Contract Costing

Contract Costing Meaning

Contract Costing is a contract made between two parties known as a contractor (i.e., the person executing the job) and contractee (i.e., the person for whom the job is done), wherein specific job orders are undertaken for a relatively larger time frame, which may take years to complete, and the billing for the same is done after completion of each milestone in the contract.

Contract Costing

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Source: Contract Costing (wallstreetmojo.com)

Features of Contract Costing

Example of Contract Costing

Let’s have following details for calculation purpose –

Contract Costing Example
Solution

Contract Costing Example 1

Explanation

Types of Contract Costing

The three types of contracts are explained further –

Contract Costing Types

Specific Aspects of Contract Costing

There are specific terms associated with contract costing that is usually helpful in calculating the cost involved in the contract:

  • Work-in-progress is an important aspect of contract costing. This refers to the amount of pending work & not yet completed as on a specific date. In the balance sheet, the cost of completed & certified (by the expert) and the amount of profit earned in presented under the head “Certified Work-in-progress.” Also, the value of uncertified work includes the cost of work not yet certified, the cost of laborCost Of LaborCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, material, and other expenses connected with the contract.
  • The cost of certified work is decided as per the milestones set in the contract. Thus, experts such as architects, engineers, surveyors, etc. are appointed to certify the work completed to date. As per the work completion, the revenue is recognized by the contractor.
  • As per the work completion criteria, the contractor is set to receive the progress payments from the customer. The contract longs for a considerable period & the working capital is invested in the contract by the contractor. Thus, it is always suggested to have the policy of progress payments.
  • The contractee/customer keeps some amount of money with himself as retention money (or security deposit), ensuring that the work is carried out as per the plan decided in the contract & the end work is defect free. The amount is used to settle any discrepancies between the two parties.
  • Profits are estimated at two stages. One at the time when work certified by the contractor, it is called as notional profit. After completion of the whole contract, the actual profit is calculated.

Advantages

  • The contractor controls the costs involved in the contract for labor, material, other fixed expenses, etc.
  • A contract account is prepared for each customer, identifying the cost incurred to date & work completion.
  • Control is also maintained over the defectives arising out of quality deficiency.
  • Expert advice is helpless in completing a contract & he also helps to identify defects before completion of the whole contract.
  • Retention money becomes a reason for inspiration to provide quality work.
  • A team spirit is built.

Disadvantages

  • The biggest disadvantage is that it is time-consuming.
  • Each customer may not agree with the escalation clause.
  • Lack of accounting may lead to improper calculation of profits.
  • Lack of control may make the contract loss-making for the contractor.
  • A continuous eye on market conditions is required.
  • Larger time gives rise to complications in the completion of work.

Recommended Articles

This has been a guide to Contract Costing and its meaning. Here we discuss features, types of contract costing, and an example, importance, advantages, disadvantages, and differences. You can learn more about financial analysis from the following articles –