MUBS: Makerere University Business School

[Costing systems]

COSTING SYSTEMS METHODS

Definition
Costing systems or Methods:
Ways designed to determine costs of jobs or products manufactured or services provided in the
manner suited to the production requirements or nature of production activities.
OR They are methods adopted to collect cost data of any business enterprise.
Definition _Cont
The method of costing that suits a drink manufacturer would not be appropriate for furniture making.
Therefore, a costing method is a way adopted to collect cost data basing on the way goods are
manufactured or the way services are provided
Basis of a costing system or method for an Organization
1. Nature of the products produced or services provided. Costing method for identical products is
different from that of non identical products. This is because the resources and processes required in each
case are not the same.
2. Stages products go through before it becomes a final product. Products subjected to a series of
stages, cannot have the same costing method like products which are not subjected to any
stages.
3. The time taken to process the products. The costing method should match with the duration of the
every product
4. The cost involved in installation and maintenance of the costing system. Systems required to
capture and analyze production costs do not have the same cost.
5. The volume of output involved. Identical and high volume outputs require a costing method different
from that for unique and single units produced according to customer requirements.
Categories of costing methods
Two broad categories are used;1. Specific order costing
2. Continuous operation or process costing method.
Specific order costing
The method involves the costing of different cost units or single units in form of jobs, contracts, or
batches.
Units are generally identifiable and distinguishable from one another and from the start to completion.
Therefore it is a method best suited to industries that produce specialized or made to order outputs.
Examples; - Furniture making, construction, motor garage, etc firms or enterprises.
Subdivisions of Specific order costing
a) Factory job costing
b) Batch costing
c) Contract costing
Continuous operational /Process costing
In this category, an average cost per unit is established for a number of identical cost units produced
during the period.
The key feature is the presence of a continuous series of processes or operations producing identical
or near identical products or services.
It is used in processing industries, like oil refining, food and drink manufacturers, mining and so on.
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When applied to services it is known as service costing.

Service costing is widely used in both private and public sector services.
For example; hospitals, transport, local authorities, education etc.

The procedure for Specific Order costing

Direct materials and labour are charged directly to the cost units.
Overheads must be charged first to cost centers then spread over the cost units by the absorption
process.
This procedure is necessary because the cost units (i.e. jobs, batches, and contracts) are all different.
Accordingly the individual amounts of materials and labour in the jobs and the varying times spent
producing them or their varying usage of activities must be reflected in the product cost.
Factory job costing
It is a form of specific order job costing used where the job is characterized by;
Done in the house (factory, work shop, saloon, parlor)
Takes short time to complete.
A Job in this case may be; - product, batch, project, contract
Jobs move through processes and operations as continuously identifiable units.
The job identification numbers are used to distinguish jobs.
Each customer order is unique i.e. depends on customers specifications.
Job costing suitable to the following industries; Contractors,
Builders,
Garages,
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[Costing systems]

Jobbing engineers,
Accountancy firms
Etc.
Objectives of job costing
The main objective of job costing is to determine the total cost of a particular job.
To help management in controlling costs by comparing the actual costs with the estimated costs.
Enable management detect those jobs which are more profitable and those which are unprofitable.
Provide a basis for determining the cost of similar jobs undertaken in future. Thus helps in future
production planning.
Cost of each job/order is ascertained separately - helping management to find out the profit or loss on
each individual job.
Advantages of Job costing
More accurate costing is possible because all costs are compiled and specifically identified with a
specific order or product.
It helps in identifying profitable and unprofitable jobs since each job is specific.
It provides a basis for comparing one job cost to another or for comparing a job cost sheet to a cost
estimate.
It helps in preparation of estimates when submitting quotations for similar jobs.
Job cost sheets can be used to control efficiency and estimate future work.
Disadvantages of Job costing
It requires a detailed record of documents and accounts because each job requires a separate record.
The record keeping for different jobs may prove to be more complicated.
The costing procedure
The cost unit is the job and the costing system shows the profit or loss on individual jobs.
All costs incurred for a particular job are charged to that very job since jobs differ from one another.
This is always done by creating a job cost card /Sheet for every job, each of which is given its own
number for identification and control purposes.
On a job cost card, a record is taken of all prime costs and a share of the overheads of each cost
centre charged to jobs by means of overhead absorption rates.

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[Costing systems]

Job Card/Sheet

Client Name

Date of Commencement.

Job Number.

Date of
Completion.

Materials

Labour costs

Date Ref.No Qty Amt Date

.

Total

xx

Dept

Overhead costs
Hrs Amt Date
Wkd

xx

xx

Dept Hrs Amt

xx

Example 1
The management Accountant of Apex Furniture Ltd has estimated the following costs to be incurred on
making a customer dining table. Job No. 14001.
Direct materials
Department A 10kgs @70/=
B

5kgs @300/=

3kgs @ 600/=

Wages
Department

60 hours @ Shs 3/= per hour

40 hours@ Shs 2/= per hour

20 hours@Shs 5/=per hour

Overhead expenses for these three departments estimated as follows:

Variables overheads
Department
ABC-

Shs 5,000 for 5,000 labour hours

Shs 3,000 for 1,500 labour hours
Shs 2,000 for 500 labour hours

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Fixed overheads
Estimated at Shs 20,000/= for 10,000 normal working hours.
Required:
Calculate the cost of job NO. 14001 and calculate the price to give profit 25% on selling price.
Batch costing
A special type of order costing concerned with costing when a batch produced consists of identical
items.
The batch is treated as a cost unit.
The total cost of the batch is spread over the number of units produced in the batch.
The procedure of batch costing is very similar to the factory job costing.
This kind of costing is common in the manufacture of shoes, toys, ready-made garments, printing etc.
Cost per unit =Total Cost
Quantity produced in the batch
Example 2:
The budgeted overheads of Isabirye printers Ltd for the year are given as under;Variable overheads:Department
Amount of
Overhead
Overhead

Absorption base Units

Typesetting

150,000

15,000 Labour hours

Plate making

200,000

20,000 labour hours

Printing

300,000

30,000 machine hours

Binding

120,000

20, 0000 labour hours

Fixed production overheads:Estimated at Shs 1,000,000/= for 100,000 normal working hours.
The following additional information is in respect of Batch no, 215 is provided.
Materials

98,400

Labour
Typesetting

150 hours at Shs 12 per hour

Plate making

40 hours at Shs 25 per hour

Printing

60 hours at 20 per hour

Binding

100 hours at Shs 10 per hour

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[Costing systems]

Selling and administration overheads are charged at 10% of production cost. Profit is charged at 25% on
total cost. An order for 1,100 counter books was received from a publisher. The batch number of this order
is 215.
Required: Calculate the total cost of the batch, cost per unit, selling price of the batch and per unit.
Contract Costing
Principles of job costing are applied in contract costing.
A separate Contract Account is maintained for each individual contract.
All costs incurred in order to complete a contract are charged to the specific contract.
The difference between the value of work certified and costs charged is the profit made on the contract
for a particular period.
Contract costing is applied to those projects which are of constructional nature e.g. bridges, road
construction, buildings, dams etc.
The work takes relatively long duration to be completed (usually longer than a year) and
A significant part of the work is normally carried out on the customers site.
Because of the self-contained nature of most site operations, many costs normally classified as
indirect can be considered as direct and charged straight to the contract
For example; power usage, site telephone, transportation, supervisory salaries etc.
Cost control is a problem on many contracts because of their scale and the size of sites.
Difficulties include; Material theft and wastage, pilferage, problems of labour control and so on.
Good site management can help to reduce on these though no perfect solution.
Main features of contract costing
Direct expenses.
In addition to direct materials and direct labour, a high proportion of direct expenses are incurred.
Direct expenses include; hire charges of plant and machinery, site office expenses, site power usage
and so on.
Most of the expenses are direct because these can be identified in respect of any particular contract.
Overheads
Expenses such as the site telephone, electricity, repairs, water etc are allocated to the respective
contract account.
All other overheads incurred for the company as a whole are apportioned on a suitable basis to all
contracts.
The proper share of these overheads is charged to a specific contract.
Materials
These are charged or debited to a specific contract.
They are classified as materials issued from store and materials purchased for a contract from the
local market.
Sometimes the excessive materials are returned to the store and these materials are credited to the
contract account.
The materials on the site at the end of the accounting period are valued at cost and carried forward to
the next period.
Direct wages
Both paid and accrued are all debited to the contract account.

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[Costing systems]

Contract plant
A feature of most contract work is the amount of plant used.
This includes trucks, mixers, Lorries etc.
When plant is on lease basis then the leasing charges are directly charged to the contract.
When the plant is purchased, then this plant is charged to that contract for which it was purchased.
At the end of the year or on completion of the contract the contract account is credited with the value
of plant at the time, in this way, the depreciation of plant is charged to the respective contract.
If plant is moved frequently from one contract to another contract, then each contract is charged the
depreciation of the plant at a specific rate.
Sub contracts
Sometimes the contractor assigns some work to sub-contractors e.g. electrical work, plumbing work,
the work of painting, special flooring, steel work etc.
The amount paid to sub contractors is charged to the respective contract.
The contract price
It is usually agreed in advance.
The contractee invites the tenders from the interested contractors.
Normally, the lowest quotation is accepted and the contract is awarded to the contractor who gives the
lowest quotation.
Architects certificate
The architect inspects the work done periodically and certifies the amount of work completed.
This is known as work certified
The contractor can claim the amount of work certified from the contractee.
The architect is appointed by the contractee.
Retention money
A specific percentage of the value of work certified is withheld by the contractee or client.
This amount withheld is known as retention money. This amount is paid to the contractor on the
completion of the contract.
The main purpose of this retention money is to ensure that the contract has been completed according
to the satisfaction of the client and all defects in the work have been rectified by the contractor.
If the contractor does not remove such defects then the retention money is not released by the
contractee.
This retention money is shown as debtors in the books of the contractor
Work uncertified
If the progress of a work is unsatisfactory or the work has not reached the stipulated stage, though
certain work is completed, such work does not qualify for a certificate by the Contractee's Architect or
Surveyor.
This is termed as "Work Uncertified." It is valued at cost and credited to Contract Account and
debited to Work in Progress Account.
Profit on uncompleted contracts
Contracts which are started and completed during the same financial year raise no accounting
problems.
But contracts which take more than one year to complete raise a problem of profit computation.
The problem is usually whether profit on such contracts should be worked out only on the completion
of the contract or at the end of each year on the partly completed work.
If profit is computed only on the completion of the contract, profit will be high in the year of completion
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of contract, whereas in other years of working on contract profit will be nil.

This would result not only in distorted profit pattern but also higher tax liability because income tax at
higher rates may have to be paid.
Therefore, when contracts extend beyond a year, it becomes necessary to take into account the profit
earned (loss incurred) on the work performed during each year.
This helps in avoiding distortion of the year to year profit trend of the business.
There are two aspects of profit computation;1. Computation of estimated or notional profit at the end of the year when contract is not complete.
2. Computation of the portion of such profit to be transferred to profit and loss account.
Note: The entire amount of estimated or notional profit at the end of the year is not transferred to profit and
loss account.
This is because of the hazards involved in contract work e.g. unexpected underground streams
discovered on the site, presence of an unexpected quality in the earth, which makes excavation more
difficult.
In such cases, it is not wise to take credit for the whole of the notional profit
To be prudent, only part of the notional profit is transferred to profit and loss account and the
remaining profit is kept as a reserve for any contingent losses on the incomplete portion of the
contract.
The method of computing estimated or notional profit and the proportion of such profit to be
transferred to profit and loss account largely depends upon the stage of completion of the contract.
Computing stage of completion (%ge)
%ge of Completion = Work certified
Contract price
OR
= Cost to date
Total estimated Contract cost
Rules when computing Notional Profit
Follow the following rules generally to determine the amount of notional profit to be credited to P&L A/c
for each year;-.
1) Work certified is valued at contract price i.e. (selling price) and work uncertified is valued at cost. Thus
the profit element is present in only value of work certified.
2) When work certified is less than of the contract price, no profit transferred to profit and loss account.
This is based on the principle that no profit should be taken into account unless the contract has
reasonably advanced.
At this stage, the outcome of the contract cannot be assessed or foreseen with reasonable certainty
even if the contract account shows a profit figure to date.
3) When work-in-progress certified is more than but less than (>25 %< 50%) of the contract price, then
generally 1/3 of the profit is transferred to profit and loss account.
The balance amount is treated as reserve.
Thus profit to be transferred to profit and loss account is computed by the following formula; Profit to P & L = Notional profit x 1/3

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4) When work certified is more than of the contract price, but contract is not near completion
(>50%<85%), then the profit to be transferred to profit and loss account is only 2/3 of the notional profit.
Profit to P&L A/c = Notional profit x 2/3.
5) When contract is near completion, then we compute the total estimated contract profit as follows;Contract price
xx
Cost of work certified (cost of sales to date) (xx)
Cost of work not certified
(xx)
Estimated costs to completion
(xx)
Estimated total contract profit
xx
The profit to P & L A/c is determined as follows;Estimated profit x Work certified x Cash received
Contract price
Work certified
Estimated profit x Cost of work to date x Cash received
Estimated total cost of work Work certified
The procedure;
Prepare the Contract Account to determine the notional profit.

Determine the percentage of completion

Determine the amount of notional profit posted to the P & L A/c and the Reserve A/c.
Format of the Contact Account
Details
Material cost
Direct wages
Direct expenses
Overhead costs
Sub contract charges
Plant
Totals
Contract cost to date b/d
To P & L A/c
To Reserve A/c
Totals

Amount
x
x
x
x
x
x
XXX
xx
xx
xx
XXX

Details
Unused materials at site
Book value of Plant
Materials returned
Contract cost to date (BF) c/d

Amount
x
x
x
xx

Work certified
Work uncertified

XXX
xx
xx
XXX

Example 3. William Construction Company Ltd. obtained a contract for the erection of a multi-story
building. Building operations started in July 2015. The contract price was Rs. 900,000,000. On 30th June
2016, the cash received on account was Rs. 360,000,000 being 80% of the amount on the surveyor's
certificate.
The following additional information is given below (Amounts in Uganda Shillings):Materials issued to contract
180,000,000
Materials on hand 30. 6. 2016
7,500,000
Wages
246,600,000
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Plant purchased especially for contract and to be depreciated at 10% per annum} 30,000,000
Direct expenses incurred
12,900,000
General overhead allocated to contract
7,600,000
Work finished but not yet certified: cost
15,000,000
Your required to prepare;a) Contract to determine the contract cost to date
b) Determine the amount of notional profit to be recognized in the P & L for the year ended 30th June
2016.
c) Prepare the contractee/Customers Account
Example 4. Jogo Construction Ltd commenced work of putting up an arcade on 1st September 2015 with
agreed contract price of U.Shs.1, 150,000,000. Work will be completed in the next 3 years.
The following transactions were carried out during the first year that has just ended on 31 st August 2016:U.Shs
Materials purchased and delivered to work site
450,000,000
Materials issued from site stores
45,000,000
Materials returned to stores
5,000,000
Site wages
150,000,000
Site office expenses
23,000,000
Plant transferred to site
50,000,000
Plant returned from site
15,000,000
Consulting and design fees
13,000,000
Sub contract work
52,000,000
Central Office Overhead @ 10% Site Wages
Year end figures;Plant at site
18,000,000
Material at site
10,000,000
Prepayments for site office expenses
2,000,000
Cost of work done but not certified
35,000,000
The On account payment of U.Shs.776, 250,000 was received in respect of work certified less 10%
retention money.
Your required to prepare;(a) Contract to determine the contract cost to date
(b) Determine the amount of notional profit to be recognized in the P & L for the year ended 31st August,
2016 and the balance to be posted to the reserve Account.
(c) Prepare the contractee/Customers Account

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