Meaning, Features, Applications of Contract costing18th July 2021 2 By indiafreenotes
Contract Costing is otherwise called as terminal costing. It is one of the methods of Job Costing. Contract costing is also prospered just like job costing. A separate number is allotted to each contract and records are also maintained for each contract separately. The cost unit is each contract account.
Contract Costing is a special type of job costing, where the unit of cost is a single contract. The contract itself is a cost center and is executed under the customer’s specifications. Contract costing is a variant of job costing system applicable, particularly in case of the organization’s doing construction work. It is also known as terminal costing. Each contract, short term, or long term, is treated as a job.
The Institute of Cost and Management Accountants (I.C.M.A.) London, defines contract costing as, “that form of specific order costing which applies where work is undertaken to customer’s special requirements and each order is of long duration.”
- There is no heavy investment on assets initially in the case of contract costing.
- In case of complete contract, there is the problem of determination of the amount of profit to be carried to current year’s Profit and Loss Account, and the amount of profit to be carried forward.
- In the case of contract costing, work commences on receipt of order from the customer.
- As the contract or work is done at the contract site far away from the premises of the contractor, the problem of cost control is greater in the case of contract costing. There can be loss of materials and equipment, damage to plants and wastage of labour, posing problem of cost control.
- As the contract is undertaken at the contractee’s promises most of the items of cost chargeable to a contract are direct costs. Indirect costs are very few.
- Contract costing is concerned with the costing of construction work or repair work and not with the costing of any goods.
- Each contract or work involved in contract costing is executed or done as per the specifications given by the contractee. So, one contract may be dissimilar to another contract.
- Plant and equipment may be purchased for the contract or may be hired for the duration of the contract.
- Contract costing is less detailed and simpler than job costing.
- Penalties may be incurred (paid) by the contractor for failing to complete the work within the agreed period.
- A contract generally takes more than one year to complete.
- Payments by the contractee are made at various stages of completion of the contract based on architect’s certificate for the completed stage. An amount known as retention money is withheld by the contractee as per agreed terms.
- Most expenses, such as, electricity, telephone, insurance, etc. are also direct in nature.
- Generally, all labourers are treated as direct labourers.
- Most of the materials are specially purchased for each contract. These will, therefore, be charged direct from the supplier’s invites. Any materials drawn from the store are charged to contract on the basis of material requisition notes.
- Separate Contract Account is prepared for each contract in the books of contractor to ascertain profit or loss on each contract.
- Each contract undertaken is treated as a cost unit.
- Work on contract is carried out at the site of contracts and not in factory premises.
- Comparison of actual cost with estimated cost.
- Detailed analysis of cost to provide a basis for cost-plus pricing.
- Calculation of profit which may reasonably be taken each year on a long-term contract.
- Guidance to management on the utilization of resources.
Contract Costing can suitably be applied:
- Readymade Garments
- Pharmaceutical Industries
- Manufacturing Industries.
- Industries engaged in the construction of building, roads, ships, dams, boiler house, bridges or other construction work.
- Industries undertaking engineering projects, civil engineering works, mechanical engineering firm.
- Public works contractors involved in railway line contracts.
Generally, two parties are involved in a contract viz., the contractor the person who undertakes the contract, and the contractee the person who assigns the contract.
Under Contract Costing, a separate number is allotted for each contract and all related costs are accumulated for each contract. That means, a separate set of accounts are kept and maintained for each individual contract undertaken by the company.
Fixed Price Contract
Under Fixed-Price Contract, the contractor and the contractee both parties agree to a fixed contract price.
In this case, the manufacturer is not assured of a certain percentage of profit in advance and is not protected against any fluctuations in the market prices of the various cost elements involved in the production.
Cost Plus Contract is a contract in which the value-of-the contract is ascertained by adding a fixed margin of profit to the total cost of the contract.
In this case, the manufacturer is assured of a certain percentage of profit in advance and is protected against any fluctuations in the market prices of the various cost elements involved in the production.
As a result of the viewpoint of the manufacturer, the possibility of incurring any loss is eliminated.
Advantages to the Contractor:
- Free from losses.
- Certainty of profits in case of increasing prices of labour and material.
- In times of uncertainty execution of contract becomes possible.
- Free from getting approval of tender price.
- In case of urgency of execution of a contract.
- Availability of the services of experts, raw materials and labour.
Advantages to the Contractee:
- Quick completion of work.
- Quality work.
- Easy to get the work done in emergency.