MGT Accounting for PGDBA by Moses Bukenya1 COSTING METHODS BY BUKENYA MOSES Lecturer Dept of Accounting, FOC, MUBS or Mobile:

MGT Accounting for PGDBA by Moses Bukenya2 Costing systems Interlocking Vs integrated costing systems Under the interlocking system, cost accounts have no double entry connection with financial accounts although they use the same data. Thus the cost ledger and financial ledger are maintained differently. Differences in the profits are usually reconciled. The integrated system is a single set of accounts producing both financial and cost information. Cost and financial accounting profits are the same. Thus no need of reconciliation.

MGT Accounting for PGDBA by Moses Bukenya3 Costing methods Ways used to determine costs of jobs or products in a manner suited to the production requirements of the product. Two broad categorizations Specific order job costing Continuous/operation costing.

MGT Accounting for PGDBA by Moses Bukenya4 FACTORS TO CONSIDER IN CHOOSING A COSTING METHOD Place of the job Time requirement of the job Production process of the job Nature of the out-put

MGT Accounting for PGDBA by Moses Bukenya5 SPECIFIC ORDER JOB COSTING Used where the job is identifiable and distinguishable from start to completion. Job identification numbers are used to distinguish jobs. Can be further sub divided into; Factory job costing Batch costing Contract costing

MGT Accounting for PGDBA by Moses Bukenya6 FACTORY JOB COSTING Used when the job has the following X-tics: Done on customers order and specifications Done in house (factory, work shop, saloon, etc.) Takes a short time to complete the job The job is unique The cost of the job is obtained by aggregating direct materials costs, direct labour costs and absorbed/recovered overheads. All costs incurred on the job are captured in the Job card. The Card indicates the Job Number, the Job description, the quantity required and all the costs incurred to complete the Job.

MGT Accounting for PGDBA by Moses Bukenya7 BATCH COSTING A batch is a group of identical items Batch costing is a form of specific order job costing used where the job is characterized by: Off the shelve production Several identical units (batch) treated as a single job In house production Takes short time to complete Unit cost is obtained by dividing net production costs by the batch size Bread and Brick baking fall under this category.

MGT Accounting for PGDBA by Moses Bukenya8 CONTRACT COSTING A form of specific order job costing used where the job is of construction nature and; Done on the site e.g. dam building & road construction Takes considerably long time to complete Done on customers order and specifications There is progress payment based on the architects certificate The job is unique for each customer There is retention money Retention money refers to the proportion retained by the contractee as security for the contract being completed

MGT Accounting for PGDBA by Moses Bukenya9 Terms Specific to contract costing ‘Contractee’ is the person whose contract work is being done. ‘Contractor’ is the person undertaking to do the contract job. ‘Cost to date’ refers to costs incurred from start of contract to bringing the work to its current level of completion ‘Cost of work certified’, is the cost for doing the work the architect certified ‘Cost of work not certified’, is the cost of work done since the surveyor was last on the site and therefore with no certificate issued ‘Notional profit’, is the difference between certificate value and cost of work certified. ‘Further costs to completion’ are additional costs expected to be incurred to get the contract completed. ‘Contract price’ is the amount agreed to be paid by contractee to contactor for the contract work.

MGT Accounting for PGDBA by Moses Bukenya10 Problems in contract costing Determination of profits as work may cut across several years (long-term contracts) Treatment of progress payments, this is because these are not commensurate to work done. Valuation of work in progress (construction cost is preferred).

MGT Accounting for PGDBA by Moses Bukenya11 Profit determination There are two approaches i.e. The completed contract approach in which no profits are taken until the contract is completed. This approach is misleading when used in long term contracts as there are no profits matched with costs in the earlier years of the contract The Percentage of completion approach; where the percentage of completion is ascertained using either the physical approach, costs proportion approach or certificate value/ cash received approach.

MGT Accounting for PGDBA by Moses Bukenya12 Profit determination The percentage of completion is used to avoid wide fluctuations in annual profits. The following formulae are then used Profit (л) = Cost to date X Estimated contract profit Total estimated contract cost Profit (л) = Certificate Value X Estimated contract profit Contract price Profit (л) = Cash received X Estimated contract profit Contract price Estimated contract profit is sometimes referred to as notional profit.

MGT Accounting for PGDBA by Moses Bukenya13 Profit determination Note that: Estimated contract profit = Contract price – estimated total contract costs When the contract is in the early stages (<25%) no profits are taken. When the contract is in its maturity take 2/3 of the Notional profit at the current level of completion. When the contract is nearing its completion, take the full proportion of the notional profit at the %ge of completion. When there are contract losses, these are charged in total to General P& L A/C Profit/loss for each contract is taken to general P&L a/c to determine company profits.

MGT Accounting for PGDBA by Moses Bukenya14 Structure of contract account Cost to date + notional profit –Value of work certified = cost of work not certified

MGT Accounting for PGDBA by Moses Bukenya15 Contractee account This appears in the contractors books Dr. with Certificate Value. Cr. With cash paid. The balance reflects amounts due from the contractee. More or less a debtors account.

MGT Accounting for PGDBA by Moses Bukenya16 Subcontracts The contractor can assign some work to sub contractors Examples include; Electrical and plumbing The amount paid to subcontractors is charged to the respective contract account.

MGT Accounting for PGDBA by Moses Bukenya17 EXAMPLE You are an accounts assistant of GEM contractors Ltd currently constructing a road. You are required to prepare a contract and the contractee accounts and indicate the profit to be recognized in the P & L A/C. {Hence determine the cost to-date} Bellow is a list of facts from the site manager;UGX (Millions) Contract price…………………………………………….600 Materials delivered to site………………………..…..130 Wages paid…………………………………………………30 Accrued wages ……………………………………...……20 Plant delivered to site………………………………… 350 Materials returned to HQs ……………………………… 5 Head office overheads…………………………………...15 Cash received…………….……………… … …..… 250 Value of work certified ………………………… At the end of the year the following items were on site Plant valued at ……………………………………………………………310 materials valued at ………………………………………………………..10 It is estimated that further cost to complete the contract is….150

MGT Accounting for PGDBA by Moses Bukenya18 Process Costing

MGT Accounting for PGDBA by Moses Bukenya19 Process Costing System An operation costing method used when costing units pass through clearly defined processes. Product or service cost is obtained by assigning costs to masses of uniform units of output. Conversion costs are costs that are applied uniformly in a department – including DL & OH costs Materials costs are assumed to be applied at discrete points in the production process Transferred costs are costs transferred from one department to another department

MGT Accounting for PGDBA by Moses Bukenya20 Process costing In short, it applies where production follows a series of sequential processes with the following distinctive features Standardized/ homogeneous products Mass production Final products are produced after a specific number of processes. An account is kept for each process Output of one process is input into another Costs are accumulated in processes i.e. all costs incurred to complete a process are debited to the process Cost per unit is the average process cost. Unit cost of the product = Total process cost Expected output

MGT Accounting for PGDBA by Moses Bukenya21 Process losses and gains Losses may be registered in process in form of normal and abnormal process losses. Normal loss refers to an expected loss that is unavoidable due to the nature of the production. It is caused by such factors as evaporation. The cost of normal loss is absorbed into good production and if the defective units can be sold for a reduced value, then the proceeds reduce the cost, Hence; Unit cost = Total process cost Less scrap value of normal loss Expected Good production

MGT Accounting for PGDBA by Moses Bukenya22 Process losses and gains Abnormal loss represents lost or damaged units under abnormal conditions. It is never foreseen and the main causes include defective materials, accidents etc. Abnormal loss occurs where actual loss is greater than normal loss and the units of abnormal loss are valued at the same rate as good production. Double entry would be; To recognize the loss value Dr. Abnormal loss A/C xx Cr. Process A/C xx Recognize the sales value of scrapped units Dr. Scrap debtors/receivables/bank a/c xx Cr. Abnormal loss A/c xx The balance in the abnormal loss accounts is charged to the P & L A/C as an expense.

MGT Accounting for PGDBA by Moses Bukenya23 Process losses and gains Cnt’d Abnormal Gain occurs where the actual loss is less than the expected normal loss. The difference between the actual loss and normal loss is the abnormal gain which is valued at the cost of good production. Double entry would be; To recognize the value of abnormal gain Dr. Process Account XX Cr. Abnormal Gain A/C xx Scrap as opposed to waste is the material that can not be used for its original purpose but can be sold at a much lower price than the cost. Process losses are usually reduced by the proceeds from scrap.

MGT Accounting for PGDBA by Moses Bukenya24 ILLUSTRATION a) Manufacture of a certain product requires two distinct processes numbered 1 & 2 and on completion, the product is passed on to finished goods stock. 200 units of raw material each at 25,000/= were issued to process 1 and the costs incurred were as follows. Required; a) Prepare process 1 and process 2 accounts b) Assume in the above example, that normal loss was expected at 5% of total inputs, and the actual output from process 1 was 180 liters, prepare process 1 and the loss accounts. Assume further that the scrap value of each unit was 5000/= prepare process 1 and the loss accounts. Cost elementProcess 1Process 2 Direct Materials500,0001,200,000 Direct Labor3,000,0002,000,000 Direct expenses280, ,000 Overheads4,500,0003,000,000

MGT Accounting for PGDBA by Moses Bukenya25 Process costing with WIP The work in process/progress represents uncompleted production in each process at the end of the accounting period. WIP is carried forward to the next accounting period. It consists of all cost inputs of the process There may be opening and closing WIP WIP is valued by determining the finished goods equivalent of incomplete units using either FIFO or WACO. For purposes of this course WIP computations are not examinable.

MGT Accounting for PGDBA by Moses Bukenya26 Service Costing It is a form of operation/continuous costing Used by companies which provide services rather than physical products Services may be for sale e.g. Transportation or hotel accommodation Services may also be in house such as maintenance. Determining a cost unit is the real problem in service costing & varies from firm to another. Cost per unit = Total cost of the period/No. of service units Seasonal demand variation for services causes costing and cost management problems especially in light of fixed costs when service capacity is not fully utilized.

MGT Accounting for PGDBA by Moses Bukenya27 “If you think education is expensive, try ignorance” Derek BokDerek Bok The object of education is to prepare the young to educate themselves throughout their lives. ~Robert Maynard Hutchins. Thank you