Contract Costing

Cost Plus Contract.

 

Provides for the payment by the customer or the contractee, of the actual cost of manufacture plus a stipulated profit. The item of expenditure to be included in the actual costs are broadly agreed upon in advance, and the books and documents of the manufacturer are open to check and scrutiny by the customer or his representative. The profit to be added to the actual cost may be a fixed amount or it may be in the form of a suitable percentages on cost or on the capital employed.

 

Cost plus contracts are entered into when at the time of undertaking work, it is not possible to estimate the cost of contract with reasonable degree of accuracy due to unstable conditions of material, labour, services etc. are likely to fluctuate. Such contracts are also entered into when special items of work requiring high quality and precision, where estimating is difficult, are to be manufactured and supplied.

 

Cost plus contracts are advantageous both for the manufacturer and the customer, as neither party stands to lose. A fair price is offered to the customer and a reasonable profit accrues to the manufacturer.

 

What are the main features of ‘Cost-Plus-Contracts’.

 

Answer:  The main features of cost-plus-contracts are as follows :

 

1.         This method is adopted in the case of those contracts where the probable cost of the contract can not be ascertained in advance with a reasonable accuracy.

2.         These contracts are preferred when the cost of material and labour is not steady and the contract completion may take number of years.

3.         The different costs to be included in the execution of the contract are mutually agreed, so that no dispute may arise in future in this respect.  Under such type of contracts contractee is allowed to check or scrutinise the concerned books, documents and accounts.

4.         Such a contract offers a fair price to the contractee and also a reasonable profit to the contractor.

5.         The contract price here is ascertained by adding a fixed and mutually pre-decided component of profit to the total cost of the work.

 

 

2.         Discuss briefly the principles to be followed while taking credit for profit on incomplete contracts.

 

            Ans: Principles to be followed while taking credit for profit on incomplete contracts :

 

The portion of profit, to be credited to, profit and loss account should depend on the stage of completion of the contract.  This stage of completion of the contract should refer to the certified work only.  For this purpose, uncertified work should not be considered as far as possible.  For determining the credit for profit, all the incomplete contracts should be classified into the following four categories.

i.    Contract less than 25% complete

ii.    Contracts between 25% and 50% complete

iii.   Contracts more than 50% complete

 

 

 

 

 

            The transfer of profit to the profit and loss account in each of the above cases is done as under :

 

i.          Contract less than 25% complete :    If the contract has just started or it is less than 25% complete, no profit should be taken into account.

 

ii.          Contract between 25% and 50% complete :   In this case one third of the notional profit reduced in the ratio of cash received to work certified, may be transferred to the profit and loss account.  The amount of profit to be transferred to the profit and loss account may be determined by using the following formula :

 

                                   1/3  x  Notional profit  x  Cash received

                                                                         Work certified

 

iii.         Contract more than 50% : In this case, two third of the notional profit, reduced by the portion of cash received to work certified may be transferred  to the profit and loss account.  In this case the formula to be used is as under ;

 

                                   2/3  x  Notional profit  x Cash received

                                                                                      Work certified

Contract nearing completion  :When a contract is nearing completion or 90% or more work has been done on a contract.  The amount of profit to be credited to profit and loss account may be determined by using any one of the following formula.

 

            Estimated profit  x  Work certified

                                Contract price

 

            Estimated profit  x  Work certified  x Cash received

                                      Contract price     Work certified

 

.                                               or Estimated profit  x   Cash received                       

                                                                          Contract price

 

            Estimated profit  x  Cost of work to date

                                 Estimated total cost

 

d.         Estimated profit  x  Cost of work to date  x  Cash received

                                                                                  Estimated total cost       Work certified

 

                                    e.         Notional profit  x  Work certified

                                                                              Contract price

 

 

3.         Escalation Clause.

 

Answer: Escalation Clause: This clause is usually provided in the contract as a safeguard against any like changes in the price or utilisation of material and labour.  If during the period of execution of a contract, the price of materials or labour  rise beyond a certain limit, the contract price will be increased by an agreed amount.  Inclusion of such a term in a contract deed is known as an ‘escalation clause’.

An escalation clause usually relates to change in price of inputs, it may also be extended to increased consumption or utilisation of quantities of materials, labour etc. In such a situation the contractor has to satisfy the contract  that the increased utilisation is not due to his inefficiency


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