What is Contract Account? – Definition
When a contract has been accepted by the contractor, a separate account is opened for each contract in order to bring together all costs relating to a particular contract, and a serial number is given to each contract, which is called contract account.
Explanation of Contract Account
All expenses incurred on account of a contract i.e., materials, wages, direct expenses, cost of sub-contracts, cost of special plant, indirect expenses etc., are debited to Contract Account.
Similarly, expenses accrued or outstanding on the contract at the end of the accounting period are also debited to Contract Account. Materials returned to the supplier, materials and plant returned to store, transferred to other contracts, stolen, destroyed, sold and in hand at the end of the accounting period will appear on the credit side of the Contract Account.
Materials and plant stolen or destroyed are abnormal losses and should be charged to Profit and Loss Account. Similarly, profit or loss arising from the sale of the plant or materials should also be transferred to Profit and Loss Account by way of abnormal items. The Other items to be shown on the credit side of the Contract Account are Contract Price (in case of completed contracts) and the work-in-progress consisting of value of certified work and cost of uncertified work (in case of incomplete contracts).
Format/Specimen of Contract Account
A specimen of Contract Account may be given as follows:
Treatment of various items in the Contract Account
The treatment of the various items included in the Contract A/c has been discussed hereunder:
The cost of materials purchased directly or issued from the stores will appear on the debit side of Contract A/C. Materials returned to suppliers and stores will appear on the credit side. Amount received from the sale of surplus materials will be credited to Contract A/C, any profit or loss arising therefrom to be transferred to Profit and Loss Account by way of abnormal item.
Materials lost, stolen or destroyed by accident, fire etc., will be charged to Profit and Loss A/c by way of abnormal loss. Values of material in hand at the end of the accounting period will appear on the credit side of Contract A/C. Sometimes, materials are transferred from one contract to another contract. In such a case, the contract receiving the materials is debited and the contract sending the materials is credited. The treatment of the various items of material in Contract Account can be explained with the help of the following example.
B undertook a Contract No. 5 for the construction of a cinema building. He purchased material for the contract at a cost of $80,000. Issues from stores were $45,000. Materials valued $3,000 were returned to stores while materials costing $2,000 were stolen and those costing $500 were destroyed by fire. Materials costing $5,000 were sold for $4,800. Materials worth $25,000 were received from Contract No. 3 which was completed. Materials worth $1,000 were transferred to Contract No. 15. Materials in hand at the end of the accounting period were valued at $10,000. Show the treatment of the materials in Contract Account No. 5.
(B) Labour Cost:
All the workers engaged at the site of a particular contract, irrespective of the nature of the work performed by them, are treated as direct workers and the amount of wages paid to them as direct wages. Such wages are to be charged to the particular contract directly. In case a worker (generally the supervisory staff) is engaged at two or more contracts, his total wages may be apportioned to different contracts on the basis of time devoted to each contract or on some other equitable basis. Wages accrued or outstanding at the end of the accounting period should appear on the debit side of the Contract Account.
The following data are available for the year ending 31st March, 2019 relating to Contract No. 2, commenced on 1st April, 2018. Direct Wages paid $85,000 wages Accrued on 31st March, 2019 $12,000 Show the treatment of these items in Contract No. 2 Account.
The plant purchased by the contractor for executing the contract may be divided into two parts —Special Plant and General Plant.
Special plant refers to the plant which is specially purchased for a particular contract and is expected to be used for that contract over a long period. The value of the special plant at the commencement of the use period (i.e., the original cost including installation charges or written down value) is debited to the Contract Account.
At the end of the accounting period, value of the plant after providing appropriate amount of depreciation i.e., depreciated value, shall be credited to Contract Account. In this way, the amount of depreciation on plant is automatically charged to the contract account. While calculating the value of plant in hand, the value of plant returned to store, plant sold, and plant destroyed, etc., should also be taken into account.
A plant costing $80,000 was purchased for Contract No. 5 on 1.4.2019. Plant worth $4,000 was returned to store and plant costing $4,000 was sold for $6,000. Plant worth $2,000 was stolen and worth $8,000 destroyed by fire. Value of plant in hand at the end of the year 31.3.2020 was $40,000. Show how the plant would be treated in Contract Account No. 5.
B purchased a plant for Contract No. 5 on 1st July, 2019 at a cost of $40,000. Show the treatment of plant in contract account by depreciating it by (i) 10 percent and (ii) 10 percent per annum, assuming that accounts are closed on 31st March, each year.
A contractor purchased a plant on 1.4.2019 for Contract No. 3 at a cost of $1,00,000. Plant costing $20,000 was returned to stores on 31.12.2019. Plant costing $5,000 was lost in an accident on 30.9.2019. Plant costing $10,000 was found unsuitable and sold immediately at $11,500. Show the treatment of the plant by providing depreciation at 20% per annum. The books are closed on 31st March, each year.
General Plant refers to the plant which is purchased for use at two or more contracts. In the case of general plant, an hourly, daily, weekly or monthly rate of depreciation may be ascertained and the amount of depreciation can be charged to each contract according to the actual use of the plant at the site of the contract. The treatment of depreciation on general plant can be explained with the help of the following example:
A plant was purchased for $52,000 on 1st April, 2019. It was expected that the life of the plant is 5 years and at the end of the 5th year, its scrap value will be $2,000. The plant was used for 73 days on Contract No. 31. Show the treatment of plant in Contract No. 31 Account.
(D) Direct Expenses:
All expenses (other than material cost and direct wages) which have been incurred specifically for a particular contract are direct expenses and shall be debited to contract account. Example of direct expenses are: hire charges of special plant (not owned), carriage on materials purchased, traveling expenses relating to the contract, etc.
(E) Indirect Expenses:
There are certain expenses which cannot be directly charged to a particular contract e.g., salary of general manager, salary of architect engaged at a number of contracts simultaneously, salary of store-keeper, expenses of store and office expenses. Since these expenses are incurred for the business as a whole, they are to be apportioned to the different contracts on some equitable basis.
(F) Cost of Sub-contracts:
Generally, the work of a specialized character e.g., road construction in a building- installation of lifts, electrical fittings is passed on to some other contractor by the main contractor. In such cases, the work performed by the sub-contractor forms a direct charge to the contract concerned and the sub-contract price paid shall be debited to Contract Account.
(G) Cost of Extra Work:
Sometimes, in case of a contract, some additional work or variations of the work originally contracted for, may be required by the contractee. Since the additional work required will not be covered by the terms and conditions of the original contract, it will be the subject of a separate charge. If the additional work required by the contractee is quite substantial, it should be treated as a separate contract and dealt with in a separate account to be opened for it.
But in case the additional work is not substantial, the expenses incurred on extra work should be debited to contract account as Cost of Extra Work and the extra amount which the contractee has agreed to pay to the contractor should be added to the original contract price.
(H) Contract Price:
The contract price is the agreed price at which the contractor undertakes to execute the contract. The contract account is credited with the contract price if it has been completed. In such a case, the amount of contract price is debited to the Contractee’s Personal Account and credited to the Contract Account. No entry is passed in respect of the contract price in case of incomplete contracts.
The amount of work-in-progress to be included on the credit side of the contract account in respect of an incomplete contract comprises:
(i) Work Certified. and
(ii) Work done but not certified.
(i) Work Certified
In case of large contracts, it is usual for the contractor to receive sums on account from the contractee from time to time. These sums will be paid against issued by the contractee’s architect, surveyor or engineer as to the value of the work so far completed by the contractor. The work completed by the contractor and certified to be complete by the contractee’s architect or engineer is as Work certified or Work certified or Work completed and certified.
(ii) Work done but not Certified
Work relating to an incomplete contract which has been done but has not yet been certified by contractee’s engineer or architect is known as Uncertified Work or Work done but not Certified. It comprises the work done since the date of the last certification and should be valued on the basis of the actual cost.
The amount of work-in-progress (work certified and work done but not certified) in case of incomplete contracts at the end of the accounting period is debited to Work-in-Progress Account and credited to Contract Account. At the beginning of the next accounting period, such amount is debited to Contract Account and credited to Work-in-Progress Account.
Generally, the terms of the contract provide that the whole of the amount shown by the architect’s certificate shall not be paid to the contractor but a specified percentage or portion (say 10% or 20%) thereof shall be retained by the contractee till the completion of the contract. The money so retained is known as Retention Money. Suppose, the total value of work certified is $1,00,000 and it is agreed that 20% of the work certified shall be retained till the completion of the contract, the contractee shall pay $80,000 to the contractor immediately and keep $20,000 (20% of $1,00,000) as Retention Money till the completion of contract.