CMA/U1 Topic 3 Methods and Techniques of Cost Accounting
Methods to be used for the ascertainment of cost of production differ from industry to industry. It primarily depends on the manufacturing process and also on the methods of measuring the departmental output and finished products.
Basically, there are two methods of costing (as per CIMA Terminology) viz.:
(i) Specific Order Costing (or Job/Terminal Costing) and
(ii) Operation Costing (or Process or Period Costing.)
Specific Order Costing is the category of basic costing methods applicable where the work consists of separate jobs, batches or contracts each of which is authorised by a specific order or contract. Job costing, batch costing and contract costing are included in this category.
Operation Costing is the category of basic costing methods applicable where standardized goods or services result from a sequence of repetitive and more or less continuous operations or process to which costs are charged before being averaged over units produced during the period.
All these methods are discussed briefly as under:
1. Job Costing:
Under this method, costs are collected and accumulated for each job, work order or project separately. Each job can be separately identified; so it becomes essential to analyse the cost according to each job. A job card is prepared for each job for cost accumulation. This method is applicable to printers, machine tool manufacturers, foundries and general engineering workshops.
2. Contract Costing:
When the job is big and spread over long periods of time, the method of contract costing is used. A separate account is kept for each individual contract. This method is used by builders, civil engineering contractors, constructional and mechanical engineering firms etc.
3. Batch Costing:
This is an extension of job costing. A batch may represent a number of small orders passed through the factory in batch. Each hatch is treated as a unit of cost and separately costed. The cost per unit is determined by dividing the cost of the batch by the number of units produced in a batch. This method is mainly applied in biscuits manufacture, garments manufacture and spare parts and components manufacture.
4. Process Costing:
This is suitable for industries where production is continuous, manufacturing is carried on by distinct and well defined processes, the finished products of one process becomes the raw material of the subsequent process, different products with or without byproducts are produced simultaneously at the same process and products produced during a particular process are exactly identical.
As finished products are obtained at the end of each process, it will be necessary to ascertain not only the cost of each process but also cost per unit at each process. A separate account is opened for each process to which all expenditure incurred thereon is charged.
The cost per unit is obtained by averaging the expenditure incurred on the process during a certain period. Hence, this is known as average costing. As the products are manufactured in a continuous process, this is also known as continuous costing. Process costing is generally followed in Textile Industries, Chemical Industries, Tanneries, Paper Manufacture etc.
5. One Operation (Unit or Output) Costing:
This is suitable for industries where manufacture is continuous and units are identical. This method is applied in industries like mines, quarries, oil drilling, breweries, cement works, brick works etc. In all these industries there is natural or standard unit of cost. For example, a barrel of beer in breweries, a tonne of coal in collieries, one thousand of bricks in brickworks etc.
The object of this method is to ascertain the cost per unit of output and the cost of each item of such cost. Here cost accounts take the form of cost sheets prepared for a definite period. The cost per unit is determined by dividing the total expenditure incurred during a given period by the number of units produced during that period.
6. Service (or Operating) Costing:
This is suitable for industries which render services as distinct from those which manufacture goods. This is applied in transport undertakings, power supply companies, municipal services, hospitals, hotels etc. This method is used to ascertain the cost of services rendered.
There is usually a compound unit in such undertakings, e.g., tonne kilometre (transport undertaking), kilowatt-hour (power supply) and patient day (hospitals).
7. Farm Costing:
It helps in calculation of total cost and per unit cost of various activities covered under farming. Farming activities cover agriculture, horticulture, animal husbandry (i.e., rearing of live-stocks), poultry farming, pisciculture (i.e., rearing of fish), dairy, sericulture (i.e. silkworm breeding), nurseries for growing and selling of seedlings and plants and rearing of fruits and flowers.
Farm costing helps to improve the farming practices to reduce cost of production, to ascertain the profit on each line of farming activity which ensures better control by management and to obtain loans from banks and other financial institutions as they give loans on the basis of proper cost accounting records.
8. (Multiple) Operation Costing:
Multiple operation method of manufacture consists of a number of distinct operations. It refers to conversion cost i.e., cost of converting the raw materials into finished goods. This method takes into consideration the rejections in each operation for calculating input units and cost. The different operations in machine screw are—stamps, knurl, thread and trim. The cost per unit is determined with reference to final output.
9. Multiple Costing:
It represents the application of more than one method of costing in respect of the same product. This is suitable for industries where a number of component parts are separately produced and subsequently assembled into a final product. In such industries each component differs from the others as to price, material used and process of manufacture undergone. So it will be necessary to ascertain the cost of each component.
For this purpose, process costing may be applied. To ascertain the cost of the final product batch costing may be applied. This method is used in factories manufacturing cycles, automobiles, engines, radios, typewriters, aeroplanes and other complex products. This method has been dropped from the latest CIMA Terminology.
Types or Techniques of Costing:
Following are the main types or techniques of costing for ascertaining costs:
1. Uniform Costing:
It is the use of same costing principles and/or practices by several undertakings for common control or comparison of costs.
2. Marginal Costing:
It is the ascertainment of marginal cost by differentiating between fixed and variable cost. It is used to ascertain the effect of changes in volume or type of output on profit.
3. Standard Costing:
A comparison is made of the actual cost with a pre-arranged standard cost and the cost of any deviation (called variances) is analysed by causes. This permits management to investigate the reasons for these variances and to take suitable corrective action.
4. Historical Costing:
It is ascertainment of costs after they have been incurred. It aims at ascertaining costs actually incurred on work done in the past. It has a limited utility, though comparisons of costs over different periods may yield good results.
5. Direct Costing:
It is the practice of charging all direct costs, variable and some fixed costs relating to operations, processes or products leaving all other costs to be written off against profits in which they arise.
6. Absorption Costing:
It is the practice of charging all costs, both variable and fixed to operations, processes or products. This differs from marginal costing where fixed costs are excluded.
Any of the methods of costing like unit or output costing, service costing, process costing etc. can be used under any techniques of costing.