Quick answer: Contract costing finds the cost and profit of each long-term contract, such as building or civil engineering work. Key ideas are work certified and uncertified, retention money held back by the contractee, escalation clauses, sub-contract costs, and the rule that profit on an incomplete contract is taken only in part (none below 25% completion, then one-third or two-thirds of notional profit adjusted for cash received).
| Stage | Profit taken |
|---|---|
| Completion below 25% | No profit taken |
| 25–50% | 1/3 × notional profit × cash received / work certified |
| 50–90% | 2/3 × notional profit × cash received / work certified |
| Above 90% | Estimated total profit method |
Contract costing is an agreement between contractor and contractee that the contractor will complete work specified in the contract in a given period for a certain sum of amount.
Contract Costing: Questions and Solutions
1. What do you mean by Contract?
Under the contract, a specified work is performed in a stipulated period at a specific rate.
2. What is contract costing?
It is a method of cost accounting to ascertain the cost of a contract and the profit earned or loss suffered thereupon.
3. What is meant by Batch Costing?
Batch costing is a specific order costing under which each batch is treated as a cost unit and costs are accumulated and calculated separately for each batch.
4. What is meant by Sub-Contract?
When a contractor assigns a portion of the contract to any other person for the completion of that portion it is known as a subcontract.
5. What is meant by Subcontract Cost?
The amount paid to a subcontractor is subcontract cost. It is treated as a direct expense and debited to the contract account.
6. What do you mean by a Cost-plus contract?
The contract price is determined by adding a certain percentage of profit or a certain amount of profit to the actual cost.
7. What is meant by retention money in contract costing?
Retention money is the part of the value of work certified that the contractee holds back instead of paying immediately, commonly 10–20%. It protects the contractee against defects and is released after the contract is completed satisfactorily. For example, if work certified is ₹10,00,000 and 80% is paid, ₹2,00,000 is retention money.
8. Explain the escalation clause in contract costing.
An escalation clause allows the contract price to be revised if the prices of materials, labour or other inputs rise beyond an agreed level during the contract. It protects the contractor from losses caused by inflation over a long contract.
9. How is work-in-progress valued in contract costing?
Work-in-progress = work certified + work uncertified (at cost) − reserve for unrealised profit. In the balance sheet, cash received from the contractee is also deducted from this figure.
10. Give two reasons for creating a reserve for unrealised profit.
(1) To avoid overstating profit on a contract whose final outcome is still uncertain. (2) To provide for unforeseen losses, rectification costs or claims that may arise before the contract is completed.
11. How is work-in-progress shown in the balance sheet?
It is shown on the assets side under current assets: work certified plus work uncertified, less the reserve for unrealised profit, less cash received from the contractee.
12. State the meaning of the Job Costing method and give 4 Examples.
Job costing is a method to ascertain the cost of a product or service of required by the customer job costing organization is known for jobbing type industries that manufacture goods against the order of the customer example: the printing press, repairing units, machine tools manufacturing, furniture industries.
13. What are the Salient Features of Contract Costing?
- Generally, its period exceeds more than one year.
- The contractor may get the work done by a subcontractor.
- In case of a huge amount, payment may be made in installments.
14. Why is profit taken on an incomplete contract, and how much?
Contracts often run for two or three years. If profit were recognised only on completion, the profit and loss account would show nothing for years and then a large jump, which misrepresents performance. So part of the profit is recognised each year, but conservatively:
- Less than 25% complete: no profit is taken.
- 25% to 50% complete: 1/3 × notional profit × (cash received ÷ work certified).
- 50% to 90% complete: 2/3 × notional profit × (cash received ÷ work certified).
- Nearly complete (above 90%): estimated total profit × (work certified ÷ contract price) × (cash received ÷ work certified).
Example: contract price ₹20,00,000, work certified ₹12,00,000 (60% complete), cash received ₹9,60,000 (80% of certified), notional profit ₹3,00,000. Profit taken = 2/3 × 3,00,000 × 9,60,000 ÷ 12,00,000 = ₹1,60,000; the remaining ₹1,40,000 goes to the reserve.
Note: under Ind AS 115, listed Indian companies recognise contract revenue over time based on progress, but the fractional method above remains standard in Indian cost accounting syllabi.