Costing Methods

Cost Accounting Notes – Emma Charles 0787-080-333/0753-236-367 |
COSTING METHODS & TECHNIQUES

Costing is the technique and process of ascertaining costs. In order to do the same, it
is necessary to follow a particular method of ascertaining cost. Different methods of
costing are applied to different industries depending upon the type of manufacture
and their nature.
Classification of costing methods
Broadly the costing methods are classified into the following:
a. Specific Order Costing (Job or Terminal Costing)
b. Operation Costing or Process or Period Costing
Specific Order Costing: Specific order costing is the category of basic costing methods
applicable where the work consists of separate jobs, batches or contracts each of which
is authorized by a specific order or contract. It includes;
 Job costing
 Batch costing and
 Contract costing.
Operation Costing: Operation costing is the category of basic costing method
applicable where standardized goods or services result from a sequence of repetitive
and more or less continuous operations or process to which costs are charged before
being averaged over the units produced during the period. This category includes;
 Process costing and
 Service costing.
JOB ORDER COSTING:
Industries which manufacture products or render services against specific orders as
distinct from continuous production for stock or sales use the job costing or job order
method of cost accounting.
Thus, it’s a costing method applied to determine the cost of specific jobs or lots of
production generally manufactured according to customer’s specifications. This
method is also known under various other names, such as specific order costing,
production order costing, job lot costing or lot costing.
In job costing, there is no averaging of costs except to the extent that in the
ascertainment of unit cost, the cost of a lot of products in one order is obtained. A
job or an order may extend to several accounting periods and job costs are, therefore,
not related to particular periods.
Job cost accounting is followed in three types of manufacturing organizations:
 Jobbing concerns.
 Small firms.
 Large enterprises manufacturing a variety of products.
Production orders may, in general, be of three types:
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 Assembly type of order.

 Sub-assembly type of order.
 Components or parts production type.
Assembly type of order: Where components are purchased and assembled into a
product in the factory. A production order for assembly only is required.
Sub-assembly type of order: Components are purchased and sub-assemblies and
assemblies are made in the factory. Production orders for each sub-assembly and final
assembly will be necessary.
Components or parts production type: Components are manufactured and sub-
assembled and the sub-assemblies are assembled into the final product. Separate
production orders for each component, sub-assembly and final assembly are issued.
Advantages of Job Costing:
Job costing offers the following advantages:
 The cost of material, labour and overhead for every job or product in a department
is available daily, weekly or as often as required while the job is still in progress.
 On completion of a job, the cost under each element is immediately ascertained.
Costs may be compared with the selling prices of the products in order to
determine their profitability and to decide which product lines should be pushed
or discontinued.
 Historical costs for past periods for each product, compiled by orders,
departments, or machines, provide useful statistics for future production planning
and for estimating the costs of similar jobs to be taken up in future. This assists in
the prompt furnishing of price quotations for specific jobs.
 The adoption of predetermined overhead rates in job costing necessitates the
application of a system of budgetary control of overhead with all its advantages.
 The actual overhead costs are compared with the overhead applied at
predetermined rates; thus, at the end of an accounting period, overhead variances
can be analyzed.
 Spoilage and defective work can be easily identified with specific jobs or products.
 Job costing is particularly suitable for cost-plus and such other contracts where
selling price is determined directly on the basis of costs.
Limitations of Job Costing:
The limitations of job costing are:
 Job costing is comparatively more expensive as more clerical work is involved in
identifying each element of cost with specific departments and jobs.
 With the increase in the clerical processes, chances of errors are enhanced.
 The cost as ascertained, even where they are compiled very promptly, are historical
as they are compiled after incidence.
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 The cost compiled under job costing system represents the cost incurred under
actual conditions of operation. The system does not have any scientific basis.
Job Cost Sheet/Job Card
This is a document prepared for ascertaining cost of each job in job costing. A separate
cost sheet is prepared for each job in which direct material, direct labour &other
overheads are charged relating to a specific job.
Both direct materials & labour are charged at usual costs &overheads i.e.
manufacturing overheads are charged at predetermined overhead rate. Each job sheet
bears a job number for easy identification, description of work, & details of cost of
materials, labour & overheads.
Format of Job Cost Sheet
BBA JOB COST SHEET
Job No. __________________ Date Initiated ______________
Supervisor ________________ Date Completed______________
Item _____________________ Units Completed _____________
Direct Materials Direct Labour Manufacturing Overheads
Req. No. Amount Ticket No. Hours Amount Hours Rate Amount
Cost Summary:
Direct materials
Direct labour
Manufacturing overheads
Total cost
Unit cost
Summary Format of Job Costing

Job No. 456
Shs
Direct materials xx
Direct labour xx
Direct expenses xx
Prime Costs xxx
Production Overheads xx
Work Costs/Production xxx
Other overheads xx
Cost of the Job (production) xxx
Profits (%) xx
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Selling Price xxx

Worked examples
The following information relates to Job No. 4568 which is being carried by BBA Co.
Ltd to meet a customer’s demand
Shs
Materials issued for the Job 52,000
Productive wages 9,200
Direct expenses 1,000
The management of BBA Co. ltd provides 50% on productive wages for work on cost
1
and 10 % work on cost plus prime costs for office on cost. Profits to be realized on
2
the selling price are at 5%.
Required:
Prepare a cost sheet for Job No. 4568
Solution:
BBA Co. Ltd.’s
Cost Sheet
For Job No. 4568
Shs
Direct materials 52,000
Direct Labour (productive wages) 5,200
Prime costs 58,200
Add other overheads
Work on cost (50%×5,200) 2,600
1
Office on cost (102 %×60,800) 6,384
Production/Work costs 67,184
Add Profit margin 3,536
Selling price 70,720
Working Note:
Note 1: selling Price: =(Cost + Mark-up)
1
If profit margin is 5% = 5/100 = 20
1 1
Mark-up = =
20−1 19
1
× 67,184 = 3,536
19
= 67,184 + 3,536
𝑆ℎ𝑠. 70,720
Example II
BBA Co. Ltd manufactures Rice products and most of them pass through two distinct
departments X & Y. the company has just received an order form one of its clients
who has ordered for Rice porridge. In an attempt to meet his order, the management
Accountant managed to estimate the following costs that are expected to be incurred.
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Department Department
X Y
Materials 3,000 units @ Shs. 500 each 2,400 units @ 600 each
Labour costs 2,000 hours @ Shs 400 each 10,000 hours @ Shs 300 each
Factory overhead costs incurred include the following;
Variable overhead costs Shs. 300,000 for department x & Shs. 400,000 for
department y
Total fixed overhead costs charged to the whole factory amounted to Shs. 48,000,000
based on 160,000 labour hours worked for in the factory in the period.
The company has policy of absorbing fixed overheads to cost units on the basis of
labour hours worked.
Required:
Advise the company’s management on the following issues;
i. Cost of Rice porridge
ii. What the company can charge the customer if the company targets a profit of
10% on sales.
Solution:
i. Job order cost
BBA CO. LTD
JOB COST SHEET FOR PORRIDGE RICE
Shs. ‘000’ Shs. ‘000’
Direct materials 𝑥(3,000 𝑢𝑛𝑖𝑡𝑠 × 500) 1,500
𝑦(2,400 𝑢𝑛𝑖𝑡𝑠 × 600) 1,440 2,940
Direct Labour 𝑥(2,000 ℎ𝑟𝑠 × 400) 800
𝑦(10,000 ℎ𝑟𝑠 × 300) 3,000 3,800
Prime Costs 6,740
Overhead Costs: 𝑥 300
𝑦 400
Fixed overheads 𝑥(2,000 ℎ𝑟𝑠 × 300) 600
𝑦(10,000 ℎ𝑟𝑠 × 300) 3,000 4,300
Total production costs 11,040
Note 1: 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝐴𝑏𝑠𝑜𝑟𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 = 48,000,000⁄160,000 = 𝑆ℎ𝑠. 300 𝑃𝑒𝑟 𝑙𝑏𝑟. ℎ𝑟.
ii. Amount charged to a customer
Selling Price: =(Cost + Mark-up)
1
If profit margin is 20% = 20/100 = 5
1 1
Mark-up = 5−1 = 4
1
× 11,040 = 2,760
4
= 11,040 + 2,760
𝑆ℎ𝑠. 13,800
Students’ Exercise
Page 5 of 79
The following information relates to Job No. 1234 which is being carried out by DBA
Co. ltd to meet a client’s order;
Department. A Department. B
Direct materials 10,000 6,000
Direct labour rate 800 400
Production overheads/direct labour hour 8 10
Administration/other overheads is 40% of full production cost
Profit margin is 50% of sales price
Required;
Determine the selling price of Job No. 1234
BATCH COSTING
Batch Costing is that form of specific order costing under which each batch is treated
as a cost unit and costs are accumulated and ascertained separately for each batch.
Each batch consists of a number of like units.
Basic Features
 Each batch is treated as a cost unit.
 All costs are accumulated and ascertained for each batch.
 A separate Batch Cost Sheet is used for each batch and is assigned a certain number
by which the batch is identified.
 The cost per unit is ascertained by dividing the total cost of a batch by the number
of items produced in that batch.
Applications
Batch Costing is applied in those industries where similar articles are produced in
definite batches for internal consumption in the production of finished products or
for sale to customers generally. It is generally applied in –
 Read made Garments Manufacturing Industries
 Pharmaceutical/ Drug Industries
 Spare parts and Components Manufacturing Industries
 Toys Manufacturing Industries
 Tyre and Tubes Manufacturing Industries.
Note; when a batch is completed, the unit cost of individual items in the batch is
found by dividing the total batch cost by the number of items in the batch.
𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑏𝑎𝑡𝑐ℎ
𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑖𝑛 𝑎 𝑏𝑎𝑡𝑐ℎ
The selling prices of batches are calculated in the same way as the selling price of jobs,
i.e. by adding a profit to the cost batch.
Worked examples
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Pink Limited undertakes to supply 1,000 units of a component per month for the
months of January, Feb. and March 2X20. Every month a batch order is opened
against which materials and labour costs are booked at actual. Overheads are levied at
a rate per labour hour. The selling price is contracted at Shs.15,000 per unit.
Month Batch output Material cost (Shs Labour cost (Shs
(No.) Shs.’000’ ‘000’) ‘000’)
Jan. 2x20 1,250 6,250 2,500
Feb. 2x20 1,500 9,000 3,000
March 2x20 1,000 5,000 2,000
Labour is paid at a rate of Shs. 200 per hour. The other details are;
Month overheads Total labour hours
Jan. 2x20 12,000 4,000
Feb. 2x20 9,000 4,500
March 2x20 15,000 5,000
Required:
From the above data, present the cost and profit per unit of each batch order and the
overall position of the order for the 3,000 units.
Solution;
Pink Limited’s
Cost Per unit of each Batch
Months
Particulars January Shs February (shs March Shs Total
‘000’ ‘000’ ‘000’
Batch output (No.) 1,250 1,500 1,000 3,750
Sales Value 18,750 22,500 15,000 56,250

Materials 6,250 9,000 5,000 20,250
Wages 2,500 3,000 2,000 7,500
Overheads 3,750 3,000 3,000 9,750
Total Cost 12,500 15,000 10,000 37,500
Profit per batch 6,250 7,500 5,000 18,750
Cost per Unit 10 10 10 10
Profit per unit 5 5 5 5
Pink Limited’s
Profit Statement per unit of each batch
Particulars Shs. ‘000’
Sales value (3,000 × 𝑆ℎ𝑠. 15,000) 45,000
Page 7 of 79
Less: Total Cost (3,000 × 𝑆ℎ𝑠. 10) 30,000

Profit 15,000
Working Notes:
𝐿𝑎𝑏𝑜𝑢𝑟 𝐻𝑟𝑠 2500 3,000
Note 1: Labour hrs. 𝐿𝑎𝑏𝑜𝑢𝑟 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝐻𝑟. 𝐽𝑎𝑛. 2𝑥20 =
2
= 1,250 𝐹𝑒𝑏. 2𝑥20 =
2
= 1,500
2000
𝑀𝑎𝑟𝑐ℎ. 2𝑥20 = = 1,000
2
𝑇𝑜𝑡𝑎𝑙 𝑂/𝐻 12,000 9,000
Note 2: Overheads/hr. 𝑇𝑜𝑡𝑎𝑙 𝐿𝑎𝑏𝑜𝑢𝑟 𝐻𝑟.
𝐽𝑎𝑛. 2𝑥20 = = 𝑆ℎ𝑠. 3 𝐹𝑒𝑏. 2𝑥20 =
4,000 4,500
= 𝑆ℎ𝑠. 2
15,000
𝑀𝑎𝑟𝑐ℎ. 2𝑥20 = = 𝑆ℎ𝑠. 3
5,000
Note 3: Overheads for Batch. (𝐿𝑏𝑟 ℎ𝑟𝑠.× 𝑂/𝐻) 𝐽𝑎𝑛. 2𝑥20 = 1,000 × 3 = 𝑆ℎ𝑠. 3,000 𝐹𝑒𝑏. 2𝑥20 = 1,500 × 2 =
𝑆ℎ𝑠. 3,000 𝑀𝑎𝑟𝑐ℎ. 2𝑥20 = 1,000 × 3 = 𝑆ℎ𝑠. 3,000
Example II
DBA Co. Ltd dealers in Wood products received an order from BBA Co. Ltd for
4,000 desks of standard size. DBA Co. Ltd estimated that the following costs would
be incurred if the order is to be met.
1. Materials
 Timber 800 metres @ Shs 4,000
 Nails 400 Kgs @ Shs 5,000
 Vanish 20 litres @ 50,000
2. Labour costs- workers to be got from two departments, 𝑥 and 𝑦.
 Department 𝑥- 200 labour hours @ Shs 10,000
 Department 𝑦- 60 men working for 20 days at a rate of Shs. 4,000 per day per man
3. Variable overheads
 Department 𝑥- overheads are absorbed on the basis of direct labour hours at a rate
of Shs. 6,000
 Department 𝑦- overheads are absorbed at 40% of prime costs required for the
order.
4. Fixed manufacturing overheads
 Fixed manufacturing costs per batch is Shs. 800
Required; assuming the company would process it as batch No. 20;
i. Determine the unit cost of each desk
ii. What price would be charged to BBA Ltd per desk, if DBA Co. Ltd. Targets a
gross profit of 50% profit on cost?
iii. What price would be charged to BBA Co. Ltd per desk if DBA Co. Ltd targets
a gross profit of 50% on sales?
Solution:
DBA Co. Ltd’s
Cost Sheet
For Batch No. 20 of 4,000 desks
Particulars Shs ‘000’ Shs ‘000’
Material costs:
Page 8 of 79
Timber (800 𝑚𝑒𝑡𝑟𝑒𝑠 × 4,000) 3,200

Nails (400 𝐾𝑔𝑠 × 5,000) 2,000
Vanish (20 𝐿𝑖𝑡𝑟𝑒𝑠 × 50,000) 1,000 6,200
Labour Costs:
Dept. 𝑥: (200 ℎ𝑟𝑠 × 10,000) 2,000
Dept. 𝑦: (60 𝑚𝑒𝑛 × 20 𝑑𝑎𝑦𝑠 × 4,000) 4,800 6,800
Prime Costs 13,000
Variable Costs:
Dept. 𝑥: (200 ℎ𝑟𝑠 × 6,000) 1,200
Dept. 𝑦: (40% × 13,000) 5,200 6,400
Fixed manufacturing costs:

(800 × 4,000 𝑏𝑒𝑛𝑐ℎ𝑒𝑠) 3,200
Total Batch costs 22,600
𝑇𝑜𝑡𝑎𝑙 𝐵𝑎𝑡𝑐ℎ 𝑐𝑜𝑠𝑡 22,600,000

Total batch Cost per Unit = 𝑁𝑜.𝑜𝑓 𝐷𝑒𝑠𝑘𝑠
= 4,000
= 𝑆ℎ𝑠. 5,650
b). Selling Price = 𝑐𝑜𝑠𝑡 + 𝑀𝑎𝑟𝑘 − 𝑢𝑝
1
= 5,650 + × 5,650
2
= 𝑺𝒉𝒔. 𝟖, 𝟒𝟕𝟓
1 1
c). If margin is , then mark – up is
2 1
1
Thus, selling price = 5,650 + 1 × 5,650
= 𝑺𝒉𝒔. 𝟏𝟏, 𝟑𝟎𝟎
CONTRACT C0STING (TERMINAL COSTING)
IAS 11, defines a contract as those activities that take a considerable long period to be
accomplished and are usually undertaken from the firm’s premises. Contract costing
thus is the application of specific order costing to relatively large cost units especially
those that take a considerable long period to be accomplished.
Contract Costing is a type of costing used in constructional activities such as
construction of buildings, roads, bridges etc. The person who takes contract for a price
is called the Contractor and the person from whom it is taken is called the
Contractee. We are mainly concerned with the books of the contractor.
Contract costing has many similarities to job costing and is usually applied to work
which is;-
 Undertaken to customer requirements
 Relatively long duration
 Site-based sometimes overseas
 Frequently of a constructional nature
Characteristics of contract costing
Page 9 of 79
Although details vary, certain characteristics are common to most contract costing
systems;
Higher proportion of direct costs; because of the self-contained nature of most site
operations, costs can be identified specifically with a contract/site & thus can be
charged directly.
Low indirect costs; for most contracts, the only item of indirect cost would be a charge
of head office expense. This is usually only a small proportion of the contract cost &
is absorbed normally on some overall basis such as % of total contract cost.
Difficulties of cost control; because of scale of some contracts & the size of the site,
there are frequently major problems of cost control concerning; material usage &
losses, pilferage, labour supervision & utilization, damage to & loss of plant & tools,
etc.
Surplus materials; all materials bought for a contract would be charged directly to the
contract. At the end of a contract account would be credited with the cost of the
materials not used and if they were transferred directly to another account, the new
contract account will be debited.
Contract plant; a feature of most contract work is the amount of plant used. This
includes cranes, tracks, mixers, Lorries, etc. if plant is on lease basis then the leasing
charges are directly charged to the contract. On the other hand, if the plant is
purchased, then the plant is charged to the contract for which it was purchased. At
the end of the year, or on completion of the contract, the contract account is credited
with the value of the plant at the time.
Sub-contracts; sometimes the contractor can assign some work to sub-contractors e.g.
electrical or plumbing work. The amount paid to sub-contraction is charged to the
respective contract.
Contract price; this is usually agreed in advance. The contractee invites the tenders
form the interested contractors. Normally the lowest quotation is accepted and the
contract is awarded to the contractor who gives the lowest quotation.
Certification of work done (Architect’s certificate)
Normally, the contractee (owner of the Job) appoints architects whose responsibility
is to certify & verify work as it progresses & issues certificate to the extent of work
satisfactorily completed by the contractor. The contractor is then paid by agreement
on the strength of the architect’s certificate. The architect will visit the site at regular
intervals & will issue a certificate stating his/her estimate of the value of work done
and in terms of the total contract price.
 For work certified: Dr. Contractee A/c
Cr. Contract A/c with the value of certified work
 For payment of certified work; Dr. Bank A/c
Page 10 of 79
Cr. Contractee A/c with the amount paid.

Retention money
Normally, the terms governing the contract will contain a clause concerning retention
money. This is amount (usually stated as a % of work certified) which will be withheld
by the contractee when paying off the contractor. This money is held back in case;
 The contract isn’t completed within the stated date
 Against the claims for faulty workmanship (defective work)
Note that, this retention money is shown as debtors in the books of the contractor.
Profit Estimation
There are various approaches for profit estimation but the recommended approach
under IAS 11 is the % of completion method. This method is an application of the
accrual concept where contract revenue is matched with the contract cost incurred in
reaching a specific stage of completion. Thus, revenues, costs & profits are attributed
to the proportion of work completed.
In this regard, the following rules are applied;
1. If the contract is in its preliminary stage i.e. when the outcomes can’t easily be
assessed with reasonable degree of certainty (between 0 – 25%), no profits may be
taken.
2. If the work done is greater than 25% but less than 50%, then the profits taken to
the Income Statement are estimated as follows;
(26-49% of work)= 13 × 𝐴𝑝𝑝𝑎𝑟𝑒𝑛𝑡/𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 × 𝑊𝑜𝑟𝑘
𝐶𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑
𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑
3. If the work is greater than 49% but less than 80%, then profits taken into account
are calculated as;
Work is in Maturity = 23 × 𝐴𝑝𝑝𝑎𝑟𝑒𝑛𝑡/𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 × 𝑊𝑜𝑟𝑘
𝐶𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑
𝐶𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑
4. If the work is nearing completion stage (80-100%), then amount of profits taken
is determined as;
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑤𝑜𝑟𝑘 𝑐𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑
= 𝐴𝑝𝑝𝑎𝑟𝑒𝑛𝑡/𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 ×
𝐶𝑜𝑛𝑡𝑟𝑎𝑐𝑡/𝑐𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑 𝑝𝑟𝑖𝑐𝑒
Note;
1. In case a contract realizes a notional loss, then the whole loss will be taken to the income
statement
2. Apparent/Notional profit – is the estimated profit on the contract as at a given year end
3. Prudent profit- is the fraction of the notional profit that is chargeable to the Income
statement.
4. Notional profit = (Value of work completed – Costs incurred to date)
Format of a contract Account
BBA Co. Ltd
Contract A/c for the period …………….
Page 11 of 79
DR CR
Particulars Amount Particulars Amount
(Shs) (Shs)
Cost of materials xx WDV of plant & Machinery xx
Direct labour xx Unused materials xx
Sub-contract charges xx Sale of materials xx
Cost of plant & machinery xx Materials returned to stores xx
Machinery hire xx Prepaid expenses xx
Value of certified work xx
Cost of completed but uncertified work xx
Notional Profit (Bal. fig) xx Notional loss (Bal. fig) xx
xxx xxx
Plant & machinery B/d xx Any Accruals B/d xx
Value of materials B/d xx Provision for profits B/d xx
Value of completed (uncertified work) xx
Any prepayments B/d xx
WORKED EXAMPLES
Example 1
BBA Builders Co. Ltd has been engaged to construct the head office for DBA
confectionaries. Construction work commenced on 01st March 2019. The following
information has been given regarding the contract.
Shs ‘000’
Materials delivered to the site from stores 550,000
Contract price 2,000,000
Payment for direct wages 480,000
Accrued wages 20,000
Materials returned to stores 5,000
st
Plant & equipment (cost)- 01 /3/2019 300,000
Installation costs 250,000
Payment of direct expenses 150,000
th
Value of plant & equipment 30 Nov. 2019 200,000
Direct expenses accrued 10,000
th
Materials on site 30 .Nov.2019 55,000
Value of work certified 1,600,000
Cost of work not yet certified 100,000
Cash received form DBA Confectionaries 1,500,000
Required:
Prepare a Contract A/c & a Contractee’s A/c as they would appear in the records of
BBA Builders Ltd showing the profits to be transferred to the Income Statement.
Solution
Page 12 of 79
BBA Builders Co. Ltd

Contract A/c for the period ended 30th/Nov./2019
DR CR
Particulars (Shs. ‘000’) Particulars (Shs. ‘000’)
Materials delivered to site 550,000 Materials returned to stores 5,000
Direct expenses payment 480,000 Plant & machinery C/d 200,000
Accrued wages C/d 20,000 Materials on site C/d 55,000
Plant & equipment –cost 300,000 Cost to date C/f 1,500,000
Installation-cost 250,000
Payment for direct expenses 150,000
Direct expenses accrued C/d 10,000
1,760,000 1,760,000
Cost to date B/d 1,500,000 Value of work certified(Contractee A/c) 1,600,000
Notional/Apparent profit C/f 200,000 Cost of work –uncertified C/d 100,000
1,700,000 1,700,000
Income Statement A/c (Note 2) 160,000 Notional/Apparent profit B/d 200,000
Profit provision C/d (Note 3) 40,000
200,000 200,000
Plant & equipment B/d 200,000 Accrued wages B/d 20,000
Materials on site B/d 55,000 Accrued Expenses B/d 10,000
Cost of work not yet certified B/d 100,000 Provision for profit B/d 40,000
(200,000-160,000)
Note; there is need to get the exact profit to be taken to the income statement. This is
obtained by establishing the stage of completion i.e. the amount of work done so far.
Working notes;
Note 1: Work stage determination.
= × 100
1,600,000
= × 100
2,000,000
= 𝟖𝟎%
This implies that the work has gone 80% to completion.
Note 2: Profit to be taken.
Profit at 80% can then be computed as follows;
= 𝐴𝑝𝑝𝑎𝑟𝑒𝑛𝑡/𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 ×
1,600,000
= 200,000 ×
2,000,000
= 𝑺𝒉𝒔. 𝟏𝟔𝟎, 𝟎𝟎𝟎
This is thus the profit to be taken to the Income Statement.
Note 3: Provision for profit B/d = 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝐸𝑥𝑎𝑐𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
= 200,000 − 160,000
= 𝑺𝒉𝒔. 𝟒𝟎, 𝟎𝟎𝟎
DBA Confectionaries Ltd (Contractee’s A/c)
DR For the period ended 30th.Nov. 2019 CR
Page 13 of 79
Particulars Shs ‘000’ Particulars Shs ‘000’

Contract value- certified work 1,600,000 Bank (Cash received) 1,500,000
Retention money (Bal. C/d) 100,000
1,600,000 1,600,000
Example 2
DBA Construction Co. Ltd won a contract for the construction of a multi-story
building at a cost of Shs. 200,000,000. The data relating to the contract for the year
ended 31/12/2019 were as follows;
Shs ‘000’
Materials issued on site 80,000
Direct wages paid 5,800
Direct wages accrued 350
Plant purchased & installed 48,800
Direct expenses paid 1,780
Direct expenses accrued 70
Established charges 180
Materials returned to stores 850
Work certified 150,000
Cost of work not certified 3,800
Materials on site – 31/12/2019 5,330
Value of plant – 31/12/2019 41,500
Materials purchased locally 15,700
The Company had received from the client payments amounting to Shs 126,000,000
Required; prepare,
a) Contract A/c
b) Contractee A/c
Solution:
DBA Construction Co. Ltd
Contract A/c for the period ended 31st/Dec./2019
DR CR
Materials issued on site 80,000 Materials returned to stores 850
Materials purchased locally 15,700 Materials on site C/d 5,330
Plant purchased & Installed 48,800 Plant on site C/d 41,500
Direct wages paid 5,800 Cost to date C/d 105,000
Accrued wages C/d 350
Payment for direct expenses 1,780
Direct expenses accrued C/d 70
Establishment charges 180
152,680 152,680
Cost to date B/d 105,000 Contractee A/c-work certified 150,000
Page 14 of 79
Notional Profit C/d 48,800 Cost of work not yet certified 3,800
153,800 153,800
Income Statement A/c (Note 2) 27,328 Notional profit B/d 48,800
Profit provision C/d (Note 3) 21,472
48,800 48,800
Materials/Stock on site B/d 5,330 Direct wages Accrued B/d 350
Plant on site B/d 41,500 Direct expenses Accrued B/d 70
Cost of work not certified 3,800 Profit provision B/d 21,472
Contractee’s A/c
DR For the period ended 31st .Dec. 2019 CR
Particulars Shs ‘000’ Particulars Shs ‘000’
Contract value- certified work 150,000 Bank (Cash received) 126,000
Retention money –Bal C/d 24,000
150,000 150,000
Working Notes:
Note 1: Work stage determination.
= × 100
150,000,000
= × 100
200,000,000
= 𝟕𝟓%
This implies that the work has gone 75% to completion.
Note 2: Profit to be taken.
Profit at 75% can then be computed as follows;
2 𝐶𝑎𝑠ℎ 𝑟𝑒𝑐𝑒𝑖𝑣𝑒𝑑
= × 𝐴𝑝𝑝𝑎𝑟𝑒𝑛𝑡/𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 ×
3 𝑊𝑜𝑟𝑘 𝑐𝑒𝑟𝑡𝑖𝑓𝑖𝑒𝑑
2 126,000
= × 48,800 ×
3 150,000
= 𝑺𝒉𝒔. 𝟐𝟕, 𝟑𝟐𝟖
This is thus the profit to be taken to the Income Statement.
Note 3: Provision for profit B/d = 𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝐸𝑥𝑎𝑐𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
= 𝑆ℎ𝑠. 48,800 − 𝑆ℎ𝑠. 27,328
= 𝑺𝒉𝒔. 𝟐𝟏, 𝟒𝟕𝟐
Example 3
The following example relates to contract No. 220 on Luwero Construction Site at
31st December, 2018
Shs. ‘000’
Wages 42,156
Materials delivered direct to the site 54,203
Materials from main stores 657
Plant purchased (@ cost) 12,500
Plant transferred to Luwero site 5,250
Materials transferred to Mukono site 1,590
Page 15 of 79
Sub-contractors charges 19,580

Site expenses (power, etc.) 5,086
st
Materials on site – 31 December, 2018 18,300
st
Plant on site – 31 December, 2018 14,750
st
Prepayments at 31 December, 2018 507
st
Accrued wages-31 December, 2018 921
Sales value of stages completed 117,500
Cost of stages completed 102,300
Head office charges are 10% of wages
Progress payments received from the client 115,000
The contract value is Shs. 550,000,000 & it’s anticipated that there will be further
costs of Shs. 375,000,000.
As this is the first year of the contract, no profit has been taken previously.
Required;
Prepare contracts’ A/c for the year ended 31st December, 2018
Solution:
Luwero Construction Site
Contract A/c for the period ended 31st/Dec./2018
DR CR
Site Wages 42,156 Materials transferred out (Mukono site) 1,590
Add Accrued 921 43,077 Prepayments C/d 507
Materials purchased 54,203 Materials at the site C/d 18,300
Materials from stores 657 54,860 Plant at Site C/d 14,750
Plant purchased 12,500 W.I.P C/d (Note 1) 7,214
Plant transferred to the site 5,250 17,750 Cost of stages completed C/d 102,300
Sub-contractors charges 19,580
Site expenses 5,086
Head office charges 4,308
144,661 144,661
Cost of stages completed B/d 102,300 Sale value of stages completed 117,500
Profit for the year C/d 15,200
117,500 117,500
Prepayments B/d 507 Wages Accrued B/d 921
Materials at the site B/d 18,300
Plant at site b/d 14,750
W.I.P B/d 7,214
Working Note:
Note 1: the total cost to date are Shs. 109,514,000 i.e. Shs. 144,661,000 less items C/d &
transferred out Shs. 35,147,000
Contract balance (W.I.P)
Shs ‘000’
Page 16 of 79
Cost to date 109,514

Less Cost of sales 102,300
Long-term contract balance (W.I.P) 7,214
A firm of Builders, carrying out large contracts kept in contract ledger, separate
accounts for each contract on 30th June, 2019, the following were shown as being the
expenditure in connection with Contract No. 444.
Shs ‘000’
Materials purchased 116,126
Materials issued from stores 19,570
Plant which has been used on other contracts 25,046
Additional plant 7,220
Wages 147,268
Proportionate establishment expenses 17,440
st
The contract which had commenced on 1 February, 2019 was for Shs. 600,000,000
and the amount certified by the Architect, after deduction of 20% retention money,
was Shs. 241,600,000 the work being certified on 30th June, 2019. The materials on
site were Shs. 19,716,000. A contract plant ledger was also kept in which depreciation
was dealt with monthly the amount debited in respect of that account is Shs.
2,260,000.
Required: Prepare;
Contract Account showing profit on the contract.
PROCESS COSTING (OPERATING COSTING)

Process costing is that aspect of operation costing which is used to ascertain the cost
of the product at each process or stage of manufacture. This method of accounting is
used in industries where the process of manufacture is divided into two or more
processes.
The objective is to find out the total cost of the process and the unit cost of the process
for each and every process. Usually the industries where process costing used are
textile, oil industries, cement, pharmaceutical etc.
Thus, this costing method is used in production processes where it is not possible to
identify separate units of production or Jobs usually because of continuous nature of
the production process.
Features of Process Costing:
Page 17 of 79
i. Production is done having a continuous flow of products having a continuous

flow of identical products except where plant and machinery is shut down for
repairs etc.
ii. Clearly defined process cost centres and the accumulation of all costs by the
cost centres.
iii. The maintenance of accurate records of units and part units produced and cost
incurred by each process.
iv. The finished product of one process becomes the raw material of the next
process or operation and so on until the final product is obtained.
v. Avoidable and unavoidable losses usually arise at different stages of
manufacture for various reasons.
vi. In order to obtain accurate average costs, it is necessary to measure the
production at various stages of manufacture as all the input units may not be
converted into finished goods.
vii. Different products with or without by-products are simultaneously produced at
one or more stages or processes of manufacture. The valuation of by-products
and apportionment of joint cost before joint of separation is an important
aspect of this method of costing.
viii. Output is uniform and all units are exactly identical during one or more
processes. So the cost per unit of production can be ascertained only by
averaging the expenditure incurred during a particular period.
Applications of Process Costing:
The industries in which process costs may be used are many. In fact a process costing
system can usually be devised in all industries except where job, batch or unit or
operation costing is necessary. In particular, the following are examples of industries
where process costing is applied:
 Chemical works  Coke works
 Textile, weaving, spinning etc.  Paper mills
 Soap making  Paint, ink and varnishing etc.
 Food products  Biscuit works
 Box making  Meat products factory
 Canning factory  Oil refining
 Distillation process  Milk dairy, etc.
DEALING WITH LOSSES IN PROCESS COSTING

In most manufacturing processes that involve process costing, there will be losses
occurring between processes. A loss occurs when the quantity of material output from
a process is less than the quantity input.
Page 18 of 79
Normal process loss

It is the loss which is unavoidable on account of inherent nature of production
process. Such loss can be estimated in advance on the basis of past experience or
available data. The normal process loss is recorded only in terms of quantity and the
cost per unit of usable production is increased accordingly. This loss is not usually
given a cost.
Abnormal process loss;
This is a loss resulting when actual loss is greater than normal or expected loss and it
is given a cost. This loss is caused by unexpected or abnormal conditions such as;
plants breakdown, sub-standard materials, carelessness, accident etc., or loss in excess
of the margin anticipated for normal process loss, i.e. Abnormal loss results when;
Actual Loss > Expected (Normal) loss or
Actual Output < Expected Output
The units of abnormal loss or gain are calculated as under:
(𝑁𝑜𝑟𝑚𝑎𝑙 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑁𝑜𝑟𝑚𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡)
𝐴𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑙𝑜𝑠𝑠 = × 𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑎𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠
(𝑁𝑜𝑟𝑚𝑎𝑙 𝑂𝑢𝑡𝑝𝑢𝑡)
Double entries
 Abnormal loss valued on unit cost basis Dr. Abnormal loss a/c
Cr. Process a/c
 Any balancing figure in abnormal loss a/c: Dr. P & L a/c
Cr. Abnormal loss a/c
 Abnormal loss represented by scrap Dr. Scrap sales a/c
Cr. Abnormal loss a/c
Abnormal gain;
This is a gain resulting when actual loss is less than Normal or expected loss & it is
given a negative cost. i.e.
Actual Loss < Expected (Normal) loss OR
Actual output > Expected Output
Double entries
 Abnormal gain valued on unit cost basis Dr. Process a/c
Cr. Abnormal gain a/c
 Any balancing figure in abnormal gain a/c: Dr. abnormal gain a/c
Cr. P & L a/c
 Abnormal gain represented by scrap Dr. abnormal gain a/c
Cr. Scrap sales a/c
Rules in Process Costing
 Normal Loss is given no share of process cost i.e. it is valued at zero (nil)
 Cost of output is based on expected good output.
Page 19 of 79
 Abnormal gain/loss are valued at the same rates as good output and are charged
to P & L A/c via abnormal gain/loss A/c.
 Any balance on the abnormal gain/loss A/c is transferred to P & L A/c.
Steps in Process Costing
1. Determine the Output & Losses (Total Process costs)
2. Determine Expected Output i.e. Expected Output = 𝐼𝑛𝑝𝑢𝑡 − 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠
3. Calculate cost per unit of output in each process as follows;
𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒
𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡 =
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑂𝑢𝑡𝑝𝑢𝑡
4. Complete the process accounts
Format of Process A/c
BBA Co. Ltd
Process Account
Dr. For the period ended …. Cr
Particulars Unit Cost Amount (Shs) Particulars Unit Cost Amount (Shs)
Material Input xx xx Output xx xx
Labour costs xx xx Normal Loss xx xx
Overhead Costs xx xx Abnormal Loss xx xx
Abnormal gain xx xx Closing stock xx xx
Total xxx xxx xxx xxx
Worked examples
Example 1
Café Javas processes customers’ orders through three processes I, II and III. Budgeted
costs to be incurred in processing customer orders are given in the table below:
Particulars (Items) Total Costs Processes
I II III
Direct materials 1,740,000 1,440,000 220,000 80,000
Direct wages 360,000 120,000 160,000 80,000
Direct expenses 300,000 260,000 - 40,000
Additional information:
Production overheads incurred is Shs. 640,000 and is to be recovered on 400% of
direct wages. Units introduced to process I amount to 20,000 units. No loss is
expected at any stage and there was no closing stock or opening work in progress.
Required;
Prepare process accounts to record the above information
Solution:
PROCESS 1
1. Determining Total process costs (Output):
Direct materials 1,440,000
Direct wages 120,000
Page 20 of 79

Production overheads 480,000
Total Process Costs 2,260,000
2. Determining expected output: 𝐼𝑛𝑝𝑢𝑡 − 𝑁𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠
20,000 𝑈𝑛𝑖𝑡𝑠 − 0
= 𝟐𝟎, 𝟎𝟎𝟎 𝑼𝒏𝒊𝒕𝒔
3. Determining Unit Cost per Unit:
2,260,000 − 0
=
20,000
2,260,000
=
20,000
= 𝑺𝒉𝒔. 𝟏𝟏𝟑 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Café Javas’
Process I Account
Particulars Unit Unit Amount Particulars Unit Unit Amount
Cost (Shs) Cost (Shs)
Material Input 20,000 72 1,440,000 Output to Process II 20,000 113 2,260,000
Direct Wages 120,000 Normal Loss - - -
Overhead Costs 480,000
Total 20,000 2,260,000 20,000 2,260,000
PROCESS II
4. Determining Total process II costs (Output):
Previous process Costs 2,260,000
Direct wages 160,000
Direct expenses -
20,000 𝑈𝑛𝑖𝑡𝑠 − 0
= 𝟐𝟎, 𝟎𝟎𝟎 𝑼𝒏𝒊𝒕𝒔
3,280,000 − 0
=
20,000
3,280,000
=
20,000
= 𝑺𝒉𝒔. 𝟏𝟔𝟒 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Café Javas’
Process II Account
Page 21 of 79

Prev. process Costs 20,000 113 2,260,000 Output to Process III 20,000 164 3,280,000
Material Input 220,000 Normal Loss - - -
Direct Wages 160,000
Direct expenses -
Total 20,000 3,280,000 20,000 3,280,000
PROCESS III
7. Determining Total process III costs (Output):
Previous process Costs 3,280,000
Direct wages 80,000
20,000 𝑈𝑛𝑖𝑡𝑠 − 0
= 𝟐𝟎, 𝟎𝟎𝟎 𝑼𝒏𝒊𝒕𝒔
3,800,000 − 0
=
20,000
3,800,000
=
20,000
= 𝑺𝒉𝒔. 𝟏𝟗𝟎 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Café Javas’
Process III Account
Prev. process Costs 20,000 164 3,280,000 Output to Stores 20,000 190 3,800,000
Material Input 80,000 Normal Loss - - -
Direct Wages 80,000
Total 20,000 3,800,000 20,000 3,800,000
Example 2 (Process Costing with normal Loss)

DBA Ltd. operates a manufacturing process and during the month of January 2020,
the following processing took place:
Page 22 of 79
Items Amount (Shs)

Opening Inventory Nil
Closing inventory Nil
Units introduced 1,000
Output to process II 900 units
Costs incurred 4,500
Normal loss 100 units
Required:
Determine the cost of output in following circumstances & complete the relevant
accounts
a) If the expected or normal loss is 10% of input
b) If the expected loss is 10% of input & actual output is 920 units
Solution
Inputs to process I 1,000 units
Normal loss = 10% × 1,000 = 100 𝑈𝑛𝑖𝑡𝑠
Expected output = 1,000 − 100 = 900 𝑈𝑛𝑖𝑡
Actual Output = 900 Units (since losses are assumed to be at normal level).
Abnormal gain/loss = Nil
Cost per unit

4,500 − 0
=
900
4,500
=
900
= 𝑺𝒉𝒔. 𝟓 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Output to Process II
Output to process II (900 × Shs. 5) = Shs. 4,500
Normal Loss (100 × Shs. 0) = Shs. 0
Total = Shs. 4,500
DBA Ltd.’
Process I Account
Dr. For the period ended Jan.2020 Cr
Material Input 1,000 4.5 4,500 Output to Process II 900 5 4,500
Normal Loss 100 - 0
Total 1,000 4,500 1,000 4,500
PROCESS II
Items Shs
Page 23 of 79
Material Input 1,000

Expected/Normal loss 100
Expected output 900
Actual output 920
Abnormal gain (Actual OP>Expected OP) 20
Cost per unit

4,500 − 0
=
900
4,500
=
900
= 𝑺𝒉𝒔. 𝟓 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Output to process II (920 × Shs. 5) = Shs. 4,600
Abnormal Gain (20 × Shs. 5) = Shs. 100
DBA Ltd.’
Process II Account
Material Input 1,000 4.5 4,500 Output to Process II 920 5 4,600
Abnormal gain 20 5 100 Normal Loss 100 - 0
Total 1,020 4,600 1,000 4,600
Example 3
Caltex Ltd. Produces gas packed in cylinders through processes. In a given week, the
following costs were incurred;
Process I
Input materials 5,000 cylinders Shs. 500,000
Direct labour Shs. 300,000
Process II
Materials added Shs. 200,000
Direct labour Shs. 400,000
 No losses are expected in process I
 10% of normal loss is expected in process II
 Output from process I was 4,800 cylinders & 4,500 cylinders from process II.
Required: prepare,
Page 24 of 79
a) Process I & Process II A/c

b) Abnormal loss A/c
c) Abnormal gain A/c
Solution:
Working Notes:
Input to process I 5,000 Cylinders
Normal loss = 0
Expected output = 5,000 − 0 = 5,000 𝐶𝑦𝑙𝑖𝑛𝑑𝑒𝑟𝑠
Actual Output = 4,800 Units
Abnormal Loss = Actual output – Expected output
= 4,800 – 5,000
= 200 Cylinders
Total Process Costs: Material costs 500,000
Labour Costs 300,000
Overheads (50%×300,000) 150,000
Total 950,000
Cost per unit
𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠

950,000
=
5,000
= 𝑺𝒉𝒔. 𝟏𝟗𝟎 𝒑𝒆𝒓 𝑪𝒚𝒍𝒊𝒏𝒅𝒆𝒓
Output to process II (4,800 × Shs. 190) = Shs. 912,000
Normal Loss - = Shs. 0
Abnormal Loss (200 × Shs. 190) = Shs. 38,000
Total = Shs. 950,000
Caltex Co. Ltd.’
Process I Account
Material Input 5,000 100 500,000 Output to Process II 4,800 190 912,000
Labour costs 300,000 Normal Loss 0 0 0
Overheads 150,000 Abnormal Loss 200 190 38,000
Total 5,000 950,000 5,000 950,000
PROCESS II
Input to process II 4,800 Cylinders
Normal loss = 10% × 4,800 = 480 𝐶𝑦𝑙𝑖𝑛𝑑𝑒𝑟𝑠
Expected output = 4,800 − 480 = 4,320 𝐶𝑦𝑙𝑖𝑛𝑑𝑒𝑟𝑠
Actual Output = 4,500
Abnormal gain (Actual Output > Expected Output) = 180
Total Process Costs: Process I costs 912,000
Materials added 200,000
Page 25 of 79

Overheads (50%×400,000) 200,000
Total 1,712,000
Cost per unit
𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠

1,712,000
=
4,320
= 𝑺𝒉𝒔. 𝟑𝟗𝟔. 𝟑 𝒑𝒆𝒓 𝑪𝒚𝒍𝒊𝒏𝒅𝒆𝒓
Alternatively, price for finished goods & abnormal gain can be obtained by forming an equation as
follows;
Let Price be ‘x’ per unit.
4,500x = Shs. 1,712,000 + 180x
4,320x = Shs. 1,712,000
X = Shs. 396.3
Output to stores (Finished goods) (4,500 × Shs. 396.29) = Shs. 1,783,333
Total = Shs. 1,783,333
Abnormal gain (180 × Shs. 396.29) = Shs. 71,333
Caltex Ltd.’
Process II Account
Dr. For the period ended … Cr
Process I 4,800 190 912,000 Output to stores 4,500 396.29.. 1,783,333
Materials 200,000 Normal Loss 480 - 0
Labour cost 400,000
Overheads 200,000
Abnormal gain 180 396.29.. 71,333
Total 4,980 1,783,333 4,980 1,783,333
Caltex Co. Ltd.’

Abnormal loss Account
Particulars Amount (Shs) Particulars Amount (Shs)
Process I A/c 38,000 P/L A/c 38,000
Total 38,000 38,000
Caltex Co. Ltd.’

Abnormal gain Account
Page 26 of 79
P/L A/c 71,333 Process II A/c 71,333
Total 71,333 71,333

Note: In the above cases, there was no scrap value for both abnormal loss & abnormal gain
units. However, entries would have been different if there was scrap value.
Accounting for Scrap:

Scrap is a residue of materials from certain manufacturing operations that has a
relatively minor recovery value. E.g. saw dusts, filings & Molasses. Thus, revenue from
scrap is treated as a reduction in process cost and not an addition to sales revenue.
The scrap value of normal loss reduces material cost of the process & double entry is
as follows;
 Dr. Scrap A/c
 Cr. Process A/c (with scrap value of normal loss)
The scrap value of abnormal loss is used to reduce the cost of the abnormal loss, this
implies that it reduces the rate of P/L a/c & thus the double entry is as follows;
 Dr. Scrap A/c
 Cr. Abnormal loss A/c (with scrap value units of abnormal loss)
However, this doesn’t pass through the process account.
Scrap value of abnormal gain is treated exactly opposite to the abnormal loss & double
entry is shown below;
 Dr. Abnormal gain A/c (with scrap value of units of abnormal gain)
 Cr. Scrap A/c
Note; this too doesn’t pass through the process account.
Example 4
Coca-Cola Co. Ltd produces a product that passes through 2 processes. The following
data has been supplied to you regarding the 2 processes.
Process 1
 Materials 3,000 Kgs @ Shs. 600 per Kg
 Labour costs Shs. 450,000
 Production overheads Shs. 369,000
The Company normally provides for a normal wastage of 20% of total input, of which
½ can be sold as scrap at Shs. 3,000 per Kg.
Output of the 1st process is transferred to the 2nd process for further processing &
conversion costs required at process 2 will include;
 Labour costs Shs. 90,000
 Production overhead costs Shs. 180,000
Page 27 of 79
The Company normally provides for normal wastage of 10% of input to process 2.
The expected loss doesn’t attract any value i.e. it is waste. Assuming losses will be at
the normal level & there will be no W.I.P.
Required; prepare,
a) Process I A/c
b) Process II A/c
c) Norma loss A/c
d) Scrap A/c
Solution:
Input to process I 3,000 Kgs
Normal loss = 20% × 3,000 = 600 𝐾𝑔𝑠
Expected output = 3,000 − 600 = 2,400 𝐾𝑔𝑠
Actual Output = 2,400 Units (since losses are assumed to be at normal level).
Total Process Costs: Materials 1,800,000
Total 2,619,000
Scrap Value = (1⁄2 × 600 × 3,000) = 𝑆ℎ𝑠. 900,000
Cost per unit

2,619,000 − 900,000
=
2,400
1,719,000
=
2,400
= 𝑺𝒉𝒔. 𝟕𝟏𝟔. 𝟐𝟓 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Output to process II (2,400 × Shs. 716.25) = Shs. 1,719,000
Normal Loss (300 × Shs. 3,000) = Shs. 900,000
Total 2,619,000
Coca-Cola Co. Ltd.’
Process I Account
Material Input 3,000 600 1,800,000 Output to Process II 2,400 716.25 1,719,000
Labour costs 450,000 Normal Loss 600 3,000 900,000
Production O/H 369,000
Total 3,000 2,619,000 3,000 2,619,000
PROCESS II
Input to process II 2,400 Kgs
Normal loss = 10% × 2,400 = 240 𝐾𝑔𝑠
Expected output = 2,400 − 240 = 2,160 𝐾𝑔𝑠
Page 28 of 79
Actual Output = 2,160 Units (since losses are assumed to be at normal level).
Total Process Costs: Process I costs 1,719,000
Labour Costs 90,000
Total 1,989,000
Cost per unit

1,989,000 − 0
=
2,160
2,889,000
=
2,160
= 𝑺𝒉𝒔. 𝟗𝟐𝟎. 𝟖𝟑 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Output to stores (2,160 × Shs. 920.83) = Shs. 1,989,000
Total = Shs. 1,989,000
Coca-Cola Ltd.’
Process II Account
Process I 2,400 716.25 1,719,000 Output to stores 2,160 920.83 1,989,000
Labour cost 90,000 Normal Loss 240 - 0
Production O/H 180,000
Total 2,400 1,989,000 2,400 1,989,000
Coca-Cola Ltd.’
Normal loss Account
Process I A/c 900,000 Scrap A/c 900,000
Total 900,000 900,000
Coca-Cola Ltd.’
Scrap Account
Normal loss A/c 900,000 Bal. C/d 900,000
Total 900,000 900,000

Example 5
Page 29 of 79
Total Oil Co. Ltd makes oil that passes through three production processes 1, 2 & 3.
In the month of February 6,000 litres of the basic raw material priced at Shs. 240,000
were introduced into process- 1. Subsequently the following costs were incurred;
PROCESS
Particulars TOTAL (Shs)
1 2 3
Direct materials (additional) 87,500 30,000 40,000 17,500
Direct labour 110,000 40,000 50,000 20,000
Direct expenses 16,900 6,000 1,600 9,300
Normal loss per process was estimated as;
 Process 1 10%
 Process 2 5%
 Process 3 8%
Output of each process was;
 Process 1 5,300
 Process 2 5,000
 Process 3 4,700
The loss in each process presented scrap which could be sold off at the following
values;
 Process 1 Shs. 10 per unit
There was no stock of material or W.I.P at the beginning or the end of the month.
The output of each process passes directly to the next process & finally to finished
stock.
Production overhead is absorbed by each process on a basis of 50% of the cost of
direct labour.
Required: prepare,
a) Separate process accounts for each of the three processes
b) Abnormal loss, abnormal gain & scrap accounts.
Solution:
Process 1
Input 6,000
Normal loss (10% × 6,000) 600
Expected output 5,400
Actual output 5,300
Abnormal loss 100
Total Process Costs: Raw materials 240,000
Direct labour 40,000
Page 30 of 79
Production Overheads (50%×40,000) 20,000

Total 336,000
Scrap value (600 × Shs. 20) = Shs. 12,000
Cost per unit

336,000 − 12,000
=
5,400
= 𝑺𝒉𝒔. 𝟔𝟎 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Total Oil Co. Ltd.’
Process I Account
Materials 6,000 40 240,000 Output to Process 2 5,300 60 318,000
Materials (added) 30,000 Normal Loss 600 20 12,000
Labour cost 40,000 Abnormal loss 100 60 6,000
Overheads 20,000
Total 6,000 336,000 6,000 336,000
Process 2
Input 5,300
Normal loss (5% × 5,300) 265
Actual output 5,000
Abnormal loss 35
Total Process Costs: Process 1 318,000
Total 434,600
Cost per unit

434,600 − 11,660
=
5,035
= 𝑺𝒉𝒔. 𝟖𝟒 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Process II Account
Page 31 of 79

Process 1 costs 5,300 60 318,000 Output to process 3 5,000 84 420,000
Labour cost 50,000 Abnormal loss 35 84 2,940
Overheads 25,000
Total 5,300 434,600 5,300 434,600
Process 3
Input 5,000
Normal loss (8% × 5,000) 400
Actual output 4,700
Abnormal Gain 100
Total Process Costs: Process 2 Costs 420,000
Total 476,800
Cost per unit

476,800 − 26,000
=
4,600
= 𝑺𝒉𝒔. 𝟗𝟖 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Process III Account
Process 1 costs 5,000 84 420,000 Output to stores 4,700 98 460,600
Labour cost 20,000
Overheads 10,000
Abnormal Gain 100 98 9,800
Total 5,100 486,600 5,100 486,600

Page 32 of 79

Process 2 A/c 6,000
Total 8,940 8,940

P/L A/c 9,800 Process 3 A/c 9,800
Total 9,800 9,800

Scrap Account
Process 2 A/c 11,660
Process 3 A/c 26,000
Total 49,660 49,660
Example 6
Riham Co. Ltd deals in producing beverage products. The processing process involves
only 1 process. The budgeted amount for the month of February 2020, includes the
following.
Units introduced are 30,000 liters at Shs. 400 each
Conversion costs include: Direct wages Shs. 6,000,000
Direct expenses Shs. 3,525,000
Overheads absorbed at 50% of direct wages
Rihams’ policy is to provide for normal loss of 5% of total input to the process &
scrapped units are sold at a give a way price of Shs. 200 per litre. However, scrapped
units as a result of abnormal loss attract Shs. 250 per litre. At the end of the process,
actual output amounted to 28,000 litres and there was no W.I.P.
Required; prepare,
a) Process a/c
b) Normal loss, Scrap, and Abnormal loss a/c
Solution:
Input 30,000
Normal loss (5% × 30,000) 1,500
Actual output 28,000
Page 33 of 79
Abnormal loss 500

Total Process Costs: Raw materials (30,000 ltrs × 400) 12,000,000
Direct Wages 6,000,000
Direct expenses 3,525,000
Production Overheads (50%×12,000,000) 3,000,000
Total 24,525,000
Scrap value (1,500 × Shs. 200) = Shs. 300,000
Cost per unit

24,525,000 − 300,000
=
28,500
= 𝑺𝒉𝒔. 𝟖𝟓𝟎 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Riham Co. Ltd.’
Process Account
Dr. For the period ended Feb, 2020 Cr
Materials 30,000 400 12,000,000 Output to stores 28,000 850 23,800,000
Direct wages 6,000,000 Normal Loss 1,500 200 300 ,000
Direct expenses 3,525,000 Abnormal loss 500 850 425,000
Overheads 3,000,000
Total 30,000 24,525,000 30,000 24,525,000
Riham Co. Ltd.’

Normal loss Account
Dr. For the period ended Feb. 2020 Cr
Process A/c 300,000 Scrap A/c 300,000
Total 300,000 300,000
Riham Co. Ltd.’

Scrap Account
Particulars Amount Particulars Amount (Shs)
(Shs)
Normal loss A/c 300,000 Bal. C/d 425,000
Abnormal loss A/c (500 ltrs. × 250) 125,000
Total 425,000 425,000
Riham Co. Ltd.’
Page 34 of 79

P & L A/c 175,000
Total 300,000 300,000
Example 7
A manufacturing processes shoes through a single process. At the end of the month
of March, 2020, raw materials were 10,000 kgs, at Shs. 600 each which were
introduced & processed. Other costs incurred during the process include;
Direct wages Shs. 4,300,000
Direct expenses Shs. 627, 600
Production overheads absorbed at 25% of the cost of materials introduced. The policy
of the company is to provide for normal loss of 12% of input to process & any scrap
unit can attract a price of Shs. 600 per Kg. at the end of manufacture, the company
registered actual output of 9,000 Kgs.
Required; prepare,
Process, abnormal gain & scrap a/c.
Solution;
Input 10,000
Normal loss (12% × 10,000) 1,200
Actual output 9,000
Abnormal gain 200
Total Process Costs: Raw materials (10,000 Kg. × 600) 6,000,000
Direct Wages 4,300,000
Production Overheads (25%×10,000,000) 1,500,000
Total 12,427,600
Scrap value (1,200 × Shs. 600) = Shs. 720,000
Cost per unit

12,427,000 − 720,000
=
8,800
= 𝑺𝒉𝒔. 𝟏, 𝟑𝟑𝟎. 𝟒 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕
Manufacturing Co. Ltd.’
Process Account
Dr. For the period ended March, 2020 Cr
Materials 10,000 600 6,000,000 Output to stores 9,000 1,330.4 11,973,682
Page 35 of 79
Direct wages 4,300,000 Normal Loss 1,200 200 720,000

Overheads 1,500,000
Abnormal gain 200 1,330.4 266,082
Total 10,000 12,693,682 10,000 12,693,682

Dr. For the period ended Mar. 2020 Cr
Scrap A/c 120,000 Process A/c 266,082
P & L a/c 146,082
Total 266,082 266,082

Scrap Account
Normal loss A/c 720,000 Abnormal gain A/c 120,000
Bal C/d 600,000
Total 720,000 720,000

Normal loss Account
Dr. For the period ended Mar. 2020 Cr
Total 720,000 720,000

Loss on scrap: expected sale of scrap = 1,200Kgs × 600 =720,000
Less Actual sale of scrap = 1,000 kgs × 600 = 600,000
Lost amount (200 Kgs × 600) = 120,000
Student exercise
Meat product is obtained after it passes through three distinct processes. You are
required to prepare process account from the following information:
Processes
Items
Totals 1 2 3
Materials 15,000 6,800 3,000 5,200
Direct wages 8,000 4,000 6,000 8,000
Production overheads 18,000 - - -
Page 36 of 79
1,000 units @ Shs. 600 per unit was introduced in Process 1 production overhead to
be distributed at 100% on direct wages.
Actual output Unit Normal loss Value of scrap per unit
Process 1 9,500 5% 400
Process 2 8,400 10% 800
Process 3 7,500 15% 1,000
JOINT & BY – PRODUCTS

In several industries more than one product emerge from the manufacturing process.
These products are sometimes produced intentionally while in some cases they emerge
out of the main manufacturing process. Such products are termed as either joint
products or by-products.
According to CIMA, joint products are “two or more products separated in the course of
processing each having a sufficiently high value to merit recognition as a main product”. Joint
products imply that they are produced from the same basic raw material, are
comparatively of equal importance, are produced simultaneously by a common
process and may require further processing after the point of separation.
Examples of Joint products may include; petrol & paraffin, butter & Cheese, hides &
skins, etc.
Terms used in Accounting for Joint products
Split - Off Point: This is a point up to which, input factors are commonly used for
production of multiple products, which can be either joint products or by-products.
After this point, the joint products or by-products gain individual identity. In other
words, up to a certain stage, the manufacturing process is the same for all the products
and a stage comes after which, the individual processing becomes different and
distinct. For example, in a dairy, several products like, milk, ghee, butter, milk powder,
ice-cream etc. may be produced. The common material is milk. The pasteurization of
milk is a common process for all the products and after this process; each product has
to be processed separately. This point is of special significance in the accounting of
joint product and by-products because the joint cost incurred before this point is to
be apportioned appropriately in the joint products.
Joint Costs: Joint cost is the pre - separation cost of commonly used input factors for
the production of multiple products. In other words, all costs incurred before or up
to the split off point are termed as joint costs or pre - separation costs and the
apportionment of these costs is the main objective of joint product accounting. Costs
incurred after the split off point are post - separation costs and can be easily identified
with the products.
ACCOUNTING FOR JOINT PRODUCTS
Page 37 of 79
In case of joint products, the main objective of accounting of the cost is to apportion
the joint costs incurred up to the split off point. As seen earlier, the manufacturing
process is the same up to a certain stage and after crossing that stage; each product has
distinct manufacturing process. Therefore the main problem is apportionment of the
joint cost or the cost incurred up to the split off point. The total cost of production of the
joint product will be cost incurred up to the split off point duly apportioned plus the cost incurred
after the split off point. There is no problem of charging the cost incurred after the split
off point as the cost can be identified easily.
Apportioning costs of Joint products
The main problem Joint product costing is that of apportionment of the joint costs
and for this reason, the following methods are used for apportioning the same.
Physical Quantity Method: Under this method, cost apportionment is made in
proportion to the volume (physical weight/value) of production. These physical
measures may be units, pounds, liters, kilos, tones, gallons, etc. this method is more
suitable where Joint products have almost equal value.
Formula; 𝑪𝒐𝒔𝒕 𝑨𝒑𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒆𝒅 𝒕𝒐 𝒆𝒂𝒄𝒉 𝒑𝒓𝒐𝒅𝒖𝒄𝒕 = 𝑻𝒐𝒕𝒂𝒍 𝑼𝒏𝒊𝒕𝒔 𝒐𝒇 𝒆𝒂𝒄𝒉 𝒑𝒓𝒐𝒅𝒖𝒄𝒕
𝑻𝒐𝒕𝒂𝒍 𝒖𝒏𝒊𝒕𝒔 𝒐𝒇 𝒂𝒍𝒍 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒔
× 𝑱𝒐𝒊𝒏𝒕 𝑪𝒐𝒔𝒕𝒔
Worked example 1
A process produces three products namely, A, B, & C. Total joint costs for the month
of April, 2020 were Shs. 960,000. The output & selling prices of these products were
as follows;
Product Units
produced
A 2,000
B 1,600
C 1,200
Required;
Apportion the joint costs & calculate the profit of each product using Physical unit
method.
Solution;
Product Output/weight Share of joint costs Unit cost
𝟐, 𝟎𝟎𝟎 𝟒𝟎𝟎, 𝟎𝟎𝟎
A 2,000 = × 𝟗𝟔𝟎, 𝟎𝟎𝟎 = 𝟒𝟎𝟎, 𝟎𝟎𝟎 = = 𝑺𝒉𝒔. 𝟐𝟎𝟎
𝟒, 𝟖𝟎𝟎 𝟒, 𝟎𝟎𝟎
B 1,600 =
𝟏, 𝟔𝟎𝟎
× 𝟗𝟔𝟎, 𝟎𝟎𝟎 = 𝟑𝟐𝟎, 𝟎𝟎𝟎 =
𝟑𝟐𝟎, 𝟎𝟎𝟎
= 𝑺𝒉𝒔. 𝟐𝟎𝟎
𝟒, 𝟖𝟎𝟎 𝟏, 𝟔𝟎𝟎
C 1,200 𝟏, 𝟐𝟎𝟎 𝟐𝟒𝟎, 𝟎𝟎𝟎

= × 𝟗𝟔𝟎, 𝟎𝟎𝟎 = 𝟐𝟒𝟎, 𝟎𝟎𝟎 = = 𝑺𝒉𝒔. 𝟐𝟎𝟎
𝟒, 𝟖𝟎𝟎 𝟏, 𝟐𝟎𝟎
Total 4,800 Shs. 960,000
Page 38 of 79
Selling Price/market value Method: Under this method, the joint cost is apportioned
on the basis of sales value at the split off point. The logic is that a product should bear
the share of the joint cost according to its sale price. If sales price is higher than that
of the other products, more share of joint cost should be charged to that product and
if it is comparatively less than that of other products, less share of joint cost should be
charged to the same. Though logically this method seems to be sound, in practice,
charging higher share of joint cost to the product with higher sales value may not be
justified due to the fact that lesser efforts are required for manufacturing of the same.
𝑻𝒐𝒕𝒂𝒍 𝑺𝒂𝒍𝒆𝒔 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒂 𝒑𝒓𝒐𝒅𝒖𝒄𝒕
𝑱𝒐𝒊𝒏𝒕 𝒄𝒐𝒔𝒕 𝒂𝒑𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒎𝒆𝒏𝒕 = × 𝑱𝒐𝒊𝒏𝒕 𝒄𝒐𝒔𝒕𝒔
𝑻𝒐𝒕𝒂𝒍 𝑺𝒂𝒍𝒆𝒔 𝒐𝒇 𝒂𝒍𝒍 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒔
Worked example 2
Using the same information in worked example 1, assume the Company selling prices
of joint products as follows;
Product Units Selling price per
produced unit (Shs)
A 2,000 260
B 1,600 300
C 1,200 500
Required;
Apportion the joint costs & calculate the profit of each product using selling price
method
Solution;
Product Units Sales value Costs Profit Apportioned costs Ratio Unit cost
A 2,000 2,000 × 260 = 520,000 400,000 120,000 312,000 32.5% 156
B 1,600 1,600 × 300 = 480,000 320,000 160,000 288,000 30% 180
C 1,200 1,200 × 500 = 600,000 240,000 360,000 360,000 37.5% 300
Total 4,800 1,600,000 960,000 640,000 960,000 100%
Note:
Sales value = units × selling price
Profit = Sales value – costs
Ratio = Product’s sales value/Total sales value × 100
Unit cost = Apportioned costs/product’s units
Worked example:
BBA Co. Ltd., in the course of refining crude oil obtains four joint products A, B, C
and D. The total cost till the split-off point was Shs. 97,600,000. The output and sales
in the year 2019 were as follows:
Product Output Bal. Sales Separate costs
A 500,000 115,000 30,000
B 10,000 10,000 6,000
Page 39 of 79
C 5,000 4,000 –
D 9,000 30,000 1,000
Required:
a) Calculate the net income for each of the products if the joint costs are apportioned
on the basis of sales value of the different products.
b) What would be the net income of the company from each product if it decides to
sell the products at the split off point itself A - Shs150, B – Shs 500, C – Shs 800
and D – Shs 3,000 per gallon.
c) In case the company expects to operate at the same level of production and sales
in the year 2020 could the company increase the net income by altering its
processing decisions? If so, what would be the expected overall net income? Which
product should be sold at split off? Assume that all costs incurred after the split -
off are variable.
Solution:
BBA Co. Ltd
Profit after Further Processing Statement
Particulars Products
A (Shs B (Shs C (Shs D (Shs Total Shs
‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales after further processing 115,000 10,000 4,000 30,000 159,000
Separate costs 30,000 6,000 - 1,000 37,000
Sales at split-off 85,000 4,000 4,000 29,000 122,000
Joint costs (NRV basis) 68,000 3,200 3,200 23,200 97,600
Profit 17,000 800 800 5,800 24,400
Note; sales = selling price × output per unit
NRV (sales at split-off) = Sales – Separate costs
Joint costs = Sales at split-off/Total sales at split-off × Joint costs
BBA Co. Ltd
Profit Before Further Processing Statement
‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales at Split-off 75,000 5,000 4,000 27,000 111,000
Profit 7,000 1,800 800 3,800 13,400
BBA Co. Ltd
Incremental /Additional Profit By Further Processing Statement
Page 40 of 79

‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales after further processing 115,000 10,000 4,000 30,000 159,000
Sales before further processing 75,000 5,000 4,000 27,000 111,000
Incremental sales 40,000 5,000 - 3,000 48,000
Incremental /separate costs 30,000 6,000 - 1,000 37,000
Incremental Profit/loss 10,000 (1,000) Nil 2,000 11,000
Therefore, products A & D should be further processed because there is an additional profit
whereas, products B & C need not to be further processed because there is no additional profit.
Computation of profit by implementing decision.
Shs ‘000’
Profit from A 17,000
Profit from B 1,800
Profit from C 800
Profit from D 5,800
Total 25,400
Constant Gross profit % method: under this method, constant gross profit % of all
Joint products is determined by calculating the ratio of absolute gross profit to total
sales of Joint products.
𝑨𝒃𝒔𝒐𝒍𝒖𝒕𝒆 𝒈𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕 = 𝑻𝒐𝒕𝒂𝒍 𝒋𝒐𝒊𝒏𝒕 𝒑𝒓𝒐𝒅𝒖𝒄𝒕 𝒔𝒂𝒍𝒆𝒔 − 𝒕𝒐𝒕𝒂𝒍 𝒑𝒓𝒐𝒄𝒆𝒔𝒔 𝒄𝒐𝒔𝒕𝒔
𝑻𝒐𝒕𝒂𝒍 𝒑𝒓𝒐𝒄𝒆𝒔𝒔 𝒄𝒐𝒔𝒕𝒔 = 𝑱𝒐𝒊𝒏𝒕 𝒄𝒐𝒔𝒕𝒔 + 𝒇𝒖𝒓𝒕𝒉𝒆𝒓 𝒑𝒓𝒐𝒄𝒆𝒔𝒔 𝒄𝒐𝒔𝒕𝒔
𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕
𝑪𝒐𝒏𝒔𝒕𝒂𝒏𝒕 𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕 = × 𝟏𝟎𝟎
𝑻𝒐𝒕𝒂𝒍 𝑺𝒂𝒍𝒆𝒔
The % so calculated is then applied on individual joint product’s sales to determine
the gross profit for individual products which is offset from the products’ sales to get
total process costs.
Worked example 3
Gas petrol Station processes oil products including petrol, paraffin & Gas through a
joint process. The following information represents details for the month of January,
2020.
Products units
Petrol 30,000 litres
Paraffin 22,000 litres
Gas 9,000 Kgs
The costs of raw-materials & conversion prior to the split-off point includes 70,000
litres of petrol at 300 shs each, labour costs are Shs. 10,000,000 & overhead costs
are Shs. 9,800,000.
Gas petrol station could not sell all these products at the split-off point & all were
subjected to another process & the following conversion costs were incurred;
Page 41 of 79
Costs Petrol Paraffin Gas

Labour costs 2,500,000 2,500,000 2,500,000
Overhead costs 3,000,000 2,700,000 2,000,000
The Company managed to sell the products at the following prices after they have
been further processed.
Products selling price per unit (shs)
Petrol 2,000
Paraffin 900
Gas 4,000
Required;
a) Apportion Joint costs to Joint products using constant gross profit % method
b) Prepare profit for each product & overall statement for all Joint products if the
operating expenses are as follows;
Products selling price per unit (shs)
Petrol 3,300,000
Paraffin 2,200,000
Gas 5,100,000
c) Calculate the selling price of each Joint product if Gas Petrol station’s target is to
get 30% gross profit on sales.
Solution;
Determining gross %
Gross profit = Total sales – Total process costs
Calculating Total sales
Product Shs ‘000’
Petrol (30,000 ltrs × Shs. 900) 27,000
Paraffin (22,000 ltrs × Shs. 2,000) 44,000
Gas (9,000 Kgs × Shs. 4,000) 36,000
Total sales Shs. 107,000
Calculating Total Process Costs
Product Shs ‘000’
Petrol (Raw-material) (70,000 ltrs × Shs. 300) 21,000
Labour costs 10,000
Overhead costs 9,800
Total Joint costs 40,800
Add: further process costs:
Petrol: Labour Costs 2,500
Overhead costs 3,000 5,500
Paraffin: Labour costs 2,500
Gas: Labour costs 2,500
Page 42 of 79

Total process costs 56,000
Thus, Gross profit = Total sales – Total process costs
= 107,000 - 56,000
= shs. 51,000
Gross profit % = 𝑮𝒓𝒐𝒔𝒔 𝑷𝒓𝒐𝒇𝒊𝒕
𝑻𝒐𝒕𝒂𝒍 𝑺𝒂𝒍𝒆𝒔
× 𝟏𝟎𝟎
= 𝟏𝟎𝟕,𝟎𝟎𝟎 × 𝟏𝟎𝟎
𝟓𝟏,𝟎𝟎𝟎
= 48%
a) Apportionment of Joint product costs
Product Petrol Paraffin Gas Total
Total sales 27,000 44,000 36,000 107,000
Gross Profit 48% sales (12,960) (21,120) (17,280) (51,360)
Total process costs 14,040 22,880 18,720 55,640
Less further costs (5,500) (5,200) (4,500) (15,200)
Apportioned Joint costs 8,540 17,680 14,220 40,440
b) Profit statement
Product Petrol Paraffin Gas Total
Total sales 27,000 44,000 36,000 107,000
Less process costs 14,040 22,880 18,720 55,640
Gross profit 12,960 21,120 17,280 51,360
Operating expenses 3,300 2,200 5,100 10,600
Net profit 9,660 18,920 12,180 40,760
c) Determining Unit selling price
Product Units Process costs Unit cost Unit selling px.
Petrol 30,000 14,040 468 702
Paraffin 22,000 22,880 1,040 1,560
Gas 9,000 18,720 2,080 3,120
Note:
Unit cost = Total production costs/No. of units
Total product costs = Apportioned costs + Further process costs
Unit selling price = unit cost + (Mark-up × unit cost)
Mark-up = 48/100 = ½, since margin = 1/3
Thus, Petrol = 468+ (1/2 × 468) = 702
Paraffin = 1,040 + (1/2×1,040) = 1,560
Gas = 2,080 + (1/2 × 2,080) = 3,120
Net Realizable value method; this method is used if the sales value of the Joint
products can’t be readily determinable at the split-off point. Because of this, these
products need to be further processed so that they can be made ready for sale. Since
they need to be subjected to another process, more costs will be incurred to run the
operation and these costs are known as further process costs. Such cost are treated as
direct costs to the product being processed.
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To apply this method, further process costs incurred are offset from individual sales
of the joint product to determine estimated sales at the split-off point. The estimated
(notional sales) are based on to apportion or assign joint costs to joint products in a
proportion each product’s notional sales bear to total notional sales of the Joint
products.
Notional sales = Products’ sales – Further costs
Worked example:
A vegetable Oil refining Company obtains 4 products whose cost details are:
Joint costs of the 4 products Shs. 829,600
Outputs: A - 500,000 litres
B- 10,000 litres
C - 5,000 litres
D - 9,000 Kgs.
Further processing costs: A - Shs. 240,000
B- Shs. 48,000
C - Shs. Nil
D - Shs. 8,030
The products can be sold as intermediates i.e. at split-off point without further
processing. The sale prices are:
As finished product As Intermediate
A – Shs. Per litre 1,840 1,200
B – Shs. Per litre 8,000 4,000
C – Shs. Per litre 6,400 6,400
D – Shs. per Kg. 26,670 24,000
Required;
a) Determine the product-wise profit allocating joint costs on net realizable values
b) Compare the profitability in selling the products with & without further
processing.
Solution:
Vegetable Oil Refining Co. Ltd
Profit after Further Processing Statement (Finished Product)
‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales after further processing 920,000 80,000 32,000 240,030 1,272,030
Further costs 240,000 48,000 - 8,030 296,030
NRV (sales at split-off) 680,000 32,000 32,000 232,000 976,000
Profit 102,000 4,800 4,800 34,800 146,400
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Note; sales = selling price × output per unit

NRV (sales at split-off) = sales – further costs
Joint costs = Products’ NRV/Total NRV × Joint costs
Profit Before Further Processing Statement (Intermediate Product)
‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales at Split-off 600,000 40,000 32,000 216,000 888,000
Profit 22,000 12,800 4,800 18,800 58,400

‘000’) ‘000’) ‘000’) ‘000’) ‘000’
Sales after further processing 920,000 80,000 32,000 240,030 1,272,030
Sales before further processing 600,000 40,000 32,000 216,000 888,000
Incremental profit 320,000 40,000 - 24,030 384,030
Incremental costs 240,000 48,000 - 8,030 296,030
Profit 80,000 (8,000) Nil 16,000 88,000
Therefore, products A & D should be further processed because there is an incremental profit
whereas, products B & C need not to be further processed.
Worked Example
Beauty soap Company manufactures four different brands of soaps namely Olive oil,
Lovely, Makeup and Nice. The data on production and sale of these brands during
2019 is reproduced below.
Brand Name Olive Oil Lovely Make-up Nice
Production & sales (Units) 300,000 500,000 70,000 40,000
Sales value 15,000 31,000 2,800 1,200
All the above soaps are manufactured jointly up to a particular process. At split off
point they are formed into cake-sand packed. The annual cost data were as under.
Direct material costs Shs 3,000,000
Value added Shs. 2,000,000
This includes profit at 25% on total cost
Out of the above brands, Make up is sold in unpacked condition without further
processing while other 3 brands further processed at an additional cost:
Olive Oil Shs. 120,000
Lovely Shs. 130,000
Page 45 of 79
Nice Shs. 50,000

You are required to:-
a) Work out the profit and cost of each brand of soap after allocating joint cost on
the basis of Net Realizable value at split up point. (Per unit cost not required).
b) Find out revised cost and profit on each brand if the company decides to sell all
soaps at split up point at following prices; Olive Oil Shs. 4.50; Lovely Shs. 6.00;
Make up Shs. 4.00 and Nice Shs. 1.50 per unit. Assume that for allocation of joint
cost net Realizable value method is used.
c) With the working results in (a) and (b) above advise Beauty Soap Company about
the processing decision as to which soap to be sold at split of point and which to
be processed further so as to maximize profit. Substantiate your decision with
suitable costing to technique.
Solution:
Computing Joint Costs
Particulars Shs ‘000’
Add value added 2,000
Total sales 5,000
Less Profit @ 25% on cost (i.e. 20% on sales) 1,000
Total costs 4,000
Less separate costs 300
Joint costs 3,700
Note: margin is on Cost & mark-up is on Sales
i.e. 25% profit on cost = 25/100 = ¼
profit on sales = ¼ + 1 = 1/5 = 20%
Beauty Soap Co. Ltd
Profit after Further Processing Statement
Olive Oil Lovely Make-up Nice) Total
Sales after further processing 1,500,000 3,100,000 280,000 120,000 5,000,000
Further costs 120,000 130,000 - 50,000 300,000
NRV (sales at split-off) 1,380,000 2,970,000 280,000 70,000 4,700,000
Joint costs (NRV basis) 1,086,333 2,338,085 220,426 55,106 3,700,000
Profit/loss 293,617 631,915 59,574 14,894 1,000,000
Note; sales after further processing = Products’ Sales Value/Total sales value × Total sales
Beauty Soap Co. Ltd
Profit Before Further Processing Statement
Olive Oil Lovely Make-up Nice Total
Sales at Split-off 1,350,000 3,100,000 280,000 60,000 4,690,000
Joint costs (NRV basis) 1,086,383 2,338,085 220,426 55,106 3,700,000
Profit 293,617 661, 915 59,574 4,894 990,000
Page 46 of 79
Beauty Soap Co. Ltd

Olive Oil Lovely Make-up Nice Total
Sales after further processing 1,500,000 3,100,000 280,000 120,000 5,000,000
Sales before further processing 1,350,000 3,000,000 280,000 60,000 4,690,000
Incremental sales 150,000 100,000 - 60,000 310,000
Separate costs 120,000 130,000 - 50,000 300,000
Additional Profit/loss 30,000 (30,000) Nil 10,000 10,000
Therefore, products Olive Oil & Nice should be further processed because there is an additional
profit whereas, Lovely & Make-up need not to be further processed.
Weighted Average Method: Under this method, weights are assigned to each unit
based upon size of the units, difference in type of labor employed, material
consumption, market share, efforts of labour required and so on. The joint cost is
apportioned on the basis of the weights assigned to each product. This method is
highly useful if the weights assigned are on objective basis. If subjective element creeps
in, the method may not give accurate results.
Worked example:
The following data have been extracted from the books of Gulu Coke Co. Ltd
Joint products Yield in LB of recovered products per Tonne of coal
Coke 1,420
Coal Tar 120
Benzol 22
Sulphate of Ammonia 26
Gas 412
Total 2,000
The price of coal is Shs. 80,000 per tonne. The direct labour & overhead costs to the
point of split-off are Shs. 40,000 & Shs. 60,000 respectively per tonne of coal.
Required;
Calculate the material, labour & total cost of each product on the basis of weight.
Solution:
Elements
Costs Coke Coal tar Benzol Sulphate Gas
Total 1,420 120 22 26 412
Materials 80,000 56,800 4,800 880 1,040 16,480
Labour 40,000 28,400 2,400 440 520 8,240
Overheads 60,000 42,600 3,600 660 780 12,360
180,000 127,800 10,800 1,980 2,340 37,080
MEANING OF BY-PRODUCTS:
Page 47 of 79
The term ‘by-products’ is sometimes used synonymously with the term ‘minor products’.
The by-product is a secondary product, which incidentally results from the
manufacture of a main product. By–products are also produced from the same raw
material and same process operations but they are secondary results of operation.
The main difference between the joint product and by - product is that there is no
intention to produce the by-product while the joint products are produced
intentionally. The relationship between the by-product and the main product changes
with changes in economic or industrial conditions or with advancement of science.
The by-product of an industry may become a main product and main product may
become a by-product subsequently.
For example, (a) in sugar industry, sugar is a main product and molasses is a by-product
(b) in coke ovens, gas and tar are incidentally produced in addition to the main
product coke. Gas and tar are, therefore, treated as by-products. These minor
secondary products have saleable or usable value and are incidentally produced in
addition to the main product.
According to CIMA, By-product is “a product which is recovered incidentally from the
material used in the manufacture of recognized main products such as having either a net
realizable value or a usable value which is relatively low in comparison with the saleable value
of the main products. By products may further be processed to increase their realizable value”.
Thus the term ‘by-product’ is generally used by businessmen and accountants to
denote one or more products of relatively small value that are produced
simultaneously with a product of greater value.
Classification of By-Products:
By-products can be classified into two groups according to marketable conditions at
the split off point:
a) Those sold in the same form as originally produced, and
b) Those which may undergo further processing before sale.
Accounting treatment of By - Products:
By-products are jointly produced products of minor importance and do not have
separate costs until the split off point. They are not produced intentionally but are
emerging out of the manufacturing process of the main products.
Methods used in Accounting for By - Products
The following methods are used for accounting of by-products. The methods are
broadly divided into Non-Cost Methods and Cost Methods.
1. Non-Cost Methods: The following methods are included in this category.
a) Other income or miscellaneous income method: Under this method, sales value
of by-products is credited to the Profit and Loss Account and no credit is given in
the Cost Accounts. The credit to the Profit and Loss Account is treated as other
Page 48 of 79
income or miscellaneous income. No effort is made for ascertaining the cost of the
product. No valuation of inventory is made and all costs and expenses are charged
to the main product. This is the least scientific method and is used where the sales
value of the by-product is negligible.
Worked example
DBA Company processes 3,400 Kgs of meat in a month & this is sold at Shs. 2,000
per Kg. the total costs of products arising from the main production process is Shs.
2,750,000. Bones totaling to 7,000 Kgs are obtained & sold at Shs. 90 per Kg. the
Company however spends Shs 32 per Kg for packing & distribution of bones.
Required. Compute the company’s profit using miscellaneous income method
Solution:
Sale of main product (3,400 Kg × 2,000) 6,800
Less Joint costs (production costs) 2,750
Gross profit 4,050
Add: by-product income (90 – 32) × 7,000 406
Grand profit 4,456
b) Total sales less total cost: Under this method, sales value of by-product is added to
the sales value of the main product. Further the total cost of the main product
including the cost of the by-product is deducted from the sales revenue of the main
product and by-product. All costs and expenses are charged to the main product.
Worked example
Required. Compute the company’s profit using total sales less total cost method
Solution:
Particulars Shs ‘000’ Shs ‘000’
Add by-product sales (7,000 Kgs × 90) 630 7,430
Less Total Costs:
Joint costs (production costs) 2,750
By-product costs (7,000 Kgs × 32) 224 2,974
Grand profit 4,456
c) Total cost less sales value of by-product: In this method, the total cost of
production is reduced by the sales value of the by-product. This method seems to
be more acceptable because like waste and scrap, by-product revenue reduces the
cost of major products.
Worked example
Page 49 of 79
Required. Compute the company’s profit using total cost less sales value of by-product
method
Solution:
Less Joint costs (production costs) 2,750
Less by-product income (90 – 32) × 7,000 406 2,344
Grand profit 4,456
d) Total cost less sales value of by-products after setting off selling and distribution
overheads of by-products: Sales value of the by-product minus the selling and
distribution overheads of by-product is deducted from the total cost. Selling and
distribution overheads are charged against by-products actually sold.
e) Reverse cost method: This method is based on the view that the sales value of the
by-product contains an element of profit. It is agreed that this element of profit
should not be credited to the Profit and Loss Account. The cost of by-product is
arrived at by working backwards. Selling price of the by-product is deflated by an
assumed gross profit margin. Thus under this method, sales value of the by-product
is first reduced by, an estimated profit margin, selling and distribution expenses
and then the post- split - off costs and then the cost of the main product is thus
reduced by this net figure.
Worked example
In manufacturing the main product ‘A’ a company processes the resulting waste
material into two by products B and C.
Total cost up-to separation point was Shs 68,000
Products
Particulars
A B C
Sales (all production) 164,000 16,000 24,000
Estimated net profit (% to sales value) - 20% 30%
Estimated selling expenses as % of sales value 20% 20% 20%
Cost after separation - 4,800 7,200
Required:
Prepare a comparative profit and loss statement of the three products from the above
data using reversal cost method of by-products.
Solution:
Apportionment of Joint expenses for the products
Page 50 of 79
Particulars B C
Sales 16,000 24,000
Less profits 3,200 7,200
Total costs 12,800 16,800
Less selling expenses 3,200 4,800
Manufacturing costs 9,600 12,000
Less separate expenses 4,800 7,200
Joint expenses 4,800 4,800
Profit & loss Statement
Products
Particulars Total
A B C
Joint Cost 58,400 4,800 4,800 68,000
Add Separate costs - 4,800 7,200 12,000
Manufacturing costs 58,400 9,600 12,000 80,000
Add Selling expenses 32,800 3,200 4,800 40,800
Total costs 91,200 12,800 16,800 120,800
Profits 72,800 3,200 7,200 83,200
Sales 164,000 16,000 24,000 204,000
Note: Joint expenses of product A = 68,000 – (4,800 + 4,800) = 58,400
2. Cost Methods: The following methods are included in this category.
i. Replacement or opportunity cost method: If the by-products are consumed
captively, they are valued at the opportunity cost method or replacement cost
method. This means the cost which would have been incurred had the by-product
been purchased from outside. For example, bagasse, which is one of the main by-
product of sugar industry and which is used for the factory as a fuel in the boiler
is valued at the market value, i.e. the price that would have been paid if it would
have been purchased from outside.
ii. Standard cost method: Under this method, the by-product is valued at the
standard cost determined for each product. The standard cost may be based on
technical assessment. Standard cost of the by-product is credited to the process
account of the main product. Accordingly, the cost control of main product can
be exercised effectively
iii. Joint cost proration: Where the by-product is of some significance, it is appropriate
that the joint costs should be apportioned between the main products and by-
products on a most suitable and acceptable method. Thus in this method, no
distinction is made between the joint product and by-product. Industries, where
the by-products are quite important, use this method. For example, in a petroleum
refinery, gas was earlier considered as a by-product. Now it has assumed the
importance like petrol, diesel etc. and is being treated as joint product.
Accordingly, the joint cost is prorated between the joint product and the by-
product.
Page 51 of 79
Worked example
In the course of manufacture of the main product ‘X’ by-products ‘Y’ and ‘Z’ also
emerge. The joint expenses of manufacture amount to Shs. 119,550. All the three
products are processed further after separation and sold as per details given below:
Main product By - products
Particulars
x Y Z
Sales 90,000 60,000 40,000
Costs incurred after separation 6,000 5,000 4,000
Profit as % on sales 25 20 15
Total fixed selling expenses are 10% of total cost of sales which are apportioned to the
three products in the ratio of 20 : 40 : 40.
Required:
a) Prepare a statement showing the apportionment of joint costs to the main product
and the two by products.
b) If the by-product Y is not subjected to further processing and is sold at the point
of separation for which there is a market, at Shs. 58,500 without incurring any
selling expenses. Would you advise its disposal at this stage? Show the workings.
Solution:
DBA Co. Ltd
Share of Joint expenses statement
Particulars Main product By - products Totals
x Y Z
Sales 90,000 60,000 40,000 190,000
Less Profit 22,500 12,000 6,000 40,500
Cost of sales 67,500 48,000 34,000 149,500
Selling expenses 2,990 5,980 5,980 14,950
Manufacturing costs 64,510 42,020 28,020 134,550
Less Costs of separation 6,000 5,000 4,000 15,000
Share of Joint expenses 58,510 37,020 24,020 119,550
b).It is better to sell by-product ‘Y’ at split-off point because it yields more profit of Shs. 21,480
against profit after processing of Shs. 12,000 as shown in the working below;
Shs
Sales at split-off (Y) = 58,500
Less Joint costs = 37,020
Profit 21,480
Note: selling expenses of the products = 10% of 149,500 × ratio
i.e. main product = 14,950 × 20/100 = 2,990
Difference between Main product & Joint and By-Products:
Page 52 of 79
It is very difficult to make distinction between the joint products, main products and
by-products. There are, however, two checks which may be applied to determine if a
product is a by-product or a joint product or a main product:
Value: If one of the products is of considerably large value than the others it will
usually be considered the main product. Conversely any product which is of
considerably less value is likely to be classified as a by-product. If both or some or all
the products are more or less of equal value, they are likely to be classified as joint
products.
Manufacturing objective: If the company’s objective is to produce A, then B, C and
D produced simultaneously will be classified as by-products. This is independent of
the comparative values of the various products. If the objective is to produce A and B,
they become joint products and C and D become by-products. For example, in coke
oven, the objective being production of coke, this is considered as the main product,
and gas and tar as by-products.
There are instances when a by-product attains so much importance in terms of sales
value and/or the company objective, then it is regarded as a main product. There are
also instances when a by-product is more important than the main product, so that
they by-product becomes the main product and the main product becomes the by-
product.
MARGINAL (Variable Costing) & ABSORPTION COSTING

Marginal costing is a costing technique in which only variable costs are accumulated
& cost per unit is ascertained only on the basis of variable costs. Prime costs & variable
factory overheads are used to value inventories. Fixed costs which are by & large
uncontrollable, aren’t taken into account under this technique while ascertaining per
unit cost but they are not ignored. It should be borne in mind that variable costs per
unit are fixed and fixed costs per unit are variable with changes in level of output.
CIMA has however defined marginal cost as cost of one unit of product or service
which would be avoided if that unit were not produced or provided. Thus marginal
costing is defined as the accounting system in which variable costs are charged to cost
units and fixed costs of the period are written-off in full against the aggregate
contribution. It is a technique of applying the existing methods in a particular manner
in order to bring out the relationship between profit and volume of output.
Profit = Total contribution – Fixed costs
Contribution (gross margin) = Sales – marginal cost of sales
Note; contribution is also termed as marginal income, variable gross margin, profit
contribution or contribution to fixed costs
Features of Marginal Costing
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 Costs are separated into fixed & variable elements & semi-variable costs
 Only variable costs are taken into account for computing the value of stocks of
W.I.P & finished products
 Fixed costs are charged off to revenue wholly during the period in which they are
incurred and aren’t taken into account for valuing product costs
 Prices may be based on marginal costs & contribution but in normal
circumstances, prices would cover costs in total
 It combines the techniques of cost recording & reporting
 Profitability of departments or products is determined in terms of marginal
contribution
 The unit cost of a product means the average variable cost of manufacturing the
product
ADVANTAGES OF MARGINAL COSTING
i. Simple to Operate; this so because MC does not involve the problems of overhead
apportionment and recovery.
ii. Easier to explain to management; E.g. Fluctuations in profit are easier to explain
because they result from cost volume interactions and not from changes in
inventory valuation.
iii. Easier to make decisions on the basis of marginal cost presentations, e.g.,
marginal costing shows which products are making a contribution and which are
failing to cover their avoidable (i.e., variable) costs.
iv. Useful in cost analysis and cost presentation. MC enables the presentation of data
in a manner useful to different levels of management for the purpose of controlling
costs. Thus, it is an important technique in cost control.
v. Useful for Future profit planning of the business enterprises. The contribution
ratio and marginal cost ratios are very useful to ascertain the changes in selling
price, variable cost etc. Thus, marginal costing is greatly helpful in profit planning.
vi. Helpful in evaluating performance of several units & products; i.e. when a
business concern consists of several units and produces several products.
vii. It is helpful in forecasting.
viii. Helpful in determining optimum product Mix; i.e. when there are different
products, the determination of number of units of each product, called Optimum
Product Mix, is made with the help of marginal costing.
ix. Helpful in determining optimum sales mix i.e., sales of each and every product
to get maximum profit can also be determined with the help of marginal costing.
LIMITATIONS OF MARGINAL COSTING:
Page 54 of 79
i. Difficult to separate Costs. The separation of costs into fixed and variable
present’s technical difficulties and no variable cost is completely variable nor is a
fixed cost completely fixed.
ii. Understates inventories, i.e., under marginal cost system, stock of finished goods
and work-in-progress are understated. E.g. after all, fixed costs are incurred in order
to manufacture products and as such, these should form a part of the cost of the
products. It is, therefore, not correct to eliminate fixed costs from finished stock
and work-in-progress.
iii. Inaccurate results in Final accounts; the exclusion of fixed overhead from the
inventories affects the Profit and Loss Account and produces an unrealistic and
conservative Balance Sheet, unless adjustments are made in the financial accounts
at the end of the period.
iv. Unrealistic monthly operating statements; in MC system, marginal contribution
and profits increase or decrease with changes in sales volume and where sales are
seasonal, profits also fluctuate from period to period, thus leading to unrealistic
monthly operating statements.
v. Creates unrealistic decisions by management; during the earlier stages of a period
of recession, the low profits or increase in losses, as revealed in a magnified way in
the marginal costs statements, may unduly create panic and compel the
management to take action that may lead to further depression of the market.
vi. Does not give full information. E.g., increased production and sales may be due
to extensive use of existing equipments (by working overtime or in shifts), or by an
expansion of the resources, or by the replacement of labour force by machines. The
marginal contribution fails to reveal these.
vii. Not useful in determining long term profits; though for short-term assessment of
profitability marginal costs may be useful, long term profit is correctly determined
on full costs basis only.
viii. Does not eliminate Variable Costs; although marginal costing eliminates the
difficulties involved in the apportionment and under and over-absorption of fixed
overhead, the problem still remains so far as the variable overhead is concerned.
ix. Ignores fixed costs; with increased automation and technological developments,
the impact on fixed costs on products is much more than that of variable costs. A
system which ignores fixed costs is therefore, less effective because a major portion
of the cost is not taken care of.
x. Fails to provide any standard for evaluation of performance. A system of
budgetary control and standard costing provides more effective control than that
obtained by marginal costing.
ABSORPTION COSTING (Full/Conventional Costing)
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Under this method, the cost of the product is determined after considering the total
cost i.e., both fixed and variable costs. Thus this technique is also called traditional or
total costing. The variable costs are directly charged to the products where as the fixed
costs are apportioned over different products on a suitable basis, manufactured during
a period. Thus under absorption costing, all costs are identified with the
manufactured products.
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑/𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡𝑠
Note, Unit fixed cost = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑/𝑛𝑜𝑟𝑚𝑎𝑙 𝑜𝑢𝑡𝑝𝑢𝑡
LIMITATIONS OF ABSORPTION COSTING:
i. Being dependent on levels of output which vary from period to period, costs are
vitiated due to the existence of fixed overhead. This renders them useless for
purposes of comparison and control. (If, however, overhead recovery rate is based
on normal capacity, this situation will not arise).
ii. Carryover of a portion of fixed costs, i.e., period costs to subsequent accounting
periods as part of the cost of inventory is unsound practice because costs pertaining
to a period should not be allowed to be vitiated by the inclusion of costs pertaining
to the previous period.
iii. Profits and losses in the accounts are related not only to sales but also to
production, including the production which is unsold. This is contrary to the
principle that profits are made not at the stage when products are manufactured
but only when they are sold.
iv. There is no uniformity in the methods of application of overhead in absorption
costing. These problems have, no doubt, to be faced in the case of marginal costing
also but to a less extent because of the exclusion of fixed costs, as different
assumptions made in the matter of application of fixed overhead will not arise in
the case of marginal costing.
v. Absorption costing is not always suitable for decision making solutions to various
types of problems of management decision making, where the absorption cost
method would be practically ineffective, such as selection of production volume
and optimum capacity utilization, selection of production mix, whether to buy or
manufacture, choice of alternatives and evaluation of performance can be hard
with the help of marginal cost analysis. Sometimes, the conclusion drawn from
absorption cost data in this regard may be misleading and lead to losses.
DIFFERENCES BETWEEN MARGINAL COSTING & ABSORPTION
COSTING
Marginal costing Absorption Costing
 Only variable costs are considered for product  Both fixed and variable costs are considered for
costing and inventory valuation. product costing and inventory valuation.
Page 56 of 79
 Fixed costs are regarded as period costs. The  Fixed costs are charged to the cost of production.
profitability of different products is judged by Each product bears a reasonable share of fixed
their P/V ratio. cost and thus the profitability of a product is
 Cost data are presented to highlight the total influenced by the apportionment of fixed costs.
contribution of each product.  Cost data are presented in conventional pattern.
 The difference in the magnitude of opening stock Net profit of each product is determined after
and closing stock does not affect the unit cost of subtracting fixed cost along with their variable
production. cost.
 In case of marginal costing the cost per unit  The difference in the magnitude of opening stock
remains the same, irrespective of the production and closing stock affects the unit cost of
as it is valued at variable cost. production due to the impact of related fixed cost.
 In case of absorption costing the cost per unit
reduces, as the production increases as it is fixed
cost which reduces, whereas, the variable cost
remains the same per unit.
CONTRIBUTION
As mentioned earlier, contribution is the difference between selling price & variable
cost of sales. It is visualized as some sort of a fund or pool, out of which all fixed costs,
irrespective of their nature are to be met, and to each product has to contribute its
share. The excess of contribution over fixed costs is the profit. If the total contribution
does not meet the entire fixed costs, there will be loss.
In normal circumstances, selling prices contain an element of profit but there may be
circumstances, when products may have to be sold at cost or even at loss. Thus, the
character of contribution will have the following composition under different
circumstances;
 Selling price containing profit: Contribution = Fixed costs + Profit
 Selling price at cost: Contribution = Fixed cost
 Selling price at loss: Contribution = Fixed costs - Loss
DETERMINATION OF PROFIT UNDER MARGINAL & ABSORPTION
COSTING
Under MC, only factory overhead costs that tend to vary with volume are charged to
product cost in addition to prime costs. While evaluating inventory, only direct
materials, direct labour & variable factory overheads are included and are considered
as product costs. Fixed factory overheads under marginal costing is not included in
inventory. Thus, profit emerges only after charging fixed expenses to contribution.
In Absorption costing however, profit emerges after charging all costs – fixed costs
and variable costs. Thus,
Contribution = Selling price - Variable costs
Profit = Contribution – Fixed costs
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If profit & FC are known, then; contribution = FC + profit

This gives us a basic marginal equation as;
If there is a profit:
Sales – MC = contribution = FC + profit
OR
Sales = MC + FC + Profit
Note 1. Since closing stocks don’t have any element of FC, profit shown by MC
technique may be different from that shown by Absorption costing.
Note 2. When entire stock is sold, there is no inventory i.e. closing or opening stock,
the profit revealed by both methods will be the same. But when sales & production
are out of balance, difference in net profit is reported.
Note 3. When absorption costing is applied, fixed manufacturing costs are shifted form
one year to another year as a part of inventory cost, i.e. stock
Note 4. If a company produces more than it sells in a given period, not all of the
current manufacturing costs will be deducted from sales, i.e. closing stock will include
a portion of FC. In other words, inventory will be valued at a higher figure in
absorption costing; thus profit will be more compared to that in MC. Thus, profit will
not necessarily increase with an increase in sales value & vice versa in case a company
produces less than it sells in a given period.
Therefore, MC can produce a net profit figure which is similar, greater than or equal
to the net profit shown under absorption costing.
FORMAT OF AN INCOME STATEMENT
Tripple x Ltd.
Income Statement
Based on Marginal Costing
Particulars Shs Shs
Sales xx
Less: Costs of sales
Opening Stock (Qty × Unit VC) xx
Add production costs (Qty. produced × Unit Cost) xx
COGAS xx
Less closing stock (Units × Unit VC) xx xx
Total contribution xxx
Less operating expenses
Selling & distribution costs xx
Net contribution xxx
Less Fixed Costs
Manufacturing costs xx
Administration costs xx xx
Net profit/loss xxx
Tripple x Ltd.
Page 58 of 79
Income Statement
Based on Absorption Costing Technique
Particulars Shs Shs
Sales xx
Opening Stock (Qty × Unit VC) xx
Add production costs (Qty. produced × full Unit Cost) xx
COGAS xx
Less closing stock (Unsold units ×full Unit Cost) xx xx
Gross profit xxx
Add/deduct over/under absorbed costs xx/ (xx)
Total profit xx
Selling & distribution costs xx
Fixed administration costs xx xx
Net profit/loss xxx
Worked examples
BBA Company Ltd. has provided you with following information and needs your
assistance in preparing Income statements under Absorption & marginal costing.
Production capacity = 200,000 units per year.
Normal capacity utilization is reckoned at 90%.
Standard Variable Production costs are Shs. 11per unit.
The fixed costs are Shs. 360,000 per year.
Variable selling costs are Shs. 3 per unit
Fixed selling costs are Shs. 270,000 per year.
The unit selling price is Shs. 20.
In the year just ended on 30th June, 2019, the production was 160,000 units and sales
were 150,000 units.
The closing inventory on 30th-6-2019 was 20,000 units.
The actual variable production costs for the year was Shs. 35,000 higher than the
standard.
Required; Calculate:
a) The profit for the year
i. by absorption costing method
ii. by the marginal cost method.
b) Explain the difference in profits.
Solution:
a) The profit for the year
BBA Co. Ltd.
Income Statement
Based on Absorption Costing As on June, 2019
Page 59 of 79
Particulars Shs Shs

Sales (150,000 ×20) 3,000,000
Opening Stock (10,000 × 13)* 130,000
Add production costs (160,000 × 11) 1,760,000
Add variance 35,000
Actual variable production costs 1,795,000
Add fixed production recovered costs
(160,000 × 2)* 320,000
Add under absorbed fixed production cost
(360,000 – 320,000) 40,000
Production costs of goods manufactured 2,155,000
COGAS 2,285,000
Less closing stock (2,155,000/160,000 ×20,000) 269,375 2,015,625
Gross profit 984,375
Selling costs
Variable (150,000 × 3) 450,000
Fixed 270,000 720,000
Net profit 264,375
Working note:
Variable costs = 11.00
Add fixed production cost per unit (360,000/200,000) × 90% = 2.00*
= 13.00
BBA Co. Ltd.
Income Statement
Based on Marginal Costing As on June, 2019
Particulars Shs Shs
Sales (150,000 × 20) 3,000,000
Opening Stock (10,000 × 11) 110,000
Add production costs (1,760,000 + 35,000) 1,795,000
COGAS 1,905,000
Less closing stock (1,795,000/160,000 × 20,000) 224,375 1,680,625
Total contribution 1,319,375
Selling costs (150,000 × 3) 450,000
Net contribution 869,375
Less Fixed Costs
Fixed costs 360,000
Fixed selling costs 270,000 630,000
Net profit 239,375
b) The difference in profit shown by absorption costing and marginal costing is due to valuation of
costs i.e., stocks are valued at total production cost in absorption costing and at variable
production cost in marginal costing.
The difference in profits can be explained as follows:
Page 60 of 79
Inventory Absorption Marginal Profit is (less)/more in

Costing costing Absorption costing
Opening stock 130,000 110,000 (-) 20,000
Closing stock 269,375 224,375 (+) 45,000
25,000
The following data relates to DBA Co. Ltd for the month of Feb, 2020
Opening stock = 2,000 units at Shs. 70,000 including variable costs of Shs. 25 per
unit.
Fixed manufacturing costs Shs. 120,000
Variable cost per unit Shs. 30
Normal output Shs. 15,000
Actual production Shs. 20,000
Sales Shs. 14,000 units @ Shs. 100 per unit
Selling & distribution costs Shs. 200,000
Fixed administrative costs Shs. 400,000
Stock is valued on the basis of FIFO method.
Required:
Prepare Income statement based on Marginal & Absorption costing principles
Solution
Unit cost of opening stock = 70,000/2,000 = Shs. 35
Unit variable cost = Shs. 25
Unit fixed cost = Total unit cost – Unit VC = (35 – 25) = Shs. 10
Determination of current produced units
Unit FC = Fixed manufacturing costs/Normal output
= 120,000/15,000
= Shs. 8
Under absorption costing = unit VC + unit FC
= 30 + 8 = Shs. 38
DBA Co. Ltd.
Income Statement
Based on Absorption Costing
Particulars Shs Shs
Sales (14,000 ×100) 1,400,000
Opening Stock (2,000 × 35) 70,000
Add production costs (20,000 × 38) 760,000
COGAS 830,000
Less closing stock (8,000 × 38) 304,000 526,000
Total contribution 874,000
Add over absorbed costs 40,000
Total profit 914,000
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Fixed Costs
Fixed selling & distribution costs 200,000
Fixed administration costs 400,000 600,000
Net profit 314,000
Working Notes:
Note 1: Determination of Over absorption:
Over Absorption = (Actual output – Normal Output) × FC
= (20,000 – 15,000) × Shs. 8
= Shs. 40,000
Alternatively,
Over absorption = Actual fixed OH - Normal fixed OH
= (20,000 × 8) – (15,000 × 8)
= 160,000 – 120,000
= Shs. 40,000
DBA Co. Ltd.
Income Statement
Based on Marginal Costing
Particulars Shs Shs
Sales (14,000 ×100) 1,400,000
Opening Stock (2,000 × 25) 50,000
Add production costs (20,000 × 30) 600,000
COGAS 650,000
Less closing stock (8,000 × 30) 240,000 410,000
Total contribution 990,000
Fixed Costs
Fixed manufacturing costs 120,000
Fixed selling & distribution costs 200,000
Fixed administration costs 400,000 720,000
Net profit 270,000
Worked example 3
A company makes and sells a single product. At the beginning of the period I, there
is no opening stock of the product, for which the variable production cost is Shs. 4 &
the sale price is Shs. 6 per unit. Fixed costs are Shs. 2,000 per period of which Shs.
1,500 are fixed production costs.
The following details are available:
Period I Period II
Sales 1,200 units 1,800 units
Production 1,500 units 1,500 units
Required, determine the profit in each period using;
a) Absorption costing (assuming normal output is 1,500 units per period), and;
b) Marginal costing
c) Reconcile the profits obtained under the two techniques
Page 62 of 79
Solution:
Absorption rate of fixed OH = 1,500/1,500 = Shs. 1 per unit
A company’s
Income statement
Based on absorption costing
Particulars Period 1 Period II Total
Shs Shs Shs Shs Shs Shs
Sales (1,200×6) 7,200 (1,800×6) 10,800 18,000
Add Production costs:
Variable (1,500×4) 6,000 6,000 12,000
Fixed (1,500×1) 1,500 1,500 3,000
7,500 7,500 15,000
Add opening stock Nil 1,500 Nil
7,500 9,000
Less closing stock (300 × shs. 5) 1,500 Nil
Production costs of sales 6,000 9,000 15,000
Add other costs 500 500 1,000
Total costs 6,500 9,500 16,000
profit 700 1,300 2,000
Note: Shs. 5 = Shs. 4 + Shs. 1
A company’s
Income statement
Based on marginal costing
Particulars Period 1 Period II Total
Shs Shs Shs Shs Shs Shs
Sales (1,200×6) 7,200 (1,800×6) 10,800 18,000
Add Production costs:
Variable (1,500×4) 6,000 6,000 12,000
Add opening stock Nil 1,200 Nil
6,000 7,200 12,000
Less closing stock (300 × shs. 4) 1,200 Nil Nil
variable production costs of sales 4,800 7,200 12,000
Contribution 2,400 3,600 6,000
Less fixed costs 2,000 2,000 4,000
Profit 400 1,600 2,000
b). Company’s
Reconciliation of profits statement
Period I Period II
Particulars
Shs Shs
Marginal costing profits 400 1,600
Add difference in closing stock 300 Nil
Less difference in opening stock Nil 300
Net profit as per absorption costing 700 1,300
Page 63 of 79
DBA (U) Ltd a producer of a single product has provided the following data to you.
Abias, Assistant Management Accountant prepared the following cost structure based
on budgeted level of output of 60,000 litres.
Particulars Cost per unit in Shs
Material cost 8
Direct labour 6
Variable overheads 10
Selling & distribution costs 4
Fixed manufacturing costs 8
Total 36
st
At the beginning of the 1 quarter, DBA Co. Ltd had opening stock amounting to
20,000 litres whose value is based on the above cost structure.
The budgeted selling & administration overheads totaled to Shs. 200,000 per quarter.
The Company however, sells products at Shs. 50 per unit.
The production & sales for each quarter were as follows:
quarters
Particulars
Qrt. I Qrt. II Qrt. III Qrt. IV
Production in Units 45,000 60,000 40,000 70,000
Sales in Units 50,000 55,000 60,000 70,000
Required, determine the profit in each period using;
a) Absorption costing and;
b) Marginal costing technique
c) Reconcile the profits obtained under the two techniques
APPLICATION AREAS OF MARGINAL COSTING TECHNIQUE BY
MANAGEMENT
1. PROFIT PLANNING
This is the planning of future operations of a business so as to attain maximum profit
or to maintain a specified level of profit. The contribution ratio (i.e. a ratio of marginal
contribution to sales) indicates the relative profitability of the different sectors of the
business whenever there is a change in selling price, variables costs or product mix.
Due to merging together of fixed and variable costs, absorption costs fail to bring out
correctly the effect of any such changes on the profit of the concern,
Therefore, there are four ways in which profit performance of a business can be
improved, and these are by:
 Increasing volume
 Increasing selling price
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 Decreasing variable costs &

 Decreasing fixed costs
Jinping Co. Ltd. A toy manufacturer makes an average net profit of Shs. 2,500 per piece
on a selling price of Shs. 14,300 by producing & selling 60,000 pieces or 60% of the
potential capacity. His cost of sales is:
Direct materials Shs. 3,500
Direct wages Shs. 1,250
Works overheads Shs. 6,250 (50% fixed)
Sales overheads Shs. 800 (25% variable)
During the current year, the Company anticipates that its charges will go up by 10%,
while the rates of direct material and direct labour will increase by 6% & 8%
respectively. But the company has no option of increasing the selling price.
Under this situation, the Company obtains an offer for an order equal to 20% of its
capacity. The concerned customer however, is a special customer.
Required: determine,
What minimum price will you recommend for acceptance to ensure the manufacturer
earns an overall profit of Shs. 167,300?
Solution:
Previous Year Current Year’s Budget Prior to Acceptance of
20% excess orders
Particulars
Amt Amount
Shs ‘000’ Per piece Shs ‘000’ Per piece
‘000’ ‘000’
Sales 14,300 858,000 14,300 858,000
Less variable costs:
Direct material 3,500 3,710
Direct labour 1,250 1,350
Variable works OH 3,125 3,125
Variable sales OH 200 8,075 484,500 200 (8,385×60) 503,100
Contribution 6,225 373,500 8,385 354,900
Less fixed Costs:
Works overheads (3,125×60) 187,500 (10%+187,500) 206,250
Sales overheads (600×60) 36,000 223,500 (10% + 36,000) 39,600 245850
Profits 150,000 109,050
Shs ‘000’
Marginal cost of additional 20,000 units: Shs. 167,700
(20,000×8,385)
Increased contribution required (167,300 – 109,050) = Shs. 58,250
Total sales price expected for 20,000 units Shs. 225,950
Sales price per unit = 225,950/20,000 = Shs. 11.297
Note: such concessional price is acceptable only for special markets like export markets or special
customers like the government and only if idle capacity exists.
Worked example
Page 65 of 79
Nytil manufacturing Company has provided you with the following data:
Plant capacity: 400,000 units per annum
Present utilization: 40%
Actuals for the year were:
Selling price Shs. 50,000 per unit
Material cost Shs. 20,000 per unit
Variable manufacturing costs Shs. 15,000 per unit
Fixed costs Shs. 2,700,000
In order to improve capacity utilization, the following proposals are being considered:
Reduce selling price by 10%
Spend additionally Shs. 300,000 on sales promotion.
Required: determine,
How many units should be made & sold in order to earn a profit of Shs. 500,000 per
year?
Solution:
Particulars Shs Shs
Revised selling price (50,000 – 10%) 45,000
Material costs 20,000
Variable manufacturing costs (per unit) 15,000
Total variable cost 35,000
Contribution 10,000 per unit
Total contribution required:
Fixed costs 2,700,000
Additional promotion expenses 300,000
Profit 500,000
Shs. 3,500,000
Total No. of units to be made & sold to earn a contribution of Shs. 3,500,000 is given by:
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 3,500,000
= = = 350 𝑢𝑛𝑖𝑡𝑠
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 10,000
2. EVALUATION OF PERFORMANCE
The various sections of a concern such as a department, a product line, a specific
market or a sales division, have different revenue earning potentialities. A company
always concentrates on the departments or product lines which yield more
contribution than others. The performance of each sector can be brought out by a
means of cost-volume profit analysis or the contribution approach. The analysis will
help the company to take decisions that will maximize the profits.
Worked example
A business produces three products Shoes, Laces & Clothes for which the standard
variable costs and budgeted selling prices are given below;
Items Products
Page 66 of 79
Shoes Laces Clothes

Direct materials 3 6 8
Direct wages 4 4 10
Variable overheads 3 5 7
Selling price 18 25 48
In two successive periods, sales were as follows:
Sales per unit
Periods
Shoes Laces Clothes
Period 1 10,000 10,000 10,000
Period 2 20,000 13,000 5,000
The budgeted fixed overheads amounted to Shs. 135,000 for each period. In spite of
the increased sales, the profit for the 2nd period has fallen below that of the 1st period.
Required; as a Management Accountant of the Company,
Present figures to management to show why this fall in profits should, or should not
have occurred.
Solution:
Shoes Laces Clothes Total
Particulars
Period I Period II Period I Period II Period I Period II Period I Period II
Sales (units) 10,000 20,000 10,000 13,000 10,000 5,000 30,000 38,000
Sales (value) 180 360 250 325 480 240 910 925
Less variable costs 100 200 150 195 250 125 500 520
Contribution 80 160 100 130 230 115 410 405
Less fixed OH 135 135
Net profit 275 270
MCR (%) 44.4% 40.0% 47.9%
Comments: sales have increased by 8,000 (38,000 – 30,000) units but the sales value has
increased by Shs. 15,000 (925,000 – 910,000). Marginal costs have increased by Shs. 20,000
(520,000 – 500,000) to meet the cost of increased units of production, resulting in the fall of
profit by Shs. 5,000 (275,000 – 270,000)
Clothes which yield the highest % of contribution to sales is the most profitable line. Shoes come
next & laces is the least profitable of the three products.
Therefore, the unsatisfactory position in period 2 is because of unfavorable sales mix as the
production of most profitable product (clothes) has been cut down & less profitable products,
Shoes & laces have been pushed up.
Working Notes:
Note 1. Sales Value:
Sales value for Shoes = selling price × sales per unit
Period 1 period 2
= (18 × 10,000) = (18 × 20,000)
= Shs. 180,000 = Shs. 360,000
Note 2. Variable Costs:
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Variable costs Amount Amount

Direct materials 3 3
Direct wages 4 4
Variable overheads 3 3
Total 10 10
Thus, Variable Cost = (10 × 10,000) = (10 × 20,000)
= Shs. 100,000 = Shs. 200,000
Note 3. Marginal Contribution Ratio:
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
Marginal Contribution Ratio (MCR) = × 100
𝑆𝑎𝑙𝑒𝑠 𝑠𝑎𝑙𝑒𝑠
240,000
= × 100 = 𝟒𝟒. 𝟒%
540,000
Contribution = 80,000 + 160,000 = 240,000
Sales value = 180,000 + 360,000 = 540,000
Perform the same calculations for the rest of the products i.e. Laces & Clothes.
3. MAKE OR BUY DECISIONS
When management is confronted with the problem of whether it would be
economical to purchase a component or a product from outside sources, or to
manufacture it internally, marginal cost analysis renders useful assistance in the
matter. Under such circumstances, a misleading decision would be taken on the basis
of the total cost analysis.
In case the proposal is to buy from outside then, what is already being made, and the
price quoted by the outsider should be lower than the marginal cost. If the proposal
is to make something, what is being purchased outside, the cost of making should
include all additional costs like depreciation on new plant, interest on capital involved
& that cost should be compared with the purchase price.
Worked example
Lasonic Co. Ltd a T.V. manufacturing Company finds that while it costs to make
component X, the same is available in the market at Shs. 5,750 each, with all assurance
of continued supply. The breakdown of costs is as follows:
Costs Amount
Materials Shs. 2,750 each
Labour Shs. 1,750 each
Variable costs Shs. 500 each
Depreciation & other fixed costs Shs. 1,250 each
Total Shs. 6,250 each
Required:
a) Should the Company make or buy the Component?
b) What should be your decision if the supplier offered a component at Shs. 4,850
each?
Solution:
Page 68 of 79
Determination of marginal cost per unit of Component X

Costs Amount
Materials Shs. 2,750 each
Labour Shs. 1,750 each
Variable costs Shs. 500 each
Total Shs. 5,000
a) The purchase cost of the above component is Shs. 5,750 each. Therefore, if the Company is
having spare capacity which cannot be filled with more remunerative jobs, it is recommended
that the above component be manufactured in the company since the marginal cost at shs.
5,000 each is less than the purchase cost of Shs. 5,750.
b) In the event of purchase cost of Shs. 4,850 each being less than the marginal cost of Shs.
5,000 each, it is recommended that the component be bought from the supplier as this results
in a saving of Shs. 150 each (5,000 – 4,850). The spare capacity thus available can be
utilized for the purposes, as far as possible.
Worked example 2
BBA Enterprises Ltd. manufactures 2,000 components used to make Pan Cakes. They
provided the following cost structure;
Items: cost per unit
Direct Materials Shs. 4,000
Direct Labour Shs. 12,000
Variable costs Shs. 6,000
Fixed overheads Shs. 8,000
Total Shs. 30,000
An outside supplier Emma is offering to sell the component to BBA for Shs. 22,000
each. The labour force is in short supply & existing labour force is fully occupied. To
produce the component, the company will have to divert Asiku & Joram the two
workers currently producing Pan Cakes & each worker currently contributes Shs.
8,000 per unit if each component is to be produced. Asiku & Joram are part of the
permanent staff but each worker’s salary will increase by Shs. 2,000 for every
component produced.
All the materials to make the required components are already in the store & have no
alternative use at all. The materials were purchased at a cost of Shs. 4,000 per unit. if
the components are to be manufactured, Saida’s salary who happens to be a
purchasing manager will reduce by Shs. 4,000 for every component produced but
Devis’s salary a supervisor will increase by Shs. 6,000 per unit made.
However, for every component manufactured or purchased, quality test will be carried
out at a rate of Shs. 8,000 per unit.
Required;
Page 69 of 79
a) Advise BBA enterprises whether the component should be manufactured or

purchased or whether the offer should be accepted.
b) Other the cost criteria, what non-financial performance factors are likely to affect
the decision made above?
Solution:
Determination of relevant Costs in a manufacture of Pan Cakes
Costs Amount
Direct Labour costs: opportunity cost (8,000 × 2) Shs. 16,000
Future costs Shs. 4,000
Increase in Supervisor’s salary Shs. 6,000
Decrease in purchasing manager’s salary Shs. 4,000
Variable costs Shs. 6,000
Total Shs. 36,000
Comments:
a) Since the relevant cost of making Pan Cakes is more than the purchase price from Emma,
it is advisable to purchase the component from the supplier. This will increase the Company’s
earnings by Shs. 14,000 per unit.
b) Non-financial performance factors which may influence the decision made above are;
 The component’s quality supplied by Emma has to be considered by BBA Enterprises.
 The lead time i.e. possibilities of delays by the supplier has to be taken into account
 Existing workers morale most especially those whose salaries will be affected such as the
supervisor’s salary has to be considered
 Reliability of the supplier both financially & technically has to be considered, etc.
4. SHUT-DOWN DECISIONS OF A DEPARTMENT/PRODUCT
As discussed earlier, marginal costing technique helps in deciding the profitability of
a product. It provides the information in a manner that tells us how much each
product contributes towards fixed cost & profit; the product that gives the least
contribution should be discarded except for a short period of time. If management is
to choose some products out of the given ones, then the products giving the highest
contribution should be chosen & those giving the least should be discontinued.
Worked example;
Meat Packers (U) Ltd produce three meat products, Beef, Mutton & Pork. The
Income statement for the Company as at Feb, 2020 was as follows;
Meat Products
Particulars
Beef Mutton Pork Total
Sales 300,000 360,000 320,000 980,000
Variable costs 180,000 344,000 220,000 744,000
Contribution 120,000 16,000 100,000 236,000
Fixed overheads 34,000 36,000 40,000 110,000
Profit/Loss 86,000 (20,000) 60,000 126,000
Page 70 of 79
Meat Packers (U) Ltd is concerned about its poor profit performance and the
Company is considering whether or not to cease selling Mutton. It is speculated that
selling prices cannot be raised or lowered.
Therefore, if the production of mutton is suspended, Shs. 12,000 of fixed costs will
be avoided because the cost is directly related to the production of mutton. Assuming
that mutton cannot be substituted by any other meat product & that investment in
assets cannot be reduced if mutton is dropped. All other fixed costs are however
considered to remain the same.
Required:
As a Cost Management Accountant of the Company, advise the Company’s
management on their decision to shut down the production of mutton & make any
reservations.
Solution:
Meat Packers (U) Ltd
Mutton Shut Down Analysis Statement
As on February, 2020
Particulars Shs.
Reduction in FC (Cost saving) 12,000
Contribution lost 16,000
Further contribution loss 4,000
Meat Packers (U) Ltd
Profit Analysis Statement After Mutton Shut-down
As on February, 2020
Meat Products
Particulars
Beef Pork Total
Sales 300,000 320,000 620,000
Variable costs 180,000 220,000 400,000
Contribution 120,000 100,000 220,000
Fixed overheads 98,000
Profit/Loss 122,000
It is then observed that, when mutton is no longer produced, a company will incur a further loss
of Shs. 4,000 and as a result, affecting the current profit of the company by the same amount.
Likewise, profits will reduce from Shs. 126,000 to Shs. 122,000. This is because, the company
will continue to incur some of the fixed costs even if mutton production is shut.
Therefore, managements’ shut-down decision should be reversed but rather continue with the
production of mutton since it is not viable to suspend its operations as analyzed in the statements
above. In summary however, if a department/product has a contribution no matter how small
it may be, it is advisable not to close its operations/production because the company’s profits
will drop further.
Note; fixed costs of Shs. 98,000 = (110,000 – 12,000)
Page 71 of 79
5. MAINTAINING A DESIRED LEVEL OF PROFITS

A company has to cut prices of its products from time to time because of competition,
government regulations & other compelling reasons. The contribution per unit on
account of such cutting is reduced while the industry is interested in maintain a
minimum level of its profits. In case the demands for the Company’s products is
elastic, the maximum level of profits can be maintained by pushing up the sales. The
volume of such sales can be found out marginal costing techniques.
Worked example
DBA Ltd manufactures & markets a single product. The following information is
available;
Items Shs per unit
Materials 8,000
Conversion costs (variable) 6,000
Dealers’ margin 2,000
Selling price 20,000
Fixed costs 250,000,000
Present sales 90,000 units
Capacity utilization: 60%
There is acute competition and extra efforts are necessary to sell the product.
Suggestions have been made for increasing sales as follows;
 Reducing sales price by 5%
 Increasing dealers margin by 25% over the existing rate
Required, determine;
Which of the two suggestions would you recommend if the company desires to
maintain the present profit level? Give reasons.
Solution:
Determination of Company’s current marginal cost per unit:
Items Shs
Materials 8,000
Conversion costs 6,000
Dealer’s margin 2,000
Total 16,000
Contribution per unit = Selling price – Marginal Cost (VC)
= 20,000 – 16,000
= Shs. 4,000
Total contribution = (4,000 × 90,000) = Shs. 360,000,000
Profit = Contribution – Fixed costs
= 360,000,000 – 250,000,000
= Shs. 110,000,000
Since in both suggestions, fixed costs remain unchanged, the present profit can be maintained by
keeping the total contribution at the present level i.e. Shs. 360,000,000
Page 72 of 79
a) Reducing Sales price by 5%

New sales price = 20,000 – (5% × 20,000) = Shs. 19,000
New dealers margin = (10% × 19,000) = Shs. 1,900
New Variable costs = 8,000 + 6,000 + 1,900 = Shs. 15,900
New Contribution per unit = New sales price – new VC
= 19,000 – 15,900
= Shs. 3,100
Sales (units) required to maintain the present level of profit
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 360,000,000
= = = 116,129 𝑈𝑛𝑖𝑡𝑠
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 3,100
b) Increasing dealers’ margin by 25%
New dealers’ margin = 2,000 + (25% of 2,000) = 2,500
New variable costs = 8,000 + 6,000 + 2,500 = Shs. 16,500
Contribution = 20,000 – 16,500 = Shs. 3,500
360,000,000
Sales units = = 3,500 = 102,857 𝑈𝑛𝑖𝑡𝑠
Therefore, the second proposal is recommended because the contribution per unit is higher & the
sales (in units) are lower. This means that lower sales efforts & less finance would be required
in implementing the 2nd proposal.
6. OFFERING QUOTATIONS
One of the best ways for sales promotion is to offer quotations at low rates. E.g. a
company is producing 80,000 units (80% of capacity) & making a profit of Shs.
240,000. Suppose the Ugandan government has given a tender notice for 20,000
units. It is expected that the units taken by the government will not affect the sale of
80,000 units which the company is already selling & the company also wishes to
submit the lowest possible quotation. The company may quote any amount above
marginal cost because it will give an additional marginal contribution & hence profit.
7. ACCEPTING AN OFFER/EXPORTING BELOW NORMAL PRICE
Sometimes the volume of output and sales may be increased by reducing the normal
prices of additional sale. In this case, the concern should be cautious enough to see
that the sale below normal price in additional markets should not affect the normal
market. To be on the safe side, the product may be sold under the label of a different
brand. If there is additional sale because of export orders, goods may be sold at a price
below normal.
Worked example
The cost of a manufacturing company for the product is:
Items Shs
Materials 12
Labour 9
Variable expenses 6
Page 73 of 79
Fixed expenses 18
Total 45
The unit of product is sold for Shs. 51
The company’s normal capacity is 100,000 units. The figures given above are for
80,000 units. The company has received an offer for 20,000 units @ Shs. 36 per unit
from a foreign customer.
Required
a) Advice the manufacturer on whether the order should be accepted.
b) Also advice if the order is from a local merchant.
Solution:
Determination of Marginal cost for additional 20,000 units
Particulars Per unit For 20,000 units
Materials 12 240,000
Labour 9 180,000
Variable costs 6 120,000
Marginal cost 27 540,000
Additional Revenue to be realized (20,000 × 36) 720,000

Less Marginal cost 540,000
Net additional revenue (marginal contribution) 180,000
a) Thus, the offer should be accepted because it gives an additional contribution of Shs. 180,000. The total
profit will also increase by Shs. 180,000 because fixed expenses have already been recovered from the local
market.
b) Furthermore, the order from the local customer should not be accepted at Shs. 36 per unit or at any rate
below the normal price i.e. Shs. 45 because it will result in the general reduction of selling prices of the
product.
Note: Acceptance of the additional order should not lead to production being in excess of the
present capacity since in that case, some fixed expenses may also go up substantially. If there is
such an increase in fixed expenses, the increase should also be considered by inclusion in the total
additional cost to be compared with the additional revenue.
8. ALTERNATIVE USE OF PRODUCTION FACILITIES
When alternative use of production facilities/methods of manufacturing a product
are available, contribution analysis should be used to arrive at the final choice. The
alternative which will yield the highest contribution, shall generally & obviously be
selected.
9. PROBLEM OF KEY FACTOR
The product giving the greatest contribution will be the most profitable. To maximize
profit, resources should be mobilized towards that which gives the maximum
contribution. But contribution is not the only criterion for deciding profitability. In
Page 74 of 79
real life, there may be several factors which may put a limit on the number of units to
be produced even if the products give a high contribution.
These factors are equally important for arriving at managerial decisions because these
factors limit the volume of output at a particular point of time or over a period. These
are called key factors, scarce factors, limiting factors, principal budget factors or
governing factors. Examples may include, sale, raw materials, labour, plant capacity,
& availability of capital. For example, a concern established in a relatively new town,
labour may be a key factor or the concern may find it difficult to acquire an unlimited
quantity of raw materials because of scarcity or the quota system, etc. in the latter case,
materials will be a key factor.
The extent of influence of these factors should be carefully examined before arriving
at a particular decision. Contribution per unit of key factor should be considered and
that course of action should be adopted which gives the highest contribution per unit
of key factor.
Worked example
You are given the following information in respect of product X & Y of Bee Cee co.
Ltd.
Items Product x Product Y
Selling price 42 33
Direct material 15 15
Labour hours (shs. 50/hour) 18 hrs. 9 hrs.
Variable overheads 50% of direct wages
Required: Show which product is more profitable during labour shortage
Solution:
Computation of Marginal contribution
Particulars Product X Product Y
Selling price 42 33
Less variable costs 28.50 21.75
Marginal contribution 13.50 11.25
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 13.5 11.25

Profitability = = 0.75 = 1.25
𝐾𝑒𝑦 𝑓𝑎𝑐𝑡𝑜𝑟 18 9
Therefore, Product Y is more profitable than X during labour shortage
10.SELECTION OF A SUITABLE PRODUCT MIX
A concern, which manufacturers more than one product, may have to decide in what
proportion should these products be produced or sold. The technique of marginal
costing helps to a great extent in the determination of most profitable products or sale
mix. The bet product mix is that which yields the maximum contribution. In the
Page 75 of 79
absence of the key factor, contribution under various mix will be found out and the
mix which gives the highest contribution will be selected for production.
Steps
 Determine contribution per unit (Selling price – Variable costs)
 Determine contribution per limiting factor, i.e.
 = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡⁄𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑠𝑐𝑎𝑟𝑐𝑒 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒 𝑡𝑜 𝑚𝑎𝑘𝑒 𝑐𝑜𝑚𝑝𝑙𝑒𝑡𝑒 𝑢𝑛𝑖𝑡
 Rank the products by contribution per limiting factor by assigning numbers
beginning with one for a highest contribution per limiting factor.
 Produce to full satisfaction of each product following the ranking order until the
limiting factor units are used up.
Worked example:
A company engaged in plantation activities has 200 hectares of virgin land which can
be used for growing jointly or individually Tea, Coffee & Yams. The yield per hectare
of the different crops & their selling price per Kg are as under:
Crops Yield (Kgs) Selling Price (Shs)
Tea 2,000 20
Coffee 500 40
Yams 100 250
The relevant costs data are given below:
Variable cost per Kg;
Costs Tea Coffee Yams
Labour charges 8 10 120
Packing materials 2 2 10
Other costs 4 1 20
Total costs 14 13 150
Fixed costs per annum:
Fixed costs Shs
Cultivation & growing cost 1,000,000
Administrative cost 200,000
Land revenue 50,000
Repairs & maintenance 250,000
Other costs 300,000
Total cost 1,800,000
The policy of the company is to produce and sell all the three kinds of products and
the maximum & minimum are to be cultivated per product as follows:
Product Max. Area (Hectare) Min. Area (Hectare)
Tea 160 120
Coffee 50 30
Page 76 of 79
Yams 30 10
Required;
Determine the priority of production, the most profitable product mix & the
maximum profit which can be achieved by the company.
Solution:
Determination of contribution of various products:
Particulars Tea Coffee Yams
Selling price per Kg. 20 40 250
Less Variable cost per Kg:
Labour charges 8 10 120
Packing materials 2 2 10
Other costs 4 1 20
Contribution per Kg 6 27 100
Contribution per hectare 12,000 13,500 10,000
Rating on the basis of 2 1 3
Contribution per hectare
Note: Contribution per Hectare = (contribution per Kg × Yield per Kg)
Therefore, to maximize profit, subject to other constraints, the order of priority of production
would be Coffee, Tea & Yams
Determination of Optimum product mix:
Area Yield Total Production
(Hect.) (Kg./Hect.) (Kgs.)
Maximum of coffee 50 500 25,000
Minimum of Yams 10 100 1,000
Balance of Tea 140 2,000 280,000
200 2,600 306,000
Determination of maximum profit
Production (Kgs.) Rate (Shs) Total (Shs)
Contribution form coffee 25,000 27 675,000
Contribution form Yams 1,000 100 100,000
Contribution form Tea 280,000 6 1,680,000
2,455,000
Less: fixed costs 1,800,000
Profit 655,000
11.SPECIAL ORDER DECISIONS
In some situations it makes sense for the company to sell a product as a price below
total cost but above incremental costs. As long as incremental revenues are in excess
of incremental costs, a company will increase short term profits or reduce losses if it’s
currently making losses.
The decision arises when a customer outside the normal customer base offers a price
less than the normal selling price. For a decision to be accepted, first consider the
Page 77 of 79
operating capacity to service the order & then compute the relevant cost of the order
i.e. marginal cost with the price offered & if there is any contribution, accept the offer.
Worked example
An order for 6,000 chairs has been received from a customer. The Company’s
budgeted production for the period is for 32,000 chairs which represent 80% of
company’s capacity to manufacture chairs.
The budgeted data for the period is given below;
Shs. Shs
Sales 1,344,000
Materials 384,000
Labour 392,000
Overheads 400,000 1,176,000
Profit 168,000
It is also given that Shs. 40,000 of labour and 20% of overheads are fixed in nature
and the rest of the costs are variable.
Required:
a) Determine whether the offer should be accepted if a customer was prepared to pay
the following amounts:
i. Shs. 60 per chair
ii. Shs 62 per chair. Justify your answer.
b) What other factors should the company need to take into considerations before
accepting or rejecting the offer?
Solution:
Determining Unit Variable costs:
384,000
Materials = = 𝑆ℎ𝑠. 12
32,000
392,000−40,000
Labour costs = = 𝑆ℎ𝑠. 11
32,000
400,000 ×80%
Overheads = = 𝑆ℎ𝑠. 10
32,000
Determining Contributions at different selling prices.
Selling Prices
Particulars
Shs. 60 Shs. 72
Total sales (6,000× 60) 360,000 (6,000× 72) 372,000
Material costs (6,000 × 12) 72,000 72,000
Labour costs (6,000 × 11) 66,000 66,000
Overhead costs (6,000 ×10) 60,000 198,000 60,000 198,000
Total contribution 162,000 234,000
Page 78 of 79
Therefore, the company should accept an order of selling price at Shs 72 per unit since the
contribution is higher than that of Shs. 60 towards fixed cost of Shs. 198,000.
Page 79 of 79

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Costing Methods

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Cost Accounting Notes – Emma Charles 0787-080-333/0753-236-367 |

COSTING METHODS & TECHNIQUES

 Assembly type of order.

Summary Format of Job Costing

Selling Price xxx

Sales Value 18,750 22,500 15,000 56,250

Total Cost 12,500 15,000 10,000 37,500

Profit per batch 6,250 7,500 5,000 18,750

Cost per Unit 10 10 10 10

Profit per unit 5 5 5 5

Less: Total Cost (3,000 × 𝑆ℎ𝑠. 10) 30,000

Timber (800 𝑚𝑒𝑡𝑟𝑒𝑠 × 4,000) 3,200

Fixed manufacturing costs:

𝑇𝑜𝑡𝑎𝑙 𝐵𝑎𝑡𝑐ℎ 𝑐𝑜𝑠𝑡 22,600,000

Cr. Contractee A/c with the amount paid.

BBA Builders Co. Ltd

Particulars Shs ‘000’ Particulars Shs ‘000’

Sub-contractors charges 19,580

Cost to date 109,514

PROCESS COSTING (OPERATING COSTING)

i. Production is done having a continuous flow of products having a continuous

DEALING WITH LOSSES IN PROCESS COSTING

Normal process loss

Direct expenses 260,000

Dr. For the period ended …. Cr

Example 2 (Process Costing with normal Loss)

Items Amount (Shs)

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Total 1,000 4,500 1,000 4,500

Material Input 1,000

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Total 1,020 4,600 1,000 4,600

a) Process I & Process II A/c

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠

Labour Costs 400,000

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠

Caltex Co. Ltd.’

Total 38,000 38,000

Caltex Co. Ltd.’

P/L A/c 71,333 Process II A/c 71,333

Total 71,333 71,333

Accounting for Scrap:

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Total 900,000 900,000

Total 900,000 900,000

Production Overheads (50%×40,000) 20,000

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Particulars Unit Unit Amount Particulars Unit Unit Amount

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Total Oil Co. Ltd.’

Process I A/c 2,940 P/L A/c 8,940

Total Oil Co. Ltd.’

Total 9,800 9,800

Total Oil Co. Ltd.’

Abnormal loss 500

𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑐𝑒𝑠𝑠 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒

Total 30,000 24,525,000 30,000 24,525,000

Riham Co. Ltd.’

Total 300,000 300,000

Riham Co. Ltd.’