Unit, Batch, Job and Service Costing
Weightage: Chapter 6 of ICAI's Paper 4 syllabus, roughly 12 marks. Four methods, each the cost sheet applied to a specific costing situation, with one distinct additional computation attached to each.
Unit Costing
Used where a single, homogeneous product is manufactured continuously, and cost is expressed per unit of output — the ordinary cost sheet, computed per unit rather than only in total, generally by dividing each total figure by units produced.
Cost per unit = Total cost of production ÷ Number of units produced.
The only real complication at this level is ensuring the number of units used as the divisor matches the cost being divided precisely — dividing total Cost of Production by units produced (not units sold) to get cost of production per unit, but dividing total Cost of Sales by units sold (not units produced) to get cost of sales per unit, since production and sales volumes in a period rarely coincide exactly.
Batch Costing
A batch — a group of identical units — is treated as one job for costing purposes: costs are accumulated for the whole batch and then divided by the number of units in the batch to arrive at cost per unit.
Economic Batch Quantity (EBQ)
The one genuinely distinct computation this chapter adds is EBQ, the batch-production analogue of EOQ, answering: what batch size minimises the total of setup cost and carrying cost for a product manufactured in batches rather than purchased in one-off orders?
where A = annual demand, S = setup cost per batch (the batch-manufacturing analogue of ordering cost), C = carrying cost per unit per annum.
The formula is structurally identical to EOQ, and the intuition transfers directly: a larger batch means fewer setups (lower total setup cost) but more average inventory (higher total carrying cost), and EBQ is the batch size at which the sum of the two is minimised.
Job Costing
Used where production is against specific customer orders, each distinct, and cost is accumulated for each job separately using a Job Cost Sheet (or job card), tracking materials issued, labour hours booked, and overhead absorbed against that specific job number.
Overheads are absorbed into a job using a predetermined absorption rate (developed in the overheads chapter), applied to the job's actual base (its actual direct labour hours, machine hours, or direct labour cost, according to whichever base the department uses).
Pricing a job — where a job is priced to yield a specified profit margin, either on cost or on selling price, the computation must be done carefully according to which base the margin is stated on:
Confusing these two — treating a margin stated on selling price as though it were stated on cost — is a common and consequential error, since the two formulas produce materially different prices for the same underlying margin percentage.
Contract Costing
A variant of job costing for large-scale, long-duration work, typically at the customer's site, and it introduces its own vocabulary because contracts commonly span more than one accounting period.
Notional profit on an incomplete contract = Value of work certified − (Cost of work certified + Cost of work uncertified), computed at the end of an accounting period for a contract still in progress.
Work certified is the value of work the contract's architect or engineer has formally certified as complete, on which the client makes progress payments; work uncertified is further work done but not yet formally certified.
Recognising profit on an incomplete contract follows a prudence-driven convention, tied to the stage of completion (work certified as a proportion of contract price):
- Where completion is very low (typically below 25%), no profit is transferred to the profit and loss account; the whole notional profit is retained as a reserve against the risk that the contract may not ultimately be as profitable as the early figures suggest.
- Where completion is between roughly 25% and 50%, one-third of notional profit, adjusted by the cash ratio received, is typically transferred.
- Where completion is between roughly 50% and 90%, two-thirds of notional profit, adjusted by the cash ratio, is typically transferred.
- Where completion is 90% or more (near completion), a more refined estimated total profit basis is used, transferring a proportion of the estimated total profit on the whole contract based on the proportion of work certified (or cash received) to contract price, rather than continuing to use the cruder notional profit fractions.
The cash ratio adjustment exists because work certified is not the same as cash actually received (clients typically retain a percentage as retention money until final completion), and transferring profit based on certified value alone, without adjusting for what has actually been collected in cash, would recognise profit on amounts not yet received, which is exactly the kind of premature recognition the prudence convention is designed to prevent.
Retention money is the portion of work certified that the client withholds (commonly 10%) as security until the contract is fully complete and any defects liability period has passed; it is not part of the cash received for the cash ratio computation above, since it has, by definition, not actually been paid.
Service (Operating) Costing
Used where the cost object is a service rather than a physical product, and the defining challenge is choosing an appropriate cost unit for the specific service, since no single unit fits every kind of service:
- Transport: cost per passenger-kilometre or cost per tonne-kilometre (a composite cost unit, combining a measure of load with a measure of distance, since neither alone captures what a transport service actually delivers).
- Hospitals: cost per patient-day, or cost per bed occupied.
- Hotels: cost per room-day (or room-night).
- Power generation: cost per kilowatt-hour.
- Canteens: cost per meal served.
Fixed and variable classification matters particularly here, because service costing frequently requires computing cost per unit of a composite base (like passenger-kilometres), where the fixed cost component (driver salary, vehicle depreciation, insurance — independent of distance run) and the variable cost component (fuel, tyres — dependent on distance run) behave quite differently as the composite base changes, and getting the classification right is what makes a per-unit rate meaningful rather than misleading.
