What are Batch Level Costs?
Batch level costs are costs that are attributed to a batch or bunch of items. It is not possible to allocate the expenditure to a specific product or item. Such costs are generally the production costs incurred to produce a batch of products consisting of many or even a variety of items. Hence, expenditure on an individual unit of the product is not identifiable.
This concept helps to allocate overheads amongst units of product from a batch. Some examples of such costs are machinery set-up and installation, quality control and inspections, repairs and maintenance, etc. Every time a batch of goods is produced or processed, you need to incur the same cost.
Batch level costing is a part of the broader activity-based cost accounting method. Other than this, activity-based cost accounting includes activities at the unit level, customer level, product level, and organization level. While the cost of the unit-level and product-level activities is variable, the cost of organization-level activities is generally fixed. The cost of the batch-level activities usually is fixed irrespective of the number of units in the batch. It is only variable in the sense that it is directly related to the number of batches of goods produced throughout the year. Therefore, the cost driver in the case of batch-level activities is the number of batches.
Importance of Batch Level Costing
Batch level costing focuses on tracing the consumption of resources while producing a batch of goods and transferring this cost to the final output. It helps the company to make critical production-related decisions at the managerial level.
Correct Pricing of Products
It helps to correctly identify small costs that should be part of the final pricing of a product. Otherwise, there is a risk of ignorance of these costs. In other words, it helps to get the pricing right of the product. Also, it may help to correct the pricing of over-priced products in its portfolio. It will help give the company a competitive edge in the market and increase its sales and profitability.
Batch level costing can also help identify cost-driving processes that have become obsolete or redundant and need proper examination and change. Processes change with time and new technology. Accurate costing helps to evaluate costs that can be curtailed or eliminated by changing the methods in use. It can enable us to move to more efficient and effective overhead cost drivers. It will again help the company to minimize costs and increase its profitability.
Helps to take Producing or Outsourcing Decision
There are specific processes where the batch level costs may turn out to be unusually high. Some processes may require expensive setup or repairs or may involve a very costly quality control and inspection process. Such costs can lead to difficulty in allocation to the product price. In such cases, the company can decide to outsource those processes or buy finished products or intermediate products from other manufacturers rather than making them on its own. It may result in it being better-off.
Example of Batch Level Costs
Let us assume that company XYZ Pvt. Ltd. is manufacturing a batch of similar products of 5000 units. The expense incurred for the inspection process of this batch of 5000 units is US$5000. Therefore, we can efficiently allocate US$1 to the final price of each of the units produced (US$ 5000/ 5000 units).
It was a simple case of one batch of similar products. Let us now assume that the same company XYZ Pvt. Ltd., manufactures two batches of products consuming different lengths of time. Batch A consumed 200 labor hours, whereas batch B has consumed 300 labor hours. The machine set-up has cost the company US$10000, which will last for these two batches of products.
Now, we will calculate the total labor hours consumed, which are 200 hours + 300 hours= 500 hours. For allocating the machine setup cost of US$10000 to each of the batches, we will divide it by the number of labor hours consumed. Hence we get 10000/500= US$20 per labor hour.
Now, we can allocate the machine set up cost to each of the batches correctly.
Batch A= 200 hours x US$20= US$4000
Batch B= 300 hours x US$20= US$6000.
Now the calculation of the per-unit share of the machine set up cost allocation to the price of each product can quickly be done. Suppose batch A consists of 1000 units of a product. Therefore, US$4000/1000= US$4 should be allocated to the price of each of the units to arrive at its correct final price.
Continue reading – Types of Costs and their Basis of Classification
Batch level costing helps to identify cost pools about various overhead costs correctly. Instead of combining all the overhead costs, batch-level costing helps break it up and correctly attribute it to batches of products. Further breaking it down will give us the cost per unit of the product. It, in turn, helps to get the pricing correct of the products, mainly when a company produces a large number of products. Thus, proper batch-level costing is the key for a company to effectively fight competition, increase its sales, market share, and, most importantly, its profitability.