Contract Costing – Characteristics And Calculations Of Progress Payments And Interim Profits (Spreadsheets).

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Do you have a contract that has the following characteristics?

  1. Problems of cost control concerning pilferage, material usage, labor utilization and supervision, vandalism and sometimes losses. The scale and size of the site may be responsible for these problems,

2. Direct costs traceable to the contract are in high proportion. Such direct costs may include transportation, design cost, wages and salaries, telephony and power usage,

3. Are the indirect costs low? And is there a likelihood of having surplus materials at the end of the contract?

The above are characteristics of a contract which progress payments are made at specific stages or intervals of the work.

Progress or interim payments are usually made on the basis of certificate of work (job completion certificate) satisfactorily done. It is usually issued by an expert in the field relevant to the awarded contract.

The certificate issued at every interval shows the value of the work done at contract prices (or selling prices). It is standard practice to attach this certificate to the invoice (and other necessary accompanying documentation) sent to the customer.

The amount paid by the customer to the contractor is normally made of the certified value minus percentage retention. The percentage retention is released when the contract is completed, all snags cleared and the job is accepted by the customer.

An example; if a customer had already made a progress payment of $100,000 for a work assessed and valued at $300,000 and the retention percentage is 10 percent. The current progress payment would be;

The formula is,

Current payment = (Value certified) – (Retention) – (Payments already made)

      = ($300,000) – (10% of 300,000) – (100,000)

    = 300,000 – 30,000 – 100,000

       = $170,000.

The next progress payment would be $170,000 (check attached spreadsheet).

How is profit calculated for uncompleted contracts?

Contract costing is needed to show the profit or loss on a completed contract. This is not possible when the contract is still in progress. However,

it is necessary to estimate the profit earned from a particular contract within a financial year so that the true financial position (complete with realistic figures) of a business is known.

There is an important thing to note when calculating the profit of an uncompleted contract. The profit should be conservatively calculated to allow for unforeseen challenges and fluctuations of costs.

On the other hand, when losses are anticipated, they should be allowed for in full as early as possible.

The profit of an uncompleted contract should always reflect prudence and the degree of completion. Experts suggest that interim profits should only be taken when the final outcome of the contract can be ascertained with a high degree of confidence.

There are some options for estimating interim profits. These options include;

  1. When substantial costs have been incurred. Some have suggested that substantial costs are made at more than 30% complete and above.

The profit taken is calculated using the formula:

(2/3 or ¾ of the Notional profit) x (cash received from progress payments/value of work certified)

The Notional profit = (Value of Work Certified) –(Cost of Work Certified)

2. When the eventual profit can be estimated with a high degree of certainty. At this stage, the contract is nearing completion, maybe at over 80% complete.

The formula for calculating the profit taken is:

(Progress payments to date/contract price) x (estimated total profit on completion)

The formula above makes allowance for retention percentage but where there is no retention percentage, the following formula is used to calculate profit taken:

(Value of Work Certified/contract price) x (estimated total profit).

Use the attached spreadsheets for calculations.

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