Discuss classification of costs.Write notes on: Ascertainment of profit on contracts nearing completion

(a) Ascertainment of profit on completed contracts

(b) Ascertainment of profit on contracts nearing completion.(2021)

Classification of Costs

Costs can be classified in several ways based on their nature, behavior, function, and how they relate to specific projects or activities. Ascertainment of profit on contracts nearing completion Here’s an overview of the major classifications:

1. Based on Nature:
   
   1. Fixed Costs: Fixed costs are unchanged regardless of production or activity in the organiza (e.g., rent, salaries).
   2. Variable Costs: Vary directly with the level of production or activity (e.g., raw materials, direct labor). Ascertainment of profit on contracts nearing completion
   3. Semi-Variable Costs: Costs that have both fixed and variable components (e.g., electricity bills, which have a fixed base charge and a variable usage charge).
2. Based on Function:
   
   1. Production Costs: Costs directly related to the production of goods or services (e.g., raw materials, direct labor).Ascertainment of profit on contracts nearing completion
   2. Administrative Costs: These Costs are concerned with the administration and management of the business Who manage tasks as per the planning done ( e.g., office salaries, utilities ).
   3. Selling & Distribution Costs: Costs related to marketing, sales, and distribution (e.g., advertising, transportation).
   4. Finance Costs: Costs related to financing the business, such as interest on loans.Ascertainment of profit on contracts nearing completion
3. Based on Behavior:
   
   1. Direct Costs: These costs Can be found directly within a specific product, department, or project (e.g., direct materials, direct labor).
   2. Indirect Costs (Overheads): These costs can’t be found directly from a product, project, or department (e.g., utilities, rent, office supplies).
4. Based on Traceability:
   
   1. Product Costs: These costs are concerned with the production of goods, and it involves direct costs as well as a portion of indirect costs (e.g., direct material, direct labor).
   2. Period Costs: Not directly related to production but incurred for a specific period (e.g., administrative expenses, marketing costs). Ascertainment of profit on contracts nearing completion
5. Based on Relevance to Decision Making:
   
   1. Sunk Costs: Which Costs have been incurred and these can’t be recorded. (e.g., past investments).
   2. Relevant Costs: Which Costs can be changed as per the changing decision making. (e.g., incremental costs due to additional production). Ascertainment of profit on contracts nearing completion
   3. Opportunity Costs: When investors have many best alternatives for the opportunity to invest. What is the best plan. Ascertainment of profit on contracts nearing completion

(a) Ascertainment of Profit on Completed Contracts

Ascertainment of profit on completed contracts involves determining the profit earned from a contract after it has been fully completed. This method is commonly used in industries like construction, where long-term contracts are executed over multiple years.

Steps for Ascertainment of Profit:

1. Revenue Recognition: The total contract revenue (price agreed upon in the contract) is recognized as income when the contract is completed.
2. Cost Allocation: All costs related to the contract (direct and indirect) are charged to the contract. This includes:
   
   • Direct costs: Materials, labor, etc. Ascertainment of profit on contracts nearing completion
   • Indirect costs: Overheads allocated to the project.
3. Profit Calculation: Profit is calculated as:
   Profit = Revenue from Contract−Total Costs Incurred
   Once all costs have been accounted for and the contract is completed, the profit is realized. The entire profit from the contract is recognized at this point.
4. Journal Entries:
   
   • Revenue is recognized as income when the contract is completed.
   • All costs incurred during the contract execution are accounted for under expense accounts. Ascertainment of profit on contracts nearing completion

(b) Ascertainment of Profit on Contracts Nearing Completion

For contracts that are nearing completion, the percentage-of-completion method is typically used to ascertain profits. This method estimates the profit based on the progress made on the contract, even before it is completed.

Steps for Ascertainment of Profit (Near Completion):

1. Determine the Progress of the Contract: The degree of completion is estimated by comparing the costs incurred to date with the total estimated costs of the contract. A common approach is:
   Percentage of Completion =Costs Incurred to DateTotal Estimated Costs\Percentage of Completion
2. Revenue and Profit Recognition: Based on the percentage of completion, a corresponding percentage of the contract’s total revenue and profit is recognized. For example, if the contract is 80% complete, 80% of the expected revenue and 80% of the expected profit can be recognized. Ascertainment of profit on contracts nearing completion
3. Profit Calculation: The profit recognized at any point during the contract is:
   Recognized Profit =Total Revenue×Percentage of Completion−Total Costs Incurred
   This approach helps spread the recognition of profit over the life of the contract, even if the contract is still not fully completed. So in this “Estimated Profit” can be find as

Estimated Profit

Estimated Cost

Estimated Profit On Completion

1. Journal Entries:
   
   • Revenue is recognized as the contract progresses, based on the percentage of completion.
   • Costs are recorded as incurred. Ascertainment of profit on contracts nearing completion
   • Adjustments are made for any changes in estimated total costs or revenue.

Conclusion:

• Profit on Completed Contracts is determined at the completion of the contract by comparing total contract revenue with total costs incurred, resulting in a clear and final profit figure. Ascertainment of profit on contracts nearing completion
• Profit on Contracts Nearing Completion uses the percentage-of-completion method, which estimates profits based on the progress made so far, offering a more timely reflection of the contract’s financial performance before it is fully completed.

Both methods ensure that companies in industries like construction or long-term projects can recognize and report their profits in a systematic and reasonable manner, depending on the stage of the contract. You can find the syllabus on the official website of gndu.

Essential Questions of Cost Accounting

1. Budget and Budgetary control notes.
2. Objective of budgetary control.

Ascertainment of profit on contracts nearing completion