COSTING SYSTEMS

SPECIFIC ORDER COSTING

This is a broad costing system, which is applicable where work jobs consist of
separate jobs, batches or contracts. Each job, batch or contract is a cost unit and
in most cases, it is different from another. Each order made can be identified
separately and the system is designed to find the cost of each order. Specific order
costing is subdivided into:

a) Job costing
b) Batch costing
c) Contract costing

JOB COSTING
This is a costing method which is applied when a job/cost unit is relatively of small
size, is undertaken to fit the customer’s specifications and is of comparatively
short duration: Each job moves through the operations continuously as an
identifiable unit. The method is usually adopted by businesses, which receives
orders for work peculiar to the needs of individual customers.

a) Features of Job costing

Product is against the customer’s order and not on job stocks
Each job has its own characteristics and requires special attention and skills.

b) Procedures of Job Costing

The application of job costing method begins when a customer’s order is received.
After accepting an order, an individual work/job order number is assigned to each
job for or separate order identification.. Production order is then made giving
authority for the job to start. A job cost account for each job is then opened. In
this account, all costs relating to that particular job are recorded and this account
closed only when the job is complete. After completion of the job, an invoice is
prepared and served to the customer.

 Materials for each job are made using material requisition forms
 Labour is charged on the basis of the amount of time used to complete that
particular job as recorded in time-keeping records.
 Overheads are charged on the basis of an predetermined overhead
absorption rate.

Applied Overhead absorption rate = Budgeted Overheads ÷ Denominator value
The Denominator value where the denominator value refers to units of some
specified overhead absorption base e.g. machine hours, direct labour hours.

6.1.2 Accounting for Job Order Costing

1. (a) Direct materials
(i) Dr Stores ledger control A/c Cr Cash A/c – for cash purchasers X
 (ii) Dr Stores ledger control A/c Cr Creditors A/c – for credit purchasers
X
(b) Return of materials to suppliers
Dr Cash A/c or creditors control A/c X
Cr Stores ledger control A/c X
(c) Issue of materials from the store
Dr – W.I.P. Control A/c X
Cr stores ledger control A/c for direct materials.
X
Indirect materials: Dr Factory overheads control A/c X
Cr Stores ledger control A/c
X
2. Direct Labor
Dr W.I.P. Control A/c
Cr Cash A/c

3. Accrued Direct Wages

Dr W.I.P. Control A/c
Cr Wages Control A/c

Indirect Wages
Dr Factory overheads control A/c
Cr Wages Control A/c
1. Production Overheads
(i) (not yet paid) Dr Factory overhead control A/c
Cr Expenses/Creditor control A/c
(ii) (When paid) Dr Expense/creditors A/c
Cr Cash A/c
Note
Overheads entries apply when there is an interlocking accounting system.
5. Finished goods transferred to the store:
 Dr Finished goods stock control A/c
Cr W.I.P Control A/c
6. Sale delivery of finished goods to customers:
(i) On Credit: Dr Debtors control A/c Cr Sales
A/c
(ii) In Cash: Dr Bank/Cash A/c Cr(Sales A/c
7. Cost of goods sold to customers:
Dr Cost of sales A/c
Cr Finished goods control A/c
8. (i) When there is over absorption of production overheads:
Dr Factory overheads control A/c
Cr P & L A/c
(ii) When there is under absorption of production overheads:
Dr P& L A/c
Cr Factory overheads control A/c
9. When there are non-manufacturing overheads:
Dr P & L A/c
Cr Non-manufacturing overheads control A/c or non-
manufacturing overheads/expenses are regarded as period
costs & are therefore not changed To W.I.P control A/c.

Job Cost Account

Dr Cr
Direct materials issued from stock X Materials returned to the store X
Materials transferred to other jobs
Direct wages X X
Cost of completed jobs transferred
Production overheads absorbed X to finished goods A/c X
Materials transferred from other X Balance c/d (Total cost of that job) X
jobs
XX XX

Illustrations:
The following transactions were made by Z limited in the month of December.
Direct Materials
  8,000/= was bought on credit, out of these, materials worth 5,000/= were
returned to the suppliers.
 50,000/= was issued from the store
 Indirect materials issued amounted to 5,000/=
 Direct wages allocated to production amounted to 20,000/=
 Goods worth 200,000/= were sold
 Finished goods worth 100,000/= were transferred to the store.
 The cost of goods sold was 140,000/=
 Unpaid indirect expenses were 32,000/=
 Indirect wages allocated amounted to 15,000/=
 Non-manufacturing overheads incurred amounted to 20,000/=
 Overhead expenses charged to the jobs – 60,000/=

Required
a) Prepare the stores ledger control A/c
b) Factory overhead control A/c
c) W.I.P. control A/c
d) Costing P & L A/c

Stores Ledger Control A/c

Creditors (material) 8,000 Creditors control 5,000
W.I.P 50,000
(Indirect materials)
Factory overheads 5,000

Factory Overheads Control A/c

Stores Ledger (material) 5,000 W.I.P 60,000
Creditors (wages) 32,000
Incurred wages 15,000
P + LA/c
Overabsorption 8,000 _____
60,000 60,000

W.I.P Control A/c

Stores Ledger (material) 50,000 Finished goods stock
control 100,000
Control (D wages) 20,000

Overhead expenses 60,000

Costing P and L A/c

Finished goods control 140,000 Sales 200,000
Non manufacturing Factor overhead 8,000
Overheads 20,000 absorption
Costing profit 48,000
6.2 BATCH COSTING
This is a type of job costing that is used when production consists of limited
repetitive work and definite number of item manufactured in one batch. A batch is
defined as a cost unit consisting of a group of identical item in particular sizes and
colors of shoes, toys, spare parts etc. The total cost incurred in production is
spread on the number of units made when the batch is completed.

a) Procedures:
 Allocation of batch number
 Production order is made
 Creation of batch costs account
 Completion of the work and closure of the batch cost account
 Allocation of costs to individual units in the batch
 Determination of selling price/batch and unit.

Illustrations
The budgeted variable overheads of Githurai Ltd for the year 2001 are given as
below:

Department Overhead(shs.) Absorption base

A 150,000 15,000 direct labour hours
B 200,000 25,000 direct labour hours
C 120,000 20,000 direct labour hours
D 300,000 30,000 machine labour hours
Additional Information
 Selling and administering overheads are changed at 10% of total production
costs while the profit mark up is 25 of total costs:
 An order for 2,000 units was received from a customer. The batch number
of this order is 510. The following additional information in respect of this
batch is provided below:
 Direct materials – 87,000/=
 Direct Labor – Dept A (150 direct labor hrs) – 12shs. Direct labor hour.

o Dept B (40 direct labor hrs) @ 15shs. Per hr

o Dept C (60 direct labor hrs) @20shs. Per hr

o Dept D (100 direct labor hrs) @10shs. Per hr

A total of 50 machine hours were used in this job

Required
a) Calculated the total cost of the batch
b) Cost/Unit
c) Selling Price of the batch
d) Selling Price unit
Solution
Githurai Limited
Batch 510
Particulars Shs.
D Materials 87,000
D Labour: Dept A (150 x 12) 1,800
Dept B (40 x 50) 6000
Dept C (60 x 20) 1,200
Dept D (100 x 10) 1,000 4,600
Prime Cost 91,600

Variable Overheads: Dept A –15,000/15,000 x 150 1,500

Dept B – 200,000/25,000 x 40 320
Dept C – 120,000/20,000 x 60 360
Dept D – 300,000/300,000 x 50 500 2,680
Total Production Cost 94,280
Selling and admin costs – 10% (94,280) 9,428
Total Costs 103,708
Mark-up: Mark-up @ 25% x 103,708 25,927
Cost/Unit = 103,708/2000 units = 51.854 Selling Price unit = 129,635/2,000 =
64.8175

CONTRACT COSTING
This is a form of specific order costing that is applied to relatively large cost units,
which normally take a considerable length of time to complete e.g. building or
construction works. Contract jobs are undertaken in accordance with specific
requirements of contractee/Customer. Contracts may be distinguished from job
orders by the following features:
The money value of a contract is much larger than that of a job order.

 A contract consumes significantly larger amounts of resources than a job

order.
 For a contract, special progress reports are usually made while in job
costing, reports are made after the completion of the job.
 For a contract, indirect costs are relatively smaller in relation to direct costs
but the vice versa is time for job order.

To second the progress of contract works, a special account known as a contract

account is maintained.

CONTRACT ACCOUNTS
This is a separate account that is opened and maintained for each contract
undertaken for the purpose of accumulating cots. Each contract is given a number
and all costs relating to that particular contract are recorded in this account. A
typical contract account is as shown below:

Contract No. XYZ Account

Materials b/f x Materials returned to store x
Materials purchased x Materials c/d x
Direct wages x Machinery c/d x
Indirect wages x Balance c/d: Cost of work x
done
Subcontractors fees x
Cost of special plant x
Machinery/Plant b/f x

Cost of work done b/d x Value of work certified x

Notional Profit x Cost of work done but not x
certified
xx xx

Contract Costing Terminology

Principles of profit income recognition in contracts

The Notional Profit

It is a component of 2 items:
a) Profit taken = Notional profit x 2/3 x cash received/work certified
This formula of calculating the part of national profit taken in the year is
used when substantial costs have been incurred on the contract but the
contract is not near completion. But when the contract is near completion
the profit taken is calculated as:
Profit taken = Estimated profit x cash received/contract price.
Where Estimated profit = Contract price – Estimated total cost and
Estimated total cost = Costs incurred to date and estimated future costs.

b) Profit not taken = refers to the part of the national profit that is not
recognized in the current period. It is profit carried forward to be
recognized in the years that follow.

c) Retention Money
This is a portion of the value of work certified that is retained by the
contractor to protect himself from faulty work that might be evident at the
time of progress payments or at the completion of the contract. This amount
is released after satisfactory performance under the contract.

Illustration
XYZ limited has been awarded a contract to build a house. This is a contract No 45
for the company and the contract price is shs.2.65 million. At the end of the
company’s financial year, the contract was 85% complete and hence regarded as
being near completion. You are also provided with the following information about
the contract:

Particulars Shs.
Materials purchased and delivered 580,000
Materials issued from store 60,000
Materials returned to stores 7,000
Site expenses 300,000
Site wages 200,000
Plant sent to site 100,000
Architect’s fees 30,000
Plant returned from site 10,000
Subcontractor’s fees 105,000
Head Office overheads absorbed 60,000

Valuation at the year ending disclosed the following:

Shs
Materials: 19,500
Plant on site 50,000
Work done but not yet certified 60,000

Additional Information
1. The portion of the work which was completed during the year and certified
by the architect was assessed as representing 75% of the whole contract
price. The contractee made payments to this extent less 10% retention
money.
2. The management of the company decided for the purpose of preparing the
company’s annual accounts to make a provision of a third of the national
profit against the possibility of defects and other contingencies arising later
in respect of the work already certified for payment.

Required
a) The contract account
b) Amount of profit or loss to be taken to the main profit and loss account of the
company.
c) Value of work in progress.
XYZ LTD
Contract No 45 A/c
Shs Shs
Materials Purchased: 580 ,000 Materials Returned to 9,000
stores
Materials issued from 6,000 Plants returned from site 10,000
stores
Site expenses 300,000 Materials c/f 19,500
Site wages 200,000 Plant c/f 50,000
Plant set to site 100,000 Cost of work done 1,346,50
0
Architects fees 30,000
Sub-contractors 105,000
Head office overheads __60,000
_______
1,435,500 1,435,50
0
Cost of work done b/d 1,346,500 Value of work certified
National profit: 701,000 75% x 2,650,000 1,987,50
0
Profit taken: 473,175 Work done but not
Profit in suspense 227,825 certified (closing stock) ___60,00
0
Balances b/f: materials 19,500 2,047,50
0*
Plant 50,000
Work not 60,000
certified

Profit taken
Cash Received
National Profit x
Contract Price

(90% x 1,987500) 1,788,750

701,000 x  701,000 x
2,650,000 2,650,000

473,175

Profit in Suspense = 701,000 –473,175

= Shs. 227,825

Value of Work in Progress

Shs.
Cost of work certified 1,346,500
Add: Profit taken 473,175
1,819,675
Less: Cash Received (1,788,750)
Work in progress valuation: 30,925

PROCESS COSTING
This is a costing method that is applied where there are standard operations with
continuous production of homogeneous as identical units. Hence the output is the
final product of a sequence of operations. In this type of costing, costs are
accumulated on the basis of process, and the cost per unit is arrived at by dividing
the total process costs by the number of input of the next process and further
materials can be added at each stage production. Therefore cost per unit for the
second and subsequent processes is a cumulative cost for example, the cost per
unit for the output transferred from process 2 is the cost of production for both
process 1 and 2 and not for process 2 above. The fact that the output for the first
process becomes the input for the next process means that the process costing
procedure strives to maintain the cost of each process product and charge that
with the first process. The aim is to transfer the cost accumulated in the first
process to the next process. This is illustrated below:

Process 1
Shs Shs
Direct Material: 1,000 Transferred to
Direct Labour 500 Process 2: 3,000
Overheads 1,500 3,000
3,000 3,000

Process 2
Shs Shs
Transfer from Transfer to
Process 1: 3,000 Finished Goods: 6,000
Direct material 1,500
Direct labour 1,000
Overheads 500 ____
6,000 6,000

Examples of Industries where process costing is applied

Process Costing Procedure

1. The production factory is divided into a number of processes.
2. An account is opened and maintained for each process.
3. Each process account is debited with materials, labor, direct expenses and
overheads apportioned to the process.
4. The output of a process is transferred to the next process input of that
process.
5. The finished output of the last process is transferred to the finished goods
account.

VALUATION OF WORK IN PROGRESS

The concept of Equivalent units
Equivalent Units
This is a notional quantity of completed goods in the production process. It is a
collection of work application (direct materials, direct labor and overheads)
necessary to produce one complete unit of output. They are the number of units
that would have been produced during a period of all the departments’ efforts had
resulted into completed units.
The concept is used for purposes of translating the partially completed production
into its completed units equivalent. This enables cost accountants to value the
work-in-progress in an objective, consistent, reliable manner.

Illustration 1
Suppose there are 4,000 units of a product in ending inventory out of which 60%
are fully complete whereas the remaining are 70% complete. What are the
equivalent units of the product?

Solution: 60% x 4,000 = 2,400 units fully complete.

40% x 4,000 = 1,120 units –Equivalent units.
Total Equivalent units = 3,520 units
Assume we had total process costs of shs.7,040, then each unit would cost
shs.7,040/3,520=shs.2

Illustration 2
Material A is added at the beginning of a production process. Labor and overheads
are added continuously during the production process. At the end of the process,
10,000 units were complete and 2,000 units were 60% complete as per labor and
overheads. The cost of raw materials used during the period amounted to
shs.220,000, labour shs.150,000 and overheads shs.74,000. There was no opening
inventory.

Required
Determine the cost per unit of both the completed units, and the units in the
ending inventory.
Solution:
Conversion
Physical Materials (direct Labour
Units and overheads
Completed 10,000 10,000 10,000
Ending Inventory 2,000 2,000 1, 200
12,000 ______ _______
Equivalent Units 12,000 11,200
Cost for the Period 220,000 224,000
Cost per Equivalent Shs.18.33 220,000/1,200=sh18.33
Unit: 224,000/11,200=sh20
Total Cost/Equivalent =18.33+sh.38
Unit .33
In the above illustrations, there is no opening work in process. When it exists, we
need to adopt a method of valuing it and incorporating it into the process accounts.
The two main methods used for purposes of valuing the opening work in progress:

1. Weighted Average Method

2. First In First Out (FIFO) Method.
Using these methods enables the cost of the opening work in progress to be
appropriately assigned to the finished goods an the closing work in process.

a) Weighted Average
When this method is used, all costs of production are considered in assigning
costs to inventory. The method puts together opening work in process
inventory costs and cost of production. It mixes the costs of previous period
with those of current period in determining costs per unit.

Under this method, equivalent units are calculated as follows:

Equivalent Units = Units completed and Transferred + Ending work in progress
inventory: (% completion)
Cost per Equivalent Unit = Previous Period costs + Current period costs

In beginning working process

Equivalent units of work done.

Under weighted average approach, we do not distinguish the “units started and
completed in the current period” from the `units completed and transferred ` and
the `Ending working period`

a) First In First Out (FIFO)

This method considers only those costs incurred during the current period.
Equivalent units are calculated as follows:
Equivalent Units= Units completed and transferred + (Units in ending W.I.P x
% of completion – Units in beginning )

X % of completion
Cost/Equivalent Unit = Current Costs
Equivalent Units

Carefully Note that FIFO distinguishes the “units started and completed in the
current period” from the units completed and transferred. This is done by
subtracting the “beginning W.I.P.” from the “units completed and transferred”
and “the ending work in process”.
 Illustration
The following work in progress account relates to the blending department of
ABC Limited, a soft-drinks company for the month of January 1999. Raw
materials were introduced at the start of the work while labour and overheads
were incurred through-out the blending process.
Blending Department: W.I.P A/C
Particulars Shs Particulars Sh
Bal b/f = 5,000L (4/5) = 65,000 Completed and transferred out: -
29,000L
Raw materials added 125,00 Ending W.I.P (2/3) -
(30,000L) 0 6,000L
Direct Labour 145,00
0
Factor Overheads 201,00
0

Additional Information
1. Beginning W.I.P. consists of the following:
- Raw materials shs.15,000
- Direct Labor shs.20,000
- Factory Overheads shs.30,000.
Required
Calculate cost/equivalent units using:
a) Weighted average
b) FIFO
Weighted Average
Total Physical Material Conversio
Units s n
Completed Transferred 29,000 29,000 29,999
Out:
Ending W.I.P 6,000 6,000 4,000
______ ______ (2/3 X
6,000)
35,000 35,000 33,000

Process Costs: In beginning Inventory: 15,000 50,000

Current Costs: 125,000 346,000
140,000 396,000

Cost per equivalent Unit: Shs.140, Shs.396,0

000 00
33,00
35,000 0
= Shs.4 Shs.12
Total Cost per equivalent Unit: 4 + 12 =
Shs.16

FIFO
Total Physical Units Materials Conversion
Beginning W.I.P 5,000 1,000 = (1/5 X
500)
Units started and
completed during
The current period
= (2,900 – 5,000) 24,000 24,000 24,000
Ending W.I.P 6,000 6,000 4,000 = (2/3 x
6,000)
35,000

Equivalent Units 30,000 29,000

Current Costs: 125,000 346,000
Cost/Equivalent Units 125,000 346,000
30,000 29,000
Total Cost Per Shs,16.10 = Shs.4.20 Shs.11.90
Equivalent Unit:

* Equivalent Units of 5,000 x (1 – 4/5) = 1,000 units was the work done in the
period to complete the beginning W.I.P.
Note that the previous period costs in the beginning W.I.P (Materials. shs.15,000
and converting – shs.50,000) have been excluded in *

PROCESS COST REPORT

This is a commonly used statement which traces the flow of units produced and
costs incurred in the production process. The report is prepared for each process
and it provides a reconciliation of the physical flow of units and the total costs for
the period . Assuming no spoilage or losses, the following relationships will always
hold:
1. Physical Units:
Beginning W.I.P + Units started during – Units to account for the period.
= Units completed and transferred + Ending work in progress – Units
accounted for.

2. Costs:
Cost of Beginning W.I.P. + Current costs incurred – Costs to account for = Costs
of units completed and transferred

Example
Assume that the beginning work in progress in Maendeleo Company Ltd in the
month of November was 1,000 units which were 100% complete in terms of
materials and 75% complete as to conversion. Raw materials costs relating to
beginning work in progress amounted to shs.3,000 and conversion was shs.1,000.
10,000 units were completed during the period and transferred to finished goods
stock a/c. 2,000 units were still in process and were 100% complete in relation to
materials and 50% complete in relation to conversion costs. Costs incurred during
the period were raw materials shs.33,000, conversion shs.43,000;
Required
Use both weighted average and FIFO methods, to determine cost per equivalent
unit and value of ending inventory. Prepare the process cost report.

MAENDELEO COMPANY LIMITED.

PROCESS COST REPORT
For the month of December
 (Weighted Average Method)
1st Step Physical Units
Beginning W.I.P 1,000
Units started during 11,000 (10,000 + 2,000 – 1,000)
the period
Units to account for: 12,000
2nd Step Equivalent Units
Total Materials Conversion
Units Costs
Units completed during the 10,000 10,000 10,000
period:
Ending W.I.P 2,000 2,000 =(100% x 1,000= (50% x
2,000) 2,000)
Units accounted for 12,000 12,000 11,000
3rd Step Cost Determination
Total Material Cost Conversion
Units Costs
Beginning W.I.P Materials: 3,000 - -
Conversion
Current costs 1,000 - -
Cost to account for: 76,000 33,000 43,000
80,000
33,000 43,000
11,000 10,250
Shs.7 Shs.3 Shs.4
th
4 Step: Cost Assignment:
Units started and completed during the current period: 9,000 x 7: 63,000
Ending W.I.P = Materials: 2,000 x 3: 6,000
= Conversion: 1,000 x 4: 4,000 10,000
Beginning W.I.P Materials 3,000
Conversion: 1,000 4,000
Cost of work done to complete beginning
W.I.P
 costs 750 x 4 3,000
Costs Accounted for 80,000
PROCESS LOSSES
a) Most manufacturing processes result in some portion of the raw materials used
not being converted into a reliable half hence losses. These losses may take the
form of waste, scrap, rework, and spoilt units.
 Waste: are materials lost in the process, which are irrecoverable or have
no recoverable value.
 Scrap: Material held after a productive process, which are irrecoverable or
have no recoverable value.
 Rework: These are finished goods that do not meet quality standards but
which with some additional work can be sold.
 Loss: Refers to finished or partially finished units, which cannot be
reworked or used for their intended purpose. They may be discarded or sold
for minimal value. There are two types of spoilage;
- Normal Loss: is loss expected and unavoidable even under the most
efficient systems of production. Normal spoilage cost is normally included in
product cost.
- Abnormal Spoilage: This is loss that is avoidable with efficient operating
conditions. The cost is regarded as controllable and can be eradicated if due
diligence and supervision are exercised. The cost is normally treated as a
loss and charged to profit and loss account.

b) Accounting Treatment of Spoilage Costs

1) Normal Spoilage Costs: These costs are assigned to the good
output using two approaches:
(i) Omission Approach: Under this approach, the normally spoilt units are
not included in the calculation of equivalent units. This means that the
cost of the normally spoilt units will automatically be distributed to the
good output. By excluding the normal spoilage in the computation to the
good output, a lower figure will be derived. The weaknesses of this
method are;
(a) The cost of normal spoilage is spread equally into the finished
goods and the ending W.I.P regardless of whether the ending
W.I.P. has passed the inspection stage or not.
b) It does not allow the manager to see the costs of spoilage
because these costs are not computed.

(ii) Recognition and Re-Assignment Approach In this approach, the

normal spoilage is included in the equivalent units computation; further,
 the normally spoilt units will be assigned costs just like any other unit.
The spoilage costs will then be reallocated to these good units that have
passed the inspection point. The steps to follow under this method are:
(a) Compute equivalent units including normal spoilage.
(b) Assign costs to all units including normal spoilage.
(c) Reassign normal spoilage costs to good output.

2) Abnormal Spoilage Costs

These costs do not add any production benefit to the company and are
treated as accounting losses. The costs are written off directly as losses for
the period in which they occur.
Illustration
Mombasa Limited manufacturer a product through two departments. The
following is the data in respect of department for the month of January:

Beginning W.I.P. (25% complete as to conversion): 10,000 units

Costs for beginning W.I.P:
Transferred in Shs.82,900
Conversion costs Shs.42,000
Units started in the current period. 70,000 units
Current costs: Transferred in Shs.645,100
Conversion Shs.612,500
Additional
Materials*
Units completed and transferred: 50,000 units
Units in ending W.I.P (95% complete as to conversion) 20,000 units
Spoilt Units 10,000 units

Additional Information
1. Normal spoilage is 10% of all good units that pass inspection
2. Inspection occurs when production is 80% complete.
3. Conversion costs are incurred evenly through-out the process.
Required
 Prepare a process cost report using
(a) Weighted Average
(b) FIFO
Apply both the recognition re-assignment approach in dealing with the
spoilage.

Solution
Mombasa Limited.
Process Cost Report (Dept 2)
Weighted Average Approach
Physical Units Physical Transferre Additional Conversion
Units d In Materials
Beginning W.I.P. 10,000
Units started in 70,000
Current Period
Units to Account for 80,000
Equivalent Units:
Finished Goods: 50,000 50,000 50,000 50,000
Ending W.I.P 20,000 20,000 20,000 19,000
Normal Spoilage @
10%
(50,000 + 20,000): 7,000 7,000 - 5,600 -
(80%x70)
Abnormal Spoilage:
(10,000 – 3,000) 3,000 3,000 - 2,400 -
(80%x30)
Equivalent Units 80,000 80,000 70,000 77,000

Cost Determination Total Transferred Additional Conversion

Cost In Materials
Beginning W.I.P 124,900 82,900 - 4,200
Current Costs 1,908,60 645,100 651,000 612,500
0
Costs to Account for: 2,033,50 728,000 651,000 645,500
 0
Divided by Equivalent 80,000 70,000 77,000
Units
Cost per equivalent Shs.26.90 Shs.9.30 Shs.9.30 Shs.8.50
Unit

Cost Assignment Transferred In Cost: 7,000 x 9.10 63,700

=

Normal Spoilage Added Material: 7,000 x - -

=
Conversion Costs: 5,600 x 8.50 47,600
=
Normal Spoilage
costs recognized
111,300
(and to be assigned)
Finished Goods Excluding Normal Spoilage: 50,000 x 26.90 1,345,0
Costs = 00
Normal spoilage costs assigned: 50,000 x 111,300
=
79,5
70,000 00
1,424,5
00
Ending W.I.P: Excluding Normal Spoilage:
Transferred in costs 20,000 x 9.1 = 182,000
=
Additional Material = 20,000 x 9.3 = 186,000
Conversion Costs = 19,000 x 8.5 = 161,500
Normal Spoilage costs = 20,000 x 111,300 = 31,800
70,000
561,30
0

Abnormal Spoilage:
Transferred in costs = 3,000 x 9.10 = 27,300
Additional Material = = -
Conversion Costs = 2,400 x 8.5 = 20,400
 47,70
0
Costs Accounted for 2,033,5
00

Mombasa Limited, Process Cost Report

Weighted Average Method (Omission Approval)
Physical Units: Total Transferred In Materia Conversio
l n
Beginning W.I.P 10,000
Started and 70,000
Transferred
Units to account for 80,000
Equivalent Units
Finished Goods 50,000 50,000 50,000 50,000
Ending W.I.P 20,000 20,000 20,000 19,000
Normal Spoilage 7,000 - - -
Abnormal Spoilage 3,000 3,000 - 2,400
Units Accounted for 80,000 73,000 70,000 71,400

Cost Flow Total Costs

Beginning W.I.P. 124,900 82,900 - 42,000
Current costs 1,908,600 645,000 651,000 612,500
Cost to Account for: 2,033,500 728,000 651,000 651,500
Cost per equivalent 28.44 9.97 9.3 9.167
unit

Cost Assignment:
Finished Goods: 50,000x28.44 1,422,000
Ending W.I.P: Transferred in: 20,000 x 9.97 = 199,460
Materials: 20,000 x 9.30 = 186,000
Conversion: 19,000 x 9.167 = 174,173 559,663
Abnormal Spoilage: Transferred in: 3,000 x 9.97 = 29,919
Conversion: 2,400 x 9.167 = 22,000
51,919
Total Costs Accounted for 2,033,552

SHRINKAGE
This refers to a loss or disappearance of material inputs used during the
production process. It occurs mainly through the evaporation. This is unlike
spoilage in which the units are still existing only that they will be of a lower value
than the good units. Shrinking is common in chemical mixtures which produce or
use liquid gases as material inputs. The problem associated with shrinking is
the reconciliation of the beginning and ending inventory. This problem is
resolved by expressing the various layers of production in terms of what its
weights or volume would be either at the beginning or end of the process.
Illustration
Assume that a chemical company, which is processing one of its products through
one of its processes, must start with 100kg of a certain chemical for its 80kg of
finished products. Assume that all the chemical is added at the beginning of the
process and 20% of the evaporation takes place gradually through-out the process.
The actual weights through measurement were as follows:

Beginning W.I.P Inventory (75%complete) 21,250kg.

Units started 110,000kg.
Finished Goods Transferred 80,000kg.
Ending W.I.P (25%) 33,250kg.
Costs:
Beginning W.I.P: 100,000
Current Conversion Costs: 252,000
Current Material Costs: 220,000

Prepare a cost report:

(i) Using the FIFO method
(ii) Using ending weight
(iii) Using beginning weights
For beginning W.I.P: actual weight – 21250kg (75% By 75%), only 20%x75%=15%
evaporation will have incurred. Therefore beginning weight (without evaporation)
=
100
21250 x 85

= 25,000kg

Solution
Evaporation rate = 20%
75%x20% = 15%
21,250 –85% Therefore
21,500
X 100% 25,000 - 21,250 Kg
85
Thus evaporation should be 25,000kg (75%complete) at 20% evaporation. For
ending W.I.P., we have 33,250kg actual weight (25% complete).

By 25% completion, 20% (25%) = 5% evaporation will have occurred. Therefore

the ending
Weight without evaporation =
32,250
X 100% 35,000 Kg
95

Thus evaporation should be: 35,00kg (25% complete) at 20% evaporation.

PROCESS COST REPORT

FIFO Method: Assuming Beginning weights

Physical Units Materials Conversion
Beginning W.I.P. 25,000
Units started 110,000
Units to account 135,000
for
Beginning W.I.P 25,000 - 6,250(25%)
Units started & 75,000 75,000 75,000 done
completed
Ending W.I.P 35,000 35,000 8,750(25%x35,000)
 Cost Statement Total Costs Materials Costs Conversion costs
Beginning W.I.P 100,000 - -
Current Costs 472,000 220,000 252,000
Costs to A/c for 572,000 220,000 252,000
Costs per unit Shs.4.80 Shs.2 Shs.2.80

Cost
Assignment
Units started and completed: (75,000x4.80) = 360,000
Ending work in process:
Material: 35,000 x 2 = 70,000
Conversion (8,750 x 2) = 24,500 94,500
Beginning W.I.P: Process Cost: b/f 100,000
Conversion (6,250x2.80) = 17,500 117,500
Costs Accounted for 572,000

Using the Ending Weights

Start End
Beginning W.I.P. 25,000kg 80% 20,000kg
Units Started 110,000kg 88,000kg
Finished goods 100,000kg 80,000kg
Losing W.I.P 28,000kg

Physical Units Materials Conversion

Beginning W.I.P 20,000 (21,250 x
80%)
0.85
Units Started: 88,000
(110,000x80%)
108,000
Finished Goods: 80,000 80,000 80,000
Ending W.I.P. 28,000 28,000 7,000(25% x 28,000)
Units accounted 108,000
for
Less: Equiv Units of work 108,000 87,000
Done previously: 25%of beginning (20,000) (15,000) (75% x 20,000)
W.I.P.
88,000 72,000(60,000+7,000+
5,000)

Total Cost Materials Conversion

Beginning W.I.P. 100,000 - -
Add Current Costs: 472,000 220,000 252,000
Costs to account for: 572,000 220,000 252,000
Equivalent Units
88,000 72,000
Cost/Equiv Units Shs.6 Shs.2.50 Shs.3.50

ALLOCATION OF JOINT COSTS

When two or more products of relatively high value emerge simultaneously from a
single process, they are called joint products. The process that gives rise to
these products is called a joint process and the costs involved are referred to as
joint product costs. Joint products are not separately identifiable as individual
products until their split off point. Split-off point is the point at which joint
products become separate entities or are individually identifiable.

Allocation of joint costs involves assigning the costs of the joint process to the
products emerging at the split off point. Any costs beyond the split off point are
referred to as separable costs.

Methods Used to Allocate Joint Costs

1) Physical/Unit Measure
2) Constant gross margin rate
3) Net realizable value.
1) Physical Measure/Unit
Joint costs are allocated to the joint products according to the ratio of physical
measurement of the outputs at the split off point.

2) Constant Gross Margin Rate

This method assumes that each product contributes an equal percentage of gross
profit for every shilling of sales. It works back from gross margin to the joint costs
allocation. It involves the following steps:

(i) Calculate the overall rate of gross margin for al the products
(ii) Multiply the computed overall rate by the sales of every product to
obtain the gross margin of the product.
(iii) Deduct the gross margin from the sales value of the product to
determine the total costs for each product.
(iv) Deduct separable costs from the total costs to obtain joint costs
allocated.

3) Net Realizable Value

Under this method, joint costs are allocated according to the net realizable*
Net Realizable Value = Ultimate Sales Value – Separable Costs.

Illustration
A company produces three products, Y1, Y2, and Y3 in the same process. The
data below reflects average monthly results:

Y1 Y2 Y3
Monthly output (kg) 40,000 20,000 20,000
Sales Value at split off (shs.) 0 30,000 105,000
Sales Value after Split off 45,000 100,000 155,000
Costs of further processing 20,000 40,000 65,000

The joint costs were Shs.100,000

Required
Allocate the joint cost using the three methods used to allocate joint costs.

Solution
(i) Physical/Measurement/Unit Method

Y1 Y2 Y3 TOTAL
Physical Output: (Kg) 40,000 20,000 20,000 80,000
Proportion 50% 25% 25%
Joint costs allocated 50,000 25,000 25,000

(ii) Constant Gross Margin Rate Method

Total Sales Value after slit-off: Y1 = 45,000

Y2 = 100,000
Y3 = 155,000
300,000
Less: Total Costs:
Joint Costs: 100,000
Further Processing Costs: 20,000
Y1
Y2 40,000
Y3 65,000 (225,000)
75,000
Costs Allocated To: Y1 Y2 Y3 TOTAL
Sales Value: 45,000 100,000 155,000
Less Gross Margin (11,250) (25,000) (38,750)
Total Costs 33,750 75,000 116,250
Less Separate Costs (20,000) (40,000) (65,000)
Joint Costs Allocated : 13,750 35,000 51,250 100,000

(iii) Net Realizable Value/Method

 Net Realizable Value = Ultimate Sales Value – Separable Costs
Y1 Y2 Y3 TOTAL
Ultimate Sales Value: 45,000 100,00 155,00
0 0
Less: Separable Costs (20,000 (40,000 (65,00
) ) 0)
Net Realizable Value: 25,000 60,000 90,000 175,000
Proportion on Net Realizable 14% 34% 52%
Value
Allocation of Joint Costs: 14,000 34,000 52,000 100,000

UNIFORM COSTING
This is a common system using agreed concepts, principles and standard
accounting practices adopted by different entities in the same industry to ensure
that they all deal with accounting information in a similar manner so as to facilitate
inter-firm comparison.

The objectives of uniform costing are:

a. To promote uniformity of costing methods, so that valid costs comparisons
can be made between similar organization
b. To eliminate inefficiencies and promote good practice revealed by the cost
comparison.
c. Serve as a basis for government subsidies or grants which weed similar
costing systems to ensure equitable distribution.
d. Serve as a basis for competitive bidding.

Requirements of Uniform Costing

Uniform costing systems should process the following features:
1. Cost statements and reports should be organized and laid out in a similar
format so that each element of cost and revenue can be compared quite easily.
2. Accounting periods must be the same in all firms in the industry.
3. The methods of valuing stocks and work in progress must be the same.
4. The basis of valuing fixed assets must be the same.
5. The method and actual rates of depreciation for each type of asset must be the
same.
6. The basis of cost or overhead apportionment and absorption must be similar.
7. Cost classification systems must be the same in all the firms in the industry so
that similar items are classified in the same names.

Advantages of Uniform Costing

1. It enables costs to be compared easily
2. It makes it easier to computerize the accounting system of various
organizations in the industry.
3. It leads to easier cost transferability between organizations.
Disadvantages
1. It may not be appropriate or suitable to an individual organization in the
industry if there is a difference in size and structure.
2. It is slow to adopt to changing conditions and demands.
Other Costing Methods
a) Unit Costing
b) Service Costing
 BUDGETARY PLANNING AND CONTROL
INTRODUCTION
This lesson explores Budgetary, Planning and Control Techniques looking at the
purpose, preparation, application and interpretation of budgets as well as their
behavioural aspects
Nature and Purposes of Budgets
Budgeting refers to the process of quantifying the plans of an organization so as to
enable it achieve its objectives in the defined period. The result of the process is
budgets, which are used for cost control, performance evaluation and future
decision making.

Budgetary Planning and Control may be seen a s short-term quantification and

monitoring of long-term strategic plans of the organizations. Strategic planning
involves preparation of strategic plans, which define the objectives to be pursued
within the framework of corporate policy. It is by budgeting that a long-term
corporate plan is put into action.

Budgets may be prepared for departments, functions or financial and resource

items. In fact, some people refer to budgeting as a means of coordinating the
combined intelligence of the entire organization into a plan of action.

OBJECTIVES OF BUDGETARY PLANNING

1) Coordination
The budgetary process requires that visible detailed budgets are developed to
cover each activity, department or function in the organization. This is only
possible when the effort of one department’s budget is related to the budget of
another department. In this way, coordination of activities, function and
department is achieved.

2) Communication
The full budgeting process involves liaison and discussion among all levels of
management. Both vertical and horizontal communication is necessary to
ensure proper coordination of activities.

3) Control
This is the process for comparing actual results with the budgeted results and
reporting upon variances. Budgets set a control gauge, which assists to
accomplish the plans set within agreed expenditure limits.

4) Motivation
Budgets may be seen as a bargaining process in which managers compete with
each other for scarce resources. Budges set targets, which have to be
achieved. Where budgetary targets are tightly set, some individuals will be
positively motivated towards achieving them.
5) Clarification of Responsibility and Authority
Budgetary process necessitates the organization of a business into
responsibility and budget centres with clear lines of responsibilities of each
manager. This reduces duplication of efforts.

6) Planning
It is by Budgetary Planning that long-term plans are put into action. Planning
involves determination of objectives to be attained at a future predetermined
time. When monetary values are attached to plans they become budgets.

Limitations of Budgeting
 Too mush reliance may cause resistance (inflexibility) to change.
 Difficult to set levels of attainment. This may result into too tight budgets that
cause loss of morale.
 Antagonism where budgets exert undue pressure.
 Budgeting control is a terminate exercise and therefore any report from
investigation of variances may b of little use to the current operations.

Organization of budgetary control

Budgetary control ideally involves the following steps:

1. The creation of budget centres.

2. The introduction of adequate accounting records.
3. The preparation of organization charts.
This defines the functional responsibilities of each member of management.
4. The establishment of a budget committee:
It will consist of operating and financial managers, who will be required to
review,
discuss and co-ordinate business activities. The main function of this
committee
involves:

 To issue instructions regarding budget requirements, deadline dates for the

receipt of budgets e.t.c.
 Draw up the budget preparation timetable. It takes the form of network
analysis whereby some activities are preceded by some others.
 To define the general policies of management in relation to the budget.
 Checking initial draft and problems considered. Limiting factors are usually
considered.
 Ensuring that the budgets are synchronized within the boundaries of
available resources.
 To analyze comparison of budgets and actual results and to recommend
corrective action where necessary.
 Review of budgets.
 Prepare the master budget after functional budgets have been prepared.
 The preparation of a budget manual. This is a document, which sets out the
responsibilities of the persons engaged in the routing of, and the forms and
records required for budgeting control. Such manual will provide such
information as:

- Description of the system and its objectives.

- Definition of the responsibilities and duties.
- Reports and statements required for each budget period.
- Deadline dates by which data are to be submitted.
PREPARATION OF BUDGETS
THE MASTER BUDGET FRAMEWORK
The master budget is the overall quantifications of the budgeting plan. In it,
functional budgets are incorporated. A functional budget is a budget if income
and/or expenditure for a particular function. The master budget therefore
combines all the budgets of the various departments in an organizations. It is
useful in ensuring that all the individual budgets are consistent with one another
and also presents a ‘unit’ picture of the entire organization.

It is made up of both production and non-production budgets.

Production budgets include:

 Sales Budget
 Finished Goods Budgets
 Material budges
 Labour budgets
 Overheads budgets.

Non-Production Budgets Include

 Selling & Distribution
 Administration Budget
 Cash Budget
 Research and Development – Capex
 All these budgets translate into the
projected profit and loss a/c and the
budgeted Balance Sheet.
 The relationship between all these
budgets is summarized in the next page.
 Sales Selling and Admin
Budget dist. Budget Budget

Finished
goods stock
budget

Production Cash
Budget budget
Budgete
d
P/L &
B/S
Material Direct Productio
Usage Labour n over Researc
Budget Budget head h and
Budget develop
Material ment
Stock budget
Budget
Material Capital
Purchase Expen
s Budget diture
Budget

Sales budget
 Sales Budget
It gives volume of sales and sales mix of the current operations. The sales forecast
is initially prepared and upon completion the sales budget is finalized. The
following are usually considered in coming up with the sales forecast.

 Actual sales in the previous periods.

 Reports from salesmen.
 Market research information.
 Level of orders already obtained in advance.

It essentially forecasts what the company can reasonably expect to sell to the
customer during the budget period.

Production budget
It is the forecast of the products to be manufactured during the budget period to
most forecasted sales above.

It is expressed as units of each type of product. The following are usually

considered:
 Available production capacity.
 The sales forecast.
 Finished goods stock level policy.

The cycle for the preparation of the above budget usually is determined by the
budget committee. It is as follows:

i. Determine the production capacity available.

ii. Consider the possible ways in which the available production capacity may
be expanded if required.
iii. Linkage of production capacity available to the stock level.
iv. Determine the detailed budgets within the production budget.

Format

6 (Units) P (Units) J (Units)

Required Stock xx xx xx
31/12/19-0
Add: Sales during the year xx xx xx
Less: Estimated Stock (xx) (xx) (xx)
01/01/19-0
Production xx xx xx
Requirements

It has two purposes

 Ensures that production is sufficient to meet sales demand.

  Ensures that economic stock levels are maintained according to the stock
policy.

Direct Materials Budget

This budget shows the estimated quantities and costs of all the raw materials and
components needed for the output demand by the production budget. This
consists of:

i. Direct Materials Usage Budget: Which shows the estimated quantities

of materials required for budgeted production.
ii. Direct Materials Purchases Budget: It ensures that materials are
within the planned materials stock levels i.e. after considering both usage
material stock required.

Direct Labour Budget

It represents the forecasts of direct and indirect labour requirements to meet the
demands of the company during the budget period.

The budgeted direct labour cost is therefore determined by multiplying direct

labour hours with the wage rates for every category of labour.

Factory Overhead Budget

This budget represents the forecasts of all the production fixed and variable and
semi-variable overheads to be incurred during the budget period.

The summation of budgeted costs of production for the budget period makes up
Production Cost Budget. It includes:

 Budgeted Materials Cost

 Budgeted Labour Cost
 Budgeted Overhead Cost

Non-Production Budgets
a) Selling and Distribution Cost Budget

It is the forecast of all costs incurred in selling and distributing the company’s
product during the budget period. It is closely concerned with the sales budget
in that it is mainly based on the volume of sales projected for the period.

Expenses included are:

 Selling office costs

 Salesman salaries and commission
 Advertising expenses

b) Administration Costs Budget

It represents the costs of all administration expenses. Each department or
budget centre will be responsible for the preparation of its own budget.
Management, Secretarial, Accounting and Administration costs which cannot
be directly related to the production are included here.

The budget will be mainly incremental i.e. previous year’s figure will tend to
apply for its next budget with an allowance for inflation.

c) Research and Development Cost Budget

These are costs, which are discretional in nature i.e. they are determined on
need basis by the managers concerned. Research cost is the cost of original
investigation undertaken in order to gain new scientific or technical knowledge
and directed towards a specific practical aim objective.

Development cost is the cost of using scientific or technical knowledge in order

to produce new or substantially improved materials, devices, products,
processes systems or services prior to the commencement of commercial
production.

d) Capital expenditure Budget

It represents the expenditure on all fixed assets during the budget period.
Addition intended to benefit future accounting periods, or expenditure which
increases the production capacity, efficiency lifespan or economy of an existing
fixed assets are also incorporated.

e) Cash budget
It records the cash inflows and outflows, which are expected to take place in
respect of each functional budget. It may be prepared for a period span of one
week, month or quarter of the budget period. It has the following
benefits/advantages:

 It ensures that sufficient cash is available when required.

 It shows whether capital expenditure projects can be financed internally.
 It indicates the cash needed for current operating activities.
 It indicates the effect the position of each seasonal requirements, large
stocks, unusual receipts and laxity in collecting account receivable.
 It indicates the availability of cash for taking advantage of discounts.
 It reveals the availability of excess cash so that short-term investments may
be considered.
 It serves as a basis for evaluating the actual cash management performance
of responsible managers.

Illustration
Venus plc produces two products Niks and Args. The budget for the next year to
31st 20X8 is to be prepared. Expectations for the forthcoming year includes the
following:

Venus PLC
BALANCE SHEET AS AT 1 APRIL 20X7

Fixed Assets Shs

Shs Shs
Land and buildings 45,000
Plant and Equipment (NBV) 112,000
Current Assets
Raw materials 7,650
Finished goods 23,615
Debtors 19,500
Cash
4,300
55,065
Current Liabilities
Creditors 6,800
Taxation 24,500 (31,300) 23,765
180,765
Financed by
150,000 ordinary shares of Shs1 150,000
each
Retained profit 30,765
180,765

(b) Finished Products NIKS ARGS

The Sales Director has estimated the following:
(i) Demand for the Co’s products 4,500 4,000 units
units
(ii) Expected S.P per unit Shs32 Shs44
(iii) Closing stock @ 31 March 20X8 is required 400 units 1200 units
to be
(iv) Opening stocks at 01 April 20X7 900 units 200 units
(v) Unit cost of this opening stock will be Shs20 Shs28
(vi) The amount of plant capacity required for
each 15min 24min
product is: Machining
Assembling 12min 18min
(vii) The raw material content per unit is
Material A 1.5 kg 0.5 kg
Material B 2.0 k g 4.0 kg
(viii) Direct labour hours required @ unit of
each 6 hrs 9 hrs
product is:

Finished goods are valued at FIFO basis at full factory cost.

(c) Raw Materials Material A Material B
(i) Closing stock requirements kilos at 31
March 20X8 600 1000
(ii) Opening stock at 1 April 20X7 kilos 1100 6000
(iii Budgeted cost of raw materials per kilo Shs1.50 Shs1.0
)

Actual cost per kilo of opening stocks are as budgeted cost for the coming year.

(d) Direct Labour

The standard wage rate of direct labour is Shs1.50/hr.
(e) Factory overhead

Factory overhead is absorbed on the basis of machining hours with separate

absorption rates for each department.

The following are expected overheads in the production cost centre budgets.

Machinery Deport Assembly Deport

Shs Shs
Supervisors salaries 10,000 9,150
Power 2,400 2,000
Maintenance and running 2,100 2,000
costs
Consumables 3,400 500
General Expenses 19,600 5,000
39,500 18,650

Depreciation is taken at 5% straight-line on plant and machinery equipment. A

machine costing the company Shs20,000 is due to be installed on 1 October 20X7
in the machining department which already has machinery installed to the value of
Shs100,000 at cost.

(f Selling and distribution Shs

) expenses
Sales commission and salaries 14,300
Traveling distribution 3,500
Office salaries 10,100
General administration 2,500
expenses
30,400

(g) There is no opening or closing work in progress and inflation should be

ignored.

Required
Prepare the following budgets for the year ended 31 March 20X8 for Venus PLC.

i) Sales budget
ii) Production budget (units)
iii) Plant utilization budget
iv) Direct materials utilization budget
v) Direct labour budget
vi) Factory overhead budget
vii) Direct materials purchases budget
viii) Cost of goods sold budget
ix) Budgeted profit and loss account

Solutions

Venus PLC

(i) Sales Budget

Qty (units) Revenue
(Shs)
NIKS 4,500 144,000*1
ARGS 4,000 176,000*2
TOTALS 320,000

(ii) Production Budget (units)

NIKS ARGS
(units) (units)
Sales 4,500 4,000
Add: Closing Stock 400 1,200
Total 4,900 5,200
requirements
Less: Opening stock (900) (200)
Production budget 4,000 5,000

(iii) Plant Utilization Budget

Machinery Assembling
NIKS (4,000 units) *3 1000 hrs 800 hrs
ARGS (5000 units) *4 2000 1,500
TOTAL PLANT UTILIZATION 3,000 hrs 2,300 hrs

*3 = 4000 x ; 4000 x
15 min 12 min
60 min 60 min
*4 = 5000 x ; 5000 x
24 min 18 min
60 min 60 min

(iv) Direct Material Uses Budget

Units @ Material @ Material

A B
NIKS 4,000 1.5 6,000 2.0 8,000
ARGS 5,000 0.5 2,500 4.0 20,0
00
Total Direct 8,500 28,000
Materials kg kg
USAGE

(v) Direct Materials Purchases Budget

Mat A Mat B (kg)

(kg)
Current usage 8,50 28,00
0 0
Add: Closing stock 60 1,00
0 0
Total Req 9,10 29,00
0 0
Less: Opening stock (1,100) (6,000)
Material To Be Purchased (Kg) 8,00 23,00
0 0
Cost per Kg. Shs1.5 Shs1.0
Material purchase
Budget Shs 12,000 23,000

Total Material Purchases Budget:

Shs.
12,000
+ 23,000
35,000

(vi) Direct Labour Budget

Hrs
NIKS 4000 x 6 24,000
ARGS 5000 X 9 45,000
Direct Labour hrs 69,000
Standard Wage rate/hr Shs
1.6
Direct Labour Cost Budget Shs 110,400

Factory Overhead Budget

Machining Department Assembly

(Shs) department
(Shs)
Budgeted Overheads 39,500 18,650
ex
Cluding depreciation
Add: Depreciation
Less: Existing plant *5 4,350
5,000
New plant *6 -
500
Total budgeted overheads 45,000 23,000
Absorption Base (Machine 3,000 2,300
hrs)
Overhead Absorption Rate *7 Shs 10 mach hr
Shs1.5/mach hr

*5 = 100,000 x 5%; 87,000 x 5%

*6 = 20,000 x 5% x
6
12
*7 = ;
45000 23000
3000 2300

(viii) Cost of goods sold budget

Niks Args
(Shs) (Shs)
Opening stock 18,000 5,600
(WI)
Add: Production (WII) 78,400 140,750
Less: Closing stock 7,840 33,780
(WIII)
Cost of goods 88,560 112,570
sold

Workings

I: Opening stocks

Niks: 900 x 20 = 18,000

Args: 200 x 28 = 5,600

II PRODUCTION COST PER UNIT OF FINISHED

PRODUCT

NIKS ARG

Materials: A 1.5 x 1.5 2.25 0.5 x 1.5 0.75

B 2.0 x 1.0 2.0 4.0 x 1.0 4.0
Labour: 6hrs x 1.6 9.6 9 hrs x 1.6 14.4
Overheads
Machining 15 x 3.75 15 x 6.0
15 24
60 60
Assembly 10 x 10 x
12 2.0 18 3.0
60 60
Total production @ unit Shs19.6 28.15
Production Units 4000 5000
Valuation 78400 140750

III CLOSING stock valuation

NIKS ARGS

Closing stock units 400 1200

Unit cost 19.6 28.15
Stock units 7840 33780

(iv) BUDGETED PROFIT AND LOSS ACCOUNT

NIKS ARGS TOTAL

(Shs) (Shs) (Shs)

Sales 144000 176000 320000

Cost of goods sold 88560 112570 201130
Gross Profit 55440 63430 118870
Less: Selling and administrations 30400
expenses
Net Profit 88470

KASNEB JUNE 1996

QUESTION FIVE
The following information related to the proposed budget for K.K Ltd for the
months ending 31 December 1996.

Material Production Administra

tion
Month Sales Purchase Wages Overheads Overheads
s
Sh. ‘000’ Sh. ‘000’ Sh. Sh. ‘000’ Sh. ‘000’
‘000’

July 72000 250000 10000 6000 55000

August 97000 31000 12100 6300 6700
Septemb 86000 25500 10600 6000 7500
er
October 88600 30600 25000 6500 8900
Novembe 102500 37000 22000 8000 11000
r
Decembe 108700 38800 23000 18200 11500
r

Additional Information
1. Depreciation expenses are expected to be 0.5%of sales.
2. Expected cash balance in hand on 1 July 1996 is Sh. 72,500,000
3. 50% of total sales are cash sales
4. Assets are to be acquired in the months of August and October at Shs.
8,000,000 and Shs. 25,000,000 respectively
5. An application has been made to the bank for the grant of a loan of Shs.
30,000,00 and it is hoped that it will be received in the month of November
6. It is anticipated that a dividend of Shs. 35,000,000 will be paid in December
7. Debtors are allowed one month’s credit
8. Sales commission at 3% on sales is paid to the salesmen each month

Required
A cash budget for the six months ending 31 December 2003.

CASH BUDGET
SUGGESTED SOLUTION: KASNEB JUNE 1996 QUESTION 5

K.K LTD

Workings I: Depreciation = 0.5% of sales

July Aug Sept Oct Nov Dec

Sales 72000 97000 86000 88600 10250 108700
0
Depreciation 360 485 430 443 512.5 543.5

II Cash Production Overheads

 July Aug Sept Oct Nov Dec
Production overheads 6000 6300 6000 6500 8000 8200
Less: Depreciation 360 485 430 443 512. 543.5
5
Cash production 5640 5815 5570 6057 7487.5 7656.5
overheads

III Receipt from sales

July Aug Sept Oct Nov Dec

Total sales 72000 97000 86000 88600 10250 108700
0
Cash Sales (50%) 36000 48500 43000 44300 51250 54350
Receipt from Debtors - 36000 48500 43000 44300 51250
Total cash receipts 36000 84500 91500 87500 95550 15560

IV Sales Commission (3% of Sales)

July Aug Sept Oct Nov Dec

Sales 72000 97000 86000 88600 10250 108700

0
Sales Commission 2160 2910 2580 2658 3075 3261
KK
CASH BUDGET FOR SIX MONTHS ENDING 31 DECEMBER 1996

July Aug Sept Oct Nov Dec Total

RECEIPTS ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’

Opening b/d 72500 96340 12169 15649 15256 207485 72500

0 5 7
Cash receipts 36000 84500 91500 87500 95550 105600 500450
Loan 3000 3000
- - - - 0 - 0
10850 18084 21319 24379 27811 313085 602950
0 0 0 5 7
PAYMENTS
Materials - 25000 31000 25500 30600 37000 149100
Wages 10000 12100 10600 25000 22000 23000 102700
July Aug Sept Oct Nov Dec Total
RECEIPTS ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’

Pdtn overheads - 5640 5815 5570 6057 7487.5 3056.5

Admin - 5500 6700 7500 8900 11000 39600
overheads
Cash assets - 8000 - 25000 - - 33000
Dividends - - - - 35000 - 35000
Sales 216 2910 2580 2658 3075 3261 16644
commission 0
Total payments 12160 5916 5669 9127 7036
0 5 8 2 . .
Closing balance 96340 12169 15649 15256 20748 196336 196336
c/d 0 5 7 5 .5 .5

FIXED AND FLEXIBLE BUDGETING

The master budget discussed before is a fixed budget.

A fixed budget is defined by:

 Only one level of activity

 Not adjusted to reflect actual activity level when change occurs

A fixed budget has the following limitations:

 It provides little assistance at the planning stage. It does not give implication of
various alternative strategies which management may wish to consider.
 It fails to provide relevant and reliable base against which to measure actual
performance where actual activity differs from the budget.
 Little motivation to management to use the budgeting control system as a
control aid.
Flexible budget is a budget which is designed to change in accordance with the
level of activity attained. It involves budgeting at various levels in anticipation of
changes. The original budget is adjusted (flexed) to reflect the actual conditions in
which the performance was done.

It is more useful than fixed budgeting due to:

 It provides a range of information at the planning stage which will assist in

short term planning.
 Control: It provides control data when compared with actual performance.
 Motivation: More likely to be acceptable to management to provide a positive
motivational stimulus because the control data is adjusted to conform with
current activity level.

CHOICE OF BUDGET FLEXING BASIS

The most appropriate flexing basis should be considered in that it assists in the
comparison of alternative budget data at the planning stage and for the
comparison of budget and actual data at the control stage.
Different organizations use different flexing bases but the following are most
commonly used.

 Machine hours
 Direct labour hours
 Input to a cost centre
 Output from a cost centre

For the above flexing bases to be used a number of requirements must be fulfilled.

1. The flexing bases should be correlated with the way in which costs vary. E.g.
does the number of miles traveled by distribution vehicles affect the repairs and
maintenance expenses?
2. The flexible bases should be easily understood by the management and not
subject to manipulation.
3. The flexible bases should be readily obtainable.
4. It should be independent of other factors.

Illustration
Mini Bakeries Ltd. has budgeted to produce and sell 100,000 units of cakes during
the next period. The selling price per cake is Sh. 20 and variable cost per cake is
Sh. 12. Fixed overheads are budgeted to at Sh. 6000,000.

Additional information

1. Fixed costs will increase to Sh. 700,000 where activity is in excess of 110,000
units; Fixed costs will fall to Sh. 480,000 where activity level is less than 90,000
units.
2. Variable costs will fall by 5% per unit (cake) of all units where activity is in
excess of 100,000 cakes because of the economies of scale.
The actual results of the period in which 115,000 units (cakes0 were produced and
sold were:

1. Sales revenue Sh. 2,242,500

2. Variable costs Sh. 1,320,000
3. Fixed costs Sh. 67,000

Required
1. Prepare a summary, which shows the budgeted results for activity levels from
80,000 to 120,000 cakes using the above information.
2. Prepare a control statement comparing budgeted with actual results where a
fixed budget system is used based on 100,000 units.
Solution
Flexible Budget Summary

Units 80,00 90,000 100,00 110,00 120,00

0 0 0 0
Sales 1,600,00 1,800,000 2,000,000 2,200,000 2,400,000
Revenue 0
Variable 690,000 108,000 120,000 1,254,000 1,368,000
cost
Contribution 640,000 720,000 800,000 946,000 1,032,000
Fixed Costs 480,000 600,000 600,00 600,000 700,000
Net Profit 160,000 120,00 200,000 346,000 332,000

Control Statement (Fixed Budget)

Budget Actual Variance

Units 100,000 115,00 15,00 (F)

Sales Revenue 2,000,000 2,242,500 242,500 (A)
Variable Cost 1,200,000 1,320,000 120,000 F
Contribution 800,000 922,500 122,500 (A)
Fixed Costs 600,000 670,000 70,000 (A)
Net Profit 200,000 252,500 525,000 (F)

ZERO BASED BUDGETING

It is also referred to as priority based budgeting. It is a cost benefit approach
budgeting where it is assumed that the cost allowance is Zero for any item until
the manager responsible justifies its existence in terms of costs and benefits.

CIMA definition: A method of budgeting whereby all activities are re-evaluated

each time the budget is set. It is concerned with alternative means that
established activities have been compared with alternative uses of the same
resources.

It takes away the implied right of existing activities to continue receiving resources
unless they can be shown to be the best use of such resources.

Stages of Implementation
1. Definition of decision package.
This is the comprehensive description of the organizations functions or
activities.
2. Evaluation and ranking of packages.
This is on benefit basis.
3. Resource allocation according to priorities.

Advantages
1. More efficient allocation of resources.
2. Focus attention on values for money and makes clear relationship between
input and output.
3. Develops a questioning altitude and makes it easier to identify obsolete,
inefficient and less cost effective operations.
4. Leads to greater staff and management knowledge of operations.

Disadvantages
1. Time consuming.
2. High skills required.
3. May encourage wrong impression that all decisions must be made through
budgets.
4. Short – term benefits may be emphasized to the detriment of long-term
benefits.