,

9

Contract Costing

We have discussed in the previous chapter the specific-order costing, that is, job costing and batch costing. In this chapter, we are going to discuss “contract costing”, which is also a special form of job costing.

9.1 MEANING AND DEFINITION OF CONTRACT COSTING

The terminology of CIMA defines contract cost as, “the aggregated costs relative to a single contract designated a cost unit” Further, it defines contract costing as, “that form of specific-order costing which applies where work is undertaken to customer’s special requirements and each order is of long-term duration (compared with those to which job costing applies). The work is usually constructional and in general the method is similar to job costing”. From this definition, we can understand that contract costing is essentially a form of job costing. The cost of each contract is calculated separately. The work mainly involves a constructional activity. They are of a long duration.

9.2 SPECIAL FEATURES OF CONTRACT COSTING

1. Activity: In contract, the work mainly involved is construction activity.
2. Site: The work is carried out at the customer’s site, away from the factory premises.
3. Duration: Contract work is generally of a long duration extending beyond an accounting period.
4. Risk: It involves risk and uncertainty.
5. Meet requirements of customers: Contract work is done as per the tastes and requirements of customers.
6. Accounting contract: Like job costing, a job-order member is assigned to each contract. Costs are accumulated and ascertained for each contract.
7. Identifiable: In contract costing, it is possible to identify each contract from the start to the finish.

9.3 CONTRACT-COSTING PROCEDURE

Just like job costing, the cost of each contract has to be ascertained separately. Treatment of items of expenses in contract accounts is explained in detail as follows (otherwise, steps in contract-costing procedure):

Step 1: Separate Number: Each contract is assigned a separate job number.

Step 2: Separate Account: A separate contract is to be opened and maintained for each contract.

Step 3: Charging Costs: All costs with respect to a particular contract are charged to respective contract accounts.

Step 4: Collection of Costs.

9.3.1 Accounting for Material

1. Materials which are sent to site are charged to a particular contract account on the basis of material requisitions
2. Purchases of material for a particular contract are charged to the respective contract account based on the invoices
3. The transfer of materials from one contract site to another site is credited to the transferor’s contract account and charged to the transferee’s contract account based on the material transfer note
4. The returns of material to stores are credited to the contract account on the basis of material return note
5. At the end of the accounting period, the stock is valued and credited to the contract accounts
6. While the amount is realized from the sale of defective items, the surplus is credited to the contract account
7. Unused materials after the completion of contract is valued and credited to the contract account
8. Wherever the contractee himself has supplied the materials for the contract, it is not charged to the contract account

9.3.2 Accounting for Labour

1. All labourers whoever have worked at the site should be considered as direct labour and charged to the contract account
2. The salary of supervisors and other staff, who spent their whole-time attention to a contract, should be charged to contract account
3. In some cases, the wages of labour or supervisory or any other staff which cannot be identified with a particular contract will be apportioned among all the contracts on a suitable basis
4. Where the contract comprises several sections and is required to ascertain the labour cost of each section, each worker should be given a job card and there should be accurate time-keeping records too.
5. In case a number of contracts are in execution, then a separate wage sheet for each contract may be maintained.
6. Or, at times, the whole of wages paid will be recorded on a “Wages Abstract” as follows:

9.3.3 Accounting for the Use of Plant

1. The plant purchased for the specific use of a contract is to be charged to the contract account.

   At the end of each accounting period, the written-down value of the plant is credited to the contract account.

   The difference between these represents the cost or the value for the use of plant.

2. Another approach is to debit the depreciation charge to the contract account.
3. Where the plant is taken on hire, the hire charges are debited to contract account.

9.3.4 Accounting for Overheads

1. Generally, the major portion of the expenses is specific and direct
2. In case the numbers of contracts are more, the contractor may have a common office, common supervisory staff, and so on, and such common expenses incurred are to be apportioned to different contracts on a suitable basis

9.3.5 Accounting for Sub-Contracts

The contractors, at times, entrust some part of the work to petty contractors at a predetermined, agreed rates. Payments to such sub-contractors are charged to respective contract accounts.

9.4 TYPES OF CONTRACTS

Contracts are classified into:

1. Fixed-price contract with escalation clause
2. Cost-plus contract.

9.4.1 Fixed-Price Contract with Escalation Clause

Contracts of some nature extend over a long period, covering more than a few accounting periods. During such a lengthy period, there may be changes in the prices of materials, labour, and so on. At the time of acceptance of a contract, such factors have to be foreseen and estimated properly. If such factors are not taken into account, then the contractor may not be able to attain the profit target; and on account of this, even the work may come to a standstill. In order to safeguard against this, a special clause known as “escalation clause” is incorporated in fixed-price contracts. Escalation clause is a provision in a contract which provides the formula to determine the amount of escalation, namely, the amount by which the contract price is to be modified when the prices of goods or services forming part of the contract change.

Contracts with escalation clause are beneficial to both contractor as well as the contractee in case of high rise in the prices of materials, labour or other services. It protects the contractor from cost increases. At the same time, the customer is freed from paying more amounts unnecessarily. All future deliveries are governed by this clause.

9.4.2 Cost-Plus Contracts

Under this type of contract, the contractee agrees to pay the contractor the contract price plus an agreed percentage above the contract price or a fixed fee. Cost-plus contracts are generally used in Government only.

1. Where the estimates cannot be made or predetermined, this is suitable.
2. If the service is innovative and no precedent is available, then cost-plus contracts may fit.

9.4.2.1 Guidelines to be Followed in Cost-Plus Contracts

1. Absorption-costing technique has to be employed
2. Allocation and apportionment of expenses are to be based on the principles of equity
3. The contract should contain clear-cut definitions of cost
4. Depreciated charge of special equipments should be charged suitably
5. Abnormal gains and losses should be excluded
6. The method of pricing the issue of materials and the methods of labour remuneration should be agreed
7. Predetermined rates should form a part of contract
8. The “plus” factor should be included in the contract. It should be specified in an unambiguous manner

9.4.3 Advantages

1. The contractor is assured of some extra amount, thereby getting a definite profit.
2. The customer feels contended as he is charged at a reasonable fixed price to execute the work.
3. The contractor is relieved of unnecessary and elaborate calculations as in the case of escalation-clause contracts

9.4.4 Disadvantages

1. “Plus” factor is determined on the total cost. In order to attain more profit, the contractor is interested in increasing the cost. The customer gets affected.
2. The customer is not in a clear-cut position to know exactly the cost of work till it gets completed.

9.4.5 Incomplete Contracts and Profit

As already stated, contracts may extend beyond an accounting period. In practice, it may be found that only a certain portion of the contract has been completed and the remaining is under progress. It may take time to complete. So, proper care should be taken while ascertaining the profits for the completed as well as the incomplete work. There is no problem in crediting the profit on the completed work to profit and loss account (P&L A/c). But the real difficulty arises in assessing the profit for the contracts who are still under progress.

9.5 GUIDELINES TO ASSESS PROFIT ON INCOMPLETE CONTRACTS

Standard costing principles should be adopted for the recognition of profit for each period. In case of incomplete contracts, only a certain portion of the profit can be taken to P&L A/c based on the work completed. The firm must provide for the unforeseen losses and contingencies. The following are the general guidelines that may be followed for the assessment of profit on incomplete contracts:

1. Profit should be completed on the basis of “work certified”
2. Uncertified work should be valued at

1. In case the value of work certified is less than 25% or 1/4th of the contract price, then no profit has to be taken into consideration. The entire profit has to be kept as a reserve for meeting the contingencies.
2. In case the value of work certified is >25% but < 50% of the contract price, [>1/4th bus <1/2]

   Formula:

   
   1. 1/3 of profit after adjusting the percentage of cash received from the customer (contractee) to be credited to P&L A/c
   2. Balance amount of profit is kept as a reserve
3. In case the value of work certified is ≥50% of the contract price, [≥1/2]

   Formula:

   
   1. 2/3 of profit after adjusting the percentage of cash received from the customer to be credited to P&L A/c
   2. Balance amount of profit is kept as a reserve
4. In case the contract is nearing completion <100% of the contract price:

   Formula:

   
   1. Estimate the total cost of completing contract and then calculate the estimated profit
   2. Estimate the profit after adjusting for percentage of cash received and percentage of work certified
5. Profit remaining as the reserve is shown as a deduction from the work-in-progress (WIP) on the Assets side of the Balance Sheet.
6. In case there is any LOSS, the entire amount of loss should be debited to P&L A/c.
7. As per A S-7 (Revised), Accounting for construction contracts, a foreseeable loss on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed.
8. The journal entry for transfer of profit to P&L A/c and WIP for unrealized profit is as:

   Contract A/c (With total profit) Dr …

   To P&L A/c (with profit transferred)……

   To WIP A/c (with profit kept as reserve)…

9.6 WORK-IN-PROGRESS

In contract accounts, the value of work-in-progress consists of the following two items:

1. Work Certified and
2. Work Uncertified

These are shown on the Assets side of the Balance sheet under “Current Assets” as depicted in the following:

Certification of work and “Retention Money”

1. In case of large contracts, work should not have been completed; however, payments would be made to the contractors for the work done.
2. As such, at the end of an accounting period, the customer agrees to pay a part of contract price depending on the progress of the work.
3. This progress of work is to be assessed by the customer’s architect or engineer or surveyor, who after assessing will issue a certificate, which is termed as the work certified.
4. This certificate contains the value of work done as on the date of assessment.
5. Based on the value shown in “work certified”, the customer (Contractee) pays the amount to the contractor.
6. But, the customer will not pay the entire amount of the value of work certified. Generally, 70% to 80 % will be paid, as per the terms of the contract.
7. The balance (remaining 20% to 30% of the value of work certified) not paid is termed as the “Retention Money ”.

9.7 ACCOUNTING TREATMENT

Although there are two approaches to deal with the value of the work certified and the consequent payment, the most common approach is as follows:

1. A memorandum of work certified is maintained.
2. The cash received from the contractee is credited to his personal account.
3. The value of work is debited to WIP account and credited to the contract account.
4. The WIP is shown as an asset in the Balance Sheet after deducting the amount received from the contractee.
5. On the completion of the contract, the contractee’s personal account is debited and the contract account is credited.
6. Accordingly, the journal entries will be as follows:

1. For the value of work certified:

   WIP        Dr

       To Contract A/c.

2. For the cash received from the contractee:

   Bank A/c           Dr

      To Contractee’s A/c.

Work Uncertified:

1. That part of work of the contract which has not been assessed by the contractee’s surveyor is known as “Work Uncertified”.
2. This is valued at cost.
3. This value is credited to the contract account and debited to WIP A/c.
4. This will be transferred to the debit of contract account in the beginning of the next accounting period.

Simple Problems (Basic)

Illustration 9.1

1. Model: Simple Finished Contracts

The following are the expenses of Renu & Co in respect of a contract which commenced on 1 April 2009.

	Rs.
Materials Purchased	60,000
Materials on hand	5,000
Direct wages	80,000
Plant issued	50,000
Direct expenses	30,000

The contract price was Rs. 5,00,000 and the same was duly received when the contract was completed in December 2009. The charge indirect expenses at 10% on direct wages provide a 10% depreciation on the plant per annum.

You are required to prepare the contract A/c and the Contractee’s A/c.

Solution

Step 1 Open a Contract A/c (Ledger).

Step 2 Debit all the expenses (Expenses are to be entered on the debit side of the contract A/c)

Basic calculation:

1. Indirect expenses: 10% on direct wages

          = 10% of Rs. 80,000.

          = 10/100 × 80,000 = Rs. 8,000.

2. Depreciation = 10% p.a. on Plant

          = April to December = 9 months.

          = 10/100 × 9/12 × 50,000 = Rs. 3,750.

Step 3 Credit the contract price and materials on hand (These items are to be entered on the credit side of the A/c).

Step 4 Balance the figures. The balancing figure is profit or loss depending on the problem.

Step 5 Open a Contractee’s A/c. The contractor price is entered as ‘To Contract A/c’ on the debit side and “By Bank” on the credit side.

 

Illustration 9.2

Model 2: Treatment of Plant

2. From the following information, you are required to show the treatment of plant in contract A/c:

1. Plant issued to contract on 1 January 2009 – Rs. 1,00,000
2. The plant costing Rs. 10,000 was transferred to another contract on 30 June 2009
3. A plant costing Rs. 5,000 was stolen in transit and another costing Rs. 4,000 was destroyed by fire
4. A plant costing Rs. 3,000 was sold for Rs. 5,000
5. The plant at the end of December was valued by charging depreciation at 10 % per annum

Solution

Step 1: Plant issued is to be debited to contract A/c.

Step 2: Plant costing Rs. 10,000 that was transferred to another contract is to be credited to contract A/c after providing depreciation as follows:

 

Plant transferred: Rs. 10,000.
Less: depreaction @ 10% p.a.
(from 1 Jan to 30 June = 6 Months)	=
	= Rs. 500.

Step 3: Plant stolen and destroyed are to be transferred to be P & L A/c and credited to contract A/c at Rs. 5,000 + Rs. 4,000.

Step 4: Plant sold at Rs. 5,000 is credited to contract A/c. Its cost is Rs. 3,000 but sold for Rs. 5,000. So, there is a profit of Rs. 2,000 (Rs. 5,000 – Rs. 3,000). This profit on the sale of the plant is transferred to P&L A/c and debited to contract A/c.

Step 5: Plant at site is to be shown as follows:

 

Cost of plant at the end	=	Rs. 2,00,000 − Rs. 5,000 (stolen)
		−Rs. 4,000 (destroyed)−
		Rs. 10,000 (Transferred) −
		Rs. 3,000 (Plant sold)
	=	Rs. 1, 78,000.

Step 6: depreciation per annum @ 10% has to be provided =17,800

(Assume that the plant was stolen and destroyed at the beginning. If date is given, then depreciation for the respective period has to be calculated.)

Step 7: Preparation of contract A/c:

 

Illustration 9.3

Model 3: Transfer of profit: Unfinished contract

3. The following expenses were incurred on an unfinished contract during the year 2009:

 

Materials	85,000
Wages	65,000
Other expenses 15,000

Rs. 2,00,000 was received from the contractee, being 80%of the work certified. Work done but not certified was Rs. 15,000. Determine the profit to be credited to P&L A/c in the alternatives given as follows:

1. Contract price is Rs. 15,00,000.
2. Contract price is Rs. 6,00,000.
3. Contract price is Rs. 3,25,000.

Solution

Step 1: Calculation of work—certified:

Method I:

 

80% work certified	=	Rs. 2, 00,000
100% work certified	=	?
	=
(Or)	=	Rs. 2,50,000.

Method II: Cash received = 80%of work certified

If cash received is 80, then the work certified = 100

If cash received is Rs. 2, 00,000, then the work certified

NOTE: Any method may be adopted.

Step 2: Preparation of contract A/c

 

Step 3: This is the crucial step.

The ratio of work certified to total contract price has to be calculated.

Percentage (Ratio) for case (a): Contract Price: Rs. 15,00,000.

That is, work certified is less than 25%.

Important Note

If the work certified is less than 25% (or 1/4th)—No profit should be taken to P&L A/c as per the principles that are to be adopted in dealing with an incomplete contract.

Hence, in this case (a), no profit is taken to P&L A/c.

∴ the entire notional profit of Rs. 1, 00,000 is kept in Reserve.

Step 4: Case (b) Contract price – Rs. 6,00,000.

Important Note

If the work certified is less than 50% but mote than 25%, then the profit to be transferred is to be ascertained by applying the formula:

Profit to be credited to P&L A/c = Rs. 26,666.66.

Balance amount from profit = Rs. 1,00,000 – Rs. 26,666.66

                                      = 73,333.34 which is to be kept as Reserve.

Step 5: Case (c) Contract price is Rs. 3, 25,000.

Important Note

If the work certified is more than 50% of the contract price, then the profit to be credited is determined by applying the formula:

Profit to be credited to P&L A/c = Rs. 53,333.33

Balance to be kept as reserve = Rs.1,00,000 – Rs. 53,333.33

                                              = Rs. 46,666.67.

Illustration 9. 4

Model: 4 Computation of work uncertified

4. Vasanth Construction Co. has undertaken a contract for construction of a Conference Hall in a Star Hotel for a total value of Rs. 72 lakhs on 1 January 2009. It was estimated that the contract would be completed by 30 June 2010. You are required to prepare a contract A/c for the year ending 31 December 2009 from the following information:

	Rs.
Wages	18,00,000
Materials	9,00,000
Materials at site (on 31 December 2009)	1,00,000
Special plant	5,00,000
Overheads	3,60,000
Work certified	50,00,000

Depreciation at 10% per annum on the plant.

Cash received is 80% of the work certified, 10% of the value of materials issued, and 6% of the wages that may be taken to have been incurred for the portion of the work completed but not yet certified. Overheads that are charged as percentage of direct wages have been incurred for the portion of work completed but not yet certified. Overheads are charged as percentage of direct wages.

Solution

Step 1: Value of uncertified work is to be ascertained, which is added to work certified and shown as WIP on the credit side of the contract A/c in order to determine Notional Profit Expenses incurred:

	Rs.
(i) Materials – 10% of materials to be included in the completed work 10% of Rs. 9,00,000	90,000
(ii) Wages – 6% of wages – to be taken into account.6% of Rs.18,00,000	1,08,000
(iii) Overheads as percentage of direct wages:	21,600
(iv) Work uncertified: (Add i + ii + iii)	2,19,600

Step 2: As work certified is more than 50 % of the contract price, the formula to transfer Notional Profit to P&L A/c has to be applied

Step 3:	Depreciation has to be found out:
	Plant:	Rs. 5,00,000
Less:	Depreciation @ 10%: 50,000	50,000
		Rs. 4,50,000

Step 4: Preparation of contract A/c:

 

Illustration 9.5

Model 5: Estimated Profit & Transfer to P&L A/c

(Contract is nearing completion)

5. The expenditure on a contract till 31 March 2010 was Rs. 5,00,000 and the work certified was Rs. 8,00,000. The contract price is Rs. 10,00,000 and the contractee has paid Rs. 7,00,000 till 31.3.2010. The cost of work done but not certified on that date amounted to Rs. 1,00,000.

It is estimated that the contract will take a further period of 3 months to complete and will necessitate an additional expenditure of Rs. 1,00,000.

You are required to ascertain the amount to be credited to P&L A/c on 31 March 2010. Also state the different amounts of profit that may reasonably be credited to the P&L A/c.

Solution

STAGE I: First, the notional profit is to be determined by preparing the contract A/c as follows:

 

Step 1: As expenditure to complete the contract is given in the question and as the contract is nearing completion too, the estimated profit has to be determined as follows:

	Rs.
(i) Total cost of contract     (total expenditure till 31 March 2010) (given)	5,00,000
Add:(ii) Additional estimated expenditure to complete contract	1,00,000
(iii) Estimated total cost of contract (i) + (ii)	6,00,000
(iv) Contract price (given)	1,00,000
(v) Estimated profit step(iv) – step(iii)	4,00,000

Step 2: This estimated profit of Rs. 4,00,000 may be credited to P&L A/c by any one of the following ways:

Approach I: Formula:

Substituting the values in the above formula, we get:

Rs.3,20,000 is to be transferred to P&L A/c and the balance (Rs. 4,00,000 – Rs. 3,20,000) Rs. 80,000 has to be kept in reserve.

Approach II: Formula to transfer part of estimated profit to P&L A/c is:

Substituting the values in the above formula, we get:

Rs.2,80,000 is to be credited to P&L A/c and the balance (Rs. 4,00,000 – Rs. 2,80,000) Rs.1,20,000 has to be kept in reserve.

Approach III: Formula:

Substituting the values in the above formula, we get:

Rs. 3,33,333.33 is to be credited to P&L A/c and the balance (Rs. 4,00,000 – Rs. 3,33,333,33) Rs. 66,666.67 is to be kept in reserve.

Approach IV: Formula:

Substituting the values in the above formula, we get:

The balance (Rs. 4,00,000 – Rs. 2,91,666.67) Rs.1,08,333.33 is to be kept in reserve.

Illustration 9.6

Model: Computation of Profit & WIP

BMR & Co. Ltd, a contractor, is currently engaged in the construction of a Mall in one of the Metros. From the following information as on 31 December 2009, you are required to calculate:

1. Cost of WIP at the year end,
2. Profit to be transferred to P&L A/c

	Rs. in ‘000
Direct expenses	10,000
Materials sent to site for construction	20,000
Plant issued to site	1,200
Plant returned from site	1,000
Materials returned to stores	2,000
Labour working in site	12,000
Material remaining in site	8,000
Outstanding wages	1,000
Uncertified work	48,000
Certified work	60,000
Cash received	50,000
Establishment cost	1,000
Contract price	1,30,000

Solution

Prepare the contract account first as follows:

 

Step 1: Formula:

Step 2: Substituting the values in the formula we get,

Step 3: This is >25% but <50%.The formula to ascertain profit to be credited to P&L A/c is

Step 4: Substitute the values, we get:

Step 5: Rs. 20,500 is to be transferred to P&L A/c.

Step 6: Balance (Rs. 73,800 – Rs. 20,500) = Rs. 53,300 is to be transferred to WIP (Reserve).

II: Calculation of WIP as on 31 December 2009:

 

	Rs. in ‘000
Step 1: Work certified	60,000
Step 2: Work uncertified	48,000
Step 3: Add (Step 1+Step 2)	108,000
Step 4: Less: Provision (Ref: Contract A/c: WIP)	53,300
	54,700
	50,000
Step 5: Less: Cash received 5	50,000
Step 6: WIP at the end of the year	4,700

Illustration 9.7

Model: Estimated Profit on Completion of Contract

VRS Ltd is engaged in construction of a Flyover Project in Chennai. From the following information as on 31 March 2010 you are required to calculate:

1. Profit to be transferred to P&L A/c (i.e., estimated profit to date on the contract)
2. Estimated profit on completion of the contract
3. Cost of the WIP at the year end.

Contract price	Rs.40,00,000
Work certified	Rs.20,00,000
Uncertified work	Rs.10,00,000

Surveyor’s estimation of work completed:

 

Direct labour	50%
Direct materials	80%
Overheads	50%
Materials sent to site	Rs.5,00,000
Labour	Rs.2,80,000
Overhead	Rs.3,20,000
Materials in hand	Rs.1,00,000

Solution

(Based on the estimate of the work completed)

(a)

 

1. Calculation of profit transferred to P&L A/c:

Step 1: The stage of completion is computed by using the following formula:

Step 2: Work has reasonably advanced to 50%.Formula to ascertain the profit to be credited to P&L A/c is:

Step 3: Substituting the values we get:

Step 4: WIP:

Balance (Rs. 20,00,000 – Rs. 10,66,667) = Rs. 9,33,333.33.

(b) Estimated profit on the completion of contract is to be computed

(c) Calculation of WIP as on 31 March 2010

	Rs.
Step 1: Work certified	20,00,000
Step 2: Uncertified Work	10,00,000
Step 3: Add (Step 1 + Step 2)	30,00,000
Step 4: Less: Provision (Ref: Contract A/c:)	9,33,333
	20,66,667
Step 5: Less: Cash received	16,00,000
Step 6: W.I.P. at the end of the year	4,66,667

Illustration 9.8

Model: Calculation of Profit

The total contract price of a contract is Rs. 80,000. Three-fourth of the work has been approved by the contractee. The costs incurred so far for the contract are Rs. 40,000.It is estimated that Rs. 20,000 will be required further to complete the contract. The contractee pays 75% of the work certified by him.

1. You are required to calculate the profit to be credited to P&L A/c
2. Calculate the profit if the estimated further costs are not given in the question

Solution

 

		Rs.
(a) Step 1: Contact price		80,000
Step 2: Less: Total estimated costs	Rs.
(i) Costs incurred:	40,000
(ii) Costs estimated to be incurred:	20,000	60,000
Step 3: Total estimated profit (Step 1 – Step 2)		20,000
Step 4: Profit to be credited to P&L A/c:

(b) It the estimated further costs are not given:

1. Profit	=	Value of work certified – cost of work certified
   	=	Rs. 60,000 (3/4 of Rs. 80,000) − Rs. 40,000 (cost incurred)
   	=	Rs. 20,000.

    

2. As work has been completed 3/4^th, that is, 75%, this is>50%.
   

Illustration 9.9

Model: Profit on Contract

Vijay & Co. obtained a contract for the construction of a residential building of Rs. 9,00,000.Building operations are started on 1 April 2009 and at the end of the financial year, that is, 31 March 2010, they received from the party a sum of Rs. 3,60,000 being 80% of the amount of the surveyor’s certificate. The following additional information is available:

	Rs.
Stores issued to contract	1,80,000
Stores on hand as on 31 March 2010	15,000
Wages paid	2,46,000
Plant purchased for the contract	30,000
Direct expenses	12,900
Plant to be depreciated @ 10%

You are required to prepare an account showing profit on contract up to 31 March 2010. Also discuss whether Vijay & Co. would be justified in taking the full amount of this profit to the credit of their P&L A/c.

Solution

STAGE I: (i) First, the work certified is calculated as follows:

                   Cash received by the contractor = Rs.3,60,000

This is 80%of the Surveyor’s Certificate.

                 80%of the work certified = Rs.3,60,000

 

100% of the work certified	=	x (assumption)
80% × x	=	100% × Rs. 3,60,000
x	=
	=	Rs. 4,50,000.
∴ Value of work certified	=	Rs. 4,50,000.

(ii) Contract work has not been completed but has been advanced reasonably, that is, 50% . Hence, the company is not entitled to credit the entire amount to P&L A/c. The formula to be used is

STAGE II: Preparation of Contract Account

 

STAGE III: Profit to be transferred to P&L A/c

Step 1: Write the formula to Compute Profit. (The work has been advanced to 50%.)

Model: Retention Money & Normal Loss of Materials

Illustration 9.10

A public works contractor secured a contract at a price of Rs. 10,00,000. The work began on 1 July 2009 and the contract ledger showed the following items debited up to 31 March 2010:

 

	Rs.
Materials	1,80,000
Wages	2,10,000
Direct charges	10,000
Plant	32,000

The measurement on March 31 reads as follows:

		Rs.
Total work done certified till date		4,80,000
Total work done as per last measurement		4,20,000
Total work done for the month		60,000
Less: Retention Money@ 10%		6,000
		54,000
Materials returned to stores	Rs.
Materials on site:	10,000
Less: 20%	2,000	8,000
Amount payable		62,000

You are required to prepare a proforma account for the contract showing the profit earned till date, and indicate by means of a note on the basis of which you arrive at the amount which might be credited to P&L A/c. Allow for a depreciation on the plant @ 10% per annum.

Solution

Basic calculations:

^*1(i) Depreciation on the plant:

^*2(ii) Cash received: Work certified –Retention money

       = Rs. 4,80,000 − (10% of 4,80,000) 48,000

       = Rs. 4,32,000.

 

STAGE III: Calculation of profit to be transferred to P&L A/c:

Step 1: Stage of completion of work is calculated as follows:

Formula:

Substituting the values, we get:

Step 2: As the value of work is less than 50%, the formula to be used for crediting profit to P&L A/c is:

Substituting the values we get,

Step 3: Amount of profit to be transferred to P&L A/c is Rs. 25,680.

Step 4: Balance of notional profit, that is, Rs. 85,600 – Rs. 25,680 = Rs. 59,920 is to be transferred to WIP and kept as a reserve to meet the contingencies.

Illustration 9.11

Model: Balance Sheet Entries

A company undertook a contract for construction of large housing apartments. The construction work commenced on 1 January 2009 and the following data are available for the year that ended on 31 December 2009.

	Rs.(in ‘000)
Contract price	70,000
Work certified	40,000
Progress payments received	30,000
Materials issued to site	15,000
Planning and estimate costs	2,000
Direct wages paid	8,000
Materials returned from site	500
Plant hire charges	3,500
Wage-related costs	1,000
Site-office costs	1,356
Head-office expenses apportioned	750
Direct expenses	1,804
Work uncertified	298

The contractors own a plant which originally cost Rs. 40 lakhs and it has been continuously in use in this contract throughout the year. The residual value of the plant after 5 years of life is expected to be Rs.10 lakhs. Straight Line Method of depreciation is in use.

As on 31 December 2009, the direct wage that is due and payable amounted to Rs.5,40,000 and the materials at site were estimated at Rs.4,00,000.

1. Prepare the contract account for the year ended 31 December 2009
2. Show the calculation of profit to be taken to P&L A/c of the year
3. Show the relevant balance-sheet entries

Solution

Basic calculations:

1.  

   

   ∴ Plant at site = Rs.40,00,000 – Rs.6,00,000 = Rs.34,00,000.

   ^*1NOTE:

   1. Plant at cost (Rs.40 lakhs) is directly debited to contract A/c.
   2. Plant at cost (after deducting depreciation as shown above) is to be credited to contract A/c.
   3. Plant hire charges—a separate item—are to be debited to contract A/c.

   Students should thoroughly understand these steps (of the plant), while preparing the contract Account.

2. Wages:

   Wages paid: Rs.80,00,000

   Add: Due as on 31 December 2009: Rs.5,40,000

                Rs.85,40,000 = or Rs.8,540 (in’000)

   Now, contract Account is to be prepared as follows:

STAGE II: Calculation of profit to be undertaken to P&L A/c

Step 1: Stage of completion of work

Substituting the values, we get:

Step 2: As the work has reached an advanced level,

i.e., >50%, the formula used is:

Substituting the values,

Hence, the amount to be transferred to P&L A/c = Rs.3,324

Step 3: The balance (Rs.6,628 – Rs.3,324) = Rs.3,324 is to be transferred to WIP, to be kept as a reserve to meet the contingencies.

STAGE III: Extracts from Balance Sheet is to be shown as follows:

 

Illustration 9.12

Model: Contractee Account Retention of % for a specified period

XL & Co. Ltd has undertaken the construction of a bridge over the River Cauvery for Trichy Municipal Corporation. The value of the contract is Rs. 50,00,000 subject to a retention of 20% until one year after the certified completion of the contract and the final approval of the Corporation engineer. The following are the details as shown in the books on 31 December 2009:

	Rs.
Labour on site	16,20,000
Materials direct to site Less returns	16,80,000
Materials from store	3,24,800
Hire and use of plant—plant upkeep Account	48,400
Direct expenses	92,000
General overhead allocated to the contract	1,48,400
Materials in hand on 30 June 2009	25,200
Wages accrued on 30 June 2009	31,200
Direct expenses accrued on 30 June 2009	6,400
Work not yet certified at cost	66,000
Amount certified by the Corporation engineer	44,00,000
Cash received on account	35,20,000

You are required to prepare

1. Contract account
2. Contractee’s account and
3. Show how the relevant items would appear in the Balance Sheet

Solution

 

NOTE 1: Calculation of profit to be taken to P&L A/c: As values of work completed has reached the advance level, the formula that is to be used is as follows:

Balance (Rs. 5,40,000 – Rs. 2,88,000) = Rs.2,52,000 has to be transferred to WIP and kept as a reserve to meet the contingencies.

NOTE 2: Total profit made to date may be arrived at by another approach:

		Rs.
Total expenditure on the contract:		39,51,200
Less: Value of materials in hand		25,200
		39,26,000
Value of work certified =	44,00,000
Value of work uncertified =	66,000	44,66,000
Total profit to be made (difference)		5,40,000
∴ Profit to be transferred: 2/3 × 5,40,000 × 80/100		Rs.2,88,000
Profit to be carried forward to reserve =		Rs. 2,52,000

NOTE 3: Value of WIP:

	Rs.
Value of work certified:	44,00,000
Value of work uncertified	66,000
	44,66,000
Less: Reserve (Note:2)	2,52,000
	42,14,000

Based on the Notes 2 & 3, and if it is desired that the contract work should show the value of WIP and only the amount of profit has to be taken to P&L A/c, then the contract account will vary accordingly and appears as follows:

 

Important Note

Now, the students may note the difference in the approaches of preparing contract A/c—if WIP is to be shown in the contract A/c, then this procedure has to be adopted. That is, from Note 2 to preparation of contract A/c, that is, this stage. Otherwise, students could follow the usual procedure up to Note-1 stage in this solution.

(b) Preparation of Contractee’s Account

 

(c) Items to be shown in the Balance Sheet

 

Illustration 9.13

Model: Contract A/c & Contractee’s A/c for 2 years

RBS Ltd took up a construction work of a building at a contract price of 30,00,000. During the first year, the following amounts were spent as against a sum of Rs. 11,25,000 which represented 90% of the work certified and received by the contractor.

 

	Rs.
Materials	5,25,000
Wages paid to workers	3,00,000
Overhead expenses	75,000

During the second year, the firm spent the following amounts:

 

	Rs.
Materials	7,50,000
Labour cost	6,00,000
Overhead expenses	1,50,000

In the second year, the contract was completed and a sum of Rs.17,50,000 was received by the contractor. Prepare the contractor and contractee’s account for both the years and calculate the profit.

NOTE: Consider only 2/5th of the notional profit that is to be taken to the credit of the profit and loss in the first year, as the work done is less than 50%.

 

[I.C.W.A. Inter – Modified]

Solution

As specific instruction is given (in the illustration—i.e., Question), instead of 1/3rd in the usual procedure, 2/5th of the notional profit has to be considered for taking into P&L A/c.

(a) Contract Account for the first year.

 

(b) Contract Account for the second year

 

(c) Contractee’s Account at the end of the first year

 

(d) Contractee’s Account at the end of the Second year

 

Illustration 9.14

Model: Plant & Materials loss

Vas Ltd. was engaged on a contract of which the contract price was Rs. 10,00,000, on 1 January 2009.

Of the plant and materials charged to the contract, the plant which costs Rs. 10,000 and materials which cost Rs. 8,000 were lost in an accident.

On 31 December 2009, the plant which costs Rs. 10,000 was returned to the store, the cost of work done but uncertified was Rs.4,000 and the materials costing Rs.8,000 were in hand on site.

Charge 10% depreciation on the plant, crediting two-thirds of profit received with P&L A/c and compile a contract Account and Balance sheet from the following:

 

	Rs.	Rs.
Share capital		2,40,000
Creditors		20,000
Cash received on contract – 80% of work certified		4,00,000
Land and Building	86,000
Bank balance	50,000
Charged to contract:
Materials	1,80,000
Plant	50,000
Wages	2,80,000
Expenses		14,000
	6,60,000	6,60,000

Solution

1. In this problem, plant and materials were given as lost in an accident. Total costs (for both, i.e., plant Rs.10,000 + materials Rs.8,000) of Rs.18,000 are treated as abnormal loss and charged to P&L A/c.
2. 80% of work certified = Rs.4,00,000.

   

3. As direction is given in the problem itself, 2/3 × Notional Profit × Work Certified formula has to be used.

 

Illustration 9.15

Model: Two Contracts & Material transfer from one to another

RR Construction Ltd is engaged on two contracts, Contract No, 105 and 106 during the year 2009. The following particulars are obtained at the end of the year 31 December 2009.

	Contract 105 Rs.	Contract 106 Rs.
Contract price	3,00,000	2,50,000
Materials issued	80,000	30,000
Materials returned	2,000	1,000
Materials on site	11,000	4,000
Direct labour	75,000	21,000
Direct expenses	33,000	17,500
Establishment expenses	12,500	3,500
Plant installed at cost	40,000	35,000
Value of plant (December 31)	32,500	32,000
Cost of work not yet certified	11,500	5,000
Value of work certified	2,10,000	67,500
Cash received from contractees	1,89,000	62,500
Architect’s fees	1,000	500

During the period, materials amounting to Rs. 4,500 have been transferred from Contract 105 to Contract 106. The date of commencement of Contract No.105 is 1 April and Contract No. 106 is1 September. You are required to show:

1. Contract Accounts
2. Contractee’s Accounts, and
3. Extract from Balance Sheet as on 31 December, clearly showing the calculation of WIP.

[I.C.W.A. (Inter) – Modified]

Solution

1. Contract Accounts are to be prepared separately, as in the manner in the previous illustrations.
2. However, the values relating to contracts are to be shown in the Balance Sheet.
3. Material transfer has to be dealt with cautiously.

1.

 

1.

 

2.

 

2.

 

(a) For Contract 105:	Rs.
Work certified	2,10,000
Work uncertified	11,500
	2,21,500
Less: Reserve	12,000
	2,09,500
Less: Cash received	1,89,000
*1WIP for 105 =	20,500

(b) For Contract 106:	Rs.
Work certified	67,500
Work uncertified	5,000
	72,500
Less: cash received	62,500
*2WIP for 106 =	10,000

3. Extracts from Balance sheet as on 31 December 2009

FOR PROFESSIONAL COURSE

Recognition of Profits on Incomplete Contracts:

Accounting Standard (AS) – 7 – Revised 2002

The main principle envisaged in (AS) – 7 – Revised is explained as follows:

• The basic principle of ascertaining profits on incomplete contracts is to provide credit to share of profit on the outcome of a contract which can reasonably be foreseen.
• In computing the total estimated profit on the contract it is essential and unavoidable to take into account:
  1. Total costs incurred till date
  2. Total estimated future costs to complete the contract.
  3. The estimated future cost of rectification and guarantee work
  4. Any other future work to be undertaken
• These [Total Estimated Cost of Contract (i to iv above)] are then compared with the Total Contract Value to ascertain Estimated Profit/Loss on contract.
• It should be further noted that the profit taken in any year is to be calculated on a cumulative basis having regard to profit taken in the earlier years.
• The amount to be shown in the years P&L A/c will be the appropriate proportion of this total profit (with special reference to the work done to date) LESS any profit already taken in the previous year.
• Further (AS) – 7 dealing with “Construction Contracts” stipulates that when the outcome of a construction contract can be estimated reasonably, contract revenue and contract costs associated with the construction contract should be recognized as revenue and expense, respectively, by reference to the stage of completion of the contract activity at the reporting date.
• An expected loss on the construction should be recognized as an expense immediately.

1. Profit or loss as estimated in the Memorandum Format is given as follows:

   Particulars	Rs.	Rs.
   TOTAL CONTRACT VALUE LESS:		–
   (i) Costs incurred to date	–
   (ii) Estimated future costs to complete the work	–
   (iii) Estimated cost of Rectification and Guarantee work	–
   TOTAL ESTIMATED COST OF CONTRACT		–
   ESTIMATED PROFIT/LOSS ON CONTRACT		–

2. The estimated profit is to be adjusted against the formula as follows:
   
3. The amount of profit to be recognized in the CURRENT PERIOD is to be determined on cumulative principles as follows:

   	Rs.
   Profit to date	–
   Less: Profit recognized at the end of the previous period =	–
   Profit recognized in the CURRENT PERIOD =	–

   Illustration 9.16

   The following cost data relate to a construction company:

   	Rs.
   Contract price	50,00,000
   Cumulative figures:
   To end of previous period – Profit recognized:	2,00,000
   To end of current period – Total costs:	25,00,000
   Cost of work certified:	20,00,000
   Estimate future costs to completion:	15,00,000
   Estimated rectification costs, 10% of contract price

   You are required to calculate:

4. Estimated contract profit
5. Profit to date
6. Profit in current period

Solution

1. Calculation of Estimated Contract Profit: (Memorandum Form) (As per (AS) – 7 (Revised))

   Particulars	Rs.	Rs.
   (a) TOTAL CONTRACT VALUE		50,00,000
   Less: (i) Cost incurred to date	25,00,000
   (ii) Estimated future cost to complete contract	15,00,000
   (iii) Estimated cost of rectification(10% of contract price)	5,00,000
   (b) Total estimated costs of contract		45,00,000
   *(c) Estimated contract profit (a) – (b)		5,00,000

2. Profit to date is calculated as follows:
   

   Substituting the values in the above formula, we get:

   
3. Calculation of Profit in Current Period:

   	Rs.
   Profit to date	2,22,222.22
   Less: Profit recognized at the end of previous period (given);	2,00,000.00
   ∴ Profit in current period:	22,222.22

Illustration 9.17

Model: Estimated Profit

A fabrication company undertakes long-term contracts which involve the fabrication of pre-stressed concrete blocks and the erection of the same on the construction site:

The following information is supplied regarding the contract which is incomplete on 31 March 2010:

	Rs.
Cost incurred:
Fabrication costs to date:	8,40,000
Direct materials	2,70,000
Direct labour	2,25,000
Overheads	13,35,000
Escalation costs to date	45,000
Total	13,80,000
Contract price	24,57,000
Cash received on account	18,00,000
Technical estimate of work complete to date:
Fabrication:
Direct materials: 80%
Direct labour & overheads = 75%
Erection = 25%

You are required to prepare a statement of

1. The estimated profit on completion of contract
2. The estimated profit to date on the contract

[I.C.W.A. Inter – Modified]

Solution

Statement showing

1. the estimated profit to date and
2. on completion of contract

(i) Estimated profit to date:

   Contract price – Total cost = Total estimated profit

   Rs. 24,57,000 – Rs. 18,90,000 = Rs. 5,67,000.

Illustration 9.18

Model: Actual & Estimate Contract Particulars—Ascertainment of Profit.

VPR Ltd commenced a contract on 1 January 2009. The total contract was Rs. 40,00,000 (estimated by the contractee) and was accepted by VPR Ltd at 10% less. It was decided to estimate the total profit and take to the credit of P&L A/c that the proportion of estimated profit on cash basis which the work completed bore to the total contract price. Actual expenditure in 2009 and estimated expenditure in 2010 are given as follows:

	2009 Actual Rs.	2010 Estimated Rs.
Materials	6,00,000	10,40,000
Labour: Paid	4,00,000	4,80,000
Accrued	40,000	–
Plant purchased	3,20,000	–
Expenses	1,60,000	–
Plant returned to store (on cost)	80,000	2,00,000
	on 31 December 2009	on 30 September 2010
Materials at site	40,000	–
Work certified	16,00,000	Full
Work uncertified	60,000	–
Cash received	12,00,000	Full

The plant is subjected to annual depreciation @ 20% of cost. The contract is likely to be completed by 30 September 2010. You are required to prepare the contract Account.

 

[C.A. (Inter) – Modified]

Solution

Hint:

4. Contract Account is to be prepared based on the figures relating to Actual, i.e., 2009.

5. Profit to be taken to P&L A/c is to be determined after preparing the estimated contract account.

6. The estimated contract account is to be prepared based on the figures relating to actual and estimated.

 

NOTE: Accrued wages for 2009 would be paid in 2010. So, the wages for 2010 actually are Rs. 4,40,000.

PROFESSIONAL COURSES (ADVANCED-LEVEL PROBLEMS)

Illustration 9.19

PVS contractors has been engaged in a construction work. The contract price being Rs. 8,00,000. Work commenced on 1 January 2009 and the expenditure during the year were: Plant and tools – Rs. 40,000, Stores and materials = Rs. 1,44,000, Wages – Rs. 1,30,000, Sundry expenses – Rs. 10,600 and Establishment charges – Rs. 23,400.

Certain materials costing Rs. 24,000 were unsuited to the contract and were sold for Rs. 29,000. A portion of the plant was scrapped and sold for Rs. 4,600.

The value of the plant and tools on the sites on 31 December 2009 was Rs. 12,400 and the value of stores and materials on hand was Rs. 6,800. Cash received on account was Rs. 2,80,000 representing 80% of the work certified. The cost of the work done but not yet certified was Rs. 43,800; and this was certified for Rs. 50,000.

PVS contractors decided

1. to estimate what further expenditure would be incurred.
2. to compute from the estimate and expenditure already incurred, the total profit that would be made on the contract and
3. to take to the credit of P&L A/c for the year 2009 that portion of the total which corresponds to the work was certified by 31 December 2009. The estimate was as follows:
   1. That the contract would be completed by 30 December 2010.
   2. That the wages in the contract in 2010 would amount to Rs. 1,43,000.
   3. That the cost of stores and materials required in addition to those stocked on 31 December 2009 would be Rs. 1,37,200 and that the further expenses relating to the contract would amount to Rs. 12,000.
   4. That a further Rs. 50,000 would have to be laid out on plant and tools and that the residual value of plant and tools on 30 September 2010 would be Rs. 6,000.
   5. That the establishment charges would cost the same per month as in 2009.
   6. That of the total cost of the contract would be due to defects, temporary maintenance and contingencies.

You are required to prepare the contract account for the year ended 31 December 2009 and show your calculation of the amount credited to P&L A/c for the year.

 

[C.S. (Inter) – Modified]

Solution

I Basis calculations:

1. Calculation of work certified

Cash received by the contractor: Rs. 2,80,000.

80%of the value of work certified: Rs. 2,80,000

100%of the value of work certified

*¹ (Ref: Total estimated Profit calculation).

*¹2. Calculation of Profit to be transferred to P&L A/c.

As per the direction in the problem, the profit is to be estimated as follows:

Balance Rs. 45,466 (Rs. 93,600 – Rs. 48,134) is to be kept as a reserve.

 

Illustration 9.20

Model: Three Contract Accounts

Three contracts x, y and z commenced on 1 January, 1 July and 1 October 2009, respectively, were undertaken by ABC Ltd, and their accounts on 31 December 2009 showed the following position:

The plant was installed on the date of commencement of each contract, and depreciation is to be taken at 10%p.a.

You are required to prepare the contract accounts in a tabular form and show how they would appear in the Balance Sheet as on 31 December 2009.

 

[C.S. (Inter) – Modified]

Solution

 

Calculations: 1. Depreciation on Plant

Illustration 9.21

Model: Profit to be taken to P & L A/C Different methods

An expenditure of Rs. 3,88,000 has been incurred on a contract to the end of 31, March 2010. The value of work certified is Rs. 4,40,000. The cost of work done but not yet certified is Rs. 12,000. It is estimated that the contract will be completed by 30 June 2010, and an additional expenditure of Rs. 80,000 will have to be incurred to complete the contract. The total estimated expenditure on the contract is to include a provision of 2½%for contingencies. The contract price is Rs. 5,60,000 and Rs. 4,00,000 has been realized in cash upto 31 march 2010.

You are required to calculate the proportion of profit to be taken to the profit and loss Account as on 31 March 2010 under different methods.

 

[B.Com (Hons)-Delhi
C.S. (Inter)-I.C.W.A. (Inter)
M.Com Madras University]

Solution

 

The Notional Profit is to be transferred to P & L A/C: (2/3 because the contract has reached the reasonable level of completion i.e > 50%)

Method I:

Method II:

Method III: Computation of Estimated Profit

Estimated profit may be calculated in the following different methods:

		Rs.
Contract price		5,60,000
Less: Cost incurred (total exp.)	3,88,000
Estimated additional cost	80,000
Provision for contingencies (3,88,000 + 80,000)×	12,000	4,80,000
∴ Estimated profit =		80,000

Profit to be transferred to P & L A/c are to be calculated as follows:

Method IV:

Method V:

Method VI:

Results will vary on account of basis applied for apportionment of profit that is to be taken to P&L A/c.

Illustration 9. 22

Model: Cost Escalation claim

VRV Ltd undertook a contract for Rs. 10,00,000 on 1 June 2008. On 31 May 2009, when accounts were closed the following details were obtained:

	Rs.
Materials purchased	2,00,000
Wages paid	90,000
General expenses	20,000
Plant purchased	1,00,000
Materials on hand on 31 May 2009	50,000
Wages accured on 31 May 2009	10,000
Work certified	4,00,000
Work certified	4,00,000
Cash received	3,00,000
Work uncertified	30,000
Depreciation on plant	10,000

The above contract contained an escalation clause which read as follows:

“In the event of price of materials and rates of wages increase by more than 5%, the contract price will be increased accordingly by 25%of the rise in the cost of materials and wages beyond 5%in each case”.

It was found that since the date of signing the agreement the prices of materials and wage rates increased by 25%. The value of work certified does not take into account the effect of the above clause.

You are required to prepare the contract account

 

[B.Com (Hons) – Delhi – C.A. (Inter);
[I.C.W.A. (Inter) C.S. – (Inter) – Modified]

Solution

NOTE:

1. All expenses in relation to the contract are to be debited to contract A/c.
2. WIP, materials in hand and net of contract escalation are to be credited to the contract A/c.
3. Profit arrived to be apportioned and to be transferred to P & L A/c and WIP accordingly.

STAGE I: Escalation charges are to be computed as under:

Step 1. Effect of increase in the price of materials:

Step (a) Material purchased = Rs. 2,00,000

     Less: Materials in hand = Rs. 50,000

         Materials consumed = Rs. 1,50,000

 

		Rs.
Total increase	=
Step (b) Up to 5%	=

Step (c) Beyond 5% = [Step (a) – Step (b)] = 24,000

Step 2: Effect of increase in Wage Rate:

 

Step (a) Wages paid:	Rs.90,000
Add: Accrued wages:	Rs. 10,000
Total wages	Rs. 1,00,000

Step 3: Total Increase:         Rs.

Step 1(c) + Step 2 (c) (Rs. 24,000 + Rs. 16,000) = 40,000

 

*Step 4: Increase in contract =	Rs
Price: (25% increase beyond 5% level) =	10,000

STAGE II: Preparation of Contract Account

 

Note: As the work completed falls – >25% but <50%, 1/3rd of profit earned has reduced on cash basis and transferred to P&L A/c.

Contract cost may be defined as the aggregate costs relative to a single contract designated a cost unit. Contract costing is a form of job costing.

Special features of contract costing: (i) construction activity (ii) work as customer’s site (iii) long duration (iv) work as per customer’s requirements (v) cost accumulation for each contract (vi) high risk and uncertainty and (vii) identifiable at each stage contract costing procedure. Ref: Text.

Types of contracts: (i) fixed price contract with Escalation clause & (ii) cost plus contract. Main features, advantages and disadvantages of each type is explained is detail. For guidelines to assess profit on incomplete contracts refer the text.

Special features of As-7 (Revised) relating to accounting for construction contracts are discussed in detail. Ref: Text. Value of WIP consists (i) work certified & (ii) work uncertified progress of work would be assessed by the customer’s engineer or surveyor who in turn would issue a certificate known as ‘work certified’. The customer would pay to the contractor on the basis of certificate. Usually the entire amount will not be paid. The balance of unpaid amount on the value of work certified is termed as ‘Retention money’. For accounting treatment refer the text.

Contract Costing: A form of specific-order costing which applies wherever work is undertaken to specific requirements of customers, work being long duration.

Fixed-Price Contract with Escalation Clause: To compensate the price rise in future, a special clause is incorporated into fixed-price contracts.

Cost-Plus Contracts: The actual allowable costs incurred in executing a contract plus an agreed percentage of these costs or a fixed fee payable to contractors.

Retention Money: The amount which the customer retains till the date of final completion of work.

Work Certified: Percentage of work completed to be approved by the contractee or his nominee, forming the basis for payment and profit computation.

Work Uncertified: Work would have been completed (to a certain percentage) but not approved by the contractee or his nominee.

Incomplete Contracts: Contracts that have not been completed and treated as WIP.

QUESTION BANK

 

I: State whether the following statements are true or false

1. Contract costing is a form of job costing.
2. Completion of contracts will not be more than that of an accounting period, as they are of short duration.
3. In contract, the work mainly involved is construction activity.
4. Costs are accumulated and determined for each contract.
5. It is difficult to identify each contract.
6. In contract, the work is done at the contractor’s premises.
7. Cost-plus contract and fixed-price contract are one and the same.
8. Deductions are made from the progress payments by customer and full amount is not paid for the value of work done.
9. The contractor is compensated for the increase in costs by escalation clause.
10. The actual cost of the contract includes abnormal costs.
11. The costs which are incurred for contracts are mainly of direct nature.
12. Overhead is insignificant in contract costing.
13. As profit is stated as a percentage of cost in cost-plus contracts, it is advantage to contractors.
14. Loss arising on incomplete contracts should be defined to P&L A/c.
15. Profit is generally recognized only after the entire work is completed.

Answers:

 

1. True	2. False	3. True	4. True
5. False	6. False	7. False	8. True
9. True	10. False	11. True	12. True
13. False	14. True	15. False

 

II: Fill in the blanks with apt word(s)

1. Contract cost may be defined as the aggregate cost relative to a ______ designated a cost unit.
2. In a contract, work is mainly involved in ______ activity.
3. Generally, contracts are of ______ duration.
4. Contract-costing method is similar to ______ .
5. The contract work is carried out according to ______ of customers.
6. Progress payments are made on the basis of ______ .
7. Deductions that are made from progress payments are called __________ .
8. To encourage an early completion of contracts, ________ clause and _____ clause are incorporated in contracts.
9. The contractor is compensated for price rise by including ________ clause.
10. There are two types of contracts: 1: fixed-price contract and 2: _________ .
11. The costs which are incurred for contracts are mainly of _________ .
12. Apportionment of administration overheads are done on the basis of _________ .
13. Payments to sub-contractors are charged to respective _________ .
14. Where no cost estimate is possible ________ contracts are suitable.
15. When the completion stage of contract is less than 1/4, the total expenditure on contract is transferred to _________ .

Answers:

1. Single contract
2. construction
3. longer
4. job costing
5. specific requirements
6. architect’s
7. deduction money
8. penalty bonus
9. escalation
10. cost-plus contract
11. direct costs
12. sales value
13. contract account
14. cost-plus contract
15. WIP

III: Multiple choice question: choose the correct answer

1. Where the job is of large and longer duration, the suitable method of costing is
   1. Contract costing
   2. Job costing
   3. Batch costing
   4. Backflush costing
2. When no estimates can be possible, the suitable method is
   1. Fixed-price contract
   2. Cost-plus contract
   3. Fixed-price contract with escalation clause
   4. All of these
3. To compensate the price rise, one of the following clauses is provided:
   1. Penalty clause
   2. Bonus clause
   3. Escalation clause
   4. None of these
4. Profit in incomplete contract is known as notional profit because
   1. It is not real profit
   2. Real profit will be ascertained when the work is complete
   3. There is no such incomplete contract
   4. The profit is only an approximation
5. Loss arising to incomplete contract is
   1. Transferred to P&L A/c
   2. Debited to WIP
   3. Debited proportionately to WIP
   4. Not dealt in cost accounts
6. WIP in contract means
   1. Work certified
   2. Work certified and work uncertified
   3. Work uncertified only
   4. None of these
7. Contract Costing is suitable of
   1. Bakery
   2. Brick
   3. Construction
   4. Chemicals
8. Cost of a contract is determined by preparing
   1. Cost sheet
   2. Profit and Loss Account
   3. Balance Sheet
   4. Separate ledger account
9. When a contract work is completed to the extent of 20%of the contract price, profit to be credited to P&L A/c is
   1. Nil
   2. Full amount
   3. of profit
   4. of profit
10. Profit remaining as Reserve is
    1. Transferred to P&L A/c
    2. Deducted from WIP
    3. Not taken into account in costs
    4. Debited to cost price of contract

Answers:

 

1. (a)	2. (b)	3. (c)	4. (d)	5. (a)
6. (b)	7. (c)	8. (d)	9. (a)	10. (b)

1. What do you mean by “contract costing”?
2. What are the main features of contract costing?
3. Distinguish between job costing and contract costing?
4. Name the industries that are suitable for contract costing?
5. What are the two types of contracts?
6. Explain: “Escalation clause”.
7. What is meant by “Cost-plus contract”?
8. What is “Surveyor’s certificate”?
9. What is “Retention money”?
10. How would you deal with “Materials” in contract costing
11. How would you deal with “plant” in contract costing?
12. How will you show “WIP” in contract costing?
13. How will you calculate profit on an incomplete contract?
14. Explain the term: “work certified”.
15. Explain the term: “work uncertified”.

1. Define “contract costing”. What are the special features of contract accounting?
2. Explain the steps involved in ascertaining the cost of each contract.
3. How would you deal with incomplete contracts and profit?
4. What are the different methods of incomplete contracts in the Balance Sheet?
5. Explain the salient features of Account Standard in respect of accounting for construction contracts.
6. In contract-cost accounts it may be necessary to make a charge for the use of plant and machinery. Explain briefly two methods of dealing with the charge and state in what circumstances you would adopt each method.

 

[Model: Treatment of Plant]

1. A plant costing Rs. 75,000 was issued to a contract on 1 January 2009. Plant costing Rs. 5,000 was transferred to another contract on 30 June 2009. A plant costing Rs. 2,500 was stolen. Another plant worth Rs. 2,000 was destroyed by fire. A plant costing Rs. 1,500 was sold for Rs. 2,000. Charge depreciation is @ 10%p.a. Ignore the depreciation for plant stolen, destroyed and sold. Show the extracts from contract Account relating to plant.

[Ans: Closing balance of plant Rs. 57,600

         Depreciation on plant Rs. 6,400

         Total debit to contract A/c Rs. 75,500

         Total credit to contract A/c Rs. 68,850]

[Model: Treatment of WIP]

2. A contractor undertook a contract for Rs. 5,00,000 on 1 January 2009 to be completed over a period of two years. His accounting year ends on 31 December 2009. Show at value the WIP on 1 January 2010 which will appear in the contract A/c in each of the following cases:

1. WIP on 1 January 2010 Rs. 75,000 (including Rs. 3,000 estimated profit which was taken to P&L A/c in 2009)
2. WIP on 1 January 2010 Rs. 75,000 (including Rs. 3,000 estimated profit was not taken to P&L A/c in 2009)
3. WIP on 1 January 2010 Rs. 75,000 (excluding Rs. 3,000 estimated profit which was taken to P&L A/c in 2009)
4. WIP on 1 January 2010 Rs. 75,000 (excluding Rs. 3,000 estimated profit which was not taken into P&L A/c in 2009)

[Ans:

1. Rs. 75,000
2. Rs. 75,000
3. Rs. 73,000
4. Rs. 72,000]

[Model: Transfer to P&L A/c]

3. How much profit, if any, would you allow to be considered in the following case:

 

	Rs.
Contract cost	11,20,000
Contract value	20,00,000
Cash received	10,80,000
Uncertified work	1,20,000

Deduction made from bills by way of security deposit 10%

[Ans: Notional profit: Rs. 2,00,000

        Profit to be considered: Rs. 1,20,000]

4. The following expenses were incurred on a contract that was still unfinished on 31 December 2009:

 

	Rs.
Materials	1,50,000
Wages	1,30,000
Other expenses	95,000

Rs. 7,50,000 was received from the contractee being 75%of work certified. Work uncertified was Rs. 37,500. You are required to calculate the profit to be credited to P&L A/c:

1. If the contract price was Rs. 20,00,000
2. If the contract price was Rs. 30,00,000
3. If the contract price was Rs. 50,00,000

[Ans: Notional Profit: Rs. 6,62,500

        Profit to be transferred to P&L A/c:

1. Rs. 3,31,250
2. Rs. 1,65,625
3. Nil ∵ Less than 25%of work completed]

[Model: Completed Contracts—Simple]

5. The following is the summary of transactions as on 31 December 2009, relating to a special contract completed during the year:

 

	Rs.
Materials purchased	7,500
Materials issued from stores	2,500
Wages	12,200
Direct expenses	1,470
Work on cost	25% of direct wages
Office on cost	10% of prime cost
Contract price	Rs. 30,000

You are required to prepare a contract account keeping in view that material returned amounted to Rs. 1,200.

[Ans: Profit: Rs. 2,235 Office on cost: Rs. 2,245]

6. Geo Construction Co. undertook a contract for construction of a building from 1 July 2009. The contract price was Rs. 6,00,000. He incurred the following expenses:

 

	Rs.
Materials issued	36,000
Materials in hand at the end	6,000
Wages	30,000
Direct expenses	1,20,000
Plant purchased	60,000

The contract was completed on 31 December 2009 and the contract price was duly received. Provide depreciation @ 20%p.a. on plant and charge indirect expenses @ 20%on wages. Prepare contract account in the books of the company.

[Ans: Profit: Rs. 4,08,000]

[Model: Incomplete Contracts (Loss on Contract)]

7. Vasant & Co. undertook a contract, the contract price being Rs. 3,00,000. The contract commenced on 1 January 2009. During the year the work certified was valued at Rs. 1,50,000 of which 75%was received. Work uncertified amounted to Rs. 30,000. The following expenses were incurred:

Materials – Rs. 90,000, Labour – Rs. 60,000, Plant – Rs. 30,000, Direct expenses – Rs. 24,000 and Indirect expenses – Rs. 15,000. At the end of the year wages accrued were Rs. 6,000, Materials in hand was Rs. 3,000 and plant in hand was Rs. 4,500. Prepare contract account.

[Ans: Loss on contract: Rs. 37,500]

[Model: When certified work is less than 25%of the contract price]

8. A construction company took a contract for the construction of a certain building on 1 January 2009. The contract price was agreed at Rs. 40,00,000. The company had made the following expenditure during the year:

 

	Rs.
Direct materials purchased	1,00,000
Materials issued from stores	1,50,000
Direct labour	1,50,0000
Plant	4,00,000
Direct expenses	1,00,000

From the following information, prepare a contract account and find out the value of tender:

 

	Rs.
Direct materials purchased	1,00,000
Value of plant on 31 December 2009	3,00,000
Stock of materials at site	50,000
Materials returned to stores	10,000
Cash received from contractee	7,00,000
Cost of work not yet certified	40,000

[As the work certified is less than th (25%) of the contract price, no profit would be taken to P&L A/c. WIP = Rs. 5,40,000]

[Model: Work certified is 1/4th or more than 1/4th but less than 1/2 of the contract price]

9. ‘x’ undertook several contracts and his ledger contained a separate account for each contract. On 30 June 2009, the account of the Contract No 108 showed the following amount expended there on:

 

	Rs.
Materials directly purchased	2,70,000
Materials issued from stores	2,40,000
Plant purchased	10,80,000
Wages	3,66,000
Direct expenses	36,000
Proportion of establishment charges	81,000
	10,68,000

The contract price was for Rs. 22,50,000 and up to 30 June, Rs. 8,70,000 has been received in cash which represented the full amount certified less 20%as retention money. The materials on site unconsumed valued at Rs. 22,500. The contraction plant was to be depreciated by Rs. 24,000.

Prepare the contract account showing what profit thereon has been earned to date. And also state what amount should be taken to the P&L A/c of the period.

[Ans: Notional Profit: Rs. 2,58,000; Profit to be taken to P&L A/c = Rs. 68,799]

[Model: Value of work certified is 1/2 (50%) or more than 1/2 of the contract price.]

10. The following is the information relating to Contract No. 115.

 

	Rs.
Contract price	12,00,000
Wages	3,28,000
General expenses	17,200
Raw materials	2,40,000
Plant	40,000

As on date, the cash received was Rs. 4,80,000 being 80%of work certified. The value of materials remaining at site was Rs. 20,000. Depreciate plant by 10%. Prepare contract account showing profit to be credited to P&L A/c.

[Ans: Notional Profit: Rs. 30,800; Profit transferred to P&L A/c: Rs. 16,426]

11. M/s Verma Building Contractors began to trade on 1 January 2009. The following was the expenditure on contract for Rs. 9,00,000.

 

	Rs.
Materials issued from stores	2,25,000
Materials purchased	60,000
Plant installed at cost	1,05,000
Wages paid	3,60,000
Direct expenses paid	33,000
Establishment expenses	30,000
Direct expenses accrued due	4,500
on 31 December 2009
Wage accrued due on	3,000
31 December 2009

Of the plant and materials charged to the contract, the plant which cost Rs. 7,500 and materials costing Rs. 6,000 were lost. Some parts of the materials costing Rs. 3,750 were sold at a profit of Rs. 750. On 31 December 2009 the plant which cost Rs. 3,000 was returned to stores and the plant which cost Rs. 2,250 was transferred to some other contract.

The work certified was Rs. 7,20,000 and 80%of the same was received in cash. The cost of work done but uncertified was Rs. 4,500. Charge depreciation on plant was at 10%p.a. You are required to prepare the contract account for the year that ended on 31 December 2009, by transferring to P&L A/c the portion of profit, if any, you consider reasonable.

[Ans: Notional Profit: Rs. 24,000; Profit transferred to P&L A/c: Rs. 12,800]

[Model: Work Uncertified—Calculation]

12. M/s Rajesh and Co. commenced work on a particular contract on 1 April 2009. They closed their books of accounts for the year on 31 December each year. The following information is available from their closing records on 31 December 2009:

 

	Rs.
Materials sent to site	1,00,000
Foreman’s salary	24,000
Wage paid	2,00,000

A machine consisting Rs. 64,000 remained in use on site for 1/5th of the year. Its working life was estimated at 5 years and scrap value at Rs. 4,000. A supervisor is paid Rs. 4,000 p.m. and had devoted one-half of his time on the contract.

All other expenses were Rs. 30,000. The material on site was Rs. 18,000. The contract price was Rs. 8,00,000 on 31 December, 2/3rd of the contract was completed. However, the architect gave certificate only for Rs. 4,00,000 on which 75%was paid.

Prepare the contract account in the company’s books.

[Ans: Notional Profit: Rs. 1,33,700; Profit transferred to P&L A/c: Rs. 66,350; Cost of work uncertified Rs. 89,100]

13. Khush Construction Co.undertook a contact for constructing a bridge for a total value of Rs. 12 lakhs on 1 January 2009. It was estimated that the contract would be completed by 30 June 2010. You are required to prepare a contract account for the year ending 31 December 2010.

 

	Rs.
Wages	3,00,000
Materials	1,50,000
Materials at site on 31 December 2009	20,000
Special plant	1,00,000
Overheads	60,000
Work certified	8,00,000

Depreciation is at 10%p.a. on plant. Cash received is 80%of the work certified. 8%of the value of materials issued and 7%of wages may be taken to have been incurred for the portion of the work completed but not yet certified. Overheads are charged as a percentage of direct wages.

[Ans: Notional profit Rs. 3,37,200

         Profit transferred to P&L A/c Rs. 1,79,840

         Work uncertified Rs. 37,200]

[Model: Escalation clause]

14. Shree Construction Co.undertook a contract on 1 January 2009 for construction of a farm house with an escalation clause which provides that if material prices and wage rates increase by more than 12%, then the contractor gets a compensation for 35%of such rise in the cost of material and wages beyond 12%. It was agreed that since the signing of the agreement the material prices and wages rates have gone up by 42%on an average. The value of work certified does not take into account the effect of escalation clause.

The following are the details relating to the contract for the year that ended on 31 December 2009.

 

	Rs.
Contract price	15,00,000
Materials issued	3,00,000
Wages	4,00,000
Overheads	25,000
Plant installed at site	50,000
Material in hand as on 31	25,000
December 2009
Work certified	10,00,000
Cash received	8,00,000
Work done but uncertified	25,000
Depreciate plant @ 10% p.a.

Prepare a contract account and show the profit that is to be taken to P&L A/c.

[Ans: Notional profit: Rs. 3,69,910; Profit transferred to P&L A/c: Rs. 1,97,285. Compensation for escalation in prices to be credited to the contract account: On material-Rs. 20,335; On wages-Rs. 29,575]

15. Excel Ltd. undertook a contract for Rs. 10,00,000 on 1 February 2009. On 31 January 2010, when the accounts were closed, the following details about the contract gathered:

 

	Rs.
Materials purchased	2,00,000
Wages paid	90,000
General expenses	20,000
Plant purchased	1,00,000
Materials on hand on 31 January 2010	50,000
Wages accrued on 31 January 2010	10,000
Work certified	4,00,000
Cash received	3,00,000
Work uncertified	30,000
Depreciation of plant	10,000

The above contract contained an escalation clause which reads as follows:

“In the event of prices of materials and rates of wages increase by more than 5%of the contract price, then the prices will be increased accordingly by 25%of the rise in the cost of materials and wages beyond 5%in each case”.

It was found that since the date of signing the agreement the prices of materials and wage rates increased by 25%. The value of work certified does not take into account the effect of the above clause. Now prepare the contract account.

[Ans:Notional profit: Rs. 1,60,000; Profit transferred to P&L A/c: Rs. 40,000 Compensation for escalation in prices to be credited to the contract account:

         On materials: Rs. 24,000

         On wages: Rs. 16,000

         Increase in contract price as per escalation clause = Rs. 10,000]

[Model: Preparation of contract account and balance sheet extract.]

16. Mr X and Mr Y undertook a contract for Rs. 5,00,000 for construction of a building. The following is the information concerning the contract during the year 2009:

 

	Rs.
Materials sent to site	1,70,698
Labour engaged on site	1,48,750
Plant installed at site at cost	30,000
Direct expenditure	6,334
Establishment charges	8,252
Materials returned to store	1,098
Work certified	3,90,000
Value of plant as on 31 December 2009	22,000
Cost of work not yet certified	9,000
Materials at site - 31 December 2009	3,766
Wage accrued on 31 December 2009	4,800
Direct expenditure accrued on 31 December 2009	480
Cash received from contractee	3,60,000

Prepare contract account, contractee’s account and show the balance sheet as on 31 December 2009.

[Ans:Notional Profit: Rs. 56,550; Profit transferred to P&L A/c Rs. 34,798; WIP: Rs. 21,752.

         Work certified and work uncertified are to be added and from the total Reserve (WIP) is to be deducted and the net amount is shown under the head “WIP” on the assets side of the balance sheet.

         As the balance sheet is not in a complete form, both sides cannot be totalled. Hence, the total is not shown in the balance-sheet extracts]

[Model: Preparation of Contract Account and Balance Sheet from Trial Balance:]

17. The following Trial Balance was extracted from the books of a contractor as on 31 December 2009:

	Dr Rs.	Cr Rs.
Share capital	–	2,40,000
Creditors	–	24,000
Land and Building	1,02,000	–
Cash at bank	27,000	–
Materials	2,40,000	–
Plant	45,000	–
Wages	3,15,000	-
Expenses	15,000	-
Cash received being 80%of the	-	4,80,000
work certified
	7,44,000	7,44,000

Of the plant and materials charged to the contract plant costing Rs. 6,000, materials costing Rs. 6,000 were destroyed by an accident. On 31 December 2009, the plant which cost Rs. 12,000 was returned to stores. The value of materials on site was Rs. 12,000 and the cost of work done but not certified was Rs. 6,000. Charge depreciation was at 10%on plant and carry to P&L A/c 2/3rd of profit on cash basis, after preparing the contract account.

[Ans: Notional Profit: Rs. 50,100; Profit taken to P&L A/c: Rs. 26,721; Balance sheet total: Rs. 2,78,721]

18. AONE Construction Co. Ltd which commenced its business of construction on 1 January 2009 showed the following balances:

	Dr Rs.	Cr Rs.
Paid-up share capital	-	5,00,000
Cash received on account of	-	6,00,000
contract (80%of work certified)
Land and Buildings	1,50,000	–
Machinery at cost (75%at site)	2,00,000	–
Bank	20,000	–
Materials at site	2,00,000	–
Direct labour	2,75,000	–
Expenses at site	10,000	–
Lorries and Vehicles	1,50,000	–
Furniture	5,000	–
Office equipment	50,000	–
Postage and Telegrams	2,500	–
Office expenses	10,000	–
Rates and Taxes	15,000	–
Fuel and Power	12,500	–
	11,00,000	11,00,000

The contract price is Rs. 15,00,000 and the work certified is Rs. 7,50,000. The work completed since certification is estimated at Rs. 5,000 (at cost). Machinery costing Rs. 10,000 was returned to stores at the end of the year. Stock of materials at site on 31 December 2009 was of the value of Rs. 25,000. Wages outstanding were Rs. 1,000. Depreciation on machinery is 10%. You are required to calculate the profit from the contract and prepare the Balance Sheet as on 31 December 2009.

[Ans: Notional Profit: Rs. 2,79,000; Profit to P&L A/c: Rs. 1,48,800; WIP in balance sheet: Rs. 24,800; Balance sheet total: Rs. 6,04,800]

[Model: Two or more contracts]

19. Two contracts were commenced on the following months: 1 January and 1 July 2009. Their accounts as on 31 December 2009 showed the following:

	Contract I Rs.	Contract II Rs.
Contract Price	16,00,000	10,80,000
Expenditure:
Raw materials	2,88,000	2,32,000
Wages paid	4,40,000	4,49,600
General charges	16,000	11,200
Plant installed	80,000	64,000
Materials in hand	16,000	16,000
Wages accrued	16,000	16,000
Work certified	8,00,000	6,40,000
Work finished but	24,000	32,000
uncertified
Cash received for	6,00,000	4,80,000
work certified

The plane was installed on the date of commencement of each contract, and depreciation is to be taken at 10%per annum.

Prepare the contract accounts and show how they would appear in the Balance Sheet as on 31 December 2009.

[Ans: Contract I: Notional Profit: Rs. 72,000; Profit taken to P&L A/c: Rs. 36,000; WIP in B/s total – Rs. 1,88,000.

Contract II: Notional Profit – Loss: Rs. 24,000; Loss taken to P&L A/c: Rs. 24,000 (in full); WIP in B/s total: Rs. 1,92,000]

20. Three contracts were commenced on the following months: 1 January, 1 July and 1 October 2009. They were undertaken by a contractor and their accounts as on 31 December 2009 showed the following:

The plant was installed on the date of commencement of each contract. Depreciation is to be taken at 10%p.a. You are required to prepare profit contract accounts.

[Ans: Contract I: Notional Profit: Rs. 9,000; Profit taken to P&L A/c: Rs. 4,500.

         Contract II: Loss: Rs. 3,000

         Contract III: Notional Profit: Rs. 1,500.
Profit cannot be taken to P&L because work certified is less than 1/4th]

[Model: Contract account for 2 or more years]

21. The following information relates to a construction company in respect of a contract for Rs. 20,00,000:

	2008 Rs.	2009 Rs.
Materials issued	6,00,000	1,68,000
Direct wages	4,60,000	2,10,000
Direct expenses	44,000	20,000
Indirect expenses	12,000	2,800
Work certified	15,00,000	20,00,000
Work uncertified	16,000	-
Materials at site	10,000	14,000
Plant issued	28,000	4,000
Cash received from contractee	12,00,000	20,00,000

The value of the plant at the end of 2008 and 2009 was Rs. 14,000 and Rs. 10,000, respectively.

Prepare (i) Contract account and (ii) Contractee’s account for the years 2008 and 2009 taking into consideration such Profit for transfer to P&L A/c as you think appropriate.

[Ans: For 2008: Notional Profit: Rs. 3,96,000; Profit taken to P&L A/c: Rs. 2,11,2000.

         For 2009: Profit: Rs. 2,64,000 Fully taken to P&L A/c]

22. The following information relates to a contract for Rs. 15,00,000. (The contractee paying 90%of the value of work done and certified by the architect and rest on the completion of the contract).

The value of plant at the end of 2007, 2008 and 2009 was Rs. 16,000, Rs. 10,000 and Rs. 4,000, respectively. Prepare the contract account for the three years.

[Ans: 2007: Loss: Rs. 14,000; to be transferred to P&L A/c. 2008: Notional Profit: Rs. 3,15,000; Profit credited to P&L A/c: 1,89,000; Profit kept in reserve: 1,26,000.
2009: Profit: Rs. 1,65,000; Transferred to P&L A/c: Full]

[Model: Contract Price is not given]

23. The following information was related to a construction company:

The construction started on 1 January 2009: Expenditure incurred during the year 2009:

 

	Rs
Materials issued	5,50,000
Wages	2,00,000
Direct expenses	1,00,000
Plant purchased on 1 January 2009	5,00,000
Materials in hand	25,000

Depreciate the plant @ 10%p.a. Other works expenses to be charged @ 20%of wages and office expenses @ 10%of work cost.

The amount certified by the engineer up to 31 December 2009 was Rs. 15,00,000, retention money being 20%of certified value. Prepare a contract account showing there in the amount of profit or loss to be transferred to P&L A/c.

[Ans: Notional Profit: Rs. 4,93,500; Profit to be taken to P&L A/c: 2,63,200]

[Model: Profit to be kept in Reserve as per instruction]

24. The following information is available in respect of a contract in 2009, the contract price being Rs. 9,00,000.

 

	Rs.
Materials issued	76,500
Plant installed at site	22,500
Wages paid	1,21,500
Other expenses	7,500

Cash received on contract on 31 December 2009 amounted to Rs. 3,84,000, being 80%of work certified. Of the plant and materials charged to the contract, the plant which cost Rs. 9,000 and materials costing Rs. 7,500 were lost. On 31 December 2009, the plant costing Rs. 6,000 was returned to stores. The cost of work done but uncertified was Rs. 3,000 and materials costing Rs. 6,900 were in hand. Charge 15%depreciation on the plant. Reserve 1/3rd profit earned and prepare the contract account from the above particulars.

[Ans: Notional Profit: Rs. 2,89,875; Profit to be kept in reserve: Rs. 96,625; Profit to be transferred to P&L A/c Rs. 1,93,250]

[Model: Contract Related to Extra Work]

25. M/s Lal and Tandon undertook a contract for construction of a building at a contract price of Rs. 5,00,000. Their account books show the following regarding the contract for the year that ended on 31 December 2009.

 

	Rs.
Materials issued from stores	1,00,000
Wages paid	40,000
Wages to be paid	5,000
Plant issued on 1 July 2009 (for 6 months)	2,00,000
Indirect expenses 10,000	10,000
Sub-contract cost	25,000
Materials at site at the end	10,000
Cash received being 90% of the work certified	2,70,000
Work done but not yet certified	15,000

Plant costing Rs. 25,000 was sold on 31 October 2009 for sum of Rs. 20,000. This plant is to be valued after charging a depreciation at 12% p.a. Extra work was done and completed on this contract (not included in terms of contract). A sum of Rs. 30,000 was agreed to be paid for it separately and the cost of this work to the contractor was Rs. 22.500 only. Prepare the contract account and show the amount of profit to be credited to P&L A/c on cash-received basis.

[Ans: Notional Profit: Rs. 1,33,500; Profit transferred to P&L A/c: Rs. 80,100; Profit on extra work done: Rs. 7,500]

[Model: Value of Tender]

26. From the following information, prepare a contract account and find out the value of tender:

 

	Rs.
Materials issued	76,500
Materials used	1,80,000
Productive wages	1,35,000
Direct expenses	15,000

Provide 60%on wages for works overheads and 12½%on works cost for office on cost. Profit should be 15%of the tender price.

[Ans: Rs. 5,43,970 – 60]

[Model: Contract Meaning Completion]

27. The following information relates to a contract which is 95%completed and in respect of which the contractor having estimated a further expenditure that will be incurred in completing the contract, has decided to carry to the credit of P&L A/c that proportion of the estimated net profit that is to be realized on contract which the cash received bears. to the contract price.

	Rs.
Total expenditure incurred during 2008	54,000
Expenses during 2009:
Labour	74,000
Materials	46,000
Indirect expenses	20,000
Contract price	2,80,000
Value of work certified up to 31 December 2009	2,20,000
Cost of work not certified up to 31 December 2009	6,000
Cash received till 31 December 2009	2,00,000
Estimated additional expenses	40,000

The total estimated additional expenditure on the contract is to include a provision of 1/2%for contingences. You are requested to prepare the contract account and show the calculations for the amount of profit that you would credit to the P&L A/c for the year that ended on 31 December 2009.

[Ans: Notional Profit up to 2009: Rs. 32,000; Estimated profit on full contract: Rs. 40,000; Profit credited to P&L A/c in 2009: Rs. 28,572]

 

28. A contractor undertook a contract for Rs. 50,000 on 1 January 2009 to be completed over a period of two years. His accounting year ends on 31 December 2009. State with reasons at what value the WIP on 1 January 2010 will appear in the contract account in each of the following cases:

1. WIP on 1 January 2010 is Rs. 14,000 (including Rs. 800 estimated profit which was taken to P&L A/c in 2009)
2. WIP on 1 January 2010 is Rs. 14,000 (including Rs. 800 which was not taken to P&L A/c in 2009)
3. WIP on 1 January 2010 is Rs. 14,000 (excluding Rs. 800 estimated profit which was not taken to P&L A/c in 2009)
4. WIP on 1 January 2010 is Rs. 14,000 (excluding Rs. 800 estimated profit which was taken to P&L A/c in 2009)

[B.Com (Hons) – Delhi]

29. The following Trial Balance was extracted on 30 April 2010 from the books of a contractor:

	Dr Rs.	Cr Rs.
Share capital	–	1,40,720
P&L A/c (Last year)	–	10,000
Provision for depreciation on	–	25,200
plant
Cash received on contract	–	5,12,000
Creditors	–	32,480
Land and Buildings at cost	29,600	–
Plant at cost	20,800	0
Cash at bank	18,000	0
Expenditure on contract:
Materials issued	2,40,000	–
Direct labour	3,32,000	–
Expenses	16,000	–
Plant at cost	64,000	–
	7,20,400	7,20,400

The contract was begun on 1 May 2009. The contract price is Rs. 9,60,000 and the customer has so far paid Rs. 5,12,000, being 80%of the work certified. The cost of work done since certification is estimated at Rs. 6,400 on 30 April 2010. After the above trial balance was extracted, the plant costing Rs. 12,800 was returned to stores and materials then on site were valued at Rs. 10,800. Provision is to be made for labour accrued Rs. 2,400 and depreciation on plant is at 1/2%. You are required to (a) write up contract account and (b) prepare a balance sheet as on that date.

[Ans: Notional profit: Rs. 58,800; Profit taken to P&L A/c: Rs. 31,360]

30. X Ltd. closes its accounts on 31 December each year. The company commenced work on a contract on 1 January 2009. The following information relates to the contract as on 31 December 2009:

 

	Rs.
Materials issued	2,51,000
Wages	5,65,600
Salary to foreman	81,300

A machine costing Rs. 2,60,000 has been on the site for 146 days. Its working life is estimated at 7 years and its final scrap value at Rs. 15,000. A supervisor who is paid Rs. 8,000 per month had devoted half of his time to the contract. Other expenses and administration charges amounted to Rs. 1,36,500. Materials at site at the end of the year cost Rs. 35,400. The contract price is Rs. 20,00,000. On 31 December 2009, two-thirds of the contract was completed. The architect had issued certificate of approval covering 50%of the contract price and the contractor had been credited Rs. 7,50,000 on his account.

Prepare the contract account and WIP account. Also show how the WIP will appear in the balance sheet of the contractor as on 31 December 2009.

 

[C.S. Inter – Modified]

[Ans: Notional Profit: Rs. 2,04,250; Profit taken to P&L A/c Rs. 1,02,126]

31. Excellent Erectors Ltd. took up a contract for construction of a building at a contract price of Rs. 15 lakhs. During the first year, the following amounts were spent as against a sum of Rs. 5,62,500, which represented 90%of the work certified and received by the contractor.

 

	Rs.
Materials	2,62,500
Wages paid to workers	1,50,000
Overhead expenses	37,500

During the second year, the firm spent the following amounts:

 

	Rs.
Materials	3,75,000
Labour cost	3,00,000
Overhead expenses	75,000

In the second year, the contract was completed and the sum of Rs. 8,75,00 was received by the contractor. Prepare the contract and contractee’s accounts for both the years and calculate the profit.

(Note: Consider 2/5th of the notional profit of the credit of P&L A/c in the first year.)

 

[I.C.W.A. (Inter)]

[Ans: First year: Notional Profit: Rs. 1,75,000;

         Transferred to P&L A/c: Rs. 70,000

         Second year: Profit Rs. 2,30,000]

32. A contractor commenced a building contract on 1 October 2008. The contract price is Rs. 8,80,000. The following data pertaining to the contract for the year 2008–2009 have been compiled from his books and is as under

 

		Rs.
1 April 2009	WIP not certified	1,10,000
	Materials at site	4,000
2009–2010	Expenses incurred:
	Materials issued	2,24,000
	Wages paid	2,16,000
	Hire of plant	40,000
	Other expenses	68,000
31 March 2010:	Materials at site	8,000
	WIP (not certified)	16,000
	Certified	8,10,000

The cash received represents 80%of the work certified. It has been estimated that further costs to complete the contract will be Rs. 46,000 including the materials at site on 31 March 2010.

Required:

Determine the profit on the contract for the year 2009–2010 on a prudent basis, which has to be credited to P&L A/c.

 

[C. A. Inter – Modified]

[Ans: Profit taken to P&L A/c: Rs. 1,33,546]

33. New Century Builders have entered into a contract to build an office building complex for 480 lakhs. The work started in April 2008 and is estimated that the contract will take 15 months to be completed. Work has progressed as per schedule and the actual costs charged till March 2010 are as follows:

 

	Rs.(in lakhs)
Materials	112–20
Labour	162–00
Hire charges for equipments and other charges	36–00
Establishment charges	32–40
	342–60

The following information is available:

 

Materials in hand (31 March 2010)	6–60
Work certified (of which Rs. 324 lakhs have been paid) as on 31 March 2010	400–
Work not yet certified as on 31 March 2010	7–50

As per management estimates, the following further expenditure will be incurred to complete the work:

 

	(Rs. in lakhs)
Materials	10 – 50
Labour	16–00
Sub-contractors	20–00
Equipments hire and other charges	3–00
Establishment charges	6–90

You are required to prepare the contract account after considering a reasonable margin of profit. Make a provision for contingencies amounting to 5%of total costs.

 

[I.C.W.A. Inter – Modified]

[Ans: Profit to be taken to P&L A/c: Rs. 50 lakhs; Estimated profit on contract: Rs. 60 lakhs]

34. Lon & Ton Ltd is a turnkey contractor who has entered into a contract with a customer for the construction of a bridge. The following details are available from its contract:

Materials	Quantity Ton.	Rate Rs.
Cement	100	2,000
Steel	10	15,000
Bricks	No. 10,000	Rs. 1 each
Gravel	10	500
Labour	Hours	Hourly rate
Skilled	100	5
Semi-skilled	50	2
Unskilled	100	1

The following data are available from their records once the construction work is compete: Materials (Actuals)

	Quantity Ton.	Rate Rs.
Cement	100	2,100
Steel	10	16,000
Bricks	No. 11,000	Rs. 1.50 each
Gravel	12	800
Labour	Hours	Hourly rate
Skilled	105	4
Semi-skilled	50	3
Unskilled	105	2

The escalation clause in the contract provides for escalation in contract price based on the rise in the prices of material and increase in the wage rates. Calculate the escalation amount and final claim.

[Ans: Total escalation amount: Rs. 28,050; Final claim: Rs. 3,93,750]

35. LMN contractors obtained a contract to build houses, the contract being Rs. 2,00,000. Work commenced on 1 January 2009 and the expenditure incurred during the year was:

Plant and tools: Rs. 10,000; Stores and materials: Rs. 36,000; Wages: Rs. 32,500; Sundry expenses: Rs. 2,650; and Establishment charges: Rs. 5,850.

Certain materials costing Rs. 6,000 were unsuited to the contract and were sold for Rs. 7,250. A portion of the plant was scrapped and sold for Rs. 1,150.

The value of the plant and tools on the sites on 31 December 2009 was Rs. 3,100 and the value of stores and materials on hand was Rs. 1,700. Cash received on account was Rs. 70,000 representing 80%of the work certified. The cost of the work done but not certified was Rs. 10,950 and this was certified for Rs. 12,500.

LMN contractors decided (i) to estimate what further expenditure would be incurred, (ii) to compute from this estimate and expenditure already incurred, the total profit that would be made on the contract and (iii) to take to the credit of P&L A/c for the year 2009 that proportion of the total which corresponds to the work certified on 31 December. The estimate was as follows:

1. That the contract would be completed by 30 September 2010
2. That the wages on the contract in 2010 would amount to Rs. 35,750
3. That the cost of stores and materials required in addition to those stock on 31 December 2009 would be Rs. 34,300 and that further expenses relating to contract would amount to Rs. 3,000
4. That a further amount of Rs. 12,500 would have to be laid out on plant and tools on 30 September 2010 would be Rs. 1,500
5. That the establishment charges would cost the same per month as in 2009.
6. That of the total cost of the contract would be due to defects, temporary maintenance and contingencies.

Prepare the contract account for the year that ended on 31 December 2009 and show your calculation of the amount credited to P&L A/c for the year

 

[I.C.W.A. (inter) & C.S. (Modified)]

[Ans: (i) Notional Profit: Rs. 23,400; (ii) Transfer to P&L A/c: Rs. 12,033; (iii) Estimated Total Profit on Contract: Rs. 27,505]