Contract Account – SS3 Financial Accounting Lesson Note (Second Term)

A contract account is a system of cost accounting used by contractors engaged in construction and building works. It is used when a firm carries out many separate contracts at the same time, and when each contract may continue over a long period, sometimes many years. It helps the contractor to find the profit on each contract.

Behavioural objectives

By the end of the lesson, students should be able to:

1. Define contract account.
2. State the features of a contract and the reasons for a contract account.
3. Distinguish between short-term and long-term construction contracts.
4. Mention and explain some terms used in contract accounts.

What are the features of a contract?

1. The direct costs are large.
2. It is site-based.
3. It is undertaken to the customer’s special requirements.
4. It is of relatively long duration.
5. There is a low indirect cost.

Why is a contract account kept?

1. To find the profit of each contract.
2. To ascertain the level of contract execution.
3. To take care of businesses whose nature of work does not conform to a financial year’s calculation of profit.

What is a construction contract?

A construction contract is the execution of building and civil engineering projects, mechanical and electrical engineering installations and other fabrications. It is usually evidenced by an agreement between two or more parties (that is, the contractor and the customer).

Types of construction contract

1. Short-term construction contract
2. Long-term construction contract

Short-term construction contract: a contract that is expected to start and finish within one accounting period.

Long-term construction contract: a contract entered into for the manufacture or building of a single substantial entity, or for the provision of a service. The time taken is such that a substantial proportion of the contract work will extend for a period exceeding one year.

What are the terms used in contract accounts?

1. Revenue recognition: the process of accounting for revenue in the financial statements when it has been earned.
2. Contract work in progress: the accumulated certifiable cost of a contract that is yet to be completed.
3. Mobilisation fees: the amount advanced by the employer to a contractor to enable construction work to start.
4. Contract certification: the process by which the project’s architect or engineer issues a certificate to evidence the value of work done on a construction contract as at a particular date.
5. Retention monies: a contract clause often entitles the customer to withhold payment of a proportion of the contract value (10%) for a specified period after the end of the contract.

Evaluation

1. Define contract account.
2. Mention and explain some terms used in contract accounts.

Assignment

1. State three reasons for keeping a contract account.
2. Distinguish between a short-term and a long-term construction contract.