# Contract Costing
## Definition
A form of specific order costing where each contract is treated as a separate cost unit. Costs are accumulated and ascertained independently for each contract.
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## Features of Contract Costing
- A separate contract account is prepared for each contract
- Contracts are usually large in scale, typically spanning more than one year
- Work is executed at the site of the contract (not in the factory)
- Only a small number of contracts are handled simultaneously
- Two parties: Contractor (undertakes the work) and Contractee (awards the contract)
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## Job Costing vs. Contract Costing
| Aspect | Job Costing | Contract Costing |
|---|---|---|
| Scale | Smaller work | Large-scale work |
| Location | Factory premises | Site of contract |
| Indirect costs | Higher proportion | Lower proportion |
| Number undertaken | Usually many | Usually few |
| Duration | Short-term | Often > 1 year |
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## Key Terms and Formulae
| Term | Meaning | Formula |
|---|---|---|
| Value of Work Certified (VOWC) | Work completed and certified by contractee's architect | Contract Price × % certified |
| Progress Payment (PP) | Payments received based on architect's certificate | VOWC − Retention Money |
| Retention Money (RM) | Security withheld by contractee | VOWC − Payment actually received |
| Cost of Work Uncertified (COWU) | Cost of completed but uncertified work | Total cost to date − Cost of certified work |
| Notional Profit | Profit on the certified portion | VOWC − Cost of Work Certified |
| Estimated Profit | Total expected profit on the entire contract | Contract Price − Estimated total cost |
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## Cost Plus Contract (Contract Plus Costing)
Contract price = Total Actual Cost + Fixed % of Profit
When used: When estimating contract cost with reasonable accuracy is not possible (novel, complex, multi-year projects).
### Features
- Suitable when contract completion will take several years
- Contractee has the right to inspect the contractor's books
- Aims for fair price to contractee and reasonable profit to contractor
### Advantages and Disadvantages
| Party | Advantages | Disadvantages |
|---|---|---|
| Contractor | Assured fixed % profit — no loss risk; protected against cost escalations | Cannot exploit favorable market conditions; no reward for cost efficiency; fear of cost objections |
| Contractee | Can verify actual costs via book access; gets benefit of cost decreases; price based on actuals not estimates | Bears risk of contractor's inefficiency; may pay higher costs due to contractor's reduced incentive to control costs |
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## Escalation Clause
A contractual safeguard clause that revises the contract price upward if prices of materials or labour rise beyond a specified threshold. Protects the contractor from unforeseeable cost increases over a long contract period.
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## Sub-Contract
When a contractor assigns a portion of the work to another party — the sub-contractor. The sub-contractor is accountable to the main contractor (not the contractee). Cost of sub-contract work is treated as a direct cost of the main contract.
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## Profit Recognition on Incomplete Contracts
General principles:
| Stage of Completion | Profit Credited |
|---|---|
| Less than 25% | Nil — no profit recognized |
| 25% to 50% | 1/3 × Notional Profit × Cash Ratio |
| 50% to 90% | 2/3 × Notional Profit × Cash Ratio |
| Above 90% | Reasonable estimated profit, adjusted for contingencies |
Cash Ratio = Progress Payment ÷ Value of Work Certified