Unit, Batch, Job and Service Costing — Practice

Question 1

A company's Cost of Production for the period is Rs.12,00,000 for 20,000 units produced, and its Cost of Sales is Rs.13,50,000 for 18,000 units sold. Compute cost of production per unit and cost of sales per unit, and explain why the two divisors differ.

Accepted Answer

Cost of production per unit is Total Cost of Production divided by units produced: 12,00,000 divided by 20,000, giving 60 per unit. Cost of sales per unit is Total Cost of Sales divided by units sold: 13,50,000 divided by 18,000, giving 75 per unit. The two divisors differ because production and sales volumes in any period rarely coincide exactly, and each cost figure must be matched to the activity that actually generated it: Cost of Production reflects the cost of the 20,000 units the factory actually made during the period, so it is properly divided by that production figure to give a meaningful cost per unit produced, while Cost of Sales reflects the fuller cost, including selling and distribution overhead, attributable to the 18,000 units actually sold during the period, and dividing by units sold is what gives a meaningful cost per unit sold. Dividing Cost of Production by units sold, or Cost of Sales by units produced, would each produce a distorted, meaningless figure, since the numerator and denominator would then relate to different underlying activity levels rather than the same one; the 2,000 unit gap between production and sales here, presumably reflecting a build-up of finished goods inventory during the period, is exactly why the two per-unit figures must be kept separate rather than computed from a single blended volume figure.

Question 2

A company manufactures a component in batches. Annual demand is 36,000 units, setup cost per batch is Rs.400, and carrying cost is Rs.3 per unit per annum. Compute EBQ, the number of batches per year, and explain the structural parallel to EOQ.

Accepted Answer

EBQ is computed as the square root of two times annual demand times setup cost per batch, divided by carrying cost per unit per annum: square root of (2 times 36,000 times 400) divided by 3, that is square root of 2,88,00,000 divided by 3, giving square root of 96,00,000, which is approximately 3,098 units per batch. The number of batches to be run per year is annual demand divided by EBQ: 36,000 divided by 3,098, giving approximately 11.6 batches, in practice rounded to a whole number of batch runs as production scheduling requires. The structural parallel to EOQ is exact: EOQ answers how much to order at a time to minimise the sum of ordering cost and carrying cost for a purchased item, while EBQ answers how large a batch to manufacture at a time to minimise the sum of setup cost and carrying cost for a manufactured item, and the formula is identical in form, with setup cost per batch simply substituting for ordering cost per order, since setting up a production run for a new batch is the manufacturing analogue of placing a purchase order; both formulas balance the same two opposing forces, fewer, larger batches (or orders) reducing total setup (or ordering) cost while increasing average inventory and therefore carrying cost, and more, smaller batches (or orders) doing the reverse, with the optimum occurring where the sum of the two costs is at its lowest point.

Question 3

A job's total cost is Rs.60,000. Compute the selling price if the company wants a profit margin of 25% on cost, and separately if it wants a profit margin of 25% on selling price, and explain why the two answers differ despite the same percentage figure.

Accepted Answer

Where the margin is stated on cost, selling price is total cost multiplied by one plus the margin percentage: 60,000 times (1 plus 0.25), that is 60,000 times 1.25, giving 75,000; the profit embedded in this price is 15,000, which is indeed 25% of the 60,000 cost. Where the margin is stated on selling price, selling price is total cost divided by one minus the margin percentage: 60,000 divided by (1 minus 0.25), that is 60,000 divided by 0.75, giving 80,000; the profit embedded in this price is 20,000, which is 25% of the 80,000 selling price, though it works out to a larger absolute profit and a higher price than the margin-on-cost computation produced. The two answers differ despite the same 25% figure because the base the percentage is applied to is different in each case: a margin on cost is 25% of a smaller number (cost alone), while a margin on selling price is 25% of a larger number (the selling price itself, which by construction is larger than cost), so achieving a margin that is 25% of the larger base requires a higher absolute markup than achieving a margin that is 25% of the smaller base. Confusing the two, applying the margin-on-cost formula when a margin-on-selling-price figure was actually intended, or the reverse, produces a materially wrong price and is a commonly tested and commonly made error in this chapter, making it essential to identify precisely which base a given percentage margin is stated against before selecting a formula.

Question 4

A contract has a contract price of Rs.50,00,000. At the end of the year, cost of work certified is Rs.18,00,000, cost of work uncertified is Rs.1,00,000, value of work certified is Rs.22,00,000, and cash received from the client is Rs.19,80,000, being 90% of work certified (10% retained). Compute notional profit, the cash ratio, the stage of completion, and the profit to be transferred to the profit and loss account applying the appropriate convention.

Accepted Answer

Notional profit is value of work certified less the sum of cost of work certified and cost of work uncertified: 22,00,000 less (18,00,000 plus 1,00,000), that is 22,00,000 less 19,00,000, giving notional profit of 3,00,000. Cash ratio is cash received divided by value of work certified: 19,80,000 divided by 22,00,000, giving 0.90, that is 90%, consistent with the stated 10% retention. Stage of completion is measured by value of work certified as a proportion of contract price: 22,00,000 divided by 50,00,000, giving 44%, which falls within the roughly 25% to 50% completion band. At this stage of completion, the applicable convention is to transfer one-third of notional profit, adjusted by the cash ratio, to the profit and loss account, reflecting a still-cautious but somewhat more confident recognition than the nil transfer required below roughly 25% completion. Profit transferred is one-third of notional profit, that is one-third of 3,00,000, giving 1,00,000, further adjusted by the cash ratio of 0.90, giving 1,00,000 times 0.90, that is 90,000, transferred to the profit and loss account for the year. The remaining notional profit, 3,00,000 less 90,000, that is 2,10,000, is retained as a reserve, held back against the risk that the contract's ultimate profitability may differ from what these early-stage figures suggest, consistent with the prudence principle that governs profit recognition on long-duration, incomplete contracts throughout this convention.

Question 5

Explain why retention money is excluded from the cash ratio computation, and what would go wrong if it were included as though it had been received.

Accepted Answer

Retention money is the portion of work certified, commonly around 10%, that the client deliberately withholds as security until the contract is fully complete and any defects liability period has passed, and by its very nature it has not actually been paid to the contractor at the point the cash ratio is computed; it remains a promise of future payment contingent on satisfactory completion, not a cash receipt. The cash ratio is computed as cash actually received from the client divided by the value of work certified, and its purpose within the contract costing profit recognition convention is to adjust the profit transferred so that recognition tracks not merely formal certification of work, which the architect or engineer may grant somewhat generously, but genuine cash collection, which is a harder, more objective test of whether the contract is proceeding as expected and whether the client is satisfied enough to actually pay. If retention money were included as though received, the cash ratio would be artificially inflated towards 100%, understating the caution the retention arrangement is specifically designed to build in, and the contractor would end up recognising more profit than the prudence convention intends at this stage of an incomplete contract, precisely the premature recognition the whole convention exists to prevent. Excluding retention money keeps the cash ratio an honest measure of what has genuinely been collected, which is the entire point of layering it onto the notional profit figure before transferring any of it to the profit and loss account.

Question 6

A transport company operates a single truck covering 40,000 kilometres in a year, carrying an average load of 6 tonnes per trip. Annual fixed costs (driver salary, depreciation, insurance) are Rs.3,00,000, and variable costs (fuel, tyres) are Rs.8 per kilometre run. Compute the composite cost unit (tonne-kilometres) for the year and the cost per tonne-kilometre, explaining why a simple per-kilometre rate would be inadequate.

Accepted Answer

The appropriate composite cost unit for a goods transport service is the tonne-kilometre, combining a measure of load carried with a measure of distance covered, since neither alone captures what the service actually delivers to a customer, who pays for both the weight moved and the distance it is moved over. Total tonne-kilometres for the year is average load per trip multiplied by total kilometres run, treating the load as constant across the distance for this computation: 6 tonnes times 40,000 kilometres, giving 2,40,000 tonne-kilometres. Total cost for the year is fixed cost plus variable cost: 3,00,000 fixed, plus variable cost of 8 per kilometre times 40,000 kilometres, that is 3,20,000 variable, giving a total cost of 6,20,000. Cost per tonne-kilometre is total cost divided by total tonne-kilometres: 6,20,000 divided by 2,40,000, giving approximately 2.58 per tonne-kilometre. A simple per-kilometre rate would be inadequate because it would treat a truck running empty and a truck running fully loaded as costing the same to operate per kilometre travelled, when in commercial reality the value delivered, and often the actual variable cost incurred through greater fuel consumption when loaded, differs substantially with the load carried; a per-kilometre rate alone tells a customer or manager nothing about whether the service is being used efficiently in terms of the load being moved, whereas the composite tonne-kilometre rate directly reflects both dimensions the service actually involves, distance and load, together.

Question 7

A pharmaceutical company runs a batch of 5,000 tablets at a total cost of Rs.2,25,000, comprising material Rs.1,00,000, labour Rs.75,000, and overhead Rs.50,000. Compute cost per tablet, and explain why this is treated as one job for costing purposes despite thousands of individual tablets being produced.

Accepted Answer

Total batch cost is material plus labour plus overhead: 1,00,000 plus 75,000 plus 50,000, giving 2,25,000. Cost per tablet is total batch cost divided by the number of units in the batch: 2,25,000 divided by 5,000, giving 45 per tablet. This is treated as one job for costing purposes, despite thousands of individual tablets being physically produced, because all 5,000 tablets in the batch are manufactured together, in a single production run, using the same setup, the same equipment configuration, and the same materials sourced and processed together; there is no meaningful way, and no commercial need, to track cost separately for each individual tablet within the batch, since they are identical and produced as one undifferentiated group. Treating the whole batch as a single job, accumulating cost against the batch as a unit and then dividing by the number of tablets to arrive at a per-unit figure, is exactly the batch costing approach: it borrows job costing's method of accumulating cost against one identifiable production run, while acknowledging that the natural unit of production here is the batch rather than any single tablet, which is why batch costing is described as a variant of job costing applied specifically to situations of this kind.

Question 8

A job requires direct material of Rs.30,000, direct labour of 40 hours at Rs.150 per hour, and the department's overhead absorption rate is Rs.80 per direct labour hour. Compute total job cost, and the selling price if the company wants a 20% margin on selling price.

Accepted Answer

Direct labour cost is 40 hours times 150, giving 6,000. Overhead absorbed into the job is 40 direct labour hours, the base this department uses, times the absorption rate of 80 per hour, giving 3,200. Total job cost is direct material of 30,000 plus direct labour of 6,000 plus overhead absorbed of 3,200, giving 39,200. Since the desired margin is stated on selling price rather than on cost, the correct formula is selling price equals total cost divided by one minus the margin percentage: 39,200 divided by (1 minus 0.20), that is 39,200 divided by 0.80, giving 49,000. The profit embedded in this price is 49,000 less 39,200, that is 9,800, which is indeed 20% of the 49,000 selling price, confirming the margin has been correctly computed on the selling price base rather than on cost; had the margin instead been stated as 20% on cost, the correct computation would instead have been 39,200 times 1.20, giving 47,040, a materially different and lower price, illustrating once again why identifying which base a stated margin percentage applies to is essential before selecting the correct formula.

Question 9

A contract with contract price Rs.80,00,000 is 95% complete based on value of work certified. Estimated total cost on completion is Rs.68,00,000, of which Rs.60,00,000 has been incurred to date. Cash received is 90% of work certified. Explain why the notional profit convention is no longer appropriate here, and compute the profit to be transferred using the estimated total profit basis.

Accepted Answer

At 95% completion, the contract has passed the roughly 90% threshold at which the cruder notional profit fractions, one-third or two-thirds of notional profit adjusted by cash ratio, are considered no longer appropriate, since a contract this close to completion can be estimated with much greater confidence than one still substantially in progress, and continuing to apply the more cautious fractional approach at this late stage would understate recognisable profit unnecessarily given how little uncertainty genuinely remains. At this stage, the more refined estimated total profit basis is used instead: estimated total profit on the whole contract is contract price less estimated total cost, that is 80,00,000 less 68,00,000, giving 12,00,000. The proportion of this total estimated profit to transfer is based on the proportion of work certified, or alternatively cash received, to contract price; using work certified, which is stated as 95% complete, the profit to transfer is 95% of 12,00,000, giving 11,40,000, though some formulations further adjust this by the cash ratio as an additional layer of caution, in which case the cash ratio of 90% would be applied to this figure, giving 11,40,000 times 0.90, that is 10,26,000. The specific formula variant, whether cash ratio is layered on top of the completion percentage or not, can differ by the particular convention a problem specifies, but the underlying shift from notional profit fractions to an estimated-total-profit basis at high completion is the conceptual point being tested: near completion, a much more precise estimate of the whole contract's eventual profit is achievable and appropriate to use, in contrast to the necessarily cruder fractional approach suited to a contract still substantially incomplete.

Question 10

A hospital ward has 30 beds, with an average occupancy of 80% over a 365-day year. Total ward costs for the year are Rs.1,09,500,000. Compute the cost per patient-day, and explain why occupancy rate matters to this computation.

Accepted Answer

Total available bed-days for the year are 30 beds times 365 days, giving 10,950 bed-days. At an average occupancy of 80%, actual patient-days, the appropriate cost unit for this service, are 80% of 10,950, giving 8,760 patient-days. Cost per patient-day is total ward cost divided by actual patient-days: 1,09,50,000 divided by 8,760, giving 1,250 per patient-day (note the total cost as given, 1,09,500,000, appears to be stated with an extra digit relative to a realistic hospital ward budget; treating it as 1,09,50,000, that is roughly 1.095 crore, for a sensible per-patient-day figure). Occupancy rate matters critically to this computation because most of a hospital ward's costs, staffing, general facility maintenance, equipment, are largely fixed regardless of how many beds are actually occupied on a given day, so cost per patient-day is highly sensitive to occupancy: a ward run at full 100% occupancy spreads the same largely fixed total cost over more patient-days, producing a materially lower cost per patient-day, while the same ward run at a lower occupancy rate spreads that cost over fewer patient-days, producing a materially higher cost per patient-day even though the absolute total cost incurred by the ward has not changed. This is precisely why occupancy rate, alongside the cost unit itself, is a critical management figure in healthcare service costing, since it directly drives the efficiency, in cost-per-patient-day terms, of a given fixed capacity, and hospital administrators actively manage occupancy specifically because of this cost relationship.

Question 11

A contract's value of work certified is Rs.30,00,000, with 12% retained by the client. Cost of work certified is Rs.24,00,000 and cost of work uncertified is Rs.1,50,000. The contract is 60% complete. Compute notional profit, cash received, cash ratio, and the profit to be transferred to the profit and loss account.

Accepted Answer

Notional profit is value of work certified less the sum of cost of work certified and cost of work uncertified: 30,00,000 less (24,00,000 plus 1,50,000), that is 30,00,000 less 25,50,000, giving 4,50,000. Cash received is value of work certified less the retained amount: with 12% retained, 88% is received, that is 88% of 30,00,000, giving 26,40,000. Cash ratio is cash received divided by value of work certified: 26,40,000 divided by 30,00,000, giving 0.88, that is 88%, consistent with the stated 12% retention. At 60% completion, falling within the roughly 50% to 90% band, the applicable convention is to transfer two-thirds of notional profit, adjusted by the cash ratio: two-thirds of 4,50,000, that is 3,00,000, further adjusted by the cash ratio of 0.88, giving 3,00,000 times 0.88, that is 2,64,000, transferred to the profit and loss account. The remaining notional profit, 4,50,000 less 2,64,000, that is 1,86,000, is retained as a reserve against the risk that the contract's final outcome may differ from the current, still-incomplete-stage estimate, consistent with the prudence principle running through this whole profit recognition convention regardless of which completion band a specific contract happens to fall into.

Question 12

State the appropriate cost unit for each: a power generation company, a hotel chain, a canteen serving factory workers, a goods transport company. Explain briefly why each is well suited to its industry.

Accepted Answer

A power generation company uses cost per kilowatt-hour as its cost unit, since electricity is generated, measured, sold and consumed in kilowatt-hours, making this the natural unit that directly matches what the business produces and what customers are billed for. A hotel chain uses cost per room-day, or room-night, since a hotel's core offering is the availability of a room for occupation over a period of a day or night, and both revenue and the underlying costs of housekeeping, utilities and general facility upkeep scale most naturally with occupied room-nights rather than with any other measure. A canteen serving factory workers uses cost per meal served, since a canteen's output is discrete, countable meals, and tracking cost per meal directly supports decisions about pricing, subsidy levels and efficiency of the catering operation. A goods transport company uses cost per tonne-kilometre, a composite cost unit combining the weight of goods carried with the distance travelled, since neither dimension alone, weight or distance, adequately captures what the transport service actually delivers to a customer, who is paying for both the amount moved and how far it is moved. In each case the chosen cost unit reflects the specific dimension of output that genuinely drives both the service's value to the customer and the underlying cost structure of delivering it.

Question 13

A hotel has 50 rooms, achieving average occupancy of 70% over a 30-day month. Fixed monthly costs (staff salaries, general maintenance) are Rs.9,00,000, and variable cost per occupied room-night (housekeeping supplies, utilities) is Rs.400. Compute total monthly cost and cost per occupied room-night, and explain why a hotel manager should be cautious about quoting this figure as a fixed 'cost per room' regardless of occupancy.

Accepted Answer

Total available room-nights for the month are 50 rooms times 30 days, giving 1,500 room-nights. At 70% occupancy, occupied room-nights are 70% of 1,500, giving 1,050. Total monthly cost is fixed cost plus variable cost: 9,00,000 fixed, plus (400 times 1,050) variable, that is 4,20,000 variable, giving a total of 13,20,000. Cost per occupied room-night is total cost divided by occupied room-nights: 13,20,000 divided by 1,050, giving approximately 1,257 per occupied room-night. A hotel manager should be cautious about quoting this figure as a fixed cost per room regardless of occupancy because it is heavily influenced by the 70% occupancy assumption used to compute it, and the fixed cost component in particular behaves very differently as occupancy changes: at a much lower occupancy, say 40%, occupied room-nights would fall to 600, and the same 9,00,000 of fixed cost would need to be spread over far fewer room-nights, pushing cost per occupied room-night up substantially even though the variable cost per room-night itself stays at 400 regardless of occupancy; at a much higher occupancy, the fixed cost spreads more thinly and cost per occupied room-night falls correspondingly. Quoting a single, occupancy-independent cost per room figure without this context risks materially misleading pricing or profitability decisions, since the true cost of serving one additional guest at existing occupancy is much closer to the 400 variable cost alone, the fixed cost being largely sunk and already committed, than to the blended 1,257 average figure that includes a share of fixed cost the hotel would incur regardless of that specific guest's stay.

Question 14

A company has two departments with different overhead absorption bases. Department 1 absorbs overhead at Rs.60 per machine hour, and Department 2 absorbs overhead at Rs.40 per direct labour hour. A job passes through both departments, using 5 machine hours in Department 1 and 8 direct labour hours in Department 2. Direct material for the job is Rs.18,000 and direct labour cost is Rs.4,800. Compute total job cost.

Accepted Answer

Overhead absorbed from Department 1 uses its machine hour base: 5 machine hours times 60, giving 300. Overhead absorbed from Department 2 uses its own, different base, direct labour hours, since different departments can and often do use different absorption bases reflecting what actually drives overhead in each: 8 direct labour hours times 40, giving 320. Total overhead absorbed into the job across both departments is 300 plus 320, giving 620. Total job cost is direct material plus direct labour plus overhead absorbed from both departments: 18,000 plus 4,800 plus 620, giving 23,420. This illustrates a point worth carrying from the overheads chapter into job costing specifically: a single job passing through multiple departments does not use a single, uniform overhead rate throughout, but rather has overhead absorbed separately in each department it passes through, using whatever base and rate that specific department has established as appropriate to its own cost structure, with the job cost sheet accumulating these separate absorptions from each department alongside the material and labour cost incurred at each stage, to build up the full total cost of the job across its entire production journey.

Question 15

A company both purchases a raw material from an external supplier and separately manufactures a semi-finished component internally in production batches, both feeding into the same final product. Explain which formula, EOQ or EBQ, applies to each, and why using the wrong one for either would produce a misleading recommendation.

Accepted Answer

EOQ applies to the externally purchased raw material, since it is bought from an outside supplier in discrete orders, and the relevant costs balanced are ordering cost, the cost of placing and processing each purchase order, against carrying cost, the cost of holding the resulting inventory; EOQ answers how much to order at a time to minimise the sum of these two costs for this purchased item. EBQ applies to the internally manufactured semi-finished component, since it is produced in batches within the company's own factory rather than purchased externally, and the relevant costs balanced are setup cost, the cost of configuring the production line or equipment for a new batch run, against the same carrying cost concept applied to the resulting batch inventory; EBQ answers how large a batch to manufacture at a time to minimise the sum of these two costs for this manufactured item. Using EOQ's ordering cost input for the manufactured component would substitute an inapplicable cost concept, since there is no external order being placed at all, only an internal production run being set up, and the actual cost driver, machine and line setup cost, may behave quite differently in magnitude and structure from a supplier's ordering cost; conversely, applying EBQ's setup cost logic to the externally purchased material would similarly misrepresent what actually drives the per-event cost for that item. Recognising which of the two situations, external purchase or internal manufacture, a given material or component genuinely represents is what determines which formula, and which specific cost inputs, are actually appropriate to use.

Practice — Unit, Batch, Job and Service Costing

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