Costing methodsgenerally refer to the various approaches used in calculating product cost. Itis the method of costing specifically designed for each organization to fit theparticular way that its goods or services are produced. This means that foreach business, the costing method used is determined by its production orservice delivery technique. And that each firm has a costing method with uniquefeatures and peculiar to its production method. For this, firms in similarlines of business use costing methods or systems with common features. Those inunrelated lines employing wide ranging production methods therefore havecompletely different costing methods,
In determiningcosting 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 ofthe two broad categories of costing methods to be used. If yes, operation costing and if no, specific order costing are the methodsto be respectively used. The particular system of costing to use under each ofthe broad classes above and the conditions for their application will be discussed in detail later inthe chapter. The diagram below further explains the use of each costing method.
Operation costing isused in those systems producing standard or uniform products in mass withoutconsideration for any particular customer. As also shown, if the product is atangible or a physical good, process costing is used but if intangible or aservice, service Costing isused. If not a standard product, that is each product is uniquely differentfrom the rest, the general method is specificorder costing. Here, the next consideration is the number of units ineach job. If the job consists of multiple units, that is more than one, batch costing is the method used. Forjobs of single unit, the time duration is further considered. Single unit jobsrequiring short duration to complete use the job-order costing method and those requiring long time to completeuse Contract Costing.
As Shukla and Grewal noted, depending upon thenature of industry, the following are the methods usually followed:
SPECIFIC ORDER COSTING
Specific ordercosting generally refer to all those costing methods used when production is tothe specific requirement of the customer. That is where the customer decideswhat he wants and production is patterned towards his specifications.Accounting terminology defines specific-order costing as The basic costingmethod applicable where the order consists of separate contracts, jobs or batches”.Submethods under specific order costing depending on the nature of the specialorder include:(a) Job- order costing
(b) Batch costing (c) Contract costing
JOB ORDER COSTING
Job- costing is usedfor 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 losson each job and the valuation of work -in progress.
To ensure aneffective job-order system, there must exist administrative procedures fortimely production and delivery as well as costing of jobs. The administrativeprocedures involve:
(1) Receipts ofcustomers enquiry or request
(2) Preparation andsending of quotation or estimate to customer
(3) Placing of orderby customer if quotation is acceptable or after negotiation of estimate in (2) above.
{4} Production controlraise requests for materials, labour and other requirements.
(5) Manufacture ofjob.
(6) Completion anddelivery of job.
(7) Invoicing.
For proper costing of jobs, a Job Cost Card is created for eachjob. The detailed entries on the job cards, as they are also called, aredebited to the work in progress account. The job costing procedure includes:
(i) Obtain all direct and indirectcosts of materials, labor an overheadsfrom various source documents, e.g. purchase invoices, cost analysis, storesrequisitions, time records etc.
(ii) Enter a job card for each job with costentries for direct materials, direct wages. Also enter on the job cardproduction overhead absorbed.
(iii) From each job card, debit total entriesto the work-in progress control.
(iv ) On completion of each job, transfer thetotal cost of the job to finished goods account.
(v) When completed goods are dispatched tothe customer, a sale is deemed to have taken place, depending on the policy ofthe company. The production cost is loaded with the administrative, selling anddistribution costs to determine the cost of sales.
(vi) Finally, the sales price is credited tothe costing profit/loss account, the cost of sales debited and the differenceafter any adjustment for over or under absorbed overheads is the profit or losson the job.
ADVANTAGES OF JOB ORDER COSTING
(1) More accurate costing is possiblebecause all costs are compiled and specifically identified with specific orderor product
(2) It helps to identify profitable and nonprofitable jobs since each job is specific
(3) It provides a basis for comparing onejob cost to another or comparing a cost job sheet to a cost estimate.
(4) It helps in preparation of estimateswhen submitting quotations for similar jobs.
( 5) Job cost sheet can be used to controlefficiency and estimate future work.
DISADVANTAGES OF JOB ORDER COSTING
(1) It requires a detailed record ofdocuments and accounts because each job requires a separate record
(2) The record keeping for different jobsmay prove to be more complicated.
(3) The job may becharged for inefficiencies though it has not caused it. A job cost sheetis 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 passthrough two distinct departments A &B. The company has justreceived an orderfrom one of its customers who has orderedfor the Dinning table. In attempt to meethis 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 overheadcosts incurred include the following:
- Variable overheadcosts N150,000 N200,000
- Total fixed overheadcosts 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 apolicy of absorbing fixed overheads to cost unit on the basis of labour hours worked.
- Advise the company onthe following matters:
- Cost of the Dinningtable
- What the company cancharge 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.
- Job order costs:
Direct material costs: A = 1,500 units x N250 =375,000
B = 1,200 units x N300 =360.000 735,000
Directlabour costs: A= A-1000hrsx N200 = 200,000
B -5000 hrs x N150 =750,000 950,000
1,685,000
Primecosts
Overhead costs: A 150,000
B 200,000
Fixed overheads: A 1,000 hrs x N300 300,000
B 5,000hrs xN 300 1,500,000 2,150,000
Total productioncosts 3,835,000
- The amount that can be charged to the client can be calculated asunder:
Selling price = Cost + Mark-up.
Margin =1/5, therefore Mark-up =1/4
Sellingprice = 3,835,000 + 1/4x3,835,000
Selling price = 3,835,000 + 958,750
Selling price =N4,793,750
Batchcosting Method
This is a form ofspecific order costing used where identical items or articles are manufacturedas a batch or in a group. Instead of one unit being made in response to a customer’srequest, a batch of identifiable units is produced. A is treated as a job duringthe process when batch is being processed. A batch in this case istreated as a cost unit and the cost of each identical unit that constitutes a batch is determined bydividing total batch costs by the number of units in abatch as shown below;
Unit cost =Total batch Number costs
Number of units in a batch
In attempting to apply this costing technique, the units involvedmust 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 meetcustomer’s permeations. The approach isapplied in Foot and ware industries, brick making factories, clothing industryamong others,
EXAMPLES
Matltd dealers of timberproducts, 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 tobe met.
Materials:
- Timber 400 meters @ 20,000/=
- Nails 200kgs @ 4,000/=
- Vanish 10 liters® 25,000/=
Labour cost: Workers to begot 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 dayper man.
Variable overheads:
Dept.A are absorbed on the basis of direct labour hours atrate of 3000/=@.
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 thecompany would process it as batch number 10;
- Determine the unit cost of each bench.
- What price would be charge to Team ltd per Bench if, Mat ltdtargets gross profit 25% profit on cost?
- What price would be charge to Team ltd per Bench if, Mat ltdtargets gross profit 25% profit on sales?
Suggested solution:
- Costs of batch number10 of 2000 benches.
N N
Materialcosts:
Timber 400 metersxN 2,000 800,000
Nails 200kgs xN 2,500 500,000
Vanish 10litres x N25,000 250.000 1,550,000
Labourcosts:
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
Variablecosts:
Department A .100 hours x N3,000 300,000
-Department B 20 % xN2,650,00 530.000 830,000
Fixed Manufacturing costs400 x 2,000 benches; 800,000
Total batch costs 4,280,000
Cost perbench = Total batch costs
No. ofbatches
= 4.280,000 – N2,140 per bench.
2,000
b. Sellingprice = cost + mark-up
– 2,140 + l/4X2,140
= N2,675
c. Ifmargin is 1/4, then mark-up is 1/3.
The sellingprice=2,140+ 1/3 x2,140
N2853.30
ILLUTRATION 1
The following isavailable for Job No 00172 in favor of Amadi
Direct materials
20 piecesof 2″x 5″ x 12 wood © N500 each
20 pieces of 2″ x 3″ x 12′ wood @ N200each
10 kg of special material “XI2” @ «400per kg
Wages:
Direct labor – 70 hours © N100 per hour
20machine hours @ N200 per hour
Indirectlabor – maintenance hours -20 hours @
N100 perhour
Overheads-40%prime cost
You are required toenter the above on Job card No.00172 to be transferred to the work in progresscontrol for the period.
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