NKUMBA UNIVERSITY

SCHOOL OF BUSINESS ADMINISTRATION NAME INDEX NO SUBJECT LECTURER QUARTER QUESTION : : : : : : COST ACCOUNTING

CHAPTER ONE 1.0 Introduction

Historically, because of the industrial background of cost accounting, specific order costing has tended to centre on the manufacturing environment. Given the developments both in cost accounting and performance evaluation over the last 20 years or so, cost accounting is now being applied in manufacturing, non manufacturing , service and even in non profit making organizations (CIMA, 1999). A costing method represents cost accumulation approach which is used in the determination or ascertainment of the unit cost of the product, service, process or any job. Cost accumulation in this case refers to the aggregation of cost elements that make the manufacturing/product/service costs. Cost elements include material costs, labour costs and factory overhead costs. Cost ascertainment involves collecting and analyzing all the costs, and then dividing the total production costs by the number of units produced to find the cost per unit. Determining the unit cost of a complete unit is the principal purpose of costing methods. Unit cost in this case can be determined as under: Cost per unit = Total production costs/number of units

1.1

Determinants of Costing Methods

Costing methods or approaches used by various firms may be influenced by factors among

which include the following: (i) The nature of the product or services provided by the company. The costing approach designed for identical products is completely different from the one designed for different products because the processes and resources they require will never be the same. (ii) The stages or processes products pass through before they become complete products. Products that pass through a series of stages cannot have the same treatment as those which are not subjected to any stages. This means that the designed costing method cannot fit all the situations and therefore, unique costing method should be designed to

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.

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

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

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

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) ii) iii) iv) Debit the contract account with depreciation Debit contract account with cost Credit contract account with balance c/d 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 overheads proceeds of 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

Debit Credit Illustration

bank account contract account

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 materials returned to store direct labour plant issued, at book value 1 July 2012 written down plant value as at 31 December, 2012 materials on site, 31 December, 2012 overhead costs 40000 1000 36000 50000 30000 3000 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 were issued, 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 materials materials returned labour plant issued at book value overheads 36000 50000 5000 Dr 40000 1000 Cr

plant c/d materials c/d cost of work done not certified cost of work certified 131000

30000 3000 14000 83000 131000

Work certified account turnover (profit and loss) Zion Construction company account 100000 100000

Zion Construction company account work certified cash (progress payment) balance c/d 100000 Estimating profit In the early stages, no profit will be accounted for. Total anticipated profit contract price costs incurred (14,000 + 83,000) 97000 175000 100000 70000 30000 100000

estimated costs to complete (130,000 - 97,000) 33000 130000 Estimated profit Estimated degree of completion Therefore, profit to date: Sales basis = shs.45,000 X 57.14% = shs.25,714.29 45000

Cost basis = shs.45,000 X 74.62% = shs.33,576.92 Completing the profit and loss account: turnover - value certified profit (sales basis) cost of sales costs incurred cost of sales WIP Balance sheet disclosure Cost of sales cost of work done 74285 97000 -22715 If this is negative, it is WIP, otherwise it is a provision for liabilities and charges or creditors 100000 25715 74285 97000 74285 22715

Reconciliation of WIP: value certified cost of work certified apparent profit to date profit recognized cost of work done but not certified 100000 83000 17000 25715 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 with reasonable 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

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

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 3month 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.

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

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

Total (shs.) Materials Labour: dept C dept L Factory overheads dept C dept L Total factory costs administration costs Total costs Mark up (profit) Selling price 6000 6750 12750 30225 4650 34875 11625 46500 5000 6000 11000 6475

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

price when we didn't already know what the selling price was? Tricky, but only minutes: let's rework the bottom part of the batch cost card so that we can find and selling price in the twinkling of an eye!!

for

few

the mark up

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 Mark up (profit) Selling price 34875 11625 46500 75% of selling price 25% of selling price 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

determining a cost per batch and per unit.

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 units of product completed in that period. 4.2 Establishment of product unit costs

number

of

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

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-inprogress 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.

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: 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: shs.6335

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 is referred 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

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 of output. 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

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

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 7,677 Normal loss 215 -

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

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

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 -

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 adding to profit. Thus:

Abnormal Gain Account

shs. shs. Profit/loss

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:

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

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

shs. shs. Process 1 86 Abnormal gain (25 x 0.4) 10

Bank (190 x 0.4) 76

86 86

Abnormal Gain Account

shs. shs. Process Scrap 10 Process 1 85

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 units to 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

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

Process Scrap Account

shs. shs. Process 1 86 Bank (230 x 0.4) 92 Abnormal loss (15 x 0.4) 6

92 92

shs. shs. Abnormal loss account

Process 1 51

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:

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 takes place 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:

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)]

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

Abnormal gain 80 Normal loss 500

(80 x 1.71

(500 x 0.4) 200 + 48 x 3.00) 281

10,800 45,322 10,080 45,322 Process Scrap Account

shs. shs. Process 200 Abnormal gain (80 x 0.4) 32

Bank (420 x 0.4) 168

200 200

Abnormal Gain Account

shs. shs. Process scrap 32 Process

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.

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

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 Other organizations sell CPU time on their computers at times 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 organizations as well. when they do not use it

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 Transport Hotels Tourism Solicitors Education Retail distribution Financial services Service Units Passenger miles, tones miles, total miles driven Room day, housekeeping, meals, room service

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 Petrol cost Oil Driver's wages and NI Repairs Garaging Cost of lorry when new (excludes tyres) Life of lorry Insurance Cost of a set of tyres Life of a set of tyres Estimated sales value of lorry at the end of its life Vehicle licence cost Other overhead costs 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. 8 km per 5 litres of petrol 0.36 per litre 8 per week 140 per week 72 per week 4 per day based on a seven day week 18,750 80,00 km 650 per year 1,250 25,000 km 2,750 234 per year 3,900 per year

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 Petrol consumption Petrol cost per litre Oil Driver's wages and NI Repairs Garaging Cost of lorry when new (excludes tyres) Life of lorry Insurance Cost of a set of tyres Life of a set of tyres Estimated sales value of lorry at the end of its life Vehicle licence cost Other overhead costs 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 Cost X X Standing Cost X X X X X X X X X X X X

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

Running Costs Petrol Depreciation Tyres 720 640 160

1520 Standing costs Garaging Oil Driver's wages and NI Repairs Insurance Vehicle licence Other overheads 112 32 560 288 50 18 300 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

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 TVC TFC TC Notes: 0.950 0.850 1.800

per km per half full tonne2 0.475 0.425 0.900

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

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: