Cost Accounting · Contract Costing

Introduction to Contract Costing: Meaning and Features

Updated 10 October 2026 · Fact-checked

Contract costing is a method of costing used when work is done on a large, long-duration project for a specific customer, usually at the customer's site. Each contract is treated as a separate cost unit with its own account. To solve questions, identify the contract, classify its costs as direct or indirect, and record them in a contract account.

Understand Introduction to Contract Costing

Some work is too big to finish in a few days. Think of a bridge, a building, a road or a dam. The customer places an order, the contractor builds at the customer's site, and the work may run for months or years. Ordinary job costing does not fit well here, so we use contract costing.

In contract costing, each contract is a cost unit and gets its own contract account. You collect every cost of that contract in one place and compare it with the contract price. The person who gives the work is the contractee (or contract giver). The person who does the work is the contractor.

The main features are these:
- Work is done as per the customer's specifications, so each contract is unique.
- Work is usually carried out at the contract site, not in a factory.
- Most costs are direct. Material, labour, and expenses are charged straight to the contract.
- Contracts are long, often spanning more than one accounting year, so profit on an incomplete contract has to be considered at each year end.
- Payment is received in stages, based on work certified by an architect or engineer, and a part is held back as retention money.
- Indirect costs are small. General head-office overheads are usually excluded from the contract account. Only expenses specifically incurred for the contract are charged to it.

Types of contracts commonly seen are:
- Fixed price contract: the price is fixed in advance, possibly with escalation clauses.
- Cost plus contract: the price equals the actual cost plus an agreed profit, either a fixed amount or a percentage of cost.
- Contracts can also be classified by size or purpose, such as construction, civil engineering, shipbuilding and interior work. Exam questions mostly use the first two.

Applicability: contract costing suits construction firms, civil engineers, shipbuilders, bridge and road builders, and interior decorators. A short job done in a workshop is better suited to job costing.

Key rules to remember

Contract price in a cost plus contract: Contract price = Total cost of contract + Agreed profit; Agreed profit may be a fixed sum or a percentage of cost. Check whether the percentage is on cost or on price.
Profit as a percentage of contract price: Profit on price (%) = Profit ÷ Contract price × 100; Profit of 20% on cost equals 16⅔% on price. Do not mix the two bases.
Basic contract account balance: Notional profit = Work certified (cumulative) + Closing work uncertified (at cost) + Closing stock of materials + Plant at site (depreciated value) − Total debits of the contract account; Used when the account is closed for an incomplete contract. Total debits are the opening balances of stock of materials, plant and work uncertified, plus all costs of the period. This is the same as: Notional profit = Work certified (cumulative) + Closing work uncertified (at cost) − Opening work uncertified (at cost) − Net cost of work done, where Net cost of work done = Total debits (excluding opening work uncertified) − Closing stock of materials − Plant at site (depreciated value). In the first year there is no opening work uncertified, so the formula reduces to: Notional profit = Work certified + Work uncertified − Net cost of work done. In a later year, the opening balances of stock of materials, plant and work uncertified are debited. Work certified is credited at the cumulative figure, so opening work certified is not debited or credited separately. This way the same work is not counted twice. Detailed treatment follows in later topics.
Net cost of work done: Net cost of work done = Opening stock of material + Opening plant at book value + Direct material + Direct labour + Direct expenses + Indirect costs specific to the contract + Plant at cost (if bought in the year) ± Adjustments for outstanding and prepaid expenses − Closing stock of material − Depreciated value of plant at site; Only costs specific to the contract are charged. Head-office overheads are excluded. Work uncertified is not part of net cost of work done. It is added on the credit side only, and in later years the opening work uncertified is deducted as shown in the basic formula above. For outstanding and prepaid expenses, add the closing outstanding and deduct the closing prepaid. Reverse the opening ones: deduct the opening outstanding and add the opening prepaid. Plant bought for the contract is charged at cost and its depreciated value at year end is credited. So for plant bought for the contract and still at site at year end, the net charge is its depreciation. Plant brought forward from an earlier year is debited at its opening book value instead. Closing stock of material is also deducted.

How to solve Introduction to Contract Costing questions

Use this method for theory questions and for the simple numerical questions that introduce contract costing.

1Read the question and identify the contractor, the contractee, the contract price and the contract duration.
2Decide whether the question needs a definition, features, a comparison or a numerical. Choose the answer format at once.
3For theory, write the definition first, then the features as separate numbered points, each with a one-line reason.
4For comparisons, draw a two-column table with at least five points: unit of cost, duration, location, nature of work, and treatment of profit.
5For numericals, open a contract account and list each cost under direct material, direct labour, direct expenses and indirect costs.
6Check whether the contract is fixed price or cost plus, and work out the price or profit accordingly.
7State the result with the label, such as total cost, contract price or profit, and add a one-line interpretation.

Quickest way: Five-point recall for features and comparison

When to use it: Use it when a short theory question or a 2-mark MCQ asks about the nature of contract costing or its difference from job costing.

Remember the word SLOW-D: Site, Long duration, One customer's specification, Work certified billing, Direct costs.
Link each letter to one feature and write a line of explanation.
For job costing comparison, flip each point: factory, short duration, often many small jobs, billing at completion, higher overheads.
In MCQs, eliminate any option that says contract costing is used for continuous mass production.

Common mistakes in Introduction to Contract Costing

Saying contract costing and job costing are exactly the same.
Both treat each order as a separate cost unit, so they look alike.
Fix: Remember that contract costing is a form of job costing for large, long-term, site-based work. Always add the points of difference.
Treating all contract costs as indirect and apportioning them.
Students carry over the overhead absorption approach from factory costing.
Fix: Charge material, labour and expenses used on the contract directly. Charge only indirect costs specifically incurred for the contract, and leave out general head-office overheads. If a question gives a basis for allocating site-related overheads, follow that basis and state it clearly.
Confusing the contractor with the contractee.
The terms look similar and are read quickly.
Fix: The contractor performs the work and prepares the contract account. The contractee pays for it.
Mixing up profit on cost and profit on contract price in cost plus contracts.
The words 'profit 20%' are read without checking the base.
Fix: Underline the base. If it is on cost, price = cost × 1.20. If it is on price, price = cost ÷ 0.80.
Ignoring that a contract may span several years.
Students treat the contract as complete in the question year.
Fix: Check the stage of completion. If the contract is incomplete, profit treatment is needed. Study the topic on profit on incomplete contracts.

Worked examples

Example 1

Distinguish between job costing and contract costing. Write five points of difference.

Show the solution

Define both briefly: job costing applies to work done against a customer's order, usually short; contract costing applies to large, long-term work at the customer's site.
Compare size and duration.
Compare location.
Compare overheads.
Compare billing and profit.

Answer: - Duration: A job is usually completed within a short period, often within a year. A contract usually runs for a long period and may span several years. - Size: A job is generally small. A contract is large in value and scale. - Location: A job is usually done in the contractor's own factory or workshop. A contract is usually done at the contractee's site. - Overheads: A job carries a significant share of factory overheads. In a contract, most costs are direct and indirect costs are small. - Billing and profit: A job is billed on completion. A contract is billed in stages on work certified, with retention money held back, and profit is considered at each year end for incomplete contracts.

Example 2

Shree Constructions has a cost plus contract to build a boundary wall. The cost incurred is: material ₹4,00,000, labour ₹2,50,000, direct expenses ₹50,000 and indirect costs specific to the contract ₹40,000. The agreed profit is 15% on cost. Find the contract price.

Show the solution

Total cost = 4,00,000 + 2,50,000 + 50,000 + 40,000 = ₹7,40,000.
Profit = 15% of 7,40,000 = 7,40,000 × 15 ÷ 100 = ₹1,11,000.
Contract price = 7,40,000 + 1,11,000 = ₹8,51,000.
Check: 7,40,000 × 1.15 = ₹8,51,000.

Answer: The contract price is ₹8,51,000, made up of cost ₹7,40,000 and profit ₹1,11,000.

Exam tips

Write the definition in one sentence and then list features in numbered points. Examiners look for the key terms: site, long duration, specific order, stage billing.
In comparison questions, use a table with at least five points. Each point must contrast both methods.
In MCQs, watch for options that assign factory-based or continuous production features to contract costing. Those are wrong.
In numericals, always state whether profit is on cost or on price before calculating.
Keep this topic short and move to the contract account. Numerical questions on contract accounts are common, so use this topic as the base.

Practice questions from Contract Costing

Introduction to Contract Costing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Introduction to Contract Costing: frequently asked questions

What is contract costing in simple words?

It is a method of costing for large projects done for a specific customer, usually at the customer's site and over a long time. Each contract has its own account where all costs are collected. The account is compared with the contract price to find profit.

How is contract costing different from job costing?

Contract costing is used for big, long-duration work at the customer's site, with mostly direct costs and stage billing. Job costing is used for smaller, short jobs, usually in the contractor's own factory, and carries more overheads. Both treat each order as a separate cost unit.

What are the main types of contracts in cost accounting?

The two main types are fixed price contracts and cost plus contracts. In a fixed price contract the price is agreed in advance. In a cost plus contract the price is the actual cost plus an agreed profit.

Where is contract costing used?

It is used in construction, civil engineering, road and bridge building, shipbuilding and interior work. It suits any work that is large, specific to one customer and takes a long time to finish.