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This is a form of specific order costing that is used by firms of builders and public works contractors who under take work on the contract basis. This costing method is applied to work which:

  1. Isundertake to meet customers specific requirement. This means that theconstruction is undertaken following the customers expectation.
  2. Takesa considerable long time to complete. Construction work is not normally doneand completed in a week, month and not even in a year depending on what isunder construction. Complex building can even take more than five years.
  3. Theconstruction work or the processing of the product is always done away from thefirm’s premises. This implies that the construction work is site based.
  4. Isfrequently of construction nature such as road construction, dam construction,construction of building and ship construction.

IAS 11 – Accountingfor construction contractor defines a construction contract as “ a contract forthe construction of an asset or a combination of  asset which together constitute a singleproject”. Example of activity  covered bysuch contracts include the construction of bridges, dams, ships, building andcomplex pieces of equipment and oil exploration contracts. The contract priceis normally estimated in advance of the work. Additional work found necessarymay be charged on a cost-plus basis. In addition, clause may be inserted toallow the contractor to pass on the customer additional cost incurred as aresult of increase in material, labour and other cost.

Payment by thenumber for various staged of the contract is made only on receipt ofarchitect’s certificate for the completed stage. A reduction called retentionmoney is withheld by the customer until a specific period of time, agreed inthe original contract, has passed.

A contract accountis opened for every individual contract and record all the costs incurred incarrying the contract work. All material purchased from suppliers or got fromthe ware house is debited to the contract account. Sometimes material can bescraped and sold, the scrap sales are shown on the credit side of contract ofthe contract account. Materials destroyed by fire or stolen are credited toprofit and loss account.

 Contract or Terminalcosting is seen also as the system employed by firms which devote allenergies to one or two, big contracts in a year.   Contract costing applies where a form contractis made between the customer and supplier. The work is usually undertaken customers’ special requirements, of longduration and constructional in nature, Building           and construction work, civil engineering and ship building.

This isanother form of job costing as jobs are done to owners’ specifications orrequirements. The difference being that the job is completed over a longerperiod of time and in most cases it is carried out on the site or premises ofthe contract employer or owner. Also contracts are of the nature ofconstruction or civil engineering that usually involve huge sums of money.

All materials, plantand equipment, vehicles, utilities (e.g. electricity, telephone etc.) bought ortransferred to a contract constitute the direct costs. Administration costs, aproportion of Head Office expenses and joint costs shared by other on-goingcontracts of the organization constitute indirect costs. A contract account isopened for each ‘ contract to determine its profit or loss with all costs,direct or indirect debited.

Due to the longduration and heavy cost of most contracts, progress payments are made to thecontractor on the basis of work certified by architects or engineers. Oncompletion of the contract, a percentage of the contract value is retained asrectification cost or retention fee by the contractee. The money, a kind ofquality guarantee deposit is paid back to the contractor if no material defectis found on the job, say six months after completion.

Where a contract isstarted and completed in a single accounting period, the profit or loss on thecontract is the difference between:

“The contractprice, materials c/d, materials returned from site, plant and machinery c/d onthe credit side and all direct costs, including sub-contracts and indirectcosts on the debit side.”

Where the contractextends beyond one accounting year, the profit to be transferred to thecompany’s profit & loss account will be considered


  1. A formal contract is made between the customer and the supplier.
  2. Work is undertaken to customer’s special requirements.
  3. The work is for relatively long duration.
  4. The work is frequently constructional in nature.
  5. The method of costing is similar to job costing
  6. The job frequently base on size
  7. Retention money may be deducted from progress payment.
  8. A contract includes clauses for penalty for delayed completion andbonus for early completion.
  9. Payments on account are often made against work certified.


  1. Problem ofidentifying direct cost:- Due to the large size of the job, many cost itemswhich are usually regarded as production overhead are charged as direct cost ofthe contract e.g. hire of plant, supervision, sub-contractor’s fees or charges,telephone installed in the site etc.

2.   Problem of low indirectcost:-Inview of many costs usually classified as overhead being charged as direct costof the contract, the absorption rate for overhead should only apply to costitems which are not already direct cost e.g. head office expenses.

3.   Difficulty of cost control:-Because of the scaleof contract and size of sites, there are often cost control problems e.g.

(a)   Material usage and losses – theft orpilferage.

(b)   Labor utilization and supervision.

(c)   Damage to and loss of plant and tools.

(d)   Unexpected cost involving rectificationcost, penalties for late completion, etc.

4. Problem ofdividing profit between different account period:- How to divide profit betweenthe periods particularly when a contract cover two or more accounting periodsis a problem.                      

TERMINOLOGIES in contract costing

  1. Contract price:- This refers to aprice of the contract as may be agreed between the contractor and the contract.The price is usually binding until the work done is certified.
  2. Progress payment:- The contractnormally provides for the client to make payment either at specific stages ofthe work e.g. when foundation is completed, or first floor completion or atparticular agreed interval. The basis for this interim payment is an architectcertificate of work satisfactorily completed.
  3. Architect certificate:- This is acertificate issued by experts certifying the work or any

portion of the work satisfactorily completed. It shows the workdone at selling price (market value), and this certificate accompanies theinvoice sent to the customer. The amount paid is normally the certified valueless the % retention which is released when the contract is fully completed andaccepted by the customer.

  • Retention fee:- This is the amountagreed to be withheld by the contract at the end of the contract, and whichwill be released to the contractor after the agreed period. It serves as aguarantee against any bad work or unexpected damage due to imperfect job bycontractor.
  • Estimated profit:- This is thedifference between the contract price and the estimated cost of the contract.
  • Cost-to-date:- This representsthe total cost incurred to date on the contract It is obtained by adding allcost incurred to date.
  • Work certified:- It is alwaysnecessary that at every point of the contract, an expert has to be called in bythe contract to certify that such portion performed by the contractor has beenproperly performed and according to schedule. Any uncertified portion is knownas work not yet certified e.g. 60% completed, 10% uncertified: 50% certifiedplus 10% not yet certified.
  • Cost of workcertified:- This is the total cost incurred on the portion certified. It isthe cost to date minus cost of work not yet certified.
  • Value of work certified:-This is the market value of work certified as may be determined by the costaccountant.
  • Notional profit orloss:- This is the profit earned on the contract to date. It is calculated as thedifference between the value of work certified to date and the cost of workcertified to date.

1.            Where the contract has just started

2.            Where the contract is reasonablyadvanced but is stili difficult to estimate cost necessary to    complete.

3.            Where contract is nearing completionand cost necessary to complete can be easily estimated.

1.         Wherecontract has just started

It isgenerally recommended that no profit should be taken on the contract at thisstage. But if, however, any loss is ascertained from the contract account, it shouldbe charged in full to profit & loss account. This is in line with theconvention of conservatism which forbids the anticipation of profits.

2 .If  the Contract  is Fairly Advanced

At this level only aproportion of the apparent profit on the contract to date is taken. Theproportion taken vary among companies. Most firms take 2/3 or 3/4 but for thepurpose of this book, 2/3 is recommended, and the profit taken is calculatedas:

Cash Received

  1. 2/3 x Apparent profit         x    value of work certified

Where: Apparent(Notional) profit is;

Value of workcertified                                                          

Less: Cost of work todate                                                                  

Less: Cost of worknot yet Certified                           

Apparent profit                              

3.        When the contract is nearing completion

Where the contract isclose to completion with say over 80% of total work done, and it is easy toestimate with reasonable certainty cost necessary to complete. The estimatedcontract profit is obtained by deducting from the contract price the cost todate plus estimated cost necessary to complete, provision for contingencies,including rectification cost. The profit is further reduced by the formula.

Cost of work completed

  Estimated profit        Total cost oncompletion

Any profit that hasbeen taken in previous years will be deducted to get the profit to be creditedto the current year profit and loss account.

All labour employedat the contract side should be regarded as direct labour and charged direct tothe contract concerned as debited entries. Wages accrued or outstanding at theend of the period should appear on the debit side of the contract account. Alldirect expense other than material and labour are charged to individualcontract as and when they incurred e.g sub-contractor charges. The contractaccount is shown figure  below


                                             ContractAccount Number………….

UGX                                                    NAIRA                                                            NAIRA

Materialcosts                                       xxxx                 Un-used material                   xxxx

Labourcosts                                        xxxx                 Book value of plant               xxxx

Overheadcosts                                                xxxx                 Work certified                                   xxxx

Sub-contract charges                           xxxx                   Uncertified work                  xxxx

Plantcost                                             xxxx                Other costs                               xxxx


ToP&L account                                  xxxxx                Notional profit b/d                xxxxx 

To Reserve account                             xxxxx 

Work in progressincludes the amount of work certified (valued at contract price) and the amountof work uncertified. The work in progress will appear in the balance sheet as acurrent asset. It is computed as follows:                                                                    


Workin progress:                                                       

Costincurred to date                                                    xxxxx

Profit(loss)                                                                  xxxxx


Less:Invoiced amount                                                 xxxxx

Work– in progress                                                      xxxxxx

Profit onincomplete contracts:

The principalproblem relating to accounting for construction contract is the allocation ofrevenues and related costs to accounting periods over the duration of thecontracts.

Some contract maytake more than one year and hence not matching the accounting year. A problemarises whether profit on such contract should be worked out only on itscompletion or whether some profits may be computed every year. In this case,the manner of computation of profit is largely dependent upon how far thecontract has advanced that is, the stage of completion it has reached.

The principleestablished in IAS 11 is that profit can be recognized once the outcome of acontract can be reliably as profitably. Such contract should be assessed on acontract by contract basis and reflected in the income statement by recordingrevenue and related costs as contract activity progresses.

Contract revenue isascertained in a manner appropriate to the stage of completion of the contract,the business and the industry in which is operates.

Where it isconsidered that the outcome of  a constructioncontract can be assessed with reasonable certainty before its conclusion,the  prudently, calculated attributedprofit should be recognized in the income statement as  the different between the reported andrelated cost for  that contract.

If the expectedoutcome is a profit, revenue/ expense will be recognized according to thecompletion of that contract. Under this method contract revenue, is matched,with the contract cost incurred is reaching the stage of comp99letion, resulting in the reporting of revenue, expensesand profit proportion of work done.

The standard doesnot specify the method of determining percentage of completion, but it may bearrived at using the following formulae.

Either:              Percentage of completion =Certified work

                                                                  Contract price/revenue

Or                    Percentage of completion=      Cost to date    

                                                                    Total estimated contract cost


RokoConstruction Company is engaged in a number of long- term contract. Thefollowing details relate to the three uncompleted contracts in the company’sbooks at 31 December 2015.

ContractNumber                                 021                       022                  023

                                                            N                            N                    N

Costof work to 31st Dec. 2015                        1,218,000        1,091,200          545,600


Valueof work to 31st Dec. 2015                     1,540,000         880,000              72,000

Progresspayment made                                   1,320,000         704,000            440,000

Progresspayment received                  1,100,000         704,000            440,000

Estimateof full cost + future cost        1,320,000         1,540,000      2,640,000

Finalcontract price                              1,672,000         1,232,000      3,520,000

Note: The cost of work to 31stDecember 2015 has been determined after crediting unused material and thewritten down value of plant use.


  1. Preparea statement for the managing director showing your calculation for each contractof the valuation of work in progress at 31st December 2015, and thenet profit (loss) included therein.
  2. Showas an extract the information which should appear in the Balance sheet for thework in progress.


ContractNo.                            021                  022                  023

Degreeof completion:            

= Value of workcertified        1,540,000        880,000          572,000

Contractprice                          1,672,000        1,232,000        3,520,000

                                                92%                 71%                 16%


ContractN0.                                        021                  022                  023

                                                            N                     N                     N

Contractprice                                      1,672,000        1,232,000        3,520,000

Estimatedtotal cost to

Completion                                          1,230,000        1,540,000        2,640,000

Attributable profit/loss                       352,000           (308,000)         880,000

Valuationof work in progress:

Costincurred to date                            1,218,000        1,091,200        545,600                       2,854,800

Profit (loss)                                             323,840        (308,000)         ———–          15,840

                                                          1,541,840             783,200                    545,600                       2,870,640

Work in progress for balancesheet

WIPto date                                          1,541,840        783,200                       545,600                       2,870,640

Less invoiced amount                          1,320,000        704,000           440,00                         2,464,000

                                                            221,840          79,200             105,600                       406,640


  1. ContractNo. 021

Theprofit of  N 352,000 should be recognizedsince the contract has already reached advanced stage.

  • ContractNO. 022

Hasa for seeable loss of N308,000 which is to be charged in full against profitand loss account for the year.

  • ContractNO. 23

Hasnot advanced since its degree of completion of 16% is less than the recommended25%. NO profit is to be recognized in this contract.

The following particularsrelate to a contract undertaken by Roko construction


Chuks  Construction Ltd. worked on two majorcontracts during a financial period. The contracts Nos. 25 1 and 252 were atvarious stages of

Completion and otherdetails were as follows:


            No. 251 No. 252
  N’000 N’000
Contract price 90,000 150,000
Total cost to date 27,200 95,450
Estimated cost to completion 37,600 15,500
Contingencies 50
Value of work certified 37,800 129,000
Cost of work not yet certified 4,700 9,600
Cash received 32,000 125,000
Rectification cost 2,000
Profit earlier taken 16,800


Calculate the profitto be taken to the years profit and loss account in respect of contract Nos.251 and 252.

To be able calculateprofit to be taken, first estimate the level of completion for each contract.Estimated level of completion =

                              Cost to date X                100

                                            Totalcost to completion

                                                N27,200,000x 100

Contract No. 251         =          N64,800,000

                                    =          42%

                                                N95,450,000x 100

            Contract No. 252         =               N111,002,000

                                                =         86%

At 42% and 86% levelsof completion contract Nos. 251 and 252 can be respectively said to be fairlyadvanced and nearing completion. Therefore profit to be taken can be calculatedas.

Contract No. 251

N’000                                   N’000

Value of work certified                                                                                  37,800

Less: cost to date                                 27,200

Less: cost of work not yet certified      4,700   22,500

Apparent profit                                                                                N 15,300

Profit taken = 2/3 x Apparent Profit x

Cash Receivedvalue of work             certified Nl5,300,000N32,000,00037,800,000

Contract No. 252

N ‘ 000                                N ‘000

Contract price                                                                                        150,000

Less: Cost to date                                                          95,450

Estimated cost to complete                                         15,500

Contingencies                                                                          50

Rectification cost                                                           2                     111,002

Estimated contract profit                                                                      N38,998

Profit taken =

  • cost of work completed   x       Estimated profit

Total coston completion         

= N95,450,000 x N38,998,000


              = N 33,534,162


Profit taken to date                                                                  33,534

Less: profit earlier taken                                             16,800

Profit taken this year                                                       16.734

The company’s profitand loss account for the year will be credited with N8,634,921 for contract No. 251 and N16,734,000 for contract No.252 as profit taken.

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