ken cost accounting 2
TRANSCRIPT
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NKUMBA UNIVERSITYSCHOOL OF BUSINESS ADMINISTRATION
NAME :
INDEX NO :
SUBJECT : COST ACCOUNTING
LECTURER :
QUARTER :
QUESTION :
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suit the processing method used by the company.
(iii) Level of activity or output. Identical and high volume out puts require a costing
method which is different from unique and single units that are produced to meet
customers specific requirements.
(iv) Installation and maintenance costs required. Systems that are required to capture
and analyze production costs do not require the same cost. The costing method to be put
in place by the firm may therefore be influenced by costs involved.
(vi) Time required to complete the product. Products do not take the same time to make.
It is therefore important for companies to design costing methods that suit the time
duration of every product.
1.2 Categories of costing methods
Costing methods can be broadly classified into two groups, which include specific order
costing method and continuous operation costing or process costing method. This
classification is based on the first three factors ( i.e nature of the product, production
stages involved and the level of activity) that influence the costing method to employ.
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CHAPTER TWO
2.0 Introduction
There are various types of costing methods which fall under specific order
costing method and continuous operation costing, especially for the
operations of production of goods and services
2.1 Specific Order Costing Method
This covers approaches used in ascertaining the cost of products and services which are
unique in nature
2.1.1 Contract Costing
Specific order costing is the basic cost accounting method applicable where work
consists of separate contracts, jobs or batches (CIMA)
Before we get into the detail of Contract Costing, lets consider undertaking either Zion
construction company has Project 1.
PROJECT 1: CONSTRUCTION OF A DOUBLE STORIED HOUSE AT ZANA
FOR MR. KALIISA KENNEDY (JULY 2012-JULY 2013)
At one of Zion Construction Companys building site, where a one off type job or service
is being made or provided, we follow through as much of a job or service as possible:
note the flow of materials, labour and overheads. Once Zions engineers have
observed the process(es) they can map out (flow charts are ideal for this) both the stages
of the process they have observed and the cost accumulation aspects of each stage. If
their host will allow them to do so, try to obtain copies of job cost cards/sheets and
compare and contrast them.
According to CIMA, Contract costing is a form of specific order costing; attribution of
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costs to individual contracts (Chartered Institute of Management)
It can thus be acknowledged that a contract cost is aggregated costs of a single contract;
usually applies to major long term contracts rather than short term jobs
2.2 Features of long term contracts
By contract costing situations, we tend to mean long term and large contracts: such as
civil engineering contracts for building houses, roads, bridges and so on. These could also
include contracts for building ships, and for providing goods and services under a long
term contractual agreement.
With contract costing, every contract and each development will be accounted for
separately; and does, in many respects, contain the features of a job costing situation.
Work is frequently site based.
Problems with contract costing can prop up in the following areas
Identifying direct costs
low levels of indirect costs
difficulties of cost control
profit and multi period projects
Such jobs take a long time to complete & may spread over two or more of the
contractor's accounting years.
Features of the Zion project 1 Contract
The end product which is the double storied building
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The period of the contract which means the time from the foundation to finishes
The specification which includes types of materials to use,
The location of the work in this case Zana
The price to be determined
Completion by a stipulated date
The performance of the product, is it strong and can it last for a time
Collection of Costs
The quantity surveyor for Zions Project 1 open ups one or more internal job accounts
for the collection of costs. If the contract is not obtained, preliminary costs can written
off as abortive contract costs in P&L In some cases a series of job accounts for the
contract are necessary:
to collect the cost of different aspects
to identify different stages in the contract
Special features of Zions Project 1 contract costing
Materials are delivered directly to site.
Direct expenses
Stores transactions because the materials are stored for next days use.
the project has concreting plant on site
Accounting methods used in contract costing:
1. Where a plant is purchased for a particular contract & has little further value to the
business at the end of the contract
2. Where a plant is bought for or used on a contract, but on completion of the contract
it has further useful life to the business
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Alternatively the plant may be capitalized with Maintenance and running costs charged
to the contract."
Bookkeeping and contract costing projects
Direct costs: Debit the contract account
Cost of plant
Hire of plant: Debit the contract account plant bought:
i) Debit the contract account with depreciation
ii) Debit contract account with cost
iii) Credit contract account with balance c/d
iv) Debit plant account with depreciation and running costs
Debit contract account
Overheads included at the end of the contract otherwise DO NOT include them as part of
WIP c/d
Example contract account for project 1:
Debit direct costs Credit materials returned to stores
hire of plant proceeds of
overheads book value of plant transferred
cost of work done = balance c/d
Progress payments are a key feature of such contracts and they are commonly based on
the value of work done up to a certain stage. Issues involved here are
retentions
payments to date
payments due
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Debit bank account
Credit contract account
Illustration
Contract Project 1 started on 1 July 2012. Costs to 31 December 2012, when the
company's accounting year ends, are derived from the following information.
direct materials issued from store 40000
materials returned to store 1000
direct labour 36000
plant issued, at book value 1 July 2012 50000
written down plant value as at 31 December, 2012 30000
materials on site, 31 December, 2012 3000
overhead costs 5000
As at 31 December, 2012, certificates had been issued for work valued at shs 100,000 and
Mr. Kaliisa Kennedy had made progress payments of shs. 70,000. Zion Construction
Company has calculated that more work has been done since the last certificates wereissued, and that the cost of the work done but not yet certified is shs.14,000. The final
contract price is shs.175,000 and the estimated total cost of the contract is shs.130,000.
The contract account
Contract account Dr Cr
materials 40000
materials returned 1000
labour 36000
plant issued at book value 50000
overheads 5000
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plant c/d 30000
materials c/d 3000
cost of work done not certified 14000
cost of work certified 83000
131000 131000
Work certified account
turnover (profit and loss) 100000
Zion Construction company account 100000
Zion Construction company account
work certified 100000
cash (progress payment) 70000
balance c/d 30000
100000 100000
Estimating profit
In the early stages, no profit will be accounted for.
Total anticipated profit
contract price 175000
costs incurred (14,000 + 83,000) 97000
estimated costs to complete (130,000 - 97,000) 33000 130000
Estimated profit 45000
Estimated degree of completion
Therefore, profit to date:
Sales basis = shs.45,000 X 57.14% = shs.25,714.29
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Cost basis = shs.45,000 X 74.62% = shs.33,576.92
Completing the profit and loss account:
turnover - value certified 100000
profit (sales basis) 25715
cost of sales 74285
costs incurred 97000
cost of sales 74285
WIP 22715
Balance sheet disclosure
Cost of sales 74285
cost of work done 97000
-22715
If this is negative, it is WIP, otherwise it is a provision for liabilities and charges or creditors
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Reconciliation of WIP:
value certified 100000
cost of work certified 83000
apparent profit to date 17000
profit recognized 25715
cost of work done but not certified 14000
-22715
Attributable Profit
That part of the total profit reflects that part of the work performed at the accounting date,
attributable profit is not to be recognised until the outcome of contract is assessed withreasonable certainty.
Calculation of attributable profit
Taking total costs to date & total estimated further costs to completion, also the estimated
future costs of rectification & guarantee work, and any other future work is undertaken
under the terms of the contract. The Profit accounted for requires:
1. to reflect the proportion of the work carried out at the accounting date;
2. account any known inequalities of profitability in various stages of contract for
certainty of profit
Illustration II
Zion Construction Company decided to build a major addition to their plant using both
their own labor and outside subcontractors. It took 13 months to complete the building.
The first 10 months of the construction period were in one cost accounting period. At the
end of the cost accounting period the total charges, including cost of money accumulated
in the work in progress account for this project amounted to shs.750,000. However, most
of these construction costs were incurred towards the end of the cost accounting period.
In developing a method for determining a representative investment amount, appropriate
consideration must be given to the rate at which costs have been incurred. Therefore, the
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contractor averaged the 10 month-end balances and determined that the average
investment in the project was shs.245,000.
Two Cost of money rates were in effect during the 10-month period; their time-weighted
average was determined to be 8.6%. Application of the 8.6% rate for ten-twelfths of a
year to the representative balance of shs.245,000 resulted in the determination that
shs.17,558 should be added to the work in progress account in recognition of the cost of
money related to this project in its first cost accounting period.
The project was completed with the addition of shs.750,000 of additional costs during the
first 3 months of the subsequent cost accounting period. The contractor considered the 3
month-end balances (which included the shs.17,558 capitalized cost of money described
in the preceding paragraph) and determined that the representative balance was
shs.1,234,000. The cost of money rate in effect during this 3-month period was 7.75%.
Applying the rate of 7.75% for one quarter of a year to the balance of shs.1,234,000
resulted in a determination that shs.23,909 should be added to the work in progress
account in recognition of the cost of money while under construction in the second cost
accounting period. The capitalized project was put into service at the recognized cost of
acquisition of shs.1,541,467 which consists of the "regular" costs of shs.1,500,000 plus
shs.17,558 and shs.23,909 cost of money.
Note: An alternative technique would be to make separate calculations, using an
appropriate investment amount and cost of money rate, for each month. The sum of the
monthly cost of money amounts could be entered in the work in progress account once
each cost accounting period.
Zion Construction Company built a major addition with identical basic data to those
described in the previous illustration except that the costs were incurred at a fairly
uniform rate throughout the period.
Because of the pattern of cost incurrence, Zion Construction Company used beginning
and ending balances of the cost accounting period to find the representative amounts. For
the first cost accounting period the representative investment amount was the average of
the beginning and ending balances (zero and shs.750,000), or shs.375,000. Application of
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the average interest rate of 8.6% for ten-twelfths of a year resulted in the determination
that shs.26,875 should be added to the work in progress account in recognition of the cost
of money related to this project in its first cost accounting period.
During the subsequent 3 months the contractor used the representative balance of
shs.1,151,875, derived by averaging the beginning balance of shs.776,875 (shs.750,000
"regular" cost plus the shs.26,875 imputed cost from the prior period) and the balance at
the end, shs.1,526,875. Applying the 7.75% cost of money rate to this balance for a 3-
month period resulted in a determination that shs.22,317 should be added to the work in
progress account in recognition of the cost of money while under construction in the
second cost accounting period.
The capitalized project was put into service at the recognized cost of acquisition of
shs.1,549,192 which consists of the "regular" costs of shs.1,500,000 plus shs.26,875 and
shs.22,317 imputed cost of money. This practice is in accordance with 9904.417-50(a)
and other applicable provisions of the Standard.
If this contractor, acting in accordance with established Standards for financial
accounting, allocated a portion of its paid interest expense to this construction project and
the resultant acquisition cost for financial reporting purposes was not materially different
from shs.1,549,192, the contractor could use the same acquisition cost for contract costing
purposes.
Conclusions
Contract costing can represent highly complex situations as they might involve the
building of houses and housing estates, bridges and so: large amounts of money and other
resources taking months or even years to complete.
Contract costing can be as complex as some of the situations they attempt to record:
nevertheless, once the basic principles have been grasped, their complexity becomes
much more manageable.
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CHAPTER THREE
3.1 BATCH COSTING
Batch costing is not normally seen as much of an advance on job costing.
A batch is a group of similar articles which maintains its identity throughout one or more
stages of production and is treated as a cost unit (Chartered Institute of Management
Accountants)
Batch costing is a form of specific order costing; the attribution of costs to batches
(CIMA)
Considering a batch is a group of items that are closely related, and are being made for a
single customer, or are being made all at the same time; and the key point for the
companys purposes is that the group of items maintains its identity as a batch, serial
numbers, product numbers, production numbers, all identify the goods as a batch.
3.2 The accumulation and recording of costs
The accumulation and recording of costs under batch costing is very similar to the
techniques used with job costing.
Zion Construction Company uses a batch costing system for their drilling and boring
business; they use a cost plus system of price setting and set a mark up of 25% on sales
values.
Administration costs are absorbed at the rate of 10% of selling price, whereas factory
overheads are absorbed at the rate of shs.12 per direct labour hour for Department C and
shs.9 per direct labour hour for Department L.
Batch C-A.RL consists of 1,000 shafts to be drilled and bored, and the following costs
have been incurred on it:
Dept C 500 direct labour hours at shs.10 per hour
Dept L 750 direct labour hours at shs. 8 per hour
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Direct materials costing shs.6,475 have also been used on batch C-A.RL.
Zion Construction companys Batch Cost Card shows the
The total cost and total cost per unit and also the selling price and selling price per unit
Zion Construction company Batch cost card C-A.RL:
1,000 shafts, drilled and bored
Date started: xx/xx/xxxx
Date completed: xx/xx/xxxx
We now know that the total cost of the batch is shs.46,500 and the cost per unit is
Shs.46,500 /shs. 1,000 units = shs.46.50 per unit
The mark up was set at 25% of the selling price; but how could we find 25% of the selling
Total (shs.)
Materials 6475
Labour:
dept C 5000
dept L 6000 11000
Factory overheads
dept C 6000
dept L 6750 12750
Total factory costs 30225
administration costs 4650
Total costs 34875
Mark up (profit) 11625
Selling price 46500
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price when we didn't already know what the selling price was? Tricky, but only for a few
minutes: let's rework the bottom part of the batch cost card so that we can find the mark up
and selling price in the twinkling of an eye!!
We were told that the mark up is equal to 25% of the selling price. Therefore, since
Total costs + Mark up (profit) = Selling price
and
Mark up (profit) = Selling price - Total costs
then
25% = 100% - 75%
Putting this into a table now:
Total costs 34875 75% of selling price
Mark up (profit) 25% of selling price
Selling price 100% of selling price
So, if total costs = 34,875 = 25% of sales, then (we can drop the % from the calculations
now)
Selling price = 34,875 / (75 / 100) = 46,500
So, Mark up = 25% X 46,500 = 11,625
This is where our mark up and selling prices come from!
Total costs 34875 75% of selling price
Mark up (profit) 11625 25% of selling price
Selling price 46500 100% of selling price
Conclusions
Whilst job and batch costing can be equally complex, the example shown here has simply
shown the basic principles involved in gathering total batch costs together and then
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determining a cost per batch and per unit.
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CHAPTER FOUR
4.1 Process Costing
Process costing is the continuous operation costing method that is applied within
manufacturing, where there is a continuous flow of homogeneous product resulting from
a sequence of repetitive operations.
The establishment of product unit costs in a process costing system may, in many
practical situations, be calculated very straightforwardly, by dividing the total costs (direct
materials, direct labour, and overheads) for an accounting period by the total number of
units of product completed in that period.
4.2 Establishment of product unit costs
However, the establishment of product unit costs may also have to deal with the
following:
A desire to establish whether any losses of material/product occurring in the process
are normal or abnormal and to reflect these appropriately in product costs.
The incidence of partly completed production at the end of an accounting period, and
thus the need to establish a valuation for the incomplete units that reflects the degree
of completion.
Particular complexity arises where both normal/abnormal losses and part-completed
production occur simultaneously within the same process.
4.3 The concept of equivalent units
Equivalent units may be used in the establishment of product unit costs to deal both with
process losses (where these occur during, rather than at the end, of a process) and also with
period end work-in-progress.
The concept of equivalent units is that part-completed production (losses at intermediate
stages of a process or work-in-progress at the end of a period) can be converted into an
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equivalent number of completed units, in order to establish the total number of units for a
period to be divided into the total costs incurred. Equivalent units need to be determined
separately for different elements of costs (e.g., raw materials, conversion costs) if
losses/production are at different stages of completion for the different elements.
The application of the equivalent units concept will be introduced later in this article, when
losses arising at intermediate stages of a process are considered. The concept will have
greater applicability in next months article, when the valuation of end of period work-in-
progress is considered.
The following example will be used to illustrate the process cost accounting for
normal/abnormal losses and for work-in-progress using equivalent units as appropriate.
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Example 1
Question: Summarised below are data for two production processes in Zion Construction
companys production department for culverts, bricks for the month just ended:
Process 1:
Materials: shs.6335
Labour and overheads: shs.7,677
Five per cent of input units are expected to be rejected; rejects occur at the end of the process. 190
units failed inspection in the month and were rejected. After inspection, units are transferred
immediately to the next process.
Process 2:
Opening work in progress, 500 units: shs.3,576 (materials shs.3,042; labour and overheads
shs.534)
Completed output from Process 1: 4,110 units
Additional materials: shs.11,672
Labour and overheads: shs.9,485
Closing work in progress: 400 units
There are no losses in the process. Work in process is 100% complete as to materials, and both
opening and closing work in process were 50% complete as to labour and overheads:
Normal losses and abnormal gains/losses
The nature of many process operations is such that the output volume is frequently less than the
input volume. Because process operations are repetitive, the level of losses of materials/product
that could reasonably be expected under efficient operating conditions may be established. This isreferred to as a normal loss; one that is an inevitable consequence of the process operation under
efficient operation conditions and is thus considered unavoidable. Losses greater or less than
normal are referred to as abnormal and result from reduced or greater efficiency.
The normal process loss is usually expressed as a percentage of the input volume. In accounting
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for the normal loss, the cost is shared by the volume of good output expected. For example, if
1,000kg of materials are introduced into a process, and the normal loss is 10% of input, the cost
incurred in processing that quantity of material will be shared by 900 kg (1,000 x 0.9) of expected
good output. If 900 kg of good output is achieved then the cost accounting is straightforward;
process costs would be divided by 900 to establish a cost per unit that is applied to the 900 kg ofoutput.
If the actual good output achieved is not as expected, then abnormal gains or losses have occurred
i.e., good output will either be more (abnormal gain) or less (abnormal loss) than expected. For
example, assuming in the above illustration that the good output was 880 kg then an abnormal
loss of 20 kg has occurred [(1,000 x 0.9) 880]. The good output expected remains 900 kg and
this continues to be used to establish a unit cost which is then applied to both the good output of
880 kg and the abnormal loss of 20 kg, which will be highlighted as a separate charge against
profit/loss.
In this way unit costs are standardized, i.e., unaffected by fluctuations in the proportion of
process loss that actually occurs.
Turning now to the above question, losses are expected and occur in Process 1, the total amount
of input to Process 1 in the period can be established by adding the completed good output from
the process (see information provided under Process 2) of 4,110 units to the 190 units that failed
inspection, i.e., 4,300 units. The normal (expected) loss is 215 units (4,300 x 0.05) and the
expected good output is 4,085 units (4,300 x 0.95). There is thus an abnormal gain during the
period of 25 units [losses less than expected (190 215) or good output more than expected
(4,110 4,085)]. This can be set out as follows:
units
total input
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4,300
less normal loss
215
expected good output
4,085
represented by:
actual good input
4,110
less abnormal gain
25
4,085
The standardized unit cost is:
14,012 (6,335 + 7,677) = shs.3.43 per unit
4,085
which is accounted for as:
cost of good output
shs.14,098 (4,110 units at shs.3.43)
less abnormal gain
86 (25 units at shs.3.43)
costs incurred
shs.14,012
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The process account is as follows:
Process 1 Account
units
shs.
units
shs.
Materials
4,300
6,335
Transfers to
Labour
Process 2
4,070
13,960
and overheads
7,677Normal loss
215
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Abnormal loss
15
52
4,300
14.012
4,300
14,012
Continuing on the cost accounting for process losses, and referring back to the Process 1 account,
it can be seen that no cost value is attached to the normal loss i.e., the costs incurred in the process
are shared by the volume of good output expected. The unit cost is thus always based on the
expected (not the actual) good output.
If an abnormal loss (rather than gain) had occurred, the standardized output would remain at
4,085 units, actual good output would be below that amount, and the abnormal loss charged at
shs.3.43 per unit would be credited to the process account.
For example, assume instead that the good output from Process 1 in the period had been 4,070
units and that 230 units had thus failed inspection.
Relevant figures can be set out as:
units
total input
4,300 (as before but now 4,070+230)
less normal loss
215
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expected good output
4,085
represented by:
actual good output
4,070
plus abnormal loss
15 [(230-215) or (4,070-4,085)]
4,085
leading to the same calculation of standardised unit cost as before i.e.,:
14,012 = shs.3.43 per unit
4,085
which is now accounted for as:
cost of good output
shs.13,960 (4,070 units at shs.3.43)
plus abnormal loss
52 (15 units at shs.3.43)
costs incurred
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shs.14,012
The process account, in these changed circumstances, would be:
Process 1 Account
units
shs.
units
shs.
Materials
4,300
6,335
Transfers to
Labour
Process 2
4,070
13,960
and overheads
7,677
Normal loss
215
-
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Abnormal loss
15
52
4,300
14,012
4,300
14,012
Abnormal gain and abnormal loss accounts
Using the information provided originally in the above illustration, an abnormal gain of 25 units
occurred. This gain was valued at the average normal unit cost for the period and was debited to
the Process 1 account. To complete the double-entry for this gain an abnormal gain account is
opened and is credited with the cost value of the gain. This amount gained, i.e., representing
reduced costs from the normal, is subsequently transferred to the profit/loss account, thus addingto profit. Thus:
Abnormal Gain Account
shs.
shs.
Profit/loss
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86
Process 1
86
Using the changed assumptions of an abnormal loss occurring, the credit entry to the Process 1
account would be offset by a debit entry to an abnormal loss account, which, on subsequent
transfer to profit/loss, would result in reduced profit. Thus:
Abnormal Loss Account
shs.
shs.
Process 1
52
Profit/loss
52
Scrap values
In some circumstances, process losses result in sub-standard product, or waste materials,
that can be sold as scrap. In such a situation it is usual to account for the scrap value by
crediting that value against the normal loss in the process account (rather than including
the normal losses at zero cost) with a corresponding debit entry to a process scrap account.
This value of normal losses is then adjusted, in the scrap account, for any abnormal losses
or abnormal gains (i.e., more or less scrap available for sale).
Scrap values have the effect of reducing average unit costs because costs, equal to the
scrap value that is expected to be recovered, are effectively transferred out of the process
account. Referring back to our earlier example of Process 1, and using the original
information in the question, with in addition the assumption that process losses can be
sold for shs.0.40 per unit, the workings and the process account become:
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Standardized unit cost:
13,926 [6,335 + 7,677 86 (i.e., 215 x 0.4)]
4,085
= shs.3.409 per unit
which is accounted for as:
cost of good output = shs.14,011 (4,110 units at shs.3.409)
less abnormal gain = 85 (25 units at shs.3.409)
net costs incurred = shs.13,926
The process account is as follows:
Process 1 Account
units
shs.
units
shs.
Materials
4,300
6,335
Transfers to
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Labour
Process 2
4,110
14,011
and overheads
7,677
Normal loss
215
86
Abnormal gain
25
85
4,325
14,097
4,325
14,097
The scrap account and the account for the abnormal gain would be:
Process Scrap Account
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shs.
shs.
Process 1
86
Abnormal gain (25 x 0.4)
10
Bank (190 x 0.4)
76
86
86
Abnormal Gain Account
shs.
shs.
Process Scrap
10
Process 1
85
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Profit/loss
75
85
85
In the process scrap account, sales of 190 units only would be recorded (i.e., the actual lost units).
The sales value of the remaining 25 units of normal loss, which represent the abnormal gain, are
transferred to the abnormal gain account where they reduced the benefit (by not having lost unitsto sell) from the abnormal gain.
Under the changed assumptions of an abnormal loss occurring, the standardized unit cost would
remain at shs.3.409 and would be accounted for as:
cost of good output = shs.13,875 (4,070 units at shs.3.409)
plus abnormal loss = 51 (15 units at shs.3.409)
net costs incurred = shs.13,926
The process account and the process scrap/abnormal loss accounts would be as follows:
Process 1 Account
units
shs.
units
shs.
Materials
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4,300
6,335
Transfers to
Labour
Process 2
4,070
13,875
and overheads
7,677
Normal loss
215
86
Abnormal loss
15
51
4,300
14,012
4,300
14,012
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Process Scrap Account
shs.
shs.
Process 1
86
Bank (230 x 0.4)
92
Abnormal loss (15 x 0.4)6
92
92
shs.
shs.
Abnormal loss account
Process 1
51
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Process scrap
6
Profit/loss
45
51
51
This time the abnormal loss write-off is reduced by the scrap value of the additional units lost.
Disposal costs
On occasions losses have a disposal cost, rather than a saleable value. The cost accounting
treatment is the same as that applied to losses except that the disposal costs increase (rather than
decrease) the total processing costs. The normal loss quantity needs to remain on the credit side of
the process account, in order to balance the quantities, and so the disposal costs are best shown
alongside it but in brackets.
Losses occurring at different stages of a process
Thus far the concept of equivalent units, explained earlier in this article, has not needed to be
applied because losses have been assumed to represent complete units. Sometimes losses occur at
some stage part way through (rather than at the end of) a process. In such a situation, the part
completed units lost have to be converted to equivalent whole units.
Example 2
The following information relates to a manufacturing process for a period:
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Materials costs - shs.16,445
Labour and overhead costs - shs.28,596
10,000 units of output were produced by the process in the period, of which 420 failed testing and
were scrapped. Scrapped units normally represent 5% of total production output. Testing takesplace when production units are 60% complete in terms of labour and overheads. Materials are
input at the beginning of the process. All scrapped units were sold in the period for shs.0.40 per
unit.
To Prepare the process accounts for the period including those for process scrap and
abnormal losses/gains
Data concerning units of input and output can be set out as follows:
Materials
Lab & overhead
total input
10,000
less normal loss
500
expected good input
9,500
represented by:
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actual good input
9,580
9,580
less abnormal gain
80
48 (80 x 0.6)
9,500
9,532 (equivalent units)
The units of material can be balanced in the same way as the previous example. All materials are
introduced at the start of the process and thus units rejected are 100% complete as to materials,
even though the rejection takes place when production units are only 60% complete in terms of
processing time.
With labour and overheads, however, the concept of equivalent units is applied because costs are
incurred throughout the process operation. Because fewer than expected units are rejected,
additional labour and overhead costs are incurred in completing the excess units of good output
and this is reflected in the higher equivalent units used to calculate the labour and overhead costs
per unit.
The reverse would be the case if there were abnormal losses (i.e., equivalent units of labour and
overhead would be less than 9,500) because the expected final 40% of processing would not occur
on the extra lost units.
The process accounts (in answer to the above question) would be completed as follows:
Cost per unit:
Materials =
16,245 [16,445 (500 x 0.4)]
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9,500 = shs.1.71 per unit
Labour and overhead = 28,596 / 9,532 = shs.3.00 per unit
NB The scrap value of the normal loss is usually credited in full against raw materials costs,
rather than being spread over all cost elements.
Process 1 Account
units
shs.
units
shs.
Materials
10,000
16,445
Transfers out
9,580
Labour
(9,580 x 4.71)
45,122
and overheads
28,596
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Abnormal gain
80
Normal loss
500
(80 x 1.71
(500 x 0.4)
200
+ 48 x 3.00)
281
10,800
45,322
10,080
45,322
Process Scrap Account
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shs.
shs.
Process
200
Abnormal gain (80 x 0.4)
32
Bank (420 x 0.4)
168
200
200
Abnormal Gain Account
shs.
shs.
Process scrap
32
Process
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281
249
281
281
Conclusion
The main purpose of this section has been to explain, and to illustrate, the cost accounting for
process losses. The distinction between normal (expected) losses and abnormal gain and losses is
core. The use of equivalent units in situations where losses occur at an intermediate stage of a
process, and the accounting for scrap values, must also be clearly understood.
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CHAPTER FIVE
5.1 SERVICE COSTING
Service costing is a cost accounting method concerned with establishing the costs of
services rendered.
Despite this definition, we should note immediately that even though we may be dealing
with services that are intangible, the cost accounting methods we use are essentially the
same as if we were making cars, biscuits or televisions.
When organizations set up a service cost accounting system, they would need to keep in
mind the fact that the progression, for example, of a cheque through the banking system,
can be treated as items of raw material passing through a production process. Similarly,
we should readily appreciate that the provision of a transport service has much in
common, from the cost accounting point of view, with the manufacture of the lorry or
van that is being used to provide the service.
Where service costing is applied
Transport
Hotels
Tourism
Solicitors
Education
Retail distribution
Financial services
Service costing is also applied within a manufacturing setting. For example, a
manufacturer might wish to calculate the costs of the following services:
Transport
Catering
Computing and IT
Accounting
Human resources
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The Differences between Product Costing and Service Costing
There may be very few, if any, materials to worry about
Overheads will comprise the most significant portion of any costs of which, labour
costs may well comprise as much as 70%
Service Costing: profit or cost centre?
Many organizations simply want to determine the costs of operating its services from a
management control and management information point of view. However, there are
many organizations now that operate services for their own organizations as well as sub
contracting them out to other organizations. For example, there are companies that operate
their own payroll section for themselves; and offer this service to other organizations as well.Other organizations sell CPU time on their computers at times when they do not use it
themselves: for example, in overnight batch work.
One key factor here is that we might be in the situation of assessing the least cost basis for
providing a service, rather than the highest profit possible.
Service Cost Units
For a manufacturer, cost units would be
Motor cars
Packets of biscuits or boxes containing, say, 100 packets of biscuits
Television sets
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The table below shows some examples of service units for a couple of service providers: complete
the table with other examples of your own
Service Service Units
Transport Passenger miles, tones miles, total miles driven
Hotels Room day, housekeeping, meals, room service
Tourism
Solicitors
Education
Retail distribution
Financial services
Kalisa Kennedy Company distributes its goods to a regional retailer using a single lorry. The
dealer's premises are 40 km away by road. The lorry has a capacity of 10 tones and makes journeys
twice a day fully loaded on the outward journeys and empty on the return journeys. The following
information is available for a four week budget control period: period 8 of 20 X 4.
Petrol consumption 8 km per 5 litres of petrol
Petrol cost 0.36 per litreOil 8 per week
Driver's wages and NI 140 per week Repairs 72 per week
Garaging 4 per day based on a seven day week Cost of lorry when new (excludes tyres) 18,750
Life of lorry 80,00 km
Insurance 650 per year
Cost of a set of tyres 1,250
Life of a set of tyres 25,000 km
Estimated sales value of lorry at the end of its life 2,750
Vehicle licence cost 234 per year
Other overhead costs 3,900 per year
The lorry is operated on a five day week basis.
A statement to show the total costs of operating the lorry in period 8 20 X 4 analyzed into running
costs and standing costs.
By running costs and standing costs.
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Running costs are the equivalent of marginal or variable costs
Standing costs are the equivalent of fixed costs.
Even if we'd never come across those terms before, we could have guessed what they meant from
any earlier cost accounting work we had carried out.
A budget control period is probably one calendar month: it is simply an accounting period for
which a budget has been prepared and against which the actual expenses and activities are
compared.
Since we have the luxury of the computer, let's set out an attractive table showing our costs
classified according to whether they are running or standing costs:
Cost Running Cost Standing Cost
Petrol consumption XPetrol cost per litre X
Oil X
Driver's wages and NI X
Repairs X
Garaging X
Cost of lorry when new (excludes tyres) X
Life of lorry X
Insurance X
Cost of a set of tyres X
Life of a set of tyres X
Estimated sales value of lorry at the end of its life XVehicle licence cost X
Other overhead costs X
Just in case there is any doubt, the driver's wages and NI are standing costs because they do NOT
vary with the number of km driven.
Statement of Total Costs of Operating the Lorry: Period 8 20X4
Vehicle Operating Costs: Period 8 20X4
Running Costs
Petrol 720
Depreciation 640
Tyres 160
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1520
Standing costs
Garaging 112
Oil 32
Driver's wages and NI 560
Repairs 288
Insurance 50
Vehicle licence 18
Other overheads 300
1360
Total Operating Costs 2880
Working
Petrol Cost: Km driven: 40 km* 2 * 2 * 5 * 4 = 3,200 km Petrol consumption for 3200 km
8 km * 5 litres = 2,000 litres
Petrol cost = 2,000 litres */ shs.0.36 per litre = shs.720
Depreciation: (Cost of lorry (residual value / life of lorry) * km driven
= (shs.18,750 (2,750 /80,000 km) * 3,200 km = shs.0.2/km * 3,200 km = shs.640
Cost of Tyres: (cost of tyres / life of tyres) * km driven
= (shs.1,250 / 25,000 km) * 3,200 km = shs.0.05/km * 3,200 km = shs.160
Garaging: shs.4 * 7 * 4 = shs.112
Repairs: shs.72 * 4 = shs.288
Insurance: shs.650 / 52 * 4 = shs.50
Vehicle licence: 234 / 52 * 4 = shs.18
Other overhead costs: shs.3,900 / 52 * 4 = shs.300
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Other Considerations
There is additional information given that could enable Kalisa Kennedy company's accounting
staff to take their analysis further:
1 We are told that the lorry travels out full and returns empty. Consequently, we could calculate
our costs on an average half full basis or on a basis that ignores the fact that it isn't always full. The
following table illustrates this point:
per km per full tonne1 per km per half full tonne2
TVC 0.950 0.475
TFC 0.850 0.425
TC 1.800 0.900
Notes:
1 based on 1,600 fully laden km per month 2 based on the total km per month whether full or
empty
2 We have costs such as petrol consumption and we could translate this into costs per tonne: total
petrol costs / total tonnage
= shs.720 / (10shs. * 2 * 5 * 4) = shs.720 / 420 tonnes = shs.1.7142857
Similarly with the depreciation costs check and agree that it becomes shs.0.7619 per tonne
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References
Duncan Williamson (1996) Cost & Management Accounting, Prentice Hall
CIMA Terminology, Chartered Institute of Management Accountants publication
BPP Manual ACCA Study Text Foundation Paper 3: