topic 1: introduction to costing & classification of …
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TOPIC 1: INTRODUCTION TO COSTING & CLASSIFICATION OF COSTS AND
REVENUES
Learning Objectives
Students should demonstrate the ability to:
1.1 Differentiate between Financial, Management & Cost Accounting.
1.2 Understand the role of Costing.
1.3 Identify key concepts in Costing.
1.4 Classify costs into: Costs for stock valuation, Costs for decision-making and Costs for
control.
Difference between Financial Accounting and Cost Accounting
In relation to… Financial Accounting Management Accounting
USERS/AUDIENCE concerned with the provision of
information to external parties
outside the organisation
i.e. for external reporting such as to
owners, investors, creditors,
bankers, regulators (stock
exchange, tax)
concerned with the provision of
information to people within the
organisation to help them make
better decisions
PURPOSE financial reporting internal decision-making
TYPE OF
INFORMATION financial measurements
financial statements
backward-looking; past information
financial and non-financial
information
various internal reports
future-oriented
REPORT
FREQUENCY issued periodically issued as needed; can be quarterly,
monthly, weekly, daily, even hourly
PRECISION/
NATURE OF
INFORMATION
accurate, objective, reliable,
auditable
subjective, relevant, involves
estimation/approximations, flexible
SCOPE/SEGMENT highly aggregated; summarised
whole of organisation
may be more detailed; less
summarised
may focus on smaller parts of
organisation as well (e.g. individual
products, activities, departments)
LEGAL
REQUIREMENTS/
RESTRICTIONS
subject to public & regulator
scrutiny
must comply with MASB,
Securities Commission, Company
Act rules & regulations
no restrictions, upon
request/necessity
optional, and not subject to
regulations
not required by law
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Cost Accounting is concerned with the cost accumulation for stock valuation to meet the requirements of
external reporting and internal profit measurement (Drury)
"The establishment of budgets, standard costs and actual costs of operations, processes,
activities or products; and the analysis of variances, profitability, or the social use of
funds" (Lucey)
The application of accounting and costing principle, methods and technique in the
ascertainment of costs and analysis of savings and/ or excess as compared with previous
experience or with standards (CIMA)
Management Accounting
is a method of providing information to management in order to assist in planning and
control activities.
is a method in providing of appropriate information for decision making, planning,
control and performance evaluation (Drury)
Financial Accounting
is a method of analyzing, classifying and recording financial position, financial
performance and change in financial position.
is a rule requiring matching costs with revenues to calculate profit (Drury)
Theory and practice of Cost Accounting
i. The roles of Management Accountant
Management accountant performs the task of management accounting in the managerial
process to achieve the company‘s objectives. Below are the functions performed by the
management accountant:
Assist in setting up information system relating to cost accounting matters. This
system is a service to the managers.
Advises and monitors the system
Use their expertise to analyse raw data and present to the management
Interprets the figures reported and explain how the data and information can be made
useful.
ii. Purpose/role of Cost Accounting
Foundation of the internal financial information system
Management needs a variety of information to plan, to control, and to make decisions.
a) Cost accounting and control
To ensure that operations, departments, processes and costs are under control –
organisation as a whole are working efficiently towards agreed objectives
Costing system provides a sound basis of information for financial control –
monitors the results of all activities.
E.g. budgeting and standard costing
b) Cost accounting and decision making
Decision making – making a choice between alternatives
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Financial implications (information provided by the costing system) of the various
alternatives is essentially a critical factor in making such decision
c) Cost accounting and planning
Calculation of costs that will be incurred in the future and also the analysis of past
costs will assist managers in planning
iii. Techniques used in Cost Accounting
1) JIT – is a comprehensive control system in which no materials are purchased and
no products are manufactured until needed.
2) Kaizen costing - is the process of cost reduction during the manufacturing phase
of an existing product. The cost reduction is achieved through small activities
rather than through a massive change from innovation or technology.
3) Target costing -is a process whereby a company analyzes its market and
determines an estimated selling price for its products (or services). Known as a
target price, a target profit is then subtracted to yield the target cost.
The firm may have to pursue value engineering, that is, a look at the product (or
service) and possible redesign so the target cost can be achieved.
4) ABC - An ABC system assigns resource cost to a company‘s cost objects (i.e., the
cost assignment viewpoint). With a process viewpoint, the emphasis now is on
the activities themselves—what causes them, the events that trigger them, and the
related linkages.
5) Others – traditional costing techniques
iv. IT in Cost Accounting
The use of IT to support business activities has increased with the development of
electronic business communication technologies known as e-business, e-commerce or
internet commerce. These developments are having a big impact on businesses.
E-Commerce – is buying and selling products using information and
communication technology.
The growth in e-commerce is occurring because the Internet has important
advantages over more conventional marketplaces for many kinds of transactions.
For example, the Internet is an ideal technology for streamlining the mortgage
lending process because customer can complete loan applications over the Internet
rather than tying up the time of office personnel & data and funds can be sent back
and forth electronically.
Enterprise resource planning systems (ERPS)
An enterprise system integrates data across an organization into a single software
system that enables all employees to have simultaneous access to a common set of
data. In other word, an ERPS comprises a set of integrated software applications
modules that aim to control all information flows within a company. There are two
keys to the data integration inherent in an enterprise system:
All data are recorded only once in the company‘s centralized digital data repository
known as a database. The unique data elements contained within a database can be
linked together. For example, one data element such as a customer identification
number can be related to other data elements such as that customer‘s address, billing
history, shipping history, merchandise returns, and so on. The ability to forge such
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relationships explains why this type of database is called a relational database.
Furthermore, the ERPS has the significant impact on the work of management
accountant such as to reduce routine information and the processing of information.
There are number of ERPS packages such as SAP, Baan, Oracle and J.D. Edwards.
Several Cost Terms and Concepts in Costing
Cost
The amount of expenditure (actual or notional) incurred on, or attributable to, a
specified thing or activity. i.e. cost = quantity x price.
Cost units
Costs are always related to some object or function or service
A unit of product or service in relation to which costs are ascertained
May be units of production (e.g. tonnes of cement, typewriters) or units of service
(e.g. consultation hours, number of invoices processed, kilowatt-hours)
E.g. cost of making one unit of table (cost/unit), cost of producing ten tonnes of iron
ore (cost/tonne).
Direct costs
Costs which can be directly identified with a job, batch, product or service
Consists of direct materials, direct labour and direct expenses
Do not have to be spread between various categories – the whole cost can be
attributed directly to a production unit or saleable service
Total of direct costs is known as prime cost.
Indirect costs
All material, labour and expense costs that cannot be identified as direct costs are
termed indirect costs.
The three elements of indirect costs: indirect materials, indirect labour and indirect
expenses are collectively known as overheads.
In practice, overheads are usually separated in categories such as Production
Overheads, Administrative Overheads and Selling Overheads.
Cost Centre
A production or service location, function, activity or item of equipment for which
costs are accumulated.
Responsibility centre where managers are accountable for the expenses that are under
their control.
Normally consists of departments, but in some instances they consist of smaller
segments such as groups of machines within a department.
Cost allocation
To assign a whole item of cost, or of revenue, to a single cost unit, centre, account or
time period.
Applies to direct costs as well as indirect costs.
Cost apportionment
To spread revenues or costs over two or more cost units, centres, accounts or time
periods. This may also be referred to as ‗indirect allocation‘.
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The choice of an appropriate basis is a matter of judgement to suit the particular
circumstances of the organisation and wherever possible there should be a cost-cause
relationship.
The process of apportionment is an essential part of the build-up of overheads,
because many indirect costs apply to numerous cost centres rather than just to one.
Classification of costs
Costs Object/Cost Objectives
Any activity for which a separate measurement of costs is desired.
In other words, if the users of accounting information want to know the cost of
something, this “something” is called a cost object/objective.
E.g. Cost of a product, the cost of rendering a service to a direct-selling customer, the
cost of operating a particular department or job.
Cost objectives are divided into 3 broad categories:
a) Costs for stock valuation
b) Costs for planning and decision making
c) Costs for control
E.g.
i. Cost of operating an existing machine is a cost objective that may be required for
a comparison with the costs of operating a replacement machine – costs for
decision making.
ii. Cost of operating a department is a cost objective that may be required for a
comparison with the budgeted costs – costs for control
Exhibit 1: Cost objectives and possible cost classifications
Cost Objective Possible methods of cost classifications
1. Costs for stock valuation Period and product costs
Elements of manufacturing costs
Job and process costs
2. Costs for planning & decision-making Cost behaviour
Relevant and irrelevant costs
Avoidable and unavoidable costs
Sunk costs
Opportunity costs
Marginal and incremental costs
3. Costs for control Controllable and uncontrollable costs
Classification of Costs for Stock Valuation and Profit Measurement costs
Unexpired vs Expired costs
Unexpired costs:
Resources that have been acquired and that are expected to contribute to future
revenue.
They are recorded as assets in the balance sheet.
Expired costs:
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Unexpired costs that have been consumed in the generation of revenue and have
no future revenue-producing potential.
They are recorded as expense in the profit and loss account.
Example – stock (asset); becomes cost of goods sold (expense); matched against sales
(revenue).
Period and product costs
For stock valuation, only manufacturing costs should be included in the calculation of
product costs.
Product costs – costs that are identified with goods purchased or produced for resale.
Product costs are included in stock valuation for finished goods, or for work-in-
progress. (Manufacturing costs)
Prime cost – direct costs of the product = direct materials + direct labour + direct
expenses.
Direct materials – all those materials that can be physically identified with a
specific product. E.g. Wood – direct materials in producing a desk.
Direct labour – those labour costs that can be specifically traced to or
identified with a particular product. E.g. – wages of operatives who assemble
parts into the finished products (desk).
Direct expense – expenses incurred specifically for a particular product. E.g.
royalties paid per unit for a copyright design.
Manufacturing overhead – all manufacturing costs other than direct labour,
direct materials and direct expenses.
Indirect materials – Those materials that cannot be directly traced to a
particular unit of product. E.g. varnish
Indirect labour – Those labour costs that cannot be physically identified with
a particular product. E.g. salaries of factory supervisors.
Indirect expense – expenses that cannot be traced to the item being
manufactured. E.g. rent and rates of the factory
Period costs – costs that are not included in the stock valuation. Treated as expense
in the period in which they are incurred (Non-manufacturing costs)
Financial expenses: bank charges, interest on loan, discounts allowed
Selling and distribution: salesmen‘s salaries, commission
Administrative: salaries of office staff.
Job and Process Cost
Job costing
Refers to accounting system that determines the cost of individual orders (jobs).
It is suitable in a production environment where each new order is different from
the earlier or succeeding order.
E.g.
Shoe manufacturing where each order differs from the following due to
different specifications being required.
Vehicle repair shops, where each vehicle repair requires different parts
replacement and labour hours.
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Garment manufacturing, where orders received could vary significantly from
one another.
Process costing
Helps to determine the cost per unit of product produced in an environment where
identical products are produced for all customers.
E.g.
Electronic assembly line where all products produced is identical.
Biscuit manufacturing where although there may be more than one product
line, each line is a separate, continuous process producing identical products.
Classification of Costs for Planning & Decision-Making
Cost accounting is concerned with the calculation of actual product costs for stock
valuation and profit measurement, whereas management accounting is concerned with
the provision of information to help people within the organisation make good decisions.
Cost behaviour
Fixed costs
Remain constant over wide ranges of activity for a specified time period.
E.g. depreciation of the factory building, supervisors‘ salaries, rent
Graph:
Unit fixed costs decrease proportionally with the level of activity.
E.g. if the total of the fixed costs is RM5,000 for a month, the fixed costs per unit
will be as follows:
Units produced Fixed cost per unit (RM)
1 5,000
10 500
100 50
1,000 5
Therefore, the graph should look like:
Total fixed cost (RM)
Activity level
Unit fixed cost (RM)
Activity level
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Variable costs
Vary in direct proportion to the volume of activity – doubling the level of activity
will double the total variable cost.
Total variable costs are linear and unit variable cost is constant.
E.g. sales commissions, raw materials, petrol
Graph:
Semi-fixed or step fixed costs
Costs that are fixed within specified activity levels but they eventually increase or
decrease by a constant amount at various critical activity levels
E.g. labor costs. If production capacity expands to some critical level, and
therefore additional workers will be employed, labor costs could be semi-fixed.
Level of activity
Activity level (units of output)
100 200 300 400 500
5,000 4,000 3,000 2,000 1,000
100 200 300 400 500
Total Variable Cost (RM)
Activity level (units of output)
Unit Variable Cost (RM)
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Total fixed cost (RM)
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Semi-variable costs
Include both a fixed and a variable component
These are costs that change with production, but not in direct proportion to the
volume.
E.g. telephone charge which has a fixed charge for line rental of say RM68 per
month and a variable charge per minute for call charges of say RM0.30 per
minute.
Relevant and Irrelevant Costs and Revenues
--- Past vs. future
--- differ between alternatives
For decision-making, costs and revenues can be classified according to whether they
are relevant to a particular decision
Relevant costs and revenues are those future costs and revenues that will be changed
by a decision, whereas irrelevant costs and revenues are those that will not be affected
by the decision
E.g. Petrol costs is relevant in deciding whether to have a journey by own car or
public transport. But the neither car insurance nor car tax costs are relevant.
Sometimes, the terms avoidable and unavoidable costs might be replacing the terms
relevant and irrelevant costs.
Sunk costs
The cost of resources already acquired where the total will be unaffected by the
choice between various alternatives
They are the costs that have been created by the decision made in the past and that
cannot be changed by any decision that will be made in the future.
E.g. Let say you want to conduct a project. You have two alternatives whether using
the old machine or replacing it with a new machine. The cost of purchasing the old
machine is therefore sunk cost. Whether you want to use it or you want to buy a new
one, the cost has already incurred
Sunk costs are irrelevant for decision making.
Distinguished from irrelevant costs because not all irrelevant costs are sunk costs.
Opportunity costs
Cost that measures the opportunity that is lost or sacrificed when the choice of one
course of action requires that an alternative course of action be given up.
E.g. if an asset such as capital is used for one purpose, the opportunity cost is the
value of the next best purpose the asset could have been used for. Acquiring or
Total cost (RM)
68
104
Variable cost element
Fixed cost elements
120 Minutes
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renting? Let say, you choose to acquire a building. A saving of RM150 per month of
renting might be your opportunity cost.
Incremental and marginal costs/revenues
Incremental costs and revenues are the additional costs or revenues that arise from
the production or sale of a group of additional units.
E.g. You want to set up a branch in Muadzam Shah. Therefore, you need the analysis
on the incremental costs and revenues by setting up such a new branch (including
sales, advertising, staff salaries, travelling, rentals etc)
Marginal cost/revenue represents the additional cost/revenue of one extra unit of
output. If let say the cost of producing 1 unit of table is RM20, how about two units?
Classification of Costs for Control
Costs and revenues must be traced to the individuals who are responsible for incurring
them. This is called responsibility accounting
In an organisation, normally it has 3 responsibility centres:
Cost centre – managers are accountable for the expenses that under their control. E.g.
advertising department, purchasing department
Profit centre – managers are accountable for sales revenue and expenses. E.g. sales
department
Investment centre – managers are normally accountable for sales revenue and
expenses, but in addition are responsible for some capital investment decisions.
Controllable and non-controllable costs and revenues
Costs and revenues allocated to responsibility centres should be classified according
to whether or not they are controllable or non-controllable by the manager of the
responsibility centres.
A controllable cost may be defined as a cost that is reasonably subject to regulation
by the manager with whose responsibility that cost is being identified.
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TOPIC 2: COSTING FOR LABOUR
Learning Objectives
After studying this topic, students should be able to:
Identify the basic procedures to control labour cost.
Differentiate between labour cost accounting and payroll accounting.
Explain the techniques used to determine cost of labour and calculate the costs - basic pay,
piecework pay, bonuses and overtime pay.
Understand the issues concerning labour turnover.
Control Procedures for Labour Cost
Labour cost is one major cost in an organisation, thus vital for it to be kept under control.
How can we control labour cost? Various methods but the basic procedures include:
i. ensure labour times are recorded accordingly and accurately.
ii. determine the correct time spent by employees on production.
iii. accurately calculate wages paid to employees in accordance to their payment scheme.
i. How can we ensure labour times are recorded accordingly & accurately?
with the help of various record-keeping documents:
Attendance record
- a clock card given to each employee, a time recording clock will record time
entering and time leaving the premises
Time sheet
- daily or weekly records filled in by the employee and countersigned
- shows how the employee spent his/her time during the day or week
- objective is to reconcile all the time in attendance (recorded on clock card) with
time bookings either to jobs or operations
Job card
- relates to single jobs or batch and contain time spent on a particular job by several
employees.
- completed job cards will have a full record of times and quantities involved in the
job or batch
- difficult to reconcile work time and attendance time especially for jobs which
stretched over several weeks
Operation card (piecework tickets)
- Provided to each operation or stage of manufacture. Hence, a job to manufacture
one item may have several operation cards
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- Contains data such as Batch quantity, Quantity produced, Number of rejected
units etc.
Idle time card
- simply record the amount of time a particular employee is left idle, or unoccupied
- also records the reason for idle time, for example machine breakdowns, material
shortages or bottlenecks
Employee record card
- records the personal details of an employee, for example, address, employee
number, payment scheme, pay rate, contact numbers, skills etc.
ii. How do we determine the correct time spent by employees on production?
carefully analyse all the relevant records (time sheets, attendance records, job cards,
piecework tickets etc)
identify occurrence of idle time (idle time? ~ the amount of time an employee is
unoccupied)
iii. How do we accurately calculate wages paid to employees in accordance to their payment
scheme?
correctly identify their respective payment scheme (perhaps by way of coding)
thoroughly understand the underlying concepts and applications of the various
payment schemes
Elements of costs
a. Wages - Payment for labour or services to a worker, especially remuneration on an
hourly, daily, or weekly basis or by the piece.
b. Salaries - is a form of periodic payment from an employer to an employee, which is
specified in an employment contract. It is contrasted with piece wages, where each job,
hour or other unit is paid separately, rather than on a periodic basis.
c. Bonus - Compensation paid to an employee or employees for achieving a particular
target or organisational objective. This is above and beyond a salary or wage.
Techniques to determine cost of labour
a. Basic pay (time-based pay)
- employee is paid for the number of hours worked at a basic rate per hour
- Basic pay = hours worked * hourly rate
- Advantages:
Simple to understand and administer.
Simplifies wage negotiations – use only one rate.
- Disadvantages:
No incentive to increase output.
Employees in the same grade are paid the same rate regardless performance.
Constant supervision is necessary.
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b. Incentive schemes
Relate payment to output in some way or other, either in terms of quantity or time
taken to complete production
Advantages:
Increase production and reduces overheads per unit
Provides competitive edge during inflation
Improve employees‘ morale
Attract more efficient workers
Disadvantages:
Difficult to establish performance levels and rates
Complex incentives are difficult to administer
Unskilled group of workers may also earn higher wages – may affect morale of
skilled workers.
Piecework and Bonus Schemes are examples of an incentive scheme, whose main
objective is to reduce cost per unit (i.e. increase productivity).
i) Piecework scheme
Without piecework scheme – Worker B With piecework scheme – Worker B
Hourly rate: RM6 (10 x 60 sen) Piecework rate: 50 sen per unit
Produces 10 units in 1 hour Produces 14 units in 1 hour
Average labour cost per unit: 60sen Hourly rate increases to RM7 (i.e. 14 x
50sen)
Overall effect of piecework scheme increase in hourly rate;
reduction in labour
cost per unit
…Wage = Higher of
[piecework rate at RM 0.50 x 14 < # of units completed>] = RM 7
OR
[guaranteed min wage at RM 6 per hour.]
…When production is low, employee gets min wage.
Difference between actual amount he should have earned (piecework) and min wage
charged to factory OH account
ii) Bonus scheme
The time allowed for a specific operation is 20 hours and the actual time taken by
an employee was 16 hours. A bonus scheme is in operation where employees
receive a bonus of 50% of the time saved. The hourly wage rate is RM8 per hour.
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The employee, having worked for 16 hours, will receive a time rate wage of RM128
(16 hours at RM8) plus a bonus of RM16 (50% of 4 hours saved at RM8 per hour).
(Example 3.1, pg. 55)
Time allowed: 20 hours
Actual time taken by Employee: 16 hours
Hourly wage rate: RM8
Bonus system in place: 50% of the time saved
Total wage received by Employee:
Normal time rate wage: 16hrs x RM8 = RM128
+ Bonus premium: 50% x 4hrs saved x RM8 = RM 16
Total wage: RM144
Bonus scheme. (e.g. if time achieved < standard set.) bonus based on time savings
Total amount due = basic pay + bonus (based on time saved)
c. Overtime premium
- A variation of the basic pay system, however the rate is higher because the time
worked is OVER and ABOVE the normal working hours
- Eg: Consider a situation where an employee is paid time and a half for weekly hours
worked in excess of 40 hours. Assume that the employee works for 50 hours and that
the 10 hours of overtime were spent on a particular activity. The hourly wage rate is
RM8.
(Pg. 56)
OT scheme: time & half for weekly hours > 40 hours
Employee A: works 50 hours; that extra 10 hours were spent on Job X
Hourly wage rate: RM8
A‘s weekly wage:
Normal time rate wage: 50 hours at RM8 = RM400
Overtime premium (1/2 x 10 hours at RM8) = RM 40
RM 440
charge to job carried out during OT hours
… if OT due to RUSH ORDER (URGENT REQUEST)
charge to manufacturing overheads (i.e. overall production) through general OH
account….
… if OT because of GENERAL FACTORY PRODUCTION PRESSURE
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Labour turnover
- Refers to the movement of employee in and out of a business.
- High labour turnover causes problems for business because it is costly and also lowers
the productivity and morale.
Expressed as a ratio:
Number of employees replaced per period
Average total number of employees in the period
Reasons for turnover:
Redundancy
Dissatisfied employee
Lack of career structure
Lack of training or day release
Personal advancement
Retirement
Marriage, pregnancy
Discharge
Costs of turnover:
Leaving costs e.g. disruption of production
Replacement costs e.g. advertising, personnel selection, interviews
Training costs e.g. costs of internal and external courses
Learning costs e.g. slower initial production, increased scrap, accident rate
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Pre-Lecture Questions
Fill in the blanks with appropriate answer
1. There are six (6) types of record-keeping documents for labour attendance record which
are;
i. ______________________________________
ii. ______________________________________
iii. ______________________________________
iv. ______________________________________
v. ______________________________________
vi. ______________________________________
2. ________________ is a payment for labour or services to a worker, especially remuneration
on a hourly, daily, or weekly basis or by the piece.
3. Salaries are the form of _________________________ from an employer to an employee,
which is specified in an employment contract.
4. The advantages of time based pay are;
i. __________________________
ii. __________________________
5. The disadvantages of time based pay are;
i. __________________________
ii. __________________________
6. The advantages of incentives scheme pay are;
i. ___________________________
ii. ___________________________
iii. ___________________________
iv. ___________________________
7. The disadvantages of incentives schemes pay are;
i. ___________________________
ii. ___________________________
iii. ___________________________
8. Reasons for turnover are;
i. _____________________________
ii. _____________________________
iii. _____________________________
iv. _____________________________
v. _____________________________
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vi. _____________________________
vii. _____________________________
viii. _____________________________
9. Costs of turnover are;
i. ______________________________
ii. ______________________________
iii. ______________________________
iv. _______________________________
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TOPIC 3: COSTING FOR RAW MATERIALS
Learning Objectives:
After studying this topic students should be able to:
Describe control procedures for materials.
Describe the characteristics of the main issue pricing systems; First in First Out (FIFO),
Last in First Out (LIFO), Average Price and Standard Price.
Know how to calculate issue prices and stock values using the pricing systems.
Determine the cost of sales, gross profit figures & closing stocks value.
Describe the importance of a stock control system
Control procedures for materials.
Cost of direct materials represented dominant costs in manufacturing organization. The
accounting and control of materials is therefore of vital importance in manufacturing
organization.
The materials recording procedure involves the following stages:
i. Storage of materials
Stores department are responsible to ensure the optimal stock levels are
maintained.
When items of materials have reached their re-order point, a purchase requisition
is initiated.
ii. Purchase of materials
Purchasing department will select supplier and complete the purchase order.
A copy of purchase order is sent to the receiving section for checking with the
goods when they arrived.
iii. Receipt of materials
When the goods are received by the receiving section, they are inspected and
checked with the supplier‘s delivery note and a copy of purchase order.
Lists the material received on a goods received note (GRN) and forward it to the
purchasing and accounting departments.
Purchasing department will record the order and accounting department will
check the GRN with the supplier‘s invoice to ensure that the payment made only
for goods received.
GRN is the source document for entering details of the items received in the
receipts column of the appropriate stores ledger account (SLA).
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iv. Issue of materials
Stores requisition (SR) is a forms used to keep track of materials charged to a
particular job or department. The form contains such items as job number,
department, description of the material, quantity, unit cost, and dollar amount.
Each of the items listed on the materials requisition (MR) are priced from the
information recorded in the receipts column of appropriate SLA.
The information for each of the items listed in the SR is then recorded in the issue
column of the appropriate SLA and a balance of the quantity and value is
calculated for each item of material.
v. Assigning the cost of materials to cost objects.
Total cost of the items of material listed on the SR is assigned to the appropriate
customer‘s account number, overhead account or product or service code.
The details on the MR represent the source information for assigning the cost of
the materials to the appropriate cost object.
The accounting entries required for an issue of material involve:
1) Reducing the value of raw materials stocks by recording the values issued in
the issues column of the appropriate stores ledger account.
2) Assigning the cost of the issues to the appropriate customer‘s order number,
product/service code or overhead account.
Problems of Material Pricing
Change in prices of bought in materials and components
Different prices for several deliveries of stocks for materials
Difficult to identify items with their delivery consignment
Sensitivity of profit calculations to pricing method adopted
Pricing the issues of raw materials
What should be the price of raw materials that have been used in production?
Are all materials likely to be purchased at the same price?
Problem: what cost to assign to each material issue?
3 stores pricing methods:
FIFO - First in first out (FIFO): uses the price of the units in the first batch received until
all units have been issued, after which the price of next oldest is used.
Characteristics:
Actual cost system – no unrealized profits or losses
Good representation of storekeeping – issue old items first
Stock valuation based on current market value
Product costs do not reflect current condition
Acceptable by the IRB
Administratively clumsy
Difficult to compare costs between jobs
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LIFO - Last in first out (LIFO): the latest batch of materials bought will be used first.
Materials are issued at price closer to current price level
Characteristics:
Actual cost system – no unrealized profits or losses
Many batches are only partly charged to production
Product costs based on current prices
Stocks do not reflect current condition - valued at oldest prices
Not acceptable by the IRB
Provides hedge against inflation – understate profits
Administratively clumsy
Difficult to compare costs between jobs
WACO:
Average Price: the materials issued will be priced using average price i.e.
Total cost of materials in stock
Total quantity of materials in stock
Characteristics:
Not an actual buying price
Less complicated to administer than LIFO and FIFO
Effects on products costs and stock valuation – somewhere between LIFO and
FIFO
Cost comparison between jobs are easier
Reduce price fluctuation effect
No unrealized profits or losses
Why do we need to price material issues?
To allocate material costs to jobs for external reporting for stock valuation &
measurement
To determine relevant costs for decision-making and product pricing
Importance of a stock control system
• System used in a firm to control the firm’s investment in stock - includes recording and
monitoring of stock levels; forecasting future demands etc by answering these questions;
Why is it important?
Cost
How many units to order?
How many time to order?
When to order?
What re-order level?
21
• Should determine optimum level of investment by
a) Ensuring the stocks are sufficient to meet requirements of production
b) Avoiding holding surplus stocks that unnecessary (↑ increase obsolescence)
• Objective: minimize the costs associated with stock (carrying costs, ordering costs,
stock out costs)
– Carrying costs (holding cost) – storage charges, material handling costs,
insurance and security, deterioration and obsolescence
– Ordering costs – clerical and administrative works, transportation costs
– Stock-out costs – Loss current, future sales; production stoppages
Economic Order Quantity (EOQ)
– Calculated reorder quantity which minimizes the balance of cost between carrying
costs and
ordering costs
– Minimize balance of cost between carrying cost and ordering cost
– Determine HOW MUCH material should be ordered
– EOQ – the quantity which is most economic to order
– To be able to calculate a basic EOQ, certain assumptions are necessary:
A known constant carrying costs
A known constant ordering costs
Rates of demand are known
A known constant price per unit
Replenishment is made instantaneously
– Economic Order Quantity = √ (2 x total Demand x Cost per order (co))
(EOQ) holding cost per unit Ch
EXAMPLE
Famous Manufacturing Sdn. Bhd, a company manufactures electronics parts for Panasonics Sdn
Bhd, have the following stock purchase and issues for the month of August as follows:-
Stock movement for material “AB”
Purchase Issues
1/8 100 pcs @RM1.00 per
pcs
10/8
70 pcs
4/8 120 pcs @RM1.50 per
pcs
17/8 90 pcs
12/8 200 pcs @RM2.20 per
pcs
25/8
180 pcs
27/8 150 pcs @RM2.50 per
pcs
30/8 200 pcs
22
Record the above transaction in a stores ledger account by using the FIFO, LIFO and
WACO method for pricing the issues of materials “AB.
STORES LEDGER ACCOUNT/STORES LEDGER CARD
a) FIFO
Date
Purchase Issues Stock Balance
Quantity Price Amount Quantity Price Amount Quantity Price Amount
23
c) WEIGHTED AVERAGE
Date
Purchase Issues Stock Balance
Quantity Price Amount Quantity Price Amount Quantity Price Amount
Pre-Lecture Questions
1. Materials recording procedure involves a few stages. List down the procedure involved:
a. ______________________________________
b. ______________________________________
c. ______________________________________
d. ______________________________________
2. Problems in material pricing are:
a. ______________________________________
b. ______________________________________
c. ______________________________________
d. ______________________________________
3. There are 3 stores pricing methods which are ___________________,
____________________, and ________________________.
4. State any FOUR (4) characteristics of FIFO.
a. ____________________________________________________________________
b. ____________________________________________________________________
c. ____________________________________________________________________
d. ________________________________________________________________
24
TOPIC 4: COSTING FOR OVERHEADS
Learning Outcomes
At the end of this lecture, students should be able to:
Classify overhead expenses into manufacturing and non-manufacturing overheads
Allocate manufacturing overheads to individual products using the Blanket OAR and the
departmental OAR
Identify situations with overheads under or over absorption, and its subsequent treatment
Manufacturing and non-manufacturing overheads
Manufacturing overhead refers to indirect factory-related costs that are incurred when a
product is manufactured.
Manufacturing overhead includes such things as the electricity used to operate the factory
equipment, depreciation on the factory equipment and building, factory supplies and factory
personnel (other than direct labor). How these costs are assigned to products has an impact
on the measurement of an individual product's profitability.
Manufacturing Overhead includes:
– Indirect materials
– Indirect labor
– Factory property taxes
– Factory insurance
– Factory utilities
Non-manufacturing overheads (sometimes referred to as ―administrative overhead‖)
represent a manufacturer‘s expenses that occur apart from the actual manufacturing function.
Nonmanufacturing costs include activities associated with the Selling and General
Administrative functions. Examples include the compensation of nonmanufacturing
personnel; occupancy expenses for nonmanufacturing facilities (rent, light, heat, property
taxes, maintenance, etc.); depreciation of nonmanufacturing equipment; expenses for
automobiles and trucks used to sell and deliver products; and interest expenses.
Procedure for Allocating Overhead to Products
Note: For the purpose of calculating product cost, non-manufacturing overhead e.g.
electricity used in general administrative office and depreciation of photocopy machine at
administration office is not included
Applied factory overhead is an estimate of the actual overhead for the year
Note: The estimated overhead is used in the calculation as the actual overhead for the period
is not known until the end of the period. Therefore, the usage of estimated figure will make it
possible to estimate total product costs sooner
25
Some important terms to note:
allocate ~ to assign a whole item of cost to a single cost unit, centre or department
apportion ~ to spread costs over 2 or more cost units, centers, or department
absorb ~ to attach overhead costs to products/services
Allocating overhead to products generally consist of 3-stage process:
Stage 1 : allocate or apportion OH to cost centers/units/department
Stage2 : reassign service department overhead costs to production departments
Stage 3: allocate accumulated OH to products using pre-determined overhead absorption rates
(OARs)
Stage 1: Allocate or apportion OH to cost centers/units/department
Illustration:
ABC Berhad is preparing its departmental budgets and product cost estimates for the year ending
31st December 2010. The company has two production departments, Machining and Assembly,
and one service department, Maintenance. The company budgets its overhead costs for the year
ended 31 December 2010 as:
Machining Hand
Finishing
Maintenance Total
Costs (RM) :
Direct wages 50000 20000 8000 78000
Indirect wages 15000 9000 1000 25000
Direct materials 75000 45000 - 12000
Indirect materials 23000 16000 1500 40500
Electricity 32000
Depreciation 86000
Personnel 34000
Other data :
Direct labour hours 12000 10000 7000 29000
Machine hours 28000 5700 3900 37600
Number of employees 13 16 7 36
Floor area (sq. metres) 1500 500 600 2600
Net book value of fixed
assets (RM)
15000 7000 4000 26000
It has been established that the service department cost should be dealt with 80 percent to
Machining and 20 percent to Hand Finishing.
26
Required: Using overhead analysis sheet, allocate and apportion each overhead to each department using
the bases suggested below:
Indirect wages Actual
Indirect materials Actual
Electricity Floor area
Depreciation Net book value
Personnel Number of employees
(Round up your answer to zero decimal points)
Stage 2: Reassign service department overhead costs to production departments
To reassign/reapportion overhead from service departments to production departments, there
are four methods of reapportionment:
i- Direct allocation method
- Assume one service department services the next (not each other) i.e. services
flow one-way.
ii- Reciprocal Allocation method
- Where the service departments service each other (i.e. 2-way flow)
- Solve simultaneous equations for the unknowns
iii- Repeated distribution method
- Where the service departments services one another
- Repeatedly allocate / distribute service department costs based on percentages
until the amounts remaining become negligible
iv- Specified order of closing
- Where the service departments service one another
- The service departments‘ overheads are allocated to the production departments in
certain order
- The service department that does the largest proportion of work for other service
departments is closed first and eliminated from further apportionment
The most commonly used method is the direct allocation method and for the purpose of this
study we will concentrate only on this method.
Illustration (based on previous example):
27
Required:
Reapportion the overhead from service department (Maintenance) to the two production
departments (Machining and Hand Finishing).
Stage 3: allocate accumulated OH to products using pre-determined overhead absorption
rates (OARs)
The pre-determined OAR is used to apply overhead to each product/job
The OAR is calculated for each department
Formula to calculate OAR:
Estimated total overhead for the coming period / Estimated total units of cost drivers
The cost driver is the factor that drives overhead costs in each department i.e. as the factor
increases, the overhead will also increase, and vice versa
The OAR is applied using the following formula:
Overhead applied = Pre-determined OARs x actual units of cost driver
Illustration (based on previous example):
Calculate the appropriate overhead absorption rates for Machining Department and Hand
Finishing Department using the most appropriate cost driver.
(Round up your answer to two decimal points)
The OAR calculated can be applied in two situation:
i. To calculate cost for a particular product/job
Illustration (based on previous example):
The company has been asked calculate cost for job 703, this job requires the following:
Machining Hand Finishing
Direct material RM1560 RM3,788
Direct labor RM1100 RM2,650
Direct expenses RM500 RM422
Machine hours 120 hours 80 hours
Labor hours 140 hours 220 hours
28
Required:
Compute the cost for this job.
(Round up your answer to zero decimal points)
ii. To determined over or under absorbed of overhead for production
Under-absorbed: Actual amount of overhead exceeds amount applied to production
Over-absorbed: Actual amount of overhead less that the amount applied to production
Illustration (based on previous example):
Calculate the amount of under-/over-absorption of overheads if actual results were as follows:
Accounting regulations in most countries (including Malaysia) recommend that the under or
over absorbed of overhead should be regarded as period cost i.e. expense
Under-absorbed is recorded as expense in the current accounting period whereas over-
absorbed is recorded as a reduction in the expenses for the period
Blanket OAR
Single OAR used to assign all OH costs to products;
E.g.
DEPT A
DEPT B DEPT C
TOTAL
(BLANKET )
Overheads RM12 000 RM100 000 RM8 000
DLHs 20 000 20 000 20 000
OH rate per DLH RM0.60 RM5 RM0.40
Problem with blanket OAR…
- Different departments incur different amounts of OH costs
- Different departments consume different amounts of the cost driver
Therefore if a company has many departments, it is more meaningful to calculate separate
departmental OARs (as illustrated in previous sections).
Machining Hand Finishing
Total overhead costs (RM) 156000 74800
Direct labor hours 15000 8500
Machine hours 32000 6000
29
TOPIC 5: JOB ORDER COSTING & BATCH COSTING
Learning Outcomes
At the end of this lecture, students should be able to:
Describe or explain job order costing systems
Estimate product costs using job bid sheets
Calculate actual product costs using job cost sheets
Describe batch costing
Explain the differences between job order costing & batch costing
What are job order costing (JOC) systems?
A job order costing system estimates the cost of manufacturing products for different jobs
required for specific customers orders
Each job may differ in terms of:
- Materials content
- Hours of labor required
- Machine time required
- Demand placed on support activity resources (i.e., manufacturing overhead)
- Special customer needs that require customized production
With such variety, managers need to understand the costs of individual jobs so that they can
assess product and customer profitability.
Bidding using JOC
Firms are sometimes required to bid on jobs before customers decide to place an order with
them
Costs need to be estimated for each job in order to prepare a bid
Job order costing systems provide the means to estimate these costs
A job bid sheet provides a format for recording the estimated costs:
Panel 1: identifies the customer, the product, and the number of units required
Bid Number: J4369 Date: July 6, 2006 Customer: Michigan Motors Product: Automobile engine valves (Valve #L181) Engineering Design Number: JDR-103
Number of Units: 1,500
30
Panel 2: lists all the materials required to complete the job
Panel 3: lists the amount of direct labor required for the job
Panel 4: contains estimates for support costs / overhead
Panel 5: summarizes the total costs estimated for the job
Labor Hours Rate Amount Lathe operators 480 RM26.00 RM12,480 Assembly workers 900 18.00 RM16,200
Total direct labor 1,380 RM28,680
Support Costs Amount 600 machine-hours @ RM40/hour RM24,000 1,380 direct labor hours @RM36/hour RM49,680
Total support costs RM73,680
Direct material RM 99,180 Direct labor 28,680 Support costs 73,680
Total costs RM201,540
Materials Quantity Price Amount Bar steel stock 3” 3,600 RM11.30 RM40,680 Subassembly 1,500 39.00 RM58,500 Total direct materials RM99,180
31
A markup rate is applied to translate the estimated cost into a bid price
JOC & Markup
Markup rate – percent by which job costs are marked up
The markup rate depends on a variety of factors:
- The amount of support costs excluded from the cost driver rate
- The target rate of return desired by the corporation
- Competitive intensity
- Past bidding strategies adopted by key competitors
- Demand conditions
- Overall product-market strategies
Recording actual JOC
Job order cost accounting systems record costs actually incurred on individual jobs as they
are produced
Copies of all materials requisition notes and worker time cards are forwarded to the
accounting department, which then posts them on a job cost sheet
The system calculates total costs for the portion of the job completed
Structure of job cost sheet are almost the same as job bid sheet:
- Panel 1: Miscellaneous details
- Panel 2: Direct materials
- Panel 3: Direct labor
- Panel 4: Support costs / Overhead
- Panel 5: Total cost, no. of units produced, cost per unit
Illustration on calculating JOC
Portland Electronics Inc. delivered 1000 custom-designed computer monitors on February 10
to its customer, Video Shack; they had been ordered on January 1. The following cost
information was compiled in connection with this order:
Direct materials used:
Part A327: 1 unit costing RM60 per monitor
Total costs RM201,540 Add 25% markup 50,385 Bid price RM251,925 Unit cost RM134.36
Unit price RM167.95
32
Part B149: 1 unit costing RM120 per monitor
Direct labour used:
Assembly: 6 hours per monitor at the rate of RM10 per hour
Inspection: 1 hour per monitor at the rate of RM12 per hour
In addition, manufacturing support costs are applied to the job at the rate of RM5 per direct
labour hour. The company PROFIT MARGIN IS .
Required: a) Prepare job cost sheet for this job and determine cost per monitor
b) Calculate selling price per unit charged to each job if the company policy is to have a
profit mark-up of 30% of total costs.
Answer:
(a) Portland Electronics, Inc.: Job Cost Sheet
Customer: Video Shack
Product: Computer Monitors, 1,000 units
RM
Direct material
Part A327
Part B149
Total direct material cost
Direct labor
Assembly
Inspection
Total direct labor cost
Support costs
7,000 Direct labor hours
@ RM5 per hour
Total cost
Number of units produced
(b) Cost per monitor
33
Batch costing
What is it?
A form of costing which applies where quantity of identical products are manufactured as a
batch
Occurs when customer orders a quantity of identical items or when an internal
manufacturing order is raised for a batch of identical parts, subassemblies or product to
replenish stocks
In general, the procedure are similar to job costing
On completion of the batch the cost per unit can be calculated by dividing the total batch
cost by the number of good units produced
Job Order Costing Batch Costing
Production Each product is produced according
to job requirement i.e. customer
demand
Mass production
Production
requirements
Each product is unique All units has same general features
Costs & Costs
Objects
Costs measured for individual job Costs measured for individual unit
(after calculating total cost for the
batch)
34
TOPIC 6: PROCESS COSTING
Learning Objectives
After learning this subject, students will be able to:
Describe process costing
Explain the differences between job order costing & process costing
Know the treatment for normal losses, abnormal losses and abnormal gains
Calculate the equivalent unit concept
Valuing the work-in-progress using FIFO and WACO method
Preparing the Process Account with opening WIP only
What is Process Costing
"The costing method where goods or services result from a sequence of continuous or repetitive
operations or processes. Costs are averaged over the units produced during the period, being
initially charged to the operation or process"
a costing method that computes & allocates an equal amount of costs to each product (ie
average amount/cost per unit)
a system for determining job costs in which conversion costs are applied to products as they
pass through successive process stages
accumulated departmental costs are assigned to all units that flowed through that department
during the period (Raiborn, Barfield & Kinney, 1999)
could also be described as having to:
1) identify costs of material inputs required at various stages
2) add estimated conversion costs for all process stages to the material costs
3) divide by the number of units produced during that particular period
35
The differences between job order costing and process costing
Job Costing Process Costing
Production Many different jobs; usually small
batches of either single units, or
batches of units (unique & high
cost)
Continuous or mass production;
large volume (identical, low cost)
Production
requirements
Jobs built to customer order Units continuously produced for
inventory in automated process.
Costs & costs
objects
Costs accumulated by the job
Costs measured for individual
Costs accumulated by department
or process
Costs measured for individual
Variances Between actual & estimated costs
are determined for individual jobs
Between actual & estimated costs
are determined for individual
process stages
Others Processes may also produce:
joint products, or
by-products
Normal losses, abnormal losses and abnormal gains
Losses in processing materials could be due to:
evaporation, residuals, ash(powder/dust)
unavoidable handling, breakage and spoilage losses
withdrawal (goods taken) for testing and inspection
The treatment...
Normal process losses Abnormal process losses/ gains
Nature of losses In accordance with normal
practice
Above expectation, cannot be foreseen
The amount above the normal process
losses
Causes Could not be avoided, part of x : Plant breakdown, industrial
Direct materials, Direct labor, Overhead
Job 100 Job 101 Job 102
FinishedGoods
Cost ofGoods Sold
Job Costing
WIP ChoppingDepartment
WIP Mixing & BottlingDepartment
FinishedGoods
Cost ofGoods Sold
Process Costing
Direct materials, Direct labor, Overhead
36
Cost per unit (CPU) = Total process cost incurred during period
Total units processed during period
Cost per unit (CPU) = Total process cost incurred during period
Units completed + Equivalent units in process
the process result accidents, inefficient working or
unexpected defects in materials
: unexpected favourable conditions
Costs treatment
Cannot be
covered from
sales of defects
Could be covered
from sales of
defects
include in total production
costs
exclude from total
production costs
all abnormal losses or gains should
be excluded from total production
costs
The equivalent unit concept
Cost per unit (CPU)
In process costing ;
All costs, direct and indirect, incurred during the period are charged to each process
so that a total process cost for each is obtained.
The total process cost of each process is then shared equally among all the cost units
processed in the process. the basic process costing formula, therefore, is:
Illustration 1:
Total process cost incurred in processing 1,000 units of bicycle is RM600,000., the CPU
would be;
Cost per unit = RM600,000/1,000 units
=RM600
Equivalent units
Where discrete units (physically separate) are involved it is rare for every unit in a
process to be fully process by the end of the period. It might be some units are still in
process and so the number of units processed in the basic formula must include an
allowance for these as some of the process costs were incurred in their partial processing.
This allowance is made by adding to the units fully processed an equivalent units figure
which is computed by the formula:
37
Illustration 2:
Using the Illustration 1 information, assume that of the 1,000 units, 600 are complete and
400 are in process (50 per cent complete). Then:
Equivalent units in process = 400 x 50% = 200
Therefore total equivalent production = 600 + 200 = 800 units
CPU = RM600,000/800 units = RM750
Treatment of previous process costs
In process costing, units pass through a number of processes in sequence. Therefore, many
process start with units from a previous process. Thus, the cost should also be brought into
the figures of the new process, and treat such a cost as a separate cost element termed
‗previous process‘ and restrict the term ‗materials‘ to material added to production during
processing.
The degree of completion is always 100 per cent, since it is that part of the unit cost relating
to the cost of previous operations which, clearly, must be fully complete.
Notes:
In consideration of the degree of completion of any units in process, we may well find
that the degree differs according to the cost elements.
For instance, is one is baking a cake, then just before it is put in the oven the cake may
well be complete as regards all material, nearly complete as regards of labour, but only
started as regards overheads since the oven heating costs will be the largest part of this
element.
Therefore, it is necessary to treat cost elements separately and calculate a cost-per-unit
figure for each element.
Illustration 3:
Assume that RM600,000 illustrative cost was made up of: materials RM120,000; labour
RM300,000; overhead RM180,000. 600 units are complete and the 400 in process are 75%
complete in materials; 50% in labour and 25% in overheads. The total cost per unit is shown
as per table below;
Cost
elements
Costs
(RM)
Completed
units
WIP equivalent
units
Total
equivalents units
produced
CPU
(RM)
Materials 120,000 600 400 x 75% = 300 600 + 300 = 900 133.33
Labour 300,000 600 400 x 50% = 200 600 + 200 = 800 375.00
Overheads 180,000 600 400 x 25% = 100 600 + 100 = 700 257.14
Total 600,000 Total cost per
unit
765.47
38
Now, Assume that 1,000 units were transferred from previous process at a cost of RM600 a unit.
This element will appear in the computations as follows:
Cost
elements
Costs
(RM)
Completed
units
WIP equivalent
units
Total equivalents
units produced
CPU
(RM)
Previous
process
600,000 600 400 x 100% = 400 600 + 400 = 1,000 600.00
Materials 120,000 600 400 x 75% = 300 600 + 300 = 900 133.33
Labour 300,000 600 400 x 50% = 200 600 + 200 = 800 375.00
Overheads 180,000 600 400 x 25% = 100 600 + 100 = 700 257.14
Total 1,200,000 Total cost per
unit
1,365.47
Beginning and ending WIP of uncompleted units
Issue:
When opening WIP exists, an assumption must be made on allocating the opening stock to
the current accounting period to determine the unit cost for the period
Two alternatives:
1. WACO: Opening WIP is merged with the units introduced in the current period and can
no longer be identified separately
2. FIFO: Assume that the opening WIP is the first group of units to be processed and
completed during the current month
Example (Page 170-Example 6.3):
The Baltic Company has two processes, X and Y. Material is produced at the start of
Process X, and an additional material is added to process Y when the process is 70%
complete. Conversion costs are applied uniformly throughout both processes. The
completed units of process X are immediately transferred to process Y, and the completed
production of Process Y are transferred to finished goods stock. Data for the period include
the following:
Process X Process Y
Opening WIP 6000 units 60% converted,
consisting of materials
RM72,000 and conversion
costs RM45,900
2000 units 80% converted,
consisting of previous
process cost of RM91,800,
materials RM12,000 and
conversion costs RM38,400
Units started during the
period
16,000 units 18,000 units
Closing WIP 4,000 units ¾ completed 8,000 units ½ completed
Material costs added
during the period
RM192,000 60,000
39
Conversion costs added
during the period
RM225,000 259,200
Required:
Using WACO and FIFO method;
a) Prepare relevant computations for equivalent units and cost per unit with regard to
previous process, materials and conversion costs.
b) Show your computations for the value of WIP.
c) Prepare the process account.
i) Weighted Average method:
Process X
Cost
element
Opening
WIP
(RM)
Current
cost
(RM)
Total
cost
(RM)
Completed
Units
WIP
equivalent
units
Total
equivalent
units
Cost per
unit
(RM)
Materials 72,000 192,000 264,000 18,000 4,000 22,000 12.00
Conversion
costs
45,900 225,000 270,900 18,000 3,000 21,000 12.90
117,900 534,900 24.90
Value of WIP:
Materials (4000 units at RM12) 48,000
Conversion (3000 units at RM12.90) 38,700 86,700
Completed units (18000 at RM24.90) 448,200
534,900
Process X account
Opening WIP b/d 117,900 Completed
production
transferred to
process Y
448,200
Materials 192,000 Closing WIP c/d 86,700
Conversion cost 225,000
534,900 534,900
Opening WIP b/d 86,700
40
Process Y
Cost
element
Opening
WIP
(RM)
Current
period
cost
(RM)
Total
cost
(RM)
Completed
units
WIP
equivalent
units
Total
equivalent
units
Cost
per
unit
(RM)
Previous
process
cost
91,800 448,200 540,000 12,000 8,000 20,000 27.00
Materials 12,000 60,000 72,000 12,000 - 12,000 6.00
Conversion
costs
38,400 259,200 297,600 12,000 4,000 16,000 18.60
142,200 909,600 52.60
Value of WIP:
Previous process cost (8000 units at RM27) 216,000
Materials -
Conversion cost (4000 units at RM18.60) 74,400 290,400
Completed units (12000 units at RM51.60) 619,200
909,600
Process Y Account
Opening WIP 142,200 Completed
production
transferred to
finished stock
619,200
Transferred from
process X
448,200 Closing WIP c/d 290,400
Materials 60,000
Conversion costs 259,200
909,600 909,600
Opening WIP b/d 290,400
41
ii) FIFO
Process X
Cost element Current
period costs
(RM)
Completed
units (-)
opening WIP
equiv. units
Closing
WIP
equiv.
units
Current total
equiv. units
Cost per unit
Materials 192,000 12,000
(18,000 –
6,000)
4,000 16,000 12.00
Conversion
costs
225,000 14,400
(18,000 –
3,600)
3,000 17,400 12.93
417,000 24.93
Completed production:
Opening WIP 117,900
Materials (12000 units at RM12) 144,000
Conversion costs (14400 units at RM12.93) 186,207 448,107
Closing WIP:
Materials (4000 units at RM12) 48,000
Conversion cost (3000 units at RM12.93) 38,793 86,793
534,900
Process Y
Cost element Current
period costs
(RM)
Completed
units (-)
opening WIP
equiv. units
Closing
WIP
equiv.
units
Current total
equiv. units
Cost per unit
Previous
process cost
448,107 10,000
(12,000 –
2,000)
8,000 18,000 24.8948
Materials 60,000 10,000
(12,000 –
2,000)
- 10,000 6.00
Conversion
costs
259,200 10,400
(12,000 –
1,600)
4,000 14,400 18.00
767,307 48.9848
42
Cost of completed production:
Opening WIP 142,200
Previous process costs (10,000 units at RM24.8948) 248,948
Materials (10,000 units at RM6) 60,000
Conversion costs (10,400 units at RM18) 187,200 638,348
Cost of closing WIP:
Previous process costs (8,000 units at RM24.8948) 199,159
Materials -
Conversion costs (4,000 units at RM18) 72,000 271,159
909,507
43
Pre- Lecture Questions
1. Process costing is
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. List three (3) differences between job costing and process costing
3. Losses in processing material may cause by;
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
4. Kadlawo Sdn. Bhd. is manufacturing variety of wedding card. The process cost incurred to
produce 5,000 units of the wedding cards is RM10,000. The cost per unit would be;
5. ABC Company produces 1,000 units of lollipop and the cost to produce the lollipop is
RM600. The cost was made up of: materials RM120; labour RM300; overhead RM180. 600
units are complete and the 400 in process are 75% complete in materials; 50% in labour and
25% in overheads. Complete the table below in order to get the total cost per unit;
Cost
elements
Costs
(RM)
Completed
units
WIP equivalent
units
Total
equivalents units
produced
CPU
(RM)
Materials
Labour
Overheads
Total Total cost per
unit
44
Selling and
Administration
expenses
Expenses for
the period
Fixed
manufacturing
overhead
Variable
manufacturing
overhead
Direct
material and
Direct labour
Work in process
inventory
Cost of goods
sold
Closing
inventories
TOPIC 7: ABSORPTION AND MARGINAL COSTING
Learning Objectives
At the end of this lecture, students should be able to:
Define Absorption Costing and Marginal Costing.
Explain the differences between absorption costing and marginal costing.
Explain the impact on stock valuation & profit under each costing system.
Prepare multi-period absorption and marginal costing profit statements.
Definition of Absorption Costing and Marginal Costing
Absorption costing (also known as full costing) traces all manufacturing costs to products
and treats non-manufacturing overheads as a period cost.
Marginal costing traces all variable costs to products and treats fixed manufacturing
overheads and non-manufacturing overheads as a period cost.
Therefore, marginal and absorption costing differ in the treatment of fixed manufacturing
costs.
Differences between Absorption Costing and Marginal Costing
Flow of costs under Absorption Costing and marginal Costing
ABSORPTION COSTING (FULL COSTING)
PERIOD COST PRODUCT COSTS
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Selling and
Administration
expenses
Expenses for
the period
Fixed
manufacturing
overhead
Variable
manufacturing
overhead
Direct
material and
direct labour
Work in process
inventory
Cost of goods
sold
Closing
inventories
MARGINAL COSTING (VARIABLE/DIRECT COSTING)
PERIOD COST PRODUCT COSTS
Absorption Costing Marginal Costing
Product cost All manufacturing costs (Direct
expenses & marginal + fixed
manufacturing overhead
Direct expenses + marginal
manufacturing overhead
Period cost Non-Manufacturing cost Fixed Manufacturing overhead + Non-
Manufacturing costs
Which method should be used?
i) External reporting use absorption costing
– Match costs against revenues.
– In accordance with generally accepted accounting principles in which fixed
manufacturing overhead is accounted for as a product cost.
ii) Internal reporting debatable both useful in different ways
Absorption costing
o Absorption Costing does not understate the importance of fixed costs.
o Absorption Costing avoids fictitious losses being reported.
o Fixed overheads are essential for production and thus should be allocated to units
produced and included in the inventory valuation.
o To be consistent with external reporting.
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Marginal costing
o Marginal Costing provides more useful information for decision-making. (the
analysis of marginal and fixed costs is highlighted)
o Marginal Costing removes from profit the effect of inventory changes. Profit is
closely tied to changes in sales levels (not production levels), and therefore provides
a more realistic assessment of the company‘s performance.
o Marginal Costing avoids fixed overheads being capitalized in unsaleable stocks.
Illustration 1:
XYZ Company manufactures a product, called Rota. Relevant data for Rota are as follows.
Selling price RM20 per unit
Units Produced 30,000; sold 20,000; beginning inventory zero
Marginal unit costs Manufacturing RM9 (direct materials RM5, direct labour RM3, and
marginal overhead RM1)
Selling and administrative expenses RM2
Fixed costs Manufacturing overhead RM120,000
Selling and administrative expenses RM15,000
Required:
Calculate the per unit manufacturing cost under absorption costing and marginal costing.
Solution:
Absorption costing:
Manufacturing cost per unit = (manufacturing overhead/units produced) + Marginal unit costs
= (RM 120 000/30 000 units) + RM 9
= RM 13
Marginal costing:
Manufacturing cost per unit = RM 9
Impact on stock valuation & profit
Production = sales Absorption costing = Marginal costing
– No closing stock, no fixed manufacturing costs are deferred to future periods using
absorption costing.
Production > sales Absorption costing > Marginal costing
– There are units produced that become closing stock.
– AC: Fixed manufacturing costs are deferred to future periods as part of closing stock.
Closing stock ↑ as FOH included higher closing stock ↑
– MC: Fixed manufacturing costs are expensed in the current period, therefore, are not
deferred to future periods through the closing stock. Closing stock ↓ as FOH NOT
included higher closing stock ↓
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Production < sales Absorption costing < Marginal costing
– Part of the units sold covered by opening stock.
– AC: Opening stock ↑ because FOH from previous period are charged in current period
↓
– MC: No FOH in opening stock, opening stock ↓↑
Problems under Absorption Costing
– Profit decreases even though sales increase with selling price and cost structure unchanged.
– Why? Due to under/over recovery of FOH.
Absorption and Marginal Costing Profit Statement
Income Statement Formats
i) Absorption Costing:
<company name>
Income Statement
for the <period> ended dd/mm/yyyy
Sales XXX
Less: Cost of Goods Sold:
Opening stock XXX
Total production cost XXX
XXX
Closing stock (XXX)
Cost of goods sold (XXX)
Gross profit XXX
Non-manufacturing overheads/expenses (XXX)
XXX
Adjustments for (Under)/Over recovery of overheads (XXX)
Net Profit/ Loss from operations XXX
** Under/over recovery of fixed overheads occurs whenever actual production differs from the
budgeted activity level.
Illustration 2:
Veer Limited manufactures a single product, the budgeted selling price and marginal cost details
of which are as follows:
RM
Selling price 15.00
Marginal costs per unit:
Direct materials 3.50
Direct labour 4.00
Marginal overhead 2.00
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Budgeted fixed overhead costs are RM60,000 per annum, charged at a constant rate each month.
Budgeted production is 30,000 units per annum.
In a month when actual production is 2,400 units and exceeded sales by 180 units the profit
reported under absorption costing was __________.
Solution:
RM RM
Sales [ RM15 x (2,400 – 180) ] 33,300
Less: Cost of Goods Sold:
Opening stock -
Total production cost (RM11.50 x
2,400) 27,600
27,600
Closing stock (RM11.50 x 180) (2,070)
Cost of goods sold (25,530)
Gross profit 7,770
Under absorption of overhead (W1) (200)
Net Profit 7,570
(W1) Absorbed 2,400 x RM2 = RM4,800
Actual 60,000/12 = RM5,000
Under-absorbed (RM200)
ii) Marginal Costing:
<company name>
Income Statement
for the <period> ended dd/mm/yyyy
Sales XXX
Marginal costs:
Opening stock XXX
Marginal production costs XXX
XXX
Closing stock (XXX)
XXX
Marginal selling and administrative expenses XXX
Total marginal expenses (XXX)
Contribution margin XXX
Fixed costs:
Manufacturing overhead XXX
Selling and administrative expenses XXX
Total fixed expenses (XXX)
Net Profit/ Loss from operations XXX
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The Concept of Contribution Margin
Contribution margin (CM) is the excess of sales revenues over marginal costs.
In other words, CM is the amount available to cover the fixed costs, once they are covered,
any remaining amounts adds directly to the income from the operations.
Illustration 3:
Sales RM 1,000,000
Marginal costs 600,000
CM 400,000 Available to cover the FC of RM300,000.
Fixed costs 300,000
Income from operations 100,000
(Notes: think of the fixed costs as a bucket and the CM is water filling the bucket. Once the
bucket is filled, the overflow represents income from operations. Up until the point of
overflow, however, the CM contributes to fixed costs (filling the bucket)).
Illustration 4:
The following information is available for periods 1 –6 for a company that produces a single
product:
RM
Unit selling price 10
Unit variable cost 6
Fixed costs for each period 300 000
Normal activity is expected to be 150 000 units per period, and production and sales for each
period are as follows:
Period 1 Period 2 Period 3 Period 4 Period 5 Period 6
Units sold 150 000 120 000 180 000 150 000 140 000 160 000
Units produced 150 000 150 000 150 000 150 000 170 000 140 000
There were no opening stocks at the start of period 1, and the actual manufacturing fixed
overhead incurred was RM 300 000 per period. Assume that non-manufacturing overheads are
RM 100 000 per period.
Required:
Prepare the profit statement for each period using
(i) Absorption costing
(ii) Marginal costing
Contribution margin = Sales – Marginal costs
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Solution:
i) Absorption Costing Statements
Period 1
(RM‘000)
Period 2
(RM‘000)
Period 3
(RM‘000)
Period 4
(RM‘000)
Period 5
(RM‘000)
Period 6
(RM‘000)
Opening stock - - 240 - - 240
Production
cost 1200 1200 1200 1200 1360 1120
Closing stock - (240) - - (240) (80)
Cost of sales 1200 960 1440 1200 1120 1280
Adjustment
for
under/(over)
recovery of
overhead
- - - - (40) 20
Total costs 1200 960 1440 1200 1080 1300
Sales 1500 1200 1800 1500 1400 1600
Gross profit 300 240 360 300 320 300
Less: Non-
manufacturing
costs
100 100 100 100 100 100
Net profit 200 140 260 200 220 200
ii) Marginal costing statements
Period 1
(RM‘000)
Period 2
(RM‘000)
Period 3
(RM‘000)
Period 4
(RM‘000)
Period 5
(RM‘000)
Period 6
(RM‘000)
Opening stock - - 180 - - 180
Production
cost 900 900 900 900 1020 840
Closing stock - (180) - - (180) (60)
Cost of sales 900 720 1080 900 840 960
Fixed costs 300 300 300 300 300 300
Total costs 1200 1020 1380 1200 1140 1260
Sales 1500 1200 1800 1500 1400 1600
Gross profit 300 180 420 300 260 340
Less: Non-
manufacturing
costs
100 100 100 100 100 100
Net profit 200 80 320 200 160 240
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Pre-Lecture Questions
1. Define Absorption costing and Marginal costing
2. In order to determine the product cost,
Absorption costing
Marginal costing
3. JKL Company manufactures a product, called Product MNO. Relevant data for Product
MNO are as follows:
Selling price RM 50 per unit
Units Produced 50,000; sold 40,000; beginning inventory zero
Marginal unit costs Manufacturing RM25 (direct materials RM10, direct labour RM9, and
marginal overhead RM6)
Selling and administrative expenses RM5
Fixed costs Manufacturing overhead RM150,000
Selling and administrative expenses RM18,000
Required:
Calculate the per unit manufacturing cost under absorption costing and marginal costing.