CIMA - C1 Fundamentals of Management Accounting
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13: Job, batch and contract costing ⏐ Part D Costing and accounting systems
4 Batch costing
Batch costing is similar to job costing in that each batch of similar articles is separately identifiable. The cost per unit
manufactured in a batch is the total batch cost divided by the number of units in the batch.
Batch costing is a 'form of specific order costing where costs are attributed to batches of product (unit costs can be
calculated by dividing by the number of products in the batch)'. CIMA Official Terminology
4.1 Example: batch costing
A company manufactures widgets to order and has the following budgeted overheads for the year, based on normal
activity levels.
Budgeted overheads Budgeted activity
Department $
Welding 6,000 1,500 labour hours
Assembly 10,000 1,000 labour hours
Selling and administrative overheads are 20% of factory cost. An order for 250 widgets type X128, made as Batch 5997,
incurred the following costs.
Materials $12,000
Labour 100 hours welding shop at $10/hour; 200 hours assembly shop at $8/hour
$500 was paid for the hire of special X-ray equipment for testing the welds.
Required
Calculate the cost per unit for Batch 5997.
Solution
The first step is to calculate the overhead absorption rate for the production departments.
Welding =
1,500
$6,000
= $4 per labour hour Assembly =
1,000
$10,000
= $10 per labour hour
Total cost – Batch no 5997
$
$
Direct material
12,000
Direct expense
500
Direct labour 100 × $10.00
1,000
200 × $8.00
1,600
2,600
Prime cost
15,100
Overheads 100 × $4
400
200 × $10
2,000
2,400
Factory cost
17,500
Selling and administrative cost (20% of factory cost)
3,500
Total cost
21,000
Cost per unit =
250
$21,000
= $84.00
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Key terms
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Part D Costing and accounting systems ⏐ 13: Job, batch and contract costing
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Question
25% profit on selling price
A printing firm is proposing offering a leaflet advertising service to local traders.
The following costs have been estimated for a batch of 10,000 leaflets.
Setting up machine 6 hours at $10 per hour
Artwork $20 per batch
Paper $1.80 per 100 sheets
Other printing materials $15
Direct labour cost 4 hours at $6 per hour
Fixed overheads allocated to this side of the business are $1,000 per annum incurred at an even rate throughout the year.
Overheads are recovered on the basis of orders received, which are expected to be two per week for 50 weeks in the year.
The management requires 25% profit on selling price.
(a) The selling price, to the nearest cent, per thousand leaflets, for quantities of:
(i) 5,000 leaflets is $
(ii) 10,000 leaflets is $
(b) During the latest week, the firm sold two batches of 10,000 leaflets and one batch of 5,000 leaflets. All costs and
selling prices were as estimated.
The profit for the week was $
Answer
(a) (i) The selling price is $
53.20
(ii) The selling price is $
41.20
Workings
Expected orders per annum = 2 orders × 50 weeks = 100 orders
∴ Fixed overhead per order =
100
$1,000
= $10
Calculation of price per 1,000 leaflets
Batch size: (leaflets)
5,000
10,000
$
$
Setting up machine
60.00
60.00
Artwork
20.00
20.00
Paper
90.00
180.00
Other printing materials
7.50
15.00
Direct labour cost
12.00
24.00
Fixed overhead
10.00
10.00
Total cost
199.50
309.00
Profit
66.50
103.00
Selling price
266.00
412.00
Price per 1,000 leaflets
53.20
41.20
The profit is 25% on selling price ie cost (75) + profit (25) = selling price (100), and thus profit = 1/3 cost
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13: Job, batch and contract costing ⏐ Part D Costing and accounting systems
(b) The profit for the week was $
282.50
Workings
$
$
Batch profit $66.50 × 1
66.50
$103.00 × 2
206.00
272.50
Plus over-absorbed overhead:
Overhead absorbed 3 batches × $10
30.00
Overhead incurred $1,000/50 weeks
20.00
10.00
Profit for the week
282.50
5 Contracts and contract costing
•
A contract is a cost unit or cost centre which is charged with the direct costs of production and an apportionment
of head office overheads.
•
Contract costing is a form of job costing which applies where the job is on a large scale and for a long duration.
The majority of costs relating to a contract are direct costs.
In industries such as building and construction work, civil engineering and shipbuilding, job costing is not usually
appropriate. Contract costing is.
Contract costing is a 'form of specific order costing where costs are attributed to contracts'. CIMA Official Terminology
5.1 Features of contract costing
•
A formal contract is made between customer and supplier.
•
Work is undertaken to customers' special requirements.
•
The work is for a relatively long duration.
•
The work is frequently constructional in nature.
•
The method of costing is similar to job costing.
•
The work is frequently based on site.
•
It is not unusual for a site to have its own cashier and time-keeper.
5.2 Potential problems in contract costing
(a) Identifying direct costs: because of the large size of the job, many cost items which are usually thought of
as production overhead are charged as direct costs of the contract (for example supervision, hire of plant,
depreciation and so on).
(b) Low indirect costs: because many costs normally classed as overheads are charged as direct costs of a
contract, the absorption rate for overheads should only apply a share of the cost of those cost items which
are not already direct costs.
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(c) Difficulties of cost control: because of the size of some contracts and some sites, there are often cost
control problems (material usage and losses, pilferage, labour supervision, damage to and loss of plant
and tools and so on).
(d) Dividing the profit between different accounting periods: when a contract covers two or more
accounting periods, how should the profit (or loss) on the contract be divided between the periods?
6 Contract costs
6.1 Contract accounts
Contract costs are collected in contract accounts.
Guess what contract accounts are similar to? Yes, that's right, the process accounts and job accounts we have covered
already. Inputs are recorded on the left hand side, outputs on the right.
6.2 Direct materials
The direct materials used on a contract may be obtained in two ways.
6.2.1 Materials obtained from the company's central stores
(a) A material requisition note must be sent to the store keeper from the contract site. The requisition note
provides a record of the cost of the materials issued to the contract.
Contract managers prefer to have too much material, rather than run out. This means that they will often
requisition more material than actually needed and the surplus material will need to be returned to stores.
The material received will be a debit to the contract's account. As with job costing, the material returned
is classified as an output and recorded on the right hand side of the account.
(b) Materials on site which relate to an incomplete contract should be carried forward as 'closing inventory
of materials on site'.
6.2.2 Materials obtained from the company's suppliers (direct)
The entire invoice cost will be charged directly to the contract.
6.3 Direct labour
It is usual for direct labour on a contract site to be paid on an hourly basis. Employees who work on several contracts at
the same time will have to record the time spent on each contract on time sheets. Each contract will then be charged
with the cost of these recorded hours.
6.4 The cost of supervision and subcontractors
The cost of supervision, which is usually a production overhead in unit costing, job costing and so on, will be a direct
cost of a contract.
On large contracts, much work may be done by subcontractors. The invoices of subcontractors will be treated as a
direct expense to the contract.
FAST FORWARD
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13: Job, batch and contract costing ⏐ Part D Costing and accounting systems
6.5 The cost of plant
A feature of most contract work is the amount of plant used. Plant used on a contract may be owned by the company, or
hired from a plant hire firm.
(a) If the plant is hired, the cost will be a direct expense of the contract.
(b) If the plant is owned, a variety of accounting methods may be employed.
6.5.1 Method one: charging depreciation
The contract may be charged depreciation on the plant, on a straight line or reducing balance basis. For example if a
company has some plant which cost $10,000 and is depreciated at 10% per annum straight line (to a residual value of
nil) and a contract makes use of the plant for six months, a depreciation charge of $500 would be made against the
contract. The disadvantage of this method of costing for plant is that the contract site manager is not made directly
responsible and accountable for the actual plant in his charge. The contract manager must be responsible for receipt of
the plant, returning the plant after it has been used and proper care of the plant while it is being used.
6.5.2 Method two: charging the contract with current book value
A more common method of costing for plant is to charge the contract with the change in book value of the plant
during the period.
For example, suppose contract number 123 obtained some plant and loose tools from central store on 1 January 20X2.
The book value of the plant was $100,000 and the book value of the loose tools was $8,000. On 1 October 20X2, some
plant was removed from the site: this plant had a written down value on 1 October of $20,000. At 31 December 20X2,
the plant remaining on site had a written down value of $60,000 and the loose tools had a written down value of $5,000.
CONTRACT 123 ACCOUNT
$
$
1 January 20X2
1 October 20X2
Plant issued to site
100,000
Plant transferred
20,000
Loose tools issued to site
8,000
31 December 20X2
Plant value c/f
60,000
Loose tools value c/f
5,000
Depreciation (bal fig)
23,000
108,000
108,000
The difference between the values on the debit and the credit sides of the account ($20,000 for plant and $3,000 for
loose tools) is the depreciation cost of the equipment for the year.
Question
Contract AB3
Contract number AB3 commenced on 1 April and plant with a book value of $300,000 was delivered to the site from
central stores. On 1 September further plant was delivered with a book value of $24,000.
Company policy is to depreciate plant at a rate of 20% of the book value each year.
The book value of the plant on site as at 31 December is:
A $200,000
B $250,000
C $257,400
D $277,400
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Answer
D
$
Book value of plant delivered to site
324,000
Depreciation on plant delivered
1 April $300,000 × 20% × 9/12
(45,000)
1 September $24,000 × 20% × 4/12
(1,600
)
Book value of plant on site as at 31 December
277,400
6.6 Overhead costs
Overhead costs are added periodically (for example at the end of an accounting period) and are based on
predetermined overhead absorption rates for the period. You may come across examples where a share of head office
general costs is absorbed as an overhead cost to the contract, but this should not happen if the contract is unfinished at
the end of the period, because only production overheads should be included in the value of any closing work in
progress.
6.7 Recording contract costs
If we ignore, for the moment, profits on a part-finished contract (we'll come to this in a minute), a typical contract
account might appear as shown below. Check the items in the account carefully, and notice how the cost (or value) of
the work done emerges as work in progress. On an unfinished contract, where no profits are taken mid-way through the
contract, this cost of work in progress is carried forward as a closing inventory balance. Here's an example.
CONTRACT 794
$ $
Materials requisition from stores
15,247
Materials returned to stores or
Materials and equipment purchased
36,300
transferred to other sites
2,100
Maintenance and operating costs
Proceeds from sale of materials
of plant and vehicles
14,444
on site and jobbing work for
Hire charges for plant and
other customers
600
vehicles not owned
6,500
Book value of plant transferred
4,800
Tools and consumables
8,570
Materials on site c/d
7,194
Book value of plant on site b/d
14,300
Book value of plant on site c/d
6,640
Direct wages
23,890
21,334
Supervisors' and engineers' salaries
Cost of work done c/d
(proportion relating to time spent
(balancing item)
139,917
on the contract)
13,000
Other site expenses
12,000
Overheads (apportioned perhaps on
the basis of direct labour hours)
17,000
161,251
161,251
Materials on site b/d
7,194
Book value of plant on site b/d
6,640
Cost of work done b/d
139,917
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7 Progress payments and retentions
A customer is likely to be required under the terms of the contract to make progress payments which are calculated as
the value of work done and certified by the architect or engineer minus a retention minus the payments made to date.
Contracts are usually long-term projects and so it is usual for the customer to make several payments while the work is
being carried out. These payments are known as progress payments and they are based on architects' certificates.
At various stages of the contract an architect will issue a certificate which states the value of the work which has been
completed so far. The customer will not usually pay the full value of the certified work. A proportion (called a retention)
is held back as a form of insurance.
7.1 Progress payment due
The value of work done and certified by the architect or engineer
minus a retention (commonly 10%)
minus the payments made to date
equals payment due.
Thus, if an architect's certificate assesses the value of work done on a contract to be $125,000 and if the retention is 10%,
and if $92,000 has already been paid in progress payments the current payment = $125,000 − $12,500 − $92,000 = $20,500
7.2 Retention monies
Retention monies are released either when the contract is completed and accepted by the customer or within an agreed
period after this date.
8 Profits on contracts
You may have noticed that the progress payments do not necessarily give rise to profit immediately because of
retentions. So how are profits calculated on contracts?
8.1 Example: profits on contracts completed in one accounting period
If a contract is started and completed in the same accounting period, the calculation of the profit is straightforward, sales
minus the cost of the contract. Suppose that a contract, No. 6548, has the following costs.
$
Direct materials (less returns)
40,000
Direct labour
35,000
Direct expenses
8,000
Plant costs
6,000
Overhead
11,000
100,000
The work began on 1 February 20X3 and was completed on 15 November 20X3 in the contractor's same accounting year.
The contract price was $120,000 and on 20 November the inspecting engineer issued the final certificate of work done.
At that date the customer had already paid $90,000 and the remaining $30,000 was still outstanding at the end of the
contractor's accounting period. The contract account would appear as follows.
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CONTRACT 6548 ACCOUNT
$
$
Materials less returns
40,000
Cost of sales (Income
100,000
Labour
35,000
statement)
Expenses
8,000
Plant cost
6,000
Overhead
11,000
100,000
100,000
The profit on the contract will be treated in the income statement as follows.
$
Revenue
120,000
Cost of sales
(100,000
)
20,000
Here’s how we account for the contract revenue (the price is $120,000) and for amount of $30,000 outstanding from the
customer (contractee).
WORK CERTIFIED ACCOUNT
$
$
Revenue (income statement)
120,000
Contractee account
120,000
120,000
120,000
CONTRACTEE (CUSTOMER) ACCOUNT
$
$
Work certified a/c - value of work
Cash
90,000
certified
120,000
Balance c/f
(account receivable in
statement of financial
position)
30,000
120,000
120,000
8.2 Taking profits on incomplete contracts
The long duration of a contract usually means that an estimate must be made of the profit earned on each incomplete
contract at the end of the accounting period. This avoids excessive fluctuations in reported profits.
A more difficult problem emerges when a contract is incomplete at the end of an accounting period. The contractor may
have spent considerable sums of money on the work, and received substantial progress payments, and even if the work
is not finished, the contractor will want to claim some profit on the work done so far.
Suppose that a company starts four new contracts in its accounting year to 31 December 20X1, but at the end of the
year, none of them has been completed. All of the contracts are eventually completed in the first few months of 20X2 and
they make profits of $40,000, $50,000, $60,000 and $70,000 respectively, $220,000 in total. If profits are not taken until
the contracts are finished, the company would make no profits at all in 20X1, when most of the work was done, and
$220,000 in 20X2. Such violent fluctuations in profitability would be confusing not only to the company's management,
but also to shareholders and the investing public at large.
The problem arises because contracts are for long-term work, and it is a well-established practice that some profits
should be taken in an accounting period, even if the contract is incomplete.
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13: Job, batch and contract costing ⏐ Part D Costing and accounting systems
8.2.1 Example: profits on incomplete contracts
Suppose that contract 246 is started on 1 July 20X2. Costs to 31 December 20X2, when the company's accounting year
ends, are derived from the following information.
$
Direct materials issued from store 18,000
Materials returned to store 400
Direct labour 15,500
Plant issued, at book value 1 July 20X2 32,000
Written-down value of plant 31 December 20X2 24,000
Materials on site, 31 December 20X2 1,600
Overhead costs 2,000
As at 31 December, certificates had been issued for work valued at $50,000 and the contractee had made progress
payments of $45,000. The company has calculated that more work has been done since the last certificates were issued,
and that the cost of work done but not yet certified is $8,000.
Solution
The contract account would be prepared as follows.
CONTRACT 246 ACCOUNT
$
$
$
Materials
18,000
Value of plant c/d
24,000
Less returns
400
Materials on site c/d
1,600
17,600
Cost of work done not
Labour
15,500
certified c/d
8,000
Plant issued at book value
32,000
Cost of sales (income statement)
33,500
Overheads
2,000
67,100
67,100
Points to note
(a) The work done, but not yet certified, must be valued at cost, and not at the value of the unissued certificates. It
would be imprudent to suppose that the work has been done to the complete satisfaction of the architect or
engineer, who may not issue certificates until further work is done.
(b) It would appear that $50,000 should be recognised as revenue and $33,500 as cost of sales leaving $16,500 as
net profit. However it is often considered imprudent to claim this full amount of profit, and it is commonly argued
that the profit taken should be a more conservative figure (in our example, less than $16,500, so that amounts
taken to revenue and cost of sales relating to the contract should be less than $50,000 and $33,500 respectively).
(c) We have ignored retentions here.
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Question
Cost bookkeeping and contract costing
Complete the following work certified and contractee accounts.
WORK CERTIFIED ACCOUNT
$
$
Revenue
Contractee account
CONTRACTEE ACCOUNT
$
$
Work certified account
Cash
Balance c/f
Answer
WORK CERTIFIED ACCOUNT
$
$
Revenue
50,000
Contractee account
50,000
50,000
50,000
CONTRACTEE ACCOUNT
$
$
Work certified account
50,000
Cash (progress payment)
45,000
Balance c/f
5,000
50,000
50,000
8.3 Estimating the size of the profit
There are several different ways of calculating contract profits, but the overriding consideration must be the application
of the prudence concept. If a loss is expected on a contract, the total expected loss should be taken into account as
soon as it is recognised, even if the contract is not complete.
The method of calculating profit on an incomplete contract may vary and you should follow the instructions carefully in
any question on contract costing.
The concept of prudence should be applied when estimating the size of the profit on an incomplete contract and the
guidelines in the following paragraphs should be noted.
Assessment
focus point
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