Product Costing Methods
The Basic methods of product costing are:
Job Costing: allocates costs to products that are readily identified by individual units or batches, each of which is independently identifiable. When using the job cost system, costs are accumulated for each individual unit produced, or each separate order of products. This method is especially useful when producing something that is unique or custom-made. Job order costing would be used bya caterer, a garage, a helicopter manufacturer, a construction company and a textbook publisher,
Contract Costing: a subset of job costing which is applied to relatively large cost units which take a long time to complete, typically over a year (e.g. civil engineering projects, ship building, building and construction etc). A separate account is maintained for each contract. Contract accounts involve:
• determination of cost of sales
• annual comparison of value of work certified as a proportion of the contract value and the costs to date as a proportion of total costs as a means of assessing the profit that should be recognised
• record of payments received on account
• records future expenses and accrued expenses
Guidelines for Determining Profit to Date on Contracts No Profit is taken if contract is at an early stage. Reliability (prudence) concept is applied and losses are recorded as incurred or anticipatedIf the contract is near completion a proportion of the profit should be recognised having regard to work certified and costs to date
Process costing: is applied when goods or services are produced from a series of repetitive or continuous processes or operations and the costs of processing are charged to the process as a whole before being averaged out over the units produced during the period. Process costing is used in a variety of businesses including distilling, water distribution, textiles, paint mixing and glass manufacture.
Job Order Costing System
The basic records maintained in a job-costing system include: Job-cost sheet (also called job-cost record or simply job order): records all costs for a particular product, service or batch of products are recorded on the job-cost sheet from:
Materials requisitions: detail materials and components drawn from stores for particular jobs are priced and summarised, and entered as direct material costs on the job-cost record. Labour time records: show the time a particular direct worker spends on each job and are summarised to give direct labour cost on ‘the job-cost sheet. The manufacturing overhead will often be based on these labour hours or otherwise separately calculated and entered on the job cost sheet separately
Actual rate vs. predetermined rate (normal) costing system
Job-costing systems uses actual costs of direct labour and materials to determine the cost of individual jobs. However, a problem arrives with overhead costs, which are dependent on what is happening to the other jobs that are in process at the same time and can only be known after the event. Actual rate costing is a method of job costing that traces indirect costs to a cost object by using the actual indirectcost rate(s) times the actual unit of absorption base (direct labour, machine hours etc.), Predetermined rate (normal) costing systems use estimated amounts (at a normal level of activity) for the manufacturing overhead costs that are applied to each job and estimated amounts for the absorption base to calculate a predetermined overhead rate. This rate is based on the total estimated overhead costs for the period and the estimated usage of the absorption base (e.g. machine/labour hours).
General Approach to Job Order Costing
The following seven-steps approach is used to assign actual costs to individual jobs
l Identify the chosen cost object(s)
2.Identify the direct costs of the job
3.Select the cost-absorption base(s}
4.Identify the indirect costs associated with each cost-absorption base
5.Compute the rate per unit of each cost absorption base to allocate indirect costs to jobs 6.Compute the indirect costs allocated to the job
7.Compute the cost of the job by adding all direct costs assigned to it
Process Costing
Process costing (a.k.a. continuous operation costing) is a method that is applied when goods or services are produced from a series of repetitive or continuous processes or operations and the costs of processing are charged to the process as a whole before being averaged out over the units produced during the period. ‘A process costing system involves the costs of producing similar items being accumulated and allocated to the products by averaging costs over large number of nearly identical products. The average cost per unit is calculated by dividing the total production cost by the number of units produced. Process costing would be used by businesses such as food processors, household product manufacturers, chemical processors and oil refiners..
General approach to process costing
I. collect cost data for the period on production cost report;
2. prepare statement of physical flows and equivalent units of output for the period; 3. ascertain the total costs to be accounted for this period;
4. calculate the cost per equivalent unit;
5. apportion cost between finished output and work-inprogress; and
6. check that all costs accounted for
Similarities between process costing and absorption costing
Both track the same manufacturing cost elements: DMs, DL,
DEs and Mfg OhdsBoth involve WIP, FG and COGS
Differences between process costing and job costing
• No. of WIP accounts: PCS have many WIP accounts whereas
JCS have one WIP account
• Documentation to track costs
JCS = job cost sheet
• PCS = production cost report for each process
• Point at which costs are totaled
JCS - mfg costs totalled on completion
• PCS - mfg costs totalled at fixed time intervals
• Unit cost computation
JCS - total job costs/no of units produced
• PCS - total period costs/units produced in the period
WIP and EQU/V ALENT UNITS
Processes rarely deal with solely with completed units and therefore we need ‘to deal with output in terms of completed units and those still in the process at various stages of completion in the process. The notion of Equivalent Units enables work in process to be expressed in terms of completed output.
Equivalent units may be defined as: A notional quantity of completed units substituted for an actual quantity of incomplete physical units, when the aggregate work content of the incomplete units is deemed to be equivalent to that of the substituted quantity of
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