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Methods of Cost Accounting

S.V.Subrahmanyam
M.Sc., ACMA, ACS,CAIIB
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• Introduction to cost accounting


• Introduction to cost concepts
• Introduction to prime cost and overheads
• Methods of cost accounting
• Reconciliation and Integration Between Financial and
Cost Accounts
• Marginal costing
• Budgets and budgetary control
• Standard costing and variance analysis
• Introduction to advanced cost management concepts
Evaluation Criteria

S.no. Parameter Marks


1 MCQ 15
2 Assignment 10
3 Mid term test 20
4 Class test 15
Total 60
Table of Contents
• Product costing
• Job costing
• Batch costing
• Contract costing
• Process costing
• Operating costing
• Preparation of cost sheet
• Preparation of quotations
Product Costing
• Product costing methods may be grouped
under the following 3 main categories:
 Specific order costing
 Continuous operation costing
 Service / function costing
• Specific order costing is defined as the basic
costing method applicable where work consists
of separate contracts, jobs or batches each of
which is authorized by a special order or
contract.
Job-order Costing
• It is that form of specific order costing which
applies where work is undertaken to customer’s
specific requirements and each order is
comparatively shorter duration.
• The work is usually carried out within a factory
or workshop and moves through processes and
operations as a continuously identifiable unit.
When is Job-order Costing
relevant?
• Manufacture of products to customer’s specific
requirements.
• Fabrication of certain materials where raw
materials are supplied by customers.
• Repairs are done within a factory or at
customer’s premises.
• Manufacturing goods for immediate delivery.
• Internal capital expenditure jobs.
Features of Job-order Costing
• Production is generally against a customer’s
order.
• Each job is different and needs special
treatment.
• No uniformity in the flow of production from
department to department.
• Each job is treated as a cost unit.
• Each job is identified by production order.
• Cost of production of each job is ascertained at
the completion of job.
• WIP differs from period to period according to
the number of jobs in hand.
Advantages of Job-order Costing
• Detailed analysis of cost of materials, wages
and overheads used in the job order available.
• Records costs more accurately.
• To find out which job is profitable over others.
• Provides basis for estimating cost of similar
jobs taken up in future.
• Establishes mechanism for budgetary control of
overheads.
• Wastage due to spoilage and defectives can be
controlled.
• Useful in quoting in cost plus contracts.
• Determination of trends of cost possible.
Disadvantages of Job-order
Costing
• Involves a lot of clerical work.
• Scope of committing mistakes is high.
• Cost comparison is difficult when drastic
changes take place.
• Determination of overhead rates requires
budgeting of overhead expenses and bases of
apportionment and absorption.
• Job costing is a historical costing and cost is
ascertained after it has been manufactured.
Workflow for Job-order Costing
• Receive an enquiry.
• Estimation of the price of the job.
• Receiving of order.
• Issue of production order.
• Recording of costs.
• Completion of job.
• Ascertain profit/loss on the job.
Batch Costing
• It is defined as that form of specific order
costing which applies where similar articles are
manufactured in batches, either for sale or for
the use within the undertaking.
• Cost is ascertained for collection of a lot of units
which is called batch.
• Separate cost sheets maintained for each batch
of products by assigning a batch number.
When is Batch Costing relevant?
• Where the output of a job consists of a number
of units.
• Where customer’s requirements are to be
supplied in uniform quantities over the period.
• Where certain physical characteristics are
required uniformly over a collection of units.
• When an internal manufacturing order is made
out for production of components / sub parts.
Economic Batch Quantity
• The optimum quantity for a batch is that
quantity for which the setting up and carrying
costs are minimum.
• Such an optimum quantity is known as EBQ.
• Factors influencing EBQ are,
 Set up cost
 Manufacturing cost
 Interest on capital
 Storage cost
 Rate of consumption
Economic Batch Quantity
• EBQ = √ (2*S*U)÷C where
• Q is quantity or units of products
• S is set up cost per batch
• C is carrying cost per unit of production p.a
• U is annual units of production
Contract Costing
• It is defined as aggregated cost relative to a
single contract designated as a cost unit.
• This usually applies to major long-term
contracts.
• It is that form of specific order costing which
applies where work is undertaken to customer’s
special requirements and each order is of long
duration.
• Contracts fall into 2 basic types:
 Fixed price contracts
 Cost plus contracts
Features of Contract Accounts
• Generally carried out at customer’s site.
• Higher proportion of direct costs, low indirect
costs (office expenses, stores, works etc.)
• Problem of cost control and surplus materials.
• Quite common to use sub-contractors for
specialized work.
• Separate account maintained for each contract.
• The number of contracts undertaken by a
contractor at a time is usually few.
• The cost unit in contract costing is the contract
itself.
Usage of Plant and Machinery in
Contracts
• Two methods to charge P & M in contracts:
 Contract account debited with full value of the P
& M and credited with depreciated value at the
end.
 Contract account debited with an hourly rate of
depreciation.
Terms used in Contract Costing
• Work-in-progress
• Cost of work certified (value of work certified)
• Cost of work uncertified
• Progress payment
• Retention money
• Cash received
• Notional profit
• Estimated profit (excess of the contract price
over the estimated total cost of the contract).
Accounting in Running Contracts
• Notional profit = Value of work certified – (Cost
of work to date – Cost of work not yet certified).
• Principles for taking notional profit in running
contracts:
 Work completed is ≤25% - No transfer of profit to
P & L.
 Work completed is >25% but <50% - Profit to be
transferred to P & L is Notional profit*1/3*(cash
received/work certified).
 Work completed is >50% but <90% - Profit to be
transferred to P & L is Notional profit*2/3*(cash
received/work certified).
Accounting in Running Contracts
 Work completed is >90% but <99% - Profit to be
transferred to P & L is
Estimated profit*(work certified/contract price) *
(cash received/work certified)
Cost plus Contracts
• Price will cover costs and profit.
• Guarantees profit to the customer.
• Avoids complex calculations due to cost
escalations.
• Customer is assumed of paying a reasonable
amount of profit.
• Avoids delay and chances of error in
estimations.
Escalation Clause
• Escalation clause in a contract empowers a
contractor to revise the price of the contract in
case of increase in the prices of inputs due to
some macro-economic or other agreed
reasons.
• This protects the contractor from adverse
financial impacts and empowers the contractor
to recover the increased prices.
• As per this clause, the contractor increases the
contract price if the cost of materials,
employees and other expenses increase
beyond a certain limit.
• It is a risk mitigation measure for contractor.
Process Costing
• It is a method of costing used in industries
where the material has to pass through two or
more processes for being converted into a final
product.
• It is defined as “a method of Cost Accounting
whereby costs are charged to processes or
operations and averaged over units produced”.
• A separate account for each process is opened
and all expenditure pertaining to a process is
charged to that process account.
Process Costing - Features
• Each plant or factory is divided into a number of
sub divisions and each such division is a stage
of production or a process.
• Manufacturing activity is carried on continuously
by means of one or more process run
sequentially, selectively or simultaneously.
• Output of one process becomes the input of
another process.
• The end product usually is of like units not
distinguishable from one another.
• Tracing the identity of any particular lot of
output to any lot of input materials not possible.
• May give rise to Joint and/or By-Products.
Treatment of Loss / Gain
• Loss of material is inherent during processing
operation.
• Process loss is defined as the loss of material
arising during the course of a processing
operation and is equal to the difference
between the input quantity of the material and
its output.
• There are two types of material losses:
 (i) Normal loss and
 (ii) Abnormal loss.
Treatment of Loss / Gain
• Normal Process Loss:
 It is defined as the loss of material which is
inherent in the nature of work.
 It is unavoidable because of nature of the
material or the process.
 It also includes units withdrawn from the process
for test or sampling.
• Treatment of Normal Process Loss in Cost
Accounts:
 The cost of normal process loss in practice is
absorbed by good units produced under the
process.
 The amount realised by the sale of normal
process loss units should be credited to the
process account.
Treatment of Loss / Gain
• Abnormal Loss:
 It is defined as the loss in excess of the
predetermined loss (Normal process loss).
 Causes could be due to the carelessness of
workers, a bad plant design or operation,
sabotage etc.
• Treatment of Abnormal Loss in Cost Accounts :
 The cost of an abnormal process loss unit is
equal to the cost of a good unit.
 The total cost of abnormal process loss is
credited to the process account from which it
arises.
 The total cost of abnormal process loss is
debited to costing profit and loss account.
Equivalent Units
• Equivalent units or equivalent production units,
means converting the incomplete production
units into their equivalent completed units.
• Equivalent completed units = Actual number of
units in the process of manufacture * % of work
completed.
Steps in Process Costing
• Analyse the physical flow of production units.
• Calculate equivalent units for each cost
element.
• Determine total cost for each cost element.
• Compute cost per equivalent unit for each cost
element.
• Assign total costs to units completed and
ending WIP.
Inter-Process Profits
• In some process industries the output of one
process is transferred to the next process at
market value or cost plus a percentage of profit.
• The difference between cost and the transfer
price is inter-process profits.
• Advantages of Inter-Process Profits:
 Comparison between the cost of output and its
market price at the stage of completion is
facilitated.
 Each process is made to stand by itself as to the
profitability.
Inter-Process Profits
• Disadvantages of Inter-Process Profits:
 The use of inter-process profits involves
complication.
 The system shows profits which are not realised
because of stock not sold out.
Operating Costing
• Also known as service costing.
• It refers to cost of undertakings which do not
manufacture any product but which provides
services.
• It is the cost of producing and maintaining a
service.
• It could be both for internal or external purpose.
• Sometimes two measurement units are
combined together to know the cost of service
or operation which is called composite cost
units.
Operating Costing - Features
• Deals with cost of repetitive services – not
tangible products.
• Resembles with unit costing.
• Services are standardised.
• Investment in fixed asset is high and working
capital is low.
• As fixed costs occupy major portion of total
costs, economies of scale works favourably.
Operating Costing – Cost Units
• Weighted Average or Absolute basis – It is
summation of the products of qualitative and
quantitative factors.
Eg.- To calculate absolute Ton-Km for a goods
transport is calculated as follows.:
∑(Weight Carried × Distance)1 + (Weight Carried
× Distance)2 +….+(Weight Carried × Distance)n
• Simple Average or Commercial basis - It is
the product of average qualitative and total
quantitative factors.
Eg. Commercial Ton-Km is calculated by
∑(Distance1 + Distance2 + …………...…+
Distancen) × (W1+W2+W3 -----+Wn)/n
Operating Costing – Cost Units
• Transport services
• Passenger- km., or Ton- km
• Electricity supply service
• Kilowatt hour
• Hospital
• Patient per day, room per day or per bed, per
operation etc.
• Canteen
• Per item, per meal etc.
• Cinema
• Per ticket per class
Operating Costing – Cost Units
• Hotels
• Guest Days or Room Days
• Bank or FIs
• Per transaction, per services
• Educational institutes
• Per course, per student, per batch, per lecture
etc.
• IT and ITES
• Cost per project, per module etc.
• Insurance
• Per policy, per claim
Operating Costing – Statement
of Cost
• For preparing a statement of cost, costs are
usually collected and accumulated for a
specified period - A month, quarter or a year.
• It could be either on the basis of functional
classification or on the basis of variability.
• Cost sheet on the basis of variability is
prepared classifying all the costs into three
different heads:
 Fixed costs or Standing charges
 Variable costs or Operating expenses
 Semi-variable costs or Maintenance expenses
Service Costing Vs Product
Costing
• Unlike products, services are intangible and
cannot be stored, hence, there is no inventory
for the services.
• Use of Composite cost units for cost
measurement and to express the volume of
outputs.
• Unlike a product manufacturing, employee
(labour) cost constitutes a major cost element
than material cost.
• Indirect costs like administration overheads are
generally have a significant proportion in total
cost of a service as unlike manufacturing
sector.
References

• Cost and Management Accounting by S.P Jain


and K.L Narang
• Cost Accounting by Asish K. Bhattacharya
• ICAI study material