Profit on Incomplete Contracts

At the end of an accounting period it may be found that certain contracts have been completed while others are still in process and will be completed in the coming years. The total profit made on completed contracts may be safely taken to the credit of Profit and Loss Account. But the same cannot be done in case of incomplete contracts. These contracts are still in process, and there are possibilities of profits being turned into losses on account of heavy rise in prices of materials and labour and losses on account of other unforeseen contingencies. At the same time it does not also seem desirable to consider the profit only on completed contracts and ignore altogether incomplete ones because this may result in heavy fluctuation in the figure of profit from year to year. A year in which a large number of contracts have been completed will show an abnormally high figure of profit while reverse may be the case in the year in which a large number of contracts remain incomplete. Therefore, profit on incomplete contracts should be considered, of course, after providing adequate sums for meeting unknown contingencies.

There are no hard and fast rules regarding calculation of the figures for profit to be taken to the credit of profit and loss account. However, the following rules may be followed:

(a) Profit should be considered in respect of work certified only, work uncertified should always be valued at cost.

(b) No profit should be taken into consideration of the value of work certified is less than ¼ of the contract price because in such a case it is not possible to foresee the future clearly.

(c) If the value of work certified is ¼ or more but less than ½ of the contract price, 1/3 of the profit disclosed, as reduced by the percentage of cash received from the contractee, should be taken to the Profit and Loss Account. The balance should be allowed to remain as a reserve.

(d) If the value of work certified is ½ or more or the contract price, 2/3 of the profit disclosed as reduced by the percentage of cash received from the contractee, should be taken to the Profit and Loss Account. The balance should be treated as a reserve.

(e) In case, the contract is very much near completion, the total cost of completing contract should be estimated if possible. The estimated total profit on the contract can be calculated by deducting the total cost from the contract price. The profit and loss account should be credited with the proportion of total estimated profit on cash basis, which the value of work certified bears to the total contract price.

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