In this summary, you will learn the definition of the term Contract Costing, The Characteristics and Problems associated with a Contract, Terminologies in Contract Costing, Accounting for Contracts and the Format for Calculating Notional Profit.
What is Contract Costing
Contract Costing is a form of specific order costing method used for a project which takes more than a year and it is usually carried out on the contractees’ chosen site.
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Characteristics of Contract Costing
- It is site related.
- It is constructed in nature.
- Payment is usually made against work certified.
- It is more or less job costing in nature.
- There is a legal agreement between the contractor and the contractee which is enforceable by law.
- Retention fee is usually withheld by the contractee in anticipation of a structural defect.
- There is usually a penalty in case of default by the contractor and bonus if he’s able to deliver on time.
- It usually takes more than a year.
- The date of completion is usually stated in advance.
Problems Associated with Contract
- The problem of dividing the profit between different financial years.
- The problem of identifying direct and indirect cost on the project site.
- Surplus materials on site.
- The difficulty of cost control.
- Economic Instability.
Terminologies in Contract Costing
- Contract Price: This is an agreed amount between the contractee and the contractor on how much a particular project will be executed.
- Progress Payment: This is the payment made by the contractee to the contractor on completion of certain phases of the project which will be accompanied by an architect certificate which is usually issued by a professional or an expert.
- Architect Certificate: This certificate is issued by a professional or an expert in order to ascertain that the work has been done in line with the specification, this certificate will be attached with the invoice sent to the contractee before payment is made.
- Retention Fee: This is the amount withheld with the contractee in anticipation that there will be a structural defect after the project is completed, it is usually withheld for a period of 6months after completion of the project which could be higher or lower.
- Cost To Date: This is the total cost incurred on a project from inception to a particular date.
- Estimated Profit: This is an anticipated profit that is expected to be earned by the contractor on completion of the project which could be higher or lower.
- Work Certified: It is the portion of the project that has been certified by professionals or experts to show that the job has been done in line with the specification.
Any portion that is completed but yet to be certified by an expert can be regarded as an “UNCERTIFIED WORK”
- Notional Profit: This is the actual profit earned by the contractor on completion of a project. It is calculated by deducting the cost of work certified from the value of work certified.
Accounting for a Contract
The major challenge in contract costing is not the determination of the cost of the contract but the allocation of profit to different financial years and this can be treated using;
- At the early stage: Here, the contract has just been started and has not neared completion in any way. All that is needed to be done is to open a contract account and debit all expenses relating to the contract and the balance in this account is referred to as the cost of work certified or cost to date or value of work in progress.
- At a fairly advanced stage: This is the stage where the actual profit to date is recognized i.e. Notional profit and it can be calculated using the format in this video.
Format for Calculating Notional Profit
When the contract is between 30% and 80%, 2/3 is the generally accepted fraction in order to arrive at a uniform answer. Click here to download the format (ebook).
Video Guide on Contract Costing
In this video, you will learn how to derive the value for Notional Profit, how to prepare the Contractees Account and the easiest way to record the information in any given question.