All About Costing

Costing Methods


By "Costing Method" mean the procedure adopted to ascertain costs. The Method adopted would be dependent on the circumstances in which accounting is required to be made which is dependent on the product being manufactured and the nature of the industry making the product.

Depending on the nature of the business i.e. the type of the product made and the procedure adopted to make it, all the different costing methods are classified

1. Input Units
The units that are introduced at the stare of the process in the form of raw material. {Here for example 400 units.}

2. Actual Output
The output that is actually achieved after the production. Normally in questions it gives a percentage of output that would be achieved after process.

3.Normal Loss
Normal loss is that which is uncontrollable it must be occurred during the production. For example the shrinking of units in some process is normal loss.

Number of methods for calculating the loss. It is always calculated on the input.
{Here it would be 40 units (10% of input ⇒ 400 units × 10% = 40 units)}

4. Normal Output
The output that we obtained after the process under normal conditions.
[Normal Output = Gross Input − Normal Loss]
{Here it would be 360 units (400 units − 40 units)}

5. Abnormal Loss
The loss that is occurred due to inefficiency. This is controllable loss.

Method of calculating of Abnormal Loss
["Abnormal Loss" = "Normal Output" − "Actual Output"]
{Here, Normal Output (360 units) = Actual Output (360 units),
⇒ There is no abnormal loss.}

Calculation of Absorption Rate:

Production Overhead is absorbed on the bases of percentage of direct labor.

Calculation of Rate of Production Overhead= (Total Production Overhead/ Total Direct Labor Cost)*100
Suppose,
We have Total Production Overhead is Rs. 7000 and Total Direct Labor Cost is Rs. 7000 then,
Apply the above formula and we get the absorption rate,

                                                                 (7000/7000)*100
                                                                = 100%
Production Overhead is 100% of Direct Labor
Now cosider the previous exemple and apply the rate on that labor cost

Process I = Rs. 2200*100%
               = Rs. 2200

Process II = .Rs. 3500*100%
                =  Rs 3500

Process III = Rs. 1500*100%
                  = Rs. 1500

In process account the Dr. side is filled with the same input value in simple process account. The Cr. side is filled after the appropriation of  output. e.g

Dr                                                                                                                              Cr.

Particular         Quantity      Value           Particular                   Quantity          Value
                           in units         Rs.                                                  in units             Rs.

To Material          400              2,700           Output                           360                11,980
To Labor                                 2,200            Normal Loss                  40                   120
To Production
Overhead                                7,200
Total                   400             12,100                                               400                  12,100

There are two type of losses which are

Normal Loss

The loss of input/output where it is uncontrollable is normal loss. It must be occurred in production process.
Normal losses normally expressed in exact terms (like 60 units) or in proportionate terms (like 1/10th) or in percentage terms (like 5%).
In problem solving, where no specific mention is made, the loss is calculated based on gross input.

Abnormal Loss

The loss which is controllable and occur due to the inefficiency, negligence or poor control during the production.
It is calculated by "Abnormal Loss Units" = "Normal Output Units" − "Actual Output Units"

Consider the following example:


In such a situation, the cost incurred for getting an output of 800 units (900 - 100) can be interpreted in the following ways:

The cost incurred for 800 units is Rs. 80,000 (800 × 100)
The cost incurred for 800 units is Rs. 1,00,000 being the total cost incurred.

This would result in the unit output cost working out to Rs.125 (1,00,000 ÷ 800)
The cost incurred for 800 units is Rs. 99,900 (1,00,000 − 100) being the total cost incurred reduced by the amount realized on selling the loss units.

This would result in the unit output cost working out to Rs.124.88 (99,900 ÷ 800)

Where the loss is normal, this will give an idea about future transaction if the same production requirement..

Therefore the amount to be spent would be equal to the total cost relevant to 900 units i.e. Rs. 1,00,000.

The loss units are capable of being sold for Rs. 1/unit, every time such loss occurs. Thereby, the cost incurred can be set off always by using this realization. Rs. 100 for 100 units.

Thus, the net cost to be incurred for getting an output of 800 units is Rs. 99,900 (Rs. 1,00,000 − Rs.100)

Total Cost is debited to the Process a/c. Value of normal loss is deducted from the total cost to obtain the normal cost.

Deducting from the debit side item is the same as Crediting the Item.

Therefore, "Normal Loss" both in terms of units and value is recorded by

Cr. "Process " a/c and
Dr. "Normal Loss a/c"

The units are also shown along with it in the relevant column.

Suppose the following example:


In such a situation, the cost incurred for getting an output of 800 units (900 - 100) can be interpreted in the following ways:

The cost incurred for 800 units is Rs. 80,000 (800 × 100)
The cost incurred for 800 units is Rs. 1,00,000 being the total cost incurred.

This would result in the unit output cost working out to Rs.125 (1,00,000 ÷ 800)
The cost incurred for 800 units is Rs. 99,900 (1,00,000 − 100) being the total cost incurred reduced by the amount realised on selling the loss units.

This would result in the unit output cost working out to Rs. 124.88 (99,900 ÷ 800)

Where the loss is abnormal, the first idea would be the most appropriate one for deciding the cost per unit of output.

This would give an idea how much would we be required to spend if we are to produce an output of 800 units again. If the loss is abnormal in nature, we need not assume its occurrence every time. Simply we introduce only 800 units the next time we need the 800 units of output.

Therefore the amount to be spent for getting an output of 800 units would be equal to the total cost relevant to 800 units i.e. Rs. 80,000.

Normal loss with no scrap value: 

During the process certain losses are ineharent and cannot be eliminated. For example, liquid may be evaporate. These losses occur under efficient operation and are unavoidable. They are referred to as normal or uncontrollable losses. Because they are an inherent part of the production process normal losses are absorbed by the good production. Where normal losses apply the cost per unit of output is calculated by dividing the costs incurred for a period by the expected output from the actual input for that period. For example,
Actual input is 10,000 liters at a cost of Rs. 120,000 and normal loss is 1/6th of the input. Therefore the actual output is 10,000 liters so that the per unit cost is Rs. 12 (120,000/10,000 liters). Actual output is expected output so there is neither an abnormal loss or gain.

Abnormal Gain With No Scrap Value:
In process the actual loss may be less than the expected loss then this will be a abnormal gain. For example the expected output is 10,000 liters for an input of 12,000 liters but the actual output is 11,000 liters resulting in an abnormal gain of 1,000 liters.We are assuming for this case that the normal loss does not have a scrap value. Our objective is to find the cost per unit of expected output. The calculation of the cost per unit of normal output is the same as we see in normal case. Like this,

                                   input cost (Rs. 120,000) / expected output (10,000 liters)
                                                        = Rs. 12 per liter

The value of the gain is calculated in the same way as the abnormal loss and removed from the process account by debiting the account and crediting the abnormal gain account. The entry in the process account is like this,

                                                      Process Account

Particular      Liters     Unit cost     Total          Particular      Liters     Unit cost      Total
                                         Rs.          Rs.                                                    Rs.           Rs.

Input cost       12,000         10         120,000         Normal loss    2,000            -                -
Abnormal                                                           Output            11,000         12          132,000
gain               1,000            12         12,000

Total                                              132,000                                                              132,000

a. Contracting: Partly completed jobs valued at total cost up to the stated period and including, in case of long-term contracts, a percentage of the profit.
b. Manufacturing: Partially completed goods, parts, or subassemblies that are no longer part of the raw materials inventory and not yet part of the finished products inventory. Work in process inventory forms a part of the working or current assets of a firm and is valued usually at lower of cost and realizable value. Also called work in progress, goods in process.

Inventories are three kinds (a) Raw Materials, (b) Work-in-Progress and (c) Finished Goods.

Inventory at any stage, it would be treated as an asset at the time of assessing the value of assets and liabilities of the organization.
All these inventories are considered as a part of Closing Stock. Since Closing Stock is treated as an asset and it is shown on the assets side of the balance sheet.
a. Valuation of Assets:
The expenses that are incurred to bring the asset into useful condition include in the value of asset.
The above expenditure is called Capitalizing Expenses
Examples:
The expenditure incurred on installation of new machinery..
Expenditure of renewal to bring the second hand machine bring into working condition.

These expenditure may be treated as revenue in normal course of action. But due to occurred to bring the asset in working condition during the period so they are treated as part of the value of an assets.

As we know that inventories are an asset. Same principle is applied for valuation of inventory as apply for an asset. The cost incurred for bringing the inventory into working condition is the part of value of inventory.

These expenses that form the part of the value of inventory would be different for the three different types of inventory.

Raw Materials:
When the raw material is ready for using in production is called useable condition. Thus, all the expenses incurred before bringing the raw material to the actual production environment would have to form part of the value of raw materials.
It is impossible to find out the all expenses which will be part of value of raw material. Only certain expenses are possible to include in the value of raw material. Any expenses relating to storage and carriage from the stores to the production environment are thus ignored for valuing raw materials.

The closing work-in-progress of a period becomes the opening work-in-progress in the next period.
There is no need to prepare the Statement of Equivalent Production when closing stock is not existed.
Opening work in progress would be an additional input that enters into the production process apart from the other inputs that might be received from the previous process or entered directly in the current process.
More clear with practical example,


Example: