Chapter 5 - Methods Of Costing Flashcards
Unit costing
Unit costing is the cost incurred to produce one cost object.
A cost object is a unit of product, service or activity for which costs can be ascertained. Examples of cost objects in unit costing: per item manufactured, per meal served, per passenger mile.
The unit cost of production or output is always calculated as: cost of production of output/ number of cost units = unit cost
There are four unit costs that can be calculated: prime cost, marginal cost, absorption cost and total cost
Each of these include different costs of production as follows:
Direct costs - Direct materials, labour, variable poduction overheads
Direct materials and labour give the prime cost. Prime cost and the variable production overheads gives the marginal cost of production.
Indirect costs - Fixed production overheads. Marginal cost and fixed production overheads gives the absorption cost of production.
Fixed non production overheads - Administration, selling and distribution. Absorption cost plus fixed non production overheads gives us the total cost of production.
Costing methods for specific orders
This is where customers order what they want before it is made meaning that they agree to buy the product before the work is done.
Many service businesses carry out work to customers requirements. E.g accountants and solicitors. Each piece of work is different.
Costing methods which are used by businesses to collect costs and to calculate the total costs of their output include: Job costing and batch costing
Specific orders: Job costing
Job costing is used where each job can be separately identified from other jobs and costs are charged to the job.
The job becomes the cost unit to which costs are charged.
The main steps in job costing:
Customer asks for an estimate - job cost record prepared showing total cost - profit added to total cost and estimate is sent to customer - if estimate is accepted job is undertaken- actual costs charged to job cost record - job completed and dispatched to customer - variance between estimated costs and actual costs is analysed - action taken to overcome problems shown by variances
A separate job cost record is prepared for each job listing the estimates of direct materials, direct labour, direct expenses and overheads.
The actual costs are compared with the estimated costs and the differences between the two are analysed and action can be taken to correct the variances.
Specific orders: Batch costing
Batch costing is used where the output consists of a number of identical items which are produced together as a batch. E.g bakery producing a batch of standard white loaves and a batch of croissants. Each batch is the cost unit to which the costs are charged. Once batch has been produced, the total cost per unit is calculated as follows:
Total batch cost/ number of units of output = total cost per unit
Costing methods for continuous work
In both manufacturing and service industries, work may be done continuously rather than in separate jobs. This requires specific costing methods appropriate to those types of business. E.g:
A bus company runs a continuous service of buses and the customers at for thier use of the service - the output will be costed using the service costing method.
In the manufacture of chocolate bars production is a continuous process and the chocolate bars are available for customers to buy at all times - the output will be costed using the unit costing method.
Continuous work: Service costing
Example of service businesses:
A nursing home, bus service, banking services.
Such businesses use service costing to establish the unit cost of the service provided. E.g the cost per passenger mile of a bus or train service or the cost per student hour at a school or college.
The calculation of the cost per service unit is:
Total costs of providing the service for the period/ number of service units for the period = cost per service unit
Once the cost per service unit is known for external services a mark up can be applied to calculate the amount to be charged to the customer.
Continuous work: Unit costing
Unit costing is used by businesses that continuously produce a single product. Here the cost objects are identical and have the same costs.
Formula:
Total costs of production for the period/ number of units for the period = cost per unit
Total costs include material, labour and overheads. Once the cost per unit is known, a make up can be applied in order to calculate the amount to be charged to the customer.
Two considerations for unit costing:
How to calculate the number of units and value of work in progress at a given time
How to account for wastage, both normal and abnormal wastage
Work in progress - equivalent units
Part finished goods or work in progress goods can be calculated using either FIFO or AVCO.
In calculating cost per unit it is important to include the degree of completeness of work in progress which is done by making equivalent unit calculations:
Number of units in progress x percentage of completeness = equivalent units
The formula for calculating cost per unit now becomes:
Total cost of production/ number of units of output + equivalent units in progress = cost per unit
Accounting for wastage
An important aspect of most costing methods is that you don’t always get out what you put in, there is often wastage.
The aspect of costing where you don’t get out what you put in is described as a normal wastage. This is unavoidable wastage arising during the production process. This can occur as a result of factors such as evaporation, shrinkage, breakage, sampling and testing, and are included as part of the cost of the output.
Once a standard of normal wastage has been established, this then forms the expectation for future production. Any variation from this normal wastage is treated separately in the bookkeeping as abnormal wastage.
If any of the normal wastage can be sold as scrap sales the amount of money received is treated as a reduction in the total costs of production. E.g wood chipping from a fence manufacturer, scrap metal form an engineering company.
The production account gathers the total cost of production and records the amounts of normal and abnormal wastage.
Abnormal wastage
Abnormal wastage is where output is lower after normal wastage. For example
Inputs = 11,000 Kg
Less normal wastage 1,000
Expected output 10,000
Actual output (9,400)
Abnormal wastage 600
This will be credited to the production account at the same cost per unit as the output after allowing normal wastage. The amount of abnormal wastage is debited to a separate expense account.
At the end of the financial year, the balance of abnormal wastage account is debited to the statement of profit or loss:
Debit statement of profit or loss
Credit abnormal wastage account
By doing this abnormal wastage is treated as period cost instead of being included with production cost.
Scrap sales
Wastage can often be sold as scrap. Where there are revenues from scrap sales for both normal wastage and abnormal wastage we must distinguish the two.
Revenue from normal wastage is credited to the production account, where it reduces the cost of production.
Revenue from abnormal wastage is credited to abnormal wastage account so reducing the cost of abnormal wastage.
Both the transfer to finished goods and the abnormal wastage are valued at the cost per unit of the expected output:
Input cost - scrap value of normal wastage/ expected output
The value of abnormal wastage is debited to abnormal wastage account and the revenue received from scrap sales is credited to the account
The value of normal wastage account is debited to normal wastage account and revenue received from scrap sales is credited
Normal wastage
Normal wastage is credited to the production account and is included in the cost of output. It is calculated together with the cost of output.
