chartered Accountants of India
7.6
Cost Accounting
Question 4
Discuss the process of estimating profit/loss on incomplete contracts
Answer
Process of estimating profit / loss on incomplete contracts
(i)
If completion of contract is less than 25% no profit should be taken to profit and loss
account.
(ii)
If completion of contract is upto 25% or more but less than 50% then
1/3 × Notional Profit ×
Cash received
Work certified
may be taken to profit and loss account.
(iii) If completion of contract is 50% or more but less than 90% then
2/3 × Notional Profit ×
Cash received
Work certified
may be taken to profit and loss account
(iv) If completion of contract is greater than or equal to 90% then one of the following
formulas may be used for taking the profit to profit and loss account.
1.
Estimated Profit ×
Work certified
Contract price
2.
Estimated Profit ×
Work certified Cash received
×
Contract price Work certified
3.
Estimated Profit ×
Cost of the work to date
Estimated total cos t
4.
Estimated Profit ×
Cost of the work to date Cash received
×
Estimated total cos t
Work certified
5.
Notional Profit ×
Work certified
Contract price
Question 5
Brock Construction Ltd. commenced a contract on November 1, 2003. The total contract was
for ` 39,37,500. It was decided to estimate the total profit on the contract and to take to the
credit of P/L A/c that proportion of estimated profit on cash basis, which work completed bore
© The Institute of Chartered Accountants of India
Contract Costing
7.7
to the total contract. Actual expenditure for the period November 1, 2003 to October 31, 2004
and estimated expenditure for November 1, 2004 to March 31, 2005 are given below:
November 1,2003 to
October 31, 2004
(Actual)
November 1,2004 to
March 31 , 2005
(Estimated)
(`)
(`)
12,37,500
6,75,000
Material issued
5,62,500
4,50,000
Labour
Paid
25,000
Prepaid
2,500
Outstanding
3,75,000
Plant purchased
3,50,000
2,00,000
Expenses Paid
25,000
50,000
Outstanding
3,00,000
75,000
Plant return to store
(on March 31, 2004) (on March 31, 2005)
(Historical cost)
Full
20,00,000
Work certified
75,000
Work uncertified
17,50,000
Cash received
37,500
75,000
Material at site
The plant is subject to annual depreciation @ 33% on written down value method. The
contract is likely to be completed on March 31, 2005.
Required
Prepare the contract A/c. Determine the profit on the contract for the year November, 2003 to
October, 2004 on prudent basis, which has to be credited to P/L A/C
Answer
Brock Construction Ltd. Contract A/c
(November 1, 2003 to Oct. 31, 2004)
Dr.
Particulars
To Materials issued
To Labour paid
Prepaid
To Plant Purchased
To Expenses paid
4,50,000
25,000
2,00,000
Amount
(` )
6,75,000 By Plant returned to
store on
31/03/04 at cost
Less: Dep (1/3)
4,25,000 By WIP
3,75,000 Certified
Uncertified
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Dr.
Amount
(` )
75,000
10,417
64,583
20,00,000
75,000 20,75,000
7.8
Cost Accounting
To Outstanding
To Notional profit
c/d
To P/L A/c
3,34,305 ×
(17,50,000 /
20,00,000)
× (20,00,000 /
39,37,500)
To Work-in-progress
(Profit in reserve)
50,000
2,50,000 By
Plant at site
31/10/04 at Cost
Less: Dep (1/3)
6,89,583 By Materials at site
24,14,583
1,48,580 By Notional Profit
b/d
3,00,000
1,00,000
2,00,000
75,000
24,14,583
6,89,583
5,41,003
6,89,583
6,89,583
Brock Construction Ltd. Contract A/c (November 1, 2003 to March 31, 2005)
(For computing estimated profit)
Dr.
Cr.
Particulars
Amount
Amount
(` )
(` )
19,12,500 By Material at site
To Material issued
37,500
(6,75,000+12,37,500)
To Labour (paid &
10,15,000 By Plant returned to
64,583
outstanding)
stores on 31/3/04
1,72,222
(4,25,000+5,87,500+2,500)
By Plant returned to
To Plant purchased
3,75,000
stores on 31/3/05
3,00,000
Cost
1,00,000
Less: Dep.
27,778
Less: 5 month Dep.
To Expenses
5,75,000 By Contractee A/c
39,37,500
(2,50,000 + 3,25,000)
To Estimated profit
3,34,305
42,11,805
42,11,805
Question 6
Paramount Engineers are engaged in construction and erection of a bridge under a long-term
contract. The cost incurred upto 31.03.2001 was as under:
Fabrication
Direct Material
Direct Labour
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` In Lakhs
280
100
Contract Costing
7.9
Overheads
60
440
Erection costs to date
110
550
The contract price is ` 11 crores and the cash received on account till 31.03.2001 was ` 6 crores.
The technical estimate of the contract indicates the following degree of completion of work.
Fabrication – Direct Material – 70%, Director Labour and Overheads 60% Erection – 40%.
You are required to estimate the profit that could be taken to Profit and Loss Account against
this partly completed contract as at 31.03.2001.
Answer
Estimation of Profit to be taken to Profit and Loss Account against partly completed
contract as at 31.03.2001.
Profit to be taken to P/L Account
=
Cash received
2
× Notional profit ×
Work certified
3
=
2
Rs` 600 lakhs
× ` 92.48 lakhs ×
= `57.576 lakhs
` 642.48 lakhs
3
(Refer to working notes 1,2,3 & 4)
Working Notes
1.
Particulars
Statement showing estimated profit to
date and future profit on the completion of contract
Cost to date
Further Costs
%
Completion
to date
Amount
70
60
60
280.00
100.00
60.00
440.00
110.00
550.00
92.48
______
Fabrication costs:
Direct material
Direct labour
Overheads
Total Fabrication cost (A)
Erection cost: (B)
Total estimated costs: (A+B)
Profit
(Refer to working note 2)
40
(`)
(a)
642.48
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% Amount
completion
(`)
to be done
(b)
30
40
40
Total
Cost
(`)
(a) + (b)
120.00
66.67
40.00
226.67
60 165.00
391.67
65.85
______
400.00
166.67
100.00
666.67
275.00
491.67
158.33
______
457.52
1,100.00
7.10
2.
Cost Accounting
Profit to date (Notional Profit) and future profit are calculated as below:
Profit to date (Notional Profit) =
=
Estimated profit on the whole contract × Cost to date
Total Cost
` 158.33 × ` 550
` 941.67
= ` 92.48 (lakhs)
Future Profit
3.
4.
= ` 158.33 – ` 92.48 = ` 65.85
Work certified:
=
Cost of the contract to date + Profit to date
=
` 550 + ` 92.49 = ` 642.48 lakhs
Degree of Completion of Contract to date:
=
Cost of the Contract to date
` 642.48lakhs
× 100 =
× 100 =58.40%
Contract Price
` 1,100lakhs
Question 7
A construction company undertook a contract at an estimated price of `108 lacs, which
includes a budgeted profit of ` 18 lacs. The relevant data for the year ended 31.03.2002 are
as under:
(` '000)
Materials issued to site
5,000
Direct wages paid
3,800
Plant hired
700
Site office costs
270
Materials returned from site
100
Direct expenses
500
Work certified
10,000
Progress payment received
7,200
A special plant was purchased specifically for this contract at ` 8,00,000 and after use on this
contract till the end of 31.02.2002, it was valued at `5,00,000. This cost of materials at site at the end
of the year was estimated at ` 18,00,000. Direct wages accrued as on 31.03.2002 was ` 1,10,000.
Required
Prepare the Contract Account for the year ended 31st March, 2002 and compute the profit to
be taken to the Profit and Loss account.
© The Institute of Chartered Accountants of India
Contract Costing
7.11
Answer
Contract Account for the year ended 31st March, 2002
Dr.
Cr.
` ‘000
5,000
3,800
110
700
270
500
300
10,680
8,780
1,200
To Materials issued to site
To Direct wages
To Wages accrued
To Plant hire
To Site Office Costs
To Direct expenses
To Depreciation of special plant
To Cost of contract
To Profit & Loss A/c
(Refer to working note 2)
To Work-in-progress c/d
(Profit in reserve)
By Materials at site
By Materials returned
By Cost of contract
By Work certified
20
10,000
` ‘000
1,800
100
8,780
_____
10,680
10,000
_____
10,000
Working notes
1.
Percentage of contract completion =
=
2.
Cost of work certified
× 100
Value of the contract
100 lacs
× 100 = 92.59%
108 lacs
Since the percentage of Contract completion is more than 90% therefore the profit
to be taken to Profit and Loss Account can be computed by using the following
formula.
Profit to be taken to P & L A/c = Budged/Estimated Profit ×
= 1,800 ×
Question 8
Explain the following:
(i)
Notional profit in Contract costing
(ii)
Retention money in Contract costing
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Cash received Work certified
×
Work certified Contract price
7,200 10,000
7,200
×
= 1,800 ×
= ` 1,200
10,800
10,000 10,800
7.12
Cost Accounting
Answer
(i)
Notional profit in Contract costing:
It represents the difference between the value of work certified and cost of work certified.
Notional Profit = Value of work certified – (Cost of works to date – Cost of work not yet
certified)
(ii) Retention Money in Contract Costing:
A contractor does not receive the full payment of the work certified by the surveyor.
Contractee retains some amount to be paid after some time, when it is ensured that there
is no default in the work done by the contractor. If any deficiency or defect is noticed, it
is to be rectified by the contractor before the release of the retention money. Thus, the
retention money provides a safeguard against the default risk in the contracts.
Question 9
(a) Modern Construction Ltd. obtained a contract No. B-37 for ` 40 lakhs. The following
balances and information relate to the contract for the year ended 31st March, 2008:
1.4.2007
31.3.2008
(`)
(`)
9,40,000
30,00,000
•
Work-in-progress:
•
Work certified
•
Work uncertified
11,200
32,000
•
Materials at site
8,000
20,000
5,000
•
Accrued wages
Additional information relating to the year 2007-2008 are:
3,000
(`)
•
•
•
•
•
•
•
•
•
•
Materials issued from store
Materials directly purchased
Wages paid
Architect’s fees
Plant hire charges
Indirect expenses
Share of general overheads for B-37
Materials returned to store
Materials returned to supplier
Fines and penalties paid
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4,00,000
1,50,000
6,00,000
51,000
50,000
10,000
18,000
25,000
15,000
12,000
Contract Costing
7.13
The contractee pays 80% of work certified in cash. You are required to prepare:
(i)
Contract Account showing clearly the amount of profits transferred to Profit and Loss
Account.
(ii)
Contractee’s Account.
(iii) Balance Sheet
Answer
(a)
Books of Modern Constructions Ltd.
Contract No. B-37 Account for the year ended 31st March, 2008
(`)
To
(`)
To
To
WIP b/d
(9,40,000 + 11,200)
Stock (materials) b/d
Materials issued
By
9,51,200
8,000 By
4,00,000 By
To
To
Materials purchased
Wages paid
1,50,000 By
6,00,000
To
Wages Accrued c/d
3,000
To
To
To
To
To
Architect’s fees
Plant Hire charges
Indirect expenses
General overheads
Notional profit c/d
To
Profit and Loss A/c
80 ⎞
⎛2
⎜ × 8,55,800 ×
⎟
100 ⎠
⎝3
51,000 By
50,000
10,000
18,000
8,55,800
30,97,000
By
4,56,427
To
WIP Reserve c/d
Wages Accrued b/d
5,000
Materials returned to Store
Materials returned to
suppliers
WIP c/d 30,00,000
Work
Certified
Uncertified
work
32,000
Materials stock c/d
30,32,000
20,000
Notional Profit b/f
________
30,97,000
8,55,800
3,99,373
8,55,800
Note: Fines and penalties are not shown in contract accounts.
25,000
15,000
_______
8,55,800
Contractee’s Account
(`)
To
Balance c/d
24,00,000 By
________ By
24,00,000
© The Institute of Chartered Accountants of India
(`)
Balance b/d (80% of 9,40,000)
Bank
7,52,000
16,48,000
24,00,000
7.14
Cost Accounting
Balance Sheet (Extract) as on 31.3.2008
(`)
Profit and Loss A/c
Less: Fines
Outstanding wages
4,56,427
12,000
(`)
Materials stock at site
4,44,427 Materials stock in store
3,000 WIP:
Work Certified
30,00,000
Work Uncertified
32,000
30,32,000
Less: Advance
24,00,000
6,32,000
Less: WIP Reserve
3,99,373
20,000
25,000
2,32,627
Question 10
Compute a conservative estimate of profit on contract (which has been 90% complete) from the
following particulars:
(`)
Total expenditure to date
22,50,000
Estimated further expenditure to complete the contract (including contingencies)
2,50,000
Contract Price
32,50,000
Work certified
27,50,000
Work uncertified
1,75,000
Cash received
21,25,000
Answer
The contract is 90% complete, the method used for transfer of profit to Profit and Loss Account for
the current year will be on the basis of estimated profit on completed contract basis.
Credit to Proift and Loss Account = Estimated profit on completed contract
×
Work certified Cash received
×
Contract price Work certified
Estimated profit on completed contract basis = Contract Price – (Total expenditure to date +
Estimated further expenditure to completed contract)
= 32,50,000 – (22,50,000 + 2,50,000)
= ` 7,50,000.
Credit to Proift and Loss Account = 7,50,000 ×
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27,50,000 21,25,000
×
= ` 4,90,385
32,50,000 27,50,000
Contract Costing
7.15
Question 11
What is cost plus contract? State its advantages.
Answer
Cost plus contract: Under cost plus contract, the contract price is ascertained by adding a
percentage of profit to the total cost of the work. Such types of contracts are entered into when it is
not possible to estimate the contract cost with reasonable accuracy due to unstable condition of
material, labour services etc.
Following are the advantages of cost plus contract:
(i)
The contractor is assured of a fixed percentage of profit. There is no risk of incurring any loss
on the contract.
(ii)
It is useful specially when the work to be done is not definitely fixed at the time of making the
estimate.
(iii) Contractee can ensure himself about the ‘cost of contract’ as he is empowered to examine
the books and documents of the contractor to ascertain the veracity of the cost of contract.
Question 12
Explain the importance of an Escalation Clause in contract cost.
Answer
During the execution of a contract, the prices of materials, or labour etc., may rise beyond a
certain limit. In such a case the contract price will be increased by an agreed amount.
Inclusion of such a clause in a contract deed is called an Escalation Clause.
Question 13
A contract expected to be completed in year 4, exhibits the following information:
Value of work
certified
Cost of work to
date
Cost of work not
yet certified
Cash received
(` )
(` )
(` )
(` )
1.
0
50,000
50,000
0
2.
3,00,000
2,30,000
10,000
2,75,000
3.
8,00,000
6,60,000
20,000
7,50,000
End of Year
The contract price is ` 10,00,000 and the estimated profit is 20%.
You are required to calculate, how much profit should have been credited to the Profit and
Loss A/c by the end of years 1, 2 and 3.
© The Institute of Chartered Accountants of India
7.16
Cost Accounting
Answer
End of
year
Value of work
certified
(` )
Cost of work
certified*
(` )
Notional
profit**
(` )
Amount that should have been
credited to Profit and Loss A/c by the
end of year
(` )
1
0
0
0
0
2
3,00,000
2,20,000
80,000
2,75,000
1
× 80,000 ×
= 24,444
3
3,00,000
3
8,00,000
6,40,000
1,60,000
7,50,000
2
× 1,60,000 ×
= 1,00,000
3
8,00,000
Workings:
End of Completion of Contract
year
Profit credited to P & L Account
year 1
less than 25 per cent.
No profit credited
Year 2
25 per cent or more than
25 per cent but less than
50 per cent.
Cumulative profit =
1
3
× notional profit ×
Cash received
Value of work certified
Cash received
2
50 per cent or more than
Cumulative profit = × notional profit ×
3
50 per cent but less than
Value of work certified
90 per cent.
* Cost of work certified = Cost of work to date – Cost of work not yet certified
Year 3
** Notional profit
= Value of work certified – (Cost of work to date – Cost of work not yet certify
Question 14
A contract is estimated to be 80% complete in its first year of construction as certified. The
contractee pays 75% of value of work certified, as and when certified and makes the final
payment on the completion of contract. Following information is available for the first year:
(`)
Cost of work-in-progress uncertified
8,000
Profit transferred to Profit & Loss A/c at the end of year I on incomplete contract
60,000
Cost of work to date
Calculate the value of work- in-progress certified and amount of contract price.
88,000
© The Institute of Chartered Accountants of India
Contract Costing
7.17
Answer
As the contract is 80% complete, so 2/3rd of the notional profit on cash basis has been
transferred to Profit & Loss A/c in the first year of contract.
∴ Amount transferred to Profit & Loss A/c
=
2
× Notional Profit × % of cost received
3
or , 60,000
=
2
75
× Notional Profit ×
3
100
or, Notional Profit
=
60,000 × 3 × 100
= `1,20,000
2 × 75
Computation of Value of Work Certified
Cost of work to date
= ` 88,000
Add: Notional Profit
= `1,20,000
`2,08,000
Less: Cost of Work Uncertified
=
8,000
Value of Work Certified
= `2,00,000
Since the Value of Work Certified is 80% of the Contract Price, therefore
Value of Work Certified
Contract Price
=
80%
=
`2,00,000
= `2,50,000
80%
Question 15
SB Constructions Limited has entered into a big contract at an agreed price of ` 1,50,00,000
subject to an escalation clause for material and labour as spent out on the contract and
corresponding actuals are as follows:
Material:
A
B
C
D
Labour:
L1
L2
Standard
Quantity
(Tonnes)
Actual
Quantity
(Tonnes)
3,000
2,400
500
100
Hours
3,400
2,300
600
90
Hours
60,000
40,000
© The Institute of Chartered Accountants of India
Rate per
Tonne
(`)
1,000
800
4,000
30,000
Hourly Rate
(`)
15
30
56,000
38,000
Rate per
Tonne
(`)
1,100
700
3,900
31,500
Hourly Rate
(`)
18
35
7.18
Cost Accounting
You are required to:
(i)
Give your analysis of admissible escalation claim and determine the final contract price
payable.
(ii)
Prepare the contract account, if the all expenses other than material and labour related to
the contract are ` 13,45,000.
Answer
Statement showing additional claim due to escalation clause.
(i)
Std.
Qty/Hours
(a)
Material
A
B
C
D
Labour:
L1
L2
Std. Rate
Actual Rate
(b)
(c)
3000
1000
1100
2400
800
700
500
4000
3900
100
30000
31500
Material escalation claim
60,000
40,000
Variation in
Rate (`)
(d)= (c-b)
Escalation
claim (`)
(e)= (a×d)
+100
-100
-100
+1500
+3,00,000
-2,40,000
-50000
+1,50,000
1,60,000
15
18
30
35
Labour escalation claim
+3 +1,80,000
+5 +2,00,000
3,80,000
Statement showing Final Contract Price
(`)
Agreed contract price
Add: Agreed escalation claim:
Material Cost
Labour Cost
Final Contract Price
(ii)
1,50,00,000
(`)
1,60,000
3,80,000
5,40,000
1,55,40,000
Contract Account
Dr.
Cr.
(`)
To
Material:
A – 3,400 × `1,100
B – 2,300 × ` 700
C – 600 × ` 3,900
© The Institute of Chartered Accountants of India
(`)
By
Contractee’s A/c
1,55,40,000
Contract Costing
DTo
90 ×
`31,500
7.19
1,05,25,000
Labour:
L1 – 56,000 × `18
L2 – 38,000 × `35
23,38,000
To
Other expenses
13,45,000
To
Profit and Loss A/c
13,32,000
1,55,40,000
1,55,40,000
Question 16
PQR Construction Ltd. commenced a contract on April 1, 2009. The total contract was for
` 27,12,500. It was decided to estimate the total profit and to take to the credit of P/L A/c the
proportion of estimated profit on cash basis which work completed bear to the total contract. Actual
expenditure in 2009-10 and estimated expenditure in 2010-11 are given below:
2009-10
2010-11
Actual( `)
Estimated (`)
Material issued
4,56,000
8,14,000
Labour
3,05,000
24,000
3,80,000
37,500
2,25,000
1,00,000
22,500
1,75,000
25,000
-
Plant returned to stores (a historical stores)
75,000
1,50,000 (on Dec 31 2010)
Material at site
30,000
75,000
12,75,000
Full
40,000
----
10,00,000
Full
: Paid
: Outstanding at end
Plant purchased
Expenses : Paid
: Outstanding at the end
: Prepaid at the end
Work-in progress certified
Work-in-progress uncertified
Cash received
The plant is subject to annual depreciation @ 20% of WDV cost. The contract is likely to be
completed on December 31, 2010.
Required:
(i)
Prepare the Contract A/c for the year 2009-10.
(ii)
Estimate the profit on the contract for the year 2009-10 on prudent basis which has to be
credited to P/L A/c
© The Institute of Chartered Accountants of India
7.20
Cost Accounting
Answer
PQR Construction Ltd.
Contract A/c
(April 1, 2009 to March 31, 2010)
Dr.
To Materials Issued
To Labour
Paid
3,05,000
Outstanding
24,000
To Plant Purchased
To expenses
Paid
1,00,000
(-) Prepaid
22,500
To Notional Profit c/d
To Profit & Loss A/c
(Refer to Working Note 5)
To Work-in-Progress A/c
(Profit-in-reserve)
Dr.
77,500 By Plant at Site
4,37,500 (Working Note No. 2)
15,25,000
1,59,263 By Notional Profit b/d
2,78,237
4,37,500
PQR Construction Ltd.
Contract A/c
(April 1, 2009 to December 31, 2010)
(For Computing estimated profit)
Amount
12,70,000 By Material at Site
To Materials Issued
(4,56,000+8,14,000)
To Labour Cost
(Paid & Outstanding)
3,05,000 + 24,000 + ∗3,56,000 +
37,500)
To Plant purchased
To expenses
(77,500 + 1,97,500 + 25,000)
To Estimated profit
∗
Amount
4,56,000 By Plant returned to Stores
(Working Note 1)
By Materials at Site
3,29,000 By W.I.P.
2,25,000
Certified
12,75,000
Uncertified
40,000
7,22,500
By Plant returned to Stores
on 31.3.2010
By Plant returned to Stores
on 31.12.2010
2,25,000 (Working Note 3)
By Contractee A/c
3,00,000
4,32,000
29,49,500
Labour paid in 2010- 11:3,80,000 – 24,000 = 3,56,000
© The Institute of Chartered Accountants of India
Cr.
Amount
60,000
30,000
13,15,000
1,20,000
15,25,000
4,37,500
4,37,500
Cr.
Amount
75,000
60,000
1,02,000
27,12,500
29,49,500
Contract Costing
7.21
Working Notes
(`)
1.
2.
3.
4.
5.
Value of the Plant returned to Stores on 31.03.2010
Historical Cost of the Plant returned
Less: Depreciation @ 20% of WDV for one year
Value of Plant at Site 31.3.2010
Historical Cost of Plant at Site
Less: Depreciation @ 20% on WDV for one year
Value of Plant returned to Stores on 31.12.2010
Value of Plant (WDV) on 31.3.2010
Less: Depreciation @ 20% of WDV for a period of 9 months
Expenses Paid for the year 2009-10
Total expenses paid
Less: Pre-paid at the end
75,000
15,000
60,000
1,50,000
30,000
1,20,000
1,20,000
18,000
1,02,000
1,00,000
22,500
77,500
Profit to be credited to Profit & Loss A/c on March 31,2010 for the
Contract likely to be completed on December 31,2100
= Estimated Profit ×
= 4,32,000 ×
Work Cerfified
Cash received
x
Total Contract Price Work Certified
12,75,000 10,00,000
= ` 1,59,263
×
27,12,500 12,75,000
Question 17
A contractor commenced a contract on 1-7-2011. The costing records concerning the said
contract reveal the following information as on 31-3-2012.
Material sent to site
Labour paid
Labour outstanding as on 31-3-2012
Salary to Engineer
Cost of plant sent to site (1-7-2011)
Salary to Supervisor (3/4 time devoted to contract)
© The Institute of Chartered Accountants of India
Amount (`)
7,74,300
10,79,000
1,02,500
20,500 per month
7,71,000
9,000 per month
7.22
Cost Accounting
Administration & other expenses
Prepaid Administration expenses
Material in hand at site as on 31-3-2012
4,60,600
10,000
75,800
Plant used for the contract has an estimated life of 7 years with residual value at the end of life
` 50,000. Some of material costing ` 13,500 was found unsuitable and sold for ` 10,000.
Contract price was ` 45,00,000. On 31-3-2012 two third of the contract was completed. The
architect issued certificate covering 50% of the contract price and contractor has been paid
` 20,00,000 on account. Depreciation on plant is charged on straight line basis.
Prepare Contract Account.
Answer
Contract Account
(For the period 1.7.11 to 31.3.12)
Particulars
To Material Issued
To Labour
10,79,000
Add: Outstanding 1,02,500
To Salary to engineer (20,500 x 9)
3
To Salary to Supervisor 9000 × × 9
4
To Administration & other
expenses
4,60,600
Less: Prepaid 10,000
To Depreciation on Plant
(Working Note 1)
To Cost of Contract b/d
To Notional Profit c/d
To P&L A/c(W.N.3)
To Reserve
Amount Particulars
(`)
7,74,300 By Material (Sold)
By P&L A/c (Loss)
11,81,500 (13,500-10,000)
1,84,500 By Material in hand
By Cost of Contract c/d
60,750
Amount
(`)
10,000
3,500
75,800
26,39,600
4,50,600
77,250
27,28,900
26,39,600 By
work-in Progress:
-Work certified
50% of 45,00,000
2,70,300 -Work uncertified (W.N.-2)
(26,39,600-19,79,700)
29,09,900
1,60,178 By Notional Profit b/d
1,10,122
2,70,300
© The Institute of Chartered Accountants of India
27,28,900
22,50,000
6,59,900
29,09,900
2,70,300
2,70,300
Contract Costing
7.23
Working Note
1.
Calculation of depreciation on Plant
Cost of the Plant
7,71,000
Less: Residual Value
50,000
7,21,000
Estimated life
7 Years
Depreciation per annum
1,03,000
Depreciation for 9 months
=
2.
1,03,000
12
× 9 = 77,250
Cost of work uncertified = Cost incurred to date minus 50% of the total cost of contract
= `26,39,600(figure already shown in the contract A/c) - `19,79,700
= `6,59,900
3.
Calculation of Profit to be transferred =
2
3
× 2,70,300 ×
20,00,000
22,50,000
= 1,60,178
Question 18
From the following particulars compute a conservative estimate of profit by 4 methods on a
contract which has 80 percent complete:
(`)
Total expenditure to date
Estimate further expenditure to complete the contract
Contract Price
Work Certified
Work not certified
Cash received
Answer
Working Notes:
(i)
Calculation of Notional Profit =
(Work certified + work not certified) – Total expenditure to date
= ` (10,00,000+85,000) – ` 8,50,000 = ` 2,35,000
© The Institute of Chartered Accountants of India
8,50,000
1,70,000
15,30,000
10,00,000
85,000
8,16,000
7.24
(ii)
Cost Accounting
Calculation of Estimated Profit
Contract Price – (Expenditure to date + Further expenditure to be incurred)
=
`15,30,000 – ` (8,50,000 + 1,70,000) = ` 5,10,000
Computation of Conservative Estimate of Profit by following methods:
1.
Notional Profit x
2
Cash received
x
work certified
3
2 ` 8,16,000
= ` 2,35,000 x x
= ` 1,27,840
3 ` 10,00,000
2.
Estimated Profit x
= ` 5,10,000 x
3.
8,50,000
8,16,000
×
= ` 3,46,800
( 8,50,000 + 1,70,000 ) 10,00,000
Estimated Profit x
Notional Profit x
= ` 2,35,000 x
Cash received
Contract Price
8,16,000
= ` 2,72,000
15,30,000
= ` 5,10,000 x
4.
Cost of work done Cash received
×
Estimated total Cost work certified
Work Certified Cash Received
x
Contract Price Work Certified
10,00,000 8,16,000
x
= ` 1,25,333
15,30,000 10,00,000
5.
Estimated Profit x
Work Certified
10,00,000
= ` 5,10,000 x
= ` 3,33,333
15,30,000
Contract Price
6.
Estimated Profit x
Cost of work done
8,50,000
= ` 5,10,000 x
= ` 4,25,000
10,20,000
Estimated total Cost
7.
Notional Profit x
Work Certified
Contract Price
= ` 2,35,000 x
10,00,000
15,30,000
= ` 1,53,595
Most conservative Profit is ` 1,25,333, therefore profit to be transferred to Profit and
Loss a/c is ` 1,25,333.
© The Institute of Chartered Accountants of India
Contract Costing
7.25
EXERCISE
Questions for Practice
1.
(i)
Discuss the implications of cost-plus contracts from the view points of:
(a) the manufacturer
(b) the customer.
(ii)
2.
3.
4.
What is the relevance of escalation clause provided in the contracts?
Answer: Refer to ‘Chapter No. 6 i.e. Method of Costing I’ of Study Material.
Discuss briefly the principles to be followed while taking credit for profit on incomplete contracts.
Answer: Refer to ‘Chapter No. 6 i.e. Method of Costing I’ of Study Material.
What are the main features of 'Cost-Plus-Contracts'
Answers: Refer to ‘Chapter No. 6 i.e. Method of Costing I’ of Study Material.
The following particulars are obtained from the books of Vinak Construction Ltd. as on March 1983:
` 4,90,000
` 2,00,000
Plant and Equipment at cost
Vehicles at cost
Details of contract which remain uncompleted as on 31.03.1983:–
Contract Nos.
V.20
(` Lacs)
Estimated final sales value
Estimated final cost
Wages
Materials
Overheads (excluding depreciation)
Total costs to date
Value certified by architects
Progress payments received
V.24
(` Lacs)
7.00
6.40
2.40
1.00
1.44
4.84
7.20
5.00
V.25
(` Lacs)
5.60
7.70
2.00
1.10
1.46
4.56
4.20
3.20
16.00
12.00
1.20
0.44
0.58
2.22
2.40
2.00
Depreciation of Plant and Equipment and Vehicle should be charged at 20% to the three contracts in
proportion to work certified.
You are required to prepare statements to show contractwise and total:
(i)
Profit/loss to be taken to the P&L A/c for the year ended 31st March 1983;
(ii)
Work-in-progress as would appear in the Balance Sheet as at 31st March 1983.
Answer: (i)
Profit (loss) to be taken
to Profit & Loss account
(ii) Work in progress
5.
V.20
1
V.24
1.40
1.56
0.38
Deluxe Limited undertook a contract for `5,00,000 on
July, 1986. On
were closed, the following details about the contract were gathered:
© The Institute of Chartered Accountants of India
1st
30th
V.25
0.06
Total
0.46
0.40
2.34
June, 1987 when the accounts
7.26
Cost Accounting
(`)
1,00,000
Materials Purchased
Wages Paid 45,000
General Expenses
Plant Purchased
Materials on Hand 30.06.87
Wages Accrued 30.06.87
Work Certified
Cash Received
Work Uncertified
Depreciation of Plant
10,000
50,000
25,000
5,000
2,00,000
1,50,000
15,000
5,000
The above contract contained an escalator clause which read as follows:
"In the event of prices of materials and rates of wages increase by more than 5% the contract price would
be increased accordingly by 25% of the rise in the cost of materials and wages beyond 5% in each case."
It was found that since the date of signing the agreement the prices of materials and wage rates increased
by 25%. The value of the work certified does not take into account the effect of the above clause.
Prepare the contract account. Workings should form part of the answer.
Answer: Profit to be transferred ` 20,000
6.
Rex Limited commenced a contract on 01.07.1988. The total contract price was ` 5,00,000 but Rex Limited
accepted the same for ` 4,50,000. It was decided to estimate the total profit and to take to the credit of
profit and loss account that proportion of estimated profit on cash basis which the work completed bore to
the total contract. Actual Expenditure till 31.12.1988 and estimated expenditure in 1989 are given below:–
Expenses
Materials
Labour
Plant Purchased (original cost)
Misc. Expenses
Plant Returned to Stores on 31.12.88 at
original cost
Actuals
Till 31.12.88 (`)
75,000
55,000
40,000
20,000
10,000
Estimate
For 1989 (`)
1,30,000
60,000
—
35,500
35,500
As on 30.09.89
Materials at Site
Work Certified
Work Uncertified
Cash Received
5,000
2,00,000
7,500
1,80,000
Nil
Full
Nil
Full
The Plant is subject to annual depreciation @ 20% of original cost. The contract is likely to be completed on
30.09.1989.
You are required to prepare the contract account for the year ended 31.12.88. Workings should be clearly given.
It is the policy of the company to charge depreciation on time basis.
Answer: Profit to be transferred to P/L A/c ` 26,400
© The Institute of Chartered Accountants of India
Contract Costing
7.27
Profit in reserve ` 32,100
Plant returned to stores ` 27,750
7.
A contractor, who prepares his account on 31st December each year, commenced a contract on 1st April
1990. The costing records concerning the said contract reveal the following information on 31st December,
1990;
(`)
Materials charged to site
Labour engaged
Foremen's salary
2,58,100
5,60,500
79,300
Plants costing ` 2,60,000 had been on site for 146 days. Their working life is estimated at 7 years and their
final scrap value at ` 15,000. A supervisor, who is paid ` 4,000 p.m. has devoted approximately threefourths of his time to this contract. The administrative and other expenses amount to ` 1,40,000. Materials
in hand at site on 31st December, 1990 cost ` 25,400. Some of the material costing ` 4,500 was found
unsuitable and was sold for ` 4,000 and a part of the plant costing ` 5,500 (on 31.12.90) unsuited to the
contract was sold at a profit of ` 1,000.
The contract price was ` 22,00,000 but it was accepted by the contractor for ` 20,00,000. On 31st
December, 1990, two thirds of the contract was completed. Architect's certificate had been issued covering
50% of the contract price and ` 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, 1990. Workings
should be clearly given. Depreciation is charged on time basis.
Also prepare the Contractee's account and show how these accounts should appear in the Balance Sheet
as on 31st December, 1990.
Answer: Notional Profit ` 2,13,250
Profit & Loss A/c ` 1,06,625
Profit Reserve ` 1,06,625
8.
One of the building contracts currently engaged in by a construction company commenced 15 months ago
and remain unfinished . The following information relating to the work on the contract has been prepared for
the year just ended:
`' 000
Contract Price
Value of work certified at the end of year
Cost of work not yet certified at the end of year
Costs incurred:
Opening balances:
Case of work completed
Materials on site (physical stock)
During the year:
Materials delivered to site
Wages
580
© The Institute of Chartered Accountants of India
2,500
2,200
40
300
10
610
7.28
Cost Accounting
Hire of plant 110
Other expenses
Closing balance
Materials on site (physical stock)
90
20
As soon as materials are delivered to the site, they are charged to the contract account. A record is also
kept of materials as they are actually used on the contract. Periodically a stock check is maintained and any
discrepancy between book stock and physical stock is transferred to a general contract material
discrepancy account. This is absorbed back to each contract, currently at the rate of 0.5 of materials
booked. The stock check at the year end revealed a stock shortage of ` 5,000.
In addition to the direct charges listed above, general overheads are charged to contract at 5% of the value
of work certified. General overheads of ` 15,000 had been absorbed into the cost of work completed at the
beginning of the year.
It has been estimated that further costs to complete the contract will be ` 2,20,000. this estimate includes
the cost of materials on site at the end of the year finished and also a provision for rectification.
Required:
(a) Explain briefly the distinguishing features of contract costing.
(b) Determine the profitability of the above contract and recommend how much profit to nearest `'000)
should be taken for the year just ended. (Provide a detailed schedule of costs)
(c) State how your recommendation in (b) would be affected if the contract price ` 40,00,000 (rather than
rs. 25,00,000) and if no estimate has been made of costs to completion. (If required, suitable
assumption should be made by the candidate).
9.
Answer: (a) Refer to Chapter No. 6 Method of Costing
(b) Estimated Profit ` 5,07,000
Profit to be taken to Costing P/L A/c ` 4,51,034
(c) Notional Profit ` 4,67,000
A construction company under-taking a number of contracts, furnished the following data relating to its
uncompleted contracts as on 31st March, 1996.
(` In Lacs)
Contract Numbers
723
726
729
731
Total Contract Price
23.20
14.40
10.08
28.80
Estimated Costs on completion of Contract
20.50
11.52
12.60
21.60
Direct Materials
5.22
1.80
1.98
0.80
Direct wages
2.32
4.32
3.90
2.16
Overheads (Excluding Depreciation)
1.06
2.60
2.62
1.05
Profit Reserve as on 01.04.95
1.50
—
—
—
Plant issued at Cost
5.00
3.50
2.75
3.00
Expenses for the year ended 31.03.96
© The Institute of Chartered Accountants of India
Contract Costing
7.29
Material at Site on 01.04.95
0.75
—
—
—
Materials at Site on 31.03.96
0.45
0.20
0.08
0.05
Work Certified till 31.3.95
4.65
—
—
—
12.76
13.26
7.56
4.32
Work Uncertified as on 31.03.96
0.84
0.24
0.14
0.18
Progress payment received during the year
9.57
9.00
5.75
3.60
Work Certified during the year 1995-96
Depreciation @ 20% per annum is to be charged on plant issued. While the Contract No. 723 was carried
over from last year, the remaining contracts were started in the 1st week of April, 1995, required.
(i)
Determine the profit/loss in respect of each contract for the year ended 31st March, 1996.
(ii)
State the profit/loss to be carried to Profit & Loss A/c for the year ended 31st March, 1996
Answer: (i)
723
726
729
731
Profit (loss) ` In Lacs.
5.20
4.28
(1.27)
(0.06)
(ii) Profit to be taken to
2.60
1.80
-
-
Profit & Loss Account (` In Lacs)
10.
A company undertook a contract for construction of a large building complex. The construction work
commenced on 1st April 1993 and the following data are available for the year ended 31st March 1994.
Contract Price
Work certified
Progress Payments Received
Materials Issued to Site
Planning & Estimating costs
Direct Wages Paid
Materials Returned From Site
Plant Hire Charges
Wage Related Costs
Site Office Costs
Head Office Expenses Apportioned
Direct Expenses Incurred
Work Not Certified
` '000
35,000
20,000
15,000
7,500
1,000
4,000
250
1,750
500
678
375
902
149
The contractors own a plant which originally cost `20 lacs has been continuously in use in this contract
throughout the year. The residual value of the plant after 5 years of life is expected to be ` 5 lacs. Straight
line method of depreciation is in use.
As on 31st March, 1994 the direct wages due and payable amounted to ` 2,70,000 and the materials at site
were estimated at ` 2,00,000.
© The Institute of Chartered Accountants of India
7.30
Cost Accounting
Required:
(i)
Prepare the contract account for the year ended 31st March, 1994.
(ii)
Show the calculation of profit to be taken to the profit and loss account of the year.
(iii)
Show the relevant balance sheet entries
Answer: Notional Profit ` 3,324000
Profit and Loss A/c ` 1,662000
Work-in-progress in Balance Sheet ` 3,487000
11.
Compute a conservative estimate of profit on a contract (which has been 80% complete) from the following
particulars. Illustrate four methods of computing the profit:
Total expenditure to date
Estimated further expenditure to complete the contract
(including contingencies)
Contract Price
Work Certified
Work not certified
Cash Received
Answer:
Estimated profit
Notional Profit
12.
(`)
1,70,000
34,000
3,06,000
2,00,000
17,000
1,63,200
` 1,02,000
` 47,000
Explain escalation Clause.
Answer: Refer to ‘Chapter No. 6 Method of Costing (I)’ of Study Material
13.
An expenditure of ` 4,85,000 has been incurred on a contract till 31st March, 2006 and value of the work
certified is ` 5,50,000. The cost of work performed but not yet certified is ` 15,000. The profit of ` 30,000
had been taken to the credit of Profit & Loss Account till 31st March, 2005. The estimated future expenses
are ` 1,00,000. The estimated total expenses is to include a provision of 2-1/2 per cent for contingencies.
The contract price is ` 7,00,000 and the payment received till date is ` 5,00,000.
Calculate the profit to be taken to the credit of Profit and Loss Account for the year ended on 31st March,
2006.
Answer: ` 48,571.
© The Institute of Chartered Accountants of India