TEXTILE ECONOMICS; Product Costing Methods, Job Order Costing System and Process Costing

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

TEXTILE ECONOMICS; Cost Terminology, Classification and Basic concepts

Cost and Cost Terminology: 

Cost is a resource sacrificed or forgone to achieve a specific objective. It is usually measured as the monetary amount that must be paid to acquire goods and services. A cost must not be confused with an expense, that is that part of costs of the goods or services that has been used up in the process of generating revenues. Actual Cost is the cost incurred (a historical cost) as distinguished nom budgeted costs. 

Cost Object is any activity, product, service or other item for which we can make a separate cost measurement. Examples would include a product, sales area, TV advertising campaign, employee, delivery van etc. 

Costs Classification 

Costs may be analysed into: Manufacturing costs (factory/ production) - Direct: labour, materials and variable overhead Indirect: manufacturing support Non-manufacturing costs - Selling and Marketing, Distribution, Research and Development Finance, General & Administrative 

Handout: Cost classification 

There are two basic stages of accounting for costs: 

1) Cost Accumulation: the collection of cost data in some organised way based on some natural classification such as materials or labour, using an accounting system. 

2) Cost Assignment: involves 

(a) tracing accumulated costs to one or more cost objects; and 

(b) allocating/apportioning accumulated costs to one or more cost objects such as activities, departments, products, customers etc. 

Handout: Basic cost concepts: 

Cost Assignment Methods

Traceability is the ability to assign a cost directly to a cost object in an economically feasible way using a causal relationship. Tracing is the assignment of costs to cost objects using either an observable measure of the cost object s resource consumption or factors that allegedly capture the causal relationship. “ Drivers are factors that cause changes in resource usage, activity usage, costs and revenues. Resource drivers measure the demands placed on resources by activities and are used to assign the cost of resources to activities by allocation and apportionment. 

For example, factory rates apportioned by floor space or supervisor time allocated to different production departments. 

Resource drivers also allocate/apportion service activities to production activities. Activity drivers measure the demands placed on activities by cost objects and are used to assign the cost of activities to cost objects. For example, the number of inspection hours used to assign the cost of inspection to individual products, or machine hours as a basis for absorbing departmental indirect costs. 

Direct tracing is the process of assigning costs to cost objects based on physically observable causal relationships (direct materials and labour). 

Driver tracing is assigning costs using drivers, which are causal factors. Often this means that costs are first traced to activities using resource drivers and then to cost objects using activity drivers. The driver approach relies on identification of factors that allegedly capture the causal relationship. 

Handout: Functional cost classification 

All costs can broadly be classified into manufacturing and non-manufacturing costs. Manufacturing costs include all costs of converting raw materials into completed products and non-manufacturing costs are all costs other than manufacturing costs. Manufacturing costs can further be divided into direct costs and indirect costs. 

• direct costs of a cost object are those that are related to a given cost object (product, department. etc.) and that calibe traced to it in an economically feasible way. Direct costs can be divided into direct materials and direct labour (and possibly direct expenses). 

• indirect costs are related to the particular cost object but cannot be traced to it in an economicallyfeasible way instead the costs are allocated to cost objects. 

Identifying product costs for a manufacturing firm 

There are typically two major cost elements: 

• Direct costs 

• Indirect overhead Cost 

The direct costs include direct materials, labour and expenses. 

The overhead costs include indirect material, labour and expenses split between: 

• Establishment costs (expenses incurred in providing the product or service environment [factory overheads] 

• Selling and Distribution costs (all costs of marketing and distributing the product); Administration costs (all costs of directors, managers and administrators and their associated expenses in terms of office overheads) 

• Finance costs (all costs of borrowed capital including interest and expenses incurred in raising funds) For product costs we are concerned with direct costs and establishment costs. 

Direct vs. indirect materials 

The cost of those materials and components that can be directly and conveniently traced to a unit of product are called direct materials (e.g. steel, windscreen-wipers or gearbox In a car). _Materials not directly traceable, and those extremely small in monetary value, are typically called indirect materials (e.g. dishwasher detergent in a fast-food restaurant, oil for production equipment, rags for cleaning or screws in a furniture factory) 

Direct VS. indirect labour 

The costs of production labour that can be directly and conveniently traced to a unit of product are called direct labour (e.g. workers on an assembly line, or chef in a restaurant) is direct labour, while labour costs that are not directly traceable, or those extremely small in monetary value, are typically called indirect labour (e.g. storekeepers, foremen, or secretaries) 

Production/factory/manufacturing overheads 

All costs related to the manufacturing operations, except for direct materials and direct labour, are called production/factory/ manufacturing overhead. Examples of such costs include, factory rent, factory rates, factory heating and lighting, depreciation of plant and equipment, insurance of the factory, and store costs.