Crack Grade B 15

METHODS OF COSTING The fundamental principles of cost ascertainment remain the same but
the methods of analysing and presenting theses costs differ from industry to industry. However,
the different methods of costing can be further bifurcated and can be explained in detail as follows:

Job Costing: This method of costing is used in Job Order Industries where the production is as
per the requirements of the customer.

In Job Order industries, the production is not on continuous basis, rather it is only when order
from customers is received and that too as per the specifications of the customers. Consequently,
each job can be different from the other one. Method used in such type of business organizations
is the Job Costing or Job Order Costing.

This method is used for tracing specific costs to individual jobs especially where production is not
highly repetitive. The cost ascertainment is for specific jobs or orders which are not comparable
with each other.

Job Costing is a type of specific order costing which shows where industries which
manufacture products or render services against specific orders such as:
 civil contracts
 construction works
 automobile repair shop
 printing press
 machine tool manufacturing
 ship building
 furniture making
 Accounting Firms

Principles of Job Costing The job costing method may be regarded as the principal
method of costing since the basic object and purpose of all costing is to
• Analysis and ascertainment of cost of each unit of production
• Control and regulate cost
• Determine the profitability

The basic principles enunciated for the job costing method are valid essentially for all
types of industry.

Process of Job costing

• Prepare a separate cost sheet for each job
• Disclose cost of materials issued for the job
• Employee costs incurred (on the basis of bill of material and time cards respectively)
• When job is completed, overhead charges are added for ascertaining total expenditure.

Suitability of Job Costing

• When jobs are executed for different customers according to their specifications.
• When no two orders are alike and each order/job needs special treatment.
• Where the work-in-progress differs from period to period on the basis of the number of jobs in
hand.

JOB COST CARD/SHEET: Each job order is asymmetrical to other due to specific and
customized requirements. To ascertain cost of a particular job, it is necessary to record all
the expenditure related with a job separately. For this purpose, Job Cost card is used. Job
cost card is a cost sheet, where the quantity of materials issued, hours spent by different
class of employees, amount of other expenses and share of overheads are recorded. This
is helpful in knowing the total cost, profitability etc. of a job.

www.crackgradeb.com | [email protected] | 9971687048

 Crack Grade B 16
COLLECTION OF COSTS FOR A JOB:
 Collection of Materials Cost
 Collection of Labour Cost
 Collection of Overheads
 Cost for Treatment of spoiled and defective work

Job costing offers the following specific advantages:

(i) It helps management to detect which jobs are profitable and which are not. Estimates of cost
for similar work in the future may be conveniently made on the basis of accurate record of job
costs. This assists in the prompt furnishing of price quotations for specific jobs;

(ii) The cost of materials, labour and overhead for every job or product in a department is available
regularly and periodically, enabling the management to know the trend of cost and thus by suitable
comparison, to control the efficiency of operations, materials and machines;

(iii) The adoption of predetermined overhead rates in job costing necessitates the application of
a system of budgetary control of overheads with all the advantages.

(iv) Spoilage and defective work can be easily identified with specific jobs or products so that
responsibility may be fixed on departments or individuals.

(v) Job costing is particularly suitable for cost plus and such other contracts where selling price
is determined directly on the basis of costs.

CONTRACT/Agreement COSTING or terminal costing: Contract Costing is a method used in

construction industry to find out the cost and profit of a particular construction assignment. The
principles of job costing are also applicable in contract costing. In fact Contract Costing can be
termed as an extension of Job Costing as each contract is nothing but a job completed. In contract
costing each contract is treated as a cost unit and costs are ascertained separately for each
contract.

Examples:
 Builders
 public works contractors
 constructional and mechanical engineering firms
 ship builders

Sub-contract: Under the subcontract category, the contractor may hand over certain types of
specialized work such as:
 Electrical
 Plumbing
 Painting
 Carpentry
 Masonry
 Flooring

Contract Costing is a type of costing used in constructional activities such as construction

of buildings, roads, bridges etc. The person who takes contract for a price is called the
Contractor and the person from whom it is taken is called the Contractee. We are mainly
concerned with the books of the contractor. To find out profit earned or loss incurred on
the contract, the contractor prepares a nominal account in his books called ‘Contract
Account’. In this account, all the expenses incurred by the contractor are debited and the
income i.e mainly work certified is credited; the difference represents profit or loss.
www.crackgradeb.com | [email protected] | 9971687048
 Crack Grade B 17

The profit earned on a Contract Account is primarily called Notional Profit and a
portion of which would be kept on reserve against contingencies.

Features of contract costing:

 In contract costing, most of the expenses are of direct nature, overhead forms only a small
percentage of total expenditure and it represents expenses like share of head office
expenses, share of central storage cost etc.

 Under contract costing, pricing is influenced by specific clauses of the contract.

 Under contract costing, the work is usually carried out at a site other than contractee’s own
premises

RECORDING OF CONTRACT COSTS:

 Material Cost
 Employee (Labour) Cost
 Direct Expenses
 Indirect Expenses
 Plant and Machinery
 Sub-Contract
 Cost of Extra Work

Important definitions related to contract costing:

• Value of Work Certified: The value of a contract which is certified by an expert in terms
of percentage of total work.
• Cost of Work Uncertified: It represents the cost of the work which has been carried out
by the contractor but has not been certified by the expert.

• Retention Money: Portion of value of work certified, which is kept by a contractee as

security money for any loss or damage caused by the contractor.

• Cost-plus Contract: A contract where the value of the contract is determined by adding
an agreed percentage of profit to the total cost.

• Escalation Clause: A clause in a contract which empowers a contractor to revise the

price of the contract in case of increase in the prices of inputs due to some macro-economic
or other agreed reasons.

• Notional Profit: It represents the difference between the value of work certified and cost
of work certified.

Batch Costing: Batch Costing is a type of specific order costing where articles are manufactured
in predetermined lots, known as batch.

In the job costing, we have seen that the production is as per the orders of the customers and
according to the specifications mentioned by them. On the other hand, batch costing is used where
units of a product are manufactured in batches and used in the assembly of the final product.

Thus components of products like television, radio sets, air conditioners Pharmaceutical
industries, brick manufacturing and other consumer goods are manufactured in batches to
maintain uniformity in all respects.
www.crackgradeb.com | [email protected] | 9971687048
 Crack Grade B 18

More examples:
 Ready made garments
 Manufacturing of tube & tyre.
 Manufacturing of electronic parts.
 Manufacturing of toys.

It is not possible here to manufacture as per the requirements of customers and hence rather than
manufacturing a single unit, several units of the component are manufactured.

For example, in pen manufacturing industry, it would be too costly to manufacture one pen of
a particular design at a time to meet the demand of one customer. On the other hand, the
production of say 10,000 pens of the same design will reduce the cost to a sizeable extent.

The finished units are held in stock and normal inventory control techniques are used for
controlling the inventory. Batch number is given to each batch manufactured and accordingly the
cost is worked out.

Basic Features of Batch Costing:

(a) Each batch is treated as a cost unit.
(b) All costs are accumulated and ascertained for each batch.
(c) A separate Batch Cost Sheet is used for each batch and is assigned a certain number
by which the batch is identified.
(d) The cost per unit is ascertained by dividing the total cost of a batch by the number of
items produced in that batch.
COSTING PROCEDURE IN BATCH COSTING To facilitate convenient cost determination,
one number is allotted for each batch.
 Material cost for the batch is arrived at on the basis of material requisitions for
the batch.
 Labour cost is arrived at by multiplying the time spent on the batch by direct
workers as ascertained from time cards or Job Tickets.
 Overheads are absorbed on some suitable basis like machine hours, direct labour
hours etc.
Economic Batch Quantity (EBQ): Economic Batch Quantity refers to the optimum
quantity batch which should be produced at a point of time so that the Set up & Processing
Costs and Carrying Costs are together optimized.
Setting up & Processing Costs: The setting up and processing costs refer to the costs
incurred for setting up and processing operations before the start of production of a batch.
There is an inverse relationship between batch size and set up & processing costs.
Large the Batch size : Lower the set up costs because of few batches
Smaller the Batch Size : Higher the set up costs because of more batches

Carrying Costs: The carrying costs refer to the costs incurred in maintaining a given level
of inventory. There is positive relationship between batch size and carrying costs.
Large the Batch size : Higher the carrying costs because of high average inventory
Smaller the Batch Size : Lower the carrying costs because of low average inventory

www.crackgradeb.com | [email protected] | 9971687048

 Crack Grade B 19

PROCESS COSTING If a product passes through different stages, each distinct and well-defined,
with the output of one process becoming the input for the other, it is desirable to know the cost of
production at each stage. Process costing is employed to ascertain the same.

Process costing is a method of costing under which all costs are accumulated for each stage of
production or process, and the cost per unit of product is ascertained at each stage of production
by dividing the cost of each process by the normal output of that process.

Cost of production during a particular period is divided by the number of units produced during
that period to arrive at the cost per unit.

Process Costing is also a method of costing which is used in those industries where the production
is in continuous process, i.e. the output of one process becomes the input of the subsequent
process and so on.

Examples calculation of work in

Chemical works Textile, weaving, spinning progress
etc.
Soap making Food products
Box making Canning factory
Distillation process Coke works
Paper mills Paint, ink and varnishing
etc.
Biscuit works Meat products factory
Oil refining Milk dairy

www.crackgradeb.com | [email protected] | 9971687048

 Crack Grade B 20

Features of Process Costing:

(a) The production is continuous
(b) The product is homogeneous
(c) The process is standardized
(d) Output of one process become raw material of another process
(e) The output of the last process is transferred to finished stock
(f) Costs are collected process-wise
(g) Both direct and indirect costs are accumulated in each process
(h) If there is a stock of semi-finished goods, it is expressed in terms of equivalent units
(i) The total cost of each process is divided by the normal output of that process to find
out cost per unit of that process.

COSTING PROCEDURE IN PROCESS COSTING:

The Cost of each process comprises the cost of:
(i) Materials
(ii) Employee Cost (Labour)
(iii) Direct expenses, and
(iv) Overheads of production

Normal Process Loss: It is also known as normal wastage. It is defined as the loss of
material which is inherent in the nature of work or pre-determined loss. It also includes
units taken for test or sampling. It is allowed in costing of goods.

Abnormal Process Loss: It is also known as abnormal wastage. It is defined as the loss
in excess of the predetermined loss (Normal process loss). This type of loss may occur due
to the carelessness of workers, a bad plant design or operation, sabotage etc. Such a loss
cannot obviously be estimated in advance. But it can be kept under control by taking
suitable measures. It is not allowed to affect costing.

Abnormal Process Gain/ Yield Sometimes, loss under a process is less than the
anticipated normal figure. In other words, the actual production exceeds the expected
figures. Under such a situation the difference between actual and expected loss or actual
and expected production is known as abnormal gain or yield. So abnormal gain may be
defined as an unexpected gain in production under the normal conditions. This arises due
to over- estimation of process loss, improvements in work efficiency of workers, use od
better technology in production etc.

Costing of work-in-process: three methods:

(1) First-in-First Out (FIFO) method.
(2) Last-in-First Out (LIFO) method.
(3) Average Cost method (or weighted average cost method).

A paper manufacturing unit has the following processes:

 Making pulp
 Beating
 Pulp to paper
 Finishing

www.crackgradeb.com | [email protected] | 9971687048

 Crack Grade B 21
Let us assume the costs incurred for producing 1000 units is:

OPERATION COSTING The procedure of operation costing is broadly the same as for
process costing except that cost unit is an operation instead of a process.

Operation Cost is the cost of a specific operation involved in a production process or business
activity. The cost unit in this method is the operation, instead of process. When the manufacturing
method consists of a number of distinct operations, operation costing is suitable.
Improve operational efficiency
decide if one process is sucking more funds than others
For large undertakings involving a number of operations, it is important to compute the cost of
each operation. For example, the manufacturing of handles for bicycles will make use of operation
costing as it involves many operations like cutting steel sheets into proper strips, moulding,
machining and finally polishing.

Laptop computers, for example, all have built-in screens and keyboards, but the size of the screen
and the type of screen may differ. The hardware and software installed on each machine will also
differ. The computers have common characteristics, but these characteristics also serve as
distinguishing factors. Operational costing accounts for the differences in the constituent parts
used to produce a product.
operation - similar but
diff variety - eg laptops
operating - service
Service Costing or Operating Costing: based - identical
Service Costing or operation costing is normally used in service sector. When the service is not
completely standardized, it is the cost of producing and monitoring a service. It is a method of
costing applied to undertakings which provide service rather than production of commodities.
Service may be performed internally and externally.

 Services are termed as internal when they have to be performed on interdepartmental

basis in factory itself. Examples of support services are Canteen and hospital for staff,
Boiler house for supplying steam to production departments, Captive Power generation
unit, operation of fleet of vehicles for transport of raw material to factory or distribution of
finished goods to the market outlets, IT department services used by other departments,
research & development, quality assurance, laboratory etc.

 Services are termed as external when they are to be rendered to outside parties. Public
utility services 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.

Service costing is a method of ascertaining the cost of providing or services a service. It is

also known as operation costing. CIMA London, defines Service Costing as “that form of
operation costing which applies where standardized services are rendered either by an undertaking
or by a service cost renter with in an undertaking”

www.crackgradeb.com | [email protected] | 9971687048

 Crack Grade B 22

Cost Accounting has been traditionally associated with manufacturing companies. However in the
modern competitive market, cost accounting has been increasingly applied in service industries
like banks, insurance companies, transportation organizations, electricity generating
companies, hospitals, passenger transport and railways, hotels, road maintenance,
educational institutions, road lighting, canteens, port trusts and several other service
organizations. The costing method applied in these industries is known as ‘Service/Operating
Costing’.

The main features of operating/service costing are as following:

Service costing differs from product costing (such as job or process costing) in the following ways
due to some basic and peculiar nature.
(i) 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
and traceability of costs to a service may not economically feasible.

SERVICE COST UNIT: To compute the Service cost, it is necessary to understand the unit for
which the cost is to be computed. All the costs incurred during a period are collected and analyzed
and then expressed in terms of a cost per unit of service.

STATEMENT OF COSTS FOR SERVICE SECTORS For preparing a statement of cost or a cost
sheet for service sector, costs are usually collected and accumulated for a specified period viz. A
month, quarter or a year, etc.
Cost sheet on the basis of variability is prepared classifying all the costs into three different heads:
1. Fixed costs or Standing charges
2. Variable costs or Operating expenses
3. Semi-variable costs or Maintenance expenses
www.crackgradeb.com | [email protected] | 9971687048
 Crack Grade B 23

Note:
In the absence of information about semi-variable costs, the costs would be shown under fixed
and variable heads only.
Treatment of Depreciation will be considered variable cost.
Interest and finance charges will be considered as fixed cost.

Unit costing refers to the costing procedure, under which costs are accumulated and analyzed
under different elements of cost and then cost per unit is ascertained by dividing the total cost by
number of units produced. It is ideally used in case of concerns producing a single article on large
scale by continuous manufacture. The units of output are identical. The products are
homogenous. Also called Output costing. calculated at the end of production process; each grade
cost is ascertained at the end
Concern using single or output costing produces basically one product or two or more grades of
one product. It is not necessary to maintain separate cost accounts under this system. as all the
information required can be obtained only by organizing and analyzing the financial accounts.

On dividing the total expenditure incurred by the number of units produced, the cost per unit is
ascertained. This system of costing is suitable for breweries, collieries, cement works, steel,
brick making, floor mills etc.

In all these cases the unit cost of the article produced requires to be ascertained. The information
on expenditure incurred on material, labour and direct expenses can be available without any
special difficulty.

The works and administration expenses actually incurred also are included in the total cost. Items
of indirect expenses which are paid at periodical intervals are included in cost accounts on the
basis of estimates. Selling and distributing expenses are not included in cost sheets since these
have no connection with the quantity produced, If, however, it is decided to include them, the
same also are estimated on the basis of past experience.

Cost per unit =Total Cost of Production / No. of units produced

COST COLLECTION PROCEDURE IN UNIT COSTING:

 Collection of Materials Cost
 Collection of Employees (labour) Cost
 Collection of Overheads
 Cost of treatment of defective work

1. Defective items are

not to be accounted total 1. Indirect labour costs
items produced are added factory
2. If repairs is done to overheads
the defective, add the
expenses to cost

www.crackgradeb.com | [email protected] | 9971687048