Tag: Retention Money

Contract Account is a method of cost accounting used to determine the cost, profit or loss of each contract separately. It is mainly used by construction companies and contractors undertaking large and long term projects such as buildings, roads, bridges, dams and other infrastructure projects. Each contract is treated as a separate cost unit, and all expenses related to the contract are recorded in a separate Contract Account. These expenses may include materials, wages, plant, subcontracting costs and other direct and indirect expenses. Contract costing helps in measuring the progress of work, determining the profit on incomplete contracts and controlling the cost of individual projects.

Preparation of Contract Accounts:

Contract Account is prepared separately for each contract to determine the total cost, value of work completed and profit or loss. Each contract is treated as a separate cost unit. The following accounting entries are commonly used while preparing Contract Accounts.

1. Materials

Materials are an important direct cost of a contract. Materials may be purchased specifically for the contract or issued from stores. The cost of materials consumed is debited to the Contract Account. Materials returned to stores or remaining unused at the site are deducted from the contract cost.

2. Wages

Wages paid to workers directly engaged in contract work are treated as direct expenses. They are debited to the Contract Account. Wages may include payments to skilled, semi skilled and unskilled workers. Proper records of labour time and wages help in determining the actual labour cost of the contract.

3. Plant and Machinery

Plant and machinery used at the contract site are charged to the Contract Account. The amount charged depends on the value of plant used or depreciation during the contract period. When plant is returned or sold, its relevant value is credited to the Contract Account.

4. Direct Expenses

Direct expenses are expenses that can be directly identified with a particular contract. Examples include transportation, special equipment charges, architects’ fees and site expenses. These expenses are debited to the Contract Account because they are incurred specifically for completing the contract.

5. Subcontracting Charges

A contractor may assign certain portions of the work to subcontractors. The amount paid or payable to subcontractors is known as subcontracting charges. These charges are directly related to the contract and are therefore debited to the Contract Account as part of the total contract cost.

6. Overheads

Overheads are indirect expenses that cannot be directly identified with a particular contract. Examples include office expenses, supervision expenses and administrative costs. A suitable portion of these expenses is allocated to the contract and debited to the Contract Account to determine the total cost accurately.

7. Materials Returned

Materials that are not required at the contract site may be returned to the stores. The value of such materials is credited to the Contract Account because these materials no longer represent a cost of the particular contract. This adjustment helps determine the actual materials consumed.

8. Materials at Site

Materials purchased or issued for a contract may remain unused at the end of the accounting period. Such materials are called materials at site. Their value is credited to the Contract Account because they have not yet been consumed. They are generally shown as an asset.

9. Plant at Site

Plant and machinery may remain at the contract site at the end of the accounting period. The value of plant remaining after depreciation is credited to the Contract Account. This ensures that only the cost relating to the period or work performed is charged to the contract.

10. Work Certified

Work certified represents the value of work completed and approved by the architect, engineer or surveyor appointed by the contractee. It is credited to the Contract Account. Work certified is generally valued at the contract rate and is an important basis for calculating profit on an incomplete contract.

11. Work Uncertified

Work uncertified refers to work completed by the contractor but not yet approved or certified by the architect or engineer. It is valued generally at cost and credited to the Contract Account. It ensures that the cost of completed but uncertified work is properly considered while determining contract profit.

12. Profit on Contract

If the credit side of the Contract Account exceeds the debit side, the difference represents profit. For an incomplete contract, the profit recognised in the Profit and Loss Account depends on the stage of completion and cash received. The remaining profit may be retained as a reserve.

13. Loss on Contract

If the debit side of the Contract Account exceeds the credit side, the difference represents a loss. Loss on a contract is transferred to the Profit and Loss Account. In the case of an expected total loss, the entire anticipated loss is generally recognised immediately.

Important Journal Entries:

Format of Contract Account