Tracking costs in an engineering contract business
In business sectors such as engineering, ship-building or construction, costs are often incurred over many years. Also, as contracts rather than products are the mainstay of such sectors, costs are accumulated for each contract separately. For managers and accountants who want to track costs for each contract there are a number of things to watch out for. The first thing is that many more costs can be attributed to a particular contract. For example, materials and equipment used on contracts might be specific to a contract. Also, materials might be left over and used on other contracts, or even be moved around between contracts. In some cases, equipment is often useless at the end of a contract e.g. tunnel boring machines are often left in the ground as it’s too expensive to remove them. Labour costs are probably the easiest to allocate to contracts. You just need to get the costs of all employees working on the contract. Many other costs which might be considered as overheads are often easily apportioned to a contract. For example, a large contract might have an office on-site. All costs of running the office, which would normally be an overhead cost, would become a direct cost of the contract. And this is the key feature of contracting type businesses – that more costs are classified as direct. Even plant and equipment might be a direct cost, as in the case of the Channel Tunnel where the tunnel boring machines were buried beneath the seabed (see http://en.wikipedia.org/wiki/Channel_Tunnel). A high cost no doubt, but the salvage cost would have been greater.
To manage a contracting type business, you need to capture costs for each contract. This is usually simple enough, as most costs are direct costs and easily identifiable. The key thing is to keep an account of each contracts costs and revenues. This means profitability of a contract can be easily assessed. Costs will usually be approved by an architect or engineer before being used to calculate profits. Even then, accounting rules suggest that profits should not be recorded in the financial statements until the outcome of a contract is reasonably certain. In practice, this means that as a contract gets nearer completion, a higher proportion of profit is recorded. If a loss is predicted, this is recorded immediately in the books of account.