Notes
Introduction
Manufacturing costing methods are accounting techniques that are used to help understand the value
of inputs and outputs in a production process. By tracking and categorizing this information
according to a rigorous accounting system, corporate management can determine with a high degree
of accuracy the cost per unit of production and other key performance indicators. Management needs
this information in order to make informed decisions about production levels, pricing, competitive
strategy, future investment, and a host of other concerns. Such information is primarily necessary for
internal use, or managerial accounting.
JOB ORDER COSTING
Job order costing or job costing is a system for assigning manufacturing costs to an individual
product or batches of products. Generally, the job order costing system is used only when the
products manufactured are sufficiently different from each other. (When products are identical or
nearly identical, the process costing system will likely be used.)
Since there is a significant variation in the products manufactured, the job order costing system will
create a job cost record for each item, job or special order. The job cost record will report the direct
materials and direct labor actually used plus the manufacturing overhead assigned to each job.
An example of an industry where job order costing is used is the building construction industry since
each building is unique. The manufacturers of custom equipment or custom cabinetry are also
examples of companies that will keep track of production costs by item or job.
The job cost records also serve as the subsidiary ledger or documentation for the cost of the work-inprocess inventory, the finished goods inventory, and the cost of goods sold
ACCOUNTING FOR JOB ORDER COSTING
The following journal entries relate to material procurement and issue from the store to the
production process.
1. (a) Direct materials purchase
Dr Stores ledger control A/c XX
Cr Cash A/c XX
To record cash purchases
Dr Stores ledger control A/ c XX
Cr Creditors A/ c - for credit purchasers XX
To record credit purchases
(b) Return of materials to suppliers
Dr Cash A/ c or creditors control A/ c XX
Cr Stores ledger control A/ c XX
To record return of materials to suppliers
(c) Issue of materials from the store
Dr W.I.P. Control A/c X
Cr stores ledger control A/c for direct materials. XX
To record issue of direct materials from the store
Dr Factory overheads control A/ c XX
Cr Stores ledger control A/ c XX
To record issue of indirect materials from the store
Labour cost is measured and accumulated in the same way as material cost. It includes both direct
and indirect labour. Direct labour can be traced directly to the individual job where as indirect labour
cannot or if it has to be traced, it can only be done with expenditure of great effort.
Labour costs are accumulated based on the time tickets prepared by workers. The worker needs to
indicate the duration of time he/she spent on a specific job or, when not assigned to a specific job,
what type of indirect labour task he was assigned to and the amount of time expended on the task.
Total labour costs are calculated based on the time sheets submitted at the end of the day by all the
workers. An example of a time ticket is shown below STING
Below are the journal entries passed to record direct and indirect labour.
2. (a) Direct Labor
Dr W.I.P. Control A/e XX
Cr Cash a/c XX
To record direct labour Paid in cash
(b) Accrued Direct Wages
Dr W.I.P. Control Ale XX
Cr Wages Control Ale XX
To record direct wages to be paid (accruing at a specific)
(c) Indirect Wages
Dr Factory overheads control AI c XX
Cr Wages Control Alc XX
To record indirect wages (labour cost) incurred
Production overheads go along with direct materials and direct labour in determining the cost per
unit or in batch processing or the cost of a particular job. However, it is difficult to
assign manufacturing overheads because they cannot be traced directly to a particular job and it
consists of many unlike items with the variable and fixed cost components with fixed cost
constituting a large part of manufacturing overheads. Overheads are, therefore, assigned to units of
production through an allocation process.
The following journal entries are passed to record production overheads allocated for a job.
3. Production Overheads
(i) (Not yet paid) Dr Factory overhead control A/ c XX
Cr Expenses/Creditor control A/c XX
To record unpaid production overheads
(ii) (When paid) Dr Expense / creditors Ale XX
Cr Cash A/c XX
To record payment of production overheads
After the allocation of manufacturing overheads, total cost for a job can then be determined and
summarized in a job Cost Sheet or job cost account. Examples of the above are shown below
OTHER TRANSACTIONS
4. Finished goods transferred to the store:
Dr Finished goods stock control A/c XX
Cr W.I.P Control A/c XX
To record transfer of finished goods to the store
5. Sale delivery of finished goods to customers:
(i) On Credit: Dr Debtors control A/c XX
Cr Sales A/c XX
To record credit sales
(ii) In Cash: Dr Bank/Cash A/c XX
Cr (Sales A/c XX
To record cash sales
6. Cost of goods sold to customers:
Dr Cost of sales A/c XX
Cr Finished goods control A/c XX
To record cost of goods sold to customers
7. (i) When there is over absorption of production overheads:
Dr Factory overheads control A/c XX
Cr P & L A/c XX
To record over absorption of production overheads
(ii) When there is under absorption of production overheads:
Dr P& L A/c XXX
Cr Factory overheads control A/c XXX
To record under absorption of production overheads
8. When there are non-manufacturing overheads:
Dr P & L A/c XXX
Cr Non-manufacturing overheads control A/c XXX
or
Non-manufacturing overheads/expenses are regarded as period costs & are therefore not changed To
W.I.P control A/c.
Note: Overheads entries apply when there is an interlocking accounting system.
Illustration
At the start of the year, no jobs were in process. During the year, job no 2.1, 2.2 and 2.3 werestarted;
materials were purchased at a cost of Shs.100,000. Materials worth Shs.75,000 were used of which
Shs.70,000 were direct. (Shs.10,000 on job 2.1, Shs.40,000 on job 2.2 and the balance on job
no.2.3). Labour costs worth Shs.250,000 were incurred of which Shs.220,000 was direct labour
(Shs.80,000 on job 2.1, Shs.75,000 on job 2.2 and the balance on job 2.3).
Other manufacturing overhead costs of Shs.72,800 were incurred; manufacturing overhead is
applied to production on the basis of direct labour costs. Estimated manufacturing overhead for the
year was Shs.100,000 and estimated direct labour cost for the year was Shs.200,000. Jobs 2.2 and
2.3 were completed with job 2.3 being sold for Shs.200,000
Required:
a) Pass the necessary journal entries to record the above transactions.
b) Prepare a costing profit and loss account for the period above
Note: The cost of goods sold as computed above is the same as computed below when various costs
are accumulated as shown in the table.
Working
Overheads absorption rate = Estimated manufacturing overheads
Estimated direct labor cost
= Shs.100,000ื 100%
Shs.200,000
= 50%
Therefore, total manufacturing costs absorbed = 50% ื total direct labour cost
= 50% ื220,000 = 110,000
COSTING
Accumulated costs of jobs
BATCH COSTING
This is a form of costing which is used where a quantity of identical articles are produced together as
a batch. The general procedures are very similar to costing jobs. The batch would be treated as a job
during manufacture and the various costs (material, labour and overheads) collected in the usual
manner. On completion of the batch the total batch cost would be divided by the number of good
articles produced so as to provide the average cost per article. Batch costing procedures are common
in a variety of industries including; clothing, footwear, engineering components.
Illustration
The budgeted variable overheads of Githurai Ltd for the year 2001 are given as below:
Department Overhead (Shs) Absorption base
A 150,000 15,000 direct labour hours
B 200,000 25,000 direct labour hours
C 120,000 20,000 direct labour hours
D 300,000 30,000 machine labour hours
Additional information
1. Selling and administering overheads are charged at 10% of total production costs while the profit
markup is 25% of total costs:
2. An order for 2,000 units was received from a customer. The batch number of this orderis 510.
The following additional information in respect of this batch is provided below:
- Direct materials - 87,000/ =
- Direct Labor - Dept A (150 direct labor hrs) @ Shs.12. per hour.
- Dept B (40 direct labor hrs) @ Shs.15 per hr
- Dept C (60 direct labor hrs) @ Shs.20 per hr
- Dept D (100 direct labor hrs) @ Shs.10 per hr
- A total of 50 machine hours were used in this job
Required: Calculate:
a) Total cost of the batch
b) Cost/Unit
c) Selling Price of the batch
d) Selling Price unit
PROCESS COSTING
This is a product costing method applicable where similar products are produced continuously in a
series of production steps commonly known as processes.
It is used where production is continuous in a series of production steps and similar products are
produced.
This is a costing method that is applied where there are standard operations with continuous
production of homogeneous and identical units. Products are produced in the same manner and
consume the same amount of material and labour. The output is the final product of a sequence of
operations. In this type of costing, costs are accumulated on the basis of process, and individual units
of output are thus assigned the average cost per unit. The cost per unit is arrived at by dividing the
total process costs by the number of input of the next process and further materials can be added at
each stage production. Therefore, cost per unit for the second and subsequent processes is a
cumulative cost. For example, the cost per unit for the output transferred from process 2 is the cost
of production for both process 1 and 2 and not for process 2 above.
Common features
1. Similar units are produced continuously
2. The continuous nature of production results in some units being incomplete at the end of the
period.
3. Loss is a common feature due to spoilage, wastage, evaporation etc.
4. Costs cannot be identified with individual products.
5. In some cases output may be multiple products.
Definitions
a) Process losses
This represents loss of material due to spoilage, evaporation which arises due to the nature of the
product processes.
Process uses can be categorized into:-
i) Normal loss: This is the expected losses and they are unavoidable. They are cost by
inherent factors to production processes e.g. evaporation.
Normal loss is based on past experiences and indicates the expected loss under normal
working conditions.
No cost is allocated to normal loss. However, any amount realised from sale of normal loss
units reduces the cost of good output in unit cost calculation.
ii) Abnormal loss
These are extra units lost above the normal loss units.
It arises due to unfavourable working conditions i.e. substandard materials, accidents,
carelessness etc.
It carries its own cost and will be valued a good unit and the amount transferred to P&L
iii) Abnormal gain
This represents the expected loss transferred out as good output.
They are units which were expected to be loss but they were not lost.
It arises due to improved working conditions i.e. high quality material, less accidents etc.
It is also accounted at the cost of good output.
b) Scrap
These are the discarded materials with some recovery value which is either disposed of without
further processing or can be reintroduced in place of raw materials.
c) Waste
These are discarded substance with no recovery value and normally they are disposed at a cost
i.e. a cost is incurred to dispose the waste. This cost is treated as part of process cost for the
process which generated the waste.
Accounting for processes
Process costing is centered on four key steps.
The exact volume of work done in each step will depend on whether there are losses, W.I.P, joint
and by-products etc. These steps includes:-
i) Determination of inputs and outputs
ii) Calculating cost per unit and outputs
iii) Calculating the total cost of outputs
iv) Computing the necessary accounts
The procedure for process costing is as follows;-
The production factory is divided into a number of processes.
- An account is opened and maintained for each process.
- Each process account is debited with materials, labor, direct expenses and
overheadsapportioned to the process.
- The good output of a process is transferred as input to the next process. At the endof the
period, the products will include various items. These are normal loss, abnormalloss, finished
goods (or output to the next process) and work in progress.
- The finished output of the last process is transferred to the finished goods account.
Process costing with presence of process losses and gains
Losses in a process are a common feature and they should be well accounted because they have an
impact on production cost.
Most manufacturing processes result in some portion of the raw materials used not being converted
into a reliable half hence losses. These losses may take the form of waste, scrap, rework, and spoilt
units.
Waste: are materials lost in the process, which are irrecoverable or have no recoverable value. The
term also refers to discarded substances having no value and is disposed off
Scrap: Material held after a productive process, which are irrecoverable or have no recoverable
value. The term also refers to discarded materials, which have some recoverable value which is
usually either disposed off without further treatment, or reintroduced into the production process in
place of the raw materials. Scraps are process losses that can be sold for some small value.
Rework: These are finished goods that do not meet quality standards but which with some
additional work can be sold.
287
Loss: Refers to finished or partially finished units, which cannot be reworked or used for their
intended purpose. They may be discarded or sold for minimal value. There are two types of
spoilage;
i. Normal Loss: is loss expected and unavoidable even under the most efficient systems of
production. Normal spoilage cost is normally included in product cost.
ii. Abnormal Spoilage: This is loss that is avoidable with efficient operating conditions.
The cost is regarded as controllable and can be eradicated if due diligence and supervision are
exercised. The cost is normally treated as a loss and charged to profit and loss account.
Normal loss
Cost of normal loss is absorbed by the cost of good units.
Normal losses are unavoidable costs that are expected to occur under efficient operating conditions.
They are inherent in the production process and cannot be eliminated or controlled.
Illustration
1000 kgs at sh.3.60/kg were input to a process and there was a 10% loss due to evaporation.
900 good units should result and their cost per unit would be:
1000 ื sh.3.60/900 = sh.4/unit.
The level of normal loss selected as being the standard for the period under review is based on
various factors such as past experience, quality control records from the past periods and industry
norms. These costs are assigned to the good output using two approaches;
(a) Recognition and Re-Assignment Approach In this approach, the normal spoilage is included in
the equivalent units computation; further, the normally spoilt units will be assigned costs just like
any other unit. The spoilage costs will then be reallocated to these good units that have passed the
inspection point. The steps to follow under this method are:
i) Compute equivalent units including normal spoilage.
ii) Assign costs to all units including normal spoilage.
iii) Reassign normal spoilage costs to good output.
Illustration
ABC Ltd. produces and sells a certain type of insecticide, YMX. In the year just ended, ABC
material input into production process I was 2000 units at Shs.10 per unit. Labour costs incurred
amounted to Shs.30,000 while overhead costs absorbed amounted to 20,000. The normal loss in the
process is 5%. Compute the cost of spoilage and the cost per unit of output transferred to process II
after reassigning the normal loss costs.
Solution
(The process I account will help us solve the problem)
Cost per unit = Shs.70,000/2,000 units = Shs.35 per unit
Reassigning of costs to the good units
= 3500/1900 per good unit = Shs.1.84 (2.d.p)
Therefore, cost per good unit shall be Shs. (35 + 1.84) = Shs.36.84
(b)Omission Approach: Under this approach, the normally spoilt units are not included in the
calculation of equivalent units. This means that the cost of the normally spoilt units will
automatically be distributed to the good output. By excluding the normal spoilage in the
computation to the good output, a lower figure will be derived. This is the most commonly used
method of accounting for normal losses. The weaknesses of this method are;
i) The cost of normal spoilage is spread equally into the finished goods and the ending W.I.P
regardless of whether the ending W.I.P. has passed the inspection stage or not.
ii) It does not allow the manager to see the costs of spoilage because these costs are not computed.
Using the illustration above
Solution
The process I account will appear as follows
The cost per unit of the good units shall be computed using the formula given below
Cost per unit = Total accumulated cost
Expected output
Expected output = Total input (units) Normal loss (Units)
Thus the cost per unit of production transferred shall be
= Cost per unit = Shs.70,000= Shs.3.684
95% ื20,000 units
The situation above exists where normal loss with no scrap value exists. There are instances where
the normal loss will have a scrap value. For instance, in the Jua Kali industry, the metal scraps may
be used to mend patches or be sold out for some other use. In this case, the revenue obtained from
the sale of scrap is offset against costs incurred in the production process to arrive at the total costs
to be allocated to each unit. In accounting terms, the cashbook is debited with the amount received
from the sale of scrap and the process account is credited with the equivalent.
Illustration
1,000 kgs at sh.4.00/kg were input to a process and there was a 20% loss due to filtration. The
materials filtered out could be sold for sh.0.50kg.
Required;
Prepare a process account.
Solution
800 good units should result and their cost per unit would be:
1,000 ื 4 200 ื0.50= sh.4.875/unit
800
Abnormal losses
Abnormal losses and gains carry their own costs and will be valued at the cost of good output. They
are separately analyzed and the amount to P&L.
These costs do not add any production benefit to the company and are treated as accounting losses.
They are controllable losses which are not expected to occur under efficient operating conditions e.g.
improper mixing of ingredients, omission of some important chemical in the manufacture of a
product, etc. Abnormal losses are considered to result from production inefficiencies that should be
eliminated and are not an inherent part of the production process.
The cost of abnormal spoilage not included in the process cost nor included in inventory valuation
but reported separately as abnormal is written off directly as losses for the period in which it occur.
Abnormal losses, just as normal losses, may or may not have a scrap value. Abnormal loss with or
without scrap value is treated in a similar way in the process account. The sales revenue received
from sale of abnormal loss units is offset against the cost of abnormal loss in the abnormal loss
account to arrive at the net abnormal loss that shall be charged to the profit and loss account in the
period in which it arises.
Abnormal gain
In some instances, the actual output may be greater than expected or, put in other words, actual loss
less than normal or expected. In such circumstances, abnormal gains are considered to have arisen.
The main objective of preparing the process account is to determine the cost per unit of expected
output (Normal output).
In a case where abnormal gains have no scrap value, (i.e. where if scrapped would not have a value)
the cost per expected output
= Input cost
Expected output
Illustration
In August 2000 kgs of a material were introduced to a process at a cost of sh.6/kg, and 200 hours
labor were spent at a cost of sh.15/hour. Overheads are absorbed at the rate of sh.4/ labour hour.
Normal losses are incurred at the rate of 5% of input and lost units can be sold for sh.0.9 per
Kilogram. 1,800 kgs were produced.
Required;-
Calculate the total absorption cost of the good output, the treatment of any abnormally lost or gained
units, and also show the process account and loss account.
The net cost of the abnormally lost units is Sh.737.
Illustration
In May 5000 kgs of a material were introduced to a process at a cost of sh.9/kg, and labour and
overheads amounting to sh.25, 000 were also contributed.
Normal losses are incurred at the rate of 10% of input and lost units can be sold for sh.1 per
kilogram 4,700 kgs were produced
Calculate the total absorption cost of the good output, the treatment of any abnormally lost or gained
units, and also show the process account and loss account.
Required:
(i) Process A account.
(ii) Process B account.
(iii) Abnormal loss/gain account,
(iv) Normal loss account
Solution
a) ABC Chemicals Ltd
Process A
Expected output = 90% ื 5,000 = 4,500
Process Plant time = 200 ื 220 = 44,000
Scrap value = 1
Process B
Expected output = 95%ื3,000 = 2,850
Process plant time = 120ื250 = shs30,000
Scrap value = 2
ACCOUNTING FOR WORK-IN-PROGRESS (WIP)
In industries where process of manufacturing is continuous, some units may be incomplete at the
end of the period. A problem arises in unit cost as the complete units.
The solution to this problem is to express output in terms of equivalent units. Equivalent units are
assumed complete units output from a production process if a single unit is started and completed
before another is started.
It is based on percentage of completion of output e.g. if 10,000 units were started but only 8000
units were completed and the remainder was left in WIP with 60% degrees of completion, the
equivalent units which will be used for cost calculation will be given by:
Equivalents Units
Complete units 100% = 800
W-I-P 2000 @ 60% = 1200
Equivalent unit of output 9200
The cost incurred in a process are not incurred uniformly and therefore equivalent units will not be
based on the same percentage of completion i.e. output in a process will carry different degrees of
completion for equivalents unit calculation.
Cost items in a process include:-
i) Transfer in cost
This represents cost introduced in a process. These costs are accounted 100% since input is
transferred into the process as complete unit.
ii) Material added is this process
The percentage of completion depends on how the materials are added in the process.
iii) Conversion costs
This refers to the direct labour and overheads. The percentage of completion will depend on how the
cost is incurred.
Accounting for opening W.I.P
Where there is opening W.I.P the cost data relate to two production period i.e. the previous period
costs for opening and the current period costs for work started this period.
There are two methods which can be used in accounting for W.I.P.
i) Weighted Average Method
ii) FIFO Method
i) Weighted Average Method
In the method, there will be no distinction between input of opening W.I.P and what was transferred
in this period. They will be treated as if they were started at the same time.
The units of output from the process will be assumed to have come from the same batch of input of
opening W.I.P and transfer in.
The costs to account for will relate to the cost incurred in the two periods i.e. the cost will also be
assumed to have been incurred in the same period.
ii) FIFO
In this method, the Opening work in progress and units transferred in this period maintain their
identity and are account separately.
Opening work in progress enters the process first and will be assumed to be completed from O.P
W.I.P and the units started and transferred this period.
The cost incurred will only be relayed to work computed this period i.e. only current cost will be
considered for unit cost calculation.
STEPS IN PREPARING PROCESS COSTING STATEMENT
(1) FIFO Method
a. Physical flow of units; this identifies the units to be accounted for (units in beginning WIP
inventory plus the units started during the period) and the units accounted for (the units
completed during the current period plus the units in the ending WIP)
b. Equivalent units of production: the common denominator for completed units and
partially completed units are computed by multiplying the units accounted for by their
percentage of completion by each category of costs i.e. material cost (100%), labour cost,
e.t.c. (75%).
c. Costs to be accounted for: total costs to be accounted for (the cost of units in the
beginning WIP plus the costs added to production during the current period) are identified
for each category of costs.
d. Cost per equivalent unit of production: these are computed by dividing the costs to be
accounted for by the total equivalent units of production.
e. Costs accounted for (Cost allocation): total costs to be accounted for are allocated for
each category of costs to the units accounted for by multiplying the equivalent units of
production by the cost per equivalent unit of production.
WEIGHTED AVERAGE METHOD (WAM)
a) Physical flow of units; the WAM does not keep the beginning inventory units separate from the
units that were started and completed during the period
b) Equivalent units of production: in computing equivalent units of production, the WAM does
not keep the percentage of completion performed in the prior period separate from the percentage
of completion performed in the current period.
c) Costs to be accounted for: in identifying costs to be accounted for, the WAM does not keep the
costs of the units in the beginning inventory at the start of the current period separate from the
costs added to the production during the current period
d) Cost per equivalent unit of production: these are computed by dividing the costs to be
accounted for by the total equivalent units of production
e) Costs accounted for (Cost allocation): total costs to be accounted are allocated for each
category of costs to the units accounted for by multiplying the equivalent units of production by
the cost per equivalent unit of production. The WAM does not keep the cost of the units in
beginning WIP separate from the costs added to production during the current period.
Illustration
Process 2 received units from process 1 and after carrying out work on the units transferred them to
process 3. For one accounting period the relevant data were as follows:
Opening WIP 200 units (25% complete) valued at Ksh. 2,500
800 units received from Process 1 valued at ksh. 4,300
840 units were transferred to process 3
Closing WIP 160 units (50% complete)
The costs for the period were Ksh. 16,580 and no units were scrapped. It is required to prepare the
process accounts for process 2 units:
i) The FIFO method of valuation.
ii) The average cost method of valuation.
Solution
Using FIFO method
Calculation of effective units of production
Units
Completed units transferred out 840
+ Work contained in closing WIP (160ื50%) 80
920
- Work contained in opening WIP (200 x 25%) (50)
Effective units for period 870
Period cost per unit = Total cost for period i.e. process costs + transfers in
Effective units for period
= 16,580 + 4,300
870
= Ksh. 24.
This figure is used to give the closing WIP valuation, i.e.
160 ื 50%ืKsh 24 = Ksh. 1,920.
The valuation of the number of complete units transferred to process 3 is found from the balance on
the process account as follows:
The transfer value of Ksh. 21,460 is the balance on the account and is Kshs. 1,300 greater than the
period cost per unit already calculated i.e. Kshs. 21,460 - (840 x Kshs. 24) = Kshs. 1,300.
This is the amount by which the opening WIP valuation (based on the previous period's costs) is
greater than the current period costs i.e.
Kshs. 2,500 - (200 x 25% ื Kshs. 24) = Kshs. 1,300.
Thus, it would be seen that only the current period cost levels, i.e. The Kshs. 24 per unit are carried
forward to the next period in the closing WIP valuation.
Using average cost method
Using this system the effective units are the transfers to the next process (840 units) plus the work
contained in the closing WIP (80 units i.e. 50% of 160 units) that is a total of 920 units.
The costs involved are the total of the opening WIP valuation + the valuation of units transferred in
+ the process 2 costs i.e.
Kshs. 2,500 + 4,300 + 16,580 = Kshs. 23,380.
Average cost per unit = 23,380 = Kshs. 25.413.
920
This is used to value both the closing stock and transfers out thus:
Closing stock valuation = 160 x 50% x Kshs. 25.413 = Kshs. 2,033.
Transfers to process 3 = 840 x Kshs. 25.413 - Kshs. 21,347
Note-illustration (average cost method):
1. It will be seen that the effect of the average cost method is, in this example, to increase the value
of closing stock and reduce the value of transfers to process 3. This is because the previous
period cost levels (as contained in the opening WIP valuation) were higher than the current cost
levels. If the previous period cost levels were lower than current levels the average cost method
would cause the closing WIP valuations to be lower than when using the FIFO system.
2. The above example has deliberately been kept simple to show clearly the principles involved.
Examples follow which show the added complications of abnormal and normal scrap and where
the elements material, labour and overheads) or the opening and closing WIP are involved. It
must be stressed however. That these added complications merely increase the amount of
arithmetic involved, they do not alter the basic principles explained above so it is important that
these are thoroughly understood before proceeding further.
Illustration
This example illustrates the treatment of opening and closing WIP where the WIP is broken down
into its various elements.
The following data relate to process y for accounting period 2.
At the beginning of period 2, there were 800 units partly completed which had the following values
i) The FIFO method and
ii) The average cost method
Solution to the above illustration using FIFO method
As previously, the first step is to calculate the effective units of production for the period. This
follows identical principles to example 4 except that in this example it is necessary to consider the
four elements of the units (input material, material introduced, labour and overheads) instead of
simply the units as whole. When the effective production is ascertained the cost per unit, for each
element, can be calculated.
Illustration
This is more complicated example which brings together the various facets of process costing
covered in the chapter. It includes opening and closing WIP and normal and abnormal losses where
the scrapped units are not fully complete.
The following data relate to process 2 for one accounting period. Process 2 receives units from
process 1 and, after processing, transfers them to process 3.
Transfers from process 1: 4, 100 units valued at shs.5,200.
Transfers to process 3: 3, 500 units
Shs
Materials introduced 2,956
Labour 2,200
Overheads 1,900
Closing stock 800 units at the following stage of completion
Input materials 100% complete
Material introduced 60% complete
Labour 50% complete
Overheads 40% complete
400 units were scrapped at the following stage of completion
Input material 100% complete
Material introduced 100% complete
Labour 40% complete
Overheads 30% complete
The normal loss is 10% of production and the scrapped units realized 40p each. It is required to
prepare the process account for process 2 using
i) The FIFO method,
ii) The average cost method.
Solution to example 6 using FIFO method
The first stage is to calculate the amount of normal loss to see whether there is any abnormal loss or
gain involved.
The production for the period is calculated as follows:
Opening WIP 600 units
+ Transfers in 4,100
4,700
- closing WIP 800
Production 3,900 units
Normal loss is 10% of 3,900 = 390, and as the actual number scrapped were 400, there were 10 units
of abnormal loss.
The calculation of effective units for cost calculation purposes follows the same principles as in
examples 4 and 5 except that the number of units of abnormal loss must be included in the total
effective production because, as explained, abnormal losses are costed on the same basis as good
production.
Calculation of effective units and cost per unit
(This is the cost of the material introduced, Shs. 2,956, less the resale value of the normal loss,
Shs.156 i.e. 390 @ 40p each. The resale value of the 10 units of abnormal loss is credited to the
abnormal loss account not the process account.
Note: if instead of the abnormal loss, there had been an abnormal gain the treatment would be as
follows for both average cost and the FIFO methods. The total effective production would be found
as in example 5 less the number of abnormal gain units. These units would be evaluated at the cost
per unit calculated and the process account debited with the abnormal gain units and their value. It
follows that abnormal gain units will always be fully complete whereas abnormal loss units may be
partially or fully complete.
JOINT AND BY PRODUCTS
JOINT PRODUCTS
These are two or more products produced in the same process and separated at a certain separation
or split off point.
They are a group of individual products which are produced simultaneously together with each
product having a significant sales unless to merit recognition as a main product.
They are identified as individual products at a certain stage of completion where products separate to
become individual products.
Features of joint products
1. They are produced in the same process.
2. They cannot be distinguished from each other until split off point.
3. They have substantial sales value.
4. They may require further processing after separation.
Accounting for joint products
Joint products are not separately identified until the split off point. Each product should be casted
separately and the main problem is how to account for common costs in the joint costs.
There are several methods that can be used to allocate joint costs which include:
- Units of output
- Sales value at separation point
- Net realizable value
i) Units of output ( Physical measures method)
In this method joint cost are allocated on the basis of relative weight of output of each product
relative to the total output.
This method is suitable where units of measurement of the products are the same.
Limitations
Products may separate at different states in liquids, gases, solids etc.
In this case the method will be unsuitable since the products have different units of measurement.
It fails to recognize the revenue earning power of individual products and allocates the same costs to
all products irrespective of the revenue generated.
Illustration
AMC plc incurred joint costs of Shs.2,400 in manufacturing Product A and Product B to the split-off
point; Product A weighed 700 kg and had a sales value at the split-off point of Shs1,800; Product
B weighed 300kg and had a sales value at the split-off point of Shs.1,200 Cost Allocation:
Required:
Using the physical measure /unit approach, calculate the cost allocated to products A and B. Prepare
the income statement for the period.
ii) Sales value at separation point (sales value Method)
In this method, costs are allocated to the products on the basis of revenues generated at separation
point.
The method is appropriate where the products become sellable at the split-off point.
Joint costs are apportioned to each product on the basis of proportion that the sales value of the
product have relative to the total.
iii) Net Realizable value
Joint product may have no market value at the point of separation because they need further
processing for them to be ready for sale or they may be processed further to enhance their value.
Net realizable value is defined as the sales value minus additional processing and disposed costs.
In the method, joint costs to be allocated to individual products will on the basis of individual net
realizable value relative to the total net realizable value.
Illustration
A production process has joint costs of Sh.12, 000 for the input of 1,000 kgs of material. Two
products are produced from this:
Product A: 600 kgs. Selling price = Sh.25/unit. Separate costs = Sh.4, 000
Product B: 400 kgs. Selling price = Sh.40/unit. Separate costs = Sh.7,000
Required;-
Calculate the inventory value of the production using
(a) Weight to apportion the joint costs
(b) Net realisable value to apportion the joint costs.
Illustration
Jitegemee limited company uses a process costing system in its operation. In one of the production
processes, two joint products A and B and a by-product C are produced
The following additional information is provided:
1. Each processing run requires 12,500 kilograms of output. The costs incurred are as follow:-
Sh.
Materials
Labour
Overheads
456,250
295,000
268,750
2. It is expected that 20% of the input will be damaged in the production process. This is sold as
scrap at sh. 10 per kilogram. The damaged items are detected at the end of the production
process.
3. The output from the production process is as follows:-
Product Output Selling price per
kilogram
A
B
C
50%
40%
10%
200
250
20
4. Product A has to be processed further at a cost of sh. 100 per kilogram before sale
5. The joint costs are allocated to the products on the basis of net releasable value
Required:
i. Determine the total cost of the output from the production process
ii. Calculate the allocated joint costs for product A and product B
iii. Prepare a process account for the production process above
Solution
i)
Output units
Input units 12500
N. loss (20% ื12500) 2500
= 10,000kgs
Output units per product
A: 50% ื 10,000 = 5000
B: 4% x 10000 = 4000
C: 10% x 10000 = 1000
= 10,000
Total process cost
D. materials
D. labour
O/Hs
456,250
295,000
268,75 0
1,020,0000
Less:
Scrap for N. loss (2500 x 10) (25,000)
By-pdt C (1000ื20) (20,000)
Total cost Joint costs (A&B) 975,000
ii)
NRV = Sales Further process
A: (5000 x 200 (5000 x 100) = 500,000
B: (4000 x 250) 0 = 1,000,000
= 1,500,000
BY-PRODUCTS
These are products recovered incidentally from materials used to manufacture main products.
They are one or more products produced incidentally during this manufacture of the main product.
Examples of by-products; wax, hides, molasses, saw dust and coffee husks
Features of a by-product
1. They have relatively low sales value when compared to the main products.
2. They are not intended to be produced.
Joint cost will only be allocated to the recognized main product.
No costs are allocated to the by-product. However any amount realized from sale of by-products
may be accounted for as follows:
i) The sales value on the net realizable value (NRV) of the by-products is added to the sales of
the sales of the main product i.e. it is treated as additional revenue of the main product.
ii) The sales on the net realizable value of the by-products is deducted from the cost of
production of the main product is valued at net cost of production. This is the main method of
accounting and by-products.
iii) The amount realized is treated as a miscellaneous income and transferred to P&L statement.
NB If the method is not given use the amount realized to reduce the product cost of the main product
(Method ii)
SERVICE COSTING
Service costing is a cost accounting method concerned with establishing the costs of services
rendered.
Despite this definition, we should note immediately that even though we may be dealing with
services that are intangible, the cost accounting methods we use are essentially the same as if we
were making cars, biscuits or televisions.
When we set up a service cost accounting system, therefore, we would need to keep in mind the fact
that the progression, for example, of a cheque through the banking system, can be treated as items of
raw material passing through a production process. Similarly, we should readily appreciate that the
provision of a transport service has much in common, from the cost accounting point of view, with
the manufacture of the lorry or van that is being used to provide the service.
Specific Examples: where is service costing applied?
The Differences between Product Costing and Service Costing
- There may be very few, if any, materials to worry about
- Overheads will comprise the most significant portion of any costs of which, labour costs may
well comprise as much as 70%
Service Costing: profit or cost centre?
Many organisations simply want to determine the costs of operating its services from a management
control and management information point of view. However, there are many organisations now that
operate services for their own organisations as well as sub contracting them out to other
organisations. For example, there are companies that operate their own payroll section for
themselves; and offer this service to other organisations as well. Other organisations sell CPU time
on their computers at times when they do not use it themselves: for example, in overnight batch
work.
One key factor here is that we might be in the situation of assessing the least cost basis for providing
a service, rather than the highest profit possible.
Service Cost Units
What are the cost units for a service? For a manufacturer, cost units would be
Service costing is no longer an elective pursuit, it is a compulsory exercise. It ensures that tariffs
represent prices for customers and competitors. Economic, accounting and engineering costs all play
a role in determining service costs. Engineering costs measure technological relationship between
inputs, outputs, Accounting costs record, analyze historic costs according to industry rules,
Economic costs apply the theories of resource allocation to forward looking costs
Examples of operating costs include repair and maintenance, labour, site rental, utilities, license,
regulatory fees and taxes and depreciation.
Service costing can use either of the methods highlighted below:
Activity based costing; ABC assigns costs based on the activities required to deliver a service and
the resources these activities absorb. ABC might bring more transparency in the calculation of
transferred cost, making the current costing practice look redundant.
Nevertheless, ABC hides potential inefficiencies of the service provider. Even if an element or asset
is underutilized, its cost is completely shared by the services that use it and there is no incentive for
the provider to improve its efficiency
Fully distributed cost; in here, the total cost of a service, both direct and indirect costs, are
distributed among the services sold. FDC comes from historic/embedded cost. It relates prices to
information available in accounting, billing systems. However, it requires judgment in allocating
indirect costs devising methodology.
Long run average incremental cost (LRAIC): this constitutes cost of production of an additional
unit plus an allocated share of common costs. Forward-looking costs are used to approximate costs
in a competitive market, not historical costs which typically reflect inefficiencies and investment in
outdated technologies. LRAIC mimics the competitive marketplace and encourages economic
efficiencies. However, it is difficult to calculate or model the incremental costs, lacks transparency
and negotiation skills and specialized expertise on inputs required. Additionally, an amalgamation of
embedded and forward looking costs, blended together and computed on an average cost basis
should not be called incremental cost.
Marginal cost: this measures the change in total output resulting from a small change in the level
of activity. The marginal cost in this case is the cost of adding a service to an existing portfolio of
products or services.
Fully Distributed Cost (FDC) and Long Run Average Incremental Cost (LRAIC) are the common
ones in literature and in practice. FDC may be easier to calculate, but LRAIC promotes operator
Illustration
Steer & Wheel Ltd distribute its goods to a regional retailer using a single lorry. The dealer's
premises are 40 km away by road. The lorry has a capacity of 10ฝ tones and makes journeys twice a
day fully loaded on the outward journeys and empty on the return journeys. The following
information is available for a four week budget control period: period 8 of 2004.
UNIT COSTING
The unit cost of a product or service is obtained by assigning total costs to many identical or similar
units.
Companies need to allocate total product costs to units for the following reasons:
i) The company may manufacture thousands or millions of units of products in a given period of
time
ii) Products are manufactured in large quantities, but may be sold in small quantities sometimes at
one time or in dozens or bulk.
iii) It is important to determine with accuracy the cost of goods sold as it is needed, especially at the
point of transfer from finished goods to cost of sales. This calls for a correct and accurate
accounting for product cost per unit in order to properly match costs against related sales
revenue. This also helps managers to maintain cost control over the manufacturing process.
iv) A small change in unit cost can represent a significant change in overall profitability, when
selling millions of units of a product. Managers thus need to keep track of per unit cost on daily
basis through the production process while at the same time dealing with materials and output in
large quantities
v) Materials in the production process might need to be given a value, process costing allows for
this through the determination of equivalent units and cost per equivalent unit of production
