How to Record Costs, Value and Profit on Contracts?

In this article we will discuss about the procedure for recording of costs, value and profit on contracts.

Recording of Costs of a Contract:

The following is the recording procedure for different costs relating to a contract:

1. Materials:

Contract Account is debited with the following, relating to materials:

(a) Materials specially purchased and sent to contract site.

(b) Materials supplied from central stores of the firm.

(c) Materials transferred from other contracts.

(d) Materials permitted to be purchased directly by the contract supervisor.

The contract account is credited with the following relating to the materials:

(a) Materials returned to the central stores.

(b) Materials on hand at the site on completion of the contract or on the accounting date.

(c) Materials transferred to other contracts.

(d) Materials returned to suppliers from contract site due to unsuitability.

(e) Materials sold at the site, due to various reasons.

(f) Materials abnormally lost in accidents, theft, due to fire, etc.

The objective of the above treatment is to see that the contract account is debited with the actual material consumed or used for contract.

2. Labour or Wages:

The remuneration of all the employees at the contract site should be regarded as direct wages and debited to the contract account. Wages outstanding’s the date of finalising accounts or on the date of completion of the contract should also be ascertained and debited.

3. Direct Expenses:

All other expenses incurred at the contract site, other than material and wages may be taken as direct expenses and debited to the contract account.

4. Overheads:

Head office expenses, and other expenses not directly identifiable with particular contracts may be apportioned to all the contracts on a reasonable basis.

5. Plant and Machinery:

Unlike manufacturing and other service organisations, plant and machinery are utilised at contract sites in a flexible manner. There can be return or transfer or loss of plant and machinery which was sent to the contract site.

The main objective is to see that the contract is duly charged for the use of plant and machinery.

There are two ways of dealing with plant in the context of contracts:

(a) The contract can be debited with depreciation for use of plant and machinery. This method is desirable if the same plant is used on different contracts either simultaneously or for short periods. The working life and scrap value are taken into account and depreciation rates either on hourly basis or on daily basis may be determined. Each contract is debited for depreciation on usage basis.

(b) The contract can be debited with the book value of existing plant sent to site or the cost of any new plant purchased and sent to site.

At the end of the accounting year and also when the contract is completed, the plant must be revalued and credited to the contract account.

The following are the relevant debits to the contract account relating to plant and machinery:

(a) Existing plant sent to contract site at its book value.

(b) New plant purchased and sent to site at cost.

(c) Plant or machinery directly purchased at contract site, at cost.

The following are the credits to the contract account relating to plant and machinery:

(a) Plant at site, less depreciation.

(b) Plant returned to stores, less depreciation.

(c) Plant transferred to other contracts less depreciation.

(d) Plant lost abnormally in accident or theft, less depreciation till that date.

6. Extra Work:

Contractee may request for some additional work or alterations in the original contract. The additional cost is debited to contract and extra charge agreed for such changes is credited to contract account along with contract price or work certified.

7. Sub-Contracts:

Some portions or specified aspects of the contract may be given to sub-contractors. For example – special flooring, plumbing work, electrical fitting, interior decoration, etc. Amount paid to the sub-contractors is debited to the contract account, just like other costs.

Recording of Value and Profit on Contracts:

1. Work Certified:

The contractee usually engages his own experts for verification of the work done by the contractor. The experts usually certify the amount of work completed. The certificate issued by the expert forms the basis for payment of cash by the contractee. If the contract is certified as completed, the full contract price becomes payable. If work certified is shown on the credit side of the contract account as a part of work-in-progress, it is also shown in the Balance Sheet assets side as part of work-in-progress.

2. Accounting Methods of Recording Work Certified:

The following methods are in practice to record the work certified:

(a) Debiting the contractee’s account and crediting the contract account for the amount of work certified. When cash is collected the contractee is credited and cash is debited.

For the balance in his account, the contractee appears as a debtor in the Balance Sheet.

(b) Debiting the contractee for the cash payable, crediting the contract account for the total work certified. Contractee is credited when cash is paid. Retention money appears on the Balance Sheet assets side.

(c) Work certified is credited to the contract account. It also appears in the balance sheet as part of work-in-progress. When contractee pays cash, it is credited to his personal account. It is deducted from work-in-progress on the assets side of the Balance Sheet. When contract is completed, contractee is debited for the contract price and the contract account is credited. Any balance in contractee’s account represents the amount due from him. This last method is more popular and is generally used.

3. Work Uncertified:

This is work done but not yet certified by the contractee’s representative. It must be valued at cost. It is shown on the credit side of the contract account and also on the assets side of the Balance sheet along with work certified.

4. Retention Money:

When contractee’s representative certifies the work done by the contractor, the contractee usually makes cash payment, as per the terms of the contract. Generally, full value of the work certified is not paid, unless the contract is completed. The contractee pays 70% to 80% of the work certified and the balance of the work certified is kept as a provision. Such provision is called ‘Retention money’.

The retention money is intended to ensure that the contractor continues the work and completes it in due course. But for the retention money, some contractors may not continue their contracts on which-loss is expected.

5. Work-In-Progress:

Work certified and work uncertified together constitutes the work-in-progress till a contract is completed, when method ‘c’ above is adopted. The work-in-progress is shown on the credit side of the contract account. In the Balance Sheet it appears on the asset’s side. Cash received from the contractee and the profits kept in reserve are subtracted from the work-in- progress and the balance is shown as an asset.