Methods of costing....Unit, Job, Batch, Process, Contract and Operating Costing

Main object of cost accounting is ascertaining of costs of a cost object.

Cost object may be a product, service or any cost centre.

The process involves:-

(i) Element wise collection of costs
(ii) Accumulation of costs so collected for a certain period or product or cost unit.
(iii) Arranging accumulated costs in a sheet to arrive at the total cost of the period or product or cost centre. Generally costs are arranged on functional classification of elements of costs. Other basis may also be adopted based on the need.


Methods of costing are customizations applied to otherwise same costing procedure in order to make costing suitable for particular type of industry, which results in (I) processing costing information speedily and conveniently (ii) making costing information easily understood and usable for management.

For this purpose, two types of manufacturing or work patterns are generally identified to classify types of industries for costing purposes:

(i)                  Those which are engaged in mass production of standardized units using a continuous flow of manufacturing process. [Service industry having standard operating procedures are also classified under this category]

(ii)                Those which are engaged in production based upon the specifications of the customer. Here the production or output or work is different every time

 

	Type I	Type II
Description	Those which are engaged in mass production of standardized units or goods using a continuous flow of manufacturing process	Those which are engaged in production based upon the specification of the customer. Here the production or work is different every time
Type of Costing Method	Unit or Single or Output Costing Process Costing Operating Costing (Service Costing)	Job Costing Contract Costing (Terminal Costing)
Examples
	Unit Costing: FMCG items like wheat flour, Edible Salt, Biscuits, Bakery products, Stationery items, Bricks etc. Process Costing: Chemicals, Metals, Crude oil refining to get petroleum products, Sugar industry Operating costing aka Service Costing: Banking, Insurance, Transport, Electricity distribution, Hospitals, Hotels etc.	Job Costing: Softwares/applications/ websites development, furniture industry, dental and orthopedic implants, Tailoring, interior designing, styling, jobs associated with film industry i.e. script writing, music, camera work etc Contract Costing: Fly-overs, Bridges, Air-ports, Harbors, Shopping Complexes, Residential flats etc.

I Unit costing 

Unit Costing is a method of costing used where the output produced by an entity is identical and each unit of output require identical cost. Unit costing is synonymously known as single or output costing.

Total cost per unit is ascertained by dividing total cost by number of units. It finds application in industries like paper, cement, steel works, mining, breweries. These industries produce identical products and therefore units have identical costs. This costing method is also known as Single or Output costing.

Generally costing is presented in a statement commonly known as cost sheet.

 

Job and batch costing

Consider where separate work or tasks are the cost units or centres. For example a tailor of gents cloth sewing suits will treat different orders differently. This is because each suit will be distinct from the other due to different sizes, different individual preferences, quantity and quality of raw materials use, time factors etc. As a consequence, each such 'job' is a separate cost centre or cost unit for which cost is ascertained and analyzed. Generally no two jobs shall be identical.

This identification of each such job is ascertained by use of specific job or batch numbers usually taken from the specific authorization number of each such job.



Process of Job Costing:

(i) Prepare a separate cost sheet for each job

(ii) Ascertain cost of material i.e. material consumed in each job

(iii) Ascertain cost of labour and other direct costs i.e. wage bill associated to each such job

(iii) Add overheads by methods of allocation and apportionment

(iv) Aggregate of this shall be cost of the specified job.

Suitable for (i) Printing press (ii) Event Managers (iii) Caterers (iv) Furniture
(v) Interior designing (vi) specified implants (vii) Customized software.

Batch costing is derived from the word 'Batch'. Cambridge dictionary of English language defines 'batch' as "a group of things that are dealt with or produced at the same time, or a group of people who are similar in some way" Each batch of same or similar goods is given a unique batch number through which the constituent products are traced to a particular batch. All data and costs are identified, accumulated and grouped keeping various batches as the cost centre or cost unit. Thus where identical, same or similar units of a product are manufactured, fabricated, assembled or produced and considered as a 'batch' due to similarity of all cost elements viz. material, labour, overheads and time of production, Batch costing method is conveniently applied. We have seen batch numbers at the labels of tomato ketchup, hair shampoo, drugs and even day-to-day gadgets. 

S.No.	Job Costing	Batch Costing
1	Method of costing used for non-repetitive, non-standard products produced as per customer’s specification against specific orders	Where same or identical products are produced in specific lots known as batch
2.2	Cost is determined for each job	Cost is determined for each batch
3	Used in Furniture, Software, Tailoring, Printing industry	Used in Pharmaceuticals, Cosmetics, Stationery, electronics industry

II Contract costing 

Contract costing is a form of specific order costing (job costing) where job undertaken is relatively large and normally takes period longer than a year to complete. Contract costing is usually adopted by the contractors engaged in works like construction of building, roads, bridge, erection of tower, setting up of plant, Air-ports etc.

Contract costing is also known as Terminal Costing.

 

Types of contracts:

(I) Fixed Price Contracts : Here the consideration i.e the price of contract work is settled in advance and both contractee and contractor know in advance the price of the contract work. Contractee - what he has to pay and contractor - what he is to receive for contract work. for routine contract work this is the common practice.

(II) Cost Plus Contracts: These are contract where price is not fixed in advance but is settled as an amount arrived at by adding a suitable percentage of profit to the cost incurred in completing the contract work. This method is suitable where contract work is of unknown nature i.e. there is no previous knowledge or experience for such type of work. It is also used where factors of cost are uncertain for any reason or the nature of work is going to keep on changing.

Important terms and conventions in contract costing

Contract, contractor, contractee and sub-contractor :

Contract refers to the agreement and responsibility to undertake a work and complete it as per the specifications for which specified consideration i.e. contract price shall be paid to contractor by contractee.

The person who promises to undertake or execute the contract or work is known as contractor while who awards the contract and provide specifications as to the requirements of the work is known as contractee.

 As the project or work is generally of long duration exceeding one year and sometimes stretching from five to ten years, there arises a need for:

(i) Interim payments i.e. provisional payments of contract price in installment. This is because for meeting revenue as well as capital expenditure with respect to contract work, contractor has to input funds but it can not cover entire expenses of the contract. In order to maintain the liquidity of funds, contractor raises claim for intermediate payments on provisional basis. Theses interim payments can be ad-hoc or as per payment schedule of the contract or as per the level of work completed. The level of work completed i.e. say 15% or 50% of the total contract work is certified by valuers, engineers or architects on behalf of the contractee. This is known as work certified. Contractee can pay full amount of work certified or retain a part of work certified. 

Work Certified = Contract price X level of work completed i.e. %  of completion

Cost of Work Certified = Cost incurred till date - (cost of work uncertified + material and plant in hand)

Cost of Work Uncertified =  Cost incurred till date - (cost of work certified + material and plant in hand)

The portion of work certified which is retained by contractee to check the quality or completeness of work completed and is released at a later date is known as retention money.

Retention Money = Value of work certified - Cash paid towards work certified

Example: Suppose the contract Value is Rs.10,00,00,000. Payment is supposed to be made at 90% of work certified. Now, if work is certified to be completed as 30% then work certified is Rs.3,00,00,000/- and payment to be made is 90% of Rs.3,00,00,000/- i.e. Rs.2,70,00,000/-. Here balance Rs.30,00,000/- is retention money which shall be released after fulfillment of some condition or after settled number of days etc.

Work uncertified: Sometimes contractor has incurred lot of expenses both revenue and capital but work is not certified or certified to a lesser extent due to some procedural or technical difficulty. Thus work done actually is greater than work certified leading to a situation where there is substantial advancement in work which remains to be certified by engineers over and above work certified. So it can be safely said that:

Total Work done = Work Certified + Work Uncertified

Work in progress: Work in progress happens because at any given date, may be 31st March of the financial year the project would not have been completed.

value of the work-in-progress consists of:

(i) the cost of work completed, both certified and uncertified;

(ii) the cost of work not yet completed; and

(iii) the amount of estimated/ notional profit.

(ii) Calculation of Profit: Just like any other business, profit is calculated by matching costs angaint revenue. Single year contract do not pose any problem in this. Contracts which span more than one year present a very special and interesting scenario with regards to calculation of profit and its recognition. Accounting concepts of 'realizaion' and 'matching' limit recognition of full contract price as revenue in income side. This is because revenue of future periods cannot be matched against expenses of current period. Further revenue which is not conclusively accrued can not be recognized.

Revenue i.e. contract price is related to work completed and certified by the engineers of the contractee.

So long the contract is not completed and work is not certified, it is said that contract work is in progress i.e. work-in-progress. Work-in-progress is divided into (i) Work done and certified or simply work certified (ii) Work done but not certified yet or simply work uncertified (iii) Work not done yet.

Value of work certified is definitely recognizable as it has been accepted by engineers of contractee as completed and thus fallen due for payment. Same cannot be said for work uncertified. However a substantial expenditure is incurred and work is done which remains pending for certificate at the time of drawing of profit or loss statement. So consensus is to recognize it also as income. 

On expense side there are two challenges. First, the applicability or relation of a particular expense to the work certified or uncertified and also to the period of the contract has to be decided . Then there is issue of full or partial. Second question is that the benefit of expense running over for more than one year needs to be tackled.

General Format of Contract Account:

(When the contract is in progress) :
To Materials (Direct)                    --     By Material returned to Stores         --
To Materials (Indirect)                 --     By Material Trf to other sites            --
To Wages                                      --     By Material Sales                               --
To Other Direct Expenses            --     By Abnormal Loss                              --
To Sub-contract payments           --     By Closing stock of Materials            --
To Allocated indirect expenses    --     By Closing value of Plant                   --
To Plant (original cost)                --     By Work in progress
To P&L A/c (bal fig being profit   --          - Work Certified                             --
                                                                  - Work Uncertified                         -- 
                                                             By P&L A/c (bal fig being Loss)         --   
                                                            


(When the work is completed)   :

To Work in progress (opening)             By reserve for future contingencies      --
    - Work Certified                          --     By Materials returned                           --
    - Work Uncertified                      --     By Plant returned                                  -- 
To Plant (opening bal)                    --     By Contractee(with the contract price) --
To other costs                                 --
To P&L A/c  (Profit)                        --
   

Conventions for recognizing revenue and resultant profit are based on the level of completion of contracts, conservatism and realization. In cases where contract is not complete, entire book profit is not recognized, instead a portion is transferred to reserve. For this contracts are divided into three types:

(i) Contracts which have just commenced

(ii) Contracts which are mid-way

(iii) Contracts which are nearly complete.

(i)In case of contracts which have just begun, normally there is no recognition of revenue and profit  as no substantial work has been done in comparison to total contract price. Conventionally contracts where work completed is less than 25% i.e 1/4 th of contract price, no profit is recognized

(ii) Contracts which are mid way are classified as those 

(a) which have completed 1/4th or more but less than 1/2 or 50%, here notional profit is taken at 1/3rd value and remaining balance is transferred to reserves

(b) those which have completed 50% or more of contract value. In such cases notional profit is taken as 2/3rd value and balance is transferred to reserve.

(iii) Contracts which are in advanced stages or nearly complete:

COMPUTE estimated profit on a contract (which has been 90% complete) from the following particulars:

Total expenditure to date 22,50,000; Estimated further expenditure to complete the contract (including contingencies) 2,50,000; Contract price 32,50,000; Work certified 27,50,000

Calculation of Estimated Profit:
Total expenditure to date                                                                                                   22,50,000
Estimated further expenditure to complete the contract
(including contingencies)                                                                                                    2,50,000
 
Total costs                                                                                                                         25,00,000
 
Contract price                                                                                                                    32,50,000 
Estimated profit on contract (Balancing figure)                                                                  7,50,000

Contract costing has the following distinct features:

1.  The major part of the work in connection with each contract is carried out at the site of the contract.

2.  The bulk of the expenses incurred by the contractor are considered as direct.

3.  The indirect expenses mostly consist of office expenses, stores and works.

Escalation clause in a contract provides a right to the contractor to revise the price of the contract by adding an amount calculated as per the terms of the contract towards increase in the prices of inputs and other factors say on account of inflation.

Q.0 The following particulars are available in respect of a contract as on 31 March, 2008 (all figures in rupees).

(i) Contract price     5,00,000

(ii) Total cost of contract up to date 2,87,500/-

(iii) Cost of uncertified work   12,500

(iv) Cash received  2,65,625/-

(v) Retention money     @15%

Q.1The following expenses were incurred on a contract: (Rs.)

Materials purchased 6,00,000

Material drawn from stores 1,00,000

Wages 2,25,000

Plant issued 75,000

Chargeable expenses 75,000

Apportioned indirect expenses 25,000

The contract was for Rs.20,00,000 and it commenced on January 1, 20X8. The value of the work completed and certified upto 30th November, 20X8 was Rs.13,00,000 of which Rs.10,40,000 was received in cash, the balance being held back as retention money by the contractee. The value of work completed subsequent to the architect’s certificate but before 31st December, 20X8 was Rs.60,000. There were also lying on the site materials of the value of Rs.40,000. It was estimated that the value of plant as at 31st December, 20X8 was Rs.30,000.

You are required to COMPUTE value of work certified, cost of work not certified and notional profit on the contract till the year ended 31st December, 20X8.

Ans: Notional Profit Rs.3,30,000/-

Q.2 A contractor prepares his accounts for the year ending 31st December each year. He commenced a contract on 1st April, 20X8.

The following information relates to the contract as on 31st December, 20X8:

(Rs.)

Material issued 2,51,000

Wages 5,65,600

Salary to Foreman 81,300

A machine costing Rs.2,60,000 has been on the site for 146 days, its working life is estimated at 7 years and its final scrap value at Rs.15,000.

A supervisor, who is paid Rs.8,000 p.m. has devoted one-half of his time to this contract.

All other expenses and administration charges amount to Rs.1,36,500.

Material in hand at site costs Rs.35,400 on 31st December, 20X8.

The contract price is Rs.20,00,000. On 31st December, 20X8 two-third of the contract was completed. The architect issued certificates covering 50% of the contract price, and the contractor had been paid Rs.7,50,000 on account.

PREPARE Contract A/c and show the notional profit or loss as on 31st December, 20X8.

Ans: Notional Profit Rs.2,13,250/- Cost of Work Uncertified: Rs.2,62,250/-

Q.3 M/s. Bansals Construction Company Ltd. took a contract for Rs.60,00,000 expected to be completed in three years. The following particulars relating to the contract are available:

	20X6 (Rs.)	20X7 (Rs.)	20X8 (Rs.)
Materials	6,75,000	10,50,000	9,00,000
Wages	6,20,000	9,00,000	7,50,000
Transportation cost	30,000	90,000	75,000
Other expenses	30,000	75,000	24,000
Cumulative work certified	13,50,000	45,00,000	60,00,000
Cumulative work uncertified	15,000	75,000	—

Plant costing Rs. 3,00,000 was bought at the commencement of the contract. Depreciation was to be charged at 25% per annum, on the written down value method. The contractee pays 75% of the value of work certified as and when certified, and makes the final payment on completion of the contract. You are required to PREPARE a contract account for three years and total estimated profit/ loss from the contract.

Ans Profit Yr20X6: (-)65000; Profit Yr 20X7:-1038750; Profit Yr 20X8 Rs.-(-)366188

Q.4 A contractor has entered into a long term contract at an agreed price of ` 17,50,000 subject to an escalation clause for materials and wages as spelt out in the contract and corresponding actual are as follows:

	Standard		Actual
Materials	Qty (tons)	Rate (Rs.)	Qty (tons)	Rate (Rs.)
A	5,000	50.00	5,050	48.00
B	3,500	80.00	3,450	79.00
C	2,500	60.00	2,600	66.00
Wages	Hours	Hourly Rate (Rs)	Hours	Hourly Rate (Rs)
X	2,000	70.00	2,100	72.00
Y	2,500	75.00	2,450	75.00
Z	3,000	65.00	3,100	66.00

Reckoning the full actual consumption of material and wages, the company has claimed a final price of Rs.17,73,600. Give your ANALYSIS of admissible escalation claim and indicate the final price payable.

Hint: An escalation clause covers inflation and not inefficiencies of contractor.

III Process Costing

Process costing is applied where

(i)                  Production is carried through more than one stages or processes

(ii)                These processes run either continuously or sequentially or simultaneously or even selectively.

(iii)               Output of one process becomes the input of another till the last process.

(iv)                End products are homogenous i.e. not distinguishable from one another

(v)                Output product can not be generally linked to specific input raw material

(vi)               There is a possibility of emergence of by-products and joint products.

(vii)             Examples include refining of crude oil, sugar production, production of all metals i.e. iron and steel, aluminium, copper, textile etc

In case of crude oil refining broad process is :

(i)                   Input : Crude Oil

(ii)                Desalting: Removal of corrosive salts and suspended solids

(iii)               Fractional Distillation of Crude oil resulting in separation of major fractions

(iv)               Downstream processing bringing change in molecular structure by adding other chemicals or altering existing molecular structure

(v)                Purification: removing nitrogen, Sulphur or other metal contents

Here all processes from desalting to purification can be treated as separate processes i.e. cost centres for which material, labour and expenses are accumulated to ascertain the costs of each individual process separately as well as cumulatively to arrive at the total cost of the final output.

Similarly processes involved in textile manufacturing can be

(i)                  Yarning / threading

(ii)                Dyeing

(iii)               Spinning

(iv)               Weaving

In case of sugar industry, process flow broadly may be:

(i)                  Crushing of cane

(ii)                Cleaning and purification

(iii)              Crystallization

(iv)               Centrifuge process to separate grains and molasses

(v)                Purification and conditioning of crystals

Joint and By-products

Joint Product:

When two or more products are either simultaneously or sequentially produced during a manufacturing process, they are known as Joint products emerging out of that process.

Normally joint products:

(I) have significant sale value, and

(ii) emerge in considerable proportion during the manufacturing process

As a consequence, no joint product can be said as the major product or minor product.

Example: In the crude oil refinery industry, LPG, Aviation fuel, Kerosene, Petroleum, Diesel, Paraffin, Asphalt, lubricant oil, Coal-tar etc. are produced. These all can be referred to as Joint products.

By-Products:

When during a manufacturing process, a product of small value as a waste or on account of inherent nature of the production arises, such product is known as by product of main product for which the manufacturing process was carried out.

Thus, by-product emerges without any specific effort. It is of small quantity and value as compared to the main product.

Example: Bagasse and Molasses while manufacturing cane sugar (white sugar), Bagasse is used in the paper industry while molasses is used by distilleries in manufacture of liquor 

Co-products: They are interchangeably used with joint products. However, they are produced from a different raw material and mostly through a separate process

The cost issue with Joint and By-product:

Costs in the case of by-products and joint products are:

(I) common or joint costs I.e. before the emergence of by-product and joint-product

(ii) Separate costs or additional costs incurred on by=products or joint products after separation whick is also known as the split-off point

Costs incurred exclusively on by-products or joint products after split off point are easily allocated to the by-products or joint products to which costs are attributable.

Common costs pose problem of apportionment of costs between main product and by-product or between joint products

Methods for apportioning joint costs:

(I) Net realizable value at split off point

(ii) Physical units method

(iii) Using technical estimates

(iv) Market value at the point of separation

(v) Market value after further processing

Losses during Processes:

Loss represent shortfall in output as compared to input I.e. when output is less than input, we assess the difference as loss.

Losses can be normal or abnormal.

Normal loss is inherent, natural, unavoidable and accepted and arises due to the nature of raw material, production process, technology used, machinery used etc. This is common experience that certain materials like aromatic liquids I.e. petroleum, spirit etc loose quantity due to evaporation, another example is that of cutting circles out of square steel sheet invariably results in the loss of some steel as scrap. Similar is the case with manufacturing garments out of textiles, some cloth is rendered useless while cutting the desired shape and size out of cloth. Similarly, when spices are grinded for getting powder form, there is bound to be some loss of output.

Abnormal loss can be both avoidable (for eg. Use of faulty tools and machines, inappropriate drawings and dies, inferior raw material etc.) and unavoidable I.e. on account of untimely rain, flood, earthquake, fire etc.

Treatment of Normal loss in cost accounting: Normal loss is charged to production as any other cost, this is done by making the reduced output bear the entire cost including the cost of normal loss. Any realisable value from sale of scrap is credited to production account I.e. normal loss is reduced by that extent.

Treatment of Abnormal loss: Abnormal loss is charged to costing profit and loss account, instead of production account as abnormal loss is not regarded as a routine event or feature I.e. it is thought of as avoidable or non-recurring. Any recovery from insurance company or sale of scrap etc is credited to costing profit and loss account or the abnormal loss is reduced by that extent.

Operation or Hybrid Costing: Some time Manufactuing entities manufacture two or more grades of same product say for example economy, regular and deluxe shaving creams. This entail use of different ingredients in different quantity, however the process of manufacturing I.e. conversion costs covering labour costs and overheads remain same for all the grades. To manage costing in this scenario, batch costing method may be used for collecting material costs while process costing may be used for remaining coste I.e. labour and overheads. This also gives rise to another term known as hybrid costing

IV Service Costing or Operating Costing

The service costing is required either for in-house services provided by a service cost centre to other responsibility centres as support services. Examples of support services are Canteen and hospital for staff, Boiler house for supplying steam to production departments, IT department services used by other departments, or when services are offered to outside customers as a profit centre in consonance with organisational objectives as an output like goods or passenger transport service provided by a transporter, hospitality services provided by a hotel, provision of services by financial institutions, insurance and IT companies etc.

In both the situation, all costs incurred are collected, accumulated for a certain period or volume, recorded in the cost accounting system and then expressed in terms of a cost unit of service.

Service costing differs from product costing (such as job or process costing) in the following ways due to some basic and peculiar nature.

(i) Unlike products, services are intangible and cannot be stored, hence, there is no inventory for the services.

(ii) Use of Composite cost units for cost measurement and to express the volume of outputs.

(iii) Unlike a product manufacturing, employee (labour) cost constitutes a major cost element than material cost. 

(iv) Indirect costs like administration overheads are generally have a significant proportion in total cost of a service as unlike manufacturing sector, service sector heavily depends on support services.