Professional Documents
Culture Documents
Chapter 1: INTRODUCTION
Today business and industry needs costing systems to meet their individual requirements. Costing experts believe that it may not be possible to devise a single costing system to fulfill everybodys needs. They have developed different methods of costing for different industries depending on the type of manufacture and their nature. Mainly the industries can be grouped into basis types: Industries doing job work. Industries engaged in mass production of single product or identical production. A concern engaged in the execution of specification order is characterized as a firm producing several items distinguishable from one another by respective specifications and other details. Such a concern is thought of involved in performing job works. Production under job work is strictly according to customers specifications and each lot, job or production order is unique. Examples of jobs order type of production are: ship building, roads, bridges manufacture of heavy electrical machinery, machine tools, iron foundries, identity for the purpose of costing. The methods of costing and for ascertaining cost of each job are known as a job costing, contract costing and batch costing. The continuous or process type of industry is characterized by the continuous production of uniform products according to standard specifications. In such case the successive lots are generally indistinguishable as to size and form and, even if there is some variation in specifications, it is of a minor character. Examples of continuous type of industries are chemical and pharmaceutical products, paper/food products, canning, paints and varnish oil, rubber, textile etc. here the methods of costing used for the purpose of ascertaining costs are process costing, single costing , operating costing etc.
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METHODS OF COSTING The following are the methods of costing. Job Costing This method is also called as job costing. This costing method is used in firms which work on the basis of job work. There are some manufacturing units which undertake job work and are called as job order units. The main feature of these organizations is that they produce according to the requirements and specifications of the consumers. Each job may be different from the other one. Production is only on specific order and there is no pre demand production. Because of this situation, it is necessary to compute the cost of each job and hence job costing system is used. In this system, each job is treated separately and a job cost sheet is prepared to find out the cost of the job. The job cost sheet helps to compute the cost of the job in a phased manner and finally arrives the total cost of production. Batch Costing This method of costing is used in those firms where production is made on continuous basis. Each unit coming out is uniform in all respects and production is made prior to the demand, i.e. in anticipation of demand. One batch of production consists of the units produced from the time machinery is set to the time when it will be shut down for maintenance. For example, if production commences on 1st January 2007 and the machine is shut down for maintenance on 1st April 2007, the number of
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Job, Contract and Batch Costing units produced in this period will be the size of one batch. The total cost incurred during this period will be divided by the number of units produced and unit cost will be worked out. Firms producing consumer goods like television, air-conditioners, washing machines etc use batch costing. Process Costing Some of the products like sugar, chemicals etc involve continuous production process and hence process costing method is used to work out the cost of production. The meaning of continuous process is that the input introduced in the process I travels through continuous process before finished product is produced. The output of process I becomes input of process II and the output of process II becomes input of the process III. If there is no additional process, the output of process III will be the finished product. In process costing, cost per process is worked out and per unit cost is worked out by dividing the total cost by the number of units. Industries like sugar, edible oil, chemicals are examples of continuous production process and use process costing. Operating Costing This type of costing method is used in service sector to work out the cost of services offered to the consumers. For example, operating costing method is used in hospitals, power generating units, transportation sector etc. A cost sheet is prepared to compute the total cost and it is divided by cost units for working out the per unit cost. Contract Costing This method of costing is used in construction industry to work out the cost of contract undertaken. For example, cost of constructing a bridge, commercial complex, residential complex, highways etc is worked out by use of this method of costing. Contract costing is actually similar to job costing, the only difference being that in contract costing, one construction job may take several months or even years before they are complete while in job costing, each job may be of a short duration. In contract costing, as each contract may take a long period for completion, the question of computing of profit is to be solved with the help of a well defined and accepted method.
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Job, Contract and Batch Costing These Methods of Costing are broadly classified into (1) Specific Order Costing (2) Operation Costing. The term Specific Order Costing refers to the basic costing method which is applicable where the work consists of separate contracts, jobs or batches. The specific order costing is further classified into Job Costing, Batch Costing and Contract Costing. Job Costing is that form of specific order costing which applies where industries which manufacture products or render services against specific orders such as civil contracts, construction works, automobile repair shop, printing press, machine tool manufacturing, ship building and furniture making etc.
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Job, Contract and Batch Costing TECHNIQUE OF COSTING As mentioned above, costing methods are for computation of the total cost of production/services offered by a firm. On the other hand, costing technique help to present the data in a particular format so that decision making becomes easy. Costing techniques also help for controlling and reducing the costs. The following are the techniques of costing. Marginal Costing This technique is based on the assumption that the total cost of production can be divided into fixed and variable. Fixed costs remain same irrespective of the changes in the volume of production while the variable costs vary with the level of production, i.e. they will increase if the production increases and decrease if the production decreases. Variable cost per unit always remains the same. In this technique, only variable costs are taken into account while calculating production cost. Fixed costs are not absorbed in the production units. They are written off to the Costing Profit and Loss Account. The reason behind this is that the fixed costs are period costs and hence should not be absorbed in the production. Secondly they are variable on per unit basis and hence there is no equitable basis for charging them to the products. These techniques is effectively used for decision making in the areas like make or buy decisions, optimizing of product mix, key factor analysis, fixation of selling price, accepting or rejecting an export offer, and several other areas. Standard Costing Standard costs are predetermined costs relating to material, labor and overheads. Though they are predetermined, they are worked out on scientific basis by conducting technical analysis. They are computed for all elements of costs such as material, labor and overheads. The main objective of fi xation of standard cost is to have benchmark against which the actual performance can be compared. This means that the actual costs are compared with the standards. The difference is called as variance. If actual costs are more than the standard, the variance is adverse while if actual costs are less than the standard, the variance is favorable. The adverse
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Job, Contract and Batch Costing variances are analyzed and reasons for the same are found out. Favorable variances may also be analyzed to find out the reasons behind the same. Standard costing thus is an important technique for cost control and reduction. Budgets and Budgetary Control Budget is defined as, a quantitative and/or a monetary statement prepared to prior to a defined period of time for the policies during that period for the purpose of achieving a given objective. If we analyze this definition, it will be clear that a budget is a statement, which may be either in monetary form or quantitative form or both. For example, a production budget can be prepared in quantitative form showing the target production; it can also be prepared in monetary terms showing the expected cost of production. Some budgets can be prepared only in monetary terms, e.g. cash budget showing the estimated receipts and payments in a particular period can be prepared in monetary terms only. Another feature of budget is that it is always prepared prior to a defined period of time which means that budget is always prepared for future and that took a defined future. For example, a budget may be prepared for next 12 months or 6 months or even for 1 month, but the time period must be certain and not vague. One of the important aspects of budgeting is that it lays down the objective to be achieved during the defined period of time and for achieving the objectives, whatever policies are to be pursued are reflected in the budget. Budgetary control involves preparation of budgets and continuous comparison of actual with budgets so that necessary corrective action can be taken. For example, when a production budget is prepared, the production targets are laid down in the same for a particular period. After the period is over, the actual production is compared with the budget and the deviation is found out so that necessary corrective action can be taken. Budget and Budgetary Control is one of the important techniques of costing used for cost control and also for performance evaluation. The success of the technique depends upon several factors such as support from top management, involvement of employees and coordination within the organization.
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CUSTOMER'S ENQUIRY Production or job order is executed on the basis of enquiries received from the
customers. The routine enquiries may be related to expected estimated costs to be incurred, quality to be maintained and duration for production planning etc.
QUOTATION FOR THE JOB As per the customer's enquiry and specifications of work or job, a responsible
person is preparing the estimates or quotation and price is fixed for a specific job. And the same conveyed to the customer appropriately.
CUSTOMER'S ORDER If the quotation is satisfactory to the customer, he may place an order.
PRODUCTION ORDER As soon as an order is received, the Production planning and controlling. Department will make out a production order. It is in the form of instructions
issued to the foremen to execute the order and to control its physical progress. It contains all the information regarding the production. Accordingly production control department assign a production order number for each order or job.
COST ACCUMULATION The Cost Accountant is responsible to prepare a Job Cost Card on the basis of
production order. It is also termed as "Job Cost Sheet." For each job the costs are collected and recorded under separate production order number. The sources of collection of costs are:
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Job, Contract and Batch Costing Direct material can be identified or obtained either from Bill of Materials or Requisition Slips or Invoices in the case of direct purchases. Wages paid to direct labour is associated with a job and can be identified or recorded with the help of Time Sheet, Job Cards and Wage Analysis Sheet. Direct expenses are identified on the basis of direct expenses vouchers. Overheads are apportioned on some predetermined basis. It can be accumulated with the use of standing order numbers or cost account numbers . COMPLETION OF JOBS After completion of a job, the final report is sent to the costing department with regard to charging of material, labour, and overheads are recorded on the job cost sheet. The actual cost recorded under each element of cost is ascertained to find out the total cost. Any deviations from the estimated costs are also noted to take the corrective actions.
PROFIT OR LOSS ON JOB It is determined by comparing the actual cost with the price obtained.
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Job, Contract and Batch Costing show the number of transfer to job as well as transferee job (or jobs) so that, on that basis, the cost thereof can be adjusted in the work in progress ledger.
ACCONTING FOR LABOUR All direct labour cost must be analyzed according to individual jobs or work orders. Similarly, different types of indirect labour cost also must be collected and accumulated under appropriate standing order or expenses code number. The analysis of labour according to jobs or work orders is, usually, made by means of time cards or sheets. All direct labour is booked against specific jobs in the job time cards or sheets. All the idle time also is booked against appropriate standing order expense code number either in the job time card for each job or on a separate idle time card for each worker (where the job time card is issued job- wise). The time booked or recorded in the job time and idle time cards is valued at appropriate rates and entered in the labour abstract or analysis book. All direct labour cost is accumulated under relevant job or work order numbers, and the total or the periodical total of each job or work order is then posted to the appropriate job cost card or sheet in work in progress ledger. The postings are usually made at the end of each week or month. The abstraction of idle time cost under suitable standing order or expenses code numbers is likewise done and the amounts are posted to the relevant departmental standing order or expense code number in the overhead expenses ledger at periodical intervals. As regards other items of indirect labour cost these are collected from the payrolls books for the purpose of posting against standing order or expenses code number in the overheads expenses ledger.
ACCOUNTING FOR OVERHEADS Manufacturing overheads are collected under suitable standing order numbers and selling and distribution overheads against cost accounts numbers. Total overheads expenses so collected are apportioned to service and production departments on some suitable basis. The expenses of service departments are finally transferred to production departments. The total overheads of production departments is then
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Job, Contract and Batch Costing applied to products on some realistic basis, e.g. machine hour, labour hour; that the use of different methods will lead to a different amounts being computed for the works overhead charged to a job hence to different total cost. The problem of accurately absorbing, in each individual job or work order, the overhead cost of different cost centers or departments involved in the manufacture is difficult under the job costing method. It is because the cost or the expenses thereof cannot be traced or identified with any particular job or work order. In such circumstances, the best that can be done is to apply suitable overheads rate to each individual article manufactured or to each production order. This is essentially an arbitrary method.
PRICE OF JOB Price of a job may be arrived by adding the desired percentage of profit to the total cost of the job.
TREATMENT OF SPOILED AND DEFECTIVE WORK Spoiled work is the quantity of production that has been totally rejected and cannot be rectified. Defective work on the other hand refers to production that is not as perfect as the saleable product but is capable of being rectified and brought to the required degree of perfection provided some additional expenditure is incurred. Normally, all the manufacturing operations are not fully successful; they result in turning out a certain amount of defective work. Nonetheless, over a period of time it is possible to work out a normal rate of defectives for each manufacturing process which would represent the number of defective articles which a process shall produce in spite of due care. Defects arise in the following circumstances: 1) Where a percentage of defective work is allowed in a particular batch as it cannot be avoided. 2) Where defect is due to bad workmanship. 3) Where defect is due to the inspection department wrongly accepting incoming material of poor quality.
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Job, Contract and Batch Costing In the first case, when a normal rate of defectives has already been established, if the actual number of defectives is within the normal limit or is near thereto the cost of rectification will be charged to the whole job and spread over the entire output of the batch. If, on the other hand, the number of defective units substantially exceeds the normal, the cost of rectification of the number which exceeds the normal, the cost of rectification of the number which exceeds the normal will be written off as a loss in the costing profit and loss account.
In the second case, when the defective wok is due to bad workmanship the cost of rectification will be abnormal cost, i.e., not a legitimate element of the cost. Therefore, the cost of rectification shall be written off as a loss, unless by an arrangement, it is to be recovered as a penalty from the workman concerned. It is possible, however that the management did provide for a certain proportion of defectives on account of bad workmanship as an unavoidable feature of production. If that be the case, the cost of rectifying to the extent provided for by the management will be treated as a normal cost and charged to the batch.
In the third case the defect being due to negligence of the inspection department, the cost of rectification will be charged to the department and will not be considered as cost of manufacture of the batch. Being an abnormal cost, it will be written off to the costing profit and loss account.
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BILL OF MATERIAL It contains a complete list of materials and part required and part required for a given job. The acts as a substitute for material requisition.
OPERATION SCHEDULE On this schedule are listed by name and code number all labour operations to be performed in their proper sequence. It contains spaces for noting the job or operation to be done, name of the operation, description of operation and time of starting and finishing the operations.
TOOL LIST A complete list of tools required, whether special or standard, is prepared and accompanies the instructions cards of operation schedule. In this way operation schedule and tool list take care of production problems relating to labour, machines and tools.
PLANNING BOARD A planning board is in effect a timetable for scheduled production. It is based on a planning schedule whose function is to set time limits for processing the various jobs or orders. Planning board consists of a rack with suitable hooks or receptacles to hold the production order control card. Each work station at which a workman is
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Job, Contract and Batch Costing required, whether machine or assembly floor, is represented on the board by a work station number. In order to aid in the control of jobs passing through the shop, the books or receptacles should be placed on three horizontal rows across the board. This is to differentiate between jobs being worked upon, those that have been held up owing to some causes such as, waiting for machine, waiting for final instruction etc.
MOVE TICKET As job progresses, it is checked off on the operations schedule which frequently is used as a route sheet showing steps required in its completion. These move tickets accompany each lot at the time of transfer to the next department. The planning board is adjusted to record the progress made.
JOB COST SHEET The heart of the job system is the job cost sheet. Actual cost of materials, labour and overheads applicable are noted alongside the estimated cost to show the profit and loss account on the particular job.
JOB TICKET Job ticket is document which contains of several detachable portions each of which is detachable and sent by the foreman to the production control department on completion of each operation of a job. Its purpose is to ascertain the progress of a job at each operation. Job ticket is useful for ascertaining the progress of a job. For tracing jobs in the factory. For controlling the schedule of operations.
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It may be noted that though a simplified costing system is introduced, the cost of small jobs will be high owing to the existence of some fixed costs like cost of receiving order and acknowledging, issuing production orders, bill of materials, tool lists, operation schedules, etc., in order to deal with this problem, small orders may be avoided as far as possible, without prejudice to the goodwill of the concern. One may be tempted to introduce mechanized accounting procedure to deal with such small orders. But mechanization is not profitable because there is no considerable repetition. In each case a job account or ledger sheet is involved and this requires heading, collating, positing and filing. Postings are too many and cannot be reduced. Any saving in keeping accounts is counterbalanced by the depreciation and running costs of machine.
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Low indirect costs: For most contracts the main item of indirect cost would be a charge for Head Office expenses. Other indirect costs include wages of workers which cannot be identified with a particular contract, or salary of supervisory staff looking two or more contracts.
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Job, Contract and Batch Costing Difficulties of cost control: Because of the scale of some contracts and the size of the site there are frequently major problems of cost control concerning: material usage and losses, pilferage, labour supervision and utilization, damage to and loss of plant and tools.
Surplus materials: All materials bought for a contract would be charged directly to the contract. At the end of the contract, the contract account would be credited with the cost of materials not used, and if they were transferred directly to another contract, the new contract account would be debited. If they were not required immediately, the materials would be stored and the cost debited to a stock account.
Other features are as follows: A separate account is usually maintained for each contract or job undertaken for the purpose of determining profit or loss under each. The major part of the work in connection with each contract is ordinarily carried out at the site of the contract. The bulk of the expenses incurred by the contractor are considered as direct. The indirect expenses, mostly consists of office expenses of the yards, stores and works. Overheads are limited to the head office and central storage costs forming a small percentage of total cost of contracts are recovered on arbitrary basis such as, percentage of wages, material or prime cost. One of the aspects of contract costing is that most of the costs are directly allocated to the contracts. Under job costing expenditure is normally allocated first to cost centre and secondly to the individual jobs, the nature of contract costing is such that the only allocation required is direct to the contract. The number of contracts undertaken by a contractor at a time is not usually very large. The cost unit in contract costing is the contract itself.
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Job, Contract and Batch Costing paid or of the prime cost. If however, the contracts are big, the labour hour method may be used for distribution of overheads. ACCOUNTING FOR CHARGE FOR USE OF PLANT & MACHINERY For use of plant &machinery in a particular contract, the depreciation may be charged in any one of the following ways: When the plant is required to be used for a long time, the total cost of the asset is debited to the contract in which they are used. When the contract is completed or the plant is no longer required it may be sold at site and the contract is credited with the sale proceeds. If it is not sold, the contract is to be credited with the depreciated value. This method has the drawback that the debit side is unnecessarily inflated with the overcome this problem, the difference between the original cost at the commencement and depreciated value at the end of the period is obtained from the plant register or account and charged to the contract concerned as plant depreciation. When the plant is sent to contract site only for a short time the revaluation method just described is not satisfactory, and it is usual to charge the contract for the use on an hourly basis. The hourly rate is computed by dividing the depreciation and other operating expenses of the plant by the total estimated working hours of the plant. When plants are hired for use in construction work, a suitable charge for rent is made to the contracts on the basis of time taken or extent of use made by each contract. SUB-CONTRACT The contractor may entrust certain types of specialized work such as electrical, plumbing, painting, carpentry, special flooring, etc. to a sub-contractor. The subcontractor is responsible to the main contractor in terms of performing the work and he will get the payment from the main contractor. The cost of such sub-contract is debited to contract account.
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Job, Contract and Batch Costing EXTRA WORK Sometimes additional work upon the work originally contracted for is required by the contractee. This forms a separate charge, and there the amount involved is large, a subsidiary contract is generally entered into with the contractee. The extra work amount payable by the contractee should be added to the contract price. If extra work is substantial, it is better to treat it as a separate contract. If it is not substantial, expenses incurred should be debited to the contract account as cost of extra work.
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Job, Contract and Batch Costing loss account. Unless a portion of the profit on uncompleted contracts is taken, the accounts may show low profit in years when no major contract is completed and exceptionally high profits in the year which contract is completed. In these circumstances, it is considered prudent to transfer a conservative part of estimated profit on large contracts at the end of each year. The determination of amount of profit and the proportion of the profit to be taken to profit and loss account depends on the practice and circumstances of the case. The rules may be summarised as follows: When work on contract has not reasonably advanced No profit is taken into account as it too early to foresee and estimate with reasonable degree of accuracy, any profits on the small work done. When work on contract has reasonably advanced and covered by a surveyors certificate In this case, the profit (popularly called notional profit) is ascertained by deducting the cost of contract covered by surveyors certificate from the value of contract certified by surveyor. A portion of this notional profit is taken to profit and loss account and the balance is carried forward in the same contract as profit in suspense as a provision against future losses, increase in costs and other contingencies. The reasons for making a conservative provision against of profits in the accounts are Until the work is certified, it cannot be taken as complete in any respect and no credit for profit should be taken As cash received is generally less than the value of work certified, full credit for profit will mean that even the unrealised profit may stand for distribution as dividends. Moreover, taxation will be high if more profit is shown for contracts not yet complete. Withholding a part of the profit is based on the consideration that unforeseen contingencies and likely losses may reduce the profit in future. The amount of profit to be credited to profit and loss account may be
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Job, Contract and Batch Costing When the completion of the contract is less than 50%, profit to be taken is 1 / 3 x Notional Profit x Cash Received / Work Certified When the completion of the contract is 50% or more, the profit to be taken is 2 / 3 x Notional Profit x Cash Received / Work Certified Where the contract is almost complete In this case the profit (popularly called estimated total profit) is determined by deducting the aggregate of cost to-date and additional expenditure to complete the contract (determined on a liberal basis) from the contract price. A portion of this estimated total profit is credited to profit is credited to profit and loss account. The proportion ascertained by adopting any one of the following formulae Estimated profit x Value of work certified / Contract price Estimated total profit x Value of work certified / Contract price x Cash received/Work certified Estimated total profit x Cost of work to date / Estimated total cost Estimated total profit x Cost of work to date / Estimated total cost x Cash received/Work certified VALUATION OF WORK IN PROGRESS The best way of finding out the amount of work in progress for balance sheet purpose is to add profit taken to profit and loss account of cost of contract to date and from this aggregate cash received is deducted. If there be loss in a contract the loss should be deducted from the cost of contract to-date and from the amount thus arrived at cash received is deducted. This balance represents work-in-progress. In the balance sheet work-in-progress is usually shown under two heads, viz certified and not certified. Uncertified contract should be valued at cost.
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COST-PLUS CONTRACT
It provides for the payment by the customer or the contractee, of the actual cost of manufacture plus a stipulated profit. The items of expenditure to be included in the actual costs are broadly agreed upon in advance, and the books and documents of the manufacturer are open to check and scrutiny by the customer or his representative. The profit to be added to the actual cost may be a fixed amount or it may be in the form of a suitable percentage on cost or on the capital employed. Cost plus contracts are entered into when at the time of undertaking work, it is not possible to estimate the cost of contract with reasonable degree of accuracy due to unstable conditions of material, labour, services etc. are likely to fluctuate. Such contracts are also entered into when special items of work requiring high quality and precision, where estimating is difficult, are to be manufactured and supplied. Cost plus contracts are advantageous both for the manufacturer and the customer, as neither party stands to lose. A fair price is offered to the customer and a reasonable profit accrues to the manufacturer. DEFINITION OF COST-PLUS CONTRACT An agreement to pay a company for a job based on the amount of money used to buy the materials required to complete that job plus an added payment. A cost-plus contract fully reimburses a contractor for the cost of materials and then adds additional money to arrive at the total cost of the job. Cost-plus contracts are commonly used in research and development activities, where it is difficult to determine in advance how much a job should cost. For example, the U.S. government has agreed to cost-plus contracts with military defense companies that are developing new technologies for national defense.
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Job, Contract and Batch Costing FEATURES OF COST PLUS CONTRACT The practice of cost-plus contracts is adopted in the case of those contracts where the probable cost of the contracts cannot be ascertained in advance with a reasonable accuracy. These contracts are preferred when the cost of material and labour is not steady and the contract completion may take number of years. The different costs to be included in the execution of the contract are mutually agreed, so that no dispute may arise in future in this respect. Under such type of contracts, contractee is allowed to check or scrutinize the concerned books, documents and accounts. Such a contract offers a fair price to the contractee and also a reasonable profit to the contractor. The contract price here is ascertained by adding a fixed and mutually pre-decided component of profit to the total cost of the work. ADVANTAGES OF COST PLUS CONTRACT Benefits to Owner Using a cost plus contract tends to result in better quality projects because contractors do not have to skimp on materials and labor. Also, they can bank on guaranteed reimbursement and bonus fees for prepaying expenses. This type of agreement may reduce the chances of project over bidding because the contractor does not need to pad fixed expenses to avoid going over budget. Benefits to Contractor A contractor can take on an unfinished design using an cost plus contract because there is less risk that the agreed upon sum does not cover expenses and fails to make a profit, according to Guy Randles of the "The Daily Journal of Commerce." Considerations Cost plus contracts contain certain clauses, such as the maximum cost guarantee and the savings clause, which alter their advantages. The maximum cost clause reduces risk to the business because the contractor must determine if he can work within that Vivek College of Commerce Page 27 of 37
Job, Contract and Batch Costing agreed upon sum and pay for any possible overages. The savings clause gives the contractor a percentage of the amount of money under the maximum cost -- giving the incentive to work the project as efficiently as possible. ESCALATION CLAUSE Sometimes, owing to fluctuation in the prices of materials and labour costs, the contract price is altered so that neither party suffers the loss arising out of the change in price level. To protect his interest against the rise in prices, the contractor inserts a clause known as the 'escalation clause', under which, the contractee will be obliged to pay the enhanced price of the contract because of increase in the rates of materials, labour and other expenses. Similarly, to protect the interest of the contractee against the fall in the rates of materials, labour and overheads, a 'descalation clause' is inserted. However, it is to be noted that the terms and conditions under which the contract price is to be altered is to be specifically mentioned. The reasons which give rise to change in price level are to be stipulated. There should be no ambiguity in the wordings of this clause. The essentials of the escalation clause are as follows: The elements of costs on the basis of which quotation price is submitted must be specified. The elements in relation to which escalation clause applies should be specified. The escalation clause should apply to only those factors which are beyond the control of contractor. The escalation clause should mention the date from which the rise in price of the contract comes into effect. The records of the contractor are to be made available to the contractee for inspection. The provision for alteration of contract price must relate only to change in design, or any major alteration of the work but not on account of defective work.
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Job, Contract and Batch Costing DISADVANTAGES OF COST PLUS CONTRACT If you have a strict budget, cost plus contracts are a poor choice because it has much greater cost uncertainty than fixed-price contracts and you do not know the final price of the project. Also, this type of arrangement does not give contractors an incentive to work efficiently and promotes overspending to get the largest fee possible. Missed Profit Opportunities
Cost plus pricing throws money out the door. In the book, "Capon's Marketing Framework," Noel Capon writes that companies are prone to pricing too high or too low with cost-plus pricing. In markets where price isn't the most important thing to the consumer in their decision-making, his research shows that products are often under-priced. In markets where customers are counting every penny before making a buying decision, he shows that prices are often too high. Competitors are able to compete on pricing more easily with this method because they can predict your pricing ahead of time.
Fixed Costs
The concept of fixed costs means that these costs never change. Rent and salaries are fixed costs. If the company produces and sells a thousand more products one month and sells fewer the next month, the fixed costs don't change. That means if costs is the main factor in pricing, then the pricing should fluctuate from month to month. Raw materials and sales commission are variable costs or costs that change from period to period. Consumers can be skeptical of pricing fluctuations and it erodes brand trust.
Efficiency
If costs of production decrease, cost plus pricing suggests that pricing should decrease. Then, you lose out on profits. It works the opposite if production costs increase. Cost plus pricing doesn't inspire efficiency. As long as customers are paying production costs you don't have any incentive to lower costs or find faster, cheaper and more effective ways of producing products. It's easy for a company to
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Job, Contract and Batch Costing become complacent. Meanwhile, competitors are taking steps to produce a better product faster, which allows them to steal market share. Customer Value
Pricing all boils down to what consumers will pay for a product. Even if a name brand shoe only costs $4 to make, the consumer will pay $120 for it if a famous celebrity athlete's name is attached to the show. Cost plus pricing misses this important factor in pricing and profits. In the book, "Pricing with Confidence," Reed Holden and Mark Burton write that cost plus pricing "Ignores demand, image and market positioning and ignores the role of customers and the value they derive." Value based pricing is an alternative method for taking customer's perception into account for pricing.
Cost-plus pricing does have some disadvantages when suppliers use it in contracts with buyers. Percentage Markup Conflict
One main disadvantage of cost-plus supplier contracts with set percentage markups is that the supplier, or contractor, has an inherent motivation to raise its costs to boost profitability. This may seem odd, but if the supplier has more expense in a percentage markup arrangement, the profit margin increases. For instance, if a contractor pays $50 in costs and adds a 20 percent markup, the resale price is $60, with a $10 profit. If its cost basis raises to $75, a 20 percent markup means a price of $90, which yields a $15 profit.
Another conflict exists on contracts with a set amount of markup. On these contracts, the supplier simply has no motivation to try to reduce costs since its profit remains the same. If a supplier pays $50 and the contract states a $20 markup on a product, the supplier gets no benefit other than helping its client by working to cut its own costs as the margin remains $20. This means the supplier is less likely to work hard to improve efficiencies or lower its costs.
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The cost-plus pricing approach gives little consideration to market implications. In market-based pricing, consideration is given to how pricing impacts demand. Cost-plus focuses on costs and profit margin. If a supplier contract indicates a 30 percent markup that takes the reseller's price point beyond current market prices, the reseller's demand is going to take a serious hit. On the contrary, a supplier could undervalue its product with a contracted markup, if demand goes up dramatically, bringing the market price significantly higher.
Another challenge of the cost-plus pricing contract model is that it limits the ability of suppliers and resellers to partner to satisfy the needs of the end customer. This collaboration is the premise of the 21st century business system known as supply chain management (SCM). SCM is intended to give end customers the best value, so all members of the distribution channel win. Limiting cost-plus pricing contracts can prevent necessary flexibility and partnering needed to react to marketplace demands.
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Job, Contract and Batch Costing On the other hand, the larger the batch size the greater will be the number of units in inventory over a period of time and therefore the larger the space-occupancy and imputed interest cost associated with storage. These are called stock carrying costs. With the increase in the batch quantity there is an increase in the batch quantity there is an increase in the carrying cost but the setup cost per unit of products is reduced and vice versa. Thus there is one particular batch size which will involve minimum cost, and will, therefore, maximize profits. This is the economic or optimum batch quantity. Economic batch quantity (EBQ), also called "optimal batch quantity" or economic production quantity, is a measure used to determine the quantity of units that can be produced at minimum average costs in a given batch or production run. Economic Production Quantity model (also known as the EPQ model) is an extension of the Economic Order Quantity model. The Economic Batch Quantity model, or production lot-size model, is similar to the EOQ model in that an optimum is to be calculated for the batch quantity to be produced. In working with this EBQ model, principal assumptions are:
The demand (D) is known and constant within a certain period of time The unit cost of the inventory item (U) is constant The annual holding-cost per unit (Ch) is constant The setup-cost per batch (C) is constant The production time (pt) is known and constant there is one kind of product There is no interaction with other products The aspect of time does not play a role, just the setup time does The setup cost is constant and does not act upon the batch quantity.
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Job, Contract and Batch Costing The determination of optimum quantity to produce an economical batch is very important and there are different approaches and consequently formulae for each size. A simple and commonly used formula is-
Where, E = Economic batch quantity U = Annual usage or units to be produced in a year S = Set up and order processing cost per batch R = Annual rate of production C = Cost of carrying one unit in inventory for a year If, however, the batch is produced over a short period of time relative to the time between runs, U/R becomes negligible and the formula reduces to-
[The formula is similar to economic ordering quantity] Where, however, the annual rate of interest and cost of manufacture per unit is given, the formula assumes the form
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CONCLUSION
We have looked at the methods of costing used in activities where work of a non-uniform character is done for a particular customer: job, batch and contract costing. Businesses identify the direct cost of production (costs that can be directly measured in respect of a particular unit of output) and add a share of overheads. Full costing is widely used by business but it is also widely criticized for not providing relevant information. To conclude with this project report gives a clear view of the three methods of costing job, batch and contract costing clearly.
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BIBLOGRAPHY
BOOKS
COST ACCOUNTING By B. K. BHAR
WEBSITES
http://www.financedoctors.net/ http://www.kkhsou.in/ http://financenmoney.wordpress.com/ http://www.icai.org/ http://www.myicwai.com/ http://www.financedoctors.net/ http://www.scribd.com/
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