1 JOB COSTING

A form of specific order costing in which costs are attributed to individual jobs.

1.1 When used

• Work is undertaken to customers’ special requirements and each order is of comparatively short duration.
• A wide range of products or jobs is produced and each order is unique and requires different amounts of
• labour
• material
• overhead.
• Suited to industries producing specialised or made-to-order outputs. Eg
• accountants/solicitors
• service engineers/garages.

1.2 Cost records

• The cost of each order is calculated separately. Costs are accumulated via a "job card" eg
• materials purchases from GRNs/suppliers’ invoices
• materials from stores requisitions
• direct wages from time sheets
• direct expenses from invoices.

Factory overhead is usually charged at a predetermined overhead rate.

1.3 Potential problem

• Material, labour costs etc must be collected quickly and accurately therefore system is clerically expensive.

2 CONTRACT COSTING

A form of specific order costing in which costs of single contracts are aggregated. Contracts are usually long-term rather than short-term jobs.

2.1 When used

• Work undertaken to customers’ special requirements and each order is of long duration.
• Relatively large cost units taking considerable time to complete.
• Examples:
• building and construction work
• civil engineering
• ship building.

2.2 Features

• Most materials ordered are specifically for contracts.
• Nearly all labour will be direct.
• Most expenses are direct eg insurance, sub-contracts, architects’ fees.
• Nearly all overheads are head office costs (eg arising in preparing tenders, material procurement and labour administration).
• Plant and machinery may be charged in two ways

1 hours of use at an hourly rate for each item of plant
2 full plant value on arrival less depreciated value on departure.

• Architects’ certificates
• issued periodically on inspection of work
• show the value of work completed at contract price
• enclosed with invoices claiming progress payments.
• Retention money– contract clause entitles customer to withhold payment (% of contract value) for a specified period during which constructional defects must be made good.

2.3 Cost accounts

• A separate a/c is usually maintained for each contract.
• DR Direct costs of the specific contract
• DR Overheads (apportioned)
• CR Contract price

Note: This basic procedure becomes complicated when

– contracts are uncompleted (ie WIP)

– the final contract price is unknown.

2.4 Attributable profit

"... currently estimated to arise over the duration of the contract, after allowing for costs not recoverable under the terms of the contract, that fairly reflects profit attributable to work performed at the accounting date."

• Special attention must be paid to the time periods in which costs and profits are recognised.
• Only recognised when outcome of a long-term contract can be assessed with reasonable certainty.
• Attributable profit

Where

• Total sales value = contract price for a fixed price contract
• Expected overall profit = Total sales value – (actual cost to date + estimated future costs to completion)
• If any loss is anticipated, the entire loss should be recognised.

Illustration

A construction company is currently undertaking the following contract.

At 30 June 1998 the value of work certified is £2,100,000. There are no unused materials on site. Material, labour and overheads costs to completion are estimated at £305,000. At the end of the contract the plant and equipment will be transferred to another site, valued at £230,000.

Required

Calculate the attributable profit/foreseeable loss at 30 June 1998.

Attributable profit = Expected overall profit

= £405,000 (W) = £351,000

(ie 87% complete)

WORKING

	£000
Actual costs to date (940 + 675 + 225 + 50 + 50)	1,940
Costs to completion	305
Less: Value of plant and equipment	(230)
	_____
	2,015
Total sales value	2,420
	_____
Expected overall profit	405
	_____

3 BATCH COSTING

A form of specific order costing in which costs are attributed to batches of products.

 3.1 When used

• Similar articles are manufactured in batches
• Articles may also have individual as well as common characteristics.
• Examples
• footwear
• clothing
• furniture.

3.2 Product cost

• Product cost = the sum of average costs of operations + specific costs (if any) of unique operations

OVERVIEW-PROCESS COSTING

Objective

• To describe the operation of process costing methods.

1 PROCESS COSTING

The costing method used where goods result from a sequence of continuous or repetitive operations or processes.

1.1 When used

• Where more or less identical end products are produced through a series of production stages.

• In organisations producing many units of the same product during a period.

• Most appropriate in chemical, oil, paint and textile industries.

1.2 Mechanics

• An average cost per unit is calculated for a specific period of time (usually a month).
• Average cost/unit =
• Process costing therefore concerns

• ascertainment and accumulation of costs (input)

• measurement of output

• calculation of unit cost.

1.3 Potential problems

Losses:	Eg Evaporation (liquids), material wastage.
Work in progress (WIP):	Where units are only partly completed at the end/beginning of a period.
Joint products and by-products:	Where two or more types of products are produced in a single process.

Note Questions involving both completion of opening WIP and losses will not be set.

2 LOSSES

2.1 Normal loss

• "Expected" to arise under efficient (normal) operating conditions (usually given as a percentage of units input).
• Certain losses are inherent in the production process cannot be eliminated.
• It is "uncontrollable"/"unavoidable".

2.2 Abnormal loss/gain

• Not expected to occur.
• Egs

o improper mixing of ingredients losses > normal

§ use of inferior material

§ incorrect cutting of cloth

§ unexpected pilferage.

• Controllable and avoidable not included in process costs but reported separately.
• Actual loss > normal loss abnormal loss
  Actual loss < normal loss abnormal gain.

2.3 Cost per unit

• Always calculated based on

costs initially charged to the process

output under efficient operating conditions.

ie Cost/unit =

• If the normally lost units have a scrap value, this is used to reduce the costs of the process spread over the expected good output.

ie Cost/unit =

Example 1

Normal spoilage is 7% of units input.

Spoilage is detected at the end of the process, and spoiled units are sold for £16 each.

Required

Calculate the cost per unit.

Solution

Cost per unit	=
	=	= £50

2.4 Process accounts

2.4.1 Accounting entries

1 Costs are debited to the process a/c as they are incurred.

2 Normal losses are credited to the process a/c at their expected scrap value (thereby reducing the production costs to be spread over production units).

3 Actual output is credited to the a/c at the cost per unit (as calculated above).

4 Units on the a/c are then balanced

If an abnormal loss has arisen	Cr Abnormal loss (at normal cost/unit)
If an abnormal gain has arisen	Dr Abnormal gain (at normal cost/unit)

2.4.2 Proforma

2.5 Losses account

2.5.1 Abnormal loss situation

2.5.2 Abnormal gain situation

Example 2 – Losses

Required

For the process information in Example 1, draw up the process ledger account and the losses ledger account if actual output is

(i) 3,850 units
(ii) 3,950 units.

3 WORK IN PROCESS

3.1 Terminology

3.1.1 Opening WIP

Units which were not finished at the end of the previous period/beginning of the current period. These will already have some costs allocated to them relating to the work done in the previous period.

3.1.2 Closing WIP

Units started prior to the current period end but not completed.

3.1.3 Finished units

Units finished during the current period. These will be made up of:

Opening WIP finished off: and	Units in opening WIP finished during the current period.
Units started and finished	Units completely produced this period.

3.2 Cost per effective unit

3.2.1 Partial units

Since not all units have been 100% completed in the period, it is unfair to allocate the costs equally across all units.

Costs are allocated to units according to the work put into them. This is measured in terms of equivalent units of work. Eg

100 units, each of which are 60% complete	=	60 equivalent units
80 units each being 50% complete	=	40 equivalent units

3.2.2 Different stages of completion for different input costs

Eg 100 units of closing WIP might be

50% complete with respect to material	(50 EU)
40% complete with respect to labour	(40 EU)

If so, it is necessary to calculate a cost per equivalent unit (CPEU) for each type of input cost.

3.3 FIFO method

If a first-in first-out flow of physical units is assumed.

• Any previous period costs (= value of opening WIP) should be wholly attributed to the cost of units completed in the current period (ie opening WIP completed).
• CPEU need only be calculated in respect of current period costs for current period production.

3.4 Average cost method

If it is assumed that Op WIP is inextricably merged with units introduced in the current period (eg liquid processes) and cannot be separately identified.

• It is necessary to add the Op WIP cost (previous period cost) to costs incurred in the current period.
• Separately identifiable output is completed units and closing WIP.

3.5 Question approach

Step One	Establish the physical flow of total units, and if required prepare a process account (excluding the value of transfers out/finished goods and closing WIP).
Step Two	In a table, calculate EUs of work done for each type of input (for current period only if assuming FIFO).
Step Three	Calculate CPEU for the period(s) for each input cost to be apportioned.
Step Four	Value completed units and closing WIP started according to the EUs of work done. For FIFO, must distinguish Op WIP completed (don’t forget to add in previous period costs) and units started and finished. These values may then be included to complete the process account.

Leaving drawing up the process in entirety until last is not recommended because
(i) the T a/c should "work" for you and
(ii) if you run out of time, easy marks will be lost.

Example 3 – WIP

The following information relates to production in February.

Required

Calculate the cost of completed units and the value of closing WIP and produce the process account using

(i)    the FIFO method
(ii)   the average method.

3.6 Comparison of FIFO v average cost methods

Assumes Op WIP completed before current production completed.	· Assumes Op WIP inextricably merged with units introduced in current period \ cannot separately identify
· B/fwd cost of Op WIP \ wholly attributable to completed opening WIP and no analysis needed	· B/fwd costs need to be analysed to be combined with current period costs
· Calculate CPEU based on current period costs current period production (EU)	· Calculate (average) CPEU based on
· Add b/fwd cost (of Op WIP) to cost of completed transfers out

4 Joint Products and by-products

4.1 Terminology

· Joint products have significant relative sales value.

· A by-product is produced in conjunction with one or more main products but has a small relative sales value.

· Products produced are not separately identifiable until a certain stage in the production process - the split-off point (SOP).

· Costs incurred before this point (joint or pre-separation costs) must be shared (ie apportioned) between the products produced.

4.2 Apportionment of joint product costs

Pre-separation costs may be divided between joint products on a number of bases.

• Physical quantity of output.

• Market value at point of separation.

• Net realisable value at SOP (final sales value less any post-separation (ie further process) cost).

• After separation products may be sold immediately or may be processed further. Any post-separation costs will obviously be allocated directly to the product on which they are incurred.

Example 4 – Joint product costing

Dot Ltd, a chemical company, produces three joint products in one of its processes. After separation each joint product undergoes further processing. Senior management are anxious to establish the profitability of each product and request you to prepare a report for the monthly management meeting.

The following information is available from its costing department for the month of May.

(1) Joint product costs for the month total £19,000.

(2) Product data is as follows.

Required

Prepare a statement showing the estimated profit or loss for each product and in total, using the following methods of allocating joint costs

(i) weight of output

(ii) sales value at split-off point

(iii) net realisable value.

Note Process loss can be ignored.

Comparison of methods

Method	Advantages	Disadvantages
Physical measures	Simple apportionment Assumes each product receives similar benefit	· Some industries do not have common physical measures of output · Takes no account of product profitability · May "loss-making" products
Sales value @ SOP	Proportional to products’ ability to "bear costs" fairer	· May be no market value at SOP · Further process costs may "losses"
Net realisable value	Estimates sales value @ SOP Closest approx^n to revenue-generating power of joint products	· Numerous subsequent further processing stages (eg in oil refining) can make calculations too complex.

4.3 Accounting for by-products

At net realisable value †	As miscellaneous income
By-products are valued at NRV at SOP. Any net revenue is usually netted off against pre-separation costs ie Cr Process a/c	· Income recognised at point of sale ( stocks not valued) and added to main product revenue ie Cr P & L a/c
· Appropriate where by-products are of noticeable value.	· Appropriate where value is uncertain or small.
Example 5 – By-products A process produces 100 kg of by-product Alpha. Alpha can be sold at £5 per kg. At the end of March there are 30 kgs in stock. Required Show the accounting entries in the product account if by-product income is recognised at the point of (i) production (ii) sale.