Using Cost Codes In Budgeting Accounting Essay

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Job costing and batch costing are both methods of costing. Both are used in specific order costing. But job costing determines the cost of one unit of production but in batch costing, we will be unable to calculate the cost of one unit. For example you see 12 biscuits in one pack of biscuits. But this pack is the batch of 12. We will calculate the cost of one pack instead of one biscuit.

Using job costing

In a job costing system, costs may be accumulated either by job or by batch. For a typical job, direct material, labor, subcontract costs, equipment, and other direct costs are tracked at their actual values. These are accrued until the job or batch is completed. Overhead or "burden" may be applied either by using a rate based on direct labor hours or by using some other Activity Based Costing (ABC) cost driver. In either case, once overhead/burden is added, the total cost for the job can be determined. If the accountant is using a general ledger accounting system, which lacks true job costing functionality, the costs must be manually transferred out of Work in Process to Finished Goods (Cost of Goods Sold for service industries). Of course, in the days of computerized job costing software, journaling costs manually is an obsolete process. Such hand-journaling is mandatory for companies that continue to use general accounting software to do job costing. Enlightened accountants are moving forward and using job costing software, thereby improving cost control, reducing risk, and increasing the chance of profitability.

Using cost codes in budgeting

In a true job cost accounting system, a Budget is set up in advance of the job. As actual costs are accrued, they are compared to budgeted costs, to determine variances for each phase of each job. Cost Codes are used for each phase, allowing "mini-budgets" to be generated and tracked. In the construction industry, the Construction Specifications Institute (CSI) has established an industry standard Cost Coding system. Job costing system consists of various cost driver that drives job cost, moreover it

An advertising campaign for Pepsi is likely to be very specific to that individual client. Job costing enables all the specific aspects of each job to be identified. In contrast, the processing of checking account withdrawals is similar for many customers. Here, process costing can be used to compute the cost of each checking account withdrawal.

The seven steps in job costing are:

1.) Identify the job that is the chosen cost object,

2.) Identify the direct costs of the job,

3.) Select the costallocation bases to use for allocating indirect costs to the job,

4.) Identify the indirect costs associated with each costallocation base,

5.) Compute the rate per unit of each costallocation base used to allocate indirect costs to the job,

6.) Compute the indirect costs allocated to the job, and

7.) Compute the total cost of the job by adding all direct and indirect costs assigned to the job.

Example

These examples will assume that overhead is allocated on the basis of Direct Labor Hours. Direct Material is abbreviated DM, Direct Labor as DL, and Overhead as OH.

XYZ corporation manufactures airplanes. 1 order was completed (110), 2 received further work (111, 112), and 1 new order was received (113). Overhead is allocated at a rate of $100/DL Hour. All employees earn $20/hour. Beginning Work In Process Balances are as follows: 110, $25,000; 111, $10,000; 112, $12,000; 113 $0 (New Order). Below are the amounts of DM and DL used.

110 $2,000 DM, 25 DL hours. Therefore, $5,000 in new cost is added ($2,000 DM, $500 DL, $2,500 OH). The job had a total cost of $30,000. this amount is transferred out of Work in Process to Finished Goods or Cost of Goods Sold.

111 $3,000 DM, 30 DL hours. Therefore, $6,600 in new cost is added ($3,000 DM, $600 DL, $3,000 OH). The job has a new total cost of $16,600. This amount remains in Work in Process until completion.

112 $5,000 DM, 100 DL hours. Therefore, $17,000 in new cost is added ($5,000 DM, $2,000 DL, $10,000 OH). The job has a new total cost of $29,000. This amount remains in Work in Process until completion.

113 $1,000 DM, 10 DL hours. Therefore, $2,200 in new cost is added ($1,000 DM, $200 DL, $1000 OH). The job has a new total cost of $2,200. This amount remains in Work in Process until completion.

Caution: Remember, overhead is allocated on the basis of DL hours. While in this case, allocating overhead on the basis of DL cost ($5 of overhead for every $1 DL cost) would produce the same result, this may not always be the case. Since rates are developed based on a budget, if employees are actually paid a different rate from the budgeted rate, allocating at a $5 to $1 ratio would produce a different cost from the stated $100/DL hour allocation. Companies use slightly different overhead allocation methods.

PROCESS COSTING:

Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter.

The importance of process costing

Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as job costing) in some ways. In Process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. So, a lot of companies prefer to use process-costing system.

Reasons for use

Companies need to allocate total product costs to units of product for the following reasons:

A company may manufacture thousands or millions of units of product in a given period of time.

Products are manufactured in large quantities, but products may be sold in small quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc.

Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue.

Managers need to maintain cost control over the manufacturing process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets.

A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.

Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By determining what cost the part processed material has incurred such as labor or overhead an "equivalent unit" relative to the value of a finished process can be calculated.

Process cost procedures

There are four basic steps in accounting for Process cost:

Summarize the flow of physical units of output.

Compute output in terms of equivalent units.

Summarize total costs to account for and Compute equivalent unit costs.

Assign total costs to units completed and to units in ending work in process inventory.

Job costing vs. process costing

Job costing (known by some as job order costing) is fundamental to managerial accounting. It differs from Process costing in that the flow of costs is tracked by job or batch instead of by process.

The distinction between job costing and process costing hinges on the nature of the product and, therefore, on the type of production process:

Process costing is used when the products are more homogeneous in nature. Conversely, job costing systems assign costs to distinct production jobs that are significantly different. An average cost per unit of product is then calculated for each job.

Process costing systems assign costs to one or more production processes. Because all units are identical or very similar, average costs for each unit of product are calculated by dividing the process costs by the number of units produced.

Many businesses produce products with some unique features and some common processes. These businesses use costing systems that have both job and process costing features

A Detailed Worked Example

The following example illustrates how to approach a Process Costing question, paying particular attention to presentation and calculation. Candidates should always strive to present their solutions as neatly and methodically as possible, not only to help the marker follow the calculations, but also to allow themselves to check that they have not missed out a vital step. The data for the question is shown in Figure 1.

Figure 1

Jammy Ltd is a manufacturing organisation with two processes. Information for the period ended 31 July 1999 is as follows:

PARTICULARS

PROCESS1

PROCESS2

Opeing work in progress

Costs of periods:

Material 1000kg costing

labour

overheads

ransferred to process costing 2

transferred to finished goods

closing work in progress

Nil

£25650

£12750

£5950

700kg

-----

200kg

200 kg

nil

£6950

£3475

-----

800kg

150kg

Normal losses are expected to be 5% of input for each process. Losses in Process 1 have no scrap value, whilst losses in Process 2 can be sold for £10 per kg. Losses are deemed to arise at the end of the process.

Opening WIP is 60% complete with regard to Labour and Overheads. Closing WIP in Process 1 is 100% complete with regard to Material and 50% complete for Labour and Overheads. Closing WIP in Process 2 is 50% complete with regard to Labour and Overheads.Prepare the Process Accounts for each process.

SOLUTION: Step 1

The best way to approach this question is to concentrate on Process 1 first, as Process 2 cannot be completed until we know the value of the items transferred into this process from Process 1. The first step is to draw up a process account in typical 'T' account fashion. Each side of the account should have a column for 'Units' and a column for '£'. You should then enter all the information given in the question. This will make it clear as to which items have to be calculated - these items are numbered in this example for illustrative purposes.

Process 1 Account

PARTICULARS

UNITS

£

PARTICULARS

UNITS

£

CURRENT COST

MATERIAL

LABOUR

OVERHEAD

1000

-------

-------

1000

25650

12750

5950

44350

TRANSFFERD TO PROCESS 2

NORMAL LOSS

CLOSING WIP

ABNORMAL LOSS

700

50

200

50

1000

(1)

NIL

(2)

(3)

(4)

The Normal Loss figure is 5% of the 1000kg input. No cost is assigned to Normal Loss as the cost is absorbed into the "good" units. Abnormal Loss is the difference between the total units on the debit side and the total units on the credit side.

Step 2

The next step is to draw up an Equivalent Units Statement to determine the cost per unit of the equivalent "whole" units produced.

Equivalent Units Statement

PARTICULARS

MATERIAL

LABOUR

OVERHEAD

UNITS TRANSFERRED TO PROCESS 2

ABNORMAL LOSS

CLOSING WIP

Periods cost (b)

Cost per unit (b)/(a)

700

50

200

950

£25650

£27

700

50

100

850

£12750

£15

700

50

100

850

£5950

£7

Closing WIP is 50% complete for Labour and Overheads, which is equivalent to 200 x 50% = 100 "complete" units.

Step 3

The information calculated in the Equivalent Units Statement is then used to construct a Cost Allocation Statement. The layout of this statement is exactly the same as the Equivalent Units Statement.

PARTICULAR

MATERIAL

LABOUR

OVERHEAD

TOTAL

UNITS TRANSFERRED TO PROCESS 2

ABNORMAL LOSS

CLOSING WIP

18900

1350

5400

25650

10500

750

1500

12750

4900

750

700

5950

34300 (1)

2450 (3)

7600 (2)

44350

Each entry in the above statement is calculated using the cost per unit calculated in the Equivalent Units Statement and the relevant equivalent units. For example, the Material Cost of Units transferred to Process 2 (£18,900) is calculated by multiplying the Material Unit Cost (£27) by the equivalent units transferred to Process 2 in respect of Material (700). This gives us £18,900. The Labour Cost of Abnormal Loss is calculated by multiplying the Labour Unit Cost (£15) by the equivalent units of Abnormal Loss in respect of Labour (50). This gives us £750, and so on.

You will notice that the total of each column (Material, Labour and Overhead) is the same as the figures appearing in the Process Account for each of these costs.

Step 4

The final step is to complete the Process Account by using the figures calculated in the 'Total' column of the Cost Allocation Statement. Those figures labelled (1) - (3) are the figures to be slotted into the spaces similarly numbered in the Process Account in Step 1. Your final Process Account should now look thus:

Process 1 Account

PARTICULARS

UNITS

£

PARTICULARS

UNITS

£

CURRENT COST

MATERIAL

LABOUR

OVERHEAD

1000

-------

-------

1000

25650

12750

5950

44350

TRANSFFERD TO PROCESS 2

NORMAL LOSS

CLOSING WIP

ABNORMAL LOSS

700

50

200

50

1000

34300

NIL

7600

2450

44350

Step 5

We are now in the position to go through the whole "process" again for Process 2. The main differences between the two processes are the existence of Opening WIP and scrap value of losses in Process 2. Explanations for the figures in Process 2 are only given where the concepts have not been explained already in Process 1.

Construct Process Account:

Process 2 Account

PARTICULARS

UNITS

£

PARTICULARS

UNITS

£

OPENING WIP

Transferred From Process 1

LABOUR

OVERHEAD

300

700

-------

-------

1000

13000

34300

6950

3475

57725

Transferred To Finished Goods

NORMAL LOSS

CLOSING WIP

800

50

150

1000

(4)

500

(5)

(6)

Losses can be sold at £10 per kg, therefore Normal Loss is assigned a monetary value of 50 x £10 = £500.

Step 6

Construct Equivalent Units Statement:

Equivalent Units Statement

PARTICULARS

Transferred Cost From Process 1

LABOUR

OVERHEAD

OPENING WIP

UNITS STARTED & COMPLETED

CLOSING WIP

TOTAL EQUIVALENT UNIT

Periods cost (b)

Cost per unit (b)/(a)

NIL

500

150

650

£33800

£50

120

500

75

695

£6950

£10

120

500

75

695

£3475

£5

Opening WIP is already 60% complete with regard to Labour and Overheads, therefore only 40% remains to be completed in this period. Equivalent units completed in this period are therefore 300 x 40% = 120kg.

Opening WIP in respect of "Transferred Costs from Process 1" are always NIL as they were transferred in a previous period and therefore do not form part of the cost of the units transferred from Process 1 in this period.

Units started and completed during the period is the difference between the units transferred to finished goods (shown in the Process Account as 800) and the units already started at the beginning of the period (Opening WIP of 300).

The period cost given for "Transferred Costs from Process 1" has been calculated by deducting the scrap value of Normal Loss (£500) from the total transferred cost (£34,300).

Step 7

Construct Cost Allocation Statement:

Cost Allocation Statement

PARTICULAR

Transferrd Cost From Process 1

LABOUR

OVERHEAD

TOTAL

OPENING WIP

UNIT STARTED & COMPLETED

CLOSING WIP

NIL

26000

7800

33800

1200

5000

750

6950

600

2500

375

3475

1800 (*)

33500 (*)

8925 (5)

44225

(*) The calculation of the cost of units transferred to Finished Goods is slightly different when there is Opening WIP. The cost of units transferred includes 3 elements: the cost of Opening WIP brought forward from the previous period (£13,000), the cost to complete the Opening WIP in this period (£1,800) and the cost of the units started and completed in this period (£33,500). This gives us a total of £48300 to be slotted into the Process Account.

Step 8

Complete the Process Account:

Process 2 Account

PARTICULARS

UNITS

£

PARTICULARS

UNITS

£

OPENING WIP

Transferred From Process 1

LABOUR

OVERHEADS

300

700

-------

-------

1000

13000

34300

6950

3475

57725

Transferred To Finished Goods

NORMAL LOSS

CLOSING WIP

800

50

150

1000

48300

500

8925

57725

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