A contractor business accomplishes the work given on a contract basis. The contractor can be an individual or a registered company and it works till the completion of the project or even after its completion for maintenance purposes as per the terms and conditions of the contract.
For example, a building contractor in order to construct a five-story building will direct, supervise and complete the construction work as per the terms and conditions set by the two parties i.e, the contractor and its client.
Calculation of cost of goods sold for a contractor
A contractor can accomplish all the designated work by itself or can further designate or sub-contract to a third party. The duration of a contracted work can be completed in a single period it can be extended over many periods.
The universal formula of cost of goods sold applies here in a similar manner i.e, the opening inventory of direct material, direct labor, and manufacturing overheads, and add all the purchases made during the period for the completion of contracted project less the direct material and other purchases unutilized at the end of the period.
In short, the contractor’s resource consumed during the period to complete the project has termed the cost of goods sold.
Costs that cannot be included as cost of goods sold
The cost of goods sold by a contractor should not include indirect costs such as shipping and transportation. The cost of sales should only contain be included the direct cost attributable to the contracted project, not the irrelevant costs.
Nature of cost of goods sold for a contractor
The business nature of a contractor is mainly related to the construction of small houses as well multimillion mega projects. Thus a contractor needs to keep an eye on the cost of goods sold which is the ultimate and major chunk of the contractual work.
The contractor should try to reduce the associated cost of the project because it cannot avoid the main construction cost. What he can do is to keep control of the avoidable losses.
Information for decision making
The cost of contracted work is a prime decision-making factor for the contractor as well as the client. The contractor’s work ranges from a small task to a mega project which in some cases requires years or even decades to complete.
The contractor should be in a good position to correctly calculate the estimated amount of cost of goods sold at the time of the contract and the projected cost of goods sold over the period of time to gain maximum possible profitability from the contract.
Otherwise, the contractor may incur huge losses if unable to calculate the correct amount of cost of goods sold for a particular project because this is the prime cost of the whole project in the majority of the cases.
Types of contractors
Contractors can be divided into three tiers according to the size of the business entity, i.e, small contractors taking very small and simple tasks such as the construction of a small house or a building, medium contractors taking contracts for the construction of a 5 story building, or multiple of it like a housing society and finally the large contractor taking tasks of multimillion projects such as the construction of airports, motorways, dams, canals and housing scheme on a large scale.
Taxes on contractors
The contractor works with many entities simultaneously or even sub-contracts the work to timely complete the project and thus can face a complex taxation matter. It is advisable for the contractor, especially of medium and large-sized, to hire a tax specialist to fulfill all the contractor’s responsibilities on a timely basis.
Impact of costs on financial statements
The financial statements of a contractor company mainly depend on the correct calculations of the cost of goods sold because the ultimate result of gross profit or gross loss can highly affect the entity’s financial health.
Thus it is advisable and especially is a mega project to involve highly qualified officials in order to calculate the estimated cost of goods sold and the projected cost of goods sold and try to include variable terms related to the costs of the project.
The cost of goods sold for a contractor is a very risky and highly technical job; thus, care must be taken before entering into the contracts. The cost of sale can be very judgemental in deciding whether to agree with the contract or not.