Procedure of Contract costing

The basic procedure for costing of contracts is as follows:

1. Contract Account:

Each contract is given a distinguishing number and a separate account is opened for each contract.

2. Direct Costs:

Most of the costs of a contract can be allocated direct to contract. All such direct costs are debited to the contract account.

Direct costs for contracts include:

• Materials
• Labour and supervision
• Direct expenses
• Depreciation of plant and machinery
• Subcontract costs

3. Indirect Costs:

Contract account is also debited with overheads which tend to be small in relation to direct costs. Such costs are often absorbed on some arbitrary basis as a percentage on prime cost, materials, wages etc. Overheads are normally restricted to head office and storage costs.

4. Transfer of Materials or Plant:

When materials, plant or other items are transferred from the contract, the contract account is credited by that amount.

5. Contract Price:

The contract account is also credited with the contract price. However, when contract is not complete at the end of the financial year, the contract account is credited with the value of work-in-progress as on that date.

6. Profit or Loss on Contract:

The balance of contract account represents profit or loss which is transferred to Profit and Loss Account. However, when contract is not completed within the financial year, only a part of the profit arrived at is taken into account and remaining profit is kept as reserve to meet any contingent loss on the incomplete portion of the contract.

Procedure 1. Materials:

Materials purchased directly or supplied from the store or transferred from other contracts will appear on the debit side. Materials returned to store will appear on the credit side. Amount received from the sale of surplus materials will appear on the credit side, any profit or loss arising from the sale will be transferred to the Profit and Loss Account.

Materials stolen or destroyed by fire will be transferred to the Profit and Loss Account. Materials in hand at the end of the year will appear on the credit side. Sometimes materials are transferred from one contract to another contract. Contract receiving the materials is debited and the contract giving up the materials is credited.

Normal wastage incurred in stores and materials should be charged to contracts by inflating the fates at which materials are priced out. Stores used in the manufacture of tools should be charged to Works Expenses A/c. Sometimes, it happens that the contractee under the terms of the contract, supplies some materials which do not affect the contract price.

The value of such material should not be brought into the books but a note will have to be kept to account for the quantity received and issued.

Procedure 2. Labour or Wages:

All labour employed at the contract site should be regarded as direct labour and charged direct to the contract concerned. Where possible, separate wages sheets should be prepared for each contract. If this is not possible, a Wages Analysis Sheet should be prepared wherein should be entered the particulars of the daily or weekly time sheets.

The total of each column should be posted to be debit of the appropriate contract. Wages accrued or outstanding at the end of the period should appear on the debit side of the contract account.

Procedure 3. Site Expenses:

All site expenses (other than materials and wages) are charged to individual contract as and when they are incurred.

Procedure 4. Indirect Expenses:

There are certain expenses (such as engineers, surveyors, supervisors etc. engaged on various contracts) which cannot be directly charged to contracts. Such expenses may be distributed on several contracts on some suitable basis as a percentage of materials or labour.

Procedure 5. Plant and Machinery:

Careful records of plant and machinery must be maintained to ensure that none is lost or improperly disposed of and that the contract is duly charged for the use of plant.

There are two methods in use for charging contracts for the use made of plant and machinery:

(i) Contract account debited with, full value of the plant and credited with depreciated value at the end. The cost price of the plant or book value of the plant, if the plant is old, is debited to the contract, the corresponding credit being given to the plant account.

When the plant is returned, the depreciated value is credited to the contract, the corresponding debit being given to the plant account. This method is used when the plant is required for daily use at the site for a long period or when the plant is likely to work out before the contract is completed.

This method requires the revaluation of the plant at the close of each financial year, so that the depreciated value may be credited to the contract account. Further, the method does not provide information to check the economic development of the plant. If the plant is charged to a contract, there is a possibility of the plant being retained after the work is completed so that it cannot be used elsewhere.

(ii) Contract account debited with an hourly rate of depreciation. A charge for the use of the plant may be made to the contract on the basis of the time for which the plant is made use of by the contract. To determine the charge to be made an “Upkeep Account” should be maintained for each plant to which should be debited the cost of maintenance, depreciation, fuel, oil etc.

A hire rate is fixed with the help of this account and the contract is charged at this rate. This method is more scientific as compared to the first. This can be easily applied where a machine is used for a short time. For costly plants like cranes this method is useful as the cranes may be used for some hours only.

When calculating plant in hand, plant returned to store, plant sold, plant destroyed etc. should be taken into consideration.

Procedure 6. Sub-Contracts:

Generally, work of a specialised character e.g., the installation of lifts and special flooring, is passed out to any other contractor by the main contractor. In such cases the work performed by the sub-contractors forms a direct charge to the contracts concerned. Sub­contract cost will be shown on the debit side of the Contract Account.

Procedure 7. Extra Work:

In most of the contracts additional work or variations of the work originally contracted for, are required by the contractee. The additional work, being outside the original contract, will be subject to a separate charge. If the additional work is quite substantial, it should be treated as a separate contract and a separate account should be opened for it.

If it is not very substantial, expenses incurred upon extra work should appear on the debit side of the contract account as ‘cost of extra work’ and the extra amount which the contractee has agreed to pay should be added to the contract price.