COSTING METHODS
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-in-process
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
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
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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
assignmanufacturing 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
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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
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
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
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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
(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
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
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:
Pass the necessary journal entries to record the above transactions.
Prepare a costing profit and loss account for the period above.
Solution
Dr Cr
SHS SHS
1 Materials 100,000
Cash 100,000
2 Work in Progress 70,000
Manufacturing overheads 5,000
Materials 75,000
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3 Factory Labour 250,000
Page 5 of 16
Cash 250,000
To record labour costs incurred
4 Work in progress 220,000
Manufacturing overheads 30,000
Factory labour 250,000
5 Manufacturing overheads 72,800
Cash 72,800
6 Work in Progress (see working below) 110,000
Applied manufacturing overhead 110,000
To record applied overheads
7 Finished goods; Job 2.2 152,500
Finished goods; job 2.3 117,500
Work in Progress 270,000
To record transfer of jobs to finished goods
8 Cash 200,000
Sales 200,000
To record sale of job 2.3
9 Cost of goods sold 117,500
Finished goods 117,500
To record transfer of job 2.3 to cost of sales
10 Applied manufacturing overheads 110,000
Manufacturing overheads 107,800
Cost of sales 2,200
To record over absorbed overheads
Costing profit and loss account
SHS SHS SHS
Sales 200,000
Cost of goods sold
Opening stock of work in progress(WIP) - -
Opening stock of raw materials - -
Add: direct material cost 70,000
Direct labour cost 220,000
Applied overheads 110,000 400,000
400,000
Less: Closing Raw materials 0
Closing W.I.P (130,000)
Cost of goods manufactured 270,000
Add Opening Finished goods inventory 0
Goods available for sale 270,000
Less Closing Finished goods inventory (152,500)
Cost of goods sold 117,500
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Over applied overheads (2,200)
Cost of goods sold 115,300
Profit for the period 82,500
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.100,000× 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;
Direct Direct labour Applied Total Cost
materials overheads
Job no 2.1 10,000 80,000 40,000 130,000
Job no 2.2 40,000 75,000 37,500 152,500
Job no 2.3 20,000 65,000 32,500 117,500
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
Similar units are produced continuously
The continuous nature of production results in some units being incomplete at the end of the period.
Loss is a common feature due to spoilage, wastage, evaporation etc.
Costs cannot be identified with individual products.
In some cases output may be multiple products.
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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:-
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.
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.
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It carries its own cost and will be valued a good unit and the amount transferred to P&L
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.
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.
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:-
Determination of inputs and outputs
Calculating cost per unit and outputs
Calculating the total cost of outputs
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.
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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;
Normal Loss: is loss expected and unavoidable even under the most efficient systems of
production. Normal spoilage cost is normally included in product cost.
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;
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:
Compute equivalent units including normal spoilage.
Assign costs to all units including normal spoilage.
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)
Process I Account
Materials 2,000 20,000 Transferred to process II 1,900 66,500
Labour cost 30,000 Normal loss 100 3,500
Overhead cost 20,000 -
70,000 70,000
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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;
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.
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
Process 1 Account
Materials 2,000 20,000 Normal loss (5%) 100 -
Labour cost 30,000 Transferred to process II 1,900 70,000
Overhead cost 20,000 -
70,000 70,000
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.
Page 11 of 16
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
Process account
Units Sh. Units Sh.
Material 1,000 4,000 Normal loss 200@ sh.0.5 100
- - To finished goods 800@ sh.4.875 3,900
1,000 4,000 1,000 4,000
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
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. ,
Illustration
ABC Chemicals Ltd manufactures a chemical compound branded 'X' used in making plastics. The
chemical compound involves two processes; A and B. The output of process A is passed to process B
where further material is added to mix. The details of the process costs for the production period ended 30
April were as follows:
Process A:
Direct materials 5,000 kgs at Sh. 10 per kg.
Direct labour Sh. 40,000
Process plant 200 hours at Sh. 220 per hour
time Overheads
Sh. 20,000
Process B:
Direct materials 3,000 kgs at Sh. 10 per kg.
Direct labour Sh. 25,000
Process plant 120 hours at Sh. 220 per hour
time Overheads Sh. 12,000
Additional information:
Page 13 of 16
1. The expected and actual output for the processes was as follows.
A B
Expected output 90% of input 95% of input
Actual output 4,200 Kgs 7,340 Kgs
Assume no finished stock at the beginning of the period and no work in progress at
either the beginning or the end of the period.
Normal loss is sold as scrap for Sh.1.00 per kilogramme from process A and
Sh.2.00per kilogramme from process 3, for both of which immediate payment is
received
Required:
Process A
account. Process B
account.
Abnormal loss/gain account,
Normal loss account
Solution
ABC
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 = 120×250 =
shs30,000 Scrap value = 2
Process A Account
U Amount Units • Amount
nit • •
s •
’ Shs ’“ Shs
“
Direct materials 5,0 - 50,00 Output 4,2 34.111 143,267
00 0 00
Direct labour 40,00 Normal loss 50 1 500
0 0
Process plant time 44,00 Abnormal loss 30 34.111 10,233
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0 0
Overheads 20,00 -
0
5,0 154,0 5,0 154,000
00 00 00
] 9] ] • d− •
:]/e9 ‡
Page 15 of 16
%ˆ ˆ %]~ − •
, dˆ=
,
= :] %ˆ
= , , = 34.111
Process B Account
Units • • Amount Units • • Amount
’ “ Shs ’ “ Shs
Process A/c 4,200 34.111 143,267 Output 7,340 37.288 273,691
Direct materials 3,000 15 45,000 Normal loss 360 2 720
Direct labour 25,000
Process plant time 30,000
Overheads 12,500
Abnormal gain 500 37.288 18,644
7,700 274,411 7,700 274,411
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