What you'll learn
A costing system has to fit the way the business actually produces. A garage repairing one vehicle at a time, a bakery producing a run of 500 identical loaves, and a rum distillery running a continuous fermentation process cannot all use the same method, because in each case the question "what does one unit cost?" means something different.
Job costing applies where each unit of output is distinct and made to a customer's order. Costs are collected against that job, and the job is the cost unit. Batch costing applies where identical units are produced in groups: costs are collected against the batch, then divided by the number of good units in it. Process costing applies where production is continuous and units are indistinguishable, so no unit can be tracked individually and the total cost of the period is spread over the output it produced.
By the end of this topic you should be able to choose the appropriate system, build up a job cost, calculate a cost per unit for a batch, and handle process costing including normal loss, scrap value and abnormal loss.
Key terms and definitions
Job costing — costing a single identifiable unit made to order: a repair, a bespoke cabinet, an audit engagement.
Batch costing — costing a group of identical units produced together, then dividing by the units in the batch.
Process costing — costing continuous production by spreading the total cost of the period over the output achieved.
Normal loss — the loss expected in a process under efficient operation, usually stated as a percentage of input. Its cost is borne by the good output.
Abnormal loss — loss above the normal level. It is valued at the same cost per unit as good output and written off to the income statement.
Abnormal gain — output above the expected level, valued the same way and credited.
Scrap value — an amount recoverable from lost units, which reduces the cost to be spread over good output.
Equivalent units — a measure converting partly completed units into the equivalent number of complete ones.
Core concepts
Choosing the system
The test is whether units can be identified separately. If a customer can point at their own unit and it differs from the next one, job costing applies. If units are identical but made in discrete runs, batch costing applies. If units flow continuously and are indistinguishable — sugar, cement, paint, fruit juice — process costing applies.
Service businesses use job costing more often than students expect. An audit firm, a garage and a law practice all cost an engagement as a job, because each one consumes a different mix of hours and materials.
Building a job cost
A job cost is assembled the same way in every system: direct materials, plus direct labour, plus direct expenses, giving prime cost; plus absorbed production overhead, giving production cost; plus a share of administration, selling and distribution overhead, giving total cost. Adding the profit margin gives the price quoted.
The overhead is absorbed using the rate established before the period began, which is why the absorption topic comes first. A job that takes 45 labour hours in a department with an $8.00 rate absorbs $360, regardless of what the department's overhead turns out to be.
Batch costing and the cost per unit
Batch costing is job costing with one extra step. Collect the costs against the batch exactly as for a job, then divide by the number of good units produced.
The distinction matters where some units in the batch are rejected. Dividing by the units started rather than the good units understates the cost per saleable unit, and it is the cost per saleable unit that a pricing decision needs.
Process costing and normal loss
In a continuous process some input is always lost — evaporation, trimmings, spillage. The loss expected under efficient operation is normal loss, and the key principle is that its cost is absorbed by the good output. If a business expects to lose 5% of what it puts in, the cost of that 5% is simply part of what the remaining 95% costs to make.
So the cost per unit is not total cost divided by input. It is:
(total process cost − scrap value of normal loss) ÷ expected output
where expected output is input less normal loss. Dividing by input instead is the single commonest error in the topic, and it understates the cost per unit every time.
Abnormal loss and abnormal gain
If actual output falls short of expected output, the shortfall is abnormal loss. It is valued at the same cost per unit as good output and written off to the income statement, because it represents inefficiency rather than an ordinary cost of production.
If actual output exceeds expected output, the excess is an abnormal gain, valued the same way and credited.
Keeping abnormal items out of the cost per unit is the whole point. If inefficiency were absorbed into product cost, a badly run period would appear to produce more expensive units, and management would be looking at a figure that hides the problem instead of revealing it.
Equivalent units
Where units are part-finished at the period end, they cannot count as whole units. If 400 units are 25% complete, they represent 400 × 25% = 100 equivalent units for the purpose of spreading cost.
At CAPE level the common refinement is that materials are often added at the start of a process while labour and overhead are incurred evenly through it — so closing work in progress may be 100% complete for materials and only partly complete for conversion costs, requiring two separate equivalent-unit calculations.
Worked examples
Example 1 — Building a job cost (5 marks)
A garage repairs a vehicle. Direct materials (parts) $1,840; direct labour 12 hours at $45; the workshop absorbs overhead at $30 per labour hour. A 25% margin is added to total cost.
Direct labour = 12 × $45 = $540. Prime cost = $1,840 + $540 = $2,380. Absorbed overhead = 12 × $30 = $360. Total cost = $2,380 + $360 = $2,740. Price quoted = $2,740 × 1.25 = $3,425.
Note that the overhead was absorbed on the same labour hours already used for direct labour. That is normal — the hours are the base, and they do two jobs.
Example 2 — Batch costing (5 marks)
A bakery produces a batch of 500 loaves. Direct materials $4,200, direct labour $3,300, absorbed overhead $2,500.
Total batch cost = $4,200 + $3,300 + $2,500 = $10,000. Cost per loaf = $10,000 ÷ 500 = $20.00.
If 20 loaves are rejected as unsaleable, the cost per saleable loaf becomes $10,000 ÷ 480 = $20.83. The batch cost did not change; it is now carried by fewer units. Pricing on $20.00 in that situation prices below cost.
Example 3 — Process costing with normal loss (7 marks)
A process receives 1,000 units. Costs: materials $24,000, labour $6,400, overhead $4,000. Normal loss is 5% of input, and lost units have a scrap value of $4 each. Actual output is 950 units.
Total process cost = $24,000 + $6,400 + $4,000 = $34,400. Normal loss = 5% × 1,000 = 50 units. Scrap value = 50 × $4 = $200. Expected output = 1,000 − 50 = 950 units.
Cost per unit = ($34,400 − $200) ÷ 950 = $34,200 ÷ 950 = $36.00.
Actual output equals expected output, so there is no abnormal loss. The 950 good units carry $34,200 between them — the cost of the 50 lost units has been absorbed into them, which is exactly what normal loss means.
Dividing by the 1,000 input units would give $34.40 and understate every unit by $1.60.
Example 4 — Abnormal loss (5 marks)
Same process, but actual output is only 930 units.
Expected output was 950, so abnormal loss = 950 − 930 = 20 units. Valued at the normal cost per unit: 20 × $36.00 = $720.
That $720 is written off to the income statement, not absorbed into the 930 good units, which continue to be valued at $36.00 each. Management therefore sees the inefficiency as a separate figure rather than hidden inside a higher product cost.
Example 5 — Equivalent units (4 marks)
At the period end, 600 units are complete and 400 units are 25% complete for conversion costs but 100% complete for materials.
Equivalent units for materials = 600 + 400 = 1,000. Equivalent units for conversion = 600 + (400 × 25%) = 600 + 100 = 700.
Materials cost is divided by 1,000 and conversion cost by 700, giving two separate per-unit rates that are then combined to value output and closing work in progress.
Common mistakes and how to avoid them
Dividing total process cost by input units. Divide by expected output — input less normal loss.
Forgetting to deduct the scrap value of normal loss. It reduces the cost to be spread over good output.
Absorbing abnormal loss into the cost per unit. It is written off separately, so that inefficiency stays visible.
Dividing a batch cost by units started rather than good units. Pricing needs the cost per saleable unit.
Using one equivalent-unit figure for both materials and conversion. They are usually at different stages of completion.
Assuming service businesses cannot use job costing. A garage, an audit firm and a law practice all cost engagements as jobs.
Treating normal loss as a cost to be written off. It is an ordinary cost of production, borne by the good output.
How this links to your Internal Assessment
Identifying which costing system fits the business you studied is itself an analytical finding, and small businesses very often use the wrong one. A bakery that costs each product as though it were a one-off job is doing far more work than it needs to; a workshop that averages costs across dissimilar jobs is quoting badly on the complex ones.
If your business produces in batches, collect the costs of one real batch and work out the cost per saleable unit, including any rejects. Compare that figure with the price charged. If the business has never accounted for rejects, the gap between cost per unit started and cost per unit sold is a finding with a clear recommendation attached.
Where a process is involved, ask what proportion of input is normally lost and whether anyone has ever measured it. A business operating with an assumed loss rate that nobody has checked cannot know whether a bad month is abnormal, which is precisely the distinction this topic exists to draw.
Exam technique for job, batch and process costing
Identify the system before you calculate anything. A question describing continuous production with a stated loss percentage is a process costing question, and reaching for a job cost layout wastes the time you need.
For process costing, set out the four figures before dividing: total cost, scrap value, normal loss in units, expected output. Most errors are a division by the wrong denominator, and writing expected output on its own line makes that harder to get wrong.
Label the cost per unit and carry it consistently. Abnormal loss and good output are valued at the same rate, and mark schemes award the consistency as well as the arithmetic.
Command words run as elsewhere. Calculate the cost per unit wants the working including the scrap deduction. Explain why normal loss is absorbed by good output wants the reasoning that it is an expected cost of producing them. Distinguish between normal and abnormal loss wants expected versus excess, and absorbed versus written off. Recommend a costing system wants the choice justified by how the business actually produces.
Quick revision summary
- Job costing: each unit distinct and made to order, including service engagements.
- Batch costing: identical units made in runs; divide batch cost by good units.
- Process costing: continuous, indistinguishable units; spread period cost over output.
- Job cost build-up: prime cost, plus absorbed production overhead, plus other overhead, plus margin.
- Normal loss is expected and its cost is borne by the good output.
- Cost per unit = (total process cost − scrap value of normal loss) ÷ expected output.
- Expected output = input − normal loss. Never divide by input.
- Abnormal loss = expected output − actual output, valued at the normal cost per unit and written off.
- Abnormal gain is the reverse and is credited.
- Equivalent units convert part-finished work; materials and conversion usually need separate figures.