Accounting for product costs

1 Introduction

This chapter looks at how products are costed, depending on whether they are unique products or one of many identical products.

2 Job costing

Job costing is where a unique item is being made and costs can be specifically traced into that item.

The job could be large (such as building a house or a ship) or small (such as constructing a set of shelving for a room).

Often jobs are given identifying numbers, such as contract numbers or simply job numbers.

All relevant costs are labelled with that number and the total costs can be accumulated.

• Material costs: either invoices for specially bought material or requisitions from stores can be labelled with the job number so that material costs can be accounted for.
  

• Labour costs: time sheets can be filled in using the job number to track time spent on the job.
  

• Other expenses: if direct, then the job number will be noted against that cost; if indirect then expenses are often charged to a job on the basis of time and an overhead absorption rate.
  

3 Batch costing

In batch costing several identical items are produced as a batch. Each batch will be given a number so that costs can be traced into the batch. The batch costs can be averaged over the units produced.

4 Process costing - introduction

Process costing deals with manufacturing that takes place as a continuous process.

Examples of industries using process costing are:

• Oil refining
  

• Chemical works
  

Because work carries on continuously, there are no batches as creating a batch implies that you know when it starts and stops, and therefore what costs have gone into it.

In process costing, costs are worked out for periods: measure the costs that are used in a period and the output produced in the period and you have a way of working out the cost per unit.

Process costing – with losses

Many processes incur losses which are inevitable. For example, liquids evaporate or solids are filtered out. Therefore, the units of good output are often not the same as the units input.

Losses are of two kinds. A NORMAL loss is the loss the process is expected to suffer — it is unavoidable, so its cost is treated as part of the cost of the good output. An ABNORMAL loss (or gain) is the difference between the loss that was expected and the loss that actually happened, and it is NOT part of the cost of good output: it is written off, or credited, separately, so that management can see it.

If you can’t make units without some losses, then the cost of that loss is spread over (or absorbed) into the good units produced. The loss is just another cost on the way to good production.

Cost/unit = costs for the period/expected good output for the period

Sometimes the ‘lost’ material can be sold as scrap. For example, in a saw-mill, sawdust can be sold for various uses.

5 Abnormal losses and abnormal gains

The cost per unit of good output is ALWAYS worked out on the EXPECTED good output, and the normal loss is always valued at its scrap value (nil if it has none). Nothing about that changes when the actual result is different. What changes is that the process account will not balance on units, and the difference is the abnormal loss or abnormal gain.

• Abnormal loss: actual good output is LESS than expected. The shortfall is valued at the same cost per unit as good output and carried to an abnormal loss account, which is written off to profit or loss at the end of the period.

• Abnormal gain: actual good output is MORE than expected. The excess is valued at the same cost per unit and carried to an abnormal gain account, which is credited to profit or loss.

Note the point students most often get wrong: the normal loss is still recorded at its full expected quantity, even when the actual loss was smaller. An abnormal gain therefore also carries the scrap income that was expected but never earned, which is why the abnormal gain account is debited with that scrap value.

The $244 is written off to profit or loss.

The abnormal gain account is credited with $98 and debited with the scrap that was expected on those 20 units but never earned (20 @ $0.50 = $10), so $88 is credited to profit or loss.