Accounting & Financial Management for Bankers Mohammed Nadeem

Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Meaning of Job Costing

Job costing is a costing method used to Job Costing is used in
determine the cost of specific jobs, which are 1. Printing Press,
performed according to the customer’s specifications. 2. Motor Car repair shop
It is a basic costing method which is applicable where 3. Interior Decoration
work consists of separate projects or contract jobs. 4. Dry Cleaning
Total cost / number of unit produced 5. Painters
50,000/2000= 25

Sales = cost + profit

= 25 + 5

= 30
Profit = sales – cost

= 30 – 25

=5

Cost = sales – profit

= 30 – 5

= 25

Special features of Job Costing

1. Production is against customers’ orders and not for the stocks
2. Each job has its own characteristics and required special attention
3. The flow of production from one department to another is not uniform.

Advantages of Job Costing

1. Profitability for each job can be individually determined
2. Provides a detailed cost analysis of materials, labour and overheads for each job
as and when required.
3. The efficiency of the plant can be controlled by confining attention to costs relating
to individual jobs.
4. Helps in preparation of estimates
5. Comparison of actual cost with estimated cost and calculation of variances.
6. Helps in identifying unprofitable jobs
7. Helps in providing a precise quotation for a product

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Job Cost Cards/Sheets

Job cost Cards/Sheets are not prepared for specific periods but they are made

out for each job regardless of the time taken for its completion. However, material,

labour and overhead costs are posted periodically to the relevant cost sheet. The

material, labour and overhead to be absorbed into jobs are collected and recorded in

the following way.

Direct Material: -

A significant requirement of job order cost accounting is that direct materials

and their cost must be identified and recorded with specific jobs or work orders. It

involves direct material costs (materials that comprise the finished product) and

indirect material costs (materials required to complete the job but not part of the final

product). A direct cost usually includes raw materials, while an indirect cost might

include tools or machinery used to make a product or office supplies. You can

calculate material cost by adding all direct and indirect costs together.

Labor Costs

All direct labour costs must be analysed according to individual jobs or work

orders. A timesheet, job card, time ticket, or piece-work card is used to track time-

based on the operation schedule. Wages paid to direct and indirect labour are

classified in the costing department and categorized into production orders and

standing orders. Labor summaries or wages analysis sheets are prepared for each

accounting period, say a week. Amounts for idle time, overtime, shift-differential and

fringe benefits can also be included in the wages analysis sheet.

Labor costs = (Number of working days’ x daily pay rate x number of workers)

Direct Expenses

These can be identified with specific jobs and are direct charged to these job.

Overheads

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

A standing order number and a cost center are used to accumulate overhead

costs. As the case may be, each center’s overhead rates are determined or actual. The

value of overhead cost recoverable on each job order is summarised in an Overhead

Absorption or Applied Overhead analysis sheet and is posted on the relevant cost

sheets. Generally, we add overheads only when the job is over but at the end of the

accounting period.

Introduction to Batch Costing

Batch costing is a varied form of job costing. While job costing is concerned
with ascertaining the cost of executing jobs, according to customer specifications,
batch costing focuses on a group of identical products manufactured for the firm's
own stock.
Batch costing is generally applied to manufacture medicines, component parts
of complex products (e.g., cars, scooters, computers, watches, and televisions),
biscuits, food products, and ready-made garments. The products manufactured in a
batch are used for a particular purpose (e.g., spare parts for composite products are to
be used in a specific model only) or they are consumed within a specified period (e.g.,
medicines and food products).

Meaning of Batch Costing

Batch costing is nothing but a modified form Batch Costing is used in
of job costing in which the cost of each batch of 1. Garment Factories
production is calculated. This method of costing is 2. Watch Factories
suitable for manufacturing units in which items are 3. Toy Manufacture
manufactured in definite batches. The batch costing 4. Tyres & Tubes
method is also known as lot costing because products 5. Shoe Manufacture
are produced in lots of, for example, 500, 1,000, or any 6. Pharmaceutical
other number. industry

Batch Costing Procedure

The costing procedure for batch costing is similar to that of job costing. The only
difference is that a batch becomes the cost unit rather than a job. For the purpose of
costing, each batch (or group of identical products) is allotted a serial number (known
as a batch number), just like a job number.
1. The presentation of the various items of cost is made in the form of a statement
known as a batch cost sheet.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

2. The batch cost sheet includes the cost of any direct materials, direct labour, and
direct expenses that can be directly identified with a particular batch.
3. The share of overheads chargeable to the batch (calculated on some equitable
basis) is also included.
4. The total cost of a batch, as shown in the batch cost sheet, divided by the total
number of products in the batch yields the cost per product in the batch.
Cost per product in the batch = Total cost of a batch / Total number of
products in the batch
Meaning of Contract Costing
Contract Costing is a contract made between two parties known as a contractor
(i.e., the person executing the job) and contractee (i.e., the person for whom the job is
done), wherein specific job orders are undertaken for a relatively larger time frame,
which may take years to complete, and the billing for the same is done after
completion of each milestone in the contract.

Features of Contract Costing

1. Due to a larger time frame (taking more than one year for completion) involved
in each contract, the contractor undertakes a smaller quantum of contracts during
the year.
2. The execution of work is required at the work site.
3. Each customer has a separate account maintained to track work done, progress
billings & amounts received to date.
4. Direct expenses include the cost of material, labour, electricity, telephone
charges, insurance expenses, consumables, depreciation, or hire charges of
machinery used for the contract.
5. The certificate decides the progress billings from experts, wherein work
completion is specified. The proportionate billing is done accordingly.
6. It also has a special aspect of retention money given by customers to contractors
after examining the quality of the overall contract.
7. There is also a penalty clause in a few contracts, which is to be paid by the
contractor to the customer if he cannot complete the contract within the time
frame.
8. Each contract is executed as per the customer’s customization or specifications,
and hence, each contract is different.
9. It’s not the cost of material & labour involved in the relevant contract, but the work
completed to date is relevant.

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 Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

10. Substantial risk is involved in the contracts.

The difference between Job Costing VS Contract Costing is as follows:

Basis of
Job Costing Contract Costing
difference

Contract costing is a costing system

Job costing is a system used for
where work is undertaken according
completion of specific customer
Meaning to special requirements of customers
orders where each unit produced
in a location specified by the
is considered a job.
customer.

Job costing generally calculate

Area of Contract costing is used to calculate
the cost for a single or a few
work the cost for significant scale projects.
products.

A job usually spans over a small The work of a contract progresses for
Time period of time, thus job costing a long period time, thus contract
period can be completed within a short costing is conducted within an
period of time. extended time period.

The product is completed within Production or construction takes place

Place of
the premises of the company in a in construction site selected by the
work
job. customer.

When a job is done and finished In contract costing, costs and revenues
goods are sold to the customer, are recorded in proportion to the
Transfer of
the entire profit will be degree of completion and the
profit
transferred to profit and loss resulting profit is transferred to profit
account. and loss account.

Size of job Generally jobs are smaller in size. Jobs are big and complex.

Cost/
Less expenditure required. It requires huge expenditure.
expenditure

Payments are made immediately

Payments Payments are made in instalment.
after the completion of work.

Transfer of Job cannot be transferred to other Some part of contract can be given to
job parties. other parties or other sub-contractors.

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 Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Job costing is suitable for the

Contract costing is suitable for
Suitability manufacture of products under
construction works.
the customer’s specifications.

Value of
The value of work is less. The value of work is more.
work

In contract costing, we open contract

account for every contract. In this
In job costing, we make job
account, we show all expenses relating
account for every job. In this
to contract and it also show work in
Account account, we show different
progress in the form of work certified
expenses which are paid for
and work uncertified. Difference of
completing that job.
credit and debit side of this account
will show notional profit or loss.

How the Profit of Incomplete Contract is Determined?

The treatment of profit on incomplete contracts is given below:
1. Profit should be considered in respect of work certified only; work uncertified
should always be valued at cost.
2. If the work started recently and one-fourth or less is done, no profit should be
transferred to the profit and loss account.
3. If the contract has advanced and if the architect of the contractee certifies that the
work completed more than 25%, in that case, one-third of notional profit should
be recognized as profit.
PROFIT = 1/3 *cash received/work certified.
NOTIONAL PROFIT = Value of work certified-(cost of work to date-uncertified
amount)
4. If the contract is made more than 50%, but less than 90% in that situation, two-
third of notional profit should be recognized as profit.
Profit = Notional profit *2/3*cash received /work certified.
5. If the contract is made 90% or more in that situation, the total profit may be
recognized.

Meaning of Escalator Clause

An escalator clause is also known as an escalation clause, where the provision
allows for an automatic increase in the wages or prices. The increase in the wages and
prices are included in contracts such that they must be activated when certain
conditions occur, such as when the cost of living or inflation increases.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

A contract agreement usually makes a provision for the escalation clause: the
contractor is interested in being safeguarded against any charge in the price level.
The agreement specifies the procedure for the calculation of adjustment in order to
avoid all disputes.
Meaning of Retention Money
A contractor does not receive the full payment of the work certified by
the surveyor. Contractee retains some amount to be paid after some time, when it is
ensured that there is not default in the work done by the contractor. If any deficiency
or defect is noticed, it is to be rectified by the contractor before the release of
the retention money. Thus, the retention money provides a safeguard against the
default risk in the contracts.

Specific Aspects of Contract Costing

Materials
For materials, three specific forms of accounting may need to be performed. In
case materials are purchased for the contract and directly delivered to the site of the
contract, there arises no specific accounting system.
However, if the materials purchased are first delivered to the store’s
department, the contract account will be debited and the store control account will be
credited.
If, however, certain materials are charged to the contract account but returned
to stores, the store's contract account will be debited and the contract account credited.
Materials sold at the contract site are credited to the contract account. However,
if a sale is made, the resulting profit or loss is credited to the profit and loss account.
In case of a sale of contract assets and property for profit or loss, the profit and
loss account is credited.
In some cases, the contractor may supply the materials to the contractee. Here,
the value of such materials should not be charged to the contract account. The unused
materials are to be returned to the contractor.

Labour
All labour used to complete the contract is direct labour and treated as such.
The wages abstract is prepared to maintain a proper record and retain control over
the labour.

Plant and Machinery

If a plant, machinery, or equipment is specially purchased for a particular
contract and will be exhausted at the site, it will naturally be debited in the contract

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

account and any amount of depreciation shall be charged to the credit side of the
contract account.
However, if it is acquired for a shorter period, the amount is only debited with
the usual depreciation of the assets.

Any sale proceeds at the midway point of a contract or upon completion are
credited to the contract account, and profit or loss on such a sale is transferred to the
profit and loss account.

Indirect Expenses
Indirect expenses are treated and apportioned in the same manner as
any costing system.

If on three contracts, Nos. 1, 2, and 3, Rs. 3,000, Rs. 2,000, and Rs. 1,000 are spent,
respectively, on materials, labour, and plant, and if indirect expenses are Rs. 1,200, the
share in indirect expenses of contract Nos. 1, 2, and 3 will be Rs. 600, Rs. 400, and Rs.
200 at the ratio of 3: 2: 1, respectively.

Cost-Plus Contract
The cost-plus contract involves the contractee agreeing to pay the contractor
the cost price of the work carried out on the contract plus an agreed amount or
percentage thereof by way of different overheads and profit.
Extras
An agreement may be in place to charge extra money for any addition(s) or
alteration(s) to work originally agreed to be carried out under a particular contract.
In such a case, the extra money becomes payable to the contractor by the contractee
for all subsequent additions and alterations.

Sub-Contracts
The contractor (if allowed to do so by the agreement entered into) may entrust
a portion of the work to one or more than one sub-contractor(s).
The cost in this connection is the direct charge on the contract and is treated as
such in the contract costing.

Payment
In the case of small contracts, the usual practice is to make the payment to the
contractor in a lump sum upon completion.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

However, in a large contract, the payment is made in instalments on the basis of

progress made. Progress is judged by technical personnel, such as architects,
surveyors, and engineers.
Such personnel issue a certificate for the complete work, otherwise known as work
certified, which may be expressed in terms of percentage. Here, the contractor may
not pay for 100% work certification and may withhold or retain payment. This is
called retention money. The work for which certification is not granted is known as
work uncertified.

The following are the ways the value of work certified is treated in cost accounts:
1. The amount of work certified is debited to the contractee’s personal account, and
the contract account is credited.
2. The cash or bank account is debited, and the contractee’s personal account is
credited. Alternatively, there is a receipt of the money for certified work.
3. The balance of the contractee’s personal account is shown as an asset on
the balance sheet.

Objectives of Contract Costing

The main objectives of contract costing are:
1. To ascertain the total cost of a contract
2. To ascertain the profit or loss on the contract

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Process Costing
Process costing refers to a cost accounting method that is used for assigning
production costs to mass-produced goods. Or Process costing is used when there is
mass production of similar products.
Application of Process Costing
1. Process costing is applied to determine the cost of production in industries where
products pass through different phases of production before completion.
2. Under process costing, there is a finished product at each stage. This becomes the
raw material of the subsequent stage until the final stage of completion.

Characteristics of Process Costing

The main characteristics of process costing are:
1. Continuous production.
2. The end product is the result of a sequence of processes.
3. Homogeneous products with identical and standardized features ensure quality.
4. The processing sequence is specific and predetermined.
5. The finished products outputted from one process are used as the raw materials
for the next process, which happens until completion.
6. Costs are calculated process-wise.

Features of Process Costing

The main features of process costing include:
1. Production is divided into various stages (known as processes) and each process
is carried out by separate cost centres or departments.
2. Production is continuous and the final product or end product is the result of a
sequence of processes or operations.
3. The finished product of each process is treated as the raw material for the
subsequent process.
4. The units of the commodity produced are homogeneous and identical in nature.
5. The cost of production per unit is the average cost, which is obtained by dividing
the total process cost by the total number of units manufactured.
6. The sequence of processes and operations employed is pre-determined.
7. There is an indispensable loss in the production process ("normal loss"). This may
be due to the qualities of the material used for production (e.g., losses from
evaporation). The normal loss is absorbed by the cost of good units.
8. The processing of raw material may lead to joint products and by-products.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

9. Abnormal losses and gains may occur. These are treated separately under process
costing.
10. Inter-process profits are also kept in mind when transferring the output at market
price to another process. This indicates the market price and can be helpful to
identify inefficiencies and losses in a process.
11. The concept of equivalent production is also considered under process costing.
Under this concept, when some units are in the semi-finished stage, they should
be expressed in terms of equivalent completed units or effective units.
12. Profit and loss are calculated after considering the opening and closing balances
of finished stock. Process accounts are helpful for the valuation of raw materials,
work-in-progress, and finished goods. Stocks are shown in the balance sheet.

Process Costing: Explanation

Process costing refers to a type of costing procedure commonly adopted by
factories. In process costing, there is continuous or mass production and ongoing
costs, which are accumulated regularly.
The following five conditions are favourable for the use of process costing:
1. Production of a single output in a plant.
2. Division of a plant into different processes and departments. Each process is
responsible for the manufacture of a single product.
3. Processing a single product for a scheduled time, followed by successive runs of
other products. Here, costs are calculated separately for each run.
4. Production of several products that are produced simultaneously from the same
process.
5. Division of a factory into separate operations, each performing standard
protocols and procedures.
6. Costs are calculated process-wise.

Meaning of By-Products:
CIMA define By-product as “output of some value produced incidentally
in manufacturing something else (main product)”.
By-products may be defined as “any saleable or usable value incidentally
produced in addition to the product.”
Meaning of Normal Loss
The normal loss is the unavoidable loss of units in a processing department that
occurs majorly due to the nature of production operation or the nature of raw
materials being processed. This loss cannot be avoided under normal and efficient
production environment and is considered within the normal or acceptable tolerance
limit for machines and human errors.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Meaning of Abnormal Gain

If the real production units are more than the expected units after deducting
the ordinary or normal loss, the contrast between the two is known as abnormal gain.
It is avoided from the total cost because of which it doesn’t influence the expense or
cost per unit of the item.

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Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

Service Costing
The term service costing or operating costing refers to the computation of the
total operational cost incurred on each unit of the intangible product or services.
Example: - transport, electricity.

Applicability of service costing method

Service costing methods are suitable in manifold areas such as;
1. Transport service industries.
2. Hotel or food industries
3. Power supply (electricity) industry

Characteristics of service costing method

The main features of service costing are as following:
1. All completed products are intangible. In service costing methods, the targeted unit
cost is not visible.
2. Cost/expenses are divided in to fixed and variable costs. This is because it is
necessary so as to ascertain the cost of service and the unit cost of service.
3. The cost unit are expressed in a simplified manner for the sake of cost accumulation.
4. Aggregate or total cost is always divided (average) by the overall service provided.
5. Total cost is determined on the time or period basis although not always. In other
cases, we have alternative ways such as orders made by clients.
6. Service costing is suitable for both internal or external service provisions.
7. Data sheets are commonly used to record cost data to aid in determination of the
cost value of a service provided or rendered.

Objectives of Service Costing Method

The specific objectives of service costing method which is the universe of output/unit
costing, are as follows;
1. To determine the total cost a consumer of a certain service will pay or incur or will
pay the service provider.
2. To determine whether a certain service being provided to the client or service user
is profitable or not.
3. To classify the cost elements that are consumed in providing a specific service.
4. To control costs associated with the services being provided by an
organization. This involves use of comparison of cost elements for different
periods.

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 Accounting & Financial Management for Bankers Mohammed Nadeem
Module - D Costing Methods M. Com; MBA; KSET; (Ph. D)

BASIS FOR
MARGINAL COSTING ABSORPTION COSTING
COMPARISON
A decision making technique Apportionment of total costs to the
for ascertaining the total cost cost center in order to determine
Meaning
of production is known as the total cost of production is
Marginal Costing. known as Absorption Costing.
The variable cost is
considered as product cost Both fixed and variable cost is
Cost Recognition
while fixed cost is considered considered as product cost.
as period costs.
Classification of Production, Administration and
Fixed and Variable
Overheads Selling & Distribution
Profitability is measured by Due to the inclusion of fixed cost,
Profitability
Profit Volume Ratio. profitability gets affected.
Variances in the opening and
Variances in the opening and closing stock affects the cost per
closing stock does not unit.
Cost per unit
influence the cost per unit of Material
output. Labour
Overhead
Highlights Contribution per unit Net Profit per unit
Presented to outline total
Cost data Presented in conventional way.
contribution of each product.

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