Unit Cost Introduction Definition Unit or Output Cost Objectives
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UNIT COST INTRODUCTION
Different industries follow different methods to establish the cost of their product. This varies by the nature and specifics of each business. There are different principles and procedures for performing the costing. However, the basic principles and procedures of costing remain the same. Some of the methods are mentioned below :
- Unit costing
- Job costing
- Contract costing
- Batch costing
- Operating costing
- Process costing
- Multiple costing
- Uniform costing
In this module we shall understand Unit Costing.
DEFINITION OF UNIT OR OUTPUT COSTING
“Production cost accounting or unit cost accounting is such a method of cost ascertainment which is based on production unit. It is applicable where the production work is done continuously and the units are of same types of manufactured identical” – Herold J. Wheldon
From the above definition we can understand that Unit Costing is used in the industries with the following characteristics:
- Production should be uniform or homogeneous and a continuous affair;
- The units of production should be identical
- The cost units should be physical and natural
- Per unit cost has to be determined, for example per ton, per meter, per kg, etc.
Brick making, mining, cement manufacturing, flour mills are examples of industries using Unit Costing.
Under Unit Costing, generally no apportionment of cost is done because all the expenses are made on a similar type of production. But where production is done for a various grades or for various sizes, their expenses have to be apportioned on the basis of size or grades in detail.
OBJECTIVES OF UNIT COSTING :
- To know the total cost of production and per unit cost within specific Period.
- To classify cost under related categories such as Prime Cost, works cost, cost of Production, etc. and have a detailed analysis in order to determine per unit cost.
- To determine the effect of each element of cost to have control over cost.
- To compare the cost during two or more periods.
- To make efforts for cost control on the basis of comparative analysis.
- To determine proposed setting price to earn desired Profit.
- To determined tender price on the basis of cost data and future prospects.
LIMITATIONS OF UNIT COSTING :
Unit or output costing is very much important method for ascertaining the total cost and cost per unit, but it is not free from certain limitations. These are as under:
- Limitations of historical cost: unit or output costing, being basically of historical nature, suffers from all the defects of historical costing.
- Useful only for homogeneous products: this costing method can be used only for homogeneous products and not for heterogeneous products.
- Not sufficient for cost control: this costing system simply determines total cost and per unit cost of the products which is by itself not sufficient for cost Control.
- Arithmetical accuracy cannot be checked: under this system, generally a statement is prepared which does not from a part of the double entry system. Therefore, arithmetical accuracy cannot be checked under this system.
ELEMENTS OF COST UNDER UNIT COSTING :
In output costing in order to determine total cost and per unit cost, collection of various elements of cost is done as follows –
Materials – The quantity and value of material consumed is determined by preparing a Material Abstract. The materials which are issued from stock are valued on an appropriate basis.
Labour – As required, wages analysis sheet is prepared so that direct and indirect labour cost cab be determined.
Direct Expenses – In addition to material and labour, there are certain other expenses incurred which are termed as direct expenses.
Overheads – The overheads are debited to production for the period for which the cost us being determined. These overheads expenses’ are taken from the financial records. There are certain expenses which cannot be determined before the end of the accounting period.
TENDERS OR QUOTATIONS :
Very often a producer in response to an advertisement in the press is required to submit a tender or to quote prices for the supply of the commodities he produces or for completing a job. A tender has to be prepared very carefully as the receipts of orders depend upon the acceptance of quotations or tenders supplied by the manufacturer. The preparation of tenders requires information regarding prime cost, works, administration and selling overheads and profit of the preceding period.
The manufacturer has to ascertain and find out the possible changes in prices of material, rates of wages and other costs. He has to ascertain the amount of variable, semi-variable and fixed overheads on the basis of past experience. He must also have a reasonable amount of profit by taking into consideration the market condition.
In preparation of estimates or tenders, overheads are generally estimated as percentages i.e. works overheads on wages and administration, selling and distribution overheads on works cost basis.
METHODS OF UNIT OR OUTPUT COSTING :
Unit or output costing is used to determine the cost per unit of production in a specific period of time. For this, the following methods are used:
- Cost sheet
- Manufacturing account
Cost sheet :
Cost sheet is “a document which provides for the assembly of the estimated detailed cost in respect of a cost center pool a cost unit”. It is a period’s document of cost designed to exhibit the total cost and the unit cost of products in an analytically and detailed form. In other words, a cost sheet presents cost information in such a manner that it can show cost of total production, quantity produced and cost of production per unit.
Cost sheet is an operating statement. It analyses and classifies the expenses on different items for a particular period in a tabular form. It may be prepared weekly, monthly, quantity, half yearly or yearly at any convenient interval of time. Similarly, it may be prepared on the basis of actual or estimated cost depending on the purpose to be achieved. It is online memorandum statement, not an account. It does not form a part of the double entry system.
Elements of Cost Sheet:
- Direct Material
- Indirect Material
- Direct Labour
- Indirect Labour
- Direct Expenses
- Indirect Expense
All the elements described above have been discussed in detail in the Cost Sheet Module. Students are advised to refer to the same.
When the data related with the cost of goods manufactured of a commodity are presented is a conventional form of account i.e. in T shape from, and then it is known as Manufacturing Account. Generally, a manufacturing concern prepares this account to exhibit cost of production or cost of goods manufactured.
Preparation of manufacturing account
A manufacturing account is based on the principle of national account. Therefore, it shows opening stock of work-in- progress and other direct and indirect costs of goods manufactured (i.e. factory costs) on its debit side and closing side and closing stock of work-in-progress and sale of scrap or wastage on its credit side. Generally, the balancing figure takes palace in credit side which is called “cost of goods manufactured or cost of production C/D”. This account show the cost production which is transferred to the trading account.
Manufacturing account for manufacturing profit and loss
When a manufacturing account is prepared to ascertain manufacturing profit and loss, then trading value of manufacturing cost is kept in credit side instead of cost of production. In other words, all items on debit and credit side will be the same as mentioned above. But, trading price or trading value of cost of production will be shown on the credit side and balancing figure will be put on debit side of this account as “manufacturing profit” or “manufacturing loss”.
The accounts of Kool Kool Company Ltd. show for 20X6: Materials Rs 350,000;
Labour Rs 270,000;
Factory Overheads Rs 81,000
and Administration Overheads Rs 56,080.
What price should the company quote for a refrigerator? It is estimated that Rs 1,000 in material and Rs 700 in labour will be required for one refrigerator. Absorb factory overheads on the basis of labour and administration overheads on the basis of works cost. A profit of 12½ % on selling price is required.
Statement of Cost
|Total Cost of Production||757,080|
|Percentage of Factory Overheads to Labour:
=(81,000/270,000)*100 = 30%
|Percentage of Administration Overheads to Works Cost:
=(56,080/701,000)*100 = 8%
Statement of Selling Price of a Refrigerator
|Factory Overheads (30% on Labour)||210|
|Administration Overheads (8% of Works Cost)||152.80|
|Total Cost of Production||2062.80|
|Add Profit (1/8 on Sales or 1/7 of Cost)||294.69|
|Selling Price per Refrigerator||2,357.49|
- Determine whether unit costing would be appropriate in the following industries
- Brick Making
- Oil Exploration
- Original Equipment Manufacturer
- Jewelry making
- Write Short notes on:
- Unit Costing
- Advantages of Unit Costing
- When would Unit Costing be appropriate to determine costs over other methods?
A method of costing in which cost of each ‘job’ is determined is known as Job Costing. Here job refers to a specific work or assignment or a contract where the work is performed according to the customer’s instructions and requirements. The output of each job consists of normally one or less number of units. In this method, each job is considered as a distinct entity, for which cost is ascertained. Job Costing is applied when:
- The execution of the jobs is on the basis of client’s specification(s).
- All the jobs are heterogeneous in many respects, and each job requires separate
- There is a difference in WIP (Work in progress), of each
Job Costing is best suited for the industries where specialized products are manufactured as per customer needs and demands. Some examples of those industries are Furniture, Ship Building, Printing Press, Interior Decoration etc.
DOCUMENTS USED IN A JOB ORDER COST SYSTEM :
The following are the important documents used in a Job Order Cost System:
(I) Production Order or Manufacturing Order:
This is a works order authorizing the production department to produce a specified quantity of a product which constitutes the job.
(II) Cost Sheet:
For recording costs, very often a separate record called a cost sheet is used. The cost sheet and the works order may also be combined, when costs are recorded on the production order itself.
(III) Other Documents:
The other documents which are used as control mechanism by the dispatching function are: Material Requisitions, Tool Orders, Time Tickets, Inspection Order, etc.
ADVANTAGES OF JOB ORDER COSTING:
- Profitability of each job can be individually determined.
- It provides a basis for estimating the cost of similar jobs which are to be taken in future.
- It provides the detailed analysis of the cost of material, labour and overheads for each job as and when required.
- Plant efficiency can be controlled by confining attention to costs relating to individual jobs.
- Spoilage and defective work can be identified with a specific job and responsibility for the same may be fixed on individuals.
- By adopting pre-determined overhead rates in job costing, we can get all advantages of budgetary control.
- Job costing is essential for cost-plus contract where contract price is determined directly on the basis of cost.
LIMITATIONS OF JOB ORDER COSTING :
- It is expensive to operate as it requires considerable detailed clerical work.
- With the increase in the clerical work, chances of errors are increased.
- Job order costing cannot be efficiently operated without highly developed production control system. The job costing requires intricate factory organization system.
- The costs as ascertained are historical as they compiled after incidence and therefore does not provide control of cost unless it is used with standard costing system.
Batch Costing is the identification and assignment of those costs incurred in completing the manufacture of a specified batch of components. Having arrived at the batch cost, the unit cost is simply derived by dividing it by the number of components in the batch.
When orders are received from different customers, there are common products among orders; then production orders may be issued for batches, consisting of a predetermined quantity of each type of product. Batch costing method is adopted in such cases to calculate the cost of each such batch.
Cost per unit is ascertained by dividing the total cost of a batch by number of items produced in that batch. In order to do that a Batch Cost Sheet is prepared. The preparation of Batch Cost Sheet is similar to that of Job Cost Sheet. This method is mainly applied in biscuits manufacture, garments manufacture, spare parts and component manufacture, pharmaceutical enterprises etc.
Batch costing is a form of specific order costing.
- Within each batch are a number of identical units but each batch will be different.
- Each batch is a separately identifiable cost unit which is given a batch number in the same way that each job is given a job number.
- Costs can then be identified against each batch number. For example materials requisitions will be coded to a batch number to ensure that the cost of materials used is charged to the correct batch.
- When the batch is completed the unit cost of individual items in the batch is found by dividing the total batch cost by the number of items in the batch.
- Batch costing is very common in the engineering component industry, footwear and clothing manufacturing industries.
- The selling prices of batches are calculated in the same ways as the selling prices of jobs, i.e. by adding a profit to the cost of the batch.
Economic Batch Quantity
Production is usually done in batches and each batch can have any number of units of Component in it. The optimum quantity for a batch is that quantity for which the setting up and carrying costs are minimum, such an optimum quantity is known as Economic Batch Quantity or Economic lot size.
Determination of the economic lot size is important in industries where batch costing is employed.
Need for Determining Economic Lot Size:
The need for determining economic lot size arises as:
- Every time a component/product is to be made, setting up of the tool is involved. Because of this some loss in production time will be there. Therefore, maximum number of units is produced once the machine is set in order to reduce the cost per unit,
- Such large production at one run will lead to accumulation of inventory and the costs related thereto,
- Thus there is a quantity for which reduced cost of production is just offset by costs of carrying the quantity inventory. The determination of most economical batch quantity requires consideration of many related factors of costs and economic.
The factors that influence the decision in this respect are:
- Set up cost,
- Manufacturing cost,
- Interest on capital,
- Storage cost, and
- Rate of consumption
TYPES OF COSTS IN BATCH COSTING:
There are two types of costs involved in Batch Costing:
- Set up costs
- Carrying costs.
If the batch size is increased, set up cost per unit will come down and the carrying cost will increase. If the batch size is reduced, set up cost per unit will increase and the carrying cost will come down. Economic Batch quantity will balance both these opponent costs.
Economic Batch Quantity can be determined with the help of a table, graph or mathematical formula.
KEY DIFFERENCES BETWEEN JOB COSTING AND PROCESS COSTING
The following are the major differences between job costing and process costing:
- The costing method which is used for the ascertainment of the cost of each job is known as Job Costing. Conversely, by process costing, we mean the costing technique used to determine the cost of each processing.
- Job Costing is performed where the products produced of a specialized nature, whereas Process Costing is used where standardized products are produced.
- In Job Costing, the cost is calculated for each job, but in Process Costing first of all the cost of each process is calculated which is then dispersed over the number of units produced.
- In job costing the cost center is the job itself while the process is the cost center in case of process costing.
- In job costing each job requires special treatment. On the other hand, no such special treatment is required for each process in process costing.
- There is no transfer of cost in job costing, from one job to another. However, the cost of the last process is transferred to the next process in the process costing.
- The possibility of cost reduction is very less in Job Costing. In contrast to Process Costing, the scope of cost reduction is comparatively High.
- In Job Costing, the cost is ascertained after the completion of the job, but in Process Costing, the cost of each job is determined.
In situations where a company has a mixed production system that produces in large quantities but then customizes the finished product prior to shipment, it is possible to use elements of both the job costing and process costing systems, which is known as a hybrid system.
State whether the statements are true or false. (Answers in parentheses)
- Under Batch Costing, a batch is regarded as a single cost unit (True)
- Batch costing is used when items of a identical nature are produced in a batch (True)
- Batch costing can be used only in large organizations (False)
- Economic batch quantity is nothing but economic ordering quantity of materials (False)
- Set up cost can vary depending on the size of the batch (False)
- Under job costing, the job itself is a cost unit (True)
Determination of Economic Batch Quantity
|Monthly demand for a product||500 units|
|Setting up cost per batch||Rs. 60|
|Cost of manufacturing per unit||Rs. 20|
|Rate of Interest||10% p.a.|
EBQ = (2DS/C)1/2
= 600 units
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