BA2 Fundamentals of Management Accounting · Batch and job costing 231 1. Job costing Job costing or ‘job order costing’ relates to the costs to an organisation for a specific

BA2 Fundamentals of Management Accounting

Module: 13

Batch and Job Costing

Batch and job costing

231

1. Job costing

Job costing or ‘job order costing’ relates to the costs to an organisation

for a specific order where the customer has some special requirements.

This needs to be separated from regular production as it may incur

additional costs. It can also be used for companies that work mostly on a

job by job basis such as a builder or a consultancy firm.

This is important as we need to identify the profitability of the specific order

or job; this can also be done before accepting the order to see if it is worth

doing.

For example, a pie shop makes steak pies, but a customer comes in asking us

for a specific order for 1000 sausage rolls and will pay us £2000. Our

production is not set up for this but by renting some additional machinery

and ordering some one off raw materials we can fulfil the order. However, if the

cost of these extra materials and machinery costs more than the revenue we

will receive from the order, it is not worth doing.

2. Direct costs

When analysing the costs of a job or order we need to identify the specific

costs related to it. An example of this would be labour and materials that

are wholly attributable to the specific order and are not involved with regular

production.

Returning to our sausage roll example, the direct costs would be the

machinery required to fulfil the order (this is because it is an additional cost

directly attributable to the order that we won’t have to incur if we don’t go

ahead with the order. Likewise, if we have 3 employees working 40 hours a

week to complete our usual orders and to fulfil the sausage roll order we

need each employee to work a further 10 hours, the 30 extra hours will be a

direct labour cost specifically attributable to the order.

3. Overheads

Adding overheads to job orders depends on whether or not the company

already has defined processes for absorbing overheads into production.

Despite not being directly related to job costs it is still fair to attribute

overheads to them.

For example, our pie company has two cost centres A and B.

The budgeted overhead for the two centres are as follows: A

= £2,000

B = £3,000


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A is absorbed based on labour hours and our total labour hours come to 300.

Centre B is absorbed based on machine hours which come to a total of 500

hours.

So, the standard absorption rate comes to:

A = 2,000 = £6.67 per labour hour

300

B = 3,000 = £6 per machine hour

500

For this specific job we have recorded the following costs:

Materials: £300

Labour:

A = 20 hours at £6.00

B = 10 hours at £4.00

Overheads/machine hours recorded against the job on the basis of: A

= 20 hours of labour

B = 40 hours of machine time

The additional machinery required for the job comes to £500; so, let’s

calculate the profit/loss and absorption attributable to this job:


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£ £

Direct Material

Direct labour:

300

Centre A = (20 x 6) 120

Centre B = (10 x 4) 40

160

Machine hire

500

Overheads

960

Centre A = (20 x 6.67) 133.3

Centre B = (40 x 6) 240

373.3

Total cost

1343.3

Revenue

2000

Profit

656.7

As you can see, when all direct costs and overheads have been allocated to the production of this specific job, we are still in profit; therefore, it makes

sense to go ahead with the specific job order.

4. Batch costing

Batch costing is very similar to job costing but tends to be used by firms

that produce products on a batch by batch basis. A pie manufacturer

might firstly make a batch of meat pies, then vegetable pies and then

quiches. Each batch this therefore costed separately so we can see the costs

associated with each.

The process of batch costing is just the same as job costing – just use the

same approach but for a single batch as opposed to the job or order.

One minor additional element that can always be calculated for a batch is the

cost per unit.


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Total cost per unit =

Total cost

Number of units

In the earlier sausage roll example, if rather than that being a specific order for

a customer it was just another ‘batch’ of production then:

Total cost per unit =

£1,343

1,000

= £1.34 per unit

That would be necessary to know as we now know that each would need to

be priced above £1.34 to make a profit.

5. Batch and job accounts

Bookkeeping for job or batch orders is recorded in mostly the same way

except that the particular job order is separated from regular production

and has its own T-account. I.e. figures related to job X are stored in the job

X account rather than the standard production account.

Example

A company is compiling its records for the last period, during that time the

company had three specific job orders; job X, job Y and job Z.

The company pays employees who directly contribute to production (direct

labour) £8 an hour, production overheads are absorbed at a rate of £10 per

labour hour.

Job X began in the previous month and was still uncompleted at the end of the

current month. Job Y and Z both began in the current month with Y being

completed and Z finishing the period uncompleted. The following figures

have been recorded:


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Work in progress (WIP) brought forward from previous month:

Job X

Direct material

£

1,500

Direct labour 800

Production overheads 2,200

4,500

Activity during period:

Job X Y Z

Direct materials £500 £7,000 £4,800

Hours worked (direct labour) 50 94 72

Completed? Yes Yes No

Revenue from completed goods 10,000 9,000 N/A

Production overheads paid: £3,000

Material transfer from job Y to job Z: £100

Job costs in T – accounts

Job X

£ £

Balance B/F 4,500

Direct Material 500

Labour (50 x 8) 400

Overheads (50 x 10) 500

5,900

We can see our production costs for Job X comes to a grand total of £5,900.

Since this job was completed we now needs to close this account by

crediting this value to the production account in order to include it as a

production costs:


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Job X

£ £

Balance B/F 4,500

Direct Material 500 Production 5,900

Labour (50 x 8) 400


5,900 5,900

Now let’s draw up accounts for Y and Z:

Job Y

£ £

Direct Material 7,000 Job Z 100

Labour (94 x 8) 752 Production 8,592


8,692 8,692

Note: Any costs and materials transferred between jobs must be credited

from the donating account. This must be debited to the receiving jobs

account and NOT the production account. Job Y is also completed so the

balance is credited to production.

Job Z

£ £

Job Y 100 Balance C/F 6,196

Direct Material 4,800

Labour (72 x 8) 576


6,196 6,196

Note: As job Z is not complete and still a work in progress (WIP) the balance

will need to be carried forward to next period rather than going to the

production account.

Control accounts and job costing

Most companies will have a ‘control accounts’ in their accounting system

summing up the total of each job account.

This can be useful as they provide an account with the totals in them, and it

also acts as a control (as the name might suggest) as the total of the control

accounts should equal all the individual accounts added together.


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However, you also have to be careful to make sure you understand that the

job accounts are just ‘sub-accounts’ of a larger account as you’ll need to

enter all transactions twice, once in the control account and secondly in

the job accounts.

Let’s see some examples to see how this works.

WIP control account

The work in progress control account opens with the total WIP balance of

all our jobs – in this case that was just Job X as this was the only work in

progress at the time:

WIP control

£ £

Balance B/F 4,500

We then need to add in all material, labour and overheads used during the

current period of activity. In a control account that represents the total of all

jobs.

WIP control

£

Next, we credit the costs we have since transferred to the production account

for jobs X and Y and the remaining balance will become the opening balance

next period, which should be identical to the balance we carried forward in job

Z:

WIP control

£ £

Balance B/F 4,500 Production 14,492

Direct Material 12,300 Balance C/F 6,196

Labour (216 x 8) 1,728

Overheads (216 x 10) 2,160

20,688 20,688

£

Balance B/F 4,500

Direct Material 12,300

Labour (216 x 8) 1,728

Overheads (216 x 10) 2,160


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As you’ll see then, the WIP control account is just a total of all the

individual job accounts, and as long as they match then we’re happy! If

they don’t then a mistake has been made somewhere, either in one of the job

accounts or in the WIP control account, so we can now go back and check

where the mistake is.

Do take care though here – we look like we are double counting balances

which we are not – the key is to remember that the job accounts are just

sub-accounts of the WIP control and would not be part of our final trial

balance.

Production overhead control accounts

The production overhead control account follows on from the WIP control

account summarising the total overhead costs incurred, absorbed and

any under or over absorption.

In the WIP account above you will notice there is a debit to the WIP account

for the overheads (£2,160), the Credit of that goes into the production

overhead control account (see below).

We also record costs incurred of £3,000.

Remember our rule – cash paid is always a debit in Cash so must be a credit

in this production overhead account.

Production overhead control account

£ £

Production payable 3,000 Overheads (WIP) 2,160

Over/under absorption 840

3,000 3,000

The balance then represents the over or under-absorption, which is credited

to an account which is then taken to the profit and loss account.

Over/under absorption

£ £

Production overheads 840 Profit/Loss account 840

840 840

As you can see, the company charge £840 too much in overhead absorption

meaning that we can now debit this back to the profit and loss as additional

income.


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Job cost in profit accounts

Finally we need to compile and consolidate these figures to give the

profit/loss for these jobs in the given time period:

Profit/loss account

£ £

Production 14,492 Sales (10,000 + 9,000) 19,000

Over/under absorption 840

Profit for period 3,668

19,000 19,000

By calculating the revenue from the products produced in the period we can

work out the profit by working out the balance on the account. Here we can

see that with all things considered we made £3,668 profit in the last period.

6. Preparing reports for different organisations

Reports in a manufacturing organisation

Whether or not you realise it, you now have the knowledge to prepare reports for manufacturing organisations! All that time we spent looking at

costs, budgets and performance evaluations was not just for fun! Many of

the techniques you have learnt such as contribution, profit margin and all

those ratios, have important roles to play in generating reports for these

organisations.

Remember that these organisations exist to generate profit. All of the

techniques we have learnt tell us something important that can be used

to meet this objective.

Preparing reports for service organisations

What do we do when there isn't a physical object to attribute costs to? What

happens when our business is the service we provide ourselves? The answer

is...We can apply the same costing principles we have learnt about already!

With a few adjustments we will be able to calculate costs and prices for

these intangible services. The best way to show this will be through an

example so bare with me!


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A consultancy business is a prime example of a service organisation.

Our product in this instance is knowledge – this is our intangible

product.

When we look to cost a product like this we cant go through the same

avenues that we have done previously. What would our direct materials

include? Our sandwich at lunch? No, in the instance of a consultancy

business, and indeed many other services, we cost according to factors

such as distance and time.

A consultancy business has produced the following activity estimates:

• 4 employees will work 7,200 hours in the year.

• 25% of the their time will be taken up by non-client related

administration.

• 20% of their time will be idle.

• The remaining time is chargeable to the client however, 10% of

this will be travel time. As this is not deemed 'productive' work,

travel time is charged at 50% of the normal hourly rate.

Here is a list of their expected costs:

Cost Annual expenditure (£)

Consultancy Travel

We can use these estimates and costs to find out how much we should be

charging for our services. It would make sense to base this price on hours as

that is how the world works!

The first step would be to calculate how many hours we are actually

working. Let's gather all the information we have been given:

Salaries (£30,000 per

employee) 120,000

Office expenses 12,000

Business related expenses 700

Telephone charges

Fuel

1,000 3,000

Vehicle insurance 1,000

Vehicle maintenance 950

Depreciation of vehicles 4,500

Total cost 133,700 9,450


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Estimated working hours/year (4 employees)

Hours

7,600

Less: Time spent on admin (25%) (1,800)

Less: Idle time (20%) (1,440)

Time with client (chargeable) 4,360

If there was no travelling involved and the consultancy company had been

office based then we could stop at this point. The 4,360 hours would be the

amount of time that would be charged to the client. We could simply

calculate the hourly rate by dividing the costs attributable to consultancy (the

office cost, salaries etc.) and divide it by the number of hours.

Consultancy costs £133,700

Time chargeable to clients 4,360

Hourly rate £30.67

This figure of £30.67 covers all of costs and the salaries meaning that any mark-up on top of this would be profit. Unfortunately for you however, this is

not the case for us! That would be far too simple.

If you take a look back to the start of this example you will see that the final

activity estimate refers to the time spent travelling. 10% of the chargeable

time is allotted to travelling and is therefore charged at 50% of the normal

rate. This means that not all 4,360 hours are spent with the client. Let's

put this into a table to make it easier to understand.

Time chargeable to clients

Hours

4,360

Time with client (90%) 3,924

Time travelling (10%) 436

We can now see that a more accurate figure for the amount of time spent

with the client is 3,924 hours rather than 4,360. How do we cost the 436

hours that are spent travelling? These hours are charged at 50% of the

normal rate so we need to calculate a weighted figure for chargeable

time.

Weighted chargeable hours = 3,924 + 436

= 4,142

2

Now if we divide our total consultancy costs by 4,142 we will get an

hourly rate that takes into account the amount of time spent travelling:

Consultancy costs £133,700

Time chargeable to clients (hours) 4,142

Hourly rate £32.28


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You will notice that the hourly rate has increased. This is because the

amount of chargeable hours has decreased (as some time is spent travelling

and not working.) This ultimately means that we will have to charge more to

cover our costs. But at least we do not charge full price for hours spent in the

car!

From here we can easily calculate the hourly rate for travelling time too.

To do this we simply divide our hourly rate for client work by 2 (or

multiply by 50%) as we charge 50% of the normal rate for time spent

travelling:

Hourly rate for travelling time = £32.28

= £16.14

2

Remember: These costs have been calculated to cover the associated

costs of the consultancy business. They do not take into account an

amount reserved for profit. A mark-up would be applied to the hourly

rate in order to provide the desired profit.

Reports in a not-for-profit organisations

As you can probably imagine, the aims of a charity will be very different to the

aims of a car manufacturer and therefore there will be significant differences

in their management reports. The difficulty with assessing the

performance of these NFP's is that they have somewhat intangible

objectives and outputs. A charity, for instance, maybe spend funds on

helping disadvantaged children to read. How would we be able to measure

this? We cant use profit margins or contribution here.

What we can conclude about the NFP's is that they have their own set of

requirements when it comes to accounting. Charities, educational

establishments and the like all aim to provide the best service they can

within a restricted budget. The emphasis will be on limiting wastage

rather than increasing profit for these organisations.

Documents

BA2 Fundamentals of Management Accounting · Batch and job costing 231 1. Job costing Job costing or ‘job order costing’ relates to the costs to an organisation for a specific