Determination of Profit and Loss on Contract
When a certain work is done on contract then it may or may not be completed in the concerned or related financial year. If the contract is completed in the financial year, then there is no problem, the profit or loss on the contract can easily be ascertained and if the work is completed and
handed over to the contractee then the profit or loss amountnis transferred to the Profit Loss Account. But normally thisndoes not happen and most of the contracts take more thannone financial year to be completed. Now if the profit andnloss is not found out on the work done in the financial yearnand if this is postponed till the contract is completed, thennmany problems arise-for instance, if the profit for some yearsnis given together in the last year, then there will be a lot of unnecessary fluctuation in the company’s profits for the various years which can adversely affect the creditability ofnthe company and the share price of company may fall. The company may face problems in obtaining additional capital.
The company would also have to face problems in assessing income tax etc. The shareholders of the company also want to get their share of profit every year. Together with all this, this would violate the accounting laws or norms as the profit for a particular year would not be written in the financial accounts of that year but would be written in the accounts for some other year.
If a contract work is not completed in the year, and if profit is to be shown in the account then this would benestimated profit and if estimated profit is shown in the accounts then this would be considered as carelessness towards financial responsibility.
Therefore, it is essential that some compromise be arrived at between the above stated two arguments. That isnthe expenses of the financial year should be debited in the contract account and after crediting certified and uncertified work, plant and material in hand, plant and material destroyed, lost, returned etc., whatever is left as surplus or excess credited would be nominal. Since the loss or contingencies ofnthe contract in future, cannot be estimated, some provisionnhas to be made for it from this profit. Normally, the entire payment for work certified is not received; therefore the part of the amount received must be kept in mind.
There is a lack of clear accounting laws as regards this. What part or how much of the National profit amountnmust be taken in the Profit Loss Account, there are some laws stated in this context, the students must note that if some specific question is given, then they must calculate the profit- to be taken to the Profit Loss Account, on the basis of the directions given. If no directions are given then the given further rules must be followed.
1. When the Contract has been Completed
If the total of the credit side of the contract account is more than that of the debit side then it means that the contractor has earned profit. Contrary to this if the total of the debit side of the contract account is more then the credit side it means that the contractor has incurred loss. Because the contract has been completed, therefore this profit loss is transferred to the Profit Loss Account.
2. When the Contract is Incomplete
The credit balance shown in the contract account
shows the contract profit, but it is not correct toconsider this as actual profit before the contract is complete, because actual amount of profit or loss can only whether the profit would remain till the contract work is complete. It is due to this that calculation of profit during work innprogress is very difficult. In an incomplete contract, the worknof calculation of profit must be done keeping in mind the future uncertainties and with a lot of caution.
There is no rule as to what amount should be taken as actual profit under incomplete contract, normally the contractors follow thenfollowing rules in calculating actual profit. Actually whatnpart of the actual profit must be taken as actual profit and what amount in the form of work in progress depends entirely upon the direction of the contractor. Therefore, in the absence of the contractors directions, it is proper to follow the following rules, otherwise actual profit should be calculated according to the directions of the contractor.
Under Condition of Loss- If the contract account shows debit excess, then this situation would mean a state of loss. In case of loss, the entire loss is transferred to the Profit Loss Account. fit.