SEBI GRADE A 2020: COSTING: METHODS OF COSTING

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
Table of Content

Table of Content ........................................................................................................... 2

Methods of Costing:....................................................................................................... 3
Job Costing: ............................................................................................................................... 3
Features of Job Costing: ........................................................................................................... 3
Methodology used in Job Costing: .............................................................................................. 3
Advantages of Job Costing: ....................................................................................................... 4
Limitations of Job Costing: ........................................................................................................ 4
Batch costing: ............................................................................................................................ 4
Features of Batch Costing: ........................................................................................................ 5
Application of Batch Costing: .................................................................................................... 5
Contract Costing: ........................................................................................................................ 5
Other points in Contract Costing:............................................................................................... 7
Multiple Costing: ......................................................................................................................... 7
Process Costing: ......................................................................................................................... 8
Features of process costing: ..................................................................................................... 8
Advantages of process costing: ................................................................................................. 8
Limitations of process costing: .................................................................................................. 8
Preparing Process Cost Account: ............................................................................................... 8
Inter-process profit: .............................................................................................................. 10
Valuation of Work-in-Progress: ................................................................................................ 10
Unit or Single or Output or single-output Costing: ......................................................................... 11
Operating Costing: .................................................................................................................... 11
Operation Costing: .................................................................................................................... 12
Features of Operation Costing: ................................................................................................ 12

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
Methods of Costing:
The costing method varies across different business and industry and so it is not possible to have a single
costing method to meet everyone’s requirements. Hence, there are primarily two principle methods of
costing, namely, Job Costing and Process Costing. Apart from these two, there are other methods of costing
as well but then they are mostly the variation of these two principles. The following are the different costing
methodology:

1. Job Costing
a. Batch Costing
b. Contract Costing
c. Multiple Costing
2. Process Costing:
a. Unit or Single Output Costing
b. Operating Costing
c. Operation Costing

Job Costing:
Generally used in Job Industries where the production is done is as per the requirements of the customer.
Hence, in this method, the production is not continuously but only when an order is received from the
customers along with the specific requirements. Since every job will differ from another, the businesses use
Job Costing or Job Order Costing as the objective of the business is to calculate the cost of each job. This is
done by preparing the Job Cost Sheet. The job can be of a product, unit, batch, sales order, project, contract,
service, specific program or any other cost objective that can be distinguished clearly and is unique in terms
of materials and other services used. Hence, the cost of completing the cost will be the cost of materials
used, the direct labor employed, production overheads and other overheads, if any, charged the job.

Features of Job Costing:

1. It is a specific job order costing
2. Since every job will differ from another job, the standardization of control is difficult. Hence, more
detailed supervision and control is required
3. The objective of the job carried out is to meet the specific requirements of the order
4. It helps the business to ascertain the cost of a job based on which quotation for the job can be given
5. The direct costs are charged directly to the job as they can easily be traced, while the indirect expenses,
such as overheads are charged to the job on some suitable basis
6. At the end of the accounting period, there can be work-in-progress

Methodology used in Job Costing:

Since the objective of job costing is to compute the cost of finishing the job as per the requirement of the
order, it becomes important to identify the costs associated with the job and present it in the form of a job
sheet by showing different types of costs. Generally, the following costs are shown:

• Direct Material Costs: It refers to the cost of material that is used in order to complete the job. Since
this is identifiable and traceable to the specific order, it is direct in nature. The cost of material can be
sourced from the material requisition slip from which the quantity of material consumed can be worked
out.

• Direct Labour Costs: It refers to the amount paid to the labor for completing the job. As the material
cost, even this can be identified and traced to the specific order with the help of “Job Time Tickets”. The
Job Time Ticket is a document that records the time spent by the labor on the specific job/order. Once
the number of hours spent is available, the hourly rate can be multiplied to get the Direct Labour Costs.

• Direct Expense: This cost is charged directly to a particular job. The invoices or any other document
can be marked with the job number so that the amount of direct expenses can be calculated.

• Overheads: This is indirect in nature and so it can be a task to allocate this cost to the specific order.
Hence, the overheads cost are added to the job on some suitable proportion. Generally, pre-determined

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
rates of absorption of overheads are used for charging overheads to any specific job. If the
predetermined rates are used, then under or over absorption of overheads is inevitable and hence
rectification should be done.

• Work-in-Progress: After the job is completed, the total cost of the job is calculated by adding the
overhead expenses to the direct cost or prime cost. Once this is done, the job sheet is marked as
“completed” and so relevant accounting entries are passed in the finished goods ledger. However, at the
end of the accounting period if the job is still incomplete then the total cost incurred on the same is
classified as cost of work-in-progress. At the end of the accounting period, the cost of work-in-progress
becomes the closing work in progress and the same becomes the opening work in progress at the
beginning of the next accounting period. A business usually maintains a separate account for work in
progress.

Advantages of Job Costing:

Job Costing comes with the following benefits:
1. The information regarding the cost of the job completed is quite accurate and the profit earned from
that job can be calculated from the same
2. There is a proper record with regard to the amount incurred on material, labor, and overheads in order
to build the costing system
3. The cost data generated is useful from the management view-point for proper control and analysis
4. It can help in conducting a performance analysis with other jobs by comparing the data of various jobs.
However, every job completed may be different from the other
5. In case the business is using Standard Costing, then they can even compare the actual cost of a job with
the standard to find the deviation between the two
6. This method can also help in identifying the spoilage and defective work associated with the specific job
so that the concerned department/individual can be held accountable
7. There is a situation where some jobs are priced on a cost-plus basis. In such cases, the business typically
adds a profit margin to the cost of the job. Further, a customer may be willing to pay the price if the
cost data is reliable. Hence, this method ensures that the data made is reliable.

Limitations of Job Costing:

Despite having a number of advantages, Job Costing does come with the following limitations:
1. This method is quite a time consuming and the business will need to have detailed record keeping,
making it slightly expensive
2. Record keeping for different jobs may prove complicated
3. The organization inefficiencies may also get charged to a job even though it may not be responsible for
the same

Batch costing:
This is a form of job costing, where units of a product get manufactured in batches and then are used in the
assembly of the final product. Since the company manufactures a large number of those units together as
they are passed through the same manufacturing process, it becomes not only convenient to complete their
manufacturing costs but also ensure uniformity in all respect. An example of batch costing can be the
manufacturing of components of products like radio sets, ACs, television or any other consumer goods. The
company maintains a separate job cost sheets for each batch of products and every batch is allotted a
number. Further, the material requisition is prepared batch-wise, the direct labor is engaged batch-wise and
the overheads are also recovered batch-wise. Finally, the cost of the component is computed by dividing
the total cost by the number of units manufactured.

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
One of the important aspects of Batch Costing is to determine the batch size. The advantage of determining
this is that a company may save upon the total cost that it may incur on manufacturing a batch. Hence, a
concept of Economic Order Quantity steps in, where the company uses certain parameters to determine the
optimum quantity of units it shall manufacture in a batch. It can be calculated using the following formula:

Economic Order Quantity: √(𝟐𝐀𝐒/𝐂)

Where,
A = Annual requirements of the product
S = Setting up the cost per batch
C = Carrying cost per unit of inventory per annum. It includes the cost of storage, risk of pilferage, spoilage,
obsolescence, and interest on the investments blocked in the inventories

Features of Batch Costing:

A batch costing has the following features:
1. This method of costing is used in industries where identical products are produced
2. In case of batch costing, a batch consisting of a separate, readily identifiable group of product units
which maintains its separate identity throughout the production process
3. Since the output of batch consists of a number of units, it may not be economic to ascertain the cost of
every unit of output independently
4. Here, each batch is treated as a job and the costs are computed for the total batch. Once the
manufacturing or production of the batch is completed, the cost per unit is calculated by dividing the
total batch cost with total units in the batch.

Application of Batch Costing:

The following are a few industries where a batch costing is generally used:
1. Manufacturing industry for readymade garments
2. Manufacturing industry for toys
3. Manufacturing industry for tyres and tubes
4. Pharmaceuticals and drug industries for making tablets
5. Spare Parts and Components industry

Contract Costing:
Also known as terminal costing, this is another form of job order costing, where each contract is treated as
a cost unit and costs are ascertained separately for each contract. This method of costing is generally used
in businesses concerned with building or engineering projects or structural or construction contracts. The
important feature of contract costing is that most of the expenses can be easily identified and traced to a
particular contract. However, there can be certain expenses that may not be traced and so those are
apportioned to the contract on some suitable basis. In the case of contract costing, the cost calculation is
done on the following basis:

Material Cost: the company may purchase the material in huge quantities and keep it in its store for supply
to the contract whenever required. It may even be purchased and directly supplied to the contract. In the
second case, the cost of material shall be debited directly to the contract. However, in case any materials
are transferred from one contract to another, then their costs should be adjusted based on Material Transfer
Note, signed by both the transferor and transferee foreman. Further, there can be a situation where the
material charged is returned to stores and so in such a scenario, the cost of material shall be credited to
the contract account. In case the materials are stolen or destroyed by fire then the amount of such loss will
be transferred to the profit and loss account, while any material in hand at the end of the year will appear
on the credit side of the contract account.

Labour Cost: Wages paid to the labour involved on a particular contract should be charged to the contract
irrespective of the work done by them. In case there are common workers on more than one contract and/or
if the laborer is transferred from one contract to the other contract, then the timesheets must be maintained
and wages should get distributed on the basis of time spent on each contract. There will also be a situation

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
where some of the laborers may be working in the head office or central stores. In such a case, the wages
of those laborers can be apportioned to a particular contract on a suitable basis like time spent.

Expenses: Any direct expenses incurred for a particular contract should be charged to the specific contract
account. However, in case there are indirect expenses incurred for the organization as a whole, then that
should be charged to the contract on some suitable basis.

Plant and Machinery: The value of plant and machine used in a contract may be either debited to the
contract and the written down value thereof at the end of the year be entered on the credit side for closing
the contract account, or only a charge for use of the plant and machine (i.e. depreciation) may be debited
to the account.

Overhead expenses: There may be few overhead expenses related only to the administration works.
Hence, those expenses cannot be directly apportioned to the specific contract as they are indirect in nature.
These expenses are apportioned to the contract on a suitable basis.

Subcontract: There may be some work, generally of a specialized character, that may be done through the
help of other contractors by the main contractor. In other words, the main contractor may sub-contract
some work, like installation of lifts, special floorings, etc. to another contractor. In such a scenario, the cost
of such sub-contracts is a direct charge against the contract for which the work has been done.

Additional Work: There may be some additional work done, which may be necessary for addition to the
original work contracted. Such costs will form a separate charge. If the amount involved is big then a
subsidiary contract is generally entered into with the contract.

Progress payment, Retention money, and Architects’ certificate: In case of a large contract, the
system of progress payment is adopted, wherein the contractee agrees to pay a part of the contract price
from time to time depending upon satisfactory progress of the work. The progress is mostly judged by the
contractee’s architect, surveyor, or engineer who issues a certificate stating the value of work so far done
and approved by him. Such work is termed as certified work. The terms of the contract may also provide
that the whole of the amount mentioned in the certificate will not get paid immediately but a certain
percentage of it may be retained by the contractee until some time after the contract is completed. The
amount retained is called as retention money. This retention clause provides an advantage to the contractee
in case the contractor does not fulfill some of the conditions laid down by the contractor in case of faulty
work. Further, there can be a situation that at the end of the period, the work done may remain unapproved
because it has not reached a stipulated stage and so those work not approved by the contractee’s architect
or surveyor is termed as work uncertified. From the accounting viewpoint, the full value of work certified
shall be credited to the contract account and debited to the account of the contractee, while any amount
received from the contractee, the cash account is debited and contractee’s account is credited. Till the time
the contract is not completed, any amount received from the contractee will be shown as advance payments
and is deducted from work in progress in the balance sheet. On completion of the contract, the contractee’s
account is debited with the contract price and the contract account is credited.

Profit on incomplete contracts: At the end of the accounting period, there may be some contracts that
have been completed, while some others are still in progress and will get completed in the coming years.
The profit/loss on completed contracts shall get transferred to the profit and loss account. In the case of an
incomplete contract, it is better to compute the amount of profit/loss on partly completed contracts and
transfer the appropriate amount in the profit and loss account. The following guidelines may be followed:

1. The profit/loss should be considered in respect of certified work only, while uncertified work shall always
be valued at cost

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
2. No profit should be taken into consideration if the amount of work certified is less than one-fourth of the
contract price because in such a case it is may not be possible to foresee the future clearly
3. In case the amount of work certified is one-fourth or more but less than half of the contract price, then
one-third of the profit disclosed less the percentage of cash received from the contractee, should be
taken to the profit and loss account, or
Profit = 1/3 x Notional Profit x {Cash received / Work certified}
4. In case the amount of work certified is half or more of the contract price, the two-third of the profit
disclosed less than the percentage of cash received from the contractee, should be taken to the profit
and loss account.
Profit = 2/3 x Notional Profit x {Cash received / Work certified}
5. In case the contract is near to completion and if it is possible to ascertain the total cost of completing
the contract then that should be estimated and then the estimated total profit on the contract can be
computed by deducting the estimated cost from the contract price. The profit and loss on the contract
should then be transferred to the profit and loss account with that proportion of total estimated profit
on a cash basis, which the work certified bears to the total contract price.
Profit = Estimated total profit x {Work certified / Contract price}
6. Any loss incurred on the contract shall be transferred to the profit and loss account in full.

Work-in-Progress: The value of work-in-progress refers to the amount of work certified and the amount
of work uncertified. This account appears on the assets side of the balance sheet, after deducting for the
amount of cash received from the contractee and reserve for contingencies. Further, in case the expenditure
on incomplete contracts includes the value of plant and materials, then these items may be shown separately
in the balance sheet, meaning that expenditure may be split up and shown separately in the balance sheet,
under the headings of a plant at the site, material at the site, and work-in-progress, instead of showing the
entire amount under the heading work-in-progress.

Other points in Contract Costing:

Cost-plus contract: In this case, the value of the contract is ascertained by adding a certain percentage
of profit to the total cost of the work. This is generally used in those contracts where the exact cost cannot
be accurately estimated at the time of undertaking the work. The profit can be either a fixed amount or a
percentage of the cost of capital employed. These type of contracts are mostly undertaken for manufacturing
special articles not usually manufactured and is generally employed when the Government is contractee.

Target-in Price contract: In this type of contract, the contractor will receive an agreed sum of profit over
his predetermined costs. Further, a figure is agreed as the target figure and in case the actual costs are
below this target, the contractor may get a bonus for the savings.

Escalation Clause: This clause is generally provided to safeguard against any likely change in the price or
utilization of material and/or labor. The clause states that in the case of an increase in prices of items such
as raw materials, labor, etc. are increased beyond a certain limit over the prices prevailing at the time of
signing the agreement, then the contract price will be suitably adjusted. Hence, this clause safeguards the
interest of both the contractor and the contractee in case of fluctuations in the prices of material, labor, etc.

Multiple Costing:
Also known as composite costing, is a type of job costing method followed by businesses wherein a large
variety of articles are produced, each differing from the other in terms of both materials required and the
process involved in manufacturing. In such a case, the cost of each of the articles shall be computed
separately by using two or more methods of costing. Multiple costing can also be used where the components
are separately manufactured and then assembled in complex production. Here, the total cost is computed
by calculating the cost of a component which is collected by job or process costing and then adding the
costs through the use of the single or output costing system. Multiple costing is generally used by
manufacturing companies manufacturing a motor car, electronic goods (such as TV, ACs, smartphone, radio,
etc.), airplane industry, sewing machines, bicycles, etc.

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
Process Costing:
It is a method of costing used in industries where the product is in a continuous process, i.e. the output of
one process becomes the input of the next process and so on. Industries such as chemicals, textiles, steel,
rubber, sugar, shoes, petrol, etc. use this kind of costing method. Further, this method is employed where
it may not be possible to identify the items of direct or prime costs to a specific order as the identity gets
lost in continuous production. Further, in this method, it is assumed that the average cost presents the cost
per unit, as the cost of production during a particular period if divided with the number of units produced
during that period in order to arrive at the cost per unit.

Features of process costing:

The following are the features of process costing:
1. The production is in continuous flow and uniform in nature
2. The product is homogeneous
3. The process is standardized
4. In this case, the output of one process becomes the raw material of the next process and finally, the
output of the last process is transferred to finished stock
5. The costs computed are process-wise
6. Both direct and indirect costs are accumulated in each process
7. In the case of semi-finished goods, the same is expressed in terms of equivalent units
8. The total cost of each process is divided by the normal output of that process to find out the cost per
unit of that process.

Advantages of process costing:

The following are the advantages of process costing:
1. The costs get computed periodically at the end of a particular period
2. This is a simple method and involves less clerical work as compared to job costing
3. The expenses can be easily allocated to the processes in order to calculate the accurate cost
4. The method can help in preparing for tenders and quotations
5. Since the cost data is available for each process, the company can exercise good managerial control
across its operation and department.

Limitations of process costing:

The following are the limitations of process costing:
1. The cost obtained during each of the processes are historical in nature and so it may not be very useful
for effective control
2. The method of costing is based on the average cost method and so it may not suitable for the
performance analysis, evaluation and managerial control
3. In process costing, the work-in-progress is generally calculated on an estimated basis which may lead
to inaccuracy in total cost calculations
4. It may be difficult to compute the average cost where there are more than one type of products are
manufactured and a division of the cost element is necessary
5. In case there are multiple products in the same process, then the common costs are pro-rated to various
cost units, and so the individual product cost may be taken as an only approximation and so it may not
be reliable

Preparing Process Cost Account:

The following are the various elements of costs that are shown in the process accounts:

Materials: The materials and supplies are required in each process and are drawn from the stores against
material requisition. The business follows procedures with regards to preparing and authorizing the

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
requisition, pricing of the issues return of materials to the stores, transfer of material from one process to
another should be followed while issuing the materials. The cost of material consumed shall be computed
as per the method employed for the pricing of the issues. Further, the cost should be debited to the process
account.
Labour: Any wages paid to the labor and supervisory workers shall be charged to the particular process if
it is possible to identify with it. In case the labor is working on more than one process, then proper allocation
should be done on some basics like time spent on each process.

Direct Expenses: If the expenses can be identified with a particular process, they should be charged to
that process. For instance, the cost of electricity or depreciation may be charged directly to the process if
they can be identified with it.

Overheads: This is an indirect expense and so it cannot be identified with any particular process, hence
they need to be apportioned on some suitable basis and charged to the process. Generally, the following
distribution method is used to apportion different bases:

Item of Expenses Basis of Distribution

Rent, rates, and taxes
Power
Fire Insurance
Water, gas, steam, etc.
Depreciation of Plant
Area occupied by each process
Meter readings or horsepower of plant employed for each process
Value of asset and the degree of risk involved
Meter readings or technical estimates
Value of assets employed

Normal Loss: This refers to the loss that occurs during the course of the process and is inevitable. For
instance, if the input is 10, the output maybe 8, if the loss anticipated is 20%. This loss may be in the form
of normal wastage, normal scrap, normal spoilage, and normal defectiveness. In case, the normal loss units
can be sold as scrap then the sale value gets credited to process account, while if the help of some
rectification the normal loss units can be sold then the rectification cost shall be debited to the process
account. In case there is a normal loss, then the cost per unit of a process should be calculated after
adjusting for the normal loss, and so the following formula may be used:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 − 𝑆𝑎𝑙𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑐𝑟𝑎𝑝

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
𝐼𝑛𝑝𝑢𝑡 𝑈𝑛𝑖𝑡𝑠 − 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠 𝑈𝑛𝑖𝑡𝑠

Abnormal Loss: In case the actual output is less than the normal output, then the difference between the
two is termed as the abnormal loss. It is basically an avoidable loss and occurs for reasons such as plant
breakdown, substandard material, carelessness, accident, etc. Hence, abnormal losses happen only when
the actual losses are more than expected losses. Since this is avoidable in nature, this loss should not be
allowed to affect the cost of production. This loss represents the cost of materials, labor and overheads
charges and is called abnormal loss account. The sales value of abnormal loss gets credited to the Abnormal
Loss Account and the balance is written off to costing Profit and Loss Account. Abnormal losses in calculated
using the following formula:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 − 𝑆𝑐𝑟𝑎𝑝 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠

𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠 = 𝑈𝑛𝑖𝑡𝑠 𝑖𝑛 𝐴𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠 𝑥
𝐼𝑛𝑝𝑢𝑡 𝑈𝑛𝑖𝑡𝑠 − 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠 𝑈𝑛𝑖𝑡𝑠

Abnormal Gains: There may be an instance when the actual output generated is more than the normal
output, and so in such a situation it is said that there is an abnormal gain. The value of the abnormal gain
is computed using the same formula as that of abnormal loss. From the accounting point of view, the sale
value of abnormal gain units are transferred to the Normal Loss Account as it is arrived out of the savings
of Normal Loss, and the difference is transferred to Costing Profit and Loss Account as a Real gain.

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 SEBI GRADE A 2020: COSTING: METHODS OF COSTING
Inter-process profit:
As already mentioned, the output of one process is the input for the next as the same is transferred at cost
price. However, there may situations where the transfer is made at cost plus profit. This is mostly done
when the businesses treat each of the processes as a profit center. The difference between the debit and
credit side of the process account represents profit or loss which is transferred to the Profit and Loss Account.
In this case, the value of inventory at the end and beginning includes the unrealized profit/loss, which has
to be written back under this method by creating stock reserve (which can be calculated using the formula
given below). This is because if the profit element in the closing inventory is more than in the opening
inventory, then the profit is overstated, and vice-versa. The profit shall be realized only when the goods are
sold. Hence, to get the actual profit it is important to ascertain the profit included in the inventories. For
computing the profit in closing inventory and to obtain the net realized profit in the period, three-column
will be prepared in the ledger for showing the cost, unrealized profit, and transfer price.

𝑃𝑟𝑜𝑓𝑖𝑡 𝑖𝑛𝑐𝑙𝑢𝑑𝑒𝑑 𝑖𝑛 𝑡𝑟𝑎𝑛𝑠𝑓𝑒𝑟 𝑝𝑟𝑖𝑐𝑒 𝑥 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑡𝑜𝑐𝑘

𝑃𝑟𝑜𝑓𝑖𝑡 𝑖𝑛𝑐𝑙𝑢𝑑𝑒𝑑 𝑖𝑛 𝑠𝑡𝑜𝑐𝑘 =
𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟 𝑃𝑟𝑖𝑐𝑒

Valuation of Work-in-Progress:

In case of process costing, it is quite possible that there may be some incomplete units (i.e. those units on
which percentage of completion with regular to total cost is not fully completed) at the end of an accounting
period. These units are termed as Work-in-Progress and are valued in terms of equivalent or effective
production units.

The equivalent Production unit refers to the production of the process in terms of complete units, i.e. the
incomplete production units are converted into equivalents of complete units. Basically, the equivalent unit
is a notional quantity of completed units which is substituted for the actual quantity of incomplete units in
progress, when the aggregate work content of the incomplete units is deemed to be equivalent to that of
the substituted quantity. The principle can be applied when the operation costs are apportioned between
work-in-progress and completed units. Further, the equivalent units need to be calculated separately for
each of the cost elements, i.e. material, labor, and overheads. The reason is that the percentage of
completion of the various cost element may differ. The following formula can be used to compute the
Equivalent Units:

Equivalent units of work in progress = Actual number of units in progress x Percentage of work completed

From the accounting point of view, the following steps may be followed:

1. Calculate the equivalent production after considering the process losses, degree of completion of opening
and/or closing inventory
2. Then, calculate the net process cost according to the cost elements, i.e. material, labor, and overheads
3. Then, find out the cost per unit of equivalent production of each of the cost elements separately by
dividing each of the cost elements with the respective equivalent production units
4. Finally, calculate the cost of output finished and transferred work-in-progress

Further, the total cost per unit of equivalent units should be equal to the total cost divided by the effective
units, while the cost of work-in-progress should be equal to the equivalent units of work-in-progress
multiplied by the cost per unit of effective production.

The equivalent production problem can be divided into the following groups:

Situation I: Only closing work-in-progress without process losses:

Here, the process loss is ignored, while the closing work-in-progress is converted into equivalent units based
on estimates on the degree of completion of materials, labor, and production overhead. Post that the cost
per equivalent unit is computed and the same is used to value the finished output transferred and the closing
work-in-progress.

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Situation II: When there is closing work-in-progress with process loss or gain:
In case of normal loss, there should nothing be added to equivalent production, while in the case of abnormal
loss, it shall be considered as good units completed during the period. However, in case of normal loss, if
there is some reliable value that can be ascertained on the units scrapped, then the same shall be deducted
from the cost of materials in the cost statement and then it shall be divided by the equivalent units. In case
of abnormal gain, the value of gain shall be deducted to compute the equivalent units.

Situation III: Opening and closing work-in-progress without process losses:

Since there exists a possibility of opening and closing work-in-progress, the procedure of conversion of
opening work-in-progress will depend on the method of apportionment of cost followed by the business. The
business may follow the following methods:

• First-In-First-Out (FIFO) Method: This method assumes that the opening work-in-progress units are
completed first, hence the equivalent production of opening work-in-progress should be calculated as:
Equivalent Production = Units of Opening WIP x Percentage of work needed to finish the units

• Average Cost Method: It is possible that the prices of cost elements may fluctuate a lot and so this
method comes handy. Here, the average rate if obtained by adding the closing valuation of work-in-
progress in the old period to the cost of a new period. Then in calculating the equivalent production, the
opening units are not shown separately as units of work-in-progress but included in the units completed
and transferred.

• Weighted Average Cost Method: This method makes no distinction between the completed units from
opening inventory and completed units from the new production. It treats all the units finished during
the current accounting period as if they were started and finished during that period. Hence, the weighted
average cost per unit is calculated by dividing the total cost (i.e. the opening work-in-progress cost +
current cost) with the equivalent production.

• Last-In-First-out (LIFO) Method: LIFO method assumes that the units entering into the process is
the last one first to be completed. Hence, the cost of opening work-in-progress is charged to the closing
work-in-progress and the closing work-in-progress appears like the cost of opening work-in-progress.
The units completed are at their current cost.

Unit or Single or Output or single-output Costing:

This is a type of process costing, where a single article is produced or service is rendered through continuous
manufacturing activity. In this case, the cost of the whole production-cycle is ascertained as a process or
series of processes and the cost per unit is ascertained by dividing the total cost with the number of units
produced. The unit of costing is decided as per the nature of the products. The businesses generally prepare
the cost statements or cost sheets in which various items of expenses get classified and the total expenditure
is divided with the total quantity of units produced for arriving at the unit cost of production. Generally,
industries like brick-making, collieries, flour mills, and cement manufacturing use this method. Besides, this
method can even be useful for the assembly department in a factory manufacturing mechanical items like
a bicycle.

Operating Costing:
This method of costing is similar to the single output costing but is applicable where services are provided
instead of goods produced. Here, the total expenses of the operation are divided by the units to arrive at
the cost per unit of service. This method of costing is used by railways, road transport, water supply

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undertakings, telephone services, electricity companies, hospital services, municipal services, etc. to
calculate the cost of providing these services.

Since, the primary objective of operating costing is to calculate the cost of the services offered by the
organization, hence it may be important to decide the unit of cost in such cases. The different industries
may have different cost units, for instance, cost per passenger kilometer is calculated for passenger
transport. Once this is done, the next is to collect and identify various costs under different headings:
• Fixed or standing charges
• Semi-fixed or maintenance charges
• Variable or running charges.

Operation Costing:
Operation Costing or Service Costing is generally used in the service sector, i.e. applicable to those
undertakings which provide service rather than the production of commodities. Services can be provided
internally, i.e. those services which are performed on an inter-departmental basis in the factory itself, or
externally, i.e. those services which are to be provided to the outsider.

Features of Operation Costing:

The following are the primary features of operating costings:

1. Those entity using operation costing should not produce any tangible goods
2. The expenses shall be bifurcated into fixed and variable costs, as such a classification will help to compute
the cost of service and unit cost of service
3. The unit of the cost may be either simple or composite. Simple costing can be used in electricity supply,
cost per litre in water supply, cost per meal in the canteen, etc., while the composite costing can be
used in transport to compute passenger kilometers, in hospitals to compute the cost per patient-day, in
hotels to compute costs per room-day, etc.
4. The total cost gets averaged over the total amount of service provided
5. Generally, the cost is computed period-wise. But there can be a situation when it is done order-wise.
For instance, computing costs in case of utilization of vehicle is done order-wise.
6. This method of costing can be used for service provided both internally and externally

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