JOB AND PROCESS COSTING NOTES

All types of manufacturing concerns can broadly be classified

into two categories : (a) Mass production concerns and (b) Special order concerns. In mass production, firms manufacture uniform types of products. Since production is of standard products, it is on a mass scale and on a continuous basis. No customer orders or specifications are required for production. Examples of mass production concerns are textile mills, chemical plants, paper manufacturing, tyre rubber companies etc. On the other hand, special order concerns manufacture products in clearly distinguishable lots in accordance with special orders and individual specifications. Examples of specific order concerns are printing press, construction of buildings, bridges, roads, ship building etc.

In case of mass production concerns the products when produced are of the same type, and involve the same material and labour and pass through the same set of processes. In such industries each process is designated as a separate cost centre and the cost per unit is calculated by dividing the total cost of the process with the total number of units produced by the process. The cost of production of the product is obtained by adding the unit costs of various processes through which the product has passed. This method of costing is known as process costing.

Job costing or job order costing also called specific order

costing is a method of costing which is used when work is undertaken as per the customer’s special requirement (tailor-made). It is distinct from contract costing in the sense that each job is of a comparatively short duration. The job may be carried out within the factory/workshop or on the premises of the customer, depending on the nature of job.

The main features of job order costing are that in this method

of cost ascertainment, costs of materials, labour and overhead are accumulated for each job and profit or loss on it is determined. When an enquiry is received from the customer, costs expected to be incurred on the job are estimated, and on the basis of this estimate, a price is quoted to the customer. When the job has been completed, the actual costs can be compared with the estimated costs (or standard costs if a system of standard costing is in vogue). This serves as a tool of cost control.

Job costing is employed in the following cases :

1. Where the production is against the order of the customer or jobs are executed for different customers according to their specifications.
2. Where each job needs special treatment and no two orders are necessarily alike.
3. Where there is no uniformity in the flow of production from one department to another.
4. Where the work-in-progress differs from period to period on the basis of the number of jobs in hand.

Job costing is applicable to printing, furniture, hardware, ship-

building, heavy machinery, foundry, general engineering works, machine tools, interior decoration, repairs and other similar work.

19.2     OBJECTIVES OF JOB COSTING

Job costing serves the following objectives :

1. It helps in finding out the cost of production of every order and thus helps in ascertaining profit or loss made out on its execution. The management can judge the profitability of each job and decide its future course of action.
2. It helps management in making more accurate estimates about the costs of similar jobs to be executed in future on the basis of past records. The management can conveniently and accurately determine and quote prices for orders of a similar nature which are in prospect.
3. It enables management to control operational inefficiency by comparing actual costs with the estimated ones.

19.3     ADVANTAGES OF JOB COSTING

The following are the advantages of job costing :

1. It helps in identifying profitable and unprofitable jobs.
2. It helps in the preparation of estimates will submitting quotations for similar jobs.
3. Cost data under job costing enable management in preparing budgets for future.
4. It enables management to control operational efficiency by comparing actual costs with estimated ones.
5. Spoilage and defective work can be identified with a specific job and responsibility for the same can be fixed on individuals easily.

19.4     LIMITATIONS OF JOB COSTING

Job costing suffers from the following limitations :

1. It involves too much of clerical work (in estimating cost of material, labour and overheads chargeable to each job). As such it is expensive and laborious.
2. Being historical in nature, it has all the disadvantages of the historical costing. Hence, it cannot be used as a means of cost control unless it is used with techniques like standard costing.

19.5     JOB COSTING PROCEDURE

The following is the procedure adopted for costing purposes

in a concern using job costing :

1. Job Number : When an order has been accepted, an individual work order number must be assigned to each such job so that separate orders are capable of being identified at all stages of production. Assignment of job numbers also facilities reference for costing purposes in the ledger and is conveniently short for use on various forms and documents.
2. Production order : The Production Control Department then makes out a production order thereby authorising to start work on the job. Several copies of production order are prepared, the copies often being in different colours to distinguish them more easily. These copies are passed on to the following :

• All departmental foremen concerned with the job ;
• Storekeeper for issuance of materials; and (iii) Tool room-an advance notification of tools required.

Exhibit I shows a proforma of production order.

EXHIBIT-I

Production Order Name of Customer……………………..                   Job No……………….. Date of Commencement …………….                   Date …………………… Date of Completion                                         Bill of Material No……. Special instructions……….                                Drawing attached Yes/No
Quantity	Description	Machines	Tools
		to be used	required
(Sign) ………. Production Authorised by : Head of Production Control Deptt.

The columns provided in the production order differ widely,

depending largely upon the nature of production.

3. Job Cost Sheet : Job cost sheet is the most important document used in the job costing system. A separate cost sheet or card is maintained for each job in which all expenses regarding materials, labour and overheads are recorded directly from costing records. Job cost sheets are not prepared for specific periods but they are made out for each job regardless of the time taken for its completion. However, material, labour and overhead costs are posted periodically to the relevant cost sheet.

EXHIBIT-II

A proforma Job Cost Sheet is shown at Exhibit-II

The material, labour and overhead to be absorbed into jobs are collected and recorded in the following way :

• Direct Materials : The method of recording receipts and issues of materials on material requisitions or bill of materials show the quantities of materials issued to jobs from store. When copies of these documents reach the cost office, they are priced and entered in the stores ledger account in the ‘Issues’ column. Each requisition shows the job number to which the material is to be charged. Summaries of material requisitions are prepared at regular intervals on Materials Abstract or Materials Issue Analysis Sheet. These summaries facilitate debiting the job with total cost of materials rather than charging with many small items. These totals are also used for entries in stores ledger control account and work-in-progress control account.
• Direct Wages : These wages payable to workers are calculated on clock cards, job cards, time sheets etc. The summaries of job cards are made on Wages Abstract or Wages Analysis Sheets, which shows the direct wages chargeable to each job. The total of wages chargeable to various jobs is debited to work-in-progress control account.
• Direct expenses : Direct expenses which can be identified with specific jobs are directly charged to these jobs, the total being debited to work-in-progress control account.
• Overheads : Indirect materials, indirect wages and indirect expenses which cannot be identified with specific jobs are apportioned to cost centres. Absorption of overhead by the jobs passing through the cost centres is based upon percentage of direct wages or direct material cost, direct labour hours machine hours, etc.

4. Completion Report : A completion report is sent to the costing department after the completion of a job. The actual cost recorded in the job cost sheet is compared with the estimated cost. It will reveal the efficiency or inefficiency in operation. It is a guide to the future course of action.
5. Profit or Loss : Profit or loss on each job can be determined by comparing the actual cost with the price obtained.

WORK-IN-PROGRESS IN JOB COSTING

The cost of an incomplete job, that is, a job on which some

manufacturing operation is still due is termed work-in-progress. If a production order has not been duly completed by the end of an accounting period, it is essential that the closing stock of the work-in-progress be determined. Unless this is correctly done, the profits for the period will be distorted. Determination of work-in-progress is frequently essential where periodic Profit and Loss Account is required to be prepared for control purposes without reference to the closure of the accounting period.

The account is respect of such jobs may be maintained in the

following ways :

1. A composite work-in-progress account for the entire factory.
2. A composite work-in-progress account for every department. For example, if the factory has three departments A, B and C, a work-inprogress for each of these three departments will be opened.

The work-in-progress account is periodically debited with all

costs direct and indirect incurred in execution of the jobs. At intervals of month or so a summary of completed jobs is prepared and the work-inprogress account is credited with the cost of completed jobs. In case workin-progress account for each department of the factory has been opened, it will be necessary to find out the cost of completed jobs regarding each department. The balance in work-in-progress account at any time represents the cost of jobs not yet completed.

FEATURES OF PROCESS COSTING

Process Costing is a method of costing used to ascertain the cost

of a product at each process or stage of manufacture. In this method, the costs of materials, wages and overheads are accumulated for each process separately, for a given period, and then carried forward cumulatively from one process to the next process till the last process is completed. Records are also maintained to account for process losses. These losses may be normal or abnormal. Separate accounting is done for normal and abnormal losses, opening and closing workin-progress and inter-process profits, if any. This method of costing is used in those industries where mass production  of identical units is undertaken on a continuous basis and finished products are subjected to a number of production stages called processes before completion.

The system of process costing is suitable for industries

involving continuous production of the same product or products through the same process or set of processes. It is in use in plant producing paper, rubber products, medicines, chemical products. It is also very much common in flour mill, bottling companies, canning plants, breweries etc.

Process costing is that aspect of operation costing  which is

used to ascertain the cost of the product at each process or stage of manufacture, where processes are carried on having one or more of the following features:

• Production is done having a continuous flow of identical products except where plant and machinery is shut down for repairs, etc.
• Clearly defined process cost centres and the accumulation of all costs (materials, labour and overheads) by the cost centres.
• The maintenance of accurate records of units and part units produced and cost incurred by each process.
• The finished product of one process becomes the raw material of the next process or operation and so on until the final product is obtained.
• Avoidable and unavoidable losses usually arise at different stages of manufacture for various reasons. Treatment of normal and abnormal losses or gains is to be studied in this method of costing.
• Sometimes goods are transferred from one process to another process not at cost price but at transfer price just to compare this with the market price and to have a check on the inefficiency and losses occurring in a particular process. Elimination of profit element from stock is to be learnt in this method of costing.
• In order to obtain accurate average costs, it is necessary to measure the production at various stages of manufacture as all the input units may not be converted into finished goods; some may be in progress. Calculation of effective units is to be learnt in this method of costing. (viii)Different products with or without by-products are simultaneously produced at one or more stages or processes of manufacture. The valuation of by-products and apportionment of joint cost before point of separation is an important aspect of this method of costing. In certain industries, by-products may require further processing before they can be sold. A main product of one firm may be a by-product of another firm and in certain circumstances, it may be available in the market at prices which are lower than the cost to the first mentioned firm. It is essential, therefore, that this cost be known so that advantages can be taken of these market conditions.

(ix) Output is uniform and all units are exactly identical during one or more processes. So the cost per unit of production can be ascertained only by averaging the expenditure incurred during a particular period.

19.8    DIFFERENCE BETWEEN PROCESS COSTING AND JOB COSTING

Process costing and job costing differ on the following counts:

1. Job costing is applicable in situations where the objective is to identify costs with specific products or jobs. Process costing, on the other hand, is used in case of mass production of similar units that continuously pass through different departments or processes.
2. Cost Collection : In job costing, manufacturing costs are accumulated for particular jobs or batches of product using job cost sheets. In process costing, manufacturing costs are accumulated for entire departments or processes and the cost of particular jobs or batches or products is not determinable.
3. Time period assumption : In job costing, costs are accumulated for a specific product or job without taking into account the production time which may be more than one accounting period. In process costing, costs are accumulated for specific departments/processes for a given time period (say a month). That is, production is measured for specific time periods in process costing.
4. Purpose : In job costing production his generally dependent on customers’ orders and specifications. Under process costing, production is done for storing stock of goods and for future sale.
5. Computation of unit costs : In job costing unit cost is obtained by dividing the cost of the job order by units produced in the job order. Under process costing, unit costs are obtained by dividing departmental/process costs by process production.
6. Work-in-progress : In job costing, one work-in-progress account is maintained. But in process costing, individual work-in-progress accounts are prepared for each production/process department to ascertain manufacturing costs by process.

19.9     TYPES OF PROCESSING

As stated above, process costing is used in case of industries,

which involve processing of a product through different stages. The various types of processing are as follows :

• Continuous sequential processing : In case of this processing a product has to pass through different cost centres or stages of manufacturing continuously and in succession one after the other during a period. The processing being continuous and identical, the costing units for each centre or stage are identical during any period. Examples of this type of processing are cement-making, paper-making, refining of crude petroleum, etc.
• Discontinuous Processing : In case of this processing, a process is independently operated for the individual product as such at frequent intervals. The costing unit in case of this processing, dependent upon the product may vary even for the same cost centre. Examples of this type of processing are dye manufacturing, fruit preservation, vegetable canning, yarn spinning, etc.
• Parallel Processing : In case parallel processing, the operations or stages through which the product has to pass run parallel and separately. All these parallel processes ultimately join with the end process. Examples of this type of processing are manufacturing different components which ultimately join in the assembly process to make a product, meat packing etc.
• Selective Processing : In case of this processing, the combination of the processes or stages of operation depend upon the end-product to be commercialised. Examples of this type of processing are cooked meat, chloride compounds like bleaching power of zinc chloride or hydrochloric acid, etc.

19.10 ADVANTAGES OF PROCESS COSTING

The advantages of process costing can be summarised as

follows:

1. The cost of different processes as well as finished product can be computed conveniently at short intervals, say, daily or weekly.
2. Control cost and production can be advantageously effected as predetermined and actual data are available for each department or process.
3. It involves less clerical work because of the simplicity of cost records.
4. The average costs of homogeneous products can easily be computed.
5. Expenses can be allocated to different processes on rational basis and accurate cost, thus, can be ascertained.
6. It enables the correct valuation of closing inventories.

19.11 DISADVANTAGES OF PROCESS COSTING

1. The cost ascertained at the end of the process is called historical cost which is of very small use for managerial control. Since it is based on historical costs, it has all the weaknesses of historical costing.
2. The system of costing conceals weaknesses and inefficiencies in processing.
3. It does not evaluate the efforts of individual workers or supervisors.
4. The valuation of work-in-progress on the basis of degree of completion is merely a guess work.
5. If production is not homogeneous, as in the case of foundries making castings of different sizes and shapes, the average cost may give an incorrect picture of cost.

19.12 COSTING PROCEDURE

The factory or concern is divided into distinct processes or

operations and a separate account is opened for each process (cost centre). The account is debited with the value of material, labour and overheads relating to the process. The value of by products and scrap, if any, is credited to the account and the balance of this account, representing the cost of partially worked out product, is passed on to the next process becomes the raw material of the next process. In some industries, depending upon the plant arrangement, the partially worked out product of a process may be transferred to a process stock account from which it may be issued to the next process as and when required. The finished out of the last process (i.e. finished product) is transferred to the Finished Goods Account. All expenditure  of materials, labour, direct expenses and overheads are charged to the process concerned. In brief :

• Materials : Materials required for each process are drawn from store against Materials Requisitions or Bill of Materials and debited to cost. When the materials are issued in bulk, the person-incharge of the department has to keep the account of materials consumed. When the finished product of one process becomes the raw material of the next process, the account of the receiving process should be debited with the cost of transfer, in addition to the cost of additional materials, if any.
• Labour : Wages paid to labourers and workmen who are engaged in particular processes are directly allocated to the process. If workers are engaged in a number of processes, the wages paid may be apportioned on the basis of time-booking.
• Direct Expense : Direct expenses such as depreciation, insurance, electricity, repairs, etc. are directly allocated to the respective accounts.
• Overheads : Rent, telephone, lighting, gas, water, etc. which are some common expenses of one or more processes, may be apportioned to the various processes on suitable basis. Generally, these overheads are recovered at predetermined rates or based on direct wages or prime cost.

From the cost accounting point of view, there could be

processes which may or may not have process losses. Similarly, in respect of each process, there may or  may not be work-in-progress at the beginning or at the end.

Illustration 3 :  A company produces two products – P and R. They undergo two processes, namely Factory and Finishing. Raw materials used in the factory and general expenses incurred are apportioned in the ratio of output of each class.

PROCESS LOSSES AND WASTAGES

When materials are processed, they lose or gain in volume or

weight as a result of the process. It is common that process loss or scrap or wastage occur in process industries. These process losses may be of two types, viz. controllable and uncontrollable.

(a) Normal or uncontrollable loss : Because of the nature of the raw materials, some loss is inherent and is unavoidable. This is known as normal waste or normal loss. And this type of loss is expected in normal condition for example, stamping process, evaporation, etc. The percentage of such losses is anticipated from past experience by the management. Loss of this type should be absorbed by good units produced, i.e. the cost of units lost in charged to the good units output. Any value realisable on the normal loss will be credited to the process account.

Abnormal Loss or Controllable Loss  : In certain cases, it can be seen that the loss exceeds the predetermined normal loss. Any loss exceeding the normal loss is called abnormal loss. Abnormal loss should not affect the normal cost of production. It is caused by accidents, substandard materials, carelessness etc. Therefore, abnormal loss is valued just like good units and transferred to a separate account called Abnormal Loss Account.

) Abnormal Gain or Effectiveness

Sometimes, the actual loss in a process may be smaller than

what so expected on the basis of experience. This represents an exceptional or abnormal gain over what is normally anticipated. The value of abnormal gain is calculated in the same manner as that of abnormal loss and is credited to Abnormal Gain Account. The amount of scrap which would otherwise have been realised, had there been normal loss and no abnormal gain, is debited to the Abnormal Gain Account  and the balance is credited to Costing Profit and Loss Account.

Scrap and Defective : Scrap is the incidental residue from certain types of manufacture, usually of small amount and of low value, recoverable without further processing. Scrap may be sold or reused. The amount realised from sale of scrap is credited to the process account. Finished products that are not upto the predetermined standard, are known as defective. If the defective are sold, the amount realised is credited to process account. If the defective are sought to be rectified by spending additional material, labour etc. the extra amount spend is treated as overheads. If the defective units (normal) are discarded the cost of output is increased (as in the case of normal loss). For abnormal defective units the loss is transferred to Costing Profit and Loss Account (like abnormal loss).

19.14 INTER PROCESS PROFITS

Sometimes the output of one process is transferred to a

subsequent process, not at cost, but at a price, showing a profit to the transferer process. Transfer price may be made at a price corresponding to current wholesale market price or at cost plus an agreed percentage. The objects are :

• to know whether the cost of production competes with the market prices; and
• to make each process stand on its own efficiency and economies, i.e., the transferee processes are not given the benefits of economies effected in the earlier process.

This system involves a rather unnecessary complication of

the accounts, as the desired comparison could be prepared on separate cost reports for each process or by adopting a standard costing system when standards could be set for each process. The complexity brought into the accounts arises from the fact that the inter-process profits so introduced remain included in the price of process stocks, finished stocks and work-in-progress. For the balance sheet purpose, inter-process profits cannot be included in stock, as a firm cannot make a profit by trading itself. To avoid these complications a provision must be created to reduce the stock to actual cost price. This problem arises only in respect of stocks on hand at the end of the period, because goods sold will have realised the internal profits.

In order to compute the profit element in closing inventories

and to obtain the net realised profit for a period, three columns have been shown on each side of process accounts and closing stock have been deducted from the debit side of the process accounts instead of showing it on the credit side. Cost of closing stock can be easily obtained if we compare the accumulated cost and total in any process. The cost of stock can be obtained by the following formula :

 

The profit on closing stock can then be easily obtained by

deducting the cost of stock thus arrived at from the value of stock.

Sometimes opening stock and production overheads are given. We should add the opening stock at the beginning along with transfer cost, materials and wages. From the total of these, closing stock should be deducted to calculate prime cost. Then production overheads are added. This becomes the total cost of the process to which is added the desired percentage of profit.

• Calculation of unrealised profit on closing stock

For this purpose, the cost of closing stock is calculated by

taking the figures in the cost and total columns for each process before deducting the closing stock.

WORK-IN-PROGRESS

The problem of ascertaining work-in-progress in process

industries is very important and generally difficult. In most firms, production is on a continuous basis and so the problem of work-in-progress is quite common. This problem can be solved by calculating equivalent production (units) or equivalent completed (effective) units.

Equivalent Production : Equivalent production means converting the incomplete production into its equivalent completed units. In each process, an estimate is made of the percentage completion work-in-progress with regard to different elements of cost, viz., material, labour and overhead. It is most important that the estimate of percentage completion is as accurate as possible. The formula for computing equivalent completed units is :

The steps involved in the computation of equivalent

production are outlined below :

• Express the opening inventory of work-in-progress in equivalent completed units : This may be done by multiplying the units of opening work-in-progress by the percentage of work required to be done to complete the unfinished work of the previous period.
• Add to (i) above, the number of units completed out of the units introduced during the period.
• Then add (ii) above, the equivalent completed units of closing workin-progress. This can be done by multiplying the units of closing work in progress by the percentage of work done on the unfinished units at the end of the period.

The equivalent units may be required to be computed in respect

of each element of cost, viz., material, labour and production overhead.

The cost of units completed from the unfinished units of the

previous period (opening work-in-progress) plus the units completed of the current period’s input, and the units still remaining uncompleted (closing work-in-progress) should be shown separately.

In order to understand the equivalent production clearly,

illustrations on equivalent production may be divided into two groups.

• When there is only closing work-in-progress
• When there is opening as well closing work-in-progress.

Again, these may be further divided into two groups, i.e., (a) When there are no process losses, and (b) when there are process losses and gains.

I         When There is only closing work-in-progress (a) Without Process Losses

Under this case, the existence of process losses is ignored. Closing work-in-progress is converted into equivalent units on the basis of estimates as regards degree or completion of materials, labour and production overhead. After calculating the equivalent units, it is not difficult to evaluate closing work-in-progress.

With Process Losses : Generally, losses are inherent in process operations. Normal process losses are ignored in ascertaining equivalent production. But abnormal losses or gains should be treated as good units having due regard to the degree of completion. If units scrapped have any realisable value, that amount should be deducted from the cost of materiels in the cost statement before dividing it by equivalent production units. As regards abnormal loss, if the degree of completion is separately given, it has to be duly considered while preparing the Equivalent Production Statement. Otherwise, it may be assumed that the rejection (in respect of units of abnormal loss) has taken place at the stage of final inspection and abnormal loss units may, therefore, be taken to be 100% complete in all respects. But in case of abnormal gain, the degree of completion should always be taken at 100% as gain is represented by good production units.

When There are Opening As Well as Closing Work-in-Progress

Often in a continuous process there will be opening as well

as closing work-in-progress which are to be converted into equivalent of completed units before apportionment of process costs. The procedure of conversion of opening work-in-progress will vary depending upon whether average cost method or first in first out method of apportionment of costs is followed. Problems of closing work-in-progress have already been discussed in the previous pages. The following pages will discuss both methods for valuation of work-in-progress one by one :

• FIFO Method : Under this method one assumes that the raw materials issued to work-in-progress pass through the finished goods in a progressive cycle, i.e. what comes first, goes out first. This method is satisfactory when prices of raw materials and rates of direct labour and overheads are relatively stable. Work-in-progress at the end of the period becomes the opening work-in-progress for the next period, the closing work-in-progress will be valued at costs ruling during the new period, while the opening work-in-progress will valued at costs ruling during the old period. Thus, where costs are more or less the same in each period, this system is adequate. In this method opening incomplete work-inprogress units are to be converted to equivalent production after taking into consideration the percentage of work yet to be done and shown separately in the statement of equivalent production.
• Average Cost Method : Simple average method may also be employed to compute process costs in place of FIFO method. The principle underlying it is that since it is not possible to identify or first complete the opening work-in-progress, the work is carried on all units simultaneously and the units to be transferred to next process may not necessarily contain all the units of opening work-in-progress, or, so to say, the closing work-in-progress need not compulsorily be out of units introduced during this period. Moreover, the degree of completion of opening work-in-progress may not be known. Under all such circumstances, average method is to be used for computation of costs. The cost of opening work-in-progress and the cost incurred during the period are added up. The units completed and transferred and the transferred and the equivalent units of closing work-in-progress on the basis of degree of completion are added to arrive at total equivalent production. The total cost is divided by the total equivalent production to obtain the per unit cost. The evaluation may be done separately for material cost, labour cost and overhead cost as per the stage of completion reached in respect thereof.

Thus, the main difference between FIFO method and average

method is that units of opening work-in-progress and their cost are taken in full under average method while under FIFO method only the remaining work done now is considered.

ACCOUNTING FOR JOINT PRODUCTS

In certain industries, where process costing is used, the

processing of the basic raw material results in the production of more than one product. These products are called joint products or by-products. Joint products and by-products are simultaneously produced in natural proportions. In other words, production of joint and by-products cannot be avoided and their proportions cannot be changed by choice.

Joint products are products which by the very nature of the

production process cannot be produced separately, and which have more or less equal economic importance. They represent “two or more products separated in the course of the same processing operation, usually requiring further processing, each product being in such proportion that no single product can be designated as the major product”. For example, gasoline, diesel, kerosene, lubricating oil, coal tar, paraffin and asphalt are the joint products obtained from crude oil in a refinery. Different grades of lumber resulting from a lumbering operation are another example.

Sometimes a distinction is made between joint product and co-

products. Co-products do not always arise from the same operation or raw materials and the quantity of co-products is within the control of the manufacturer. For example, in the automobile manufacturing industry, a number of co-products such as cars, jeeps and trucks of various types may be produced in different quantities according to the need of the concern, while in the oil industry, the quantity of various joint products remains almost the same and cannot be changed without changing the quantity of the rest of the items.

Generally the products are not identifiable as different individual

products until a certain stage of production known as split off point. All costs incurred  prior to the split off point are called joint product costs. Accounting for joint  products implies the assignment of a portion of the joint cost to each of the joint products. Unless the joint product costs are properly and reasonably apportioned to different joint products  produced, the cost of joint products will vary considerably and this will affect valuation of inventory, pricing of products and profit or loss on sale of different products. Therefore, the basic problem in respect of joint products is that of apportioning the joint costs. The following methods of apportionment of total cost before separation point are available for application :

• Average unit cost method.
• Physical measurement method.
• Survey method or points value method.
• Contribution or gross margin method. (e) Market value method :
  • At point of separation
  • After further processing.
  • Net realisable value or reverse cost method.

The discussion on these methods is as follows :

(a) Average Unit Cost Method : This method is very simple and the total costs are assessed, yielding an average unit cost with one net profit for the total operation. This can be applied where processes are common and inseparable for the joint products and where the resultant products can be expressed in the same common unit. This means that all joint products have the same unit cost and therefore, if price fixing is based on cost of various products which may be of different grades or quality will be sold at the same unit price, resulting in a customer’s price advantage in high grades. Moreover, where the end products cannot be expressed in some common unit, this method breaks down.

• Physical Measurement Method : A physical base such as raw materials weight, linear measure volume etc., is applied in apportioning pre-separation point costs to joint products. For example, if there is 40% beef in product X and 60% beef in Product Y, 4/10 of the cost upto separation point will be charged to X and 6/10 to Y. This method is not suitable where, for example, one product is a gas and another is liquid. This method presupposes that each joint product is equally valuable, which is probably not the case in practice.

• Survey Method or Points Value Method : Under this method, the common costs are apportioned to joint products after considering a number of factors such as volume, selling price, mixture, technical, engineering and marketing processes. Accordingly, percentage or points values are assigned to individual products to denote their relative importance and costs are apportioned on the basis of total points. This method is generally considered to be more equitable than other methods in as such as a combination of related factors is considered. It can be used period after period until there are changes in the methods of production and sale.

• Contribution or Gross Margin Method : This method uses the technique of marginal costing. The joint costs are segregated into two parts-variable and fixed. The variable costs are apportioned over the joint products on the basis of units produced or physical quantities. In case the products are further produced after the point of separation, then all variable costs incurred on such processing are added to the variable costs determined earlier to ascertain the contribution of each product. The fixed costs are then apportioned over the joint products on the basis of the contribution ratio.

• Market Value Method : Under this method, joint costs are apportioned after ascertaining “What the traffic can bear”. In other words, the products are made to bear a proportion of the joint costs on the basis of their ability to absorb the same. Market value here means weighted market value, that is, quantity produced multiplied by price per unit of joint product. This is the most popular and convenient method because it makes use of a realistic basis for apportioning joint costs.
•  Market Value at the point of Separation or Relative Market Value Method : Under this method, the separation point are ascertained and joint costs are apportioned in the ratio of either selling prices or sales value. The use of selling prices may result in completely invalid apportionments and as such sales value becomes an equitable basis. This method can be effectively used when disproportionate costs are incurred on joint products after the point of separation.

• Market value after further processing : This method is easy to operate because selling prices of the various joint products will be readily available. Further processing cost is deducted from the sales value in order to calculate the ratio in which the joint costs are to be apportioned. Sales value after deducting further expenses are used as the basis for apportioning cost up to the point of separation.

 

 

• Net Realisable Value or Reverse Cost Method : From the selling price of the finished products are deducted estimated net profit, direct selling and distribution expenses and the cost of further processing after the separation point. A ratio is established on the basis of which the total costs before separation point is apportioned. Subsequent costs are added to arrive at product costs. This method is extensively used in many industries such as oil refineries, lumber mills, etc.

19.17      ACCOUNTING FOR BY-PRODUCTS

By-products refer to secondary or subsidiary products having

some saleable or usable value produced incidentally in the course of manufacturing the main product. According to ICMA terminology, a byproduct is “a product which is recovered incidentally from the material used in the manufacture of recognised main products, such a by-product having either a net realisable value or a usable value which is relatively low in comparison with the saleable value of the main products. Byproducts may be further processed to increase their realisable value”. For example, in sugar industries, sugar is the main product, and fibres from sugarcane for lining materials, molasses for the manufacture of alcohol are by-products. Similarly in coke ovens, gas and tar produced along with the main product ‘coke’ are by-products.

Distinction between Joint Products and By-products

The classification of various products from the same process

into joint products and by-products depends upon the relative importance of the products and their value. If the various end products are almost equal in importance and their value is also more or less the same, they may be identified as joint products. But, if one end-product has greater importance and higher value and the other products are of less importance and rather of low value, the latter may be classified as by-products. It may be noted that the value of some end-products may be so insignificant that they may be classified as waste or scrap. Further joint products are produced simultaneously but by-products are produced incidentally in addition to the main product.

However, cases are not uncommon where the main products

of one industry become the by-products of another. In such a case, the following factors may be taken into consideration in making distinction between joint products and by-products.

• Manufacturing Objective : If the objective of a concern is to produce say, product A, other products, say B and C, produced incidentally, will be treated as by-products because the plant objective is to produce only one product i.e. product A. On the other hand, if the objective of another concern is to produce products B and C and if product A emerges incidentally, then products B and C will be treated as joint products while Product A will be treated as a by-product. Again, if the objective of a third concern is to produce products A, B and C simultaneously, then all the three products will be termed joint products.
• Value : If the value of one product is considerably low as compared with that of another, which is simultaneously produced, then the former is liable to be classified as a by-product. On the other hand, if the value of a product, which is incidentally produced, is of considerable importance as compared with that of the main product it may be classified as a joint product.

Accounting of by-products may broadly be classified into

the categories :

(i) Non-cost or sales value methods : These methods do not attempt to cost by-products or its inventory. The following are the main methods which are included in this group :

• Other Income or Miscellaneous Income Method.
• By-product’s sales added to the main product’s sales.
• By-product’s value deducted from the total cost.
• Credit of sales value less selling and distribution expenses. (e) Credit of sales value less selling and distribution expenses as well as cost incurred after split off.

Credit of sale value less selling and distribution expenses, cost incurred after split off and estimated profit or Reverse Cost Method.

(ii) Cost Methods : These methods attempt to apportion some of the joint cost to by-products. The following methods are included under this category:

• Opportunity or replacement cost method,
• Standard cost method, and
• Apportionment on suitable basis.

These methods will now be discussed one by one.

     Non-cost or Sales Value Methods

• Other income or miscellaneous income method : Under this method, the sales value of by-product, which is negligible, is credited to the Profit and Loss Account treating it as other or miscellaneous income. By-products which are not sold and are in stock are valued at nil value for Balance Sheet purposes and thus vitiate the valuation of closing stock. Accounting of by-products by this method is also inaccurate as there is a time lag between the sale and production. There is also a possibility that by-products may arise in one period but may be accounted in another period and thus distort the profits of two periods.
• By-product’s sales added to the main product’s sales : Under this method, all costs incurred on main and by-products are deducted from the combined sales of the main product and by-products. This method is generally adopted in those cases where either the value of the by-products is very small or where the by-products are sold in the market in the state in which they emerge from the main product. By-products in stock are valued at nil value for balance sheet purposes.
• By-product’s sales deducted from total cost. Under this method, the sales value of by-products are deducted either from production costs or from the cost of sales. Fluctuating costs of by-products also affect the costs of the main product and may encourage to conceal the inefficiencies therein. The stock in this case will be valued at total cost or cost of sales basis. (d) Credit of sales value less selling and distribution expenses : Under this method, the selling and distribution costs incurred for selling the byproducts are deducted from the sales value of by-products and the net amount is either credited to process account or is deducted from total cost.

The closing stock of by-products is valued at selling price

less an estimate of the cost likely to be incurred in selling the stock of byproducts.

• Credit of sales value less selling and distribution costs and its incurred on further processing : Under this method, selling and distribution costs and costs incurred on further processing the by-products are deducted from the sale value of the by-products and net amount is credited to the process account. The closing stock of by-products is valued at selling price less an estimate of the cost likely to be incurred in selling and processing the stock of such by-products. This method suffers from the disadvantage that, if the market value of by-product fluctuates, the credit to the Process Account of main product will fluctuate accordingly. Owing to the fact that credit to the main product Process Account fluctuates, inefficiencies in that process may be concealed.

• Reverse cost method : Under this method an estimated profit from the sale of by-products, selling and distribution expenses and further processing costs after the split off points are deducted from the sales value of by-products and the net amount is credit to the main product.

(ii) Cost Methods

The following methods are included in this category :

• Opportunity or Replacement Cost Method : This method is adopted where by-products are utilised in the undertaking itself as input material for some other process. The opportunity cost, i.e., the cost which would have been incurred, had the by-product been purchased from outside suppliers is taken as the cost of the by-product. The Process Account is credited with the value of the by-products so ascertained. For example, in the production of a main product, 200 units of a by-product A are produced, which are transferred to another product where they are consumed. If the by-product were purchased from the market, the price would be Rs. 3 per unit. Thus, the amount to be credited to the main product in respect of the by-product under this method is 20 units × Rs.3 = Rs. 600.
• Standard Cost Method : Under this method, a standard cost is set on the basis of technical assessment for each by-product and credit is given to the process account on this basis. The standard may be arrived at on the basis of past average price or may be fixed according to the principles of standard costing. As credit in respect of the by-product cost is a stable figure under this method, effective control can be exercised on the cost of the main product.
• Apportionment on Suitable Basis : Where by-products are of major significance, the cost should be apportioned on the most suitable basis. This method is followed where by-products are processed (i) to dispose of waste material more profitably, or (ii) to utilise idle plant. In the first case, by-products after separation are charged with overheads at full rates, whereas in the second case, by-product costs after separation will include variable costs only.

 

18  SUMMARY

In case of mass production concerns the products when

produced are of the same type, and involve the same material and labour and pass through the same set of processes. In such industries each process is designated as a separate cost-centre and the cost per unit is calculated by dividing the total cost of the process with the total number of units produced by the process. The cost of production of the product is obtained by adding the unit costs of various processes through which the product has passed. This method of costing is known as process costing.

In business where a product passes through different stages

of production, each distinct and well defined, process costing is employed. A separate account for each process is opened and all expenditure pertaining to a process is charged to that process account. Thus, the cost of the product at each stage of manufacture is found out. The partially worked product of process may either be transferred to a Process Stock Account from where it will be sent to the next process as and when required or may be sent directly to the next process. Thus, in process costing the finished product of a preceding process becomes the raw material of the next process.

19.19 KEYWORDS

Job costing: It is method of costing which is adopted to execute the work strictly according to customers specification.

Process costing: Process costing refers to a method of accumulating cost of production by process.

Normal loss: The loss which is inherent in the production process and which cannot be controlled is known as normal loss.

Joint products: When two or more products of equal importance are simultaneously produced from the same basic raw materials from a common process, they are known as joint products.

By-product: By-products refer to any saleable or usable value incidentally produced in addition to the main product.

19.20 SELF ASSESSMENT QUESTIONS

1. What do you understand by job costing ? What are the main features of this method ? Give a proforma cost sheet under such a system.
2. What do you mean by process costing ? In what types of industries is process costing generally applied ?
3. Describe the features of Process Costing. How is unit cost determined in process costing ?
4. What do you understand by the term “inter-process profits”? What is the utility of transferring the output of one process to another process at more than cost?
5. In a manufacturing concern with several departments, the finished product of one department becomes the raw material of the next department. Would you advocate inclusion of profit in the transfer price of the material? What would be the effect of this in the profit and loss account of the manufacturing concern as a whole?
6. Define and explain the terms ‘joint Products’ and ‘by-products’. Enumerate the methods which may be employed in costing ‘joint products’.