—Purpose of Assigning Costs
Costs are assigned to objects for a variety of purposes viz :
— pricing,
— profitability studies and
— control over spending.
Cost Object
A cost object is anything for which cost data are desired
including:
1.products,
2.product lines,
3. customers,
4.jobs and
5.organizational sub-units.
Variety of sectors uses different costing systems in accordance with their requirements. E.g.
Manufacturing
Purchase raw materials and convert them into finished goods
Merchandising
Purchase and sell products without changing their basic form.
Service sector companies.
Service sector companies provide services or intangible products to their customers.
Example :
•Law firms
•Audit firms
•ISO certifiers
•Banks
•Insurance
•Advertising
•Internet based companies
•Courier service
Two type of costing systems are used to
assign costs to products or services:
—Process Costing
—Job Order Costing
—Process Costing
—In Process Costing System the cost object is masses of identical or similar units of a product or service.
—In each period , process costing system divide the total cost of producing an identical or similar product or service by the total number of units produced to obtain a per unit cost. This average unit cost applies to all.
Examples:
—Customer of Glaxo will receive same medicine
—Time magazine provide same product to each of its customer.
—UBL Bank provides same service to all of its customer when processing customer deposits.
In Job Order Costing System, the cost object is an
individual unit , batch or lot of distinct products or
services called job.
The product or services is often custom made e.g :
—Advertisement produced by R lintas.
—Software designed by IT company
—Construction project managed by Emar
—In a Job costing system ,cost are accumulated by job.
—Direct material and Direct labor are taken at
actual values. These are recorded and tackled
until the job is completed.
—Overhead is applied using a rate based on
direct labor hours or by using activity based
costing cost driver.
—Job-order costing is a versatile and widely used costing method, and may be encountered in virtually any organization where there are diverse products or services.
•It depends upon the nature of the services being provided. However definitely it usually do not include direct material.
•Generally cost in service industry include:
–Salaries Cost (Direct + Indirect)
–Administration Cost like Rent, Insurance, Stationery etc.
–Software / Hardware
–Affiliation Fee
–Marketing Expenses
•Example : Hospital, Hotel, Law firms
Example -1:
In a law firm each client represent a “job” and the costs of that job are accumulated day by day on a job cost sheet as the client’s case is handled by the firm. Legal forms and similar inputs represent the direct materials for the job; and the time expended by the lawyer represents the direct labor; and the costs of secretaries ,clerks, rent ,depreciation and so forth represent the overheads.
Example-2
In a movie studio ,each film produced by the studio is a “job”, and costs for direct materials (film etc) and direct labor (actors, directors) are accounted for and charged to each film’s job cost sheet. A share of the studio’s overhead costs such as utilities, depreciation of equipment ,salaries of maintenance workers, and so forth, is also charged to each film.
Job order costing for a service organization is somewhat simpler in that materials and supplies may not be an important cost element and these costs will be included in Overheads.
Total Job cost = Labor cost + Overheads
In a service organization, it is very important to bifurcate cost as to direct and indirect, particularly in an environment of competition.
Suppose an IT firm has designed a special software to do payroll accounting which cost Rs 500,000 and client was charged a fee of Rs 750,000.
Now for getting business from other clients one need to do bifurcation of total cost Rs 500 000 into direct and indirect. Assuming that in order to do this work for another client it will require direct cost in shape of deploying technical staff and supervision only Rs 300,000 as Rs 200,000 is an indirect cost.
STS ( Pvt. ) Limited deals in providing various services like Consulting ,Certification and Verification .
The accounting department records cost and revenue separately for all cost centers.
The details of cost are on next slide.
The company has a policy of charging 50% mark up on cost .
Required:
Work out chargeable rates for all departments.
—Charge out rate with indirect cost
Alternative working if directly identifiable costs is not determinable
Total Costs Rs. 2,480,000
Total Hours 34,800 hours
Now see the revised summary sheet on next slide
The above cost factors except payment to doctors may not be directly identifiable. Therefore a systematic basis are used for allocating various cost based on activity of each cost centers. A traditional way may be to charge other cost based on total payment being made to doctors.
But before calculating / allocating cost to out patient a broad based allocation may be required as follows:
—Segmentation may be
—Verification
—Certification
—Testing
—Training
—A segment’s contribution margin involves more than collecting sales data and variable costs for each segment. The company’s expenses be further segregated into direct and common costs, and assign them to segments.
Colorscope Inc, is a special effect photography laboratory that design printed advertisements. Competitive pressures and thin profit margins make understanding cost critical in pricing decision because the unique end products demand different amounts of Colorscope’s resources.
Previously, Colorscope charged a standard price for all its jobs. Why? Because, regardless of the end result, every customer job goes through five stages
—Job Preparation
—Scanning
—Assembly
—Film Developing &
—Quality Control.
•In job preparation stage the template of the job is created by physically cutting and pasting text, graphics and photographs and by specifying the “layout, font, color and shading".
•The job template is then scanned into a computer where the job is assembled using archives of scanned images adjusted for color and shading.
•The assembled job is then transferred and developed on a large sheet of four color film.
•Quality control ensures that the job fully satisfied the customer’s specifications. If not, or if the customer’s requirements have changed, quality control initiates rework.
Andrew Cha, Colorscope’s founder and chief executive, observed large differences in the amount of image-scanning and processing activity required by different jobs as well as varying amounts of rework across jobs. Because the jobs used different amount of resources, by charging roughly the same standard price for all the jobs, Colorscope lost money on certain jobs.
Cha concluded that a job-costing system measuring costs based on the labor-hours spent at each operation would give him better information about costs incurred on various jobs.
—Colorscope’s job-costing system now traces direct materials to jobs and allocates all other cost (wages, rent, depreciation and so on) to job using an overhead rate per labor-hour for each operation.
—Besides better tracing costs to specific jobs, Colorscope’s new job costing system has provided the traditional benefits of improving efficiency through process changes.
—For example ,the job-costing system highlighted the significant resources Colorscope had been spending on rework.
—Colorscope’s management discovered that most rework was caused by faulty scanning. These defects were not detected until the job was completed, by which time significant additional resources had also been incurred on the job.
—Colorscope implemented process changes to reduce faulty scanning and to test for quality immediately after the scanning stage.
Thus,Colorscope’s job-costing system improves its profitability :
—by pricing jobs better and
—by increasing efficiency and quality.
Job costing is very useful in service industries such as accounting and consulting firms, advertising agencies, auto repair shops and hospitals. In an accounting firm, each audit is a job. The cost of audit are accumulated on a job cost record.
On the basis of labor-time records, direct labor cost of audit partners; audit managers and audit staff are traced to individual jobs. Other direct costs such as travel, out-of-town meals and lodging, phone, fax and copying are also traced to jobs.
The cost of secretarial support, office staff, rent and depreciation of furniture and equipment are indirect cost because these cost can not be traced to jobs in an economically feasible way .Indirect cost are allocated to jobs e.g. using a cost-allocation base such as professional labor-hours.
In some service, merchandising and manufacturing organizations, a variation of normal costing is helpful because actual direct labor cost are difficult to trace to jobs when they are completed e.g. in case of audit firm, the actual direct labor cost may include bonuses that are known only at the end of the year. To obtain timely information as a job is completed rather than wait until the end of the year, an organization may choose to use budgeted rates for some direct cost in addition to using budgeted rates for indirect costs.
All budgeted rates used are calculated at the start of the budget period. Normal costing uses actual cost rates for all direct cost and budgeted cost rates only for the indirect costs.
Example:
A public accounting firm at the start of the year 2005, budgets total direct labor costs of Rs14,400,000, total indirect costs of Rs 12,960,000, and total direct (professional) labor-hours of 288,000 for the year.
Budgeted direct = Budgeted total direct labor costs
labor cost rate Budgeted total direct labor-hours
= Rs 14,400,000
288,000 hours
= Rs 50 per direct labor-hour
Assuming only one indirect labor costs as the cost-allocation base,
Budgeted indirect cost rate =
Budgeted total costs in indirect- cost pool
Budgeted total quantity of cost-allocation base
= $12,960,000
$14,400,000
= 90% of direct labor costs
Suppose an audit of a client of completed in May 2005,uses 1000 direct labor-hours. other direct costs for travel, outsourcing, computer work is Rs 25,000:
The cost of the audit is:
Rs
Direct labor costs, Rs50 x 1000 = 50,000
Other direct cost = 25,000
Indirect costs allocated,90% x $50,000 = 45000
Total = 120,000
At the end of the year, the direct costs traced to job using budgeted rates will generally not equal the actual direct costs because the actual and budgeted rates are developed at different points in time using different information. End-of-period adjustments for under- or over allocated direct cost would need to be made .In the same way the adjustments are made for under- or over allocated indirect costs.
The following example illustrates that all costing systems do not neatly match either the actual costing or normal costing system.
Engineering consulting firms often have some actual direct costs (e.g. cost of making blue prints or fees paid to out experts), and direct cost traced to jobs using a budgeted rate (professional labor costs), and indirect cost allocated to jobs using a budgeted rate(engineering and office support costs).
“Net profit participation”, contracts in which writes, actors , and directors share in the net profits of movies are common in Hollywood. For example, Winston Groom, the author of the novel Forrest Gump, has a contract with Paramount pictures Corp. that calls for him to receive 3% of the net profits on the movie. However ,Paramount claims that Forrest Gump has yet to show any profits even though it has the third-highest gross receipts of any film in history. How can this be?
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