Contents: 8 sections
Syllabus points
- Distinguish unit, job and batch costing and identify where each is appropriate.
- Prepare a job cost statement.
- Calculate a cost per unit and a selling price from a cost plus a required margin or mark-up.
Choosing the method
The costing method follows the shape of the output, not the industry.
| Method | Used when | Examples |
|---|---|---|
| Unit costing, also called output costing | Output is a continuous stream of identical units | Bricks, cement, bottled water, electricity |
| Job costing | Each order is different and made to a customer's specification | Repairs, printing, construction, an audit, a bespoke machine |
| Batch costing | Groups of identical units are made together, and the batches differ | Bakery batches, one size of shoe, a print run of one book, a pharmaceutical batch |
Batch costing is really job costing applied to a group: the batch is treated as a job, and the cost per unit is the batch cost divided by the number of good units produced.
The cost build-up
Every method builds the cost in the same order, and questions expect the layout.
Direct materials, plus direct labour, plus direct expenses, gives prime cost.
Prime cost, plus absorbed production overheads, gives production cost.
Production cost, plus a share of administration and selling and distribution overheads, gives total cost.
Total cost, plus profit, gives the selling price.
Only production overheads are absorbed into the production cost, because only production cost enters the value of inventory. Administration and selling overheads are period costs and are added afterwards when pricing.
A job cost statement
Job 214: direct materials $840, direct labour 60 hours at $14 an hour, direct expenses (a hired machine) $200. Production overheads are absorbed at $9 per direct labour hour. Administration and selling overheads are charged at 20% of production cost. The customer is quoted a price giving a margin of 25%.
| $ | |
|---|---|
| Direct materials | 840 |
| Direct labour, 60 x 14 | 840 |
| Direct expenses | 200 |
| Prime cost | 1 880 |
| Production overhead, 60 x 9 | 540 |
| Production cost | 2 420 |
| Administration and selling, 20% | 484 |
| Total cost | 2 904 |
| Profit | 968 |
| Selling price | 3 872 |
Pricing from cost
The profit line above needs care, because a margin and a mark-up are different, and the question will specify one.
- A mark-up is a percentage of cost. A 25% mark-up on a total cost of $2 904 adds $726, giving a price of $3 630.
- A margin is a percentage of the selling price. For a 25% margin, cost is 75% of the price, so the price is 2 904 divided by 0.75, which is $3 872, and the profit is $968.
Check the margin answer: 968 over 3 872 is 25%, as required. Doing that check takes a moment and catches the most common error in the topic.
Batch costing
A batch of 500 identical components costs $3 400 in materials, $2 100 in labour and $1 500 in absorbed overheads. Twenty units are rejected as faulty.
The total batch cost is 3 400 plus 2 100 plus 1 500, which is $7 000. Good units are 500 minus 20, which is 480. The cost per good unit is 7 000 divided by 480, which is $14.58.
Dividing by 500 rather than by 480 understates the cost per unit and is the standard trap. The rejected units consumed materials and time; that cost has to be carried by the units that can actually be sold.
Why the method matters
The choice of method decides what information the business gets.
- Job costing allows the actual profit on each order to be compared with the quoted price, so the estimating can be improved.
- Batch costing shows whether a longer run would reduce the cost per unit, since the set-up cost is fixed for the batch and spreads more thinly.
- Unit costing is the simplest and works only where the units really are identical, since one average is applied to everything.
Common mistakes
- Adding administration overheads before calculating production cost.
- Confusing margin with mark-up when pricing.
- Dividing the batch cost by the units started rather than the good units produced.
- Absorbing overheads on hours when the question gives a machine-hour basis, or the reverse.
- Using job costing where the output is identical, or unit costing where every order differs.
- Forgetting direct expenses, which are easy to miss because most jobs have none.