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The Contract Costing module is an integral component of the Intech PYRAMID Contract
Management suite of applications. Contract Costing resides beneath the Transaction Entry
module and integrates directly with Accounts Receivable, Accounts Payable and General
Ledger. All four modules are required to form a minimum PYRAMID configuration. The
primary function of the Contract Costing application is the financial and project management
of contracts. It is widely used and suitable for construction companies, shop-fitters,
property developers, local authority trading enterprises, roading contractors, sub-
contractors (including air-conditioning, ceilingp
and interior fit-out companies) as well as project managers. Upon acceptance of quotations
complete contract details can be established. Contract Costing has thep
ability to import estimates which have been prepared via third party software. These can be
held in summary form, or they can be broken down to a detailed work-centre level. Costs
are commonly entered as they are incurred. Progress and final claims are generated so that
full financial reporting is available at all levels.p
0   
 p
   0ull Transaction detail is maintained from the commencement of the
contract to the current date. Cost and revenue elements are analysed into ategories for
materials, labour and subcontractors.p
d    Contract information is available as required at varying levels of
detail for the purposes of both estimating and monitoring work in progress. Summary
reporting and inquiry facilities are also available.p
       A large proportion of the available reporting is based on a
µpercentage completion factor¶ and calculates estimated costs to complete together with
estimated profitability.p

  Information is stored to enable reporting on sums claimed,


certified and paid as well as the varying types of retentions held for each contract and sub-
contractor over the life of each contract.p

   ºnce sub-contractor claims have been authorised, self billing tax
invoices can be generated.p
 A cheque authorisation schedule which summarises payments due to
subcontractors can be printed. Payments to be with-held (if any) are entered and cheques /
remittances are then printed.p
ë     Up to 99 different report layouts can be established on a user-
specific basis. User defined reports can supplement the standard pre-formatted reported
that are available.p
An optional µvariations¶ sub-system is available. This module tracks variations
or chargeable µextras¶ that fall outside the contracted price and controls recovery of the
additional costs.p
 The Transaction Entry module provides seamless integration with Intech¶s
Creditors / General Ledger, Cashbook, 0ixed Assets, Debtors, Payroll and Labour Cost,
Estimating and Quoting, Stock Recording, Plant & Property and Purchase ºrder modules.
There is an interface for third-party Estimating software.p
[ 0ree format µnotes¶ can be attached to Contracts and Sub-Contractors.p
pp
pp

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This page is devoted to Contract Costing; and it is one of a series of four pages devoted to cost
accounting under the general heading of Specific Order Costing

Specific order costing is The basic cost accounting method applicable where work consists of separate
contracts, jobs or batches.
CIMA Terminology

Historically, because of the industrial background of cost accounting, specific order costing has tended to
centre around the manufacturing environment. Given the developments both in cost accounting and
performance evaluation over the last 20 years or so, cost accounting is now being applied in
manufacturing, non manufacturing , service and even in non profit making organisations.

  """   #

Before we get into the detail of Contract Costing, let me advise anyone who reads this page who has
never been inside a factory or who has never been inside an office ... and who has never thought about
the cost accounting aspects of any of that, to consider undertaking either Project 1 and/or Project 2
below.

The biggest problem that many people experience when studying cost accounting is that it is meaningless
for them: this is because they can't relate to it ... factories and offices and so on are the places to go to
help you start unravelling the wonders of cost accounting!

Project 1: Visit a building site, factory, engineering workshop, car repair shop, word processing bureau .
. . anywhere where a one off type job or service is being made or provided. Follow through as much of a
job or service as possible: note the flow of materials, labour and overheads. Once you have observed the
process(es) you should map out (flow charts are ideal for this) both the stages of the process you have
observed and the cost accumulation aspects of each stage. If your host will allow you to do so, try to
obtain copies of job cost cards/sheets and compare and contrast them with the ones in this book.

Project 2: If you are unable to set up a visit as per project 1, watch television programmes, video
recordings or films that depict jobbing situations in industry and commerce; then repeat as much of
project 1 as possible.



The final part of this discussion concerns the third of the three basic product costing systems we
introduced at the very beginning of this page: contract costing.

Contract costing is A form of specific order costing; attribution of costs to individual contracts
CIMA Terminology

A contract cost is Aggregated costs of a single contract; usually applies to major long term contracts
rather than short term jobs
CIMA Terminology

Features of long term contracts


× By contract costing situations, we tend to mean long term and large contracts: such as civil
engineering contracts for building houses, roads, bridges and so on. We could also include contracts for
building ships, and for providing goods and services under a long term contractual agreement.
× With contract costing, every contract and each development will be accounted for separately; and
does, in many respects, contain the features of a job costing situation.
× Work is frequently site based.

We might have problems with contract costing in the following areas

× identifying direct costs


× low levels of indirect costs
× difficulties of cost control
× profit and multi period projects

The source of the following has eluded me: my sincere gratitude for whoever the author might be.

"Contract Costing

Such jobs take a long time to complete & may spread over two or more of the contractor's accounting
years.

0eatures of a Contract

× The end product


× The period of the contract
× The specification
× The location of the work
× The price
× Completion by a stipulated date
× The performance of the product

Collection of Costs

Desirable to open up one or more internal job accounts for the collection of costs. If the contract not
obtained, preliminary costs be written off as abortive contract costs in P&L In some cases a series of job
accounts for the contract will be necessary:

× to collect the cost of different aspects


× to identify different stages in the contract

G ecial features

× Materials delivered direct to site.


× Direct expenses
× Stores transactions.
× Use of plant on site

"  ssible accunting meths^

1.p ] ere a plant is purc ed for  p 


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e 
 e e
 e 

6.p ] ee  p
  b     e
 
, b
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e

Ae
ey  e p
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e

e 



    e   e 
."

£ookkeeping and contract costing projects

Direct costs: Debit the contract account

Cost of plant

hire of plant: Debit the contract account


plant bought:

i) Debit the contract account with depreciation


ii) Debit contract account with cost
Credit contract account with balance c/d
iii) Debit plant account with depreciation and running costs
Debit contract account

Overheads included at the end of the contract otherwise DO NOT include them as part of WIP c/d

Example contract account:

{ p pp  p


  p   pp p
 pp p  ppp
  p p pp p   p
ppp pp  pp
p
Progress payments are a key feature of such contracts and they are commonly based on the value of
work done up to a certain stage. Issues involved here are

× retentions
× payments to date
× payments due

Debit bank account


Credit contract account

]orked example

Contract ABC started on 1 July 2002. Costs to 31 December 2002, when the company's accounting year
ends, are derived from the following information.

 p
  p p
p p p

  p   pp p p


 p  p p
 p p pp pp p  p !p
 pp p p p pp{ 
 p  pp

  pp pp{ 
 p  p p
  pp !p

Ms at 31 December, 2002, certificates had been issued for work valued at £100,000 and the contractee
had made progress payments of £70,000. The company has calculated that more work has been done
since the last certificates were issued, and that the cpost of thew work done but not yett certified is
£14,000. The final contract price is £175,000 and the estimated toital cost of the contract is £130,000.

Prepare the contract account Ʀ

Solution to the worked example

 p  p {p p

  p p
p

  p   p p
p
 p p
p
 p p pp p !p
p
  p !p
p
 pp p
p

  pp p
p
pp"p pp  p p
p
ppp  p #p
p
pp
p
$p  p  p
p p
  p%p p &p p
p
  p  p p
p
  p  p
p p
p  p p
p
 p%' p 
&p (p
p
  pp p
p
pp
p
À timating profit

In the early stages, no profit will be accounted for; and in an exam question, the profit taking method
may be GIVEN.

"otal anticipated profit

 p p (!p


p
p  p%p)p#&p *(p
p

 ppp
  p%p+p*(&ppp
,
 pp !p
p
À timated degree of completion

Therefore, profit to date:

sales basis = £45,000 * 57.14% = £25,714.29


cost basis = £45,000 * 74.62% = £33,576.92

Consider what the accountant's concept of conservatism might have to say about these calculations.

Completing the profit and loss account:

  p+p p  pp


p% p &p !(!p
pp p ( #!p
p  p*(p
pp p ( #!p
$-.p (!p

£ce eet di co re

pp p ( #!p
ppp p*(p
+ (!p
p
ñf this is negative, it is WñP, otherwise it is a provision for liabilities and charges or creditors

6ecocito of ]P:

 p  p p
ppp  p #p
  ppp  p (p
p ' p !(!p
ppp p pp  pp
+ (!p
p
Mttrbtbe Proft

That part of the total profit reflecting that part of the work performed at the accounting date, attributable
profit not be recognised until the outcome of contract be assessed with reasonable certainty.

"ermoogy

× Work certified
× Retention
× Mttributable

ccto of ttrbtbe proft

Taking total costs to date & total estimated further costs to completion, also the estimated future costs of
rectification & guarantee work, and any other future work to be undertaken under the terms of the
contract. Profit accounted for needs:

1.p to reflect the proportion of the work carried out at the accounting date;
2.p account any known inequalities of profitability in various stages of contract for certainty of profit

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1 M contractor decided to build a major addition to his plant using both his own labor and outside
subcontractors. ñt took 13 months to complete the building. The first 10 months of the construction
period were in one cost accounting period. Mt the end of the cost accounting period the total charges,
including cost of money accumulated in the work in progress account for this project amounted to
£750,000. However, most of these construction costs were incurred towards the end of the cost
accounting period. ñn developing a method for determining a representative investment amount,
appropriate consideration must be given to the rate at which costs have been incurred. Therefore, the
contractor averaged the 10 month-end balances and determined that the average investment in the
project was £245,000.

Two cost of money rates were in effect during the 10-month period; their time-weighted average was
determined to be 8.6%. Mpplication of the 8.6% rate for ten-twelfths of a year to the representative
balance of £245,000 resulted in the determination that £17,558 should be added to the work in progress
account in recognition of the cost of money related to this project in its first cost accounting period.

The project was completed with the addition of £750,000 of additional costs during the first 3 months of
the subsequent cost accounting period. The contractor considered the 3 month-end balances (which
included the £17,558 capitalized cost of money described in the preceding paragraph) and determined
that the representative balance was £1,234,000. The cost of money rate in effect during this 3-month
period was 7.75%.

Mpplying the rate of 7.75% for one quarter of a year to the balance of £1,234,000 resulted in a
determination that £23,909 should be added to the work in progress account in recognition of the cost of
money while under construction in the second cost accounting period. The capitalized project was put
into service at the recognized cost of acquisition of £1,541,467 which consists of the "regular" costs of
£1,500,000 plus £17,558 and £23,909 cost of money.

[ote: Mn alternative technique would be to make separate calculations, using an appropriate investment
amount and cost of money rate, for each month. The sum of the monthly cost of money amounts could
be entered in the work in progress account once each cost accounting period.

2 M contractor built a major addition with identical basic data to those described in the previous
paragraph except that the costs were incurred at a fairly uniform rate throughout the period.

Because of the pattern of cost incurrence, the contractor used beginning and ending balances of the cost
accounting period to find the representative amounts. For the first cost accounting period the
representative investment amount was the average of the beginning and ending balances (zero and
£750,000), or £375,000. Mpplication of the average interest rate of 8.6% for ten-twelfths of a year
resulted in the determination that £26,875 should be added to the work in progress account in
recognition of the cost of money related to this project in its first cost accounting period.

During the subsequent 3 months the contractor used the representative balance of £1,151,875, derived
by averaging the beginning balance of £776,875 (£750,000 "regular" cost plus the £26,875 imputed cost
from the prior period) and the balance at the end, £1,526,875. Mpplying the 7.75% cost of money rate to
this balance for a 3-month period resulted in a determination that £22,317 should be added to the work
in progress account in recognition of the cost of money while under construction in the second cost
accounting period.

The capitalized project was put into service at the recognized cost of acquisition of £1,549,192 which
consists of the "regular" costs of £1,500,000 plus £26,875 and £22,317 imputed cost of money. This
practice is in accordance with 9904.417-50(a) and other applicable provisions of the Standard.

[ote: ñf this contractor, acting in accordance with established Standards for financial accounting,
allocated a portion of its paid interest expense to this construction project and the resultant acquisition
cost for financial reporting purposes was not materially different from £1,549,192, the contractor could
use the same acquisition cost for contract costing purposes.

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This page has given an example of contract costing. Contract costing can represent highly complex
situations as they might involve the building of houses and housing estates, bridges and so: large
amounts of money and other resources taking months or even years to complete.

Contract costing can be as complex as some of the situations they attempt to record: nevertheless, once
the basic principles have been grasped, their complexity becomes much more manageable.

There is an appendix to this page that contains two further contract costing questions for you to try.

Other pages in this series are devoted to Job Costing, Batch Costing and a page on Service Costing.

Mppedx

cotrct co t frter qe to for yo to try


1 You are reqred to prepare the contract account for the year ended 31 December 19-0, and show the
calculation of the sum to be credited to the profit and loss account for that year. On Mpril l 19-0 MN Ltd
commenced work on a contract which was to be completed by 30 June 19-1 at all agreed price of
£520,000. MN Ltd's financial year ended on 31 December 19-0, and on that day expenditure on the
contract totalled £263,000 made up as under:

. p p
/   p  p
$ ' p *!p
0 p 1  p !p
2 p p ' p*p

Cash totalling £1985,000 had been received by 31 December 19-0 representing 75 per cent of the work
certified as completed on that date, but in addition, work costing £30,000 had been completed but riot
certified.

M sum £9,000 had been obtained on the sale of materials which had cost £8,000 but which had been
found unsuitable. On 31 December 19-0 stocks of unused materials on site had cost £10,000 and the
plant was valued at £20,000. To complete the contract by 30 June 19-1 it was estimated that:

a the following additional expenditures would be incurred:

$ ' p p
/   p (p
0 p 1  p*p

b further plant cost £25,000 would be required;


c the residual value of all plant used on the contract at 30 June 19-1 would be £15,000;
d head office charges to the contract would he at the same annual rate plus 10%

ñt was estimated that the contract would be completed on time but that a contingency provision of
£15,000 should be made. From this estimate and the expenditure already incurred, it was decided to
estimate the total profit that would be made on the contract and to take to the credit of the profit and
loss account for the year ended 31 December 19-0, that proportion of the total profit relating to tile work
actually certified to that date. (Cñ M)

2 The final accounts of Diggers Ltd are made up to 31 December of each year. Work on a certain
contract was commenced on 1 Mpril 19-5 and was completed on 31 October 19-6. The total contract price
was £174,000, but a penalty of £7,000 was suffered for failure to complete by 30 September 19-6.

The following is a summary of receipts and payments relating to the contract:

{ 'p{ 'p
p
(*!p ( p
p
. 
p
p p
/   p !*p  p
$ ' p #*p ! p
{ p,1  p  p * p
.   pp. ppp3 p*+!p  !p +p
4  p
p p
 p. p% p  &p ! p  p
0 ppp5 p*+pp p p   ppp3 p*+!p+p p

The Mount received fro the custoer in 19-5 represented the contract price of all work certified in
that year less 10 per cent retention oney.

When the annual accounts for 19-5 were prepared it was estiated that the contract would be copleted
on 30 Septeber 19-6, and that the arket value of the plant would be £4,250 on that date. ñt was
estiated that further expenditure on the contract during 19-6 would be £81,400.

For the purposes of the annual accounts, depreciation of plant is calculated, in the case of uncopleted
contracts, by reference to the expected arket value of the plant on the date when the contract is
expected to be copleted, and is allocated between accounting periods by the straight line ethod.

Credit is taken, in the annual accounts, for such a part of the estiated total profit, on each uncopleted
contract, as corresponds to the proportion between the contract price of the work certified and the total
contract price.

You are reqred to prepare a suary of the account for this contract, showing the aounts
transferred to profit and loss account at 31 Deceber 19-5 and 31 Deceber 19-6.

6eferece

Duncan Williason (1996)


Cost & anageent Mccounting
Prentice Hall

Cñ M Terinology
Chartered ñnstitute of anageent Mccountants

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6 Jy 2002 rev ed 26 Jy 2003