Costing methods and techniques (job, batch, contract, process, standard, marginal and absorption costing)
Domain 2 tests method selection and the numerical mechanics of job, batch, contract and process costing, plus the distinction between marginal and absorption costing. Questions typically require an account, a unit cost, a profit figure or a reconciliation.
Method selection
- Job costing accumulates costs on a job cost sheet for customer-specific work; production overhead is absorbed using a predetermined overhead absorption rate (OAR).
- Batch costing treats a group of identical units as a job; unit cost = total batch cost / batch quantity.
- Contract costing applies to large, site-based, long-term work; costs are collected by contract and revenue is recognised by reference to certified work, with retention and prudence adjustments.
- Process costing applies to continuous mass production; normal loss, abnormal loss or gain and equivalent units must be handled.
Absorption and marginal costing
- OAR = budgeted overhead / budgeted activity base. Absorbed overhead = OAR × actual activity. Over-absorption arises when absorbed exceeds actual; under-absorption when actual exceeds absorbed.
- Marginal costing values inventory at variable production cost only and writes off fixed production overhead as a period cost. Absorption costing values inventory at variable cost plus absorbed fixed overhead.
- Profit difference = change in inventory units × fixed overhead absorption rate per unit. If inventory increases, absorption profit is higher.
Worked example
Budgeted fixed production overhead is GHS50,000 for 10,000 units, so the OAR is GHS5 per unit. Actual production is 10,000 units, sales 9,000 units, variable cost GHS20 per unit and selling price GHS40. Absorption costing: product cost = GHS25 per unit; closing inventory = 1,000 × GHS25 = GHS25,000; profit = 9,000 × (40 - 25) = GHS135,000. Marginal costing: contribution = 9,000 × GHS20 = GHS180,000; less fixed overhead GHS50,000 = GHS130,000. The GHS5,000 difference equals 1,000 units × GHS5; absorption profit is higher because fixed overhead on unsold units is carried forward in inventory.
Contract and process points
- Contract profit: notional profit = value of work certified + work uncertified - cost to date. Recognise only a prudent, cash-backed fraction using cash received / work certified; recognise no profit at a very early stage.
- Process: abnormal loss is valued at the full process cost per good unit, not at scrap value. Abnormal gain is debited to the process account. Equivalent units = physical units × degree of completion.
Traps
- Using actual activity to set the OAR.
- Treating over-absorption as a loss.
- Ignoring work uncertified or retention in contract profit.
- Valuing abnormal loss at scrap value.
- Adding normal loss to equivalent units.
- Getting the sign wrong in the marginal/absorption reconciliation.