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Cost Accounting – I
Notes contract price if the cost rises beyond a given percentage. The objective of this clause is to
safeguard the interest of contractor against unfavourable changes in cost. The escalation
clause is of particular importance where prices of materials and labour are anticipated to
increase or where quantity of materials and labour time cannot be accurately estimated.
Just as an escalation clause safeguards the interest of the contractor by upward revision
of the contract price or contract value, a de-escalation clause may be inserted to look after
the interest of the contractee by providing for downward revision of the contract price or
contract value in the event of cost going down beyond an agreed level.
(xii) Cost-plus Contract: This is a modified method of contract costing. Cost-plus contract method
of costing is resorted to when it is not possible to determine the cost of the contract in advance
with a reasonable degree of accuracy. Under such circumstance, the contractee agrees to pay
to the contractor, the actual cost incurred together with an agreed amount of profit which
the contractor earns in the usual course of business. This type of contract is mostly followed
during the period of urgency when certain types of products are to be manufactured and
supplied as in the case of defence products, component parts and so on.
Advantages: Cost-plus contracts offer the following advantages:
To the Contractor:
z There is no risk of loss on such contract.
z There is bargain in the contract price in future under this type of contract.
z It simplifies the work of preparing tenders or quotation.
z procurement of the services of the experts.
z It protects him from the risk of fluctuations in market prices of materials, labour,
etc.
z Earliest completion of the work.
To the Contractee:
z Since the contract price is governed by the contract, the contractees will also not
suffer from risk of loss.
z Under this method, the contractor can know in advance the profit that can expect to
work on the contract on its completion.
z In the case of cost-plus contracts, generally, the quality of the work does not suffer.
z By giving to the contractee the right to inspect the accounting records of the contractor,
a cost-plus contract ensures a fair price to the contractee.
Disadvantages: The disadvantages of cost-plus contracts are:
To the Contractor:
z The contractor has to suffer for his own efficiency. This is because profit is usually
based as a percentage of cost and efficient working resulting lower cost also leads to
lower profits.
z The contractor is deprived of the advantages which would have accrued due to
favourable market prices.
To the Contractee:
z Misuse of materials and labour by the contractor.
z The price a contractee has to pay is unknown until after the completion of work.
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