What is the accounting treatment for costs in contract costing?

Accounting treatment for costs is explained below −

Sr.NoCost treatment
1Materials

  • Cost of material purchased/sent to the site is charged.

  • Cost of material unused/returned to the store is credited to the contract account.

  • Cost of material stored (for future use) is debited to the stock account.

2Labour

  • Labour charges and their related costs are charged to the contract account.

  • Administrative, supervisory staff, salaries, incentives are charged to particular accounts.

3Plant

  • If a plant is hired, then hiring charges are charged to the contract account.

  • If a plant is purchased/sent to the site, its value is charged to the contract account and value of plant returned/remaining is debited from the contract account. Plant used at the site was different between the two values.

  • Depreciation value is debited to the contract account.

4Charges (Sub contract)
Debited from the contract account.
5Overheads
Charged to the contract account.
6Cost control
Bigger the job/control, difficult to control the costs (material, damage, labour, supervision, equipment usage etc)
7Certification
In this type of work, an engineer will be appointed to inspect the work and based on that an inspection engineer will give a certificate stating completion of work.
Later on, based on that the certificate payments are made.
7Retention money
Some part of the money will be released after certification. Some part of money will be retained by the contractee, which will be released after total completion of work. The money kept by the contractee is called retention money.
8Work in progress
Value of Work certified + work appearing in contract account.
9Running contracts

  • Loss of incomplete contracts is debited from profit and loss accounts.

  • Profit is considered only for certified work (uncertified work is valued at cost).

  • If less than 25% of contract price is completed, no profit is taken and kept as reserves to meet contingencies.

  • If more than 25% and less than 50% of contract price is completed, then only 1/3 (cash received/work certified) is taken to the profit and loss account and remaining is kept in reserve.

  • If more than 50% and less than 90% of the contract price is completed, then only 2/3 (cash received/work certified) is taken to the profit and loss account and remaining is kept in reserve.

  • If work completed is more than 90% and nearing to 100%, then the amount in the profit and loss account is calculated by using estimated formulas.

Estimated formulas

The estimated formulae are as follows and the respective abbreviations are explained below −

  • EP * (WC/CP)

  • EP * (WC/CP)*(CR/WC) or EP * (CR/CP)

  • EP * (Cw/Etc)

  • EP*(Cw/Etc)*(CR/WC)

  • NP*(WC/CP)

  • (if EP is not available then NP is used)

The abbreviations are as follows −

  • EP = Estimated profit
  • WC= work certified
  • CP = contract price
  • CR = cash received
  • CR = cash received
  • Etc= estimated total cost
  • NP = notional profit

Updated on: 17-May-2022

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