BA2 Fundamentals of Management Accounting
Module: 13
Batch and Job Costing
Batch and job costing
231
1. Job costing
Job costing or ‘job order costing’ relates to the costs to an organisation
for a specific order where the customer has some special requirements.
This needs to be separated from regular production as it may incur
additional costs. It can also be used for companies that work mostly on a
job by job basis such as a builder or a consultancy firm.
This is important as we need to identify the profitability of the specific order
or job; this can also be done before accepting the order to see if it is worth
doing.
For example, a pie shop makes steak pies, but a customer comes in asking us
for a specific order for 1000 sausage rolls and will pay us £2000. Our
production is not set up for this but by renting some additional machinery
and ordering some one off raw materials we can fulfil the order. However, if the
cost of these extra materials and machinery costs more than the revenue we
will receive from the order, it is not worth doing.
2. Direct costs
When analysing the costs of a job or order we need to identify the specific
costs related to it. An example of this would be labour and materials that
are wholly attributable to the specific order and are not involved with regular
production.
Returning to our sausage roll example, the direct costs would be the
machinery required to fulfil the order (this is because it is an additional cost
directly attributable to the order that we won’t have to incur if we don’t go
ahead with the order. Likewise, if we have 3 employees working 40 hours a
week to complete our usual orders and to fulfil the sausage roll order we
need each employee to work a further 10 hours, the 30 extra hours will be a
direct labour cost specifically attributable to the order.
3. Overheads
Adding overheads to job orders depends on whether or not the company
already has defined processes for absorbing overheads into production.
Despite not being directly related to job costs it is still fair to attribute
overheads to them.
For example, our pie company has two cost centres A and B.
The budgeted overhead for the two centres are as follows: A
= £2,000
B = £3,000
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A is absorbed based on labour hours and our total labour hours come to 300.
Centre B is absorbed based on machine hours which come to a total of 500
hours.
So, the standard absorption rate comes to:
A = 2,000 = £6.67 per labour hour
300
B = 3,000 = £6 per machine hour
500
For this specific job we have recorded the following costs:
Materials: £300
Labour:
A = 20 hours at £6.00
B = 10 hours at £4.00
Overheads/machine hours recorded against the job on the basis of: A
= 20 hours of labour
B = 40 hours of machine time
The additional machinery required for the job comes to £500; so, let’s
calculate the profit/loss and absorption attributable to this job:
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233
£ £
Direct Material
Direct labour:
300
Centre A = (20 x 6) 120
Centre B = (10 x 4) 40
160
Machine hire
500
Overheads
960
Centre A = (20 x 6.67) 133.3
Centre B = (40 x 6) 240
373.3
Total cost
1343.3
Revenue
2000
Profit
656.7
As you can see, when all direct costs and overheads have been allocated to the production of this specific job, we are still in profit; therefore, it makes
sense to go ahead with the specific job order.
4. Batch costing
Batch costing is very similar to job costing but tends to be used by firms
that produce products on a batch by batch basis. A pie manufacturer
might firstly make a batch of meat pies, then vegetable pies and then
quiches. Each batch this therefore costed separately so we can see the costs
associated with each.
The process of batch costing is just the same as job costing – just use the
same approach but for a single batch as opposed to the job or order.
One minor additional element that can always be calculated for a batch is the
cost per unit.
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234
Total cost per unit =
Total cost
Number of units
In the earlier sausage roll example, if rather than that being a specific order for
a customer it was just another ‘batch’ of production then:
Total cost per unit =
£1,343
1,000
= £1.34 per unit
That would be necessary to know as we now know that each would need to
be priced above £1.34 to make a profit.
5. Batch and job accounts
Bookkeeping for job or batch orders is recorded in mostly the same way
except that the particular job order is separated from regular production
and has its own T-account. I.e. figures related to job X are stored in the job
X account rather than the standard production account.
Example
A company is compiling its records for the last period, during that time the
company had three specific job orders; job X, job Y and job Z.
The company pays employees who directly contribute to production (direct
labour) £8 an hour, production overheads are absorbed at a rate of £10 per
labour hour.
Job X began in the previous month and was still uncompleted at the end of the
current month. Job Y and Z both began in the current month with Y being
completed and Z finishing the period uncompleted. The following figures
have been recorded:
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Work in progress (WIP) brought forward from previous month:
Job X
Direct material
£
1,500
Direct labour 800
Production overheads 2,200
4,500
Activity during period:
Job X Y Z
Direct materials £500 £7,000 £4,800
Hours worked (direct labour) 50 94 72
Completed? Yes Yes No
Revenue from completed goods 10,000 9,000 N/A
Production overheads paid: £3,000
Material transfer from job Y to job Z: £100
Job costs in T – accounts
Job X
£ £
Balance B/F 4,500
Direct Material 500
Labour (50 x 8) 400
Overheads (50 x 10) 500
5,900
We can see our production costs for Job X comes to a grand total of £5,900.
Since this job was completed we now needs to close this account by
crediting this value to the production account in order to include it as a
production costs:
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236
Job X
£ £
Balance B/F 4,500
Direct Material 500 Production 5,900
Labour (50 x 8) 400
Overheads (50 x 10) 500
5,900 5,900
Now let’s draw up accounts for Y and Z:
Job Y
£ £
Direct Material 7,000 Job Z 100
Labour (94 x 8) 752 Production 8,592
Overheads (94 x 10) 940
8,692 8,692
Note: Any costs and materials transferred between jobs must be credited
from the donating account. This must be debited to the receiving jobs
account and NOT the production account. Job Y is also completed so the
balance is credited to production.
Job Z
£ £
Job Y 100 Balance C/F 6,196
Direct Material 4,800
Labour (72 x 8) 576
Overheads (72 x 10) 720
6,196 6,196
Note: As job Z is not complete and still a work in progress (WIP) the balance
will need to be carried forward to next period rather than going to the
production account.
Control accounts and job costing
Most companies will have a ‘control accounts’ in their accounting system
summing up the total of each job account.
This can be useful as they provide an account with the totals in them, and it
also acts as a control (as the name might suggest) as the total of the control
accounts should equal all the individual accounts added together.
Batch and job costing
237
However, you also have to be careful to make sure you understand that the
job accounts are just ‘sub-accounts’ of a larger account as you’ll need to
enter all transactions twice, once in the control account and secondly in
the job accounts.
Let’s see some examples to see how this works.
WIP control account
The work in progress control account opens with the total WIP balance of
all our jobs – in this case that was just Job X as this was the only work in
progress at the time:
WIP control
£ £
Balance B/F 4,500
We then need to add in all material, labour and overheads used during the
current period of activity. In a control account that represents the total of all
jobs.
WIP control
£
Next, we credit the costs we have since transferred to the production account
for jobs X and Y and the remaining balance will become the opening balance
next period, which should be identical to the balance we carried forward in job
Z:
WIP control
£ £
Balance B/F 4,500 Production 14,492
Direct Material 12,300 Balance C/F 6,196
Labour (216 x 8) 1,728
Overheads (216 x 10) 2,160
20,688 20,688
£
Balance B/F 4,500
Direct Material 12,300
Labour (216 x 8) 1,728
Overheads (216 x 10) 2,160
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As you’ll see then, the WIP control account is just a total of all the
individual job accounts, and as long as they match then we’re happy! If
they don’t then a mistake has been made somewhere, either in one of the job
accounts or in the WIP control account, so we can now go back and check
where the mistake is.
Do take care though here – we look like we are double counting balances
which we are not – the key is to remember that the job accounts are just
sub-accounts of the WIP control and would not be part of our final trial
balance.
Production overhead control accounts
The production overhead control account follows on from the WIP control
account summarising the total overhead costs incurred, absorbed and
any under or over absorption.
In the WIP account above you will notice there is a debit to the WIP account
for the overheads (£2,160), the Credit of that goes into the production
overhead control account (see below).
We also record costs incurred of £3,000.
Remember our rule – cash paid is always a debit in Cash so must be a credit
in this production overhead account.
Production overhead control account
£ £
Production payable 3,000 Overheads (WIP) 2,160
Over/under absorption 840
3,000 3,000
The balance then represents the over or under-absorption, which is credited
to an account which is then taken to the profit and loss account.
Over/under absorption
£ £
Production overheads 840 Profit/Loss account 840
840 840
As you can see, the company charge £840 too much in overhead absorption
meaning that we can now debit this back to the profit and loss as additional
income.
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Job cost in profit accounts
Finally we need to compile and consolidate these figures to give the
profit/loss for these jobs in the given time period:
Profit/loss account
£ £
Production 14,492 Sales (10,000 + 9,000) 19,000
Over/under absorption 840
Profit for period 3,668
19,000 19,000
By calculating the revenue from the products produced in the period we can
work out the profit by working out the balance on the account. Here we can
see that with all things considered we made £3,668 profit in the last period.
6. Preparing reports for different organisations
Reports in a manufacturing organisation
Whether or not you realise it, you now have the knowledge to prepare reports for manufacturing organisations! All that time we spent looking at
costs, budgets and performance evaluations was not just for fun! Many of
the techniques you have learnt such as contribution, profit margin and all
those ratios, have important roles to play in generating reports for these
organisations.
Remember that these organisations exist to generate profit. All of the
techniques we have learnt tell us something important that can be used
to meet this objective.
Preparing reports for service organisations
What do we do when there isn't a physical object to attribute costs to? What
happens when our business is the service we provide ourselves? The answer
is...We can apply the same costing principles we have learnt about already!
With a few adjustments we will be able to calculate costs and prices for
these intangible services. The best way to show this will be through an
example so bare with me!
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A consultancy business is a prime example of a service organisation.
Our product in this instance is knowledge – this is our intangible
product.
When we look to cost a product like this we cant go through the same
avenues that we have done previously. What would our direct materials
include? Our sandwich at lunch? No, in the instance of a consultancy
business, and indeed many other services, we cost according to factors
such as distance and time.
A consultancy business has produced the following activity estimates:
• 4 employees will work 7,200 hours in the year.
• 25% of the their time will be taken up by non-client related
administration.
• 20% of their time will be idle.
• The remaining time is chargeable to the client however, 10% of
this will be travel time. As this is not deemed 'productive' work,
travel time is charged at 50% of the normal hourly rate.
Here is a list of their expected costs:
Cost Annual expenditure (£)
Consultancy Travel
We can use these estimates and costs to find out how much we should be
charging for our services. It would make sense to base this price on hours as
that is how the world works!
The first step would be to calculate how many hours we are actually
working. Let's gather all the information we have been given:
Salaries (£30,000 per
employee) 120,000
Office expenses 12,000
Business related expenses 700
Telephone charges
Fuel
1,000 3,000
Vehicle insurance 1,000
Vehicle maintenance 950
Depreciation of vehicles 4,500
Total cost 133,700 9,450
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Estimated working hours/year (4 employees)
Hours
7,600
Less: Time spent on admin (25%) (1,800)
Less: Idle time (20%) (1,440)
Time with client (chargeable) 4,360
If there was no travelling involved and the consultancy company had been
office based then we could stop at this point. The 4,360 hours would be the
amount of time that would be charged to the client. We could simply
calculate the hourly rate by dividing the costs attributable to consultancy (the
office cost, salaries etc.) and divide it by the number of hours.
Consultancy costs £133,700
Time chargeable to clients 4,360
Hourly rate £30.67
This figure of £30.67 covers all of costs and the salaries meaning that any mark-up on top of this would be profit. Unfortunately for you however, this is
not the case for us! That would be far too simple.
If you take a look back to the start of this example you will see that the final
activity estimate refers to the time spent travelling. 10% of the chargeable
time is allotted to travelling and is therefore charged at 50% of the normal
rate. This means that not all 4,360 hours are spent with the client. Let's
put this into a table to make it easier to understand.
Time chargeable to clients
Hours
4,360
Time with client (90%) 3,924
Time travelling (10%) 436
We can now see that a more accurate figure for the amount of time spent
with the client is 3,924 hours rather than 4,360. How do we cost the 436
hours that are spent travelling? These hours are charged at 50% of the
normal rate so we need to calculate a weighted figure for chargeable
time.
Weighted chargeable hours = 3,924 + 436
= 4,142
2
Now if we divide our total consultancy costs by 4,142 we will get an
hourly rate that takes into account the amount of time spent travelling:
Consultancy costs £133,700
Time chargeable to clients (hours) 4,142
Hourly rate £32.28
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You will notice that the hourly rate has increased. This is because the
amount of chargeable hours has decreased (as some time is spent travelling
and not working.) This ultimately means that we will have to charge more to
cover our costs. But at least we do not charge full price for hours spent in the
car!
From here we can easily calculate the hourly rate for travelling time too.
To do this we simply divide our hourly rate for client work by 2 (or
multiply by 50%) as we charge 50% of the normal rate for time spent
travelling:
Hourly rate for travelling time = £32.28
= £16.14
2
Remember: These costs have been calculated to cover the associated
costs of the consultancy business. They do not take into account an
amount reserved for profit. A mark-up would be applied to the hourly
rate in order to provide the desired profit.
Reports in a not-for-profit organisations
As you can probably imagine, the aims of a charity will be very different to the
aims of a car manufacturer and therefore there will be significant differences
in their management reports. The difficulty with assessing the
performance of these NFP's is that they have somewhat intangible
objectives and outputs. A charity, for instance, maybe spend funds on
helping disadvantaged children to read. How would we be able to measure
this? We cant use profit margins or contribution here.
What we can conclude about the NFP's is that they have their own set of
requirements when it comes to accounting. Charities, educational
establishments and the like all aim to provide the best service they can
within a restricted budget. The emphasis will be on limiting wastage
rather than increasing profit for these organisations.