Cost Accounting · Contract Costing

Profit on Incomplete Contracts in Contract Costing

Updated 10 October 2026 · Fact-checked

Profit on an incomplete contract is the part of notional profit you take to the profit and loss account before the contract ends. Find notional profit from work certified, then apply a fraction based on stage of completion: nothing below 25%, one-third from 25% to below 50%, two-thirds from 50% onward, scaled by cash received.

Understand Profit on Incomplete Contracts

A contract may run for several years. If you wait until it ends to record profit, one year shows no profit and the last year shows all of it. So accountants take a fair share of profit each year while the contract is still incomplete.

The starting point is notional profit. It is the profit shown on the work done so far, before any caution. Work certified by the architect or engineer is valued at contract price. Work done but not yet certified is valued at cost. So notional profit = value of work certified + cost of work uncertified − total cost incurred to date.

Notional profit is not all safe to take. The contract may still run into losses, delays or disputes. So you take only a prudent part of it. How much depends on the stage of completion, measured as work certified ÷ contract price. The less complete the contract, the more caution you apply. Below 25% you take no profit. From 25% to below 50% you take one-third. From 50% onward you take two-thirds. The rest is held back as a reserve (profit in reserve).

The contractor has also not received all the money for certified work, because the contractor's client holds back retention money. So the profit taken is scaled by the ratio of cash received to work certified. The idea is that profit is recognised only in proportion to cash actually received.

For a nearly complete contract, the estimated total profit method is commonly used. You estimate the total profit on the whole contract, then take the part that matches the work done. Different methods can be asked for nearly complete contracts, so follow the method named in the question. Where a loss is expected on the whole contract, the full estimated loss is charged to the profit and loss account at once. AS 7 (Construction Contracts) uses the percentage-of-completion method, while Ind AS 115 recognises revenue over time by measuring progress towards satisfying the performance obligation. The fractions on this page are the traditional cost accounting method that ICMAI problems ask you to apply.

Key rules to remember

Notional profit: Notional profit = Work certified + Cost of work uncertified − Total cost incurred to date; Equivalent to work certified − cost of work certified, because uncertified work is valued at cost. Total cost is after adjusting for materials at site, accruals, prepayments and plant depreciation.
Stage of completion: Stage of completion = Work certified ÷ Contract price × 100; This percentage decides which fraction you apply.
Less than 25% complete: Profit transferred to P&L = Nil; The whole notional profit stays in reserve. Here 'less than 25%' means work certified below 25% of contract price.
25% or more but less than 50% complete: Profit transferred = 1/3 × Notional profit × (Cash received ÷ Work certified); Cash received is normally work certified less retention money.
50% or more complete (contract still incomplete): Profit transferred = 2/3 × Notional profit × (Cash received ÷ Work certified); Use this when the contract is more than half done but not nearly complete.
Nearly complete contract: Profit transferred = Estimated total profit × (Work certified ÷ Contract price) × (Cash received ÷ Work certified); Estimated total profit = contract price − (cost to date + estimated further cost). This is commonly used for nearly complete contracts, but other methods exist. Follow the method named in the question.
Profit held in reserve: Reserve = Notional profit − Profit transferred to P&L; This is the balancing figure on the debit side of the contract account (profit in reserve), carried forward. Only the profit transferred is credited to the profit and loss account.
Expected loss: Transfer the entire estimated loss to P&L in the current year; Do not apply any fraction to a loss.

How to solve Profit on Incomplete Contracts questions

Follow the same order each time. Most marks are lost by skipping the stage-of-completion check, not by arithmetic.

1List the data: contract price, work certified, work uncertified (at cost), cash received or retention percentage, and total cost incurred.
2Adjust costs for closing materials at site, outstanding expenses, prepaid expenses and plant at site after depreciation, so the total cost is correct.
3Find notional profit: work certified + cost of work uncertified − total cost incurred.
4Compute stage of completion = work certified ÷ contract price. Pick the rule: below 25%, 25% to below 50%, 50% or more, or nearly complete.
5Find cash received. If only retention % is given, cash received = work certified × (100% − retention %), after any cash already received is accounted for.
6Apply the formula for the right band and show the working: fraction × notional profit × cash received ÷ work certified.
7Calculate reserve = notional profit − profit transferred, and complete the contract account with the P&L transfer and the reserve as balancing items.
8Write the answer with one line of interpretation, for example 'profit of ₹X is credited to P&L and ₹Y is carried as reserve'.

Quickest way: Band, fraction, cash ratio

When to use it: Use this when the question asks only for the profit to be transferred and gives no contract account to prepare.

Compute work certified ÷ contract price in your head or on the margin. Decide: below 25%, 25–50% or 50% and above.
Write the notional profit in one line: work certified − cost of work certified. Uncertified work adds equally to the cost and to the value, so it does not change profit.
Write the fraction (nil, 1/3 or 2/3), then multiply by the cash ratio. For 80% cash, multiply by 0.8.
Subtract from notional profit to get the reserve.
Check that profit transferred is never more than notional profit.

Common mistakes in Profit on Incomplete Contracts

Applying 2/3 or 1/3 without checking the stage of completion.
Students memorise the fractions and forget the bands that select them.
Fix: Always calculate work certified ÷ contract price first and write the band before using any fraction.
Valuing uncertified work at contract price instead of cost.
Students treat all work done as if it were certified.
Fix: Only certified work is shown at contract price. Uncertified work is carried at cost, so it adds no profit.
Using cash received ÷ contract price in place of cash received ÷ work certified.
Both ratios look similar and both involve cash.
Fix: For notional profit methods, the cash ratio is cash received ÷ work certified. Contract price appears only in the stage-of-completion test and in the estimated profit method.
Forgetting to adjust total cost for materials in hand, outstanding expenses and plant depreciation.
Students rush to the profit formula and use the raw expense figures.
Fix: Prepare the contract account first. Take total cost after closing materials, accruals, prepayments and plant value are adjusted.
Transferring only a fraction of an expected loss.
Students apply the profit rules to losses too.
Fix: If the contract is expected to make a loss overall, charge the entire estimated loss to P&L at once, following prudence.
Treating retention money as cash received.
Students see 'work certified' and 'cash received' as the same figure.
Fix: Cash received = work certified − retention money. Retention is due from the contractee and is not cash yet.

Worked examples

Example 1

Sharma Constructions is building a bridge for a contract price of ₹20,00,000. At year end: work certified ₹12,00,000; cost of work certified ₹9,00,000; cost of work uncertified ₹50,000; cash received ₹9,60,000. Calculate the profit to be transferred to the profit and loss account and the reserve.

Show the solution

Total cost incurred = ₹9,00,000 + ₹50,000 = ₹9,50,000.
Notional profit = work certified + cost of uncertified work − total cost = ₹12,00,000 + ₹50,000 − ₹9,50,000 = ₹3,00,000.
Stage of completion = ₹12,00,000 ÷ ₹20,00,000 = 60%. This is 50% or more, so use 2/3.
Cash ratio = ₹9,60,000 ÷ ₹12,00,000 = 80%.
Profit transferred = 2/3 × ₹3,00,000 × 80% = ₹2,00,000 × 0.8 = ₹1,60,000.
Reserve = ₹3,00,000 − ₹1,60,000 = ₹1,40,000.

Answer: Profit of ₹1,60,000 is transferred to the profit and loss account. ₹1,40,000 stays as reserve.

Example 2

Iyer Infra has a contract priced at ₹10,00,000. At year end: work certified ₹3,00,000; total cost incurred to date ₹2,40,000, which includes ₹20,000 for work not yet certified; cash received ₹2,70,000. Find the profit to be taken to the profit and loss account.

Show the solution

Notional profit = ₹3,00,000 + ₹20,000 − ₹2,40,000 = ₹80,000.
Stage of completion = ₹3,00,000 ÷ ₹10,00,000 = 30%. This is 25% or more but less than 50%, so use 1/3.
Cash ratio = ₹2,70,000 ÷ ₹3,00,000 = 90%.
Profit transferred = 1/3 × ₹80,000 × 90% = ₹26,667 × 0.9 = ₹24,000 (exactly: ₹80,000 × 0.3).
Reserve = ₹80,000 − ₹24,000 = ₹56,000.

Answer: ₹24,000 is transferred to the profit and loss account, and ₹56,000 is carried as reserve.

Exam tips

Write the stage-of-completion percentage and the band as the first line of your answer. Step marks are usually given for this.
Show the formula with numbers substituted, not just the final figure, so a small slip still earns method marks.
When the contract account is asked for, show profit transferred and reserve as the last items so it balances.
In MCQs, check the band first. Many wrong options come from using the wrong fraction. A figure below 25% completion gives nil profit.
If the question names a method (for example estimated profit), use it exactly as stated even if you prefer another.

Practice questions from Contract Costing

Profit on Incomplete Contracts in other exams

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

CA FoundationFinal Accounts from Incomplete Records

Profit on Incomplete Contracts: frequently asked questions

What is notional profit in contract costing?

It is the profit shown by the contract account before any part is held back. You get it as work certified plus cost of uncertified work, less total cost incurred. It is only a book figure, and only part of it is taken to the profit and loss account.

What is the 2/3 rule in contract costing?

When work certified is 50% or more of the contract price and the contract is still incomplete, you transfer two-thirds of the notional profit, multiplied by cash received ÷ work certified. The remaining profit stays in reserve.

How much profit is taken if the contract is less than 25% complete?

None. When work certified is below 25% of contract price, the whole notional profit is held in reserve because the outcome of the contract is too uncertain.

How is profit calculated for a nearly complete contract?

The estimated total profit method is commonly used. First estimate total profit as contract price less cost to date and estimated further cost. Then take the share that matches the work certified, and scale it by cash received ÷ work certified if the question gives cash received. Always follow the method named in the question.