Kremel Co. produces a herbicide for lawns which also contains a weed killer. The product passes through four processes: combining, drying, mixing, and bagging.Two chemicals, X and Y, are added during the combining process. X is added at the beginning of the process and Y is added three quarters of the way through the combining process (75%). Labour and overhead are applied evenly throughout each process. After combining, the resulting product is sent to the drying department, where it is dried under heat lamps for 24 hours. After drying, the granulated product is sent to mixing where a fertiliser is mixed with the granulated herbicides. Finally, in bagging, the product is placed in 20kg bags. The following information relates to the combining process for the month of June.
- The work in process at June 1 consisted of 35,000 kg (60% complete as to conversion) with a cost of direct materials for X of $1,500 and Y of $7,500, direct labour $750 and overhead of $2,250.
- Units completed and transferred out during June consisted of 745,000 kgs. Costs added during the month are as follows:
|Direct Material X||$ 39,150|
|Direct Material Y||191,250|
- Work in process at June 30 consisted of 45,000kg (70% complete with respect to conversion costs).
The weighted average method is used to account for the costs of production.
Calculate the cost of production for completed goods and ending WIP in the combining department as at the June 30.
- physical flow of units
- equivalent units of production
- summarise costs and unit costs (rounded to 4 decimal places)
- apply costs to inventories
Muddled, who is enrolled in ACFI2003, is having trouble understanding the concepts underpinning Question 1 of the Major Assignment.
Muddled says: “I’m confused. I understood the first lecture and thought this course would be a walk in the park but now I am freaking out as new terms are being introduced in every lecture topic.
The loaf of bread example that was used in the first lecture was easy to understand: we costed the loaf of bread by tracing direct materials and direct labour to the loaf and then applied the remaining costs as overhead. I could see from the diagram showing T-accounts how materials, labour and overhead are utilised in the production of bread, and how they were transformed into WIP and finished goods.
But Question 1 does not fit the template I have developed for the loaf of bread example. For a start, Question 1’s information on the combining process provides data on WIP, units completed and transferred out. It also has material, labour and overhead being added to production at different times. I understand that. But I cannot, for the life of me, figure out what ‘equivalent units’ are, and why they are necessary. Why is Question 1 so much more complicated than the bakery example?
I decided to memorise the calculation for equivalent units as I had given up trying to understand what it meant. The calculation involves manipulating the ‘physical flow of units of production’. I do not understand the difference between the ‘physical flow’ and ‘equivalent units.’
I could get the gist of job costing – for instance, in a construction site, you have different contracts that have been undertaken, and all I have to do is to trace direct materials and direct labour to each contract, and apply overhead to each contract. Why is the manufacture of herbicides not costed in the same way?
While I was struggling with job and process costing, the course introduces actual and normal costing. I get actual costing, but do we need normal costing in an organisation? I think it just complicates matters by jumbling up actual and estimated figures. I think organisations provide management with stewardship accounts that are based on objective verifiable evidence.”
ACFI 2003 is based on the following fundamental costing principle: cost-management systems should reflect the fact that different costs are relevant for different purposes. It means that the design of a costing system should represent the unique characteristics of the production process. Muddled does not “get” this; it is far too abstract for him.
You are asked to help Muddled by explaining how this fundamental costing principle affects the way in which job and process costing systems are designed/constructed. Write an essay which compares job and process costing systems. Your essay should be in plain English.
Your essay should explain the axiom, “different costs are relevant for different purposes” by briefly describing the process and job costing systems, and explaining the production context in which each system produces relevant and useful information for management.
In explaining the axiom above, you are required to explain the following differences between job and process costing systems:
i) The cost object for job costing is a contract, but the cost object for process costing is the process (or department). Explain the rationale for choosing these different cost objects for each system.
ii) How are costs accumulated under each costing system?
Then explain the following costing concepts that are found in process costing: ‘equivalent units’ and ‘transferred in costs.’ Why are these concepts not used in job costing?Lastly, describe actual and normal cost-management systems. The indirect nature of overhead costs makes them difficult to control. Which system better enables management to control overhead costs?
1.Computation Of The Cost Of Production For Completed Goods And Ending WIP
Physical Flow Of Units
|Physical Flow Of Units:|
|Statement showing Physical Flow of Units|
|Opening Work in Process||35,000||Work on Opening WIP|
|Units introduced||7,55,000||Units introduced & completed||7,45,000|
|(balancing figure)||Closing Work in Process||45,000|
Equivalent Units Of Production – Attached In Excel
Total Cost & Cost For Each Unit
|Statement showing Total Cost & Cost for Each Unit|
|Elements of Cost||Cost of opening WIP||Cost in Process||Total cost||Equivalent Production||Cost Per unit|
Application Of Cost To Inventories
|Application of Cost to Inventories|
|Particulars||Elements||Equivalent Production||Cost Per unit||Cost||Total Cost|
Different Costs Are Relevant For Different Purposes
There are mainly two types of costs namely Variable cost & Fixed Cost. Examples of variable costs are material, labor & Overheads which keep on changing with the amount of quantity produced. Examples of Fixed Cost are Rent, Electricity and fixed nature of expenses which remains same at any level of quantity produced. A Variable cost shall remain relevant for every job and process because it shall be incurred separately but fixed costs shall not be relevant for every project (Hopper & Bui, 2016). Job costing and Process costing are two different systems. Both systems are used for cost accumulation and its allocation to each unit completed/Produced. But both are distinct in nature & suitable for different purposes.
Job Costing is used when products being manufactured are so different that single cost can’t be applied to units produced. Under job costing work is done as per customer requirement. An apt example is the use of job costing in the Automobile Workshop (Maher, 2005). On the other hand, Process Costing is utilized in regular and mass production in Industries that produce units that are alike. Bulb Industry is the one where process costing is noticed on a wide scale.
Different Purposes Have Different Type Of Costs Association
Relevant costs shall always remain important for decision making of the management. If the sale price of a product covers its relevant cost (variable cost), the product shall be profitable to sell. A cost can be relevant but not every cost is relevant for production. In the case of a Job Costing, even the fixed cost is relevant and it is allocated to the number of units produced (Horngren, 2011). But in the case of Process costing not every cost is charged to the process.
Material – $ 3 per Kg,
Labor- $ 4 per hour
Overheads- $ 3 per unit
Fixed Cost – $ 60000, Units produced -10000 Nos.
Total Cost per unit will be = $ 3+$ 4 +$ 3 + ($ 50000/10000=$6) i.e $ 16 per unit
Hence it is seen that entire cost incurred is charged to the product cost. However, in the case of Process costing, Cost of the previous stage is carried forward to next stage of the process. In the case of only one stage in the process, the only relevant variable cost shall be the total cost of the product because only that cost was involved in the project (Charles, 2012). In a factory, 3 products are produced and a 4th product is being planned to be introduced. Rent paid for the factory in which all 4 products shall be produced shall not be relevant for the 4th product because even if the 4th product was not produced, rent would have been still paid. On the other hand, material, labor & overheads for the 4th product shall be unique and will remain relevant for the 4th product. It implies that there is a huge difference between the fixed and variable cost because it entirely rests upon the purpose (Horngren & Foster, 2008). Therefore, different costs are relevant for different purposes.
Differences Between Job And Process Costing Systems
Differences Between The Two System
|Job Costing||Process Costing|
|1. When specific job order is required to be done then job costing is best suited||1. .When units of similar nature are needed to be produces then process costing is utilized for regular and mass production.|
|2. The accumulation of cost is done for every job worked.||2. Depending upon the process, as well as department the accumulation of cost is done|
|3. The computation of job costing is done when the completion of job gets over.||3. When the process gets over, it is computed.|
|4. No transfer of work takes place from one job to another till it is required to transfer the surplus work or production in excess.||4. Transfer of costs takes place here till the manufacturing of the goods is done.|
|5. Work in progress may or may not happen at the end of the period.||5. Work in progress is always present either at the beginning or at the end of the tenure.|
Job costing is specific to the contract and the above difference clearly implies that it is used when a particular contract is targeted. Hence, the main object of job costing is to accomplish a full contract whereas process costing accomplishes the work at every process steps and is suitable for a particular department.
Accumulation Of Costs Under Different Systems:
It can be termed that specific order costing where performance of work is done to cater the customer specific needs and every order comprises of short time span. It rests entirely upon the order that is received from the customer (Drury, 2011). Every order is unique and need a different amount of labor, material, and overheads and thus each order cost must be computed individually. Thus, cost is accumulated for each individual job worked and varies as per the requirement of the customer (Lanen et. al, 2008)
In process costing, Cost is accumulated according to processes and departments. The total cost of production during the time span is spread over the production of the units because individual identity of units is lost due to regular production (Don & Maryanne, 2006). It implies that the entire cost will rests upon the total production and not on a specific product. Hence, the costs are assessed and accumulated process wise.
Equivalent Units are the units in notional basis representing completed task utilized to apportion costs that is present between work in process and output that is completed. Equivalent production can be described as a method by which work done on units that are unfinished is denoted in terms of units that are completed (Robinson & Last, 2009). The idea behind this is to trace units that would have been completed if the work required to be done on unfinished units had been done for finished units only. The concept of finding out equivalent units is used for assignment of the process cost to finished and unfinished units.
Transferred-in costs refer to the transferring of closing costs from one process to another so that the total costs can be summed up at the end of the total manufacturing process (Drury, 2011). These concepts are not used in job costing as in job costing, the cost is accumulated for each individual job worked and the total work is completed without distributing the work in processes, hence there is no need to calculate equivalent units.
Actual And Normal Cost-Management Systems
The normal costing in an organization refers to the estimated costing used by the management so that the costs can be calculated on the basis of estimated production units and the costs that have actually been incurred in the past. It is done so that the management is able to chalk out a strategy and determines the process (Drury, 2013). It is thereafter compared with the actual costs incurred. It helps in tracking the deviation and take a planned course of action. This comparison is done to find out the variances between actual and normal costs and further steps are taken to control the negative variances (Robinson & Last, 2009). It is helpful for the organization because the differences can be removed at the initial stage and does not suffer at the end.
In Actual Costing, overhead rates are generally calculated by using actual costs incurred an actual production done, whereas, in normal costing, the overhead rates are calculated using the expected production units and actual overhead costs based on past performances (Shim & Siegel, 2009).
Normal Costing Is Primarily Used For The Following Purposes:-
- Establishing budgets – Budgets can be prepared that in turn helps to perform other activities and preparing financial statements.
- Controlling costs and motivating and measuring efficiencies – the difference or inefficiencies are traced easily and help to eliminate at a very early stage without any potential loss (Shim & Siegel, 2009).
- Promoting possible cost reduction – As deviations are traced at an early stage, it helps to reduce the cost of the organization.
- Simplifying cost procedures – it simplifies the procedure of cost and helps the organization to maintain a strong balance.
- Assigning costs to materials, WIP & finished goods, etc.
The indirect overheads are somewhat difficult to control such as glue, thread, chalks, etc, as it is normal as well abnormal wastage of such kind of small products during varied processes.
Normal Costing System Better Among The Two
The normal costing system is better in enabling the management in controlling overhead costs as the overhead rate that will be calculated will be more realistic irrespective of the quantity of units produced. It does not depend upon the number of units and hence is more pronounced in nature. As the per unit overhead rate is calculated keeping in mind the actual past performances, the total overhead costs will be estimated accurately and will be more reliable (Vanderbeck, 2013). The past performances are kept into consideration and therefore, the estimation is strong. This helps the management to tame the overhead cost in an efficient manner.
Charles, T.S. (2012). Cost Accounting: A Managerial Emphasis. Pearson Education
Don R. H & Maryanne M. M. (2006). Cost Management Accounting & Control. Ohio: Thomas South-Western
Drury, C. M. (2013). Management and cost accounting. Springer.
Drury, C. (2011). Cost and management accounting. Andover, Hampshire, UK: South-Western Cengage Learning.
Hopper, T & Bui, B. (2016). Has management accounting research been critical?. Management Accounting Research, 31, 10-30.
Horngren C T & Foster, G. (2008). Cost Accounting: A Managerial Emphasis. United States Edition
Horngren, C. (2011). Cost accounting. Frenchs Forest, N.S.W.: Pearson Australia.
Lanen, W. N., Anderson, S & Maher, M. W. (2008). Fundamentals of cost accounting. NY: Hang Loose press.
Maher, L. (2005). Fundamentals of Cost Accounting. McGraw-Hill
Robinson, M., & Last, D. (2009). Budgetary Control Model: The Process of Translation. Accounting, Organization and Society, NY Press
Shim, J. K & Siegel, J G. (2009). Modern Cost Management and Analysis. Barron’s Education Series
Vanderbeck, E J. (2013). Principles of Cost Accounting. Oxford university press