PRINCIPLES OF COST ACCOUNTING- MARCH 2022
COURSE CONTENTS:
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Job costing
Batch costing
Contract costing
Process costing
Joint product and by-product costing
Absorption and marginal costing
C-V-P Analysis
By Lwanga, D A
Page 1
JOB ORDER COSTING
Introduction:
Job-order costing is a form of specific order costing which is employed where work is
undertaken to meet customer’s requirements and is of relatively short durations. Where the
duration of work is long the term used is contract costing. In case of special-order concerns
products produced or job undertaken are of diverse nature. They involve materials and labour
in different quantities and entail different amounts of overheads. A separate job card or cost
sheet is maintained for each job or product in which all expenses of materials, labour and
overheads are entered and cost of completing a job or manufacturing a product is found.
Examples of the firms that use job-order costing are aircraft manufacturers, printers, furniture
manufacturers, etc.
Features of job-order costing
(a) Products are heterogeneous i.e. cost objects are distinct and separately identifiable
(b) Products are made in accordance to customers special requirements
Objectives of job-order costing
(a) It helps in finding out the production cost for every order
(b) It helps management in future estimation of similar job-order. It provides information
on progress of a job in cost term
(c) Helps to control operational efficiency
Factors to consider in job-order costing
(a) Each order or job should be continuously identifiable from raw materials stage to
completion stage
(b) The system is very expensive since it needs a lot of clerical work
Accumulating costs in a job-order costing system
In a job-order costing system, costs of direct material, direct labour, and manufacturing
overhead are assigned to each production job. These costs comprise the inputs of productcosting system. As costs are incurred, they are added to the work-in-process inventory
account in the ledger. To keep track of the manufacturing costs assigned to each job, a
subsidiary ledger is maintained. The subsidiary ledger account assigned to each job is a
document called a job-cost sheet
By Lwanga, D A
Page 2
Note: A job cost card or job cost sheet is the most important document used in the jobcosting system. This will be maintained for each job/order and expensed for material,
labour and overheads
Procedure for a job-order costing system
In job-order costing a job may be initiated internally or externally in the form of customers
order to make a particular product. For jobs which are initiated externally, the procedure
usually starts by receiving an inquiry from a customer about a particular job. The company
uses this inquiry to prepare estimates of how much a job would cost and therefore prepare
and send a quotation to the customer.
Accounting entries
Purchase of materials
When materials are purchased, the entry passed to record purchase of materials is:
Dr. Stores Control Account
xx
Cr. Accounts payable
xx
Materials requisition form
As raw materials are needed for the production process, they are transferred from a
warehouse to the production department. To authorize the release of materials, the
production department completes a materials requisition form and presents it to
warehouse supervisors. If materials issued are indirect materials the requisition, the
requisition will indicate the overhead account number to be debited. The following entry is
passed to record issue of materials to production:
Dr. Work in process- Direct materials
xx
Cr. Stores control account
xx
The above entry is used to charge the cost of direct materials to the job. Indirect materials
are charged to overheads as follows:
Dr. Manufacturing overhead control-indirect materials
xx
Cr. Stores control account
xx
Direct labour costs
By Lwanga, D A
Page 3
The assignment of direct labour costs to jobs is based on time tickets filled out by the
employee. A time ticket is a form that records the amount of time an employee spends on
each production job. The time ticket is the source document used in the cost accounting
department as the basis for adding direct labour costs to Work-in-Process Inventory and to
the job-cost sheets for the various jobs-in-process
Entries to charge labour costs to a job are similar to entries for recording materials cost
applied to the job:
Dr. Work-in-process account (direct labour)
xx
Manufacturing overheads (indirect labour)
xx
Cr. Wages control account
xx
Manufacturing overhead costs
It is relatively simple to trace direct material and direct labour costs to production jobs, but
manufacturing overheads is not easily traced to a job. By definition manufacturing overhead
is a heterogeneous pool of indirect production costs, such as indirect material, indirect
labour, utility costs and depreciation. These costs often bear obvious relationship to
individual jobs or units of products but they must be incurred for production to take place.
Therefore, it is necessary to assign manufacturing overhead costs to jobs in order to have a
complete picture of product costs. This process of assigning overhead manufacturing costs
to production jobs is called Overhead application (or sometimes overhead absorption)
Pre-determined
overhead rate
= Budgeted manufacturing costs
budgeted amount of cost driver
Applied overhead = pre-determined overhead rate x actual amount of cost driver
Overheads are charged to the job using pre-determined overhead absorption rates. Also,
actual overheads are accumulated in the manufacturing overhead control account as
follows:
Dr. Work-in-process account
Cr. Manufacturing overhead account
xx
xx
By amount of overhead applied to the job
By Lwanga, D A
Page 4
When overheads are incurred, actual amounts are recorded by debiting the manufacturing
overhead control account, i.e.
Dr. Manufacturing overhead control account
xx
Cr. Expense, creditors, accumulated depreciation, etc.
xx
When the job is completed it is transferred from the factory floor to the stores. Costs related to
the job must be transferred from work-in-process account to finished goods inventory account,
i.e.
Dr. Finished goods account
xx
Cr. Work-in-process account
xx
Completed jobs are then sold or delivered to customers. Two entries are passed at this
stage. The first entry is an entry to recognize revenue from the job and second entry is an
entry to transfer the cost from finished goods to the cost of sales account as shown below:
(i)
(ii)
Dr. Debtors/ Cash account
Cr. Sales account
Dr. Cost of sales account
Cr. Finished goods account
xx
xx
xx
xx
Note: When a job is completed, the job cost card is still maintained by the entity for future
reference. It can be used for estimating costs for similar jobs.
Discussion questions:
Question one:
Mwembechai Outfitters, Inc. worked on two production jobs for the month of November, 2011.
The data relating to these production jobs are provided below:
Job number C 12-80 deluxe wooden canoes
Job number F 16-80 deluxe aluminum fishing boats
(a) 4,000 Square metres of rolled aluminum sheet metal were purchased on account for
shs10,000,000
(b) On November 1, the following material requisitions were filed.
Requisition number 802:
8,000 board metre of lumber, at shs2,000 per
(for job number C12-80)
board metre, for a total of shs16,000,000
By Lwanga, D A
Page 5
Requisition number 803:
(for job number F16-80)
7,200 square metre of aluminum sheet metal, at
shs2,500 per square metre , for a total of shs16,000
(c) On November, 15 the following material requisition was filed:
Requisition number 804:
5 gallons of bonding glue, at shs10,000 per gallon
for a total cost of shs50,000
(d) At the end of November, the cost accounting department uses labour time tickets filed
during the month to determine the following direct labour costs of each job.
Direct labour: Job number C12-80
shs9,000,000
Direct labour: Job Number F16-80
12,000,000
Total direct labour
shs21,000,000
(e) The analysis of the labour time cards undertaken on November 30 also revealed the
following use of indirect labour.
Indirect labour: Not charged to any particular job, shs14,000,000
This cost comprises the production supervisor’s salary and the wages of various
employees who spent some of their time on maintenance and general clean up duties during
November.
(f) The following manufacturing overhead costs were incurred during November
Manufacturing overheads
Shs
Rent on factory building
3,000,000
Depreciation on equipment
5,000,000
Utilities (electricity and natural gas)
4,000,000
Property taxes
2,000,000
Insurance
1,000,000
Total
shs15,000,000
(g) Factory machine-usage records, indicate the following usage machine hours during
November
Machine hours used Job number C12-80
1,200 hours
Machine hours used Job number F16-80
2,000 hours
Total machine hours
3,200 hours
The application of overhead to the firm’s products is based on a pre-determined
overhead rate. This rate was computed by the accounting department at the beginning of
2011 as shs9,000 per machine hour.
(h) During November, the company incurred selling and administrative costs as follows:
Shs
1,500,000
Rental of sales and administrative office
By Lwanga, D A
Page 6
Salaries and sales personnel
4,000,000
Salaries of management
8,000,000
Advertising
1,000,000
Office supplies issued
300,000
Total
14,800,000
(i) Job number F16-80 was completed during November, whereas Job C12-80 remained in
process. The total cost of Job number F16-80 was shs48,000,000
(j) 60 deluxe aluminum fishing boats manufactured in Job number F16-80 were sold were
sold for shs900,000 each in November. The Cost of each unit sold is shs600,000 as
shown in the job-cost sheet
Required:
Prepare journal entries to record the above transactions
Question Two:
Masumini Printers Ltd had the following transactions during the month of January
(a) Raw materials purchased on credit shs18,000,000
(b) Direct materials issued to production during the month was shs16,500,000
(c) Indirect materials issued into production during the month was shs1,200,000
(d) Labour cost incurred during the month was analyzed as follows:
(i)
Direct wages
shs12,000,000
(ii)
Indirect wages
shs6,000,000
(e) Depreciation of factory equipment was shs4,500,000 and other factory overheads
incurred were:
(i)
Rent of factory building
shs1,000,000
(ii)
Insurance factory equipment
4,500,000
(iii)
Electricity
1,300,000
(f) Factory are applied to jobs based on direct labour hours used during the period at the
rate of shs1,050,000 per hour. In January Masumini Printers recorded 1,200 direct
labour hours as the actual labour spent on jobs.
(g) During the month Jobs costing shs35,000,000 were completed and transferred to
finished goods. Of these, jobs costing shs28,000,000 were delivered to customers
(h) Completed jobs which were delivered to customers earned Masumini Printers
income ofshs33,600,000
Required:
(a) Prepare Journal entries to record the above transactions
(b) Prepare ledger entries to record the above information and show how the entries
will appear in the Work-in-Process Control Account, Factory Overhead Control
Account and Cost of Sales account.
Question three
By Lwanga, D A
Page 7
Mecco Engineering Ltd has three departments, preparation, machining and assembly. The
budgeted direct labour hours for these three departments are 8,000, 12,000 and 10,000
respectively.
Factory fixed overheads are budgeted at shs180,000 for the year and variable overheads are as
under:Shs
Preparation
24,000
Machining
84,000
Assembly
60,000
The agreed hourly wage rates are:
Shs
Preparation
12
Machining
20
Assembly
10
The following details relevant to Job number M50-888 are also provided:
Shs
Raw materials from stock
8,500
Bought-in- components
2,700
Direct labour
Preparation
50 hours
Machining
200 hours
Assembly
120 hours
Painting by outside customers
shs3,200
Administration and selling overheads are to be absorbed by adding 10% of all the costs. Profit is
charged at 25% of total costs.
Required:
By Lwanga, D A
Page 8
Draw up a cost estimate for Job Number M50-888
Question four:
Kichangani Toy Company incurred the following costs to produce Job number TB178, which
consisted of 1,000 teddy bears which can walk, talk, and play cards.
Direct materials
Requisition Number 101: 400 metres of fabric at shs800 per metre
Requisition Number 108: 500 cubic metres of stuffing at shs300 per cubic metre
Direct labour
Time card number 72: 500 hours at shs1,200 per hour
Manufacturing overheads:
Applied on the basis of direct-labour hours at shs200 per hour
700 of bears were shipped to a local toy store
Required:
Prepare a job cost sheet and record the information given above.
Question five:
Indoor Company manufactures carpets for the hotel trade. They do not carry any inventory of
finished goods as they only manufacture specifically to customers’ orders. They do, however,
hold a range of materials in their storeroom.
At 30 November 2012 they had two incomplete jobs in progress. The details of this work and the
costs incurred up to and including the 30th November 2012 were as follows:
Job X 123
Job X 124
Direct material
shs1,250
shs722
Direct labour
shs820 (164 hour)
shs600 (120 hours)
Factory overhead
shs1,640
shs1,200
For the period from 1 December 2012 to 31 December, 2012 the Company accepted two more
jobs, X 125 and X126 and incurred additional costs as follows:
By Lwanga, D A
Page 9
Job X 123
Direct materials issued from stores
shs420
Job X 124
shs698
shs1.900
shs1,221
(shs70)
(shs217)
Direct materials returned to stores
(shs120)
Nil
Direct materials transfers
(shs100)
Nil
Direct labour hours
52
Job X 125 Job X 126
78
shs100
312
Nil
151
Direct labour is paid at the rate of shs5.00 per hour and factory production overhead is absorbed
at the rate of 200% of the labour cost
During the month of December Jobs X 123, X 124 and X 125 were completed, but Job X 126
would not be completed until January 2013. On completion of the Job the company adds 20% to
the total production cost in order to recover its selling, distribution and administration costs. The
amounts invoiced to customers during December for the completed Jobs were:
Job X 123
Job X 124
Job X 125
Shs6,250
shs6,000
shs7,900
Required:
(a) Calculate the total production cost for Jobs X 123, X 124, X 125 and X 126 taking into
account the recovery of selling, distribution and administration overhead as appropriate
(b) Calculate the profit or loss arising on those Jobs completed and invoiced to customers
during December, 2012
By Lwanga, D A
Page 10
SUGGESTED SOLUTIONS
QUESTION ONE:
(a) Dr. Stores Control (Raw materials inventory) account
Cr. Accounts payable account
(b) Dr. Work-in-process account
Cr. Stores Control
(c) Manufacturing overheads control account
Cr. Stores Control account
(d) Dr. Work-in-process account
Cr. Wages payable account
(e) Dr. Manufacturing overheads
Cr. Wages payable
(f) Dr. Manufacturing overheads
Cr. Rent
Depreciation on equipment
shs10,000,000
shs10,000,000
34,000,00
34,000,000
50,000
50,000
21,000,000
21,000,000
14,000,000
14,000,000
15,000,000
3,000,000
5,000,000
By Lwanga, D A
Page 11
(g)
(h)
(i)
(j)
Utilities (electricity and natural gas)
4,000,000
Property taxes
2,000,000
Insurance
1,000,000
Total
15,000,000
Dr. Work-in-process
28,800,000
Cr. Manufacturing overheads
28,800,000
Note: the total manufacturing overhead applied to work-in-process inventory during the
month is calculated as follows:
Machine
pre-determined
manufacturing overhead
Hours
overhead rate
applied
Job No C12-80
1,200
shs9,000
shs10,800,000
Job No F16-80
2,000
9,000
18,000,000
Total
28,800,000
Dr. Selling and administration expenses
shs14,800,00
Cr. Wages payable
12,000,000
Rental of sales and administrative office
1,500,000
Advertising
1,000,000
Office supplies
300,000
Total
14,800,00
Dr. Finished Goods Inventory
48,000,000
Cr. Work-in-process
48,000,000
Dr. Accounts receivable
54,000,000
Cr. Sales revenue
54,000,000
Dr. Cost of goods sold
Cr. Finished goods inventory
36,000,000
36,000,000
QUESTION THREE:
MECCO ENGINEERING LTD
COST STATEMENT FOR JOB NUMBER M50-888
Direct materials
shs
Raw materials from store
8,500
Bought-in-components
2,700
Direct labour
Preparation 50 hours at shs12
Machining 200 hours at shs20
shs
11,200
600
4,000
By Lwanga, D A
Page 12
Assembly department 120 hours at shs10
Prime cost
Production overheads
Variable overhead
Preparation 50 hours at shs3
Machinery 200 hours at shs7
Assembly 120 hours at shs6
Variable cost
1,200
150
1,400
720
5,800
17,000
2,270
19,270
Fixed overhead 370 hours at shs6
2,220
Factory cost
21,490
Administration and selling overheads (10%)
2,149
Total cost
23,639
Profit
5,910
Selling price
29,549
Workings:
1- Variable overhead absorption rate= variable overhead/hours worked
Preparation= shs24,000/8,000 hours = shs3 per hour
Machining = shs84,000/12,000 hours= shs7 per hour
Assembly= shs60,000/10,000 shs6 per hour
2- Fixed overhead absorption rate= fixed overhead/total hours worked
=shs180,000/ (8000+12,000+ 10,000)
Shs180,000/30000= shs6 per hour
3- Total hours worked for Job No M50-888= 50+200+120 =370
4- Administration and selling overhead is 10% of shs21,490= shs2,149
5- Profit is to be charged at 25% of total cost, it is 25% of 23,639, i.e. 5909.75 or
shs5,910
By Lwanga, D A
Page 13
BATCH COSTING
Introduction:
Batch costing consists of elements of both process costing and job-order costing. Batch costing is
therefore a variant of job costing and is therefore applicable where homogeneous products are
produced in batches and each batch is treated as a single job
A batch is a group of similar articles which maintains its identity throughout one or more stages
of production and it is treated as a cost unit (CIMA terminology)
When dealing with a batch we consider a batch as a group of items that are closely related, and
are being made for a single customer, or are being made at the same time; and the key point for
our 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. In batch costing, costs are
accumulated by batches as described in the preceding paragraph. The cost per unit of a product is
calculated at completion of the batch, by dividing total costs by number of units in a batch.
Examples of industries employing batch costing include footwear and clothing industries. The
accumulation and recording of costs under batch costing is very similar to the techniques used in
job-costing
Example one:
The budgeted overheads of Heko Printers Ltd for the year are given as under:
Variable overheads
Department
Amount
Overhead absorption base
Shs
Typesetting
150,000
15,000 labour hours
Plate making
200,000
25,000 labour hours
Printing
300,000
30,000 machine hours
Binding
120,000
20,000 labour haours
Selling and administration overheads are charged at 10% of production cost
Profit is charged at 25% of the total cost
An order for 2,000 books was received from publisher. The batch number of this order is 2315.
By Lwanga, D A
Page 14
The following additional information in respect to Batch No.2315 is provided:Materials
shs87,000
Labour:
Typesetting
150 hours at shs12 per hour
Platemaking
40 hours at shs15 per hour
Printing
60 hours at shs20 per hour
Binding
100 hours at shs10 per hour
The machine hours used on this Job were 50
Required:
Calculate the total cost of the batch, cost per unit, selling price of the batch and selling price per
unit.
Example two:
Jane Peter uses a batch costing system for her drilling and boring business; she uses a cost plus
system of price setting and sets a mark-up of 25% on a sales values. Administration costs are
absorbed at the rate of 10% of the selling price, whereas factory overheads are absorbed at the
rate of shs12 per direct labour hour for Department C and shs9 per direct labour hour for
Department L. Batch C-A consists of 1,000 shafts to be drilled and bored and the following costs
have been incurred on it:
Department C 500 direct labour hours at shs10 per hour
Department L 750 direct labour hours at shs8 per hour
Direct materials costing shs6,475 have also been used on Batch C-A
Required:
In drawing a batch cost card show
(a) Total cost and total cost per unit
(b) Selling price and selling price per unit
By Lwanga, D A
Page 15
BATCH COSTING
SUGGESTED SOLUTION:
QUESTION ONE:
Shs
Materials
shs
87,000
Labour:
Typesetting 150 hours at shs12
1,800
Platemaking 40 hours at shs15
600
Printing 60 hours at shs20
1,200
Binding 100 hours at shs10
1,000
Prime cost
4,600
91,600
Production overheads:
Variable overheads
Typesetting 150 hours at shs10
1,500
Platemaking 40 hours at shs8
320
Printing 50 hours at shs10
500
Binding 100 hours at shs 6
600
Production cost
2,920
94,520
Administration and selling overhead
(10% of shs94,520)
9,452
Total cost of the batch
103,972
Profit (25% of shs103,972)
25,993
Selling price of the batch
129, 965
Cost per unit
By Lwanga, D A
Page 16
Total cost of the batch = total cost of the batch/ number of books
= shs103,972/2,000 = shs51.98
Selling price per unit= selling price of the batch/ number of books
= shs129,965/2,000= shs64.98
Workings:
Overhead absorption rates
Typesetting = total overhead/total labour hours= shs150,000/15,000= shs10
Platemaking = total overheads/total labour hours= shs200,000/25,000= shs8
Printing= total overheads/total machine hours= shs300,000/30,000 =shs10
Binding =total overheads
heads/total labour hours= shs120,000/20,000=shs6
By Lwanga, D A
Page 17
CONTRACT COSTING
Introduction:
Contract costing is a system of job-costing that is applied to relatively large cost units which
normally take a considerable length of time to complete. Examples are buildings and
construction work, civil engineering, ship buildings, dams, bridges, roads, etc. All these contracts
are large in size and extend over more than one accounting period. A significant part of the work
is normally carried out on the customer’s site.
A contract account is maintained for each individual contract. All the direct costs of the contract
are debited to the specific contract and overheads are apportioned. The difference between the
contract price and the costs charged is a profit made from the contract
Characteristics of contract costing
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Higher proportion of direct costs: Because of the self-contained nature of most site
operations, many items are classified as direct
Low indirect costs: For most contracts, the only item of indirect costs would be a charge
of head office expenses
Difficulties of cost control: This is because of the size of the site and the nature of the
contract
Surplus materials: All materials bought for a contract would be charged directly to a
contract. At the end of a contract, a contract account would be credited with the cost of
materials not used and if they were transferred directly to another contract, the new
contract account is debited. If they are not required immediately the materials would be
stored and the cost debited to the stock account
Contract plant
(a) When a plant is leased: the leasing charges are charged direct to a contract
(b) When plant is purchased: one of the two methods are used:
i)
Charge new plant at cost to the contract for which it has a purchase, at the end
credit with the second-hand value of the plant
ii)
Where plant is moved frequently from contract to contract or where contracts
are relatively short, a “Plant Service Department” is created. This
department organizes the transfer of plant from contract as required and each
contract is charged a daily or weekly rental
Note that whatever method is used for charging capital costs of plant, the ordinary
running costs, i.e. fuel, repairs and insurance would be charged direct to the contract
By Lwanga, D A
Page 18
Progress payments and architect’s certificate:
The contract normally provides for a client to make progress payments either at specific stage of
work or at particular agreed intervals. The basis for these interior payments is an architect’s
certificate of work satisfactorily completed, which shows the value of the work done at shillings
prices and this certificate accompanies the invoice sent to the customer. The amount paid is
normally the certified values less a percentage retention which is released when the contract is
full completed by a contractor.
Retention
A specific percentage of the work certified is withheld by contractee or client. This amount
withheld is known as retention money. This amount is paid to the contractor on the completion
of a contract. The main purpose of this retention money is to ensure that the contract has been
completed according to the satisfaction of the client and all defects in the work have been cleared
by the contractor. This retention money is shown as a debtor in the books of contractor
Example one:
An architect assesses the value of the work done to be shs265,000,000. The client has already
paid shs110,000,000 and the agreed retention percentage is 15%
Required:
a) Compute the amount of progress payment
b) Pass the accounting entries for this payment when received
Profit on uncompleted contracts
Where a contract extends for a period of more than one accounting period it is necessary to
estimate the amount of profit earned in a particular period. Total profit is estimated by comparing
contract value with costs incurred and expected costs required to complete the contract
Where a loss occurs, prudence concept requires full recognition of loss in the period in which it
occurs. However, if there is a profit there must be a way of recognizing a portion of this profit
during a particular accounting period
The following guidelines are useful in determining profit attributable to contracts in progress:
(a) If the contract is in its early stages, profit should not be taken. Profit is taken when the
outcome of the contract can be reasonably foreseen;
(b) Where substantial costs have been incurred on the contract (say the contract is 30-80%
complete), profit to date is estimated as:
By Lwanga, D A
Page 19
Profit taken= 2 or 3 x Notional profit x cash received
3
4
Value of work certified
Notional profit is the value of work certified to date less the cost of work certified to date and the
provision of unforeseen losses.
(c) When the contract is nearing completion (say over 80% complete) and eventual profit can be
assessed with reasonable certainty there is no need for excessive prudence and one of the
following methods may be used:
Profit attributable= cash received to date x estimated profit from the contract
Contract price
This formula allows for retention percentage. In unlikely event of there being no retention
by the client the formula would be:
Profit taken =value of work certified x estimated profit)
Contract price
The above method is probably the most usual but there are other possibilities
Profit taken= value of work certified-cost of work certified
Or profit taken = cost of work done
x estimated total profit
Estimated cost of a contract
(d) If a loss occurs, it should be recognized in full in a period in which it occurs
Note that profit is calculated on cumulative basis, therefore profit for the current period is
determined by deducting profit taken in P&L account of the previous periods from calculated
profit.
Further, it is important to note that costs incurred on the contract are recorded in a contract
account and is debited by the amounts incurred on the contract. Credits in this account normally
consist of contract price. Thus the contract account is in effect, the profit and loss account for
each contract.
Example two:
At the year-end Apple Development has three contracts in progress and their details are as
follows:
Contract
Contract price
AP 10
AP 11
AP12
Shs
shs
shs
150,000
275,000
185,000
Costs to date
35,000
144,000
154,000
Estimated costs of completion
88,000
96,000
7,000
By Lwanga, D A
Page 20
Value of work certified
40,000
165,000
172,000
Progress payment received
34,000
140,250
146,200
Cost of work certified
28,000
138,000
150,000
Required:
What interim profits if any, should be taken on the three contracts? (no profit has been taken so
far)
Accounting entries for contracts
A separate account will be kept for each contract with the general objective of establishing the
overall contract profit or loss. In addition there are contract entries within the contract account
relating to carry forward/brought forward items, accrual and pre-payments
Book keeping and contract cost costing entries
Direct costs: Debit the contract account
Cost of plant:
Hire of the plant: debit the contract account
Plant bought:
Dr. Contract account with cost
Contract account with depreciation
Cr. Contract account with balance c/d
Dr. Plant account with depreciation and running expenses
Dr. Contract account with overheads included at the end of contract otherwise does not include
them as part of WIP c/d:
Deriving the balance sheet entries
Some items which are entered into contract accounts are conventionally and produce straight
forward balance sheet entries. The two main items in this category are unused materials on site
and plant on site
There more difficulties however with work-in-progress and the differences the amounts
recognized as turnover and the progress payments received. The balances relating to long term
contracts are split into categories:
By Lwanga, D A
Page 21
(a) The costs of work done which is not yet recognized in the profit and loss account is
shown under stocks as “long term-contract balances”
(b) The difference between
shs
i)
Amount taken as turnover
xx
ii)
Less: Progress payments received
xx
= net difference
xx
Will grouped with Debtors as Amounts recoverable on long term contracts if i) is greater than ii).
Alternatively, the net difference will be offset against the balances in (a) above if ii) is greater
than i)
Thus, it will be seen that various separate contract balances are calculated and then netted to
produce final balances which appear suitably segregated, in the firms’ aggregated published
balance sheets
Example three:
The following information relates to Contract F-887 on Mwanakwelekwe Site on 31st December
2011
CONTRACT F-887 MWANAKWELEKWE SITE
CUSTOMER – MKUNAZINI CORPORATION
Shs’000
Wages
Materials delivered direct to site
42,156
54,203
Materials from main stores
657
Materials transferred to Mwembeladu Site
1,590
Plant purchased (at cost)
12,500
Plant transferred to Mwanakwelekwe
5,250
Sub-contractor’s charges
19,580
Site expenses (power, etc.)
5,086
Materials on site 31st December 2011
18,300
Plant on site 31st December 2011
14,750
Pre-payments at 31st December 2011
507
By Lwanga, D A
Page 22
Accrued wages at 31st December 2011
921
Sales value of the stage completed
117,500
Cost of stages completed
102,300
Head office charges are 10% of wages
Progress payments received from client
115,000
The contract value is shss550,000,000 and it is anticipated that there will be further costs of
shs375,000,000 (including guarantee and rectification claims). As this is the first year no profit
has been taken previously.
Required:
From the above:
(a) Prepare a contract account for the year ended 31st December, 2011
(b) Balance sheet as at 31st December 2011
(c) The opening entries for 1st January 2012
It is the company’s policy to take as interim profit the difference between the sales value
and cost of stages completed.
Question four:
Usangu Construction Co. won a contract for the construction of a mult-story at a cost of
shs200,000,000
The data relating to the contract for the year ended 31st December, 2012 were as under:
Shs’000
Materials issued to the site
80,000
Materials purchased locally
15,700
Direct wages:
Paid
Accrued
Plant purchased and installed
5,800
350
48,800
Direct expenditure
Paid
1,780
By Lwanga, D A
Page 23
Accrued
70
Establishment charges
180
Materials returned to store
850
Work certified
150,000
Cost of work not certified
3,800
Materials on site on December 31
5,330
Value of plant on December 31
41,500
The company has received from a client payments amounting shs126,000,000
Required:
(a) Prepare the contract account
(b) Prepare the contractee account
(c) Show how the various items will appear in the balance sheet (statement of financial position)
Example five: (assignment)
A construction company is currently undertaking three separate contracts and information
relating to these contracts for the year 2010 together with other relevant data is as follows:
Contract
Contract price
Contract
Contract
Construction
Moro
Pwani
Songea
Services
dept
Tshs’000
Tshs’000
Tshs’000
800,000
675,000
1,100,000
190,000
370,000
Tshs’000
Balances b/f at beginning of the
year:
-
Cost of work completed
-
-
Materials on site
-
-
Written down value of plant
and machinery
Wages accrued
-
35,000
170,000
12,000
-
2,000
-
-
-
-
-
25,000
By Lwanga, D A
Page 24
Profit previously transferred to P&L
a/c
-
-
15,000
Materials delivered to site
40,000
99,000
180,000
Wages paid
20,000
47,000
110,000
Payments to sub-contractors
-
-
Salaries and other costs
6,000
20,000
90,000
15,000
8,000
35,000
-
25,000
21,000
Written down value of plant:
Issued to sites
Transferred from sites
-
8,000
Balances c/d at the end of the year:
Materials on site
Written down values of plant
and machinery
8,000
70,000
Wages accrued
-
Pre-payment to sub-contractors
-
Value of work certified ate the end
of the year
Cost of work not certified at year
end
90,000
-
110,000
5,000
5,000
15,000
390,000
950,000
26,000
The cost of operating the construction services department, which provides technical advice to
each of the contracts, is apportioned over the contracts in proportion to wages incurred
Contract Songea is scheduled for handing over to the contractee in the near future and the site
engineer estimates that the extra costs required to complete the contract in addition to those
tabulated above, will total shs138,000,000. This amount includes an allowance for plant
depreciation, construction services and contingencies
Required:
By Lwanga, D A
Page 25
(a) Construct a contract account for each of the three contracts for the previous year and
show the cost of work completed at the year end
(b) Recommend how much profit or loss should be taken for each contract, for the previous
year, and explain the reasons for each of your recommendations.
SOLUTIONS TO DISCUSSION QUESTIONS
Example one:
Current payment =value certified-retention-payment already made
=shs265,000-15%(265,000)- 110,000
= shs265,000-39,750-110,000
= shs115,250
The accounting entries for this payment when received are:
Dr. Bank a/c
Cr. Client account
Example two:
First check the degree of completion and whether the contracts are expected to make
profit on completion. Only if an overall profit is expected can taking an interim profit
be considered. If contract showed an overall loss, this must be taken, in full, in the
current accounting year in accordance with prudence concept
Contract price
Less: estimated total costs
Estimated contract profit
AP10
Shs
150,000
123,000
27,000
AP11
shs
275,000
240,000
35,000
AP12
shs
185,000
161,000
24,000
Approximate degree of completion
Costs to date
=35,000
144,000
154,000
Total costs
123,000
240,000
161,000
=28%
60%
96%
Thus all contracts are expected to make an overall profit on completion so taking
an interim profit can be considered provided that the degree of completion justifies
doing so
By Lwanga, D A
Page 26
Contract AP10 only 28% is complete so it would be prudent not to take any profit
until more of the contract is completed
Contract AP11 60% is complete so a prudent amount of profit can be taken. As there
is retention of 15% a reasonable method of calculation would be:
Profit taken= 2 x Notional profit
x
progress payment
3
value of work certified
= 2 x (165,000-138,000) x 140,250
3
165,000
= shs15,300
Note that the above figure is considered below the difference between the value and
cost of work certified which is shs27,000. This means that the amounts taken to the
P&L for turnover and cost of sales should be less than shs165,000 and shs138,000
respectively
AP12 96% complete so a somewhat less prudent view can be taken of the interim
profit. A reasonable calculation would be
Profit taken= Progress payments x estimated total profit
Contract price
= shs146,200 x24,000
185,000
=shs18,966
It will be seen from the initial data that, in each case there was work done but not yet
certified i.e. costs to date less cost of work certified. This must be carried at cost not
sales value.
Question three:
CONTRACT NO F-887
CUSTOMER: MKUNAZINI CORPORATION
SITE: MWANAKWELEKWE
CONTRACT ACCOUNT
Shs’000 shs’000
shs’000
Site wages
42,156
material transferred out
1,590
Add: accrued
921
43,077
prepayment c/d
507
Materials purchased 54,203
Materials fro stores
627
54,860
Plant purchased
12,500
Materials at site c/d
18,300
By Lwanga, D A
Page 27
Plant transferred in
Subcontractors
Site expenses
Head office charges
5,250
Cost of stages completed
17,750
19,580
5,086
4,308
144,661
Plant at site c/d
14,750
WIP c/d
7,214
(see note a)
Cost of stages completed 102,300
144,661
102,300
Sales value
Profit for the year
(See note b)
15,200
117,500
1st Jan,2012 (see note c)
Prepayment b/d
Materials b/d
Plant b/d
WIP b/d
117,500
507
18,300
14,750
7,214
117,500
accrued wages
921
Notes:
(a) Total costs to date are shs109,514 (shs144,661- items c/d and transferred out)
As the cost of stages completed is shs102,300 the contract balance (WIP) is:
Shs’000
109,514
Less: cost of sales
102,300
= long term contract balance
7,214
(b) Before any profit can be taken for the year it is necessary to estimate the overall
project outcome to whether a profit or loss is expected , thus:
Expected contract outcome:
Shs
Contract value
550,000
Less: costs to date
109,514
Future costs
375,000
484, 514
Expected overall contract profit
65,486
As an overall profit is expected it is reasonable to take a proportion into this
year’s accounts. The profit is the difference between the cost and the sales value
of the stages completed as shown
By Lwanga, D A
Page 28
(c) All the entries shown appear in the balance sheet as at31st December year 2011
and would be aggregated with the other pre-payments, accruals and stocks and
work in progress of the firm
In addition a balance sheet entry arises from a personal account of the client,
Mkunazini Corporation thus:
MKUNAZINI CORPORATION
BALANCE SHEET
Cash (progress payments)
Sales value of completed stages
117,500
Balance c/d (debtors)
117,500
1st January, 2012 balance b/d
115,000
2,500
117,500
2,500
The shs2,500 balance on Mkunazini account would be grouped with debtors termed “Amounts
recoverable on long-term contracts”
It should be noted that a debtor arises because the amount taken for Turnover (shs117,500)
exceeds the progress payments (shs115,000)
Question four: Refer Salemi, N.A, (2005) Cost Accounting Simplified (4ed), pg161-164
By Lwanga, D A
Page 29
PROCESS COSTING
Process costing system is used in situations where homogeneous products are produced from a
continuous production process. Given the nature of production process and the facts that the
outputs are identical, it is not feasible to identify costs with individual units or jobs.
Consequently, in a process costing system cost of a unit of a product is assumed to be the
average cost of all units produced during the period
Examples of industries where process costing is applicable includes cement, petroleum refining,
food processing and clothing manufacturing
Flow of costs in a process costing system
In an enterprise, which use process costing system production move from one process to the next
or from one department to the next. Each process performs some work on the units as part of the
total operation of transforming the units of finished product. Therefore, each process applies
resources in carrying out this transformation process
and incurs costs.
When the process is complete units are transferred to the next process where they become inputs.
Again the resources are applied to the units until a stage is reached when they are transferred to
the next process or department. This flow continues until the final processing stage where a
finished product emerges.
As the units are transferred from one process to the next, costs relating to the previous process
are also transferred with those units. Therefore the cost becomes cumulative and at the end the
finished product will bear costs incurred from the first to the last processing operation
It follows therefore that in process costing system costs are accumulated by processes and a
separate account is maintained for each process. When units are transferred from one process to
another, the process account of transferring department (or process) is credited and that of the
receiving department is debited with the costs of units transferred. When transfers are made from
the final process the finished goods account is debited.
Features of process costing
Although details vary from one concern to another, there are common features in most process
costing systems. These include:
By Lwanga, D A
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




Clearly defined cost centers and accumulation of all costs (materials, labour
and overheads) by the cost centers
The maintenance of accurate records of units and part units produced and the
costs incurred by each process
The averaging of the total costs of each process over the total production of
that process, including partly completed units
The charging of the cost of the output of one process as the raw materials
input cost of the following process
Clearly defined procedures for separating costs where the process produces
two or more products (i.e. Joint products) or where by-products arise during
production
Accounting entries
Materials
The materials used at each process are debited to the respective process account
Labour
Direct labour of each process is debited to the respective process account. In process costing, the
proportion of direct labour cost is small compared to material cost. The main reason is the use of
automatic plant or equipment in such industries
Direct expenses
Expenses incurred in respect of any particular process are debited to the process account
Production overheads
In process costing, the proportion of production overheads is comparatively high. Each process is
charged with a reasonable share of production overhead
Example one:
The manufacture of product “GWALA” requires three distinct processes numbered I-III to
finished goods stock. The following information was obtained in respect of product GWALA for
the month of March, 2012
3,000 units of raw materials at shs75,000,000 were issued to process I and the costs incurred are
given below:
ELEMENT OF COST
PROCESS
By Lwanga, D A
TOTAL
Page 31
I
II
III
Shs’000
Shs’000
Shs’000
Shs’000
Direct materials
5,000
12,000
18,000
35,000
Direct labour
30,000
20,000
10,000
60,000
Direct expenses
2,800
5,200
2,000
10,000
-
-
90,000
Production overheads
-
Production overhead is absorbed by each process at 150% of direct labour. There was no stock of
raw materials or work-in-process either at the beginning or at the end of the period
Required:
Prepare process accounts
Process Losses
With many forms of production the quantity, weight or volume of the process output will be less
than the quantity, weight or volume of materials input. This may be due to various reasons:



Evaporation, residuals, ash
Unavoidable handling, breakage and spoilage loses
Withdrawal for testing and inspection
Because of increasing material costs, careful records must be maintained of loses occurring and
the resulting cost implications. If loses are in accordance with normal practice, i.e. standard
levels, they are termed normal process losses. If they are above expectation, they are known as
abnormal process losses.
The cost of normal loss is absorbed in the cost of production for good production. If defective
units in respect of normal loss can be sold for a reduced value then the proceeds of these units
are subtracted from total cost
Process costing when output is full complete
i)
No losses within the process
To calculate the cost per unit of output for this case we merely divide the total cost incurred
for the period by the output for the period
By Lwanga, D A
Page 32
ii)
Normal losses in process with no scrap value
Certain losses are inherent in the production process and cannot be eliminated, e.g. liquids
may evaporate, part of cloth required to make a suit may be lost and losses occur in cutting
wood to make furniture. Because they are an inherent part of the production process normal
losses are absorbed by the good production. Where normal losses apply the cost per units of
an output is calculated by dividing the costs incurred for a period by the expected output
from actual input for the period
iii)
Abnormal losses in process with no scrap value
Because they are not inherent part of the production process they are not included in the
process cost, but removed from an appropriate process account and reported separately as an
abnormal loss. Abnormal losses are written off in the P&L a/c
iv)
Normal losses in a process with a scrap value
If all of the units lost represent a normal loss in process and the units lost have a scrap value
(sales value) then the sales value of the spoiled units should be offset against the cost of
appropriate process where the loss occurred
Therefore, the sales value of the normal loss is credited to the process account and a
corresponding debit entry will be made in a cash or accounts receivable (debtors) account
The calculation of the cost per unit of an output is as follows:
= input cost-scrap value of the normal loss
Expected output
v)
Abnormal losses in process with scrap value
If it happens that the lost units have a scrap value and the objective is to calculate the cost per
unit for the expected output only the scrap value of the normal loss will be deducted by
ascertaining the cost per unit
The sales value of the units lost represent revenue of abnormal nature and should not be used in
the process unit cost. This revenue is in effect against the cost of abnormal loss which is of
interest to management
vi)
Abnormal gains with no scrap value
By Lwanga, D A
Page 33
On occasions the actual loss in process may be less than expected in which case an abnormal
gains results. We are assuming that in this case abnormal gain does not have a scrap value.
The value of the gain is calculated in the same way as abnormal loss and removed from
process account by debiting the account and crediting the abnormal gains account
vii)
Abnormal gains with a scrap value
The issue is to find the cost of normal output with the scrap value, i.e. input cost less scrap
value of the normal loss. Note that the cost per unit is based on the normal production cost
per unit and is not affected by the fact that abnormal gain occurred on the sales of spoiled
units of which the sales value did not materialize. The issue is to produce the cost per unit
based on normal operating efficiency. Abnormal gain units be removed from the process
account and that it is valued at the cost per unit of normal production. However, as there is a
gain also there is a loss of sales and this lost revenue should be offset against the abnormal
gains.
Example two:
Mwenemtapa Company manufactures product “PEKEE”. During the month of February, 2012,
2000 kg of materials at shs5,000 per kg were supplied to process I. Labour costs amounted to
shs3,000,000 and production overheads of shs2,300,000 were incurred. The normal loss has
been estimated at 10%. The actual production was 1,750 kg
Required:
Prepare process account and calculate the cost per unit
Example three:
Assume the same data as in example two except that the scrap value of the normal loss and
abnormal loss was shs1,800 per kg
Required:
Prepare process account and calculate the cost per unit
Example four:
Assume the same data as in example two except that the scrap value of normal loss was shs1,800
per kg and actual production was 1,830 units
Required:
Calculate the abnormal gain and show the relevant accounts
By Lwanga, D A
Page 34
Hint: examples two-four: Refer Salemi, N.A, (2005) Cost Accounting Simplified (4ed), pages
187-191
Example five:
Chemical Company Ltd makes a chemical that passes through three production processes 1, 2
and 3. In the month of February, 2012, 6,000 liters of basic raw materials priced at shs240,000
were introduced into process 1. Subsequently, the following costs were incurred:
Element of cost
total
process
1
2
3
shs
shs
shs
87,000
30,000
40,000
110,000
16,900
40,000
6,000
shs
Direct materials
(additional)
Direct labour
Direct expenses
50,000
1,600
17,500
20,000
9,300
Normal loss per process was estimated as:
Process 1 10%
Process 2 5%
Process 3 8%
Output of each process was:
Process 1 5,300
Process 2 5,000
Process 3 4,700
The loss in each process represented a scrap which could be sold of the following
values
Process 1- shs20 per unit
Process 2 – shs44 per unit
Process 3 –shs65 per unit
There was no stock of materials or work-in-progress at the beginning or end of the month. The
output of each process passes directly to the next process and finally to the finished stock
Production overhead is absorbed by each process on basis of 50% of cost of direct labour
By Lwanga, D A
Page 35
Required:
(a) Prepare separate process accounts for each of the three processes
(b) Prepare the abnormal loss and abnormal gains accounts
The concept of equivalent units
When some of the output started during a period is partially complete at the end of the period,
unit costs cannot be computed by simply dividing the total costs for a period by output for that
period. For that case we must convert the WIP into finished equivalents (equivalent production)
so that the unit costs can be obtained. For that case we must estimate the percentage of degree of
completion of the WIP and multiply by the number of units in progress at the end of the
accounting period
Elements of costs with different degree of completion
Sometimes WIP not all as the elements that make up the total cost may have reached the same
degree of completion. Where this situation arises separate equivalent production calculations
must be made for each element of costs
Previous process cost
As production moves through processing, the output of one process becomes the input of the
next process. The next process will carry out additional conversion work and may add further
materials. It is important to distinguish between these different cost items: this is achieved by
labeling the transferred cost from the previous process “previous process cost”. This element of
cost will always be full as far as closing WIP is concerned
Valuation of opening WIP
The closing WIP at the end of specific period appears as opening WIP at the start of next period.
This opening WIP at the start of next period will be partially complete and will have a value
brought forward from a previous period. In most of the cases, there is both opening and closing
WIP. In such cases the equivalent units can be calculated by adopting two different methods:
i)
FIFO method of valuation
In FIFO method, it is assumed that the production is completed on the First-in-First Out basis. It
means the first work done in the period is the completion of the opening WIP and the closing
WIP is valued at current period costs. This method is most suitable when the costs are relatively
stable
By Lwanga, D A
Page 36
In this method, opening work in progress keeps its identity. The cost of output completed in the
period is worked in three parts:



ii)
The cost incurred during the current period to complete work-in-progress b/f
The cost of units started and completed in the current period
The cost of work started but not completed in the current period
Average cost method of valuation
This method is also known as average price method. In this method, an average cost is calculated
using the total of opening WIP valuations plus the current period costs. The opening WIP is
treated as the current production. It means the opening WIP losses its identity. Under this
method, both closing WIP and completed units are valued using the same average unit cost. The
effect of this is that previous period’s costs included in the opening WIP influences the valuation
of the closing WIP. This method is more suitable when costs fluctuate from period to period
FIFO versus Average Cost Method
FIFO and average cost methods can be used under the following conditions



When the value of the opening WIP is given in lump sum amount and the stage of
completion is given then only FIFO method is possible
When the value of the opening WIP is given in terms of material, labour and production
overhead but the stage of completion is not given then only average cost method is
possible
If the degree of completion and the value of WIP in terms material, labour and overheads
is given then use any method
Cost of production report
A departmental cost of production report shows all costs chargeable to a department. It is not
only the source of summary journal entries at the end of the month but also a most convenient
vehicle for presenting and disposing of costs accumulated during the month. A cost of
production report shows:






Total unit costs transferred to it from a preceding department
Materials, labour and factory overheads added by the department
Unit cost added by the department
Total and unit costs accumulated to the end of operations in the department
The cost of the beginning and ending work in process inventory
Costs transferred to succeeding department or to a finished goods storeroom.
By Lwanga, D A
Page 37
It is customary to divide the cost section of the report into two parts; one showing costs for
which the department is accountable, including departmental and cumulative total and unit
costs and the other showing the disposition of these costs. A quantity schedule showing the
total number of units for the department is accountable and the disposition made of these
units is also part of the department’s cost of production report. Information in this schedule
adjusted for equivalent production is used to determine the unit costs added by a department,
the cost of ending work in progress inventory, and the cost to be transferred out of the
department
A cost of production report determines periodic total and unit costs. However, a report that
would merely summarize the total cost of materials, labour and factory overheads and shows
only the unit cost for a period would not be satisfactory for controlling costs. Total figures
mean very little; cost control requires detailed data. Therefore, in most instances, the total
cost is broken down by cost elements for each department head responsible for costs
incurred. Furthermore, detailed departmental figures are required because of the various
completion stages of the work in process inventories. Either in the cost of production report
itself or in the supporting schedules, each item of material used by a department is listed,
every labour operation is shown separately, factory overhead operations are noted
individually, and a unit cost is derived for each item. To condense the illustrated cost of
production reports, only total materials, labour and factory overheads charged to the
departments are considered, and unit costs are computed only for each cost element rather
than for each item.
Example six:
Mapambo Ltd is a manufacturing company which uses a process costing system to determine
costs of one of its products, body lotion. Mapambo Ltd commenced production in March,
2012 and the following data was available at the end of March, 2012:
Opening work in process (units)
0
Units started during the period
200,000
Units completed during the month and transferred to finished
goods
160,000
shs
Cost of materials added during the month
9,600,000
Cost of labour and overheads during the month:
By Lwanga, D A
Page 38
Labour
7.680,000
Overheads
5,760,000
Materials are added in the production process at the beginning of the process, labour and
overheads are applied uniformly throughout the process. The stage of completion of units in
process at the end of the month is estimated to be 80%
Required:
Determine the cost of units completed and transferred out to finished goods and the cost of
closing work in process inventory
Solution:
The following stages are involved when determining solution for this question
(a) Summarize flow of units in the production process
(b) Compute equivalent units of production
(c) Summarize the total costs to account for during the period and calculate the cost per
equivalent unit
(d) Apply cost per equivalent units to determine cost of units completed and cost of work in
process
We present the solution in the cost of production report
Mapambo ltd
Cost of Production Report for the March, 2012
Equivalent units
Physical units
Opening work-in-process
materials
Conversion
0
Units started
200,000
Units to account for
200,000
Accounted for as follows:
By Lwanga, D A
Page 39
Completed and transferred out
160,000
160,000
160,000
Closing WIP (80%)
40,000
40,000
32,000
Units accounted for
200,000
200,000
192,000
Summary of costs
total
Opening WIP
0
0
0
Costs added during March
23,040,000
9,600,000
13,440,000
Costs to account for
23,040,000
9,600,000
13,440,000
200,000
192,000
48
70
Divide by equivalent units
Cost per equivalent units
118
Costs accounted for as follows:
Units completed and transferred
out
Closing WIP:
(160,000 x118)
18,880,000
Materials
(40,000 x48)
1,920,000
conversion
(32,000x70)
2,240,000
4,160,000
23,040,000
Opening stock
Materials
9,600,000
Labour
7,680,000
Overheads
5,760,000
Mapambo Ltd
Work-in-Process Account
0
Finished Goods
Balance c/d – closing stock
By Lwanga, D A
18,880,000
4,160,000
Page 40
23,040,000
23,040,000
Example seven:
The following information is provided in respect of Process 2 of the month of March, 2013:
Opening stock 400 units valued at shs12,800
Degree of completion:
Material
80%
Labour
50%
Overheads
50%
Transfer from Process 1
Transfer to Process
: 6,000 units at shs177, 200
3
: 5,000 units
Production costs during the period were:
Shs
Direct material
42,880
Direct labour
53,080
Production overheads
36,036
Closing stock:
800 units
Degree of completion:
Material
80%
Labour
60%
Overheads
40%
Units scrapped:
600 units
Degree of completion:
Material
100%
By Lwanga, D A
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Labour
70%
Overheads
70%
There was a normal loss in the process of 10% of production. Units scrapped were sold at
shs25 per unit
Required:
Prepare Process 2 Accounts by using FIFO method
Example eight:
The following data relates to Process Y for accounting period 2
At the beginning of period 2 there were 800 units partly completed which had the following
values:
Value
shs’000
% age complete
Input materials (from Process X)
8,200
100
Materials introduced
5,600
55
Labour
3,200
60
Overheads
2,400
45
During the period 4,300 units were transferred from Process X at a value of shs46,500,000
and other costs were:
Shs’000
Materials introduced
24,000
Labour
19,500
Overheads
18,200
At the end of the period, the closing WIP was 600 units which were at the following stages of
completion:
Input material
100%
By Lwanga, D A
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Materials introduced
50%
Labour
45%
Overheads
40%
The balance of 4,500 units was transferred to Finished Goods
Required:
Calculate the value of units transferred to Finished Goods and the value of WIP and prepare
the Process account using:
(a) FIFO method and
(b) Average Cost method
Example nine: (Assignment)
A company operates expensive process plant to produce a single product from one process. At
the beginning of October, 3,400 completed units were still in the processing plant, awaiting
transfer to finished stock. They were valued as follows:
Shs’000
Direct materials
25,500
Direct wages
10,200
Production overheads (200%of direct wages)
20,400
During October, 37,000 further units were put into process and the following costs charged to the
process:
Shs’000
Direct materials
276,340
Direct wages
112,000
Production overheads
224,000
36,000 units were transferred to Finished Stock and 3,200 units remained in WIP at the end of
October which were complete as to material and half-complete as to labour and production
overheads. A loss of 1,200 units, being normal occurred during the process
The average method of pricing is used
By Lwanga, D A
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Required:
(a) Prepare for the month of October, a statement (or statements) showing:
i)
Production cost per unit in total and by element of cost
ii)
The total cost of production transferred to Finished Goods
iii)
The valuation of closing WIP in total and by element of cost
(b) Describe five characteristics which distinguish process costing from job costing
Example seven:
The following information is provided in respect of Process 2 of the month of March, 2013:
Opening stock 400 units valued at shs12,800
Degree of completion:
Material
80%
Labour
50%
Overheads
50%
Transfer from Process 1
Transfer to Process
: 6,000 units at shs177, 200
3
: 5,000 units
Production costs during the period were:
Shs
Direct material
42,880
Direct labour
53,080
Production overheads
36,036
Closing stock:
800 units
Degree of completion:
Material
80%
Labour
60%
Overheads
40%
Units scrapped:
600 units
By Lwanga, D A
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Degree of completion:
Material
100%
Labour
70%
Overheads
70%
There was a normal loss in the process of 10% of production. Units scrapped were sold at
shs25 per unit
Required:
Prepare Process 2 Accounts by using FIFO method
By Lwanga, D A
Page 45
JOINT PRODUCT AND BY-PRODUCT COSTING
Introduction:
Joint products and by-products arise in situations where
the production of one product makes inevitable the
production of other products
A distinguishing feature of the production of joint and byproducts is that the products are not identifiable as
different products until a specific point in the production
process is reached. Before this point joint costs are
incurred on the production of all products emerging from
the joint production process. It is therefore not possible to
trace joint costs to individual products
Definitions
A joint product is the term used when two or more
products arise simultaneously in the course of processing,
each of which has a significant sales value in relation to
each other
A by-product is a product which arises incidentally in the
production of the main product(s) and which has a
relative small sales value compared with the main product
By-product costing
By Lwanga, D A
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Because by-products by definition have a relatively small
sales value, elaborate and expensive costing system
should be avoided
The following are the most common methods of dealing
with by-products:
(a) By-product net realizable value is deducted from the
total cost of the products
(b) Total cost (main product and by-products if any) are
deducted from total sales value of main and byproducts
(c) By-product receipts are treated as incidental other
income and transferred to general P&L account. This
method is generally considered unsatisfactory except
where the value is very small
(d) By-products treated as joint products. This method is
most appropriate where the value of a by-product is
relatively large
Joint-product costing
Because joint products arise due to the inherent nature
of the production process, it follows that none- of the
products can be produced separately. The various
products become identifiable at a point known as splitoff point. Up to that stage all costs are joint costs,
By Lwanga, D A
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subsequent to the split-off point any cost incurred can
be identified with specific products and they are known
as subsequent or additional processing costs
Joint costs are costs of manufacturing process that
produce two or more products simultaneously. When the
product produced have “high total sales values compared
with the total sales value of other products” (Horngren et
al,2006) they are called joint products.
There are several methods that can be used to allocate
joint costs. Some of these methods include:
i) Physical measure method
ii) Net realizable value (NRV) method
iii) Sales value at split-off point method
We shall use example one below to illustrate how these
methods are used:
Example one:
During the month of July, 2011 the Nyamisati Nakagawa
Company processes a basic raw material through a
manufacturing process that yields three products-products
By Lwanga, D A
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X, Y and Z. There were no opening inventories and the
products are sold at split-off point without further
processing.
Details of the production process and the sales revenues are given below:
Joint costs
Product
shs600,000
units
sales value per unit
X
40,000
shs7.50
Y
20,000
25.00
Z
60,000
3.33
Assume that all the output is sold during the period
Required:
Show how the above methods are used to allocate joint costs
(a)
Physical measures method
Using this method, the cost allocation is a simple
allocation of joint costs in proportion to volume. Each
product is assumed to receive similar benefits from the
joint cost, and is therefore charged with its proportionate
share of total cost.
The cost allocations using this method are as follows:
Units
Product
produced
Proportion Joint costs
to total
Cost per
allocated
unit
Shs
Shs
By Lwanga, D A
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X
40,000
Y
20,000
Z
60,000
120,000
1/
1
3
200,000
5
/6
100,000
5
½
300,000
5
600,000
Note that this method assumes the cost per unit is the
same for each of the products
Thus, an alternative method of allocating joint costs is as
follows:
Cost per unit= (shs600,000/120,000)= shs5
(b)
Sales value at split-off point method
When the sales value at split-off point method is used,
joint costs are allocated to joint products in proportion to
estimated sales value of the production on the assumption
that higher selling prices indicate higher costs. To certain
extent, this method could better be described as a means
of apportioning profits or losses, according to sales value,
rather than a method for allocating costs.
Using the information in example one, the allocations
under the sales value method would appear as follows:
By Lwanga, D A
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Proportion of
Joint
Units
Product
produced
Sales
sales value to
costs
value
total
allocated
Shs
(%)
shs
X
40,000
300,000
30
180,000
Y
20,000
500,000
50
300,000
Z
60,000
200,000
20
1,000,000
(c)
120,000
600,000
Net Realizable Value (NRV) Method
In example one above we assumed all products are sold
at the split-off point and that no additional costs are
incurred beyond that point. In practice however, it is
likely that joint products will be processed individually
beyond the split-off points and market values may not
exist at this point. To estimate the sales value at splitoff point, it is therefore necessary to use the estimated
sales value at the point of sales and then work
backwards. The net realizable value at split-off point
can be estimated by deducting from the sales revenue
the further processing costs at the point of sale.
By Lwanga, D A
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Assume the same situation in example one except that
further processing costs now apply. Details of the
production process and sales revenue are given below
Joint costs
shs600,000
Further processing
Product
Sales
Costs
Value
Shs
Shs
X
80,000
300,000
Y
100,000
500,000
Z
20,000
200,000
The calculation of the net realizable value and the allocation of joint costs using
this method is as follows:
Estimated
Costs
net realizable
Beyond
value at
split-off
split-off
value
point
point
to total
allocated
Shs
shs
shs
(%)
shs
X
300,000
80,000
220,000
27.5
165,000
Y
500,000
100,000
400,000
50.0
300,000
Z
200,000
20,000
180,000
22.5
135,000
1,000,000
200,000
Sales
Product
proportion
800,000
joint costs
600,000
By Lwanga, D A
Page 52
Note: The joint costs are allocated in proportion to each
product’s net realizable value at split-off point
Example two:
The following data relates to three joint products:
A
B
C
Sales value
shs18,000 shs15,000
shs24,000
Selling costs
4,500
1,000
3,500
Weight (kg)
240
150
180
Joint costs are shs35,000.
Required:
Calculate the profit made by each product apportioning
joint costs on:
a) Sales value basis
b) Physical basis
Solution:
By Lwanga, D A
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(a) Apportionment on sales value
Product
Sales value
costs apportioned
Apportionment
Shs
shs
A
x35,000=
24,000
14,737
( 24,000/57.000)
B
x35,000 =
18,000
11,053
(18,000/57,000)
C
x35,000 =
15,000
9,210
(15,000/57,000)
57,000
35,000
Profit statement
Product
C
Total
shs
A
B
Shs
shs
shs
Sales value
15,000 57,000
24,000
18,000
By Lwanga, D A
Page 54
Less: apportioned costs (14,737)
(9,210) (35,000)
Selling costs
(1,000)
(9,000)
Profit
4,790
(11,053)
(3,500)
(4,500)
5,763
2,447
13,000
Apportionment on physical unit basis
Product
weight
apportioned
apportionment
costs
A
11,053
180
(180/570) x shs35,000
B
737
240
(240/570) x shs35,000
C
9,210
150
(150/570) x shs35,000
14,
570
shs35,000
Profit Statement
Product
C
A
B
Total
By Lwanga, D A
Page 55
Shs
shs
24,000
18,000
(11,053)
(14,737)
Selling costs
(1,000)
(9,000)
(3,500)
(4,500)
Profit
4,790
9,447
1,237
shs
shs
Sales value
15,000
57,000
Less: Apportioned costs
(9,210)
(35,000)
13,000
Example three: (Assignment)
Two products X and Y are produced from the same
material. The material costs shs0.95 per kg and the
products appear after Process 1
X can be sold directly but Y needs further processing in
Process 2
The following data relate to one period
Materials
Overheads
Labour
Total
By Lwanga, D A
Page 56
Process
shs
1
15,000
shs
144,000
shs
shs
21,000
180,000
2
18,000
10,000
28,000
Product
(kg)
Sales
Kg sold
Closing stock
X
shs52,500
30,000
15,000
Y
shs150,750
45,000
There were no materials on hand at the end of the period
Required:
Calculate:
(a)
The unit price of X and its market value at splitoff point
(b)
The total joint cost to be apportioned between
the two products
By Lwanga, D A
Page 57
(c)
The total cost of X and Y using the sales value
method of apportionment.
Example four:
(a)
Explain why is it necessary to allocate joint costs
to products
(b)
Describe three different methods of allocating
joint costs to products
(c)
Explain the factors that should influence the
choice of method when allocating joint costs to
products
(d)
Describe the accounting treatments of by-product
COST-VOLUME-PROFIT ANALYSIS
By Lwanga, D A
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Objective of C-V-P analysis
The objective of CVP analysis is to establish what will happen to the financial results if a specified
level of activity or volume fluctuates. This information is vital to the management, since one of
the most important variables influencing sales level, total costs and profits, is output or volume.
For this reason output is given special attention, since knowledge of this relationship will not
enable management to identify the critical output levels such as levels at which neither profit nor
loss will occur.
C-V-P analysis is based on the relationship between volume and sales revenue and costs and
profits in the short-run, the short-run normally being a period of one year, or less in which the
output of the firm is restricted to that available from the current operating capacity. In the short
run some inputs can be increased but others cannot. For example, additional supplies of
materials can be obtained at short notice, but it takes time to expand the capacity of plant and
machinery. Thus output is limited in the short run because plant capacity cannot be expanded. It
also takes time to reduce capacity and therefore in a short-run a firm must operate on a relatively
constant stock of production resources. Furthermore, most of the costs and prices of a firm’s
products will have already been determined, and the major area of uncertainty will be sales
volume. Short-run profitability will therefore be sensitive to sales volume on the level of profits
in the short-run
Basic terminologies
 Relevant range
 Break-even- point
 Contribution margin
 Margin of safety
Margin of safety is the excess of budgeted (or actual) sales over the break even volume of sales.
It states the amount by which the sales can drop before losses begin to be incurred. The formula
for calculation is as follows:
Margin of safety= total budgeted (or actual) sales-break even sales
The margin of safety can also be expressed in percentage form. This percentage is obtained by
dividing the margin of safety in shillings terms by total sales:
Margin of safety percentage= margin of safety in shillings
Total budgeted (or actual) sales
Target profit analysis
By Lwanga, D A
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CVP formulas can be used to determine the sales volume needed to achieve a target profit.
One method is the use of the equation method we have discussed. Instead of solving for units
sales where profits are zero, you instead solve for units of sales are shillings amount (e.g. in
the forthcoming example shs30 000)
Sales=variable expenses+ fixed expenses + profits
Alternatively,
Units sold to attain a target profit= Fixed expenses+ target profit
Unit contribution margin
Example one:
Tema Beach Entertainment Ltd operate in the leisure and entertainment industry and one of it’s
activities is to promote concerts at locations throughout Tanzania. The company is examining the
viability of a concert in Mwanza. Estimated fixed costs are Shs6,000,000. These include the fees
paid to the performers, the hire of venue and advertising costs. Variable costs of the costs of prepacked buffet which will be provided by a firm of caterers at a price, which is currently being
negotiated, but is likely to be in a region of Shs1000 per ticket sold. The proposed price for the
sale of a ticket is Shs2000. The management of Tema Beach has requested the following
information:
a) The number of tickets that must be sold to break-even (that is, the point at which there
is neither profit or loss)
b) How many tickets must be sold to earn Shs3,000,000 target profit?
c) What profit would result if 8000 tickets were sold?
d) What selling price would have to be charged to give a profit of Shs3,000,000 on sales of
8,000 tickets, fixed cost of Shs6,000,000 and variable costs of Shs1,000,000 per ticket?
e) How many additional tickets must be sold to cover the extra costs of television
advertising of Shs800,000?
Example two:
Aziz Ally Co manufactures and sells a single product. Price and cost data regarding the company’s
product and operations are as follows:
Tshs
Selling price per unit
Tshs
2,500
Variable costs per unit:
By Lwanga, D A
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Raw materials
1,100
Direct labour
500
Manufacturing overheads
250
Selling expenses
130
Total variable expenses
1,980
Annual fixed costs:
Manufacturing overheads
19,200,000
Selling and administration costs
27,600,000
Total fixed costs
46,800,000
Required:
(a) Calculate the break-even point in units and shillings
(b) The management is considering reducing the selling price to Tshs2,400 or spend on an
advertising Tshs5,000,000 in order to increase the level of demand. What is the level of
sales in units that will make the company earn the same profits whatever the scheme is
adopted?
Example three:
(a)Mention and explain the three important assumptions of break-even-analysis
(b) The management of Company X is anxious to improve the company’s profits performance and
has asked for several items of information
Total
Per unit
Sales (20,000 units)
1,200,000
60
Less: Variable costs
900,000
45
Contribution margin
300,000
15
Less: fixed costs
240,000
Net income
60,000
Required:
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Page 61
(i) Compute the company’s break-even point in both units and shillings value. Compute the
company’s margin of safety in both shillings and percentage form
(ii) Assume that sales increase by shs400,000 next year. If cost behavior patterns remain
unchanged, by how much company’s net income increase? Use the CM ratio to determine your
answer
Example Four:
A fresh graduate from one of the VETA colleges is contemplating whether to start a brick making
business. After carrying out a brief market research he came up with the following estimates per
brick
Direct material cost
Tshs150
Direct labour cost
50
Variable overhead cost
40
240
In addition the following costs have been paid each month if he decides to start the business
Rental for the premises
Tshs45,000
Rental for the brick machine
60,000
Watchman’s salary
50,000
Other miscellaneous fixed expenses
25,000
Total fixed costs per month
180,000
He would be nearby competitors are selling each brick at shs320/=each and he believes he will
have to charge about the same price
Required:
(a)What is the monthly break-even point in both units and sales value?
(b)What is the total contribution margin at break-even point?
(c) How many units will he need to sell each month to earn a target profit of Tshs360,000 each
month?
(d)Suppose the owner of premises increases rent by Tshs720,000, but at the same time selling price
increases to shs360 per brick. What will be the new break-even point?
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(e) Mention at least five assumptions of the computations you made above (i.e. of break- even
analysis
Example five:
You have recently graduated at CBE with a Diploma in Business Studies and you have been
appointed the Production Manager of KTM Company Ltd. The company produces pairs of Khanga
to be sold within and outside the country. The following costs need to be incurred in production
of each pair of Khanga:
Shs
Raw materials
1,500
Direct labour
1,200
Variable overheads
1,300
In addition to the above, the following costs are incurred:
Salaries
shs4,000,000
Advertisement
3,000,000
Rent
5,000,000
Currently, the company produce and sell 15,000 pairs of Khanga at a price of shs5,000 per pair.
Required:
(a) Compute the break-even point in a number of pairs of Khanga sold and in shillings
(b) How many pairs of Khanga should be produced and sold to earn a profit of shs1,000,000?
Construction of Break-even Charts
Break-even Charts are used to find out profit/loss at a specific level of activity. These charts are
based on the principles of marginal costing. A break-even Chart may be defined as graph which
shows profit or loss at different levels of activity within the limited range. The break even chart
is also known as cost volume profit chart.
Contribution/sales graph
This is a simple form of break-even chart. It is also known as profit volume chart. This chart shows
the profit or loss at various levels of sales. At zero level of activity the loss is equal to total fixed
costs. The fixed costs along Y axis is joined by a straight line to the break-even point of sales and
then this line is extended to the profit point against the present sales
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Example: You are required to prepare from the following information:
(a) A break-even Chart
(b) Contribution/sales graph or profit volume graph
(c) Show the margin of safety in these charts if actual level of output is 20,000 units.
Selling price per unit
Shs100
Variable cost per unit
Fixed costs
Shs50
Shs600,000
Solution:
In order to draw break-even-chart, we assume the following levels of output and show the
relevant sales and costs against these levels output
Level of output
Units
5,000
Fixed costs variable costs
Shs
600,000
shs
250,000
total costs
shs
sales
shs
profit/loss
shs
850,000
500,000 (350,000)
10,000
“
500,000
1,100,000
1,000,000 (100,000)
15,000
“
750,000
1,350,000
1,500,00
20,000
“
1,000,000
1,600,000
150,000
2,000,000
400,000
We draw the sales and cost curves on the bases of the sales figures (levels of activity) above
(refer lecture notes on drawing graphs)
Assumptions underlying C-V-P Analysis
1) The behavior of total costs and total revenue have been reliably determined over relevant
range
2) All costs may be divided into fixed and variable elements
3) Fixed costs remain unchanged over the relevant volume range of break-even analysis
4) Total variable costs are directly proportional to the volume
5) Selling price per unit remains constant
6) A single product is being sold, and where than one products are being sold, this done in a
constant mix.
7) Volume is the only relevant factor affecting costs. Of course other factors also affect costs
and sales
Ordinary cost-volume-profit analysis is a crude oversimplification when these factors are
unjustifiably ignored.
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8) There is little or no change in ending and beginning inventory.
INCOME EFFECTS OF ALTERNATIVE COST ACCUMULATION SYSTEMS
(MARGINAL AND ABSORPTION COSTING SYSTEMS)
Tutorial Note:
By Lwanga, D A
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The main difference between marginal and absorption costing principles lies in the treatment of
fixed manufacturing overheads. Whereas marginal costing treats fixed manufacturing
overheads/costs as period costs, absorption costing system treats these costs as product costs and
forms part of inventory valuation. Marginal costing is used for internal reporting whereas
absorption costing is used for external reporting.
Absorption Costing may be defined as a technique whereby all costs are absorbed into production
and there is no distinction between variable and fixed costs. The stocks and WIP contain both fixed
and variable elements. In this system, fixed factory overheads, are absorbed on the basis of predetermined overhead rate based on the normal capacity. Under/over absorbed overheads are
adjusted before computing the profit for the period. Closing stock is also valued at cost which
includes fixed factory overhead.
Absorption costing is a traditional approach and is also known as Conventional Costing or Full
Costing.
Production overheads are recovered by absorbing them into a cost of the product.
The main aim of absorption costing is to recover overheads in a way that fairly reflects the amount
of time and effort that has gone into making a product or service
Absorption costing involves the following stages:
 Allocation and apportionment of overheads
 Reapportionment of service (non-production) cost Centre overheads
 Absorption of overheads
Marginal Costing
Under this technique, only variable manufacturing costs are charged as product costs and included
in inventory valuation. Fixed manufacturing costs are not allotted to products but are considered
as period costs and thus charged directly to the profit and loss account for that period. Fixed costs
do not enter in stock valuation.
Both marginal and absorption costing treat non- manufacturing costs (i.e. administration, selling
and distribution overheads) as period costs. i.e. these are not inventoriable costs.
Product and Period Costs
Product costs are those costs which become a part of production costs. Such costs are included in
inventory valuation. Period costs, on the other hand, are those costs which are not associated with
production. Such costs are treated as expenses of the period in which they were incurred.
Distinction between Marginal and Absorption Costing Principles
By Lwanga, D A
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The points of distinction between marginal and absorption costing are summarized as follows:
1- Treatment of fixed and Variable costs.
In marginal costing, only variable costs are charged to products. Fixed costs are treated as
period costs and charged to profit and loss account of the period.
In absorption costing all costs (fixed and variable are charged to products. The fixed factory
overhead is an absorption in units produced at the rate pre- determined on the basis of
normal capacity utilization (and not on the basis of actual overheads)
2- Valuation of stocks
In marginal costing, stocks of WIP are valued at marginal costs only.
In absorption costing stocks are valued at total cost which includes both fixed and variable
costs. Thus, stock values in marginal costing are lower than that in absorption costing
3- Measurement of Profitability
In marginal costing, relative profitability of products or departments is based on the study
of relative contribution made by respective products or departments. The managerial
decisions are thus guided by the contribution.
In absorption costing relative profitability is judged by profit figure which is also a guiding
factor for managerial decisions.
Differences in Profits under Marginal and Absorption Costing
Profits under the two systems may be different because of the difference in the stock valuation.
Position in this regard is summarized as follows:
1- Production equals to sales:
Marginal Costing profit=Absorption costing profit
2- Production more than sales
Closing stock more than opening stock
Absorption costing profit>marginal costing profit
This is because in absorption costing a part of fixed overhead included in closing stock value is
carried forward to the next accounting period in the form of closing stock.
3-Production less than sales
When production during the period is less than sales i.e. when opening stock is more than closing
stock
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Marginal costing profit> absorption costing profit
This is because under absorption costing cost of goods sold is higher because a part of fixed cost
from preceding period is added to the current year’s cost of goods sold in the form of opening
stock
Advantages of absorption costing
1- Fixed costs are related to the production
2- This method is more logical for fixing selling prices
3- Profits can be calculated more accurately
Advantages of Marginal Costing
1234-
Fixed costs are not taken because they are incurred on time basis
Under/over absorption of overheads does not arise**
This method is more simple
It helps to assess the effects of alternative policies
Example one:
A small Company that produces a single product has the following cost
structure
Number of units produced
6,000
Variable costs per unit
shs
Direct materials
2
Direct labour
4
Variable manufacturing overheads
1
Fixed costs per year
Fixed manufacturing overheads
30,000
Fixed selling and administration expenses
10,000
Required:
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(a)Compute the unit product cost under absorption costing method
(b) Compute the unit product cost under variable/marginal costing
method
Example two:
The following data relates to a manufacturing company
Number of units produced per year
6,000
Variable costs per unit
shs
Direct materials
2
Direct labour
4
Variable manufacturing overhead
1
Variable selling and administration expenses
3
Fixed costs per year
Fixed manufacturing overhead
30,000
Fixed selling and administration expenses
10,000
Units in beginning inventory
0
Units produced
6,000
Units sold
5,000
Units in ending inventory
1,000
Selling price per unit
shs20
Required:
(a)Prepare income statement using:
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i)
ii)
(b)
Absorption costing
Variable costing
Prepare a reconciliation schedule
Example three:
Tumbi Motors Limited assembles and sells motor vehicle. It uses an
actual costing system. In which unit costs are calculated on a monthly
basis.
Data relating to the month of March,2004 is as given below:Particulars
Units
Opening inventory
150
Production
400
Sales
Shs
520
Variable Cost Data:
Manufacturing cost per unit produced
10,000
Distribution costs per unit sold
3,000
Fixed Cost Data:
Manufacturing Costs
2,000,000
Marketing Costs
600,000
The selling price per motor vehicle is Shs24,000.
(a) Prepare an income statement for Tumbi Motors Ltd under:(i)
Variable Costing
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(ii) Absorption Costing
(b) Clearly explain the differences between (a) (i) and (ii) above for the
month of March
Example five:
In the year 2011 20,000 units of Karabaka were produced and sold.
Costs and revenues were
Sales
Production costs:
Variable
Fixed
Administrative and selling overheads
Fixed
Shs
100,000
35,000
15,000
25,000
Required:
Prepare operating statements based on both adsorption and marginal costing
Assume the level of activity is 25,000 units, what would be the effect.
Catarina Co. management wants to prepare an income statement for 2011 (the fiscal year just
ended) to evaluate the performance of telescope product line. The operating information for the
year is:
Units
Beginning inventory
0
Production
8,000
Sales
6,000
Ending inventory
2,000
Actual price and cost data for 2011 are:
Shs
Selling price
1,000
Variable manufacturing cost per unit:
Direct material
110
Direct manufacturing labour
40
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Manufacturing overhead
50
Total variable manufacturing cost per unit
200
Variable marketing cost per unit sold
185
Fixed manufacturing costs (all indirect)
1,080,000
Fixed marketing costs (all indirect)
1,380,000
Required:
(a) Compute inventoriable costs per unit produced in 2011 under
(i)
Marginal costing
(ii)
Absorption costing
(b) Prepare profit statements for the year 2011 under
(i)
Marginal costing
(ii)
Absorption costing
(c) Clearly explain the difference between profits in (b)(i) and (b)(ii) above
Example seven:
(a) Differentiate between direct costs and direct costing
(b) Distinguish between period costs and product costs
(c) Why does the direct costing or variable costing theorists exclude fixed manufacturing costs
from inventory valuations
(d) In the process of determining a proper sales price, what kind of cost figures are likely to be
most helpful?
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OPERATION AND SERVICE COSTING
Operation costing
Operation costing is a hybrid costing system that employs certain aspects of job order costing
and process costing systems. It is also referred to as specification costing.
In an operation costing system goods are manufactured in batches that have some common
characteristics as well as some individual characteristics. In such situations each batch is charged
with specific materials where labour and overheads are accumulated by operation or process and
then assigned to batches on a per unit basis
Operation costing is used in manufacturing processes where the conversion activities are very
similar across all of different types of products but the materials used in the various products
differ significantly.
Examples of industries where operation costing is applied include clothing and shoe making. In
these industries production is undertaken in batches, each batch representing a particular style or
decision. Batches of production are charged with specific cost of materials (a feature of job-order
costing) whereas conversion costs are charged to batches on the basis of the same per unit cost
regardless of design or style (a feature of process costing)
Thus, in operation costing system, whereas direct materials are traced to the final product,
conversion costs are not specifically traced to batches produced
In order to apply conversion costs of each operation to batches produced in an operation costing
system, an average conversion cost of each operation is computed using budgeted figures for
each operation:
Average conversion costs=budgeted conversion costs/budgeted activity
Service costing
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Service costing is a cost accounting system concerned with establishing the costs of services
rendered. Although the system deals with intangible services the accounting procedures used are
the same as if the company was engaged in the production of tangible goods. In such cases input
costs include labour and overheads that are part of the service provided
In consulting, public sector and similar service oriented organizations, the organization collects
costs by departments as well as by job or client. In some cases they also maintain work in
progress in their internal records, representing cost of services rendered but not yet billed
Examples of areas where service costing is applied include transport, tourism, hotels, financial
services, education, etc. Service costing is also applied in a manufacturing setting where, for
example, a manufacturing company wishes to establish the costs of services such as catering,
accounting, information technology, etc.
Differences between service and product costing
There are two differences between service and product costing


There are no or very few materials in service costing. Inventories in most cases comprises
supplies only
Overhead is the most significant portion of costs, of which labour contributes the largest
portion of cost
Key issues in service costing
Service costing involves the following key issues



Selecting cost units
Establishing cost centres
Selecting an appropriate rate for charging customers for service rendered
The selection of cost units is not easy task since in most cases the cost of services is related to
several factors. For example, transportation cost depends on such as distance and weight.
Therefore, a problem arises of determining a cost of unit that represents a suitable measure of the
service provided. In most cases a composite cost unit is considered most appropriate, for
example ton-km, patient days,
For each organization will have to determine what cost unit is most appropriate for its own
purposes. The cost unit selected is then used to determine the cost per unit
Cost per service unit= total cost per period/number of service units provided
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The second key issue is tom establish cost centers for the purpose of cost allocation and
apportionment. Again the decision on appropriate cost center will depend on the type of services
and the organization structure along which such services are provided.
Likewise, the selection of an appropriate charging rate for services will depend on the nature of
service provided
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