1.

The board of directors of your company is concerned about certain recent issues in the
company. Recently the company has been losing bids in tenders it thought were low, while
it has won a few bids it thought were high. The company has lately diversified into new
markets and introduced new product lines. Goods have become complex, requiring many
inputs and processes. The operations of the company have changed significantly, but the
costing system has not changed. The Board has approached you to look into the above
issues. Critically analyze the issues at hand, and suggest a suitable roadmap for the
company to revamp its costing system.

Answer: Cost is a term whereas ‘Costing’ is a process for determining the cost. It may be called
a technique for ascertaining the cost of production of any product or service in the business
organization. The real scope of this term can best be understood in the context of big
manufacturing concerns that produce hundreds of products and spend a lot of money on material,
labour and other overheads. The cost of each product in those organizations requires recording
expenses with to each product or process, classifying expenses like direct material, labour,
overheads etc, allocating direct expenses and suitable apportionment of overheads to each
product for most correct determination of per unit cost of production of each product.
Cost accounting has the following main objectives to serve:
1. Determining selling price,
2. Controlling cost
3. Providing information for decision-making
4. Ascertaining costing profit
5. Facilitating preparation of financial and other statements.

There are different methods of costing which are as follows

1. Job Costing
2. Batch Costing
3. Contract Costing
4. Composite Costing
5. Process Costing
6. Unit Costing
7. Operating Costing
8. Operation Costing

With the help of costing methods and techniques helps for collection and classification of
expenditure according to cost elements and allocation and apportionment of the expenditure to
the cost centres or cost units, or both.

As the company Recently has been losing bids in tenders it thought were low, while it has
won a few bids it thought were high. And it has lately diversified into new markets and
introduced new product lines. Goods have become complex, requiring many inputs and
processes. so, the company need to follow process costing to improved its productivity.

Process costing is an accounting methodology that traces and accumulates , and allocates 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 which attempts to
measure individual costs of production of each unit. Process costing is usually a significant
chapter.
Process costing is a type of operation costing which is used to ascertain the of a product
at each process or stage of manufacture. Defines process costing as "The costing method
applicable where goods or services result from a sequence of continuous or repetitive operations
or processes. Costs are averaged over the units produced during the period". Process costing is
suitable for industries producing homogeneous products and where production is a continuous
flow. A process can be referred to as the sub-unit of an organization specifically defined for cost
collection purpose.
Features of process costing
1. Work In Progress One of the most unique features of process costing is its work-in-
progress nature. Unlike other types of costing, i.e. job order costing; there is no need for a sales
order. Due to its continuous nature, process costing is simply divided up among workplace
departments. Each portion of the process costing is named according to department, i.e. Work-in-
progress: Shipping. The first entry into the work-in-progress system is generally made in the
form of direct, raw materials. As the product moves throughout each individual department,
more entries are added to the work-in-progress log. Labor costs are added periodically as are
indirect costs and spoilage.
2. Cost Control Another important feature of process costing is its direct relation to cost
control. When a manager needs to zone in on a budget and control costs associated with
manufacturing, process costing provides relevant feedback on month-to-month comparisons of
similar products. It allows managers to monitor and assign value to a product at any given time.
For example, a pharmaceutical company manager may want to note value of a drug midway
through the production process. He may want to determine the value prior to the addition of
certain chemicals. Process costing allows for this and, in turn, gives managers a clear view of the
value at the time of completion.
3. Per Unit Costs
Because process costing provides cost information for every step of a company's
manufacturing process, it is able to provide managers an account of all direct and indirect costs.
As costs are assigned to products and services, which sometimes include a whole month's
production, process costing breaks down information to determine average per-unit costs. Once
per-unit costs are in play, a manager can pull information from the work-in-progress log to
determine cost of a product or service at any given time during the manufacturing process.
4. Controlled
One major characteristic of process costing is the fact that the process is controlled. This
is why process costing is used--it is an industry where the process is clear-cut, which makes it
possible to assign a price to it. This means that there are a wide range of industries where process
costing will not work. For example, a law firm cannot use process costing to determine prices
because the process to produce their product (legal expertise and advice) is not the same for
every client. Indeed, its selling point is that it is different for every client. Therefore, the process
cannot be streamlined and the costs cannot be kept the same for all lawyers.
5. Cumulative
Process costing uses cumulative costs from every stage of production. So, if a factory
makes ketchup bottles, the people in charge of process costing would find the cost of the glass,
plus the cost of the labels, plus the cost of the workers in each department and maintenance of
the necessary machines. By adding up the total cost of producing a set number of ketchup
bottles, the accounting team can determine how much it costs to produce each ketchup bottle--
and therefore determine what price each bottle should sell for.
Principles of Process Costing

1. The whole factory operation is divided into several operations or production centers, each
performing standard operations.
2. All the items of process costing i.e. materials, labour and overheads are collected in
process wise.
3. The records are maintained in process wise as the number of units produced, the total
costs incurred and the cost per unit.
4. The total cost of one process is transferred to next process along with the number of units
transferred to next process for further processing.
5. The cost per unit is calculated by dividing the number of units produced in a process into
the total costs incurred for processing the same number of units in a specified period.
Advantages of process
1. Easy to Use
Process costing is an easier system to use when costing homogenous products compared
to other cost allocation methods. Business owners allocate business costs according to the
number of processes each good travels through in the production system. Each process applies
direct materials, labor and manufacturing overhead to the production cost total. Management
accountants take the total number of goods leaving the process and divide the total process cost
by this number. This creates a simple average cost for each item produced.
2. Flexible
Business owners use process costing because it creates a flexible production process.
Companies needing to refine their process can simply add or remove a process as necessary.
This also allows companies to lower their production cost for each good. Business owners
typically look for ways to refine a production process to increase cost savings. Eliminating
redundant processes often achieves this goal. Adding a process allows companies to produce
slightly different goods or improve product quality. Management accountants may review the
amount of materials and labor used in each process to determine if any costing savings is
available in the productions system. This flexibility ensures companies can produce at the most
competitive cost in the economic marketplace.
3. Cost Errors
Process costing can create cost errors in the production system. Production cost errors
often represent a significant disadvantage for cost accounting systems. Process costing does not
use direct allocation to apply business costs to individual goods. Direct allocation costing
applies a specific amount of raw materials, production labor and manufacturing overhead to
goods or services. Process costing may allow non-production costs to be included in the total
process cost. Including non-production costs will arbitrarily increase each item’s cost; this also
increases the consumer product price. Management accountants may also leave out production
costs and create under-costed products. Under-costed products usually result in lower business
profits because goods are actually more expensive than actually reported.
4. Equivalent Units
Management accountants must calculate equivalent units in the process costing system.
Equivalent units represent the amount of unfinished goods left in a process at the end of an
accounting period. This calculation may only be a best guess or an estimate by management
accountants. This information is reported as the work-in-process on a company’s balance sheet.
Inaccurate work-in-process accounts may also result in distorted finished good totals. This
creates a difficult process for managing inventory and determining how many products the
company has to sell in the open marketplace.
Q.2 A company has capacity to produce 100000 units of a product in a year, but due to
lack of adequate demand, it is producing only 80000 units / year. The product sells at Rs.
50 per unit. The following details are available regarding the unit costs of the product:

 Direct Material – Rs. 20

 Direct Wages – Rs. 12
 Fixed Factory Overhead – Rs. 2
 Variable Factory Overhead – Rs. 2
 Administrative Expenses – Rs. 3
 Fixed selling and distribution overheads – Rs. 1
 Variable selling and distribution overheads – Rs. 2
The company has recently received a special onetime order from a foreign client. The order
size is 15000 units, and the client will pay Rs. 40 per unit. Should the company accept the
order? Would your opinion change if the order had come from a regular domestic
distributor of the product?

Answer: Statement showing contribution margin of 15000 units (foreign client)

Particulars Calculation Amount(Rs)

Sales 15000 units * Rs. 40 6,00,000
Less: Variable cost
Direct material 15000 units * Rs.20 (3,00,000)
Direct wages 15000 units * Rs.12 (1,80,000)
Variable factory overhead 15000 units * Rs.2 (30,000)
Variable selling and
distribution overhead 15000 units * Rs.2 (30,000)
Contribution 60,000

From the above calculation its shows that the company can accept the special order as it would
increase the company’s operating profit by Rs. 60,000
 Statement showing contribution margin of 15000 units (domestic client)
Particulars Calculation Amount(Rs)
Sales 15000 units * Rs. 0 7,50,000
Less: Variable cost
Direct material 15000 units * Rs.20 (3,00,000)
Direct wages 15000 units * Rs.12 (1,80,000)
Variable factory overhead 15000 units * Rs.2 (30,000)
Variable selling and
distribution overhead 15000 units * Rs.2 (30,000)
Contribution 2,10,000

From the above calculation it shows that the company should accept the special order
from domestic market and reject the order from foreign client as acceptance of domestic market
would increase the operating profit of the company by Rs. 2,10,000.

3 a) A company uses a pre-determined overhead rate for production orders on a labour

cost basis of Department I and machine hour basis for the Department II. At the beginning
of 2016, the company made the following estimates:
Department Department
I II
Direct Labour Cost 5000 2500
(Rs.)
Factory Overheads 7500 12500
(Rs.)
Direct Labour Hours 4000 1250
Machine Hours 250 5000
Job order no XYZ shows the following details of cost incurred during 2016 in its
completion.
Department Department
I II
Materials Required 2 10
(Rs.)
Direct Labour Cost 5 7
(Rs.)
Direct Labour Hours 4 5
Machine Hours 1 13
Assuming that the job No. XYZ consists of 16 units of the finished product; calculate the
unit cost of the job.
3 b) For the above company, it was found that at the end of 2016 actual factory overhead
cost amounted to Rs.8000 for Department I and Rs. 12200 for Department II. Calculate
under or over-absorbed overheads.
Answer: a)
 Department I, the overhead rate has to be calculated on the basis of Direct wages:

𝐅𝐚𝐜𝐭𝐨𝐫𝐲 𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐞𝐬𝐭𝐢𝐦𝐚𝐭𝐞

Department I overhead rate = × 𝟏𝟎𝟎
𝐃𝐢𝐫𝐞𝐜𝐭 𝐥𝐚𝐛𝐨𝐮𝐫 𝐞𝐬𝐭𝐢𝐦𝐚𝐭𝐞

7500
= × 100
5000

= 150%
 Department II, the overhead rate has to be calculated on the basis of machine hours:

𝐅𝐚𝐜𝐭𝐨𝐫𝐲 𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐞𝐬𝐭𝐢𝐦𝐚𝐭𝐞

Department II overhead rate = × 𝟏𝟎𝟎
𝐌𝐚𝐜𝐡𝐢𝐧𝐞 𝐡𝐨𝐮𝐫𝐬 𝐞𝐬𝐭𝐢𝐦𝐚𝐭𝐞

12500
= × 100
5000

= 2.50 per hour

Cost sheet for job no.XYZ

PARTICULARS DEPARTMENT 1 DEPARTMENT II TOTAL COST
(RS.) (Rs.) (Rs)
Material 2 10 12
Direct labour 5 7 12
Prime cost 7 17 24
Factory overheads: 7.50 32.5 40
(Dept I: Rs. 5*150%
Dept II: Rs. 2.5 *13hrs
)
Total cost of the job 14.5 49.5 64

Total cost of the job

Cost of the job p.u of finished product =
Total number of finished product

65
=
16

= Rs. 4 per unit

Therefore cost of finish product job is Rs.4 per unit
b) Calculation of over absorbed or under absorbed overheads

PARTICULARS DEPARTMENT 1 DEPARTMENT II

Actual overheads 8,000 12,200
Absorbed overheads 7,500 12,500
Under-absorbed 500
overhead
Over-absorbed overhead 300
Department I has 500 under absorbed overheads and Department II has 300 over absorbed
overhead