ken cost accounting 2

8/2/2019 Ken Cost Accounting 2.

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NKUMBA UNIVERSITYSCHOOL OF BUSINESS ADMINISTRATION

NAME :

INDEX NO :

SUBJECT : COST ACCOUNTING

LECTURER :

QUARTER :

QUESTION :


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suit the processing method used by the company.

(iii) Level of activity or output. Identical and high volume out puts require a costing

method which is different from unique and single units that are produced to meet

customers specific requirements.

(iv) Installation and maintenance costs required. Systems that are required to capture

and analyze production costs do not require the same cost. The costing method to be put

in place by the firm may therefore be influenced by costs involved.

(vi) Time required to complete the product. Products do not take the same time to make.

It is therefore important for companies to design costing methods that suit the time

duration of every product.

1.2 Categories of costing methods

Costing methods can be broadly classified into two groups, which include specific order

costing method and continuous operation costing or process costing method. This

classification is based on the first three factors ( i.e nature of the product, production

stages involved and the level of activity) that influence the costing method to employ.


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CHAPTER TWO

2.0 Introduction

There are various types of costing methods which fall under specific order

costing method and continuous operation costing, especially for the

operations of production of goods and services

2.1 Specific Order Costing Method

This covers approaches used in ascertaining the cost of products and services which are

unique in nature

2.1.1 Contract Costing

Specific order costing is the basic cost accounting method applicable where work

consists of separate contracts, jobs or batches (CIMA)

Before we get into the detail of Contract Costing, lets consider undertaking either Zion

construction company has Project 1.

PROJECT 1: CONSTRUCTION OF A DOUBLE STORIED HOUSE AT ZANA

FOR MR. KALIISA KENNEDY (JULY 2012-JULY 2013)

At one of Zion Construction Companys building site, where a one off type job or service

is being made or provided, we follow through as much of a job or service as possible:

note the flow of materials, labour and overheads. Once Zions engineers have

observed the process(es) they can map out (flow charts are ideal for this) both the stages

of the process they have observed and the cost accumulation aspects of each stage. If

their host will allow them to do so, try to obtain copies of job cost cards/sheets and

compare and contrast them.

According to CIMA, Contract costing is a form of specific order costing; attribution of


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costs to individual contracts (Chartered Institute of Management)

It can thus be acknowledged that a contract cost is aggregated costs of a single contract;

usually applies to major long term contracts rather than short term jobs

2.2 Features of long term contracts

By contract costing situations, we tend to mean long term and large contracts: such as

civil engineering contracts for building houses, roads, bridges and so on. These could also

include contracts for building ships, and for providing goods and services under a long

term contractual agreement.

With contract costing, every contract and each development will be accounted for

separately; and does, in many respects, contain the features of a job costing situation.

Work is frequently site based.

Problems with contract costing can prop up in the following areas

Identifying direct costs

low levels of indirect costs

difficulties of cost control

profit and multi period projects

Such jobs take a long time to complete & may spread over two or more of the

contractor's accounting years.

Features of the Zion project 1 Contract

The end product which is the double storied building


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The period of the contract which means the time from the foundation to finishes

The specification which includes types of materials to use,

The location of the work in this case Zana

The price to be determined

Completion by a stipulated date

The performance of the product, is it strong and can it last for a time

Collection of Costs

The quantity surveyor for Zions Project 1 open ups one or more internal job accounts

for the collection of costs. If the contract is not obtained, preliminary costs can written

off as abortive contract costs in P&L In some cases a series of job accounts for the

contract are necessary:

to collect the cost of different aspects

to identify different stages in the contract

Special features of Zions Project 1 contract costing

Materials are delivered directly to site.

Direct expenses

Stores transactions because the materials are stored for next days use.

the project has concreting plant on site

Accounting methods used in contract costing:

1. Where a plant is purchased for a particular contract & has little further value to the

business at the end of the contract

2. Where a plant is bought for or used on a contract, but on completion of the contract

it has further useful life to the business


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Alternatively the plant may be capitalized with Maintenance and running costs charged

to the contract."

Bookkeeping and contract costing projects

Direct costs: Debit the contract account

Cost of plant

Hire of plant: Debit the contract account plant bought:

i) Debit the contract account with depreciation

ii) Debit contract account with cost

iii) Credit contract account with balance c/d

iv) Debit plant account with depreciation and running costs

Debit contract account

Overheads included at the end of the contract otherwise DO NOT include them as part of

WIP c/d

Example contract account for project 1:

Debit direct costs Credit materials returned to stores

hire of plant proceeds of

overheads book value of plant transferred

cost of work done = balance c/d

Progress payments are a key feature of such contracts and they are commonly based on

the value of work done up to a certain stage. Issues involved here are

retentions

payments to date

payments due


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Debit bank account

Credit contract account

Illustration

Contract Project 1 started on 1 July 2012. Costs to 31 December 2012, when the

company's accounting year ends, are derived from the following information.

direct materials issued from store 40000

materials returned to store 1000

direct labour 36000

plant issued, at book value 1 July 2012 50000

written down plant value as at 31 December, 2012 30000

materials on site, 31 December, 2012 3000

overhead costs 5000

As at 31 December, 2012, certificates had been issued for work valued at shs 100,000 and

Mr. Kaliisa Kennedy had made progress payments of shs. 70,000. Zion Construction

Company has calculated that more work has been done since the last certificates wereissued, and that the cost of the work done but not yet certified is shs.14,000. The final

contract price is shs.175,000 and the estimated total cost of the contract is shs.130,000.

The contract account

Contract account Dr Cr

materials 40000

materials returned 1000

labour 36000

plant issued at book value 50000

overheads 5000


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plant c/d 30000

materials c/d 3000

cost of work done not certified 14000

cost of work certified 83000

131000 131000

Work certified account

turnover (profit and loss) 100000

Zion Construction company account 100000

Zion Construction company account

work certified 100000

cash (progress payment) 70000

balance c/d 30000

100000 100000

Estimating profit

In the early stages, no profit will be accounted for.

Total anticipated profit

contract price 175000

costs incurred (14,000 + 83,000) 97000

estimated costs to complete (130,000 - 97,000) 33000 130000

Estimated profit 45000

Estimated degree of completion

Therefore, profit to date:

Sales basis = shs.45,000 X 57.14% = shs.25,714.29


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Cost basis = shs.45,000 X 74.62% = shs.33,576.92

Completing the profit and loss account:

turnover - value certified 100000

profit (sales basis) 25715

cost of sales 74285

costs incurred 97000

cost of sales 74285

WIP 22715

Balance sheet disclosure

Cost of sales 74285

cost of work done 97000

-22715

If this is negative, it is WIP, otherwise it is a provision for liabilities and charges or creditors


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Reconciliation of WIP:

value certified 100000

cost of work certified 83000

apparent profit to date 17000

profit recognized 25715

cost of work done but not certified 14000

-22715

Attributable Profit

That part of the total profit reflects that part of the work performed at the accounting date,

attributable profit is not to be recognised until the outcome of contract is assessed withreasonable certainty.

Calculation of attributable profit

Taking total costs to date & total estimated further costs to completion, also the estimated

future costs of rectification & guarantee work, and any other future work is undertaken

under the terms of the contract. The Profit accounted for requires:

1. to reflect the proportion of the work carried out at the accounting date;

2. account any known inequalities of profitability in various stages of contract for

certainty of profit

Illustration II

Zion Construction Company decided to build a major addition to their plant using both

their own labor and outside subcontractors. It took 13 months to complete the building.

The first 10 months of the construction period were in one cost accounting period. At the

end of the cost accounting period the total charges, including cost of money accumulated

in the work in progress account for this project amounted to shs.750,000. However, most

of these construction costs were incurred towards the end of the cost accounting period.

In developing a method for determining a representative investment amount, appropriate

consideration must be given to the rate at which costs have been incurred. Therefore, the


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contractor averaged the 10 month-end balances and determined that the average

investment in the project was shs.245,000.

Two Cost of money rates were in effect during the 10-month period; their time-weighted

average was determined to be 8.6%. Application of the 8.6% rate for ten-twelfths of a

year to the representative balance of shs.245,000 resulted in the determination that

shs.17,558 should be added to the work in progress account in recognition of the cost of

money related to this project in its first cost accounting period.

The project was completed with the addition of shs.750,000 of additional costs during the

first 3 months of the subsequent cost accounting period. The contractor considered the 3

month-end balances (which included the shs.17,558 capitalized cost of money described

in the preceding paragraph) and determined that the representative balance was

shs.1,234,000. The cost of money rate in effect during this 3-month period was 7.75%.

Applying the rate of 7.75% for one quarter of a year to the balance of shs.1,234,000

resulted in a determination that shs.23,909 should be added to the work in progress

account in recognition of the cost of money while under construction in the second cost

accounting period. The capitalized project was put into service at the recognized cost of

acquisition of shs.1,541,467 which consists of the "regular" costs of shs.1,500,000 plus

shs.17,558 and shs.23,909 cost of money.

Note: An alternative technique would be to make separate calculations, using an

appropriate investment amount and cost of money rate, for each month. The sum of the

monthly cost of money amounts could be entered in the work in progress account once

each cost accounting period.

Zion Construction Company built a major addition with identical basic data to those

described in the previous illustration except that the costs were incurred at a fairly

uniform rate throughout the period.

Because of the pattern of cost incurrence, Zion Construction Company used beginning

and ending balances of the cost accounting period to find the representative amounts. For

the first cost accounting period the representative investment amount was the average of

the beginning and ending balances (zero and shs.750,000), or shs.375,000. Application of


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the average interest rate of 8.6% for ten-twelfths of a year resulted in the determination

that shs.26,875 should be added to the work in progress account in recognition of the cost

of money related to this project in its first cost accounting period.

During the subsequent 3 months the contractor used the representative balance of

shs.1,151,875, derived by averaging the beginning balance of shs.776,875 (shs.750,000

"regular" cost plus the shs.26,875 imputed cost from the prior period) and the balance at

the end, shs.1,526,875. Applying the 7.75% cost of money rate to this balance for a 3-

month period resulted in a determination that shs.22,317 should be added to the work in

progress account in recognition of the cost of money while under construction in the

second cost accounting period.

The capitalized project was put into service at the recognized cost of acquisition of

shs.1,549,192 which consists of the "regular" costs of shs.1,500,000 plus shs.26,875 and

shs.22,317 imputed cost of money. This practice is in accordance with 9904.417-50(a)

and other applicable provisions of the Standard.

If this contractor, acting in accordance with established Standards for financial

accounting, allocated a portion of its paid interest expense to this construction project and

the resultant acquisition cost for financial reporting purposes was not materially different

from shs.1,549,192, the contractor could use the same acquisition cost for contract costing

purposes.

Conclusions

Contract costing can represent highly complex situations as they might involve the

building of houses and housing estates, bridges and so: large amounts of money and other

resources taking months or even years to complete.

Contract costing can be as complex as some of the situations they attempt to record:

nevertheless, once the basic principles have been grasped, their complexity becomes

much more manageable.


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CHAPTER THREE

3.1 BATCH COSTING

Batch costing is not normally seen as much of an advance on job costing.

A batch is a group of similar articles which maintains its identity throughout one or more

stages of production and is treated as a cost unit (Chartered Institute of Management

Accountants)

Batch costing is a form of specific order costing; the attribution of costs to batches

(CIMA)

Considering a batch is a group of items that are closely related, and are being made for a

single customer, or are being made all at the same time; and the key point for the

companys purposes is that the group of items maintains its identity as a batch, serial

numbers, product numbers, production numbers, all identify the goods as a batch.

3.2 The accumulation and recording of costs

The accumulation and recording of costs under batch costing is very similar to the

techniques used with job costing.

Zion Construction Company uses a batch costing system for their drilling and boring

business; they use a cost plus system of price setting and set a mark up of 25% on sales

values.

Administration costs are absorbed at the rate of 10% of selling price, whereas factory

overheads are absorbed at the rate of shs.12 per direct labour hour for Department C and

shs.9 per direct labour hour for Department L.

Batch C-A.RL consists of 1,000 shafts to be drilled and bored, and the following costs

have been incurred on it:

Dept C 500 direct labour hours at shs.10 per hour

Dept L 750 direct labour hours at shs. 8 per hour


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Direct materials costing shs.6,475 have also been used on batch C-A.RL.

Zion Construction companys Batch Cost Card shows the

The total cost and total cost per unit and also the selling price and selling price per unit

Zion Construction company Batch cost card C-A.RL:

1,000 shafts, drilled and bored

Date started: xx/xx/xxxx

Date completed: xx/xx/xxxx

We now know that the total cost of the batch is shs.46,500 and the cost per unit is

Shs.46,500 /shs. 1,000 units = shs.46.50 per unit

The mark up was set at 25% of the selling price; but how could we find 25% of the selling

Total (shs.)

Materials 6475

Labour:

dept C 5000

dept L 6000 11000

Factory overheads

dept C 6000

dept L 6750 12750

Total factory costs 30225

administration costs 4650

Total costs 34875

Mark up (profit) 11625

Selling price 46500


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price when we didn't already know what the selling price was? Tricky, but only for a few

minutes: let's rework the bottom part of the batch cost card so that we can find the mark up

and selling price in the twinkling of an eye!!

We were told that the mark up is equal to 25% of the selling price. Therefore, since

Total costs + Mark up (profit) = Selling price

and

Mark up (profit) = Selling price - Total costs

then

25% = 100% - 75%

Putting this into a table now:

Total costs 34875 75% of selling price

Mark up (profit) 25% of selling price

Selling price 100% of selling price

So, if total costs = 34,875 = 25% of sales, then (we can drop the % from the calculations

now)

Selling price = 34,875 / (75 / 100) = 46,500

So, Mark up = 25% X 46,500 = 11,625

This is where our mark up and selling prices come from!

Total costs 34875 75% of selling price

Mark up (profit) 11625 25% of selling price

Selling price 46500 100% of selling price

Conclusions

Whilst job and batch costing can be equally complex, the example shown here has simply

shown the basic principles involved in gathering total batch costs together and then


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determining a cost per batch and per unit.


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CHAPTER FOUR

4.1 Process Costing

Process costing is the continuous operation costing method that is applied within

manufacturing, where there is a continuous flow of homogeneous product resulting from

a sequence of repetitive operations.

The establishment of product unit costs in a process costing system may, in many

practical situations, be calculated very straightforwardly, by dividing the total costs (direct

materials, direct labour, and overheads) for an accounting period by the total number of

units of product completed in that period.

4.2 Establishment of product unit costs

However, the establishment of product unit costs may also have to deal with the

following:

A desire to establish whether any losses of material/product occurring in the process

are normal or abnormal and to reflect these appropriately in product costs.

The incidence of partly completed production at the end of an accounting period, and

thus the need to establish a valuation for the incomplete units that reflects the degree

of completion.

Particular complexity arises where both normal/abnormal losses and part-completed

production occur simultaneously within the same process.

4.3 The concept of equivalent units

Equivalent units may be used in the establishment of product unit costs to deal both with

process losses (where these occur during, rather than at the end, of a process) and also with

period end work-in-progress.

The concept of equivalent units is that part-completed production (losses at intermediate

stages of a process or work-in-progress at the end of a period) can be converted into an


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equivalent number of completed units, in order to establish the total number of units for a

period to be divided into the total costs incurred. Equivalent units need to be determined

separately for different elements of costs (e.g., raw materials, conversion costs) if

losses/production are at different stages of completion for the different elements.

The application of the equivalent units concept will be introduced later in this article, when

losses arising at intermediate stages of a process are considered. The concept will have

greater applicability in next months article, when the valuation of end of period work-in-

progress is considered.

The following example will be used to illustrate the process cost accounting for

normal/abnormal losses and for work-in-progress using equivalent units as appropriate.


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Example 1

Question: Summarised below are data for two production processes in Zion Construction

companys production department for culverts, bricks for the month just ended:

Process 1:

Materials: shs.6335

Labour and overheads: shs.7,677

Five per cent of input units are expected to be rejected; rejects occur at the end of the process. 190

units failed inspection in the month and were rejected. After inspection, units are transferred

immediately to the next process.

Process 2:

Opening work in progress, 500 units: shs.3,576 (materials shs.3,042; labour and overheads

shs.534)

Completed output from Process 1: 4,110 units

Additional materials: shs.11,672

Labour and overheads: shs.9,485

Closing work in progress: 400 units

There are no losses in the process. Work in process is 100% complete as to materials, and both

opening and closing work in process were 50% complete as to labour and overheads:

Normal losses and abnormal gains/losses

The nature of many process operations is such that the output volume is frequently less than the

input volume. Because process operations are repetitive, the level of losses of materials/product

that could reasonably be expected under efficient operating conditions may be established. This isreferred to as a normal loss; one that is an inevitable consequence of the process operation under

efficient operation conditions and is thus considered unavoidable. Losses greater or less than

normal are referred to as abnormal and result from reduced or greater efficiency.

The normal process loss is usually expressed as a percentage of the input volume. In accounting


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for the normal loss, the cost is shared by the volume of good output expected. For example, if

1,000kg of materials are introduced into a process, and the normal loss is 10% of input, the cost

incurred in processing that quantity of material will be shared by 900 kg (1,000 x 0.9) of expected

good output. If 900 kg of good output is achieved then the cost accounting is straightforward;

process costs would be divided by 900 to establish a cost per unit that is applied to the 900 kg ofoutput.

If the actual good output achieved is not as expected, then abnormal gains or losses have occurred

i.e., good output will either be more (abnormal gain) or less (abnormal loss) than expected. For

example, assuming in the above illustration that the good output was 880 kg then an abnormal

loss of 20 kg has occurred [(1,000 x 0.9) 880]. The good output expected remains 900 kg and

this continues to be used to establish a unit cost which is then applied to both the good output of

880 kg and the abnormal loss of 20 kg, which will be highlighted as a separate charge against

profit/loss.

In this way unit costs are standardized, i.e., unaffected by fluctuations in the proportion of

process loss that actually occurs.

Turning now to the above question, losses are expected and occur in Process 1, the total amount

of input to Process 1 in the period can be established by adding the completed good output from

the process (see information provided under Process 2) of 4,110 units to the 190 units that failed

inspection, i.e., 4,300 units. The normal (expected) loss is 215 units (4,300 x 0.05) and the

expected good output is 4,085 units (4,300 x 0.95). There is thus an abnormal gain during the

period of 25 units [losses less than expected (190 215) or good output more than expected

(4,110 4,085)]. This can be set out as follows:

units

total input


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4,300

less normal loss

215

expected good output

4,085

represented by:

actual good input

4,110

less abnormal gain

25

4,085

The standardized unit cost is:

14,012 (6,335 + 7,677) = shs.3.43 per unit

4,085

which is accounted for as:

cost of good output

shs.14,098 (4,110 units at shs.3.43)

less abnormal gain

86 (25 units at shs.3.43)

costs incurred

shs.14,012


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The process account is as follows:

Process 1 Account

units

shs.

units

shs.

Materials

4,300

6,335

Transfers to

Labour

Process 2

4,070

13,960

and overheads

7,677Normal loss

215

-


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Abnormal loss

15

52

4,300

14.012

4,300

14,012

Continuing on the cost accounting for process losses, and referring back to the Process 1 account,

it can be seen that no cost value is attached to the normal loss i.e., the costs incurred in the process

are shared by the volume of good output expected. The unit cost is thus always based on the

expected (not the actual) good output.

If an abnormal loss (rather than gain) had occurred, the standardized output would remain at

4,085 units, actual good output would be below that amount, and the abnormal loss charged at

shs.3.43 per unit would be credited to the process account.

For example, assume instead that the good output from Process 1 in the period had been 4,070

units and that 230 units had thus failed inspection.

Relevant figures can be set out as:

units

total input

4,300 (as before but now 4,070+230)

less normal loss

215


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expected good output

4,085

represented by:

actual good output

4,070

plus abnormal loss

15 [(230-215) or (4,070-4,085)]

4,085

leading to the same calculation of standardised unit cost as before i.e.,:

14,012 = shs.3.43 per unit

4,085

which is now accounted for as:

cost of good output

shs.13,960 (4,070 units at shs.3.43)

plus abnormal loss

52 (15 units at shs.3.43)

costs incurred


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shs.14,012

The process account, in these changed circumstances, would be:

Process 1 Account

units

shs.

units

shs.

Materials

4,300

6,335

Transfers to

Labour

Process 2

4,070

13,960

and overheads

7,677

Normal loss

215

-


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Abnormal loss

15

52

4,300

14,012

4,300

14,012

Abnormal gain and abnormal loss accounts

Using the information provided originally in the above illustration, an abnormal gain of 25 units

occurred. This gain was valued at the average normal unit cost for the period and was debited to

the Process 1 account. To complete the double-entry for this gain an abnormal gain account is

opened and is credited with the cost value of the gain. This amount gained, i.e., representing

reduced costs from the normal, is subsequently transferred to the profit/loss account, thus addingto profit. Thus:

Abnormal Gain Account

shs.

shs.

Profit/loss


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86

Process 1

86

Using the changed assumptions of an abnormal loss occurring, the credit entry to the Process 1

account would be offset by a debit entry to an abnormal loss account, which, on subsequent

transfer to profit/loss, would result in reduced profit. Thus:

Abnormal Loss Account

shs.

shs.

Process 1

52

Profit/loss

52

Scrap values

In some circumstances, process losses result in sub-standard product, or waste materials,

that can be sold as scrap. In such a situation it is usual to account for the scrap value by

crediting that value against the normal loss in the process account (rather than including

the normal losses at zero cost) with a corresponding debit entry to a process scrap account.

This value of normal losses is then adjusted, in the scrap account, for any abnormal losses

or abnormal gains (i.e., more or less scrap available for sale).

Scrap values have the effect of reducing average unit costs because costs, equal to the

scrap value that is expected to be recovered, are effectively transferred out of the process

account. Referring back to our earlier example of Process 1, and using the original

information in the question, with in addition the assumption that process losses can be

sold for shs.0.40 per unit, the workings and the process account become:


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Standardized unit cost:

13,926 [6,335 + 7,677 86 (i.e., 215 x 0.4)]

4,085

= shs.3.409 per unit

which is accounted for as:

cost of good output = shs.14,011 (4,110 units at shs.3.409)

less abnormal gain = 85 (25 units at shs.3.409)

net costs incurred = shs.13,926

The process account is as follows:

Process 1 Account

units

shs.

units

shs.

Materials

4,300

6,335

Transfers to


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Labour

Process 2

4,110

14,011

and overheads

7,677

Normal loss

215

86

Abnormal gain

25

85

4,325

14,097

4,325

14,097

The scrap account and the account for the abnormal gain would be:

Process Scrap Account


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shs.

shs.

Process 1

86

Abnormal gain (25 x 0.4)

10

Bank (190 x 0.4)

76

86

86


shs.

shs.

Process Scrap

10

Process 1

85


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Profit/loss

75

85

85

In the process scrap account, sales of 190 units only would be recorded (i.e., the actual lost units).

The sales value of the remaining 25 units of normal loss, which represent the abnormal gain, are

transferred to the abnormal gain account where they reduced the benefit (by not having lost unitsto sell) from the abnormal gain.

Under the changed assumptions of an abnormal loss occurring, the standardized unit cost would

remain at shs.3.409 and would be accounted for as:

cost of good output = shs.13,875 (4,070 units at shs.3.409)

plus abnormal loss = 51 (15 units at shs.3.409)

net costs incurred = shs.13,926

The process account and the process scrap/abnormal loss accounts would be as follows:

Process 1 Account

units

shs.

units

shs.

Materials


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4,300

6,335

Transfers to

Labour

Process 2

4,070

13,875

and overheads

7,677

Normal loss

215

86

Abnormal loss

15

51

4,300

14,012

4,300

14,012


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shs.

shs.

Process 1

86

Bank (230 x 0.4)

92

Abnormal loss (15 x 0.4)6

92

92

shs.

shs.

Abnormal loss account

Process 1

51


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Process scrap

6

Profit/loss

45

51

51

This time the abnormal loss write-off is reduced by the scrap value of the additional units lost.

Disposal costs

On occasions losses have a disposal cost, rather than a saleable value. The cost accounting

treatment is the same as that applied to losses except that the disposal costs increase (rather than

decrease) the total processing costs. The normal loss quantity needs to remain on the credit side of

the process account, in order to balance the quantities, and so the disposal costs are best shown

alongside it but in brackets.

Losses occurring at different stages of a process

Thus far the concept of equivalent units, explained earlier in this article, has not needed to be

applied because losses have been assumed to represent complete units. Sometimes losses occur at

some stage part way through (rather than at the end of) a process. In such a situation, the part

completed units lost have to be converted to equivalent whole units.

Example 2

The following information relates to a manufacturing process for a period:


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Materials costs - shs.16,445

Labour and overhead costs - shs.28,596

10,000 units of output were produced by the process in the period, of which 420 failed testing and

were scrapped. Scrapped units normally represent 5% of total production output. Testing takesplace when production units are 60% complete in terms of labour and overheads. Materials are

input at the beginning of the process. All scrapped units were sold in the period for shs.0.40 per

unit.

To Prepare the process accounts for the period including those for process scrap and

abnormal losses/gains

Data concerning units of input and output can be set out as follows:

Materials

Lab & overhead

total input

10,000

less normal loss

500

expected good input

9,500

represented by:


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actual good input

9,580

9,580

less abnormal gain

80

48 (80 x 0.6)

9,500

9,532 (equivalent units)

The units of material can be balanced in the same way as the previous example. All materials are

introduced at the start of the process and thus units rejected are 100% complete as to materials,

even though the rejection takes place when production units are only 60% complete in terms of

processing time.

With labour and overheads, however, the concept of equivalent units is applied because costs are

incurred throughout the process operation. Because fewer than expected units are rejected,

additional labour and overhead costs are incurred in completing the excess units of good output

and this is reflected in the higher equivalent units used to calculate the labour and overhead costs

per unit.

The reverse would be the case if there were abnormal losses (i.e., equivalent units of labour and

overhead would be less than 9,500) because the expected final 40% of processing would not occur

on the extra lost units.

The process accounts (in answer to the above question) would be completed as follows:

Cost per unit:

Materials =

16,245 [16,445 (500 x 0.4)]


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9,500 = shs.1.71 per unit

Labour and overhead = 28,596 / 9,532 = shs.3.00 per unit

NB The scrap value of the normal loss is usually credited in full against raw materials costs,

rather than being spread over all cost elements.

Process 1 Account

units

shs.

units

shs.

Materials

10,000

16,445

Transfers out

9,580

Labour

(9,580 x 4.71)

45,122

and overheads

28,596


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Abnormal gain

80

Normal loss

500

(80 x 1.71

(500 x 0.4)

200

+ 48 x 3.00)

281

10,800

45,322

10,080

45,322



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shs.

shs.

Process

200

Abnormal gain (80 x 0.4)

32

Bank (420 x 0.4)

168

200

200


shs.

shs.

Process scrap

32

Process


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281

249

281

281

Conclusion

The main purpose of this section has been to explain, and to illustrate, the cost accounting for

process losses. The distinction between normal (expected) losses and abnormal gain and losses is

core. The use of equivalent units in situations where losses occur at an intermediate stage of a

process, and the accounting for scrap values, must also be clearly understood.


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CHAPTER FIVE

5.1 SERVICE COSTING

Service costing is a cost accounting method concerned with establishing the costs of

services rendered.

Despite this definition, we should note immediately that even though we may be dealing

with services that are intangible, the cost accounting methods we use are essentially the

same as if we were making cars, biscuits or televisions.

When organizations set up a service cost accounting system, they would need to keep in

mind the fact that the progression, for example, of a cheque through the banking system,

can be treated as items of raw material passing through a production process. Similarly,

we should readily appreciate that the provision of a transport service has much in

common, from the cost accounting point of view, with the manufacture of the lorry or

van that is being used to provide the service.

Where service costing is applied

Transport

Hotels

Tourism

Solicitors

Education

Retail distribution

Financial services

Service costing is also applied within a manufacturing setting. For example, a

manufacturer might wish to calculate the costs of the following services:

Transport

Catering

Computing and IT

Accounting

Human resources


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The Differences between Product Costing and Service Costing

There may be very few, if any, materials to worry about

Overheads will comprise the most significant portion of any costs of which, labour

costs may well comprise as much as 70%

Service Costing: profit or cost centre?

Many organizations simply want to determine the costs of operating its services from a

management control and management information point of view. However, there are

many organizations now that operate services for their own organizations as well as sub

contracting them out to other organizations. For example, there are companies that operate

their own payroll section for themselves; and offer this service to other organizations as well.Other organizations sell CPU time on their computers at times when they do not use it

themselves: for example, in overnight batch work.

One key factor here is that we might be in the situation of assessing the least cost basis for

providing a service, rather than the highest profit possible.

Service Cost Units

For a manufacturer, cost units would be

Motor cars

Packets of biscuits or boxes containing, say, 100 packets of biscuits

Television sets


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The table below shows some examples of service units for a couple of service providers: complete

the table with other examples of your own

Service Service Units

Transport Passenger miles, tones miles, total miles driven

Hotels Room day, housekeeping, meals, room service

Tourism

Solicitors

Education

Retail distribution

Financial services

Kalisa Kennedy Company distributes its goods to a regional retailer using a single lorry. The

dealer's premises are 40 km away by road. The lorry has a capacity of 10 tones and makes journeys

twice a day fully loaded on the outward journeys and empty on the return journeys. The following

information is available for a four week budget control period: period 8 of 20 X 4.

Petrol consumption 8 km per 5 litres of petrol

Petrol cost 0.36 per litreOil 8 per week

Driver's wages and NI 140 per week Repairs 72 per week

Garaging 4 per day based on a seven day week Cost of lorry when new (excludes tyres) 18,750

Life of lorry 80,00 km

Insurance 650 per year

Cost of a set of tyres 1,250

Life of a set of tyres 25,000 km

Estimated sales value of lorry at the end of its life 2,750

Vehicle licence cost 234 per year

Other overhead costs 3,900 per year

The lorry is operated on a five day week basis.

A statement to show the total costs of operating the lorry in period 8 20 X 4 analyzed into running

costs and standing costs.

By running costs and standing costs.


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Running costs are the equivalent of marginal or variable costs

Standing costs are the equivalent of fixed costs.

Even if we'd never come across those terms before, we could have guessed what they meant from

any earlier cost accounting work we had carried out.

A budget control period is probably one calendar month: it is simply an accounting period for

which a budget has been prepared and against which the actual expenses and activities are

compared.

Since we have the luxury of the computer, let's set out an attractive table showing our costs

classified according to whether they are running or standing costs:

Cost Running Cost Standing Cost

Petrol consumption XPetrol cost per litre X

Oil X

Driver's wages and NI X

Repairs X

Garaging X

Cost of lorry when new (excludes tyres) X

Life of lorry X

Insurance X

Cost of a set of tyres X

Life of a set of tyres X

Estimated sales value of lorry at the end of its life XVehicle licence cost X

Other overhead costs X

Just in case there is any doubt, the driver's wages and NI are standing costs because they do NOT

vary with the number of km driven.

Statement of Total Costs of Operating the Lorry: Period 8 20X4

Vehicle Operating Costs: Period 8 20X4

Running Costs

Petrol 720

Depreciation 640

Tyres 160


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1520

Standing costs

Garaging 112

Oil 32

Driver's wages and NI 560

Repairs 288

Insurance 50

Vehicle licence 18

Other overheads 300

1360

Total Operating Costs 2880

Working

Petrol Cost: Km driven: 40 km* 2 * 2 * 5 * 4 = 3,200 km Petrol consumption for 3200 km

8 km * 5 litres = 2,000 litres

Petrol cost = 2,000 litres */ shs.0.36 per litre = shs.720

Depreciation: (Cost of lorry (residual value / life of lorry) * km driven

= (shs.18,750 (2,750 /80,000 km) * 3,200 km = shs.0.2/km * 3,200 km = shs.640

Cost of Tyres: (cost of tyres / life of tyres) * km driven

= (shs.1,250 / 25,000 km) * 3,200 km = shs.0.05/km * 3,200 km = shs.160

Garaging: shs.4 * 7 * 4 = shs.112

Repairs: shs.72 * 4 = shs.288

Insurance: shs.650 / 52 * 4 = shs.50

Vehicle licence: 234 / 52 * 4 = shs.18

Other overhead costs: shs.3,900 / 52 * 4 = shs.300


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Other Considerations

There is additional information given that could enable Kalisa Kennedy company's accounting

staff to take their analysis further:

1 We are told that the lorry travels out full and returns empty. Consequently, we could calculate

our costs on an average half full basis or on a basis that ignores the fact that it isn't always full. The

following table illustrates this point:

per km per full tonne1 per km per half full tonne2

TVC 0.950 0.475

TFC 0.850 0.425

TC 1.800 0.900

Notes:

1 based on 1,600 fully laden km per month 2 based on the total km per month whether full or

empty

2 We have costs such as petrol consumption and we could translate this into costs per tonne: total

petrol costs / total tonnage

= shs.720 / (10shs. * 2 * 5 * 4) = shs.720 / 420 tonnes = shs.1.7142857

Similarly with the depreciation costs check and agree that it becomes shs.0.7619 per tonne


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References

Duncan Williamson (1996) Cost & Management Accounting, Prentice Hall

CIMA Terminology, Chartered Institute of Management Accountants publication

BPP Manual ACCA Study Text Foundation Paper 3:

ken cost accounting 2

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