Different Costing Methods

COSTING METHODS
OVERVIEW
Objective
! To consider the costing information requirements for job costing, process

costing and service costing.
Costing
resource
outputs
JOB SERVICE PROCESS

COSTING COSTING COSTING
When used When used
Features Method
Problems Benefit
WORK IN PROCESS JOINT AND

PROGRESS WASTE BY-PRODUCTS
FIFO method Normal waste Apportioning joint

Average cost Abnormal waste costs
method Abnormal gains Accounting for
by-product revenue
 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0901

COSTING METHODS
1 JOB COSTING
1.1 When used
! A type of specific order costing used when firms make different products or
provide services to meet specific customer requirements.
! When each job/customer requires a good or service using different quantities

of inputs (ie direct materials, direct labour and overheads).
! Accountancy firms use job costing.
1.2 Features
! The costs of a job or service are collected via a job card which follows the
work during its passage through each production department.
The job card is now usually held on computer and the data is input from
sources such as timesheets and expense claims.
! Overheads are charged to the product/service usually on a direct labour hour

or machine hour basis.
1.3 Problems
! Estimating costs to enable quotes for customers to be accurate,

ie overpricing → lose customers
underpricing → failure to recover costs.
2 SERVICE COSTING
2.1 When used
! Used to establish a specific cost for an “internal service”, ie a service

provided by one department for another. Service departments include, eg
canteens, data processing departments.
! The purposes of service department costing is to control the costs and

efficiency in the service department
2.2 Method of service department costing
! First, establish a unit for measuring the service, eg distribution cost per
tonne/km, a canteen cost per employee
This can then be used to exercise control over the costs of the service
department. For example:
− compare actual costs against a target or standard;

− compare actual costs in the current period against actual costs in
previous periods

COSTING METHODS
! A subsidiary purpose of service department costing is to control the costs of

the user departments and prevent the unnecessary use of services.
If the costs of services are charged to the user department in such a way that
the charges reflect the use actually made, then:
− the overhead costs of the user departments will be established more

accurately;
− if charges are high, the user department might consider whether it is

wasteful of the service department’s service.
2.3 Benefit of service department costing
! Service costing provides a fairer basis for charging service costs to user
departments, instead of charging service costs as overheads on a broad direct
labour hour basis, or similar arbitrary apportionment basis. This is because
service costs are related more directly to use of the particular service.
3 PROCESS COSTING
3.1 Introduction
! A type of specific order costing used to enable firms to value items of

finished output and closing stock when a single product is mass-produced.
! It is used when firms mass-produce products which are identical and consist
of identical inputs (ie direct materials, direct labour and overheads), eg food
industry, chemical industry, detergents, glue, petroleum, etc. Additionally, it
is not normally possible to trace a particular unit of input to a particular unit
of output.
! The costs incurred in a period (month/year) are averaged out over the units
produced using one of two methods
Cost to be averaged out
First in first out method (FIFO) Average cost method (AVCO)
3.2 Problems
! Valuing closing work in progress – need to identify equivalent units produced

for each cost element.
! How to account for waste and substandard production.

COSTING METHODS
4 WORK IN PROGRESS
4.1 Opening and closing work in progress
There are two methods of dealing with opening work in progress.
FIFO – Assumes all items are dealt with in strict order

– No need to know the split of the opening work in progress
between materials, labour etc
AVCO – Assumes all units are equally likely to be completed in the
period
– Need to know the split of the opening work in progress
4.2 Approach to questions
(1) Work out the flow of physical units
Remember
Opening WIP + Units input = Units output + Closing WIP

Under FIFO; Units output = Opening WIP + Units started and finished
(2) Identify total costs to be apportioned
(3) Calculate the equivalent units of production
(4) Calculate costs per unit (element cost)
(5) Evaluate finished goods and closing work in progress.
4.3 Equivalent units calculation assuming FIFO

Direct Direct O/Hs
materials labour
DMs DL
Finish off opening WIP (if any) x x x
Units started and finished x x x
Units started but not finished

(ie closing WIP) x x x
— — —
This period’s equivalent units (EUs) x x x
— — —
This period’s costs (Excl opening WIP) £x £x £x

— — —
÷ by EUs x x x
— — —
= element cost =£y =£y =£y

— — —

COSTING METHODS
Having calculated the equivalent units produced this period and element costs per unit,
now value transfers out and closing WIP.
FIFO
Value of finished goods transferred out

£
Cost of WIP b/f x
+ Cost of finishing off opening WIP x
+ Cost of units started and finished x
—
x
—
Value of closing WIP
EUs × Element costs per unit x

—
4.4 Equivalent units calculation assuming AVCO
DMs DL O/Hs
Units completed x x x
Closing WIP x x x
— — —
Total EUs (AVCO) x1 x1 x1
— — —
Total costs £x1 £x1 £x1

(must include cost of WIP b/f) — — —
÷ by EUs x1 x1 x1
— — —
= element cost per unit =£y1 =£y1 =£y1
— — —
Note
! AVCO gives a higher equivalent unit figure because it includes all the
opening WIP b/f units in the equivalent units calculated.
(FIFO does not. FIFO only includes, for opening WIP b/f, the equivalent
units required to finish off the opening WIP.)
! The “costs” for direct materials, direct labour and overheads are higher for
AVCO than for FIFO because AVCO includes the costs b/f in the opening
WIP. FIFO does not.

COSTING METHODS
Example 1
Work in progress at March 1 consisted of 2,000 units which were:
50% complete for materials valued at £1,375

25% complete for labour valued at £89
Costs incurred during March:
Materials £10,500
Labour £1,680
6,000 units were completed in March.
Work in progress at March 31 consisted of 1,000 units which were:
25% complete for materials

10% complete for labour
Required:
Calculate total value of
(i) goods finished in March

(ii) closing work in progress
using both (a) FIFO and (b) AVCO methods.
Solution
(a) FIFO
Physical flow

COSTING METHODS
Materials Labour
Finish OpWIP
Units started and finished
Units started but not finished
——— ———
Total equivalent units
——— ———
Period costs
Element cost
£ £
OpWIP b/f
Completion of OpWIP Materials
Labour
——–
Started and finished Materials

Labour
——–
______
Value of finished goods
––––––
Value of closing WIP Materials

Labour
___
–––
(b) Weighted average cost
Physical flow
Materials Labour
Units completed
Closing WIP
——— ———
Equivalent units
——— ———
£ £
Cost b/f
Costs in period
——— ———
Total cost
——— ———
Element cost per unit

COSTING METHODS
£
Value of opening work in progress
Started and finished
Value of closing WIP – Materials
– Labour
——
——
Having completed the above you should be able to recognise that under AVCO
(assuming costs are rising) the lower costs b/f are spread over all production including
those items in closing WIP. Therefore:
(i) closing WIP value is lower than under FIFO;

(ii) cost of units completed is higher than under FIFO;
(iii) profits are lower than under FIFO.
5 PROCESS WASTE
5.1 Normal waste
! This is expected to arise!

! It is part of the cost of good production
! Its cost is therefore included in the cost of good output and closing WIP
! It is unavoidable.
5.2 Abnormal waste
! This is not expected and should not arise!!

! It is not included in the cost of good production or closing WIP
! It is avoidable
! Valued as if it is good production.
5.3 Process accounts

Process account
Units £ Units £
WIP b/d Output of F goods
DMs (additional) Normal waste/scrap
DL Abnormal waste/scrap
O/Hs WIP c/d
Input to the process

COSTING METHODS
Normal waste expected proceeds are credited to the process account.
The cost of abnormal waste and good production is calculated using the formula
Costs − Expected normal loss scrap proceed

Cost per unit =
Expected good production
Example 2
A process for making lead shot requires 1 kg of lead costing £40 per kg and produces
0.95 kg of shot.
The balance, which is waste, is sold for £20 per kg.
In a period 100 kg was processed and 92 kg of shot produced.
Labour costs amounted to £550 and overheads are normally allocated at 4 times the
labour cost.
Required:
Write up the following T accounts:
(i) process account;

(ii) normal waste account;
(iii) abnormal waste account.
Solution
Process account
kg £ kg £
Material Normal loss
Labour Abnormal loss (W)
Overheads Good production (W)
___ _____ ___ _____
___ _____ ___ _____
Normal waste account

kg £ kg £
Process a/c Cash
___ ___
Abnormal waste account

kg £ kg £
Process a/c Cash
P&L
___ ___
___ ___

COSTING METHODS
WORKING
Cost per unit =
5.4 Abnormal gains
When abnormal gains occur there will be a balance on the normal waste account which
reduces the abnormal gain.
Example 3
As above but good production amounted to 98 kg.
Solution
Process account
kg £ kg £
Material Normal loss
Labour Good production
Overheads
Abnormal gain
___ _____ ___ _____
___ _____ ___ _____

kg £ kg £
Process a/c Cash
Abnormal waste
__ ___ __ ___
__ ___ __ ___

kg £ kg £
Normal waste Process a/c
P&L
___ ___
___ ___

COSTING METHODS
6 JOINT AND BY-PRODUCTS
6.1 Definition
! Joint and by-products arise where the manufacture of one product makes
inevitable the manufacture of another.
! Where each product has a significant sales value, they are joint products.
! Where one or more products has a relatively low sales value, they are
considered to be by-products. They are often considered to arise incidentally
to the production of the main product or products.
! The point at which separate products become identifiable is known as the

split-off point.
! Costs incurred prior to the split-off point are joint costs or pre-separation
costs.
6.2 Method of apportioning joint costs to joint products
6.2.1 Physical measures method
! Joint costs are apportioned to joint products in proportion to some physical

measure, eg weight, volume, units.
! Advantage – simple to calculate.
! Disadvantage – bears no relationship to the product’s profitability.
6.2.2 Final sales value method
! Costs are apportioned in proportion to relative final sales value of joint

products.
! Advantage – all products appear equally profitable.
! Disadvantage – not appropriate where there are further costs after split-off
point.
6.2.3 Net realisable value method
! Costs are apportioned between products in proportion to NRV (ie sales value
less separable costs).
! Advantage – more appropriate than sales value method where separable costs
exist.
! Disadvantage – can be complex where several split-off points exist.
6.2.4 Technical estimate
! Rarely used.

COSTING METHODS
Example 4
The following information is provided about three products, A, B and C.
A B C
Sales value after further processing £12,000 £48,000 £40,000
Post separation costs £2,000 £14,000 £24,000
Proportion of total output weight 40% 25% 35%
Required:
If joint costs amount to £40,000, calculate the profit for each product using
(i) a physical measure

(ii) final sales value
(iii) net realisable value
to apportion joint costs.
Solution
(i) Physical measure
Product Final sales Joint costs Post- Profit/

value separation (loss)
costs
£ £ £ £
A 12,000 2,000
B 48,000 14,000
C 40,000 24,000
______ ______ ______ ______
100,000 40,000 40,000 20,000
——— ——— ——— ———
(ii) Final sales value

costs
£ £ £ £
A 12,000 2,000
B 48,000 14,000
C 40,000 24,000
______ ______ ______ ______
100,000 40,000 40,000 20,000
——— ——— ——— ———

COSTING METHODS
(iii) NRV
Product Final sales Post- Net Joint Profit/

value separation realisable costs (loss)
costs value
£ £ £ £ £
A 12,000 2,000
B 48,000 14,000
C 40,000 24,000
_______ ______ ______ ______ ______
100,000 40,000 20,000
––––––– –––––– –––––– –––––– ––––––
6.3 Apportioning costs with more than one split-off point
! Using NRV
Take the following three steps
(1) Draw a tree diagram noting physical inputs and outputs, joint and separable
costs, and final sales value.
(2) Set up a table with a column for each product, putting sales revenue in the top
line.
(3) Work backwards towards each split-off point deducting from sales revenue
all separable costs and allocating joint costs at each SOP on the basis of NRV
at that point.
! Using physical measure
(1) Draw a tree diagram noting physical inputs and outputs, joint and separable
costs, and fixed sales value.
(2) Set up a table with a column for each product.
(3) Work through diagram from left to right splitting joint costs at each SOP.
(4) Total costs and compare to sales revenue.

COSTING METHODS
Example 5
25 kg
Sales revenue of D
£100/kg
£500 D
B 40g
£1,200
A 100g 15 kg E Sales revenue of E

£200/kg
£640
C 60g
Sales revenue of C
£1,000 £60/kg
Required:
Work out the net profit for each product
(i) using net realisable value to split joint costs

(ii) using a physical measure to split joint costs.
Solution
(i) NRV
Products
Total C D E
£ £ £
Sales revenue
Separable costs after SOP2 (500) (500) –
——— ———
NRV at SOP2
Joint costs
Split in ratio (2000:3000)
Separable costs after SOP1 (1,000) (1,000)
——— ——— ——— ———
NRV at SOP1
Joint costs
Split in ratio (2600:1520:2280)
——— ——— ——— ———
Net profit
——— ——— ——— ———

COSTING METHODS
(ii) Physical measure
Total B C
£ £ £
Joint costs
Separable costs after SOP1 2,200 1,200 1,000
_____ _____
D E
Joint costs
Separable costs after SOP2 500 500
_____ _____ _____ _____
Total costs
Sales revenue
_____ _____ _____ _____
Net profit
––––– ––––– ––––– –––––
6.4 Accounting treatment for by-products sales revenue
There are a number of ways available for dealing with by-products. The two most
usual methods are:
(1) treat as miscellaneous income

(2) the net realisable value method.
6.4.1 Miscellaneous income
! By-product revenue is credited to P&L as additional income.
6.4.2 Net realisable value method
! By-product net realisable income is deducted from the cost of the main
product.
! By-product revenue can be deducted from the cost of the main product
either when by-product is produced

or when by-product is sold
! The former results in a closing stock value for by-products (valued at NRV).
! The latter gives zero closing stock valuation.

COSTING METHODS
Example 6
A process produces 100 kg of a by-product.
The by-product can be sold at £5 per kg.
At the end of the period 30 kg remain.
Required:
Show the entries on the by-product account if by-product income is recognised at
(i) the point of production

(ii) the point of sale.
Solution
(i) Point of production
By-product
kg £ kg £
Process account Cash
Balance c/d
___ ___
Balance b/d Closing stock

___
(ii) Point of sale
By-product
kg £ kg £
Process account Cash
Closing stock
6.4.3 Alternative treatment
! Allocate joint costs to by-products.
! Results in a closing stock valuation for by-products.
! May be appropriate where by-products are significant.
! May help with pricing decisions.
! Disadvantage – in effect treats the by-product as a joint product.

COSTING METHODS
FOCUS
You should now be able to
! apply appropriate cost accumulation methods to problems of job and service

costing
! apply appropriate cost accumulation methods to problems of process costing
! prepare statements which value losses in process and work in progress
! calculate appropriate costs for joint products and prepare process costing
statements which account for by-products

COSTING METHODS
EXAMPLE SOLUTIONS
Solution 1 – WIP
(a) FIFO
Physical flow
OWIP + Inputs = Completed + CWIP
2,000 + 5,000 (βal) = 6,000 + 1,000
Completed S&F
Op WIP
2,000 4,000
Materials Labour
Finish OpWIP 1,000 1,500
Units started and finished 4,000 4,000
Units started but not finished 250 100
——— ———
Total equivalent units 5,250 5,600
——— ———
Period costs £10,500 £1,680

Element cost £2.00 £0.30
£ £
OpWIP b/f 1,464
Completion of OpWIP Materials 1,000 × 2 2,000
Labour 1,500 × 0.3 450
——–
3,914
Started and finished Materials 4,000 × 2 8,000
Labour 4,000 × 0.3 1,200
——–
9,200
______
Value of finished goods 13,114
––––––
Value of closing WIP Materials 250 × 2 500

Labour 100 × 0.3 30
___
530
–––

COSTING METHODS
(b) Weighted average cost
Physical flow
As for FIFO, but we cannot now distinguish S&F units and completed opening WIP.
Materials Labour
Units completed 6,000 6,000
Closing WIP 250 100
——— ———
Equivalent units 6,250 6,100
——— ———
£ £
Cost b/f 1,375 89
Costs in period 10,500 1,680
——— ———
Total cost 11,875 1,769
——— ———
Element cost per unit £1.90 £0.29
£
Value of opening work in progress 2,000 × (1.90 + 0.29) 4,380
Started and finished 4,000 × (1.90 + 0.29) 8,760
Value of closing WIP – Materials 250 × 1.90 475
– Labour 100 × 0.29 29
——
504
——
Solution 2 – Losses
Process account
kg £ kg £
Material 100 4,000 Normal loss 5 100
Labour 550 Abnormal loss (W) 3 210
Overheads 2,200 Good production (W) 92 6,440
___ _____ ___ _____
100 6,750 100 6,750
___ _____ ___ _____

kg £ kg £
Process a/c 5 100 Cash 5 100
___ ___

COSTING METHODS

kg £ kg £
P&L 150
___ ___
210 210
___ ___
WORKING
4,000 + 550 + 2,200 − 100

Cost per unit = = £70
95
Solution 3 – Abnormal gain
Process account
kg £ kg £
Material 100 4,000 Normal loss 5 100
Labour 550 Good production 98 6,860
Overheads 2,200
Abnormal gain 3 210
___ _____ ___ _____
103 6,960 103 210
___ _____ ___ _____

kg £ kg £
Abnormal waste 3 60
__ ___ __ ___
5 100 5 100
__ ___ __ ___

kg £ kg £
Normal waste 3 60 Process a/c 3 210
P&L 150
___ ___
210 210
___ ___

COSTING METHODS
Solution 4 – Joint product
(i) Physical measure

costs
£ £ £ £
A 12,000 16,000 2,000 (6,000)
B 48,000 10,000 14,000 24,000
C 40,000 14,000 24,000 2,000
______ ______ ______ ______
100,000 40,000 40,000 20,000
——— ——— ——— ———
(ii) Final sales value

costs
£ £ £ £
A 12,000 4,800 2,000 5,200
B 48,000 19,200 14,000 14,800
C 40,000 16,000 24,000 Nil
______ ______ ______ ______
100,000 40,000 40,000 20,000
——— ——— ——— ———
(iii) NRV
Product Final sales Post- Net Joint Profit/

value separation realisable costs (loss)
costs value
£ £ £ £ £
A 12,000 2,000 10,000 6,667 3,333
B 48,000 14,000 34,000 22,667 11,333
C 40,000 24,000 16,000 10,667 5,334
_______ ______ ______ ______ ______
100,000 40,000 60,000 40,000 20,000
––––––– –––––– –––––– –––––– ––––––

COSTING METHODS
Solution 5 – More than one SOP
(i) NRV
Products
Total C D E
£ £ £
Sales revenue 9,100 3,600 2,500 3,000
Separable costs after SOP2 (500) (500) –
——— ———
NRV at SOP2 2,000 3,000
Joint costs
Split in ratio (2000:3000) (1,200) (480) (720)
Separable costs after SOP1 (1,000) (1,000)
——— ——— ——— ———
NRV at SOP1 6,400 2,600 1,520 2,280
Joint costs
Split in ratio (2600:1520:2280) (640) (260) (152) (228)
——— ——— ——— ———
Net profit 5,760 2,340 1,368 2,052
——— ——— ——— ———
(ii) Physical measure
Total B C
£ £ £
Joint costs
Split in ratio (40:60) 640 256 384
Separable costs after SOP1 2,200 1,200 1,000
_____ _____
1,456 1,384
D E
Joint costs
Split in ratio (25:15) 910 546
Separable costs after SOP2 500 500
_____ _____ _____ _____
Total costs 3,340 1,410 546 1,384
Sales revenue 9,100 2,500 3,000 3,600
_____ _____ _____ _____
Net profit 5,760 1,090 2,454 2,216
––––– ––––– ––––– –––––

COSTING METHODS
Solution 6 – By-product
(i) Point of production
By-product
kg £ kg £
Process account 100 500 Cash 70 350
Balance c/d 30 150
___ ___
500 500
___ ___
Balance b/d 30 150 Closing stock £150

___
(ii) Point of sale
By-product
kg £ kg £
Process account 70 350 Cash 70 350
Closing stock £0

COSTING METHODS

Different Costing Methods

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COSTING METHODS

! To consider the costing information requirements for job costing, process

JOB SERVICE PROCESS

WORK IN PROCESS JOINT AND

FIFO method Normal waste Apportioning joint

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0901

1.1 When used

! When each job/customer requires a good or service using different quantities

! Accountancy firms use job costing.

! Overheads are charged to the product/service usually on a direct labour hour

! Estimating costs to enable quotes for customers to be accurate,

2.1 When used

! Used to establish a specific cost for an “internal service”, ie a service

! The purposes of service department costing is to control the costs and

2.2 Method of service department costing

− compare actual costs against a target or standard;

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0902

! A subsidiary purpose of service department costing is to control the costs of

− the overhead costs of the user departments will be established more

− if charges are high, the user department might consider whether it is

2.3 Benefit of service department costing

! A type of specific order costing used to enable firms to value items of

Cost to be averaged out

First in first out method (FIFO) Average cost method (AVCO)

! Valuing closing work in progress – need to identify equivalent units produced

! How to account for waste and substandard production.

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0903

4.1 Opening and closing work in progress

There are two methods of dealing with opening work in progress.

FIFO – Assumes all items are dealt with in strict order

4.2 Approach to questions

(1) Work out the flow of physical units

Opening WIP + Units input = Units output + Closing WIP

(2) Identify total costs to be apportioned

(3) Calculate the equivalent units of production

(4) Calculate costs per unit (element cost)

(5) Evaluate finished goods and closing work in progress.

4.3 Equivalent units calculation assuming FIFO

Finish off opening WIP (if any) x x x

Units started and finished x x x

Units started but not finished

This period’s costs (Excl opening WIP) £x £x £x

= element cost =£y =£y =£y

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0904

Value of finished goods transferred out

Value of closing WIP

EUs × Element costs per unit x

4.4 Equivalent units calculation assuming AVCO

Total costs £x1 £x1 £x1

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0905

Work in progress at March 1 consisted of 2,000 units which were:

50% complete for materials valued at £1,375

Costs incurred during March:

6,000 units were completed in March.

Work in progress at March 31 consisted of 1,000 units which were:

25% complete for materials

Calculate total value of

(i) goods finished in March

using both (a) FIFO and (b) AVCO methods.

 Accountancy Tuition Centre (Overseas Courses) Ltd 2001 0906

Started and finished Materials

Value of closing WIP Materials

(b) Weighted average cost

Element cost per unit

_ _ _ _____

_ _ _ _____