COSTING METHODS AND TECHNIQUES

Costing methods generally refer to the various approaches used in calculating product cost. It is the method of costing specifically designed for each organization to fit the particular way that its goods or services are produced. This means that for each business, the costing method used is determined by its production or service delivery technique. And that each firm has a costing method with unique features and peculiar to its production method. For this, firms in similar lines of business use costing methods or systems with common features. Those in unrelated lines employing wide ranging production methods therefore have completely different costing methods,

In determining costing methods suitable for common production and service delivery techniques, this question should first come to mind: is it a standard product? The-answer to this, determines which of the two broad categories of costing methods to be used. If yes, operation costing and if no, specific order costing are the methods to be respectively used. The particular system of costing to use under each of the broad classes above and the conditions for their application will be discussed in detail later in the chapter. The diagram below further explains the use of each costing method.

Operation costing is used in those systems producing standard or uniform products in mass without consideration for any particular customer. As also shown, if the product is a tangible or a physical good, process costing is used but if intangible or a service, service Costing is used. If not a standard product, that is each product is uniquely different from the rest, the general method is specific order costing. Here, the next consideration is the number of units in each job. If the job consists of multiple units, that is more than one, batch costing is the method used. For jobs of single unit, the time duration is further considered. Single unit jobs requiring short duration to complete use the job-order costing method and those requiring long time to complete use Contract Costing.

 As Shukla and Grewal noted, depending upon the nature of industry, the following are the methods usually followed:

SPECIFIC ORDER COSTING

Specific order costing generally refer to all those costing methods used when production is to the specific requirement of the customer. That is where the customer decides what he wants and production is patterned towards his specifications. Accounting terminology defines specific-order costing as The basic costing method applicable where the order consists of separate contracts, jobs or batches”.Sub methods under specific order costing depending on the nature of the special order include:(a) Job- order costing

(b) Batch costing                                  (c) Contract costing

 JOB ORDER COSTING

Job- costing is used for those special work-orders done to the special requirements of the customer. Like other costing methods, its main purpose is to establish the profit or loss on each job and the valuation of work -in progress.

To ensure an effective job-order system, there must exist administrative procedures for timely production and delivery as well as costing of jobs. The administrative procedures involve:

(1)        Receipts of customers enquiry or request

(2)        Preparation and sending of quotation or estimate to customer

(3)        Placing of order by customer if quotation is acceptable or after negotiation of estimate in (2)             above.

{4}       Production control raise  requests  for materials, labour and other requirements.

(5)        Manufacture of job.

(6)        Completion and delivery of job.

(7)        Invoicing.

For proper costing of jobs, a Job Cost Card is created for each job. The detailed entries on the job cards, as they are also called, are debited to the work in progress account. The job costing procedure includes:

(i)         Obtain all direct and indirect costs  of materials, labor an overheads from various source documents, e.g. purchase invoices, cost analysis, stores requisitions, time records etc.

(ii)        Enter a job card for each job with cost entries for direct materials, direct wages. Also enter on the job card production overhead absorbed.

(iii)       From each job card, debit total entries to the work-in progress control.

(iv )      On completion of each job, transfer the total cost of the job to finished goods account.

(v)        When completed goods are dispatched to the customer, a sale is deemed to have taken place, depending on the policy of the company. The production cost is loaded with the administrative, selling and distribution costs to determine the cost of sales.

(vi)       Finally, the sales price is credited to the costing profit/loss account, the cost of sales debited and the difference after any adjustment for over or under absorbed overheads is the profit or loss on the job.

 ADVANTAGES OF JOB ORDER COSTING

(1)        More accurate costing is possible because all costs are compiled and specifically identified with specific order or product

(2)        It helps to identify profitable and non profitable jobs since each job is specific

(3)        It provides a basis for comparing one job cost to another or comparing a cost job sheet to a cost estimate.

(4)        It helps in preparation of estimates when submitting quotations for similar jobs.

( 5)       Job cost sheet can be used to control efficiency and estimate future work.

DISADVANTAGES OF JOB ORDER COSTING

(1)        It requires a detailed record of documents and accounts because each job requires a separate record

(2)        The record keeping for different jobs may prove to be more complicated.

(3)        The job may be charged for inefficiencies though it has not caused it. A job cost sheet is maintained to record all cost details regarding each job. A provides a summary of material costs, labour and factory for each job processed. Each job is given a job for easy r, and control purposes. The job cost sheet is shown in

Job cost sheet/card

Name of the Client………………….                        Date of commencement………………

Job Number…………………………..                         Date of completion…….

Materials Labour costs Overhead costs
Date Qty Amt (UGX) Date Dept Hours worked Amt (UGX) Date Dept Hre Amt (UGX)
                     
Total   X       Y       Z

Figure 7.1. Job cost sheet.

The sum of material costs(X), Labour costs(Y) and Overhead costs (Z) the amount of costs incurred in carrying out the job.

ILLUSTRATION 1

Arc Company manufactures timber products and most of them pass through two distinct departments A &B. The company has just received an order from one of its customers who has ordered for the Dinning table. In attempt to meet his order, a Management Accountant managed to estimate following costs that are expected to be incurred:

  Department A Department A
Materials 1,500 unit at N2507 each 1,200 units at 3,000
Labour costs 1000 hours at N200 each 5000 hours at N150

Factory overhead costs incurred include the following:

  1. Variable overhead costs        N150,000                N200,000
  2. Total fixed overhead costs charged to the whole factory amount to N24,000,000 based on 80,000  labour  hours worked for in the factory  in  111 period. The company has a policy of absorbing fixed overheads to cost unit on the basis  of   labour hours worked.
  3. Advise the company on the following matters:
  4. Cost of the Dinning table
  5. What the company can charge the client if the company targets  a profit of 20% profit on sales

Suggested solution:

Overhead absorption rate – 24,000,000    780,000 – 3007- per labour hour.

  1. Job order costs:

Direct material costs: A = 1,500 units x N250    =375,000

B = 1,200 units x N300    =360.000                                          735,000

Direct labour costs: A= A-1000hrsx N200    = 200,000

                                B -5000 hrs x N150           =750,000          950,000

                                                                                               1,685,000

Prime costs

Overhead costs:          A                                              150,000

                               B                                       200,000

Fixed overheads:    A   1,000 hrs x N300         300,000

                               B   5,000 hrs xN 300      1,500,000                       2,150,000

Total production costs                                                                        3,835,000

  • The amount that can be charged to the client can be calculated as under:
    Selling price        = Cost + Mark-up.
    Margin                 =1/5, therefore Mark-up =1/4

Selling price     = 3,835,000 + 1/4x 3,835,000
Selling price     = 3,835,000 + 958,750

Selling price    = N4,793,750

Batch costing Method

This is a form of specific order costing used where identical items or articles are manufactured as a batch or in a group. Instead of one unit being made in response to a customer’s request, a batch of identifiable units is produced. A is treated as a job during the process when batch is being processed. A batch in this case is treated as a cost unit and the cost of each identical unit  that constitutes a batch is determined by dividing total batch costs by the number of units in a batch as shown below;

Unit cost =Total batch Number costs

                 Number of units in a batch

In attempting to apply this costing technique, the units involved must e identical and production should consist of a limited repetitive work. Since it is a form of specific costing technique, the batch is made to meet customer’s permeations. The approach is applied in Foot and ware industries, brick making factories, clothing industry among others,

EXAMPLES

Matltd dealers of timber products, received an order from Team ltd for JOO benches of the standard size. Mat ltd estimated that the following ttts would be incurred if the order is to be met.

Materials:

  • Timber 400 meters @ 20,000/=
  • Nails 200kgs @ 4,000/=
  • Vanish 10 liters® 25,000/=

Labour cost:     Workers to be got from two departments i.e. A&B.

Dept A, 100 labor hours @ 5,000/=

Dept. B, 30 men working for 10 days at the rate of 20007= per day per man.

Variable overheads:

Dept. A are absorbed on the basis of direct labour hours at rate of 3000/[email protected]
Dept B, are absorbed as 20% of prime costs required for the order.

Fixed Manufacturing Overheads:

Fixed manufacturing cost per bench is N 400

Required; Assuming the company would process it as batch number 10;

  1. Determine the unit cost of each bench.
  2. What price would be charge to Team ltd per Bench if, Mat ltd targets gross profit 25% profit on cost?
  3. What price would be charge to Team ltd per Bench if, Mat ltd targets gross profit 25% profit on sales?

Suggested solution:

  1. Costs of batch number 10 of 2000 benches.

                                                                                           N                    N

Material costs:

Timber               400 meters xN 2,000               800,000

Nails                  200 kgs  xN 2,500                  500,000

Vanish               10 litres x N25,000                 250.000       1,550,000

Labour costs:

Department A 100 hours xN 5,000                  500,000

Department B 30 men x 10 days x 2,000   =   600.000        1,100,000
Prime costs                                                                          2,650,000

Variable costs:

Department A .100 hours x N3,000                 300,000

-Department B   20 % x N2,650,00                 530.000           830,000

  Fixed Manufacturing costs 400 x 2,000 benches;               800,000

Total batch costs                                                                 4,280,000

Cost per bench = Total batch costs

                                     No. of batches

= 4.280,000   –    N2,140 per bench.

                        2,000

b. Selling price = cost + mark-up

– 2,140 + l/4X 2,140

= N2,675

c. If margin is 1/4, then mark-up is 1/3.

The selling price=2,140+ 1/3 x2,140

                                            N 2853.30

  ILLUTRATION  1

The following is available for Job No 00172 in favor of Amadi

Direct materials

20 pieces of 2″x 5″ x 12 wood © N500 each

20 pieces of 2″ x 3″ x 12′ wood @ N200 each

10 kg of special material “XI2” @ «400 per kg

Wages:

             Direct labor – 70 hours © N100 per hour

20 machine hours @ N200 per hour

            Indirect labor – maintenance hours -20 hours @

N100 per hour

Overheads-40% prime cost

You are required to enter the above on Job card No.00172 to be transferred to the work in progress control for the period.