Costing Methods
Cost Fundamentals
Costing Methods
Syllabus tag: KASNEB CPA | Intermediate Level | CA25 Management Accounting | Topic 2 Costing Methods
Lesson objectives
By the end of this topic, you will be able to:
- Choose the costing method that suits a given business
- Cost a job and price it on a mark-up or a margin
- Compute cost per unit in a process, allowing for normal loss and scrap
- Distinguish normal loss from abnormal loss and value each
- Compute a service cost per composite unit
Why this matters
There is no single way to cost a product. A tailor making one suit and a refinery producing thousands of litres face genuinely different problems, and the method has to fit the production.
Choosing the method
| Method | Suits | Cost object |
|---|---|---|
| Job costing | One-off work to customer order | The job |
| Batch costing | Identical items made in groups | The batch |
| Contract costing | Large, long-term projects | The contract |
| Process costing | Continuous, identical output | The process |
| Service costing | Services rather than goods | A composite unit |
The test is whether output is distinguishable. If you can point at unit number 47 and say what it cost, use job or batch costing. If every litre is identical, average across the process.
Job costing
Job 214 uses direct materials KES 186,000, direct labour KES 240,000 and 600 machine hours absorbed at KES 350 per hour.
| KES | |
|---|---|
| Direct materials | 186,000 |
| Direct labour | 240,000 |
| Overhead (600 × 350) | 210,000 |
| Total job cost | 636,000 |
Pricing the job. Two phrases that sound alike and give different answers:
- 25% mark-up on cost: 636,000 × 1.25 = KES 795,000
- 25% margin on selling price: 636,000 / 0.75 = KES 848,000
A mark-up is a percentage of cost; a margin is a percentage of the selling price. Confusing the two is a common and expensive error.
Batch costing
Identical to job costing, then divided. A batch of 1,200 units costing KES 960,000 gives 960,000 / 1,200 = KES 800 per unit.
Process costing
Continuous production, so cost is averaged over output. The complication is loss.
Normal loss is the loss expected in efficient working — evaporation, offcuts, trimming. It is not an error, so its cost is absorbed by the good output. Where the loss has a scrap value, that value reduces the cost to be spread.
Abnormal loss is loss beyond the normal allowance. It is not absorbed into the good units; it is written off separately, so that the cost of inefficiency is visible rather than buried in the product cost.
Worked example. 10,000 units input, costs KES 5,040,000. Normal loss 5% of input, with scrap value KES 200 per unit. Actual output 9,300 units.
Normal loss = 5% × 10,000 = 500 units Expected output = 10,000 − 500 = 9,500 units Scrap value of normal loss = 500 × 200 = KES 100,000
Cost per unit = (5,040,000 − 100,000) / 9,500 = 4,940,000 / 9,500 = KES 520
Note the denominator: expected output, not input and not actual output. That is what makes the normal loss fall on the good units.
Abnormal loss = 9,500 − 9,300 = 200 units, valued at 200 × 520 = KES 104,000
Checking the whole: (9,300 × 520) + (200 × 520) + 100,000 = 4,836,000 + 104,000 + 100,000 = 5,040,000, which is the cost put in.
:::checkpoint Explain why abnormal loss is valued at the full cost per unit of KES 520 while normal loss is valued only at its scrap value of KES 200. What would be hidden if both were treated the same way? :::
Service costing
Services have no physical unit, so a composite unit is used: one that combines two measures.
- Transport — passenger-kilometre, or tonne-kilometre
- Hotels — occupied bed-night
- Hospitals — patient-day
- Electricity — kilowatt-hour
Total costs of KES 4,500,000 over 1,500,000 passenger-kilometres gives KES 3.00 per passenger-kilometre.
The composite unit is needed because neither measure alone is meaningful. Cost per passenger ignores distance; cost per kilometre ignores how full the bus was.
Contract costing
Long contracts spanning several accounting periods, so the question becomes how much profit to recognise before completion. The prudent treatment: take profit in proportion to work certified, and recognise any foreseeable loss in full immediately.
:::checkpoint A bus company reports its cost per kilometre has fallen while its cost per passenger has risen. Explain how both can be true at once, and say what has probably happened to the business. :::