Month: April 2020

Unit or output costing is that method of costing in which cost are ascertained per unit of a single product in a continuous manufacturing activity. Per unit cost is calculated by dividing total production cost by number of units produced. This method is also known as single costing. This method is known as ‘single costing’ as industries adopting this method manufacture, in most cases, a single variety of product.

This method is also known as ‘unit costing’, as not only the cost of the total output, but also the cost per unit of output is ascertained under this method. Under this method cost units are identical. This method is also called ‘output costing’, as cost is ascertained for the total output of a product.

Expert view

1. According to J.R. Batliboi, “Unit costing or output costing may be defined as single or output cost system is used in business where a standard product is turned out and it is desired to find out the cost of a basic unit of production.”
2. According to Walter W. Bigg, “Unit Costing Method is a method of costing applied to ascertain the cost per unit of production where standard and identical products are manufactured.”
3. According to Harold J. Wheldon, “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 or manufactured identical.”
4. The Institute of Cost and Management Accountants, London, “output costing is the basic costing method applicable where goods or services result from a series of continuous or repetitive operations or processes to which costs are charged before being averaged over the units produced during the period.”

From above definitions it is clear that single costing is a method of costing under which there is the costing of a single product which is produced by a continuous manufacturing activity. Though under this method of costing a single variety of product is manufactured, it may vary in respect of size, grade, colour, etc. The example of industries which make use of this method of costing are – brick, sugar, cloth, coal, cement, fisheries, food canning, quarries, plantation industries, etc.

Features of Output Costing:

Output costing has certain characteristics features.

The important features of output costing are:

(1) Output costing is the method of costing adopted in concerns where there is a production of single product or a few grades of the same product differing only in size, shape or quality by continuous process of manufacture. The units of production or output are identical and the costs of units are physical and natural.

(2) Under this method, the cost per unit of output, say, per ton, per barrel, per kilogram, per metre, per quintal, per bag, etc. is ascertained. The cost per unit of output is ascertained by dividing the total cost incurred on a product during a given period of time by output produced during the period.

Where the products manufactured are of different grades, first, the costs of products are ascertained grade-wise, and then the total cost of each grade of the product is divided by the number of units of that grade so as to ascertain the cost per unit of each grade of the product.

(3) Equality of cost is an important feature of this method. That is, under this method, cost units, which are identical, will have identical cost.

(4) Under this method, the cost of product is ascertained at the end of the accounting period.

(5) Under this method, the cost information relating to a product may be presented in the form of either cost sheet or production account.

(6) This method is the simplest method of all the methods of costing; in the sense that the cost collection and the cost ascertainment are quite simple.

(7) The cost per unit of output, determined under single. Costing enables the management to make real comparison between different periods and between different firms within the same industry, as the unit of output is a common factor between different periods and between different firms within the same industry.

Objectives of Output Costing:

Output costing has the certain objectives.

They are:

(1) To ascertain the total cost of the output as well as the cost per unit of output.

(2) To ascertain the profit or loss on production.

(3) To analyse the expenditure by nature, classify them into element of cost and know the extent to which each element of cost contributes to the total cost.

(4) To facilitate comparison of the cost of one period with the cost of another period to know the efficiency or otherwise of the production.

(5) To facilitate the preparation of tender or quotation.

(6) To control the cost of the product through comparative study of the costs of any two periods or through the comparison of the actual costs with the pre-determined standard cost.

Important Items Regarding Preparation of Statement of Cost and Cost Sheet:

1. Normal Loss of Materials:

This type of loss is unavoidable and arises due to the nature of material. For example – loss by evaporation of liquid materials, loss due to loading and unloading of materials, etc. This loss is not deducted from the cost of material rather it is charged to the output because it is a principle of costing that all normal expenses which are necessarily to be incurred should be included in the cost of production.

Therefore, in order to absorb normal material losses in cost, the rates of usable materials are inflated so that such losses are covered. In other words, such normal loss should be ignored and this will get automatically charged to output.

2. Abnormal Loss of Materials:

Abnormal losses are those losses which arise due to abnormal reasons such as loss by theft, loss by fire, careless handling etc. The cost of materials abnormally lost should be deducted from the value of materials purchased so that output is charged only for the materials used in production. Abnormal losses are charged to Costing Profit and Loss Account.

3. Wages of Normal Idle Time:

Normal idle time is inherent in any work situation and cannot be reduced. The cost of normal idle labour time is charged to the cost of production. Hence, wages of normal idle time is not subtracted from the labour cost.

4. Wages of Abnormal Idle Time:

Abnormal idle time arises due to unanticipated causes such as strikes, lockouts, fire, accidents, major machine break-down, earthquakes, etc. Loss of time due to such abnormal causes cannot be planned. Such causes are sudden and non-frequent.

The cost of abnormal idle time is not included in cost of production. The wages paid for abnormal idle time should be debited to Costing P/L A/c. Hence, wages of abnormal idle time is subtracted from the labour cost.

5. Sale of Scrap, Defective, Salvage or Residue:

If clear information is given, then adjustment of these sales will be made accordingly. But, if it is not clear that what the nature of scrap defective, etc., the sale value of scrap etc. is deducted before computing factory cost.

6. Defective or Rejected Work:

Sometimes, under production process there might be defective goods. The production not conforming to the standard set is known as defective. If such goods cannot be rectified, then it may be sold in the market at lower rate. Whatever the amount is collected from such sale is deducted from the factory cost. Similarly the defective units are also deducted from the number of units produced.

On the other hand, the defective units which can be rectified by incurring extra expenses, then such extra expenses incurred on such a rectification can be added in factory overhead as an extra factory overhead. After that the saleable units and their costs can be determined.

7. Cash Discount and Trade Discount:

Cash discount is not considered as the part of cost of production, since it is of financial nature. Whereas, trade discount is treated as sales promotion expense and is included in selling and distribution expenses or may be deducted from gross sales.

8. Allocation of Joint Expenses:

In absence of clear-cut information factory overhead is allocated on the basis of wages ratio and office and administration expenses and selling and distribution expenses on the basis of works cost ratio.

9. Packing Charges:

Treatment of packing charges depends upon its nature. If, in absence of packing, goods cannot be sold, then it should be treated as direct expense (i.e. packing of mustard oil etc.). Packing charges in respect of partly finished goods are considered as factory overhead. In the same way, packing expenses concerned with finished goods are included in selling and distribution expenses.

5. Cost Collection or Cost Accumulation:

Usually the following procedure is adopted under output costing for the cost accumulation of the various elements of cost:

1. Materials:

As materials both direct and indirect are issued to production against properly authorised material requisitions. The direct and indirect material costs can be ascertained through material requisitions.

Through the analysis of material requisitions, the quantities of direct and indirect materials issued to production can be ascertained, and on the basis of the prevalent method of pricing material issues, the direct and indirect material costs can be ascertained.

Accounting of Materials:

Materials are dealt in cost accounting as follows:

(i) The direct material costs are taken as a part of Prime Cost.

(ii) Indirect material costs are charged to Factory Overheads.

(iii) Normal loss of materials is adjusted by inflating the issue price of materials.

(iv) Abnormal loss of materials is not taken into account in the cost of production. It is charged to the Costing Profit and Loss Account.

2. Labour:

The labour costs are collected periodically through pay rolls kept separately for each section or type of work without the detailed job cards or chits required in job costing.

Treatment of Labour Cost in Cost Accounting:

Labour cost is dealt as follows:

(i) Direct labour costs are treated as a part of Prime Cost.

(ii) Indirect labour costs are charged to Factory Overheads.

3. Direct Expenses:

Direct expenses or chargeable expenses are separately collected from the financial record where the actual direct expenses incurred are recorded.

The main expenses under this head are:

(i) Royalty

(ii) Architect and surveyor’s fees

(iii) Expenses of drawing and designs

(iv) Excise duty etc.

Treatment:

It is treated as a part of Prime Cost.

4. Overheads:

Where cost finding is undertaken at the end of long interval, i.e., at the end of the year, after the overheads incurred are actually recorded in the financial book, the actual overheads incurred during the year are collected from the financial records.

The actual overheads collected from the financial records are analysed into three broad categories, viz.:

(1) Factory Overheads,

(2) Office and Administration Overheads, and

(3) Selling and Distribution Overheads and are treated as such for cost finding.

Cost pertaining to a cost centre or cost unit may be divided into two portions direct and indirect. The indirect portion of the total cost constitutes the overhead cost which is the aggregate of indirect material cost, indirect wages and indirect expenses. CIMA defines indirect cost as “expenditure on labour, materials or services which cannot be conveniently identified with a specific saleable cost per unit.”

Indirect costs are those costs which are incurred for the benefit of a number of cost centers or costs units. Indirect cost, therefore, cannot be conveniently identified with a particular cost centre or cost unit but it can be apportioned to or absorbed by cost centres or cost units.

Cost pertaining to a cost centre or cost unit may be divided into two portions direct and indirect. The indirect portion of the total cost constitutes the overhead cost which is the aggregate of indirect material cost, indirect wages and indirect expenses. CIMA defines indirect cost as “expenditure on labour, materials or services which cannot be conveniently identified with a specific saleable cost per unit.”

Indirect costs are those costs which are incurred for the benefit of a number of cost centers or costs units. Indirect cost, therefore, cannot be conveniently identified with a particular cost centre or cost unit but it can be apportioned to or absorbed by cost centres or cost units.

Broadly speaking, any expenditure over and above prime cost is known as overhead. In general terms, overheads comprise all expenditure incurred for or in connection with the general organisation of the whole or part of the undertaking i.e. the cost of operating supplies and services used by the undertaking including the maintenance of capital assets. The terms ‘burden’, ‘supplementary costs’, ‘on costs’, ‘indirect expenses’ are used interchangeably for overhead.

Importance of Overhead Costs:

In various five-year plans, industrialisation was given due importance. The result is that a large number of establishments have grown up both in the public and private sectors for mass production for which use of improved and costlier and special type of machines has become absolutely necessary. With the increasing trend towards plant automation, heavy expenditure is being incurred which cannot be charged directly to any particular unit and can be called as cost common to all units of production.

Overhead expenses being a significant proportion of the total cost have assumed an added importance and require analysis for purposes of cost ascertainment and control by function and for guidance in certain managerial decisions by the extent of the variability with production.

Overhead costs cannot be allocated but have to be suitably apportioned and then absorbed by suitable methods. The cost accountant is required to pay so much attention to the accounting of overhead cost as prudence choice of various bases used for apportionment and absorbing the overheads in the cost of products has to be made by him.

Are High Overhead Costs an Indication of Inefficiency?

These days we find that overhead expenses are increasing in every organisation. Some people may have the feeling that high overhead costs are an indication of inefficiency. But this is not correct.

High overhead costs do not indicate inefficiency if it is accompanied by:

(i) Large scale production or mass production

(ii) Increase in efficiency and productivity of labour

(iii) Less human efforts will be required because of automatic machines but more machine expenses will have to be incurred

(iv) More depreciation, maintenance expenditure and similar other items because of more use of machinery

(v) Improved methods of managerial control like work study, production control, cost and management accountancy techniques may reduce the direct cost but will increase the overhead costs.

Classification of Overhead Costs:

Cost classification is the process of grouping costs according to their common characteristics and establishing a series of special groups according to which costs are classified.

Thus, it involves two steps:

(i) The determination of the class or groups in which the overhead costs are subdivided,

(ii) The actual process of classification of the various items of expenses into one or the other of the groups.

The method to be adopted for the classification of overhead costs depends upon the type and size of the business, nature of the product or services rendered and policy of the management.

The various classifications are:

(i) Functional classification

(ii) Classification with regard to behaviour of the expenditure

(iii) Element-wise classification

(iv) Classification according to nature of expenditure.

A concern may adopt one or more of the above classifications. For example, the overhead expenses in a concern may be first divided according to functions i.e. manufacturing, administration, selling and distribution groups. The expenses pertaining to one group say manufacturing may further be classified into fixed, variable and semi-variable.

Each of these groups may then be grouped into the elements i.e. indirect material, indirect labour and indirect expenses and under each element, the expenses may be further subdivided according to their nature i.e. depreciation, salary, repairs and maintenance etc.

1. Functional Classification of Overhead:

When overhead expenses are classified with reference to major activity divisions of a concern, it is called functional classification of overhead. This classification is necessary for the segregation of the cost of each of the principal functional division of the concern and for having separate methods of accounting and control for the diverse nature of expenses in each division.

The main groups forming the basis of the classification are:

(a) Manufacturing Overhead

(b) Administration Overhead

(c) Selling Overhead

(d) Distribution Overhead

(e) Research and Development Expenses

2. Classification with Regard to Behaviour of Expenditure:

Under this overheads are classified with reference to their tendency to vary with production/sales volume or activity level. Some expenses vary directly with the rise and fall in output, some remain constant in spite of change in the level of activity of the concern whereas there are some other items which are constant only upto a certain level and then change their character to become variable or which vary with volume of output but less than proportionately.

Based on this behaviour, the expenses may be classified into:

(a) Fixed overhead

(b) Variable overhead

(c) Semi-variable or Semi­-fixed overhead.

The following methods are used in separation of such costs into fixed cost and variable cost. They are: 1. Industrial Engineering Method 2. Account Inspection Method 3. Scatter Graph Method 4. High and Low Method.

1. Industrial Engineering Method:

This method is used to collect cost information that is not available in an organization’s records and is particularly relevant when an organization is just beginning a new activity. Every productive process involves employing a particular mix of materials, labour and capital equipment in order to yield physical output.

When the relationship between the input and output is established by an engineer or technical expert e.g., 2 kgs. of materials + 3 hours of labour = 1 unit of output. The material and labour costs can be estimated by imputing material prices and wage rates to physical input needs. It is important to note that these costs are estimates because of possible uncertainty with regard to wastage in material usage and changes in labour efficiency in production process.

The engineering method is particularly useful when applied to material and labour costs which represent a large proportion of the total output cost. If the relationship between material and labour inputs and outputs remain static over time, then these cost estimates can be used in the future without significant adjustment. When costing new products, the engineering method is the only approach that can be used due to lack of historic data.

However, there are three main disadvantages of the engineering method:

(1) It is expensive as work measurement involves detailed analysis of the physical movements required in each task, in order to produce one unit of output.

(2) There are other costs incurred in the production process e.g., machine maintenance and supervision which cannot be associated with specific units of output, but may be direct costs of the department. The engineering method cannot be applied to these costs, whose equations will have to be derived from an analysis of past data or from subjective evaluation.

(3) Different mixes of materials and skills may be used to produce the same unit of output, leading to several conflicting cost estimates.

Although the engineering method is usually associated with production, work study techniques are applied to other areas, such as selling and administrative functions of the organization.

2. Account Inspection Method:

This method is a fast and inexpensive way of estimating costs as it simply involves examining each account and subjectively classifying the account’s total cost into either fixed or variable elements. This requires that the Management Accountant inspect each item of expenditure within the ledgers at a given level of output to determine whether a cost is fixed, variable or semi-variable.

Limitations:

This technique has the following limitations:

(a) It depends heavily on the initial decision to classify an account as fixed or variable.

(b) It fails to recognize that semi-variable costs exist.

(c) It relies on a single observation of the account to determine the cost equation rather than using an average based on several observations of each account.

(d) It assumes that transactions have been correctly charged to one account or another. The account inspection method should be used only when a crude approximation of cost behaviour is sufficient for making decisions.

3. Scatter Graph Method:

In this method, it involves plotting several observed levels of cost and their associated levels of activity on a scatter-graph and then applying statistical analysis to fit the best line through these points.

Illustration:

Output (unit)	1000	2000	3000	4000	5000	6000
Costs (Rs.)	10500	12500	13800	15100	15900	17200

The point at which the line of best fit touches the ordinate indicates fixed component of the cost i.e., Rs. 9,500 in this case. The slope of the line indicates the degree of variability of costs.

The scatter-graph as shown in figure 2.4 can be drawn with the help of the above data

The line of best fit is relatively simple to apply and it does attempt to use all the information in the relevant range of production to arrive at the estimated cost function. However, it remains rather crude and does not adequately handle data points which are far away from the main body of points (called out liners).

Another problem with this method is that each accountant using the same cost data to estimate the cost of equation may draw different total cost lines by eye, to describe the relationship between cost and activity. Despite the short-coming, the method may be sufficient for the small company that does not possess the expertise to use complicated statistical technique.

4. High and Low Method:

Under this method, the highest and lowest volumes of output and the relevant cost figures are taken into consideration. The difference of cost between volumes, i.e., incremental cost for incremental output will be arrived at. The incremental cost will be further divided by the incremental output. This will give the variable cost per unit.

Total variable cost for any level of output can be determined easily. Now, the total cost of the volume of output less the total variable cost at that level of output gives the fixed cost which will remain for all levels of activity.

Direct labor cost is wages that are incurred in order to produce goods or provide services to customers. The total amount of direct labor cost is much more than wages paid. It also includes the payroll taxes associated with those wages, plus the cost of company-paid medical insurance, life insurance, workers’ compensation insurance, any company-matched pension contributions, and other company benefits.

Direct labor costs are most commonly associated with products in a job costing environment, where the production staff is expected to record the time they spend working on various jobs. This can be a substantial chore if employees work on a multitude of different products. In the services industries, such as auditing, tax preparation, and consulting, employees are expected to track their hours by job, so their employer can bill customers based on direct labor hours worked. These are also considered to be direct labor costs. In a process costing environment, where the same product is created in very large quantities, direct labor cost is included in a general pool of conversion costs, which are then allocated equally to all of the products manufactured.

A strong case can be made in some production environments that direct labor does not really exist, and should be categorized as indirect labor, because production employees will not be sent home (and therefore not be paid) if one less unit of product is manufactured – instead, direct labor hours tend to be incurred at the same steady rate, irrespective of production volume levels, and so should be considered part of the general overhead costs associated with running a production operation.

Calculate Direct Labor Cost per Unit

The amount incurred as direct labor cost depends on how efficiently the workers produced finished items. Usually, companies calculate a standard direct labor cost against which to compare their actual direct labor costs. Here is how to calculate direct labor cost per unit of production:

1. Calculate the direct labor hourly rate

First, calculate the direct labor hourly rate that factors in the fringe benefits, hourly pay rate, and employee payroll taxes. The hourly rate is obtained by dividing the value of fringe benefits and payroll taxes by the number of hours worked in the specific payroll period.

For example, assume that employees work 40 hours per week, earning $13 per hour. They also get $100 in fringe benefits and $50 in payroll taxes. Get the sum of the benefits and taxes (100+50) and divide the figure by 40 to get 3.75. The $3.75 is added to $13 to get an hourly rate of $16.75.

2. Calculate the direct labor hours

The direct labor hours are the number of direct labor hours needed to produce one unit of a product. The figure is obtained by dividing the total number of finished products by the total number of direct labor hours needed to produce them. For example, if it takes 100 hours to produce 1,000 items, it means that 1 hour is needed to produce 10 products, and 0.1 hours to produce 1 unit.

3. Calculate the labor cost per unitThe labor cost per unit is obtained by multiplying the direct labor hourly rate by the time required to complete one unit of a product. For example, if the hourly rate is $16.75, and it takes 0.1 hours to manufacture one unit of a product, the direct labor cost per unit equals $1.68 ($16.75 x 0.1).
4. Calculate the variance between the standard and actual labor cost

The variance is obtained by calculating the difference between the direct labor standard cost per unit and the actual direct labor cost per unit. If the actual direct labor cost per unit is higher than the standard direct labor cost per unit, it means that the company incurs more to produce one unit of a product than is expected, making the cost unfavorable to the business. If the actual direct labor cost is lower, it means that it costs lower to produce one unit of a product than the standard direct labor rate, and therefore, favorable.

There are so many expenditures which are incurred in respect of the employees of the business firm which are neither official nor personal; even then these are booked as business expenditure. For example:- Tea and refreshment expenses for the employees, medical expenses for the health of the employees or their family members, uniforms given to employees, concessional foods given to employees, personal accident insurance premium paid for employees etc. For control purpose, the sub heads may be created under staff welfare expense like tea & refreshment expenses, medical expenses, personal accident expenses, uniform expenses etc.

Employee welfare entails everything from services, facilities and benefits that are provided or done by an employer for the advantage or comfort of an employee. It is undertaken in order to motivate employees and raise the productivity levels.

In most cases, employee welfare comes in monetary form, but it doesn’t always bend that way. Other forms of employee welfare include housing, health insurance, stipends, transportation and provision of food. An employer may also cater for employees’ welfare by monitoring their working conditions.

Importance of employee welfare

Employee welfare raises the company’s expenses but if it is done correctly, it has huge benefits for both employer and employee. Under the principles of employee welfare, if an employee feels that the management is concerned and cares for him/her as a person and not just as another employee, he/she will be more committed to his/her work. Other forms of welfare will aid the employee of financial burdens while welfare activities break the monotony of work.

An employee who feels appreciated will be more fulfilled, satisfied and more productive. This will not only lead to higher productivity but also satisfied customers and hence profitability for the company. A satisfied employee will also not go looking for other job opportunities and hence an employer will get to keep the best talents and record lower employee turnover.

During employment, the offered benefits will determine whether an employee commits to an organization or not. As such, good employee welfare enables a company to compete favorably with other employers for the recruitment and retention of quality personnel.

Five Techniques of Inventory Control

1. Economic Order Quantity

A problem which always remains in that how much material may be ordered at a time. An industry making bolts will definitely would like to know the length of steel bars to be purchased at any one time.

This length is called “economic order quantity” and an economic order quantity is one which permits lowest cost per unit and is most advantages.

This can be calculated by the following formula:

Q = √2AS/I

Where Q stands for quantity per order

A stands for annual requirements of an item in terms of rupees

S stands for cost of placement of an order in rupees; and

I stand for inventory carrying cost per unit per year in rupees.

2. Inventory Models

Inventory models determine when and how inventory to carry.

(i) Inventory models handle chiefly two decisions:

• How much to order at one time.
• When to order this quantity to minimize total costs.

(ii) Lowest-cost decision rules for inventory management pertain to either buying products from outside or producing then within the company.

(iii) Single inventory models assume no delivery delay and that demand is known.

(iv) Probabilistic models handle situations of risks and uncertainty.

3. ABC Analysis

In order to exercise effective control over materials, A.B.C. (Always Better Control) method is of immense use. Under this method materials are classified into three categories in accordance with their respective values. Group ‘A’ constitutes costly items which may be only 10 to 20% of the total items but account for about 50% of the total value of the stores.

A greater degree of control is exercised to preserve these items. Group ‘B’ consists of items which constitutes 20 to 30% of the store items and represent about 30% of the total value of stores.

A reasonable degree of care may be taken in order to control these items. In the last category i.e. group ‘Q’ about 70 to 80% of the items is covered costing about 20% of the total value. This can be referred to as residuary category. A routine type of care may be taken in the case of third category.

This method is also known as ‘stock control according to value method’, ‘selective value approach’ and ‘proportional parts value approach’.

If this method is applied with care, it ensures considerable reduction in the storage expenses and it is also greatly helpful in preserving costly items.

4. Material Requirements Planning

MRP is a computational technique that converts the master schedule for end products into a detailed schedule for raw material and components used in the end products. The detailed schedule indentifies the quantities of each raw material and component items. It also tells when each item must be ordered and delivered so as to meet the master schedule for the final products.

5. VED Analysis

Vital essential and desirable analysis is used primarily for the control of spare parts. The spare parts can be divided into three categories:

(i) Vital

(ii) Essential

(iii) Desirable

(i) Vital: The spares the stock out of which even for a short time will stop production for quite some time and future the cost of stock out is very high are known as vital spares.

(ii) Essential: The spare stock out of which even for a few hours of days and cost of lost production is high is called essential.

(iii) Desirable: Spares are those which are needed but their absence for even a week or so will not lead to stoppage of production.