(Theory Notes)
Q 1 Defne the terms ‘cost centre !n" ‘cost #n$t%
The term Cost Unit is defned as a unit of quantity of product, service or time (or a
combination of these) in relation to which costs may be ascertained or expressed. t
can be for a !ob, batch, or product "roup.
The term Cost Centre is defned as a location, person or an item of equipment or a
"roup of these for which costs may be ascertained and used for the purposes of Cost
Control. Cost Centres can be personal Cost Centres, impersonal Cost Centres,
operation cost and process Cost Centres.
Thus each sub#unit of an or"anisation is $nown as a Cost Centre, if cost can be
ascertained for it. n order to recover the cost incurred by a Cost Centre, it is
necessary to express it as the cost of output. The unit of output in relation to which
cost incurred by a Cost Centre is expressed is called a Cost Unit.
Q ' (h!t $s me!nt )y Proft Centre*
t is defned as an activity centre of a business or"anisation. Chief of such a centre is
fully responsible for all costs, revenues and proftability of its operation. The main
ob!ective of proft centre is to maximise the centre%s proft. Creation of proft centres
facilitates mana"ement control and implementation of the ob!ectives of responsibility
accountin". & proft centre may have a number of cost centres.
Q 3 D$st$n+#$sh )et&een Cost Centre !n" Proft Centre%
& Cost Centre is the smallest se"ment of activity or the area of responsibility for which
costs are accumulated. & 'roft Centre is that se"ment of activity of a business which
is responsible for both revenue and expenses and discloses the proft of a particular
se"ment of activity.
mportant points of distinction between Cost Centre and 'roft Centre are as below(
(a) Cost Centres are created for accountin" convenience of costs and their
control. )hereas a proft centre is created because of decentralisation of
(b) & Cost Centre does not have tar"et costs but e*orts are made to minimise
costs, but each proft centre has a proft tar"et and en!oys authority to adopt
such policies as are necessary to achieve its tar"ets.
Q , E-./!$n Proft centres !n" $n0estment centres%
Centres which have the responsibility of "eneratin" and maximi+in" profts are called
proft centres. Those centres which are concerned with earnin" an adequate return on
investment are $nown as nvestment centres.
Q 1 2$st "o&n the 3!ctors th!t yo# &$// cons$"er )e3ore $nst!//$n+ ! cost$n+
The factors which must be considered before installin" a Costin" ,ystem are listed
(i) The ob!ective of costin" system, for example whether it is bein" introduced for
fxin" prices or for insistin" a system of cost control.
(ii) The system of costin" in each case should be desi"ned for improvin" the e*iciency
of operations in a particular area.
(iii) The "eneral or"anisation of the business, with a view to introduce a system of cost
control, without alterin" or extendin" the or"anisation appreciably.
(iv) The technical aspects of the concern and the attitude and behaviour of the
supervisory sta* and wor$men.
(v) The manner in which di*erent variable expenses would be a*ected with expansion
or cessation of di*erent operations.
(vi) The manner in which Cost and -inancial accounts could be inter#loc$ed into a
sin"le inte"ral accountin" system.
Q 4 (h!t !re the essent$!/s o3 !n e5ect$0e cost$n+ system*
The essential features, which a "ood Cost &ccountin" ,ystem should possess, are as
(i) Cost &ccountin" ,ystem should be tailor#made, practical, simple and capable of
meetin" the requirements of a business concern.
(ii) The data to be used by the Cost &ccountin" ,ystem should be accurate.
(iii) .ecessary cooperation and participation of executives from various departments
of the concern is essential for developin" a "ood system of Cost &ccountin".
(iv) The cost of installin" and operatin" the system should !ustify the results.
(v) The system of costin" should not sacrifce the utility by introducin" meticulous and
unnecessary details.
(vi) & carefully phased pro"ramme should be prepared by usin" networ$ analysis for
the introduction of the system.
Q 6 D$st$n+#$sh )et&een contro//!)/e costs !n" #ncontro//!)/e costs
Controllable costs are those which can be in/uenced by the action of a specifed
member of an underta$in". & business or"ani+ation is usually divided into a number of
responsibility centres and each such centre is headed by an executive. Controllable
costs incurred in a particular responsibility centre can be in/uenced by the action of
the executive headin" that responsibility centre. 0irect costs comprisin" direct labour,
direct materials, direct expenses and some of the overhead are "enerally controllable
by the shop level mana"ement.
.on#controllable costs are those which cannot be in/uenced by the action of a
specifed member of an underta$in". -or example, expenditure incurred by the tool
room is controllable by the tool room mana"er but the share of the tool room expense
which is apportioned to the machine shop cannot be controlled by the machine shop
mana"er. t is only in relation to a particular individual that a cost may be specifed as
controllable or not.
.ote( 1. & supervisor may be unable to control the amount of mana"erial
remuneration allocated to his department but for the top mana"ement this
would be a controllable cost.
2. 0epreciation would be a non#controllable cost in the short#term but
controllable in the lon" terms.
Q 7 D$st$n+#$sh )et&een8
1% 9!r$!)/e cost !n" "$rect cost
'% Est$m!te" cost !n" st!n"!r" cost%
(i) Variable and direct cost:
& variable cost is a cost that chan"es in total in direct proportion to chan"es in the
related total activity or volume. Cost of material is an example of variable cost.
0irect cost is a cost which can be identifed either with a cost centre or with a cost
unit. &n example of direct cost is the allocation of direct materials to a department
and then to the various !obs. &ll variable costs are direct#but each direct cost may not
be variable.
(ii) Estimated cost and standard cost:
3stimated costs can be defned as the expected cost of manufacture or acquisition,
often in terms of a unit of product computed on the basis of information available in
advance of actual production or purchase. 3stimated cost are prospective costs since
they refer to prediction of costs.
,tandard Cost means a pre#determined cost. t attempts to show what the cost should
be for clearly defned conditions and circumstances. ,tandard costs represent planned
cost of a product. They are expected to be achieved under a particular production
process under normal conditions.
Q : En#mer!te the m!$n o);ect$0es o3 $ntro"#ct$on o3 ! Cost Acco#nt$n+
System $n ! m!n#3!ct#r$n+ or+!n$s!t$on
The 4ain ob!ectives of Cost &ccountin" in an or"ani+ation are
1. &scertainment of cost.
2. 0etermination of sellin" price.
5. Cost control and cost reduction.
6. &scertainin" the proft of each activity.
7. &ssistin" mana"ement in decision#ma$in".
8. 0etermination of brea$ even point.
Q 10 Write short notes on:
($) Conversion cost
($$) Sunk cost
($$$) Opportunity cost
($0) Diferential cost
(0) Pre-production Cost
(i) Conersion cost: t is the cost incurred to convert raw materials into fnished
"oods. t is the sum of direct wa"es, direct expenses and manufacturin"
(ii) S!n" cost: 9istorical costs or the costs incurred in the past are $nown as sun$
cost. They play no role in the current decision ma$in" process and are termed
as irrelevant costs. -or example, in the case of a decision relatin" to the
replacement of a machine, the written down value of the existin" machine is a
sun$ cost, and therefore, not considered.
(iii) O##ort!nit$ cost: t refers to the value of sacrifce made or beneft of
opportunity fore"one in acceptin" an alternative course of action. -or example,
a frm fnancin" its expansion plan by withdrawin" money from its ban$
deposits. n such a case the loss of interest on the ban$ deposit is the
opportunity cost for carryin" out the expansion plan.
(i) %i&erential cost: (ncremental and decremental costs). t represents the
chan"e (increase or decrease) in total cost (variable as well as fxed) due to
chan"e in activity level, technolo"y, process or method of production, etc. -or
example if any chan"e is proposed in the existin" level or in the existin"
method of production, the increase or decrease in total cost or in specifc
elements of cost as a result of this decision will be $nown as incremental cost
or decremental cost.
() Pre'#rod!ction cost: These costs forms the part of development cost,
incurred in ma$in" a trial production run, preliminary to formal production.
These costs are incurred when a new factory is in the process of establishment
or a new pro!ect is underta$en or a new product line or product is ta$en up,
but there is no established or formal production to which such costs may be
char"ed. These costs are normally treated as deferred revenue expenditure
(except the portion which has been capitalised) and char"ed to the costs of
future production.
Q 11 D$sc#ss cost c/!ss$fc!t$on )!se" on 0!r$!)$/$ty !n" contro//!)$/$ty%
Cost c/!ss$fc!t$on )!se" on 0!r$!)$/$ty
<$-e" cost
These are costs, which do not chan"e in total despite chan"es of a cost driver. & fxed
cost is fxed only in relation to a "iven relevant ran"e of the cost driver and a "iven
time span. :ent, insurance, depreciation of factory buildin" and equipment are
examples of fxed costs where the fnal product produced is the cost ob!ect.
9!r$!)/e costs
These are costs which chan"e in total in proportion to chan"es of cost driver. 0irect
material, direct labour are examples of variable costs, in cases where the fnal product
produced is the cost ob!ect.
Semi-variable costs ; These are partly fxed and partly variable in relation to output
e.". telephone and electricity bill.
Cost c/!ss$fc!t$on )!se" on contro//!)$/$ty
Contro//!)/e costs
These are incurred in a particular responsibility center and relate to a defned time
span. They can be in/uenced by the action of the executive headin" the responsibility
center e.". direct costs.
Uncontro//!)/e costs
&re costs are in/uenced by the action of the responsibility center mana"er e.".
expenditure incurred by the tool room are controllable by the foreman in char"e of
that section, but the share of tool room expenditure which are apportioned to the
machine shop are not controllable by machine shop foreman.
Q 1' Defne e-./$c$t cost% =o& $s $t "$5erent 3rom $m./$c$t cost*
E-./!$n $n )r$e3 the e-./$c$t cost &$th e-!m./es
E-./!$n $n )r$e3 the O#t o3 .oc>et cost &$th e-!m./es%
E-./$c$t costs: These costs are also $nown as out of pocket costs. They refer to those
costs which involve immediate payment of cash. ,alaries, wa"es, posta"e and
tele"ram, interest on loan etc. are some examples of explicit costs because they
involve immediate cash payment. These payments are recorded in the boo$s of
account and can be easily measured.
Im./$c$t costs8 mplicit costs do not involve any immediate cash payment. &s such
they are also $nown as imputed costs or economic costs. mplicit costs are not
recorded in the boo$s of account but yet, they are important for certain types of
mana"erial decisions such as equipment replacement and relative proftability of two
alternative courses of action.
Q 13 D$sc#ss the 3o#r "$5erent metho"s o3 cost$n+ !/on+&$th the$r
!../$c!)$/$ty to concerne" $n"#stry
-our di*erent methods of costin" alon" with their applicability to concerned industry
have been discussed as below(
(i) ?o) Cost$n+8 The ob!ective under this method of costin" is to ascertain the
cost of each !ob order. & !ob card is prepared for each !ob to accumulate costs.
The cost of the !ob is determined by addin" all costs a"ainst the !ob it is
incurred. This method of costin" is used in printin" press, foundries and
"eneral en"ineerin" wor$shops, advertisin" etc.
(ii) @!tch Cost$n+8 This system of costin" is used where small components<parts
of the same $ind are required to be manufactured in lar"e quantities. 9ere
batch of similar products is treated as a !ob and cost of such a !ob is
ascertained as discussed under 1, above. f in a cycle manufacturin" unit, rims
are produced in batches of 2,7== units each, then the cost will be determined
in relation to a batch of 2,7== units.
(iii) Contr!ct Cost$n+8 f a !ob is very bi" and ta$es a lon" time for its completion,
then method used for costin" is $nown as Contract Costin". 9ere the cost of
each contract is ascertained separately. t is suitable for frms en"a"ed in the
construction of brid"es, roads, buildin"s etc.
(i) O.er!t$n+ Cost$n+8 The method of Costin" used in service renderin"
underta$in"s is $nown as operatin" costin". This method of costin" is used in
underta$in"s li$e transport, supply of water, telephone services, hospitals,
nursin" homes etc.
Q 1, D$st$n+#$sh )et&een Per$o" Costs !n" D$scret$on!ry Costs%
Per$o" costs8 There are the costs, which are not assi"ned to the products but are
char"ed as expenses a"ainst the revenue of the period in which they are incurred. &ll
non#manufacturin" costs such as "eneral and administrative expenses, sellin" and
distribution expenses are period costs.
D$scret$on!ry costs8 ,uch costs are not tied to a clear cause and e*ect
relationship between inputs and outputs. They arise from periodic decisions
re"ardin" the maximum outlay to be incurred. 3xamples are ; advertisin", public
relations, trainin" etc.
Q 11 D$st$n+#$sh )et&een .ro"#ct cost !n" .er$o" cost%
'roduct costs are associated with the purchase and sale of "oods. n the production
scenario, such costs are associated with the acquisition and conversion of materials
and all other manufacturin" inputs into fnished product for sale. 9ence under
absorption cost, total manufacturin" costs constitute inventoriable or product cost.
'eriods costs are the costs, which are not assi"ned to the products but are char"ed as
expense a"ainst revenue of the period in which they are incurred. >eneral
&dministration, mar$etin", sales and distributor overheads are reco"ni+ed as period
Q 14 N!me the 0!r$o#s re.orts (th!t m!y )e .ro0$"e" )y the Cost Acco#nt$n+
De.!rtment o3 ! )$+ m!n#3!ct#r$n+ com.!ny 3or the #se o3 $ts e-ec#t$0es%
?arious reports that may be provided by the Cost &ccountin" 0epartment of a bi"
manufacturin" Company for the use of its executives are as under(
(i) Cost ,heets
(ii) ,tatements of material consumption
(iii) ,tatements of labour utilisation
(iv) @verheads incurred compared with bud"ets
(v) ,ales e*ected compared with bud"ets
(vi) :econciliation of actual proft with estimated proft
(vii) The total cost of inventory carried
(viii) The total cost of abnormally spoiled wor$ in factory and abnormal losses in
(ix) Aabour turnover statements
(x) 3xpenses incurred on research and development compared with bud"eted
Q 1( Defne the 3o//o&$n+8
(!) Im.#te" cost
()) C!.$t!/$se" cost
(a) Im.#te" Cost8 These costs are notional costs which do not involve any cash
outlay. nterest on capital, the payment for which is not actually made, is an
example of mputed Cost. These costs are similar to opportunity costs.
(b) C!.t$!/$se" Cost8 These are costs which are initially recorded as assets and
subsequently treated as expenses.
Q 1 D$st$n+#$sh )et&een @$// o3 A!ter$!/ !n" A!ter$!/ ReB#$s$t$on Note%
@$// o3 A!ter$!/8 t is a comprehensive list of materials with exact description and
specifcations, required for a !ob or other production units. This also provides
information about required quantities so that if there is any deviation from the
standards, it can easily be detected. t is prepared by the 3n"ineerin" or 'lannin"
0epartment in a standard form.
A!ter$!/ reB#$s$t$on Note8 t is a formal written demand or request, usually from
the production department to store for the supply of specifed materials, stores etc. t
authorises the store$eeper to issue the requisitioned materials and record the same on
bin card.
The purpose of bill of material is to act as a sin"le authorisation for the issue of all
materials and stores items mentioned in it. t provides an advance intimation to store
department about the requirements of materials. t reduces paper wor$. t serves as a
wor$ order to the production department and a document for computin" the cost of
material for a particular !ob or wor$ order to the cost department.
The purpose of material requisition note is to draw material from the store by
concerned departments.
Q ' (h!t !re the m!$n o);ect$0es o3 m!ter$!/ contro/* E-./!$n the $m.ort!nt
reB#$rements to !tt!$n these o);ect$0es%
Ob+ecties o, s$stem o, material control:
(i) 3nsurin" that no activity, particularly production, su*ers from interruption for want
of materials and stores. This requires constant availability of every item that may be
needed howsoever small its cost may be.
(ii) ,eein" to it that all the materials and stores are acquired at the lowest possible.
(iii) 4inimisation of the total cost involved, both for acquirin" stoc$s and for holdin"
(iv) &voidance of unnecessary losses and wasta"es that may arise from deterioration
in quality due to defective or lon" stora"e or from obsolescence.
(v) 4aintenance of proper records to ensure that reliable information is available for
all items of materials and stores. This will help in detectin" losses B pilfera"es. t will
facilitate proper production plannin".
-e.!irements o, material control:
4aterial control requirements are as follows(.
1. 'roper co#ordination of all departments involved viz! fnance, purchasin",
receivin", inspection, stora"e, accountin" and payment.
2. 0eterminin" purchase procedure to see that purchases are made, after ma$in"
suitable enquiries, at the most favourable terms to the frm.
5. Use of standard forms for placin" the order, notin" receipt of "oods, authorisin"
issue of the materials etc.
6. 'reparation of bud"ets concernin" materials, supplies and equipment to ensure
economy in purchasin" and use of materials.
7. ,tora"e of all materials and supplies in a well desi"nated location with proper
8. @peration of a system of perpetual inventory to"ether with continuous stoc$
chec$in" so that it is possible to determine at any time the amount and value of each
$ind of material in stoc$.
Q / D$sc#ss )r$eCy ho& the 3o//o&$n+ $tems !re to )e tre!te" $n costs8D
($) C!rr$!+e $n&!r"s r!& m!ter$!/s
($$) Stor!+e /osses
($$$) C!sh "$sco#nt rece$0e"
($0) Ins#r!nce costs on stoc>s o3 r!& m!ter$!/s%
(i) Carria0e in1ards on ra1 materials: t represents the expenditure incurred in
brin"in" raw materials to factory from outside. This expense is directly
allocated to materials and thus forms a part of the .cost of such materials. )hen
this is not practicable and allocation to specifc items of materials is di*icult,
the expense is treated as manufacturin" overhead and is char"ed to cost of
production at a predetermined rate. n some of the underta$in"s the practice is
to char"e these expenses as a percenta"e of cost, wei"ht or some other physical
unit of material.
(ii) Stora0e losses: The losses arisin" out of stora"e of material can be classifed
into two cate"ories. The treatment of losses under each cate"ory in Cost
&ccounts is as under(#
(a) Aosses due to reasons li$e evaporation, shrin$a"e, absorption and moisture,
etc. are considered as normal losses. ,uch losses are absorbed by "ood
production units by in/atin" the cost of material issued for production.
(b) Aosses due to fre, /ood, storm, theft etc. are treated as abnormal losses. f
these losses are heavy and are not recoverable from the insurance
authorities, it is preferred to char"e them to Costin" 'roft and Aoss
(iii) Cas2 disco!nt receied: t is an allowance "iven by the vendor for prompt
payment of material price. The opinion amon" accountants about its treatment
di*ers. Two prevalent approaches for treatin" the cash discount received are as
(a) The cash discount received in the course of materials buyin" should
be deducted from the invoice price of the materials. This way the
discount received will reduce the purchase price of the materials.
(b) t may be treated as an item of fnancial nature and therefore be $ept
outside the purview of cost accountin". 9owever, it can be dealt in the
followin" manner.
The full invoice price should be char"ed to the material account creditin"
the suppliers with the net invoice price, and the discount earned account
with the amount of cash discount received. f the prompt payment could
not be made, the discount lost is debited to the discount lost account. &ny
di*erence between the discount earned and discount lost may be treated
as an item of administrative overhead.
(i) Ins!rance costs on stoc"s o, ra1 materials: The amount paid as insurance
costs (insurance premium) on stoc$s of raw materials is meant for coverin" the
ris$ which may arise due to fre, theft, riot etc. The insurance cost is
apportioned over di*erent materials on the basis of their value. This cost may
be char"ed directly to the cost of material.
Q , (r$te short note on ($) Re./!cement Pr$ce !n" ($$) St!n"!r" Pr$ce
($) Re./!cement Pr$ce Aetho"
:eplacement price is defned as the price at which it is possible to purchase an item,
identical to that which is bein" replaced or revalued. Under this method, materials
issued are valued at the replacement cost of the items. This method pre#supposes the
determination of the replacement cost of materials at the time of each issueC viz! the
cost at which identical materials could be currently purchased. The product cost
under this method is at current mar$et price, which is the main ob!ective of the
replacement price method.
This method is useful to determine true cost of production and to value material issues
in periods of risin" prices, because the cost of material considered in cost of
production would be able to replace the materials at the increased price.
A"0!nt!+e8 'roduct cost re/ects the current mar$et prices and it can be compared
with the sellin" price.
D$s!"0!nt!+e: The use of the method requires the determination of mar$et price of
material before each issue of material. ,uch a requirement creates problems.
($$) St!n"!r" Pr$ce Aetho"
Under this method, materials are priced at some predetermined rate or standard
price irrespective of the actual purchase cost of the materials. ,tandard cost is usually
fxed after ta$in" into consideration the followin" factors(
(i) Current prices,
(ii) &nticipated mar$et trends, and
(iii) 0iscount available and transport char"es etc.
,tandard prices are fxed for each material and the requisitions are priced at the
standard price. This method is useful for controllin" material cost and determinin" the
e*iciency of purchase department. n the case of hi"hly /uctuatin" prices of materials,
it is di*icult to fx their standard cost on lon"#term basis.
(1) The use of the standard price method simplifes the tas$ of valuin" issues of
(2) t facilitates the control of material cost and the tas$ of !ud"in" the e*iciency of
purchase department.
(5) t reduces the clerical wor$.
(1) The use of standard price does not re/ect the mar$et price and thus results in a
proft or loss.
(2) The fxation of standard price becomes di*icult when prices /uctuate frequently.
Q 3 E-./!$n the conce.t o3 EA@C An!/ys$sE !s ! techn$B#e o3 $n0entory contro/%
ABC Anal$sis as a tec2ni.!e o, Inentor$ Control:
t is a system of inventory control. t exercises discriminatin" control over di*erent
items of stores classifed on the basis of investment involved. Usually they are divided
into three cate"ories accordin" to their importance, namely, their value and frequency
of replenishment durin" a period.
D&% cate"ory of items consists of only a small percenta"e i.e. about 1=E of total items
handles by the stores but require heavy investment about F=E of inventory value,
because of their hi"h price or heavy requirement or both.
DG% cate"ory of items are relatively less important ; 2=E of the total items of material
handled by stores and E of investment required is about 2=E of total investment in
DC% cate"ory ; F=E of total items handled and 1=E of value.
-or D&% cate"ory items, stoc$s levels and 3@H are used and e*ective monitorin" is
-or DG% cate"ory same tools as in D&% cate"ory are applied.
-or DC% cate"ory of items, there is no need of exercisin" constant control. @rders for
items in this "roup may be placed after 8 months or once in a year, after ascertainin"
consumption requirement.
Im#ortance o, ABC Anal$sis:
&GC analysis helps the mana"ement in the followin" ways(
(1) The investment in inventories is optimised throu"h a close and direct
control over & items. This would naturally release funds which can then
be channelised into more proftable areas.
(2) The orderin" and carryin" costs are reduced since the mana"ement
would attempt to optimise such costs so far as they relate to the bul$ of
the items.
(5) f the mana"ement see$s to exercise direct control over all the items of
inventory, the inventory control system would become very expensive.
&GC analysis therefore cuts down the cost of the system and relates its
cost to the attendant benefts.
(6) )ith scientifc control of inventories, the stoc$ turnover rate can be
maintained at comparatively hi"h levels.
The concept of &GC analysis can be used in areas other than inventory also. This
technique basically emphasises that where the items to be controlled are numerous,
one should cate"orise them accordin" to their importance. Close control should then
be exercised on the most si"nifcant cate"ory. @n the less important cate"ories, the
de"ree of control maybe related to the beneft from control.
Thus fnally it may be concluded that &GC analysis plays an important role for a sound
system of material control.
Q 4 Descr$)e .er.et#!/ $n0entory recor"s !n" cont$n#o#s stoc>
0er$fc!t$onFcont$n#o#s stoc> t!>$n+
'erpetual inventory records represent a system of records maintained by the stores
department. t in fact comprises of (i) Gin cards, and (ii) ,tores Aed"er.
Gin cards maintain a quantitative record of receipts, issues and closin" balances of
each item of stores. ,eparate bin cards are maintained for each item. 3ach card is
flled up with the physical movement of "oods i.e. on its receipt and issue.
Ai$e bin cards the stores led"er is maintained to record all receipts and issues in
respect of materials. 3ntries in it are made with the help of "oods received notes and
material issue requisitions.
& perpetual inventory record is usually chec$ed by a pro"ramme of continuous stoc$
verifcation. Continuous stoc$ verifcation means the physical chec$in" of those
inventory records (which are maintained under perpetual inventory) with actual stoc$.
'erpetual inventory records helps in proper material control as discrepancies in
physical stoc$ and boo$ f"ures are re"ularly reconciled throu"h continuous stoc$
Q 6 =o& $s norm!/ !n" !)norm!/ /oss o3 m!ter$!/ !r$s$n+ "#r$n+ stor!+e
tre!te" $n Cost Acco#nts*
Cost Acco!nts treatment o, normal and abnormal loss o, material arisin0
d!rin0 stora0e:
The di*erence between the boo$ balance and actual physical stoc$, which may either
be "ain or loss, should be transferred to nventory &d!ustment &ccount pendin"
scrutiny to ascertain the reason for the di*erence.
f on scrutiny, the di*erence arrived at is considered as normal, then such a di*erence
should be transferred to overhead control account and if abnormal, it should be
debited to costin" proft and loss account.
n the case of normal losses, an alternative method may be used. Under this method
the price of the material issued to production may be in/ated so as to cover the
normal loss.
Q 7 E-./!$n8
($) ?#st $n T$me (?IT) .ro"#ct$on
($$) ?#stD$nDt$me (?IT) .#rch!s$n+
(i) 5!st'in'time (5IT) #rod!ction: 'roduction system in which each component on a
production line is produced immediately as needed by the next step in the production
(ii) 5!st'in'time (5IT) #!rc2asin0: The purchase of "oods or materials such that
delivery immediately precedes demand or use. n the extreme, no inventories would
be held.
Q : GTo )e !)/e to c!/c#/!te ! )!s$c EOQ cert!$n !ss#m.t$ons !re necess!ry%
E2$st "o&n these !ss#m.t$ons% "
The computation of economic order quantity is sub!ect to the followin" assumptions(
(i) @rderin" cost (per order) and carryin" cost (per unit<annum) are $nown and
(ii) &nticipated usa"e (in units) of material for a period is uniform and $nown.
(iii) Cost per unit of the material (to be purchased) is $nown and it is constant.
Q 1H =o& !re s/o& mo0$n+ !n" nonDmo0$n+ $tem o3 stores "etecte" !n" &h!t
ste.s !re necess!ry to re"#ce s#ch stoc>s*
The existence of slow movin" and non#movin" item of stores can be detected in the
followin" ways(
(i) Gy preparin" and scannin" periodic reports showin" the status of di*erent
items or stores.
(ii) Gy calculatin" the stoc$ holdin" of various items in terms of number of days<
months of consumption.
(iii) Gy computin" ratios periodically, relatin" to the issues as a percenta"e of
avera"e stoc$ held.
(iv) Gy implementin" the use of a well desi"ned information system.
Necessar$ ste#s to red!ce stoc" o, slo1 moin0 and non'moin0 item o,
(i) 'roper procedure and "uidelines should be laid down for the disposal of non#movin"
items, before they further deteriorates in value.
(ii) 0iversify production to use up such materials.
(iii) Use these materials as substitute, in place of other materials.
Q 11 D$st$n+#$sh )et&een @$n C!r" !n" Stores 2e"+er%
Bin Card Stores 6ed0er
1. Gin#cards are maintained in the stores
and are servin" the purpose of stoc$
,tores led"er is maintained in the cost
accounts department.
2. Gin card is the stores recordin"
The stores led"er is an accountin"
5. nter departmental transfer of
materials do not appear in bin#cards.
nter departmental transfer of materials
appear only in stores led"er.
6. 3ntries in it are posted by the issue
cler$. 9e records the #uantity about
receipts, issues and closin" balance
alon" with code number of material,
maximum, minimum and reorder
9ere entries are posted by the stores
led"er cler$. 9e records the #uantities
and value about receipts, issues and
closin" balance alon" with code number
of material, maximum, minimum and
reorder levels.
7. 9ere transactions are posted
'ostin" is done at the time of issue of
9ere transactions can be posted
'ostin" is done after the issue of

Q 1' E-./!$n @$n C!r"s !n" Stoc> Contro/ C!r"s%
Gin Cards are quantitative records of the stores receipt, issue and balance. t is $ept
for each and every item of stores by the store $eeper. 9ere, the balance is ta$en out
after each receipt or issue transaction
,toc$ control cards are also similar to Gin Cards. ,toc$ control cards contain
further information as re"ards stoc$ on order. These cards are $ept in cabinets or
trays or loose binders.
Q 13 E-./!$nI &hy the 2!st $n <$rst o#t (2I<O) h!s !n e"+e o0er <$rst $n <$rst
o#t (<I<O) or !ny other metho" o3 .r$c$n+ m!ter$!/ $ss#es%
$%&O- $ast-in-'rst-out: & method of pricin" for the valuation of raw material stoc$. t is
based on the assumption that the items of the last batch (lot) purchased are the frst to
be issued. Therefore, under this method, the price of the last batch (lot) of raw
material is used for pricin" raw material issues.
The advanta"es that would accrue from the use of A-@ method of pricin" the
valuation of raw materials are as follows(#
(i) The cost of the material issued will be re/ectin" the current mar$et price.
(ii) The use of the method durin" the period of risin" prices does not re/ect undue
hi"h proft in the income statement.
(iii) n the case of fallin" price, proft tend to rise due to lower material cost, yet the
fnished "oods appear to be more competitive and are at mar$et price.
(iv) @ver a period, the use of A-@ will iron out the /uctuations in proft.
(v) 0urin" the period of in/ation, A-@ will tend to show the correct proft.
Q 1, E-./!$n <I<O metho" o3 0!/#!t$on o3 m!ter$!/ $ss#e% D$sc#ss the e5ect o3
r$s$n+ .r$ces !n" 3!//$n+ .r$ces on th$s metho" o3 .r$c$n+ o3 m!ter$!/ $ss#es%
A/so +$0e $ts !"0!nt!+es%
t is a method of pricin" the issues of materials, in the order in which they are
purchased. n other words, the materials are issued in the order in which they arrive
in the store or the items lon"est in stoc$ are issued frst. Thus each issue of material
only recovers the purchase price which does not re/ect the current mar$et price. This
method is considered suitable in times of fallin" price because the material cost
char"ed to production will be hi"h while the replacement cost of materials will be low.
Gut, in the case of risin" prices, if this method is adopted, the char"e to production
will be low as compared to the replacement cost of materials.
1. t is simple to understand and easy to operate.
2. 4aterial cost char"ed to production represents actual cost with which the cost
of production should have been char"ed.
5. n the case of fallin" prices, the use of this method "ives better results.
6. Closin" stoc$ of material will be represented very closely at current mar$et
Q 11 (h!t $s ! .#rch!se reB#$s$t$on *
& 'urchase requisition is a form used for ma$in" a formal request to the purchasin"
department to purchase materials. 'urchase requisitions are usually initiated by
1. & store department for re"ular and standard items held in the stoc$.
2. The production control department for special material required for specifc
5. The maintenance department for maintenance equipment and items of capital expen#
6. The heads of departments for o*ice equipments.
The aforesaid arran"ement is only a matter of convenience. n some concerns
distinction is made between re"ular indents and special indents, dependin" upon
whether the items are needed for replacin" stoc$s or for special orders.
3ach purchase requisition should clearly state the quantity, quality and other
specifcations in the appropriate column of the "iven specimen form alon" with the
purpose for which materials are required. t should also indicate the date by which
such materials are needed.
0ependin" upon the procedure to be followed appropriate number of copies of the
purchase requisitions may be prepared and used accordin"ly.
Q 14 (h!t $s Econom$c Or"er Q#!nt$ty*
Economic Order Q!antit$: 3conomic order quantity represents the si+e of the order
for which both orderin" and carryin" costs to"ether are minimum. f purchases are
made in lar"e quantities, inventory carryin" cost will be hi"h. f the order si+e is small,
orderin" cost will be hi"h. 9ence, it is necessary to determine the order quantity for
which orderin" and carryin" costs are minimum. The formula used for determinin"
economic order quantity is as follows(
3@H I
& is the annual consumption of material in units
G is the cost of placin" an order (orderin" cost per order)
C is cost of interest and storin" one unit of material for one year
(carryin" cost per unit per annum)
Q 16 (h!t $s m!ter$!/ h!n"/$n+ cost* =o& &$// yo# "e!/ &$th $t $n cost
(aterial handlin) cost: t refers to the expenses involved in receivin", storin", issuin"
and handlin" materials. To deal with this cost in cost accounts there are two prevalent
approaches as under(
-irst approach su""ests the inclusion of these costs as part of the cost of materials by
establishin" a separate material handlin" rate e."., at the rate of percenta"e of the
cost of material issued or by usin" a separate material handlin" rate which may be
established on the basis of wei"ht of materials issued.
Under another approach these costs may be included alon" with those of
manufacturin" overhead and be char"ed over the products on the basis of direct
labour or machine hours.
Q 17 D$sc#ss the tre!tment o3 s.o$/!+e !n" "e3ect$0es $n Cost Acco#nt$n+%
S#oila0e: ,poila"e is the tem used for materials which are badly dama"ed in
manufacturin" operations, and it cannot rectifed economically and hence ta$en out of
the process to be disposed of in some manner without further processin".
*ormal spoila"e costs are included in costs either char"in" it to production order or
by char"in" it to production overheads so that it is spread over all products. &ny value
reali+ed from spoila"e is credited to production order or production overhead account
as the case may be.
Cost of abnormal spoila"e is char"ed to costin" proft B loss &<c.
%e,ecties: 0efectives si"nifes those units or portions of production which can be
rectifed and turned cut as "ood units by application of additional material, labour or
other service.
*ormal defectives can be recovered ( char"ed to "ood production
( char"ed to "eneral overhead
( char"ed to department.
f defectives are abnormal and are due to causes beyond the control of or"ani+ation
then they should be char"ed to proft and loss &<c.
Q 1: D$5erent$!te )et&een Gscr!.J !n" J"e3ect$0esJ !n" ho& they !re tre!te"
$n cost !cco#nt$n+%
Scra#: ,crap is incidental residence from certain type of manufacture, usually of
small amount and low value, recoverable without further processin".
The cost of scrap is borne by "ood units and income scrap is treated as other income.
%e,ecties: 0efectives si"nifes those units or portions of production which can be
rectifed and turned cut as "ood units by application of additional material, labour or
other service.
*ormal defectives can be recovered ( char"ed to "ood production
( char"ed to "eneral overhead
( char"ed to department.
f defectives are abnormal and are due to causes beyond the control of or"ani+ation
then they should be char"ed to proft and loss &<c.
Q 'H %istin0!is2 !mon+st8
($) (!ste
($$) S.o$/!+e
($$$) S!/0!+e
($0) Rect$fc!t$on
(0) Scr!.%
=o& !re they tre!te" $n Cost Acco#nts*
D$sc#ss the !cco#nt$n+ tre!tment o3 "e3ect$0es $n cost !cco#nts%
(!ste8 t represents that portion of basic raw materials lost in processin" havin" no
recoverable value. )aste may be visible#remnants of basic raw materialsJor invisible,
e."., disappearance of basic raw materials throu"h evaporation, smo$e etc.
*ormal waste is absorbed in the cost of net output, whereas abnormal waste is trans#
ferred to the Costin" 'roft and Aoss &ccount.
S#oila0e: ,poila"e is the tem used for materials which are badly dama"ed in
manufacturin" operations, and it cannot rectifed economically and hence ta$en out of
the process to be disposed of in some manner without further processin".
*ormal spoila"e costs are included in costs either char"in" it to production order or
by char"in" it to production overheads so that it is spread over all products. &ny value
reali+ed from spoila"e is credited to production order or production overhead account
as the case may be.
Cost of abnormal spoila"e is char"ed to costin" proft B loss &<c.
Sala0e: ,alva"ed material refers to the material retrieved from the spoiled wor$.
,alva"e is the process by which salva"ed material is retrieved. The salva"ed units of
material are usable in the production.
The value of salva"ed material may be credited to the account to which spoila"e is
-ecti7cation: t means brin"in" bac$ the defective units either to standard units of
production or as seconds, by rewor$in". Gefore the start of rectifcation wor$, an
estimate of the cost of rectifcation is prepared and compared with the excess value to
be obtained after rectifcation. The concern only "oes ahead with the tas$ of
rectifcation if the aforesaid comparison is found favourable.
The tas$ of rectifcation is usually carried out under a K:ectifcation )or$ @rderK, and
all costs of re#wor$ are collected a"ainst this wor$ order for material, labour and
f the defective production is inherent in the process of manufacture, and arises as a
normal consequence of productive activities and if it can be identifed with specifc
!obs, the rectifcation cost is char"ed to the !obs as the cost of manufacturin" "ood
units of the product. This will have the e*ect of addin" to the cost of the !obs. f the
expenditure on rectifcation is considered abnormal, it is excluded from product costs
and char"ed to Costin" 'roft and Aoss &ccount.
Scra#: ,crap is incidental residence from certain type of manufacture, usually of
small amount and low value, recoverable without further processin".
The cost of scrap is borne by "ood units and income scrap is treated as other income.
Q '1 (r$te short notes on8
($) ReDor"er B#!nt$ty
($$) ReDor"er /e0e/
($$$) A!-$m#m stoc> /e0e/
($0) A$n$m#m stoc>
D$st$n+#$sh )et&een ReDor"er /e0e/ !n" ReDor"er B#!nt$ty%
(i) -e'order .!antit$: t refers to the quantity of stoc$ for which an order is to be
placed at any one point of time. t should be such that it minimises the
combined annual costs of#placin" an order and holdin" stoc$. ,uch an orderin"
quantity in other words is $nown as economic order quantity (3@H).
3@H I
& I &nnual raw material usa"e quantity
@ I @rderin" cost per order
C I Cost per unit
i I Carryin" cost percenta"e per unit per annum
(ii) -e'order leel: t is the level at which fresh order should be placed for the
replenishment of stoc$.
I 4aximum re#order period L 4aximum usa"e
I 4inimum level M
(iii) *a8 stoc" leel: 4aximum level of an inventory item is its maximum quantity
held in stoc$ at any time. The mathematical formula used for its determination
is as follows(
4aximum level I :e#order level ; (4inimum Consumption L 4inimum :e#order
period) M
:e#order quantity.
(i) *inim!m stoc" leel: 4inimum level indicates the lowest f"ures of
inventory balance, which must be maintained in hand at all times, so that there
is no stoppa"e of production due to non#availability of inventory. The formula
used for its calculation is as follows(
4inimum level of inventory I :e#order level ; (&vera"e rate of consumption L
&vera"e time of inventory delivery).
Q '' D$sc#ss )r$eCy the cons$"er!t$ons +o0ern$n+ the f-!t$on o3 the m!-$m#m
!n" m$n$m#m /e0e/s o3 $n0entory%
Considerations ,or t2e 78ation o, ma8im!m leel o, inentor$
4aximum level of an inventory item is its maximum quantity held in stoc$ at any time.
The mathematical formula used for its determination is as follows(
4aximum level I :e#order level ; (4inimum Consumption L 4inimum :e#order
period) M :e#order quantity.
The important considerations which should "overn the fxation of maximum level for
various inventory items are as follows(
(1) The fxation of maximum level of an inventory item requires information
about re#order level.
(2) Nnowled"e about minimum consumption and minimum delivery period
for each inventory item should also be $nown.
(5) The determination of maximum level also requires the f"ure of economic
order quantity.
(6) &vailability of funds, stora"e capacity, nature of items and their price also
are important for the fxation of minimum level.
(7) n the case of important materials due to their irre"ular supply, the
maximum level should be hi"h.
Considerations ,or t2e 78ation o, minim!m leel o, inentor$
4inimum level indicates the lowest f"ures of inventory balance, which must be
maintained in hand at all times, so that there is no stoppa"e of production due to non#
availability of inventory. The formula used for its calculation is as follows(
4inimum level of inventory I :e#order level ; (&vera"e rate of consumption L
&vera"e time of inventory delivery).
T2e main considerations ,or t2e 78ation o, minim!m leel o, inentor$ are as
1. nformation about maximum consumption and maximum delivery period in
respect of each item to determine its re#order level.
2. &vera"e rate of consumption for each inventory item.
5. &vera"e delivery period for each item. The period can be calculated by
avera"in" the maximum and minimum period.
Q 1 D$st$n+#$sh )et&een T$me >ee.$n+ !n" T$me )oo>$n+%
Attendance Proced!re 9 Time'"ee#in0( t refers to correct recordin" of the
employees, attendance time. There is di*erence between .time $eepin" and time
boo$in". The latter refers to brea$ up of time on various !obs while the former implies
a record of total time spent by the wor$ers in a factory.
&ttendance :e"ister and 4etal 0isc 4ethod are the manual methods of time#
Time :ecordin" Cloc$s and 0ial Time :ecords are the mechanical methods of time#
Time'Boo"in0: nformation "enerated by time#$eepin" department do not show(
• how the total time was put to use in the factory
• how lon" he was $ept waitin" for one reason or another due to lac$ of wor$, lac$ of
material and supplies, lac$ of instructions, machine brea$downs, power failures
and the li$e.
These are all vital pieces of information necessary for the proper collection of cost
data and for e*ective controllin" of costs. -or the collection of all such information, a
separate record, "enerally $nown as Time (or Oob) card, is $ept. This is called time#
Q ) D$sc#ss )r$eCy the $m.ort!nt 3!ctors 3or the contro/ o3 /!)o#r cost
The main points which need consideration for controllin" labour costs are the
(i) &ssessment of manpower requirements.
(ii) Control over time#$eepin" and time#boo$in".
(iii) Time B 4otion ,tudy.
(iv) Control over idle time and overtime.
(v) Control over labour turnover.
(vi) )a"e systems.
(vii) ncentive systems.
(viii) ,ystems of wa"e payment and incentives.
(ix) Control over casual, contract and other wor$ers.
(x) Oob 3valuation and 4erit :atin".
(xi) Aabour productivity.
Q 3 D$sc#ss the o);ect$0es o3 t$me >ee.$n+ K t$me )oo>$n+%
Time $eepin" has the followin" two ob!ectives(
1. Preparation of Payroll: )a"e bills are prepared by the payroll department on
the basis of information provided by the time $eepin" department.
2. Computation of Cost: Aabour cost of di*erent !obs, departments or cost
centers are computed by costin" department on the basis of information
provided by the time $eepin" department.
T2e ob+ecties o, time boo"in0 are as ,ollo1s:
i. To ascertain the labour time spent on the !ob and the idle labour hours.
ii. To ascertain labour cost of various !obs and products.
iii. To calculate the amount of wa"es and bonus payable under the wa"e
incentive scheme.
iv. To compute and determine overhead rates and absorption of overheads
under the labour and machine hour method.
v. To evaluate the performance of labour by comparin" actual time boo$ed
with standard or bud"eted time.
Q , D$sc#ss )r$eCy the 0!r$o#s 3!ctors necess!ry 3or $ntro"#c$n+ !n
$ncent$0e system%
?arious factors necessary for introducin" an incentive system are(
(i) t should be !ust both to the employer and to the employee.
(ii) t should be stron" both ways i.e. it should have a standard tas$ and a
"enerous return.
(iii) t should be unrestricted as to the amount of the earnin".
(iv) t should be reasonable, apart from bein" simple, for employee to f"ure
out his incentive in relation to his individual performance.
(v) t should be /exible and intimately related to other mana"ement controls.
(vi) t should automatically assist supervision and, when necessary, aid team
(vii) t should have employee%s support and in no way should it be
(viii) t should have mana"erial support in so far as production material,
quality control, maintenance and non#fnancial incentives are concerned.
(ix) t should not be used temporarily and dropped in recession times as
means of wa"e reduction.
Q 1 E-./!$n the me!n$n+ o3 !n" the re!sons 3or $"/e t$me !n" "$sc#ss $ts
tre!tment $n cost !cco#nt$n+
I"/e t$me refers to the labour time paid for but not utili+ed on production. t, in
fact, represents the time for which wa"es are paid, but durin" which no output is
"iven out by the wor$ers. This is the period durin" which wor$ers remain idle.
Re!sons 3or $"/e t$me8 &ccordin" to reasons, idle time can be classifed into
normal idle time and abnormal idle time. .ormal idle time is the time which cannot
be avoided or reduced in the normal course of business.
The main reasons for the occurrence of normal idle time are as follows(
1) Time ta$en by wor$ers to travel the distance between the main "ate of
factory and the place of their wor$.
2) Time lost between the fnish of one !ob and startin" of next !ob.
5) Time spent to overcome fati"ue.
6) Time spent to meet their personal needs li$e ta$in" lunch, tea etc.
The main reasons for the occurrence of abnormal idle time are(
1) 0ue to machine brea$ downs, power failure, non#availability of raw materials,
tools or waitin" for !obs due to defective plannin".
2) 0ue to conscious mana"ement policy decision to stop wor$ for some time.
5) n the case of seasonal "oods producin" units, it may not be possible for them
to produce evenly throu"hout the year. ,uch a factor too results in the
"eneration of abnormal idle time.
Acco#nt$n+ tre!tment o3 $"/e t$me &!+es $n cost !cco#nts8
*ormal idle time is inherent in any !ob situation and thus it cannot be eliminated or
reduced. -or example( time "ap between the fnishin" of one !ob and the startin" of
anotherC time lost due to fati"ue etc. The cost of normal idle time should be
char"ed to the cost of production. This may be done by in/atin" the labour rate. t
may be transferred to factory overheads for absorption, by adoptin" a factory
overhead absorption rate.
+bnormal idle time is defned as the idle time which arises on account of abnormal
causesC e.". stri$esC loc$outsC /oodsC ma!or brea$down of machineryC fre etc. ,uch
an idle time is uncontrollable. The cost of abnormal idle time due to any reason
should be char"ed to Costin" 'roft B Aoss &ccount.

Q 4 (h!t $s o0ert$me .rem$#m* E-./!$n the tre!tment o3 o0ert$me .rem$#m
$n cost !cco#nt$n+% S#++est ste.s 3or contro//$n+ o0ert$me%
Oertime #remi!m: @vertime is the amount of wa"es paid for wor$in" beyond
normal wor$in" hours as specifed by -actories &ct or by a mutual a"reement
between the wor$ers union and the mana"ement. There is a practice is to pay for
overtime wor$ at hi"her rates. 9ence, payment of overtime consists of two
elements, the normal wa"es e."., the usual amount, and the extra payment i.e., the
premium. This amount of extra payment paid to a wor$er under overtime is $nown
as overtime premium.
Treatment o, Oertime #remi!m is Cost Acco!ntin0
• f overtime is resorted to at the desire of the customer, then overtime
premium may be char"ed to the !ob directly.
• f overtime is required to cope with "eneral production pro"ramme or for
meetin" ur"ent orders, the overtime premium should be treated as overhead
cost of the particular department or cost center, which wor$s overtime.
• f overtime is wor$ed in a department, due to the fault of another
department, the overtime premium should be char"ed to the latter
• @vertime wor$ed on account of abnormal conditions such as /ood,
earthqua$e etc., should not be char"ed to cost but to costin" '<A &<c.
Ste#s ,or Controllin0 Oertime:
(i) 3ntire overtime wor$ should be duly authori+ed after investi"atin" the
reasons for it.
(ii) @vertime cost should be shown a"ainst the concerned department. ,uch a
practice should enable proper investi"ation and plannin" of production in
(iii) f overtime is a re"ular feature, the necessity for recruitin" more men
and addin" a shift should be considered.
(iv) f overtime is due to lac$ of plant and machinery or other resources,
steps may be ta$en to install more machines, or to resort to sub#contractin".
(v) f possible an upper limit may be fxed for each cate"ory of wor$ers in
respect of overtime.
Q 6 D$sc#ss the e5ect o3 o0ert$me .!yment on .ro"#ct$0$ty
,fect of overtime payment on productivity: @vertime wor$ should be resorted to
only when it is extremely essential because it involves extra cost. The overtime
payment increases the cost of production in the followin" ways(
1) The overtime premium paid is an extra payment in addition to the normal
2) The e*iciency of operators durin" overtime wor$ may fall and thus output
may be less than normal output.
5) n order to earn more the wor$ers may not concentrate on wor$ durin"
normal time and thus the output durin" normal hours may also fall.
6) :educed output and increased premium of overtime will brin" about an
increase cost of production.
Q 7 D$st$n+#$sh )et&een I"/e T$me !n" I"/e <!c$/$t$es% =o& !re they tre!te"
$n Cost Acco#nts* De0e/o. ! system o3 contro/ 3or I"/e T$me $n ! 3!ctory%
I"/e t$me refers to the labour time paid for but not utili+ed on production. t, in
fact, represents the time for which wa"es are paid, but durin" which no output is
"iven out by the wor$ers. This is the period durin" which wor$ers remain idle.
&ccordin" to reasons, idle time can be classifed into normal idle time and
abnormal idle time.
Idle ,acilities: The term .facility has a wider connotation which may also include
production capacity. -acilities may be provided by fxed assets such as buildin"
space, plants equipment capacity, etc. or by various service functions such as
material services, production services, personal services etc. f a frm fails to ma$e
full use of the facilities of its disposal, the frm may be said to have idle facilities.
Thus idle facilities refer to that part of total facilities which remains unutilised due
to any reason such as non#availability of raw material, power, lac$ of demand etc.
n Cost &ccountin" idle facilities are treated in the same way as those of idle
Treatment o, idle time in Cost Acco!ntin0: "+s )iven in - ./
Treatment o, idle ,acilities in Cost Acco!ntin0: .ormal idle facilities cost
which arises due to unavoidable reasons, should be included in the wor$s overhead.
@n the other hand, abnormal idle facilities cost which arises due to plants or
machines<facilities remainin" idle on account of trade depression or for want of
wor$ etc., should be written o* to costin" proft and loss account.
S$stem o, controllin0 idle time: 4ana"ement should aim at eliminatin"
controllable idle time and on a lon"#term basis reducin" even the normal idle time.
This would require a detailed analysis of the causes leadin" to such idle time.
0ependin" upon the particular causes, proper mana"erial action would be required to
reduce the impact of such idle time. Gasic control can be exercised throu"h periodical
reports on idle time showin" a detailed analysis of the causes for the same, the
departments where it is occurrin" and the persons responsible for it, alon" with a
statement of the cost of such idle time.
Q : (h!t "o yo# #n"erst!n" )y 2!)o#r T#rno0er* =o& $s $t me!s#re"*
(h!t !re $ts c!#ses* (h!t !re the reme"$!/ ste.s yo# &o#/" s#++est to
m$n$m$Le $ts occ#rrence*
The process of wor$ers leavin" and comin" in business or"ani+ations "ives rise to
the phenomenon of labour turnover. Aabour turnover of an or"ani+ation is the rate
of chan"e in its labour force durin" a specifed period. This rate of chan"e is
compared with an index which acts as a thermometer to ascertain its
reasonableness. The suitable index of labour turnover may be the standard or usual
labour turnover in the industry or locality, or the labour turnover rate for a past
period. & hi"her labour turnover re/ects that the wor$ers in the or"ani+ation are
new and inexperienced, and it is a matter of concern to the or"ani+ation. &lso it
accounts for an increase in cost of production and even disturbs the even /ow of
production in the mar$et.
Ae!s#rement o3 2!)o#r T#rno0er
4ethods of Calculatin" labour turnover
1. :eplacement method I
2. ,eparation method I
5. -lux method I
Causes of $abour 0urnover
The main causes of labour turnover in an or"ani+ation<industry can be broadly
classifed under the followin" heads(
(a) 'ersonal Causes
(b) Unavoidable Causes
(c) &voidable Causes
Personal Causes are those which induce or compel wor$ers to leave their !obs
purely on personal "roundsC e.".
(i) Chan"e of !ob for betterment.
(ii) 0iscontentment over the !ob and wor$in" environment.
1navoidable Causes are those under which it becomes obli"atory on the part of
mana"ement to as$ some or more of their employees to leave the or"ani+ationC
such causes may include the followin"(
(i) ,horta"e of raw material, power, demand for the products, etc.
(ii) Chan"e in the plant location.
+voidable Causes are those causes which require the attention of mana"ement on a
continuous basis so as to $eep the labour turnover ratio as low as possible. The
main causes are as follows(
(i) 0issatisfaction with !ob, remuneration, hours of wor$, wor$in" conditions
(ii) Aac$ of trainin" facilities and promotional avenues.
(iii) Aow wa"es and allowances.
2emedial steps to minimize labour turnover:
The followin" steps are useful for minimi+in" labour turnover(
(a) 3xit interview( &n interview be arran"ed with each out"oin" employee to
ascertain the reasons of his leavin" the or"ani+ation.
(b) Oob analysis and evaluation( to ascertain the requirement of each !ob.
(c) @r"anisation should ma$e use of a scientifc system of recruitment, placement
and promotion for employees.
(d) @r"anisation should create healthy atmosphere, providin" education, medical
and housin" facilities for wor$ers.
(e) Committee for settlin" wor$ers "rievances.
Q 1H (h!t $s the $m.!ct o3 ‘2!)o#r T#rno0er on ! m!n#3!ct#r$n+
or+!n$s!t$ons &or>$n+*
Aabour turnover refers to the rate of chan"e in the composition of labour force of a
concern durin" a specifed period of time. The impact of labour turnover on a
manufacturin" or"anisation%s wor$in" is many fold.
n fact the labour turnover increases the cost of production in the followin" ways(
(i) 3ven /ow of production is disturbed.
(ii) Cost of recruitment and trainin" increases.
(iii) Grea$a"e of tools, wasta"e of materials increases.
(iv) @verall production decreases due to the time lost between the leavin" and
recruitment of new wor$ers.
(v) :eduction in sales accounts for loss of contribution and "oodwill consequently.
Q 11 St!te the "$st$nct$on )et&een ?o) e0!/#!t$on !n" Aer$t r!t$n+%
3ob evaluation can be defned as the process of analysis and assessment of !obs to
ascertain reliably their relative worth and to provide mana"ement with a
reasonably sound basis for determinin" the basic internal wa"e and salary
structure for the various !ob positions. n other words, !ob evaluation provides a
rationale for di*erential wa"es and salaries for di*erent "roup of employees and
ensures that these di*erentials are consistent and equitable.
(erit ratin) is the quantitative or qualitative assessment of an employee%s
personality or his performance on the !ob made by his supervisor or other person
qualifed to !ud"e.
0he main points of distinction bet4een 5ob evaluation and merit ratin) are as
i. Oob evaluation is the assessment of the relative worth of !obs within a
company and merit ratin" is the assessment of the relative worth of the
man behind a !ob.
ii. Oob evaluation and its accomplishments are meant to set up a rational
wa"e and salary structure whereas merit ratin" provides a scientifc
basis for determinin" fair wa"es for each wor$er based on his ability
and performance.
iii. Oob evaluation simplifes wa"e administration by brin"in" an uniformity in
wa"e rates where as merits ratin" is used to determine fair rate of pay
for di*erent wor$ers.
Q 1' (h!t "o yo# #n"erst!n" )y t$me !n" mot$on st#"y*
0ime and motions study: t is the study of time ta$en and motions (movements)
performed by wor$ers while performin" their !obs at the place of their wor$. Time
and motion study has played a si"nifcant role in controllin" and reducin" labour
Time ,tudy is concerned with the determination of standard time required by a
person of avera"e ability to perform a !ob. 4otion study, on the other hand, is
concerned with determinin" the proper method of performin" a !ob so that there
are no wasteful movements, hirin" the wor$er unnecessarily. 9owever, both the
studies are conducted simultaneously. ,ince materials, tools, equipment and
"eneral arran"ement of wor$, all have vital bearin" on the method and time
required for its completion. Therefore, their study would be incomplete and would
not yield its full beneft without a proper consideration of these factors.
Q 13 D$sc#ss t&o ty.es o3 CostsI &h$ch !re !ssoc$!te" &$th /!)o#r t#rno0er
Two types of costs associated with labour turnover are(
($) Pre0ent$0e costs8
These costs are incurred to $eep the labour turnover rate at a low level. They
include costs of accommodation, transport facilities, medical services, welfare
schemes, pension schemes, environment improvement, li"htin", heatin", air#
conditionin" etc. The rate of labour turnover is usually low, if a company incurs
hi"her preventive costs.
($$) Re./!cement costs8
These costs arise due to hi"h labour turnover, e.". cost of advertisin", recruitment,
selection, trainin" B induction, abnormal brea$a"e and scrap, extra wa"es B
overheads etc., caused as a result of ine*icient and inexperienced newly recruited
Q 1, St!te the c$rc#mst!nces $n &h$ch t$me r!te system o3 &!+e .!yment
c!n )e .re3erre" $n ! 3!ctory
n the followin" circumstances the time rate system of wa"e payment is preferred
in a factory.
(i) 'ersons whose services cannot be directly or tan"ibly measured, e.".,
"eneral helpers, supervisory and clerical sta* etc.
(ii) )or$ers en"a"ed on hi"hly s$illed !obs or renderin" s$illed services, e.".,
tool ma$in", inspection and testin".
(iii) )here the pace of output is independent of the operator, e."., automatic
chemical plants.
Q 11 D$st$n+#$sh )et&een D$rect !n" In"$rect /!)o#r
0irect labour cost is the labour costs that is specifcally incurred for or can be readily
char"ed to or identifed with a specifc !ob, contract, wor$#order or any other unit of
ndirect labour costs are labour costs which cannot be readily identifed with products
or services but are "enerally incurred in carryin" out production activity.
The importance of the distinction lies in the fact that whereas direct labour cost can
be identifed with and char"ed to the !ob, indirect labour costs cannot be so char"ed
and are, therefore, to be treated as part of the factory overheads to be included in the
cost of production.
Q 14 ‘Un"er the Ro&!n Prem$#m @on#s systemI ! /ess e5$c$ent &or>er c!n
o)t!$n s!me )on#s !s ! h$+h/y e5$c$ent &or>er% D$sc#ss &$th s#$t!)/e
Gonus under :owan system I
-or example let time allowed for a !ob I 6 hours and Aabour rate I :s. 7 per
Case I : 6ess e&icient 1or"er
f time ta$en I 5 hours
Then time saved I 6 ; 5 I 1 hour
Gonus I
Case II : ;i02l$ e&icient 1or"er
f time ta$en I 1 hour
Then time saved I 6 ; 1 I 5 hours
Gonus I
,o, it can be concluded that under :owan ,ystem, the less e*icient wor$er and
hi"hly e*icient wor$er can "et the same bonus.
Q 16 Descr$)e )r$eCyI ho& &!+es m!y )e c!/c#/!te" #n"er the 3o//o&$n+
(i) G!ntt t!s> !n" )on#s system
(ii) Emersons e5$c$ency system
(iii) Ro&!n system
(iv) =!/sey system
(v) @!rth system
(i) <antt tas" and bon!s s$stem: This system is a combination of time and
piecewor$ system. &ccordin" to this system a hi"h standard or tas$ is set and
payment is made at time rate to a wor$er for production below the set standard.
)a"es payable to wor$ers under the plan are calculated as under(
Output Payment
(i) @utput below
>uaranteed time rate
(ii) @utput at
Time rate plus bonus of 2=E (usually) of time rate
(iii) @utput over
9i"h piece rate on wor$er%s output. (t is so fxed so as to
include a bonus of 2=E of time rate)
(ii) Emerson=s E&icienc$ S$stem: Under this system wa"es may be calculated as
Per,ormance >a0es
Gelow 88
Time rate without any bonus
E # 1==E
Gonus varies between 1E to 2=EP
&bove 1==E e*iciency Gonus of 2=E of basic wa"es plus
1E for every 1E increase in
P&t 1==E e*iciency the bonus percenta"e will be 2=E
(iii) -o1an S$stem: &s per this system standard time allowance is fxed for the
performance of a !ob and bonus is paid if time is saved.

(iv) ;alse$ S$stem: Under this system a standard time is fxed for each !ob. f there is
no savin" on this standard time allowance, the wor$er is paid only his day rate.
)a"es under 9alsey ,ystem I Time ta$en L Time rate M (7=E of time saved L time
(v) Bart2 S$stem:
This is particularly suitable for trainees and be"inners and also for uns$illed wor$ers.
Q 17 (h$ch "e.!rtments !re $n0o/0e" $n the contro/ o3 /!)o#r costs*
n a lar"e or"anisation, "enerally the followin" departments are involved in the
control of labour costs(
1. Personnel Department # This department is assi"ned the duty of recruitin"
wor$ers, trainin" them and maintainin" their record. t is the duty of this
department to ensure that the persons recruited possess the qualifcations and
qualities necessary to perform well the concerned !obs.
2. ,n)ineerin) and Work Study Department # This department prepares plans and
specifcations for each !ob, supervises production activities, conducts time and
motion studies, underta$es !ob analysis, etc.
5. 0ime-keepin) Department # This 0epartment is primarily concerned with the
maintenance of attendance records of the employees and the time spent by
them on various !obs, etc.
6. Payroll Department # This department is responsible for the preparation of
payroll of the employees.
7. Cost +ccountin) Department # This department is responsible for the
accumulation and classifcation etc. of all type of costs. &ll such data pertainin"
to labour costs are also collected, analysed and allocated to various !obs,
processes, departments, etc., by this department.
Q 1 D$st$n+#$sh )et&een f-e" !n" 0!r$!)/e o0erhe!"s%
&i6ed overhead e6penses do not vary with the volume of production within certain
limits. n other words, the amount of fxed overhead tends to remain constant for
volumes of production within the installed capacity of plant. -or example, rent of
o*ice, salary of wor$s man"er, etc.
7ariable overheads cost varies in direct proportion to the volume of production. t
increases or decreases in direct relation to any increase or decrease in output.
Q ' (r$te ! note on Mc/!ss$fc!t$onMI M!//oc!t$onM !n" M!)sor.t$onM o3
C/!ss$fc!t$on o3 o0erhe!"s8
t, means determination of cate"ories, classes or "roups in which overhead costs may
he sub#divided.
Usually, overhead costs are classifed under three broad cate"ories vi+, -actory
@verheadsC @*ice and administrative @verheads and ,ellin" and distribution
-actory overheads represent all those indirect costs that are incurred in the
manufacturin" process. -or example, consumable stores, factory rent, depreciation of
plant, factory buildin", repairs and maintenance.
@*ice and administrative overheads represent costs which are associated with the
administration and maintenance of the o*ice.
,ellin" and distribution overheads are the expenses incurred for sellin" and
distribution of products. t includes salaries of sales sta* and commissionC sales#
promotion expensesC advertisin" expenses, warehousin" costs etc.
Cost !//oc!t$on
Cost allocation is the allotment of whole items of cost to cost centers. -or example, if a
typist wor$s exclusively for Goard of ,tudies, then the salary paid to him should be
char"ed to Goard of ,tudies account. This technique of char"in" the entire overhead
expenses to a cost centre is $nown as cost allocation.
Cost !..ort$onment
Cost apportionment is the process of char"in" expenses in an equitable proportion to
the various cost centres or departments. This describes the allotment of proportions of
overhead to cost centres or departments. t is carried out in respect of those items of
cost which cannot be allocated to any specifc cost centre or department. -or example,
the salary of "eneral mana"er cannot be allocated wholly to the production
department, as he attends in "eneral to all the departments. Therefore, some lo"ical
basis is selected and adopted for the apportionment of such type of expenses over
various departments. Ai$ewise, factory rent can be apportioned over the production
and service departments on the basis of the area occupied by each.
Cost !)sor.t$on
t is defned as the process of absorbin" all overhead costs allocated or apportioned
over particular cost centre or production department by the units produced.
&bsorption of overheads ta$es place only after the allocation and apportionment of
overhead expenses. n other words, the overhead costs are either allocated or
apportioned over di*erent cost centres or cost units and afterwards they are absorbed
on equitable basis by the output of the same cost centres.
Q , D$sc#ss the "$5erence )et&een !//oc!t$on !n" !..ort$onment o3
The followin" are the di*erences between allocation and apportionment.
1) &llocation costs are directly allocated to cost centre. @verheads which cannot
be directly allocated are apportioned on some suitable basis.
2) &llocation allots whole amount of cost to cost centre or cost unit where as
apportionment allots part of cost to cost centre or cost unit.
5) .o basis required for allocation. &pportionment is made on the basis of area,
assets value, number of wor$ers etc.
Q ,D$sc#ss $n )r$e3 three m!$n metho"s o3 !//oc!t$n+ s#..ort "e.!rtments
costs to o.er!t$n+ "e.!rtments% O#t o3 these threeI &h$ch metho" $s
conce.t#!//y .re3er!)/e
The three main methods of allocatin" support departments costs to operatin"
departments are(
(i) Direct re-distribution method: Under this method, support department costs are
directly apportioned to various production departments only. This method does not
consider the service provided by one support department to another support
(ii) Step method: Under this method the cost of the support departments that serves
the maximum numbers of departments is frst apportioned to other support
departments and production departments. &fter this the cost of support
department servin" the next lar"est number of departments is apportioned. n this
manner we fnally arrive on the cost of production departments only.
(iii) 2eciprocal service method: This method reco"nises the fact that where there
are two or more support departments they may render services to each other and,
therefore, these inter#departmental services are to be "iven due wei"ht while re#
distributin" the expenses of the support departments. The methods available for
dealin" with reciprocal services are(
(a) ,imultaneous equation method
(b) :epeated distribution method
(c) Trial and error method.
The reciprocal service method is conceptually preferable. This method is widely used
even if the number of service departments is more than two because due to the
availability of computer software it is not di*icult to solve sets of simultaneous
Q 1 (h!t $s )/!n>et o0erhe!" r!te* In &h$ch s$t#!t$onsI )/!n>et r!te $s to )e
#se" !n" &hy*
Glan$et overhead rate refers to the computation of one sin"le overhead rate for the
entire factory. This is also $nown as plantwise or the sin"le overhead rate for the
entire factory. t is determined as follows(
Situation for usin) blanket rate:
The use of blan$et rate may be considered appropriate for factories which produce
only one ma!or product on a continuous basis, e.". chemical plant, "lass plant etc.. t
may also be used in those units in which all products utilise same amount of time in
each department. f such conditions do not exist, the use of blan$et rate will "ive
misleadin" results in the determination of the production cost, specially when such a
cost ascertainment is carried out for "ivin" quotations and tenders.
Q 4 A "e.!rtment!/ store h!s se0er!/ "e.!rtments% (h!t )!ses &o#/" yo#
recommen" 3or !..ort$on$n+ the 3o//o&$n+ $tems o3 e-.ense to $ts
(1) <$re $ns#r!nce o3 @#$/"$n+%
(') Rent
(3) De/$0ery E-.enses%
(,) P#rch!se De.!rtment E-.enses%
(1) Cre"$t De.!rtment E-.enses%
(4) Gener!/ A"m$n$str!t$on E-.enses%
(6) A"0ert$sement%
(7) S!/es Ass$st!nts S!/!r$es%
(:) Person!/ De.!rtment e-.enses%
(1H) S!/es Comm$ss$on

Items o, e8#enses Basis @or a##ortionin0
(1) -ire nsurance of Guildin". -loor &rea
(2) :ent -loor &rea
(5) 0elivery 3xpenses. ?olume or 0istance or )ei"ht
(6) 'urchase department 3xpenses .o. of 'urchase order<?alue of 'urchases
(7) Credit 0epartment 3xpenses. Credit ,ales ?alue
(8) >eneral &dministration 3xpenses. )or$s cost
(F) &dvertisement. &ctual sales
(Q) ,ales &ssistants ,alaries. &ctual<Time devoted
(R) 'ersonal 0epartment expenses. .o. of 3mployees
(1=) ,ales Commission &ctual
Q 6 In"$c!te the )!se or )!ses th!t yo# &o#/" recommen" to !..ort$on
o0erhe!" costs to .ro"#ct$on "e.!rtment8
($) S#../$es
($$) Re.!$rs
($$$) A!$nten!nce o3 )#$/"$n+
($0) E-ec#t$0e s!/!r$es
(0)Po&er !n" /$+ht
(0$) <$re $ns#r!nce
(0$$)In"$rect /!)o#r

tem Gases of apportionment
(i) ,upplies &ctual supplies made to di*erent departments
(ii) :epair 0irect labour hoursC 4achine hoursC 0irect
labour wa"esC 'lant value.
(iii) 4aintenance of
-loor area occupied by each department
(iv) 3xecutive salaries &ctual basisC .umber of wor$ers.
(v) 'ower and li"ht N ) hours or 9 ' (power)C .umber of li"ht
pointsC -loor spaceC 4eter readin"s (li"ht)
(vi) -ire insurance Capital cost of plant and buildin"C ?alue of stoc$
(vii) ndirect labour 0irect labour cost.

Q 7 (hy $s the #se o3 !n o0erhe!" !)sor.t$on r!te )!se" on "$rect /!)o#r
ho#rs +ener!//y .re3er!)/e to ! "$rect &!+es .ercent!+e r!te 3or ! /!)o#r
$ntens$0e o.er!t$on*
& method of overhead absorption is considered appropriate if the total amount of
overhead absorbed in a period does not /uctuate materially from the actual expense
incurred in the period. 0irect wa"es percenta"e rate method do not possess the
aforesaid features n other words, the overhead char"ed varies from period to period
due to chan"es in direct wa"es.
n fact, overhead expenses are "enerally a function of time. Therefore, a time base
overhead absorption rate method is always preferred over any other method. n the
case of labour intensive operations, it is advisable to use labour hour method for
overhead absorption.
Q : E-./!$n ho& #n"er !n" o0er !)sor.t$on o3 o0erhe!"s !re tre!te" $n cost
'roduction overheads are "enerally recovered or char"ed on the "oods on some
predetermined basis. rrespective of the method used for the recovery of
overheads, it has been observed that a di*erence arises between the amount of
overheads absorbed and the amount of overheads actually incurred. f the absorbed
amount is more than the overheads actually incurred then such a di*erence is
termed as an over absorption of overheads. f the recovery is less than the actual
overheads incurred then the di*erence is termed as under absorption of overheads.
Under and over absorbed overheads can be disposed o* in Cost &ccounts by usin"
any one of the followin" methods(
(i) Ase o, S!##lementar$ -ates: )hen the amount of under absorbed and over
absorbed overhead is si"nifcant or lar"e, because of di*erences due to wron"
estimation, then the cost of product needs to be ad!usted by usin" supplementary
rates (under and over absorption<actual overhead) to avoid misleadin" impression.
(ii) >ritin0 o& to Costin0 Pro7t B 6oss Acco!nt: )hen under or over absorbed
amount of overheads is quite ne"li"ible and it is not felt worth while to absorb it
by usin" supplementary rates, the said amount is transferred to Costin" 'roft B
Aoss &ccount. n case under absorption of overheads arises due to factors li$e
idle capacity, defective plannin" etc. Then also it may be transferred to Costin"
'roft B Aoss &ccount.
(iii) Carr$in0 oer to t2e ne8t $ear=s acco!nts: Under this method, the amount of
over<under absorbed overhead is carried over to the next period this method is not
considered desirable as it allows costs of one period to a*ect cost of
another<period. -urther, comparison between one period and another is rendered
di*icult. 9owever, this method may be used when the normal business cycle
extends over more than one year, or in the case of a new pro!ect, the output is low
in the initial years.
Q 1H E-./!$n )r$eCy the con"$t$ons &hen s#../ement!ry r!tes !re #se"
AC )hen the amount of under absorbed and over absorbed overhead is si"nifcant or
lar"e, because of di*erences due to wron" estimation, then the cost of product needs
to be ad!usted by usin" supplementary rates (under and over absorption<actual
overhead) to avoid misleadin" impression.
Q 11 Defne !"m$n$str!t$on o0erhe!"s !n" st!te )r$eCy the tre!tment o3
s#ch o0erhe!"s $n Cost Acco#nts
Administration Oer2ead: These are costs of formulatin" the policy, directin" the
or"anisation and controllin" the operation of an underta$in". These are not related
directly to production activity or function. n other words, all expenses, incurred on
policy formulation, direction, control, o*ice administration and business
mana"ement are included in administration overheads.
Treatment o, Administratie Oer2eads in Cost Acco!ntin0
(i) Char)e to Costin) Pro't and $oss +ccount: &ccordin" to this method
administrative overheads should be treated as fxed cost as they are concerned
with the formulation of policy. 9ence these overheads should be transferred to the
Costin" 'roft and Aoss &ccount.
(ii) +pportionment bet4een Production and Sellin) and Distribution: &ccordin" to this
method, it is assumed that administrative overheads are incurred both for
production and for sellin" and distribution. Therefore these overheads should be
divided on some equitable basis between production and sellin" and distribution
(iii) 0reat as a separate element of total cost: 9ere administration overheads are
considered as a cost of a distinct and identifable operation of the or"anisation
necessary to carry on its activity. Therefore these overheads are recovered
separately on some equitable basis which may be on cost or sales basis.
Q 1' Defne Se//$n+ !n" D$str$)#t$on E-.enses% D$sc#ss the !cco#nt$n+ 3or
se//$n+ !n" "$str$)#t$on e-.enses%
Sellin) e6penses: 3xpenses incurred for the purpose of promotin", mar$etin" and
sales of di*erent products.
Distribution e6penses: 3xpenses relatin" to delivery and despatch of "oods<products
to customers.
+ccountin) treatment for sellin) and distribution e6penses: ,ellin" and distribution
expenses are usually collected under separate cost account numbers.
These expenses may be recovered by usin" any one of followin" method of recovery.
(a) 'ercenta"e on cost of production < cost of "oods sold.
(b) 'ercenta"e on sellin" price.
(c) :ate per unit sold.
Q 13 D$sc#ss the .ro)/ems o3 contro//$n+ the se//$n+ !n" "$str$)#t$on
Problems of controllin) the sellin) 8 distribution overheads are:
(i) The incidence of sellin" B distribution overheads depends on external
factors such as distance of mar$et, nature of competition etc. which are
beyond the control of mana"ement.
(ii) They are dependent upon customersK behaviour, li$in" etc.
(iii) These expenses are of the nature of policy costs and hence not amenable
to control.
The above problems of controllin" sellin" B distribution overheads can be tac$led by
adoptin" the followin" steps(
(i) Comparin" the f"ures of sellin" B distribution overhead with the f"ures of
previous period.
(ii) ,ellin" B distribution overhead bud"ets may be used to control such overhead
expenses by ma$in" a comparison of bud"etary f"ures with actual f"ures of overhead
expenses, ascertainin" variances and fnally ta$in" suitable actions,
(iii) ,tandards of sellin" B distribution expenses may be set up for salesmen,
territories, products etc. The laid down standards on comparison with actual overhead
expenses will reveal variances, which can be controlled by suitable action.
Q 1,% (h!t $s !n $"/e c!.!c$ty* (h!t !re the costs !ssoc$!te" &$th $t* =o&
!re these tre!te" $n .ro"#ct costs*
Idle Ca#acit$: dle capacity is that part of the capacity of a plant, machine or
equipment which cannot be e*ectively utilised in production. n other words, it is
the di*erence between the practical or normal capacity and capacity of utilisation
based on expected sales. -or example, if the practical capacity of production of a
machine is to the tune of 1=,=== units in a month, but is used only to produce Q,===
units, because of mar$et demand of the product, then in such a case, 2,=== units
will be treated as the idle capacity of the machine.
The idle capacity may arise due to lac$ of product demand, non#availability of raw#
material, shorta"e of s$illed labour, absenteeism, shorta"e of power, fuel or supplies,
seasonal nature of product, etc
Idle Ca#acit$ Costs: Costs associated with idle capacity are mostly fxed in nature.
These include depreciation, repairs and maintenance char"es, insurance premium,
rent, rates, mana"ement and supervisory costs. These costs remain unabsorbed or
unrecovered due to under#utilisation of plant and service capacity. dle capacity cost
can be calculated as follows(#
dle capacity cost I L dle Capacity
0reatment of %dle capacity cost: dle capacity costs can be treated in product costin",
in the followin" ways(
(i) f the idle capacity cost is due to unavoidable reasons such as repairs,
maintenance, chan"e over of !ob, etc, a supplementary overhead rate may be used to
recover the idle capacity cost. n this case, the costs are char"ed to the production
capacity utilised.
(ii) f the idle capacity cost is due to avoidable reasons such as faulty plannin", power
failure etc., the cost should be char"ed to proft and loss account.
(iii) f the idle capacity cost is due to seasonal factors, then, the cost should be
char"ed to the cost of production by in/atin" overhead rates.
Q 11% D$sc#ss the tre!tment $n cost !cco#nts o3 the cost o3 sm!// too/s o3 short
e5ect$0e /$3e% "(ay 9: - ; marks/
,mall tools are mechanical appliances used for various operations on a wor$ place,
especially in en"ineerin" industries. ,uch tools include drill bits, chisels, screw cutter,
fles etc.
0reatment of cost of small tools of short efective life:
(i) ,mall tools purchased may be capitali+ed and depreciated over life if their life is
ascertainable. :evaluation method of depreciation may be used in respect of very
small tools of short e*ective life. 0epreciation of small tools may be char"ed to(
(a) -actory overheads
(b) @verheads of the department usin" the small tool.
(ii) (ii)Cost of small tools should be char"ed fully to the departments to which they
have been issued, if their life is not ascertainable.
Q 14 =o& "o yo# "e!/ &$th the 3o//o&$n+ $n Cost Acco#nt*
(i) 2esearch and Development ,6penses
(ii) &rin)e bene'ts
(iii) ,mployee 4elfare costs
(iv) Depreciation
(v) <ad debts
(vi) Packin) ,6penses
(vii) ,6penses on 2emoval and 2e-erection of (achinery
(viii) <onus and )ratuity
(i) -esearc2 and %eelo#ment E8#ense: :esearch and 0evelopment expense is the
expense incurred for searchin" new or improved products, production methods <
techniques or plants < equipments.
0reatment in Cost +ccounts: 3xpense of Gasic :esearch (if it is a continuous
activity) be char"ed to the revenues of the concern. t may be spread over a
number of years if research is not a continuous activity and amount is lar"e.
3xpense of applied research, if relates to all existin" products and methods of
production then it should be treated as a manufacturin" overhead of the period
durin" which it has been incurred and absorbed. ,uch expenses are directly
char"ed to the product, if it is solely incurred for it.
f applied research is conducted for searchin" new product or methods of
production etc., then the research expense treatment depends upon the outcome of
such research. -or example, if research fndin"s are expected to produce future
benefts or if it appears that such fndin"s are "oin" to result in failure then the
costs incurred may be amorti+ed by char"in" to the Costin" 'roft and Aoss
&ccount of one or more years dependin" upon the si+e of expenditure. f research
proves successful, then such costs will be char"ed to the concerned product.
0evelopment expenses be"in with the implementation of the decision to produce a
new or improved product or to employ a new or improved method. The treatment
of development expenses is same as that of applied research.
(ii) @rin0e bene7ts: n every or"anisation, wor$ers are paid some benefts in addition
to their normal wa"e or salary. These additional benefts are popularly called
frin"e benefts. They include(
(a) 9ousin"
(b) Children education allowance
(c) 9oliday pay
(d) Aeave pay
(e) Aeave travel concession to home town or any place in ndia etc.
3xpenses incurred on frin"e benefts in respect of factory wor$ers should be
treated as factory overheads and apportioned amon" the production and service
departments on the basis of number of wor$ers in each department.
-rin"e benefts to o*ice and sellin" and distribution sta* should be treated as
administration overheads and sellin" and distribution overheads respectively and
recovered accordin"ly.
(iii) Em#lo$ee >el,are Costs: t includes those expenses, which are incurred by
the employers on the welfare activities of their employees. The welfare activities on
which these expenses are usually incurred may include canteen, hospital, play
"rounds, etc. These expenses should be separately recorded as )elfare
0epartment Costs. These Costs may be apportioned to production cost centres on
the basis of total wa"es or the number of men employed by them.
(iv) %e#reciation: t represents the fall in the asset value due to its use, wear and
tear and passa"e of time. 0epreciation is an indirect cost of production and
operations. t is an important element of cost and without this true cost of
production cannot be obtained. n costin"C depreciation on plant and machinery is
normally treated as part of the factory overheads.
(v) Bad debts: There is no unanimity amon" various authors about the treatment of
bad debts. ,ome authors believe that bad debts are fnancial losses and therefore
should not be included in the cost of a particular product or !ob. &nother view is
that, bad debts are a part of sellin" and distribution overhead, especially where
they arise in the normal course of tradin". Therefore they should be treated in cost
accounts in the same way as any other sellin" and distribution expense.
(vi) Pac"in0 E8#enses: t includes the expenses incurred on wrappin", tyin",
bottles, boxes, containers or ba"s etc. n Cost &ccounts they are treated as
(a) t is treated as a direct material cost in the case of those products
which cannot be sold without the use of a pac$in". -or example in$#pot
C GreadC paste etc.
(b) t may be treated as distribution overhead if pac$in" expenses are
incurred to facilitate the transportation of fnished products.
(c) t may be treated as advertisement cost and included in sellin"
overheads if it is incurred for advertisement to ma$e the product
(vii) E8#enses on -emoal and -e' erection o, *ac2iner$: 3xpenses are
sometime incurred on removal and re#erection of machinery in factories. ,uch
expenses may be incurred due to factors li$e chan"e in the method of
productionC an addition or alteration in the factory buildin", chan"e in the follow
of production, etc. &ll such expenses are treated as production overheads. )hen
amount of such expenses is lar"e, it may be spread over a period of time.
f such expenses are incurred due to faulty plannin" or some other abnormal
factor, then they may be char"ed to Costin" 'roft and Aoss &ccount.
(viii) Bon!s and 0rat!it$: Gonus under the payment of Gonus &ct is to be paid
compulsorily to the wor$ers althou"h the amount of bonus may vary with
amount of proft earned. & minimum bonus of Q.55E is, however, payable
irrespective of proft or loss earned by the concern. The amount of bonus,
therefore, may be included in a direct labour cost to the extent of the minimum
bonus, as the same is payable even in a loss situation. &ny amount paid as bonus
in excess of the minimum may be considered as an appropriation of proft.
9owever, bonus lin$ed with productivity is defnitely a part of the overhead cost.
,o far as "ratuity is concerned, it is indeed directly lin$ed with the wa"es and is
not by any means related to the profts. &ccordin"ly, it should be treated as an
element of cost.
Q 16% E-./!$n the cost !cco#nt$n+ tre!tment o3 #ns#ccess3#/ Rese!rch !n"
De0e/o.ment cost
Cost of unsuccessful research is treated as factory overhead, provided the
expenditure is normal and is provided in the bud"et. f it is not bud"eted, it is written
o* to the proft and loss account. f the research is extended for lon" time, some
failure cost is spread over to successful research.
Q 17 (h!t $s not$on!/ rent o3 ! 3!ctory )#$/"$n+* G$0e one re!son &hy $t m!y
)e $nc/#"e" $n cost !cco#nts%
AC *otional 2ent: t is a reasonable char"e raised in the cost accounts for the use of
owned premises. @ne reason for the use of such a nominal char"e is to enable
comparison between the cost of items made in factories which are owned and in
rented factories. 9owever, it may be noted that in the case of owned factory, cost for
the same is accounted for by means of depreciation.

Non Inte0rated Acco!nts
Q 1 (r$te short note on Cost 2e"+er Contro/ Acco#nt%
Cost $ed)er Control +ccount: This control account is also popularly $nown as D>eneral
Aed"er &d!ustment &ccount% is opened in Cost Aed"er to complete double#entry.
&ll items of income and expenditure ta$en from fnancial accounts and all
transfers from cost accounts to fnancial boo$s are recorded in this account.
,ince the purpose of this account is to complete double entry in the cost led"er,
therefore all transactions in the cost led"er must be recorded throu"h the DCost
Aed"er Control &ccount%. The balance in this account will always be equal to the
total of all the balances of the impersonal accounts.
Q ' (h!t !re the essent$!/ .reDreB#$s$tes o3 $nte+r!te" !cco#nt$n+ system*(
,ssential pre-re#uisites for inte)rated accounts:
(i) The mana"ement%s decision about the extent of inte"ration of the two sets of
(ii) & suitable codin" system must be made available so as to serve the accountin"
purposes of fnancial and cost accounts.
(iii) &n a"reed routine, with re"ard to the treatment of provision for accruals,
prepaid expenses, other ad!ustment necessary for preparation of interim
(iv) 'erfect coordination should exist between the sta* responsible for the
fnancial and cost accounts and an e*icient processin" of accountin" document
should be ensured.
Q / (h!t !re the !"0!nt!+es o3 $nte+r!te" !cco#nt$n+
Inte0rated Acco!ntin0: nte"rated &ccountin" is a system of accountin" whereby
cost and fnancial accounts are $ept in the same set of boo$s. ,uch a system will
have to a*ord full information required for Costin" as well as for -inancial
&ccounts. -or instance, purchases account is eliminated and direct postin"s are
made to ,tores Control &ccount, )or$#in#'ro"ress account, or @verhead
&ccount. t also ensures the ascertainment of mar"inal cost, variances, abnormal
losses and "ains. n fact all information that mana"ement requires from a system
of Costin" for doin" its wor$ properly is made available. The inte"rated accounts
"ive full information in such a manner so that the proft and loss account and the
balance sheet can also be prepared.
The main advanta"es of nte"rated &ccountin" are as follows(
(i) ,ince there is one set of accounts, thus there is one f"ure of proft. 9ence the
question of reconciliation of costin" proft and fnancial proft does not arise.
(ii) There is no duplication of recordin" of entries and e*orts to maintain separate set of
(iii) Costin" data are available from boo$s of ori"inal entry and hence no delay is caused in
obtainin" information.
(iv) Centrali+ation of accountin" function results in economy.
Q ,% (hen $s the reconc$/$!t$on st!tement o3 Cost !n" <$n!nc$!/ !cco#nts not
)hen the Cost and -inancial &ccounts are inte"rated # there is no need to have a
separate reconciliation statement between the two sets of accounts. nte"ration means
that the same set of accounts fulfll the requirement of both i.e., Cost and -inancial
Q 1% (h!t !re the re!sons 3or "$s!+reement o3 .rofts !s .er cost !cco#nts
!n" fn!nc$!/ !cco#nts*
(hy $s $t necess!ry to reconc$/e the Profts )et&een the Cost Acco#nts !n"
<$n!nc$!/ Acco#nts*
)hen the cost and fnancial accounts are $ept separately, t is imperative that these
should be reconciled, otherwise the cost accounts would not be reliable. The
reconciliation of two set of accounts can be made, if both the sets contain
su*icient detail as would enable the causes of di*erences to be located. t is,
therefore, important that in the fnancial accounts, the expenses should be
analysed in the same way as in cost accounts. t is important to $now the causes
which "enerally "ive rise to di*erences in the costs B fnancial accounts.
The various reasons for disa"reement of profts shown by the two sets of boo$s vi+.,
cost and fnancial may be listed as below(
1% Items !..e!r$n+ on/y $n fn!nc$!/ !cco#ntsI not $n cost !cco#nts8
(i) ncome(
(a) 'roft on sale of assets
(b) nterest received
(c) 0ividend received
(d) ,hare Transfer fees
(ii) 3xpenditure
(a) Aoss on sale of assets
(b) 'reliminary expenses written o*
(c) >oodwill written o*
(d) Underwritin" commission and debenture discount written o*
(iii) &ppropriation
(a) 0ividends
(b) :eserves, ,in$in" -und, etc.
'% Items !..e!r$n+ on/y $n cost !cco#ntsI not $n fn!nc$!/ !cco#nts8
(a) .otional interest on capitalC
(b) .otional rent on premises owned.
3% Un"er or o0erD!)sor.t$on o3 o0erhe!"
n cost accounts overheads are char"ed to production at pre#determined rates while in
fnancial accounts actual amount of overhead is char"ed, the di*erence "ives rise to
under or over absorptionC causin" a di*erence in profts.
,% D$5erent )!ses o3 stoc> 0!/#!t$on
n fnancial boo$s, stoc$s are valued at cost or mar$et price, whichever is lower. n
cost boo$s, however, stoc$ of materials may be valued on --@ or A-@ basis and
wor$#in#pro"ress may be valued at prime cost or wor$s cost. 0i*erences in store
valuation may thus cause a di*erence between the two profts.
1% De.rec$!t$on
The amount of depreciation char"e may be di*erent in the two sets of boo$s either
because of the di*erent methods of calculatin" depreciation or the rates adopted.
Nee" 3or reconc$/$!t$on 8
• To ensure reliability of cost data
• To ensure ascertainment of correct product cost
• To ensure correct decision ma$in" by the mana"ement based on Cost B
-inancial data
• To report fruitful fnancial < cost data.
Q 4 2$st the <$n!nc$!/ e-.enses &h$ch !re not $nc/#"e" $n cost
-inancial expenses which are not included in cost accountin" are as follows(
• nterest on debentures and deposit
• >ratuity
• 'ension
• Gonus of 3mployee
• ncome Tax
• 'reliminary 3xpenses
• 0iscount on issue of ,hare
• Underwritin" Commissions.
Q 6 ‘Reconc$/$!t$on o3 cost !n" fn!nc$!/ !cco#nts $n the mo"ern com.#ter
!+e $s re"#n"!nt Comment
n the modern computer a"e the use of computer $nowled"e and accountin"
softwares has helped the feld of -inancial and Cost &ccountin" in a bi" way. n
fact, computers wor$ at a very hi"h speed and can process voluminous data for
"eneratin" desired output in no time. @utput produced is precise and accurate.
Computers can wor$ for hours without any fati"ue. They can brin" out di*erent
-inancial &ccountin" and Cost &ccountin" statements and reports accurately in a
presentable form. -inancial accounts and Cost accounts show their results
accurately and precisely, when maintained on a computer system, but the proft
shown by one set of boo$s may not a"ree with that of the other set.
The main reasons for the disa"reement of the proft f"ures shown by the two set of
boo$s is the absence of certain items which appear in fnancial boo$s only and are not
recorded in cost accountin" boo$s. ,imilarly, there may be some items which appear
in cost accounts but do not fnd a place in the fnancial boo$s. ,ome examples which
a*ect it are as below(
1. 'roft < loss on sale of assets
2. nterest received
5. 0ividend received
6. 'reliminary expenses, "oodwill written o*
7. Under or over#absorption of overhead
8. 0i*erent bases of stoc$ valuation
F. 0i*erent methods of 0epreciation
Under the situation of di*erential proft f"ure shown by fnancial and cost accounts, it
is necessary to reconcile the results (proft<loss) shown. ,uch a reconciliation proves
arithmetical accuracy of data, explains reasons for the di*erence in two sets of boo$s
and a*ords reliability to them. 9ence, the reconciliation of cost and fnancial accounts
is essential and not redundant even in the modern a"e of computer.
*et2od o, Costin0 (I) (5ob Costin0D Contract Costin0D Batc2 Costin0 B
O#eratin0 Costin0)
Q 1 Descr$)e ;o) Cost$n+ !n" @!tch Cost$n+ +$0$n+ e-!m./e o3 $n"#str$es
&here these !re #se"*
n !ob costin", costs are collected and accumulated accordin" to !ob. 3ach !ob or unit
of production is treated as a separate entity for the purpose of costin". Oob
costin" may be employed when !obs are executed for di*erent customers
accordin" to their specifcation.
Gatch costin" is a form of !ob costin". & lot consistin" of similar units which comprises
the batch may be used as a cost unit for ascertainin" cost. ,uch a method of costin" is
used in case of pharmaceutical industry, readymade "arments, industries
manufacturin" parts of T?, radio sets etc.
Q ) (h!t "o yo# #n"erst!n" )y @!tch Cost$n+* In &h$ch $n"#str$es $t $s
Gatch Costin" is a form of !ob costin". n this, the cost of a "roup of products is
ascertained. The unit of cost is a batch or a "roup of identical products instead of a
sin"le !ob, order or contract. ,eparate cost sheets are maintained for each batch of
products by assi"nin" a batch number. The cost per unit is ascertained by dividin"
the total cost of a batch by the number of items produced in that batch.
Gatch costin" is employed by companies manufacturin" in batches. t is used by
readymade "arment factories for ascertainin" the cost of each batch of cloths made by
them. 'harmaceutical or dru" industries, electronic component manufacturin" units,
radio manufacturin" units too use this method of costin" for ascertainin" the cost of
their product.
Q / %n <atch Costin)! ho4 is ,conomic <atch -uantity determined=
n batch costin" the most important problem is the determination of D3conomic Gatch
The determination of economic batch quantity involves two type of costs vi+, (i) set up
cost and (ii) carryin" cost. )ith the increase in the batch si+e, there is an increase in
the carryin" cost but the set#up cost per unit of the product is reducedC this situation
is reversed when the batch si+e is reduced. Thus there is one particular batch si+e for
which both set up and carryin" costs are minimum. This si+e of a batch is $nown as
economic or optimum batch quantity.
3conomic batch quantity can be determined with the help of a table, "raph or
mathematical formula. The mathematical formula usually used for its determination is
as follows(
)here, 0 I &nnual demand for the product
, I ,ettin" up cost per batch
C I Carryin" cost per unit of production per annum
Q ,% E-./!$n the $m.ort!nce o3 !n Esc!/!t$on C/!#se $n contr!ct cost
Escalation Cla!se: This clause is usually provided in the contracts as a safe"uard
a"ainst any li$ely chan"es in the price or utili+ation of material and labour. f
durin" the period of execution of a contract, the prices of materials or labour rise
beyond a certain limit, the contract price will be increased by an a"reed amount.
nclusion of such a term in a contract deed is $nown as an Kescalation clauseK
&n escalation clause usually relates to chan"e in price of inputs, it may also be
extended to increased consumption or utili+ation of quantities of materials, labour
etc. n such a situation the contractor has to satisfy the contractee that the
increased utili+ation is not due to his ine*iciency.
Q 1 D$sc#ss the .rocess o3 est$m!t$n+ .roftF/oss on $ncom./ete contr!cts
Process o, estimatin0 #ro7t 9 loss on incom#lete contracts
(i)f completion of contract is less than 27E no proft should be ta$en to proft and
loss account.
(ii)f completion of contract is upto 27E or more but less than 7=E then
1<5 L .otional 'roft L
may be ta$en to proft and loss account.
(iii)f completion of contract is 7=E or more but less than R=E then
2<5 L .otional 'roft L
may be ta$en to proft and loss account
(iv) f completion of contract is "reater than or equal to R=E then one of the
followin" formulas may be used for ta$in" the proft to proft and loss account.
1. 3stimated 'roft L
2. 3stimated 'roft L
5. 3stimated 'roft L
6. 3stimated 'roft L
7. .otional 'roft L
Q 4C E-./!$n the 3o//o&$n+8
($) Not$on!/ .roft $n Contr!ct cost$n+
($$) Retent$on money $n Contr!ct cost$n+
(i) Notional #ro7t in Contract costin0: t represents the di*erence between the
value of wor$ certifed and cost of wor$ certifed.
.otional 'roft I ?alue of wor$ certifed ; (Cost of wor$s to date ; Cost of
wor$ not yet certifed)
(ii) -etention *one$ in Contract Costin0: & contractor does not receive the full
payment of the wor$ certifed by the surveyor. Contractee retains some amount to
be paid after some time, when it is ensured that there is no default in the wor$
done by the contractor. f any defciency or defect is noticed, it is to be rectifed by
the contractor before the release of the retention money. Thus, the retention
money provides a safe"uard a"ainst the default ris$ in the contracts.
Q 6 (h!t !re the m!$n 3e!t#res o3 MCostDP/#sDContr!ctsM
These contracts provide for the payment by the contractee of the actual cost of
manufacture plus a stipulated proft, mutually decided between the two parties.
4ain features of cost#plus#contracts(
1) This method is adopted in the case of those contracts where the probable cost
of contract cannot be ascertained in advance with a reasonable accuracy.
2) These contracts are preferred when the cost of material and labour is not
steady and contract completion may ta$e number of years.
5) The di*erent costs to be included in the execution of the contract are
mutually a"reed so that no dispute may arise in future in this respect. Under
such type of contract contractee is allowed to chec$ or scrutinise the concerned
boo$s, documents accounts.
6) ,uch a contract o*ers a fair price to the contractee and also a reasonable
proft to contractor.
7) The contract price here is ascertained by addin" a fxed and mutually pre#
decided component of proft to the total cost of the wor$.
Q 7 (h!t !re the m!$n !"0!nt!+es o3 cost ./#s contr!ct*
Cost #l!s contract: Under cost plus contract, the contract price is ascertained by
addin" a percenta"e of proft to the total cost of the wor$. ,uch types of contracts are
entered into when it is not possible to estimate the contract cost with reasonable
accuracy due to unstable condition of material, labour services etc.
Costs plus contracts have the followin" advanta"es(
a) The contractor is assured of a fxed percenta"e of proft. There is no ris$
of incurrin" any loss on the contract.
b) t is useful especially when the wor$ to be done is not defnitely fxed at
the time of ma$in" the estimate.
c) Contractee can ensure himself about Sthe cost of the contractT, as he is
empowered to examine the boo$s and document of the contractor to
ascertain the veracity of the cost of the contract.
Q :C E-./!$n )r$eCyI &h!t "o yo# #n"erst!n" )y O.er!t$n+ Cost$n+* =o& !re
com.os$te #n$ts com.#te"*
Operatin) Costin)( t is method of ascertainin" costs of providin" or operatin" a
service. This method of costin" is applied by those underta$in"s which provide
services rather than production of commodities. This method of costin" is used by
transport companies, "as and water wor$s departments, electricity supply companies,
canteens, hospitals, theatres, schools etc.
Composite units may be computed in two ways(
(a) &bsolute (wei"hted avera"e) tones $ms, quintal $ms etc.
(b) Commercial (simple avera"e) tones $ms, quintal $ms etc.
&bsolute tonnes#$ms are the sum total of tonnes $ms arrived at by multiplyin" various
distances by respective load quantities carried.
Commercial tonnes#$ms, are arrived at by multiplyin" total distance $ms, by avera"e
load quantity.
*et2od o, Costin0 (II) (Process Costin0D O#eration Costin0D 5oint
Prod!cts and B$'#rod!cts)
Q 1 D$st$n+#$sh )et&een ;o) cost$n+ !n" .rocess cost$n+
5ob Costin0 Process Costin0
1. Oob costin" is a specifc
order costin"
'rocess costin" is a method of costin" used to
ascertain the cost of a product at each sta"e of
2. Cost here is determined on
!ob basis
Costs are accumulated for each process
separately for a "iven period of time.
5. 3ach !ob needs special
treatment and no two !obs
are ali$e
-inished product of one process becomes the raw
material for the next process.
6. The cost of each !ob is
compiled separately by
addin" materials, labour
and overhead costs
The unit cost here is the avera"e cost of the
process for a "iven period. ts correct
computation requires the measurement of
production at various sta"es of manufacture.
7. Costs are computed when
!ob is completed.
Costs are computed for each process at the end
of each period.
8. &s each !ob is distinct or is
of di*erent nature, more
detailed supervision and
control are necessary
&s the process operations are standardised
accumulation of costs and supervision and
control are comparatively easier.
Q '% EThe 0!/#e o3 scr!. +ener!te" $n ! .rocess sho#/" )e cre"$te" to the
.rocess !cco#nt%E Do yo# !+ree &$th th$s st!tement* G$0e re!sons%
This statement is not correct The value of scrap (as normal loss) received from its sale
is credited to the process account. Gut the value of scrap received from its sale under
abnormal conditions should be credited to &bnormal Aoss &ccount.
Q 3 E-./!$n )r$eCy the .roce"#re 3or the 0!/#!t$on o3 (or>D$nD.rocess%
The valuation of wor$#in#process can be made in the followin" three ways, dependin"
upon the assumptions made re"ardin" the /ow of costs.
;-irst#in#frst out (--@) method
;Aast#in#frst out (A-@) method
# &vera"e cost method
& brief account of the procedure followed for the valuation of wor$#in#process under
the above three methods is as followsC
&%&O method: &ccordin" to this method the units frst enterin" the process are
completed frst. Thus the units completed durin" a period would consist partly of the
units which were incomplete at the be"innin" of the period and partly of the units
introduced durin" the period.
The cost of completed units is a*ected by the value of the openin" inventory, which is
based on the cost of the previous period. The closin" inventory of wor$#in#process is
valued at its current cost.
$%&O method: &ccordin" to this method units last enterin" the process are to be
completed frst. The completed units will be shown at their current cost and the
closin"#wor$ in process will continue to appear at the cost of the openin" inventory of
wor$#in#pro"ress alon" with current cost of wor$ in pro"ress if any.
+vera)e cost method: &ccordin" to this method openin" inventory of wor$#in#process
and its costs are mer"ed with the production and cost of the current period,
respectively. &n avera"e cost per unit is determined by dividin" the total cost by the
total equivalent units, to ascertain the value of the units completed and units in
Q , E-./!$n eB#$0!/ent #n$ts
AC )hen openin" and closin" stoc$s of wor$#in#process exist, unit costs cannot be
computed by simply dividin" the total cost by total number of units still in process. )e
can convert the wor$#in#process units into fnished units called equivalent units so that
the unit cost of these units can be obtained.
3quivalent &ctual number of 'ercenta"e of
completed units I units in the process L wor$ completed
of manufacture
t consists of balance of wor$ done on openin" wor$#in#process, current production
done fully and part of wor$ done on closin" )' with re"ard to di*erent elements of
costs vi+., material, labour and overhead.
Q 1 D$sc#ss the tre!tment o3 )yD.ro"#ct Cost $n Cost Acco#nt$n+ %
Treatment o, B$'#rod!ct in Cost Acco!ntin0:
(i) When they are of small total value: f the amount realised from the sale of by#
product is small, it may be dealt in any one of the followin" two ways(
(a) The sale value of the by#product may be credited to the 'roft and Aoss
&ccount and no credit be "iven in the cost accounts. The credit to the
'roft and Aoss &ccount here is treated either as miscellaneous income or
as additional sales revenue.
(b) The sale proceeds of the by#product may be treated as deductions from
the total costs. The sale proceeds in fact should be deducted either from
the production cost or from the cost of sales.
(ii) When they are of considerable total value: n this case by#products may be
re"arded as !oint products. To determine exact cost of by#products the costs
incurred upto the point of separation, should be apportioned over by#products and
!oint products by usin" a lo"ical basis. n this case, the !oint costs may be divided
over !oint products and by#products by usin" physical unit method (at the point of
split o*) or ultimate sellin" price (if sold).
(iii) When they re#uire further processin): n this case, the net realisable value of
the by#product at the split#o* point may be arrived at by subtractin" the further
processin" cost from the realisable value of by#products.
Q 4 D$st$n+#$sh )et&een ?o$nt .ro"#cts !n" @yD.ro"#cts%
3oint Products are defned as the products which are produced simultaneously from
same basic raw materials by a common process or processes but none of the
products is relatively of more importance or value as compared with the other. -or
example spirit, $erosene oil, fuel oil, lubricatin" oil, wax, tar and asphalt are the
examples of !oint products.
<y-products, on the other hand, are the products of minor importance !ointly
produced with other products of relatively more importance or value by the
common process and usin" the same basic materials. These products remain
inseparable upto the point of split o*. -or example in 0airy industries, batter or
cheese is the main product, but butter mil$ is the by#product.
Points of Distinction:
(i) Ooint products are the products of equal economic importance, while the by#
products are of lesser importance.
(ii) Ooint products are produced in the same process, whereas by#products are
produced from the scrap or the discarded materials of the main product.
(iii) Ooint products are not produced incidentally, but by#products emer"e
incidentally also.
Q 6 (r$te short note on o.er!t$on cost$n+%
@peration Costin" is defned as the refnement of process costin". t is concerned
with the determination of the cost of each operation rather than the process. n
those industries where a process consists of distinct operations, the method of
costin" applied or used is called operation costin". @peration costin" o*ers
better scope for control. t facilitates the computation of unit operation cost at
the end of each operation by dividin" the total operation cost by total input units.
t is the cate"ory of the basic costin" method, applicable, where standardi+ed
"oods or services result from a sequence of repetitive and more or less
continuous operations, or processes to which costs are char"ed before bein"
avera"ed over the units produced durin" the period. The two costin" methods
included under this head are process costin" and service costin".
Q 7 D$st$n+#$sh )et&een O.er!t$n+ Cost$n+ !n" O.er!t$on Cost$n+%
O#eratin0 Costin0: t is a method of costin" applied by underta$in"s which provide
service rather than production of commodities. Ai$e unit costin" and process
costin", operatin" costin" is thus a form of operation costin".
The emphasis under operatin" costin" is on the ascertainment of cost of renderin"
services rather than on the cost of manufacturin" a product. t is applied by transport
companies, "as and water wor$s, electricity supply companies, canteens, hospitals,
theatres, school etc. )ithin an or"anisation itself certain departments too are $nown
as service departments which provide ancillary services to the production
departments. -or example, maintenance department, power house, boiler house,
canteen, hospital, internal transport.
O#eration Costin0( t represents a refnement of process costin". n this each
operation instead of each process of sta"e of production is separately costed. This may
o*er better scope for control. &t the end of each operation, the unit operation cost
may be computed by dividin" the total operation cost by total output.
Q : Describe brie>y! ho4 5oint costs upto the point of separation may be apportioned
amon)st the 5oint products under the follo4in) methods:
"i/ +vera)e unit cost method
"ii/ Contribution mar)in method
"iii/ (arket value at the point of separation
"iv/ (arket value after further processin)
"v/ *et realizable value method
4ethods of apportionin" !oint cost amon" the !oint products(
(i) Aera0e Anit Cost *et2od: Under this method, total process cost (upto the
point of separation) is divided by total units of !oint products produced. @n
division avera"e cost per unit of production is obtained. The e*ect of
application of this method is that all !oint products will have uniform cost per
(ii) Contrib!tion *ar0in *et2od: Under this method !oint costs are se"re"ated
into two parts ; variable and fxed. The variable costs are apportioned over the
!oint products on the basis of units produced (avera"e method) or physical
quantities. f the products are further processed, then all variable cost incurred
be added to the variable cost determined earlier. Then contribution is calculated
by deductin" variable cost from their respective sales values. The fxed costs
are then apportioned over the !oint products on the basis of contribution ratios.
(iii) *ar"et Val!e at t2e Time o, Se#aration: This method is used for
apportionin" !oint costs to !oint products upto the split o* point. t is di*icult to
apply if the mar$et value of the products at the point of separation are not
available. The !oint cost maybe apportioned in the ratio of sales values of
di*erent !oint products.
(iv) *ar"et Val!e a,ter ,!rt2er Processin0: 9ere the basis of
apportionment of !oint costs is the total sales value of fnished products at the
further processin". The use of this method is unfair where further processin"
costs after the point of separation are disproportionate or when all the !oint
products are not sub!ected to further processin".
(v) Net -ealisable Val!e *et2od: 9ere !oint costs is apportioned on the basis of
net realisable value of the !oint products,
.et :ealisable ?alue I ,ale value of !oint products (at fnished sta"e)
(#) estimated proft mar"in
(#) sellin" B distribution expenses, if any
(#) post split o* cost
Standard Costin0
Q 1% E-./!$n )r$eCy ho& st!n"!r"s !re com.$/e" 3or m!ter$!/ !n" /!)o#r costs
3or ! .ro"#ct%
*aterial .!antit$ standards: The followin" procedure is usually followed for settin"
material quantity standards.
(a) Standardisation of products: 0etailed specifcations, blueprints, norms for normal
wasta"e etc., of products alon" with their desi"ns are settled.
(b) Product classi'cation: 0etailed classifed list of products to be manufactured are
(c) Standardisation of material: ,pecifcations, quality, etc., of materials to be used in
the standard products are settled.
(d) Preparation of bill of materials: & bill of material for each product or part showin"
description and quantity of each material to be used is prepared.
(e) 0est runs: ,ample or test runs under re"ulated conditions may be useful in settin"
quantity standards in a precise manner.
6abo!r .!antit$ standards: The followin" are the steps involved in settin" labour
quantity standards(
(a) Standardisation of products: 0etailed specifcations, blueprints, norms for normal
wasta"e etc., of products alon" with their desi"ns are settled.
(b) Product classi'cation: 0etailed classifed list of products to be manufactured are
(c) Standardisation of methods: ,election of proper machines to use proper sequence
and method of operations.
(d) (anufacturin) layout: & plan of operation for each product listin" the operations
to be performed is prepared.
(e) Time and motion study is conducted for selectin" the best way of completin" the
(f) The operator is "iven trainin" to perform the !ob or operations in the best possible
Q ' =o& !re 0!r$!nces "$s.ose" o5 $n ! st!n"!r" cost$n+ system* D$sc#ss
AC The followin" are the various methods(
(a) )rite o* all variances to proft and loss account or cost of sales every month.
(b) 0istribute the variance pro#rata to cost of sales, wor$#in#pro"ress and fnished
"ood stoc$s.
(c) )rite o* quantity variance to proft and loss account but the price variances may
be spread over cost of sales, wor$#in#pro"ress and fnished "oods stoc$s. The reason
behind apportionin" price variances to inventories and cost of sales is that they
represent cost althou"h they are described as variance.
Q 3 D$sc#ss the 0!r$o#s #ses F !"0!nt!+es !n" cr$t$c$sms /e0e/e" !+!$nst
st!n"!r" cost$n+%
Adanta0es o, Standard Costin0:
"i/ t serves as a basis for measurin" operatin" performance and cost control. Gy
settin" standards, proper classifcation and determination of variances, is
possible. This serves as a si"nal for prompt corrective action.
"ii/ t aids price fxin"
"iii/ ntroduction of standard costin" facilitates evaluation of !obs and introduction
of incentives.
"iv/ ,tandard costin" facilitates the estimation of the cost of new products with
"reater accuracy.
"v/ t serves as a basis for inventory valuation. ,tandard costs are used for
inventory valuation because less clerical wor$ is involved in carryin" inventory
at standard cost.
"vi/ ,tandard costin" is also used for the measurement of profts.
"vii/ ,tandard costin" "reatly aids business plannin", bud"etin" and mana"erial
decision ma$in".
"viii/ t provides ob!ectives and tar"ets to be achieved by each level of mana"ement
and defnes the responsibilities of departmental mana"ers.
Criticism o, Standard Costin0:
(i) 7ariation in price: @ne of the chief problem faced in the operation of the standard
costin" system is the precise estimation of li$ely prices or rate to be paid.
(ii) 7aryin) levels of output: f the standard level of output set for pre#determination of
standard costs is not achieved, the standard costs are said to be not realised.
(iii) Chan)in) standard of technolo)y: n case of industries that have frequent
technolo"ical chan"es a*ectin" the conditions of production, standard costin" may
not be suitable.
(iv) ,tandards may be either too strict or too liberal because they may be based on
• theoretical maximum e*iciency
• attainable "ood performance or
• avera"e past performance.
*ar0inal Costin0
Q 1 D$sc#ss )r$eCy the re/e0!nt costs &$th e-!m./es
:elevant costs are those expected future cost which are essential but di*er for
alternative course or action.
(a) 9istorical cost or sun$ costs are irrelevant as they do not play any role in the
decision ma$in" process.
(b) ?ariable costs which will not di*er under various alternatives are irrelevant.
Q ) (h!t $s ! m!r+$n!/ cost*
4ar"inal cost is the amount at any "iven volume of output by which a""re"ate
variable costs are chan"ed if the volume of output is increased by one unit. n practice
this is measured by the total variable cost attributable to one unit. 4ar"inal cost can
precisely be the sum of prime cost and variable overhead.
n this context a unit may be a sin"le article, a batch of articles, an order, a sta"e of
production capacity, a process or a department. t relates to the chan"e in output in
particular circumstances under consideration.
Q 3 (h!t $s contr$)#t$on* =o& $s $t re/!te" to .roft*
Contribution or the contributory mar"in is the di*erence between sales value and the
mar"inal cost. t is obtained by subtractin" mar"inal cost from sales
revenue of a "iven activity. t can also be defned as excess of sales revenue over the
variable cost. The di*erence between sales revenue and mar"inal<variable cost is
considered to be the contribution towards fxed expenses and proft of the entire
Contribution I -ixed Cost M 'roft @:
'roft I Contribution ; -ixed Cost
Q , (h!t $s ! /$m$t$n+ or >ey 3!ctor* G$0e e-!m./es%
Ney factor or Aimitin" factor is a factor which at a particular time or over a period
limits the activities of an underta$in". t may be the level of demand for the products
or services or it may be the shorta"e of one or more of the productive resources,
e."., labour hours, available plant capacity, raw material%s availability etc.
Q 1 (hy $s $t $m.ort!nt to c/!ss$3y costs !s f-e" !n" 0!r$!)/e*
,e"re"ation of all expenses into fxed and variable elements is the essence of mar"inal
costin". The primary ob!ective of the classifcation of expenses into fxed and variable
elements is to fnd out the mar"inal cost for various types of mana"erial decisions. The
other uses of it are as below(
(i) Control of e6penses : The classifcation of expenses helps in controllin"
expenses. -ixed expenses are said to be sun$ costs as these are incurred
irrespective of the level of production activity and they are re"arded as
uncontrollable expenses. ,ince variable expenses vary with the production they
are said to be controllable.
(ii) Preparation of bud)et estimates: This distinction between fxed and variable
cost also helps the mana"ement to estimate precisely the bud"eted expenses.
Q 4 (h!t $s ! m!r+$n!/ cost eB#!t$on*
The contribution theory explains the relationship between the variable cost and
sellin" price. t tells us that sellin" price minus variable cost of the units sold is the
contribution towards fxed expenses and proft. f the contribution is equal to fxed
expenses, there will be no proft or loss and if it is less than fxed expenses, loss is
incurred. ,ince the variable cost varies in direct proportion to output, therefore if the
frm does not produce any unit, the loss will be there to the extent of fxed expenses.
These points can be described with the help of followin" mar"inal cost equation(
(, L U) ; (? L U) I - M '
, I ,ellin" price per unit
? I ?ariable cost per unit
U I Units
- I -ixed expenses
' I 'roft
Q 6 D$5erent$!te )et&een !)sor.t$on cost$n+ !n" m!r+$n!/ cost$n+%
*ar0inal costin0 Absor#tion costin0
1. @nly variable costs are
considered for product costin"
and inventory valuation.
Goth fxed and variable costs are considered for
product costin" and inventory valuation.
2. -ixed costs are re"arded as
period costs. The 'roftability
of di*erent products is !ud"ed
by their '<? ratio.
-ixed costs are char"ed to the cost of
production. 3ach product bears a reasonable
share of fxed cost and thus the proftability of a
product is in/uenced by the apportionment of
fxed costs.
5. Cost data presented hi"hli"ht
the total contribution of each
Cost data are presented in conventional pattern.
.et proft of each product is determined after
subtractin" fxed cost alon" with their variable
6. The di*erence in the
ma"nitude of openin" stoc$
and closin" stoc$ does not
a*ect the unit cost of
The di*erence in the ma"nitude of openin" stoc$
and closin" stoc$ a*ects the unit cost of
production due to the impact of related fxed
Q 7 (h!t !re the !"0!nt!+es !n" "$s!"0!nt!+es o3 m!r+$n!/ cost$n+*
Adanta0es o, *ar0inal Costin0
1. The mar"inal cost remains constant per unit of output whereas the fxed cost
remains constant in total. ,ince mar"inal cost per unit is constant from period to
period within a short span of time, frm decisions on pricin" policy can be ta$en.
2. f fxed overheads are included on the basis of pre#determined rates, there will be
either under#recovery or over#recovery of overheads. 4ar"inal costin" avoids such
under or over recovery of overheads.
5. The stoc$ of fnished "oods and wor$#in#pro"ress are carried on mar"inal cost basis
and the fxed expenses are written o* to proft and loss account as period cost. This
shows the true proft of the period.
6. 4ar"inal costin" helps in the preparation of brea$#even analysis which shows the
e*ect of increasin" or decreasin" production activity on the proftability of the
7. ,e"re"ation of expenses as fxed and variable helps the mana"ement to exercise
control over expenditure.
8. 4ar"inal costin" helps the mana"ement in ta$in" a number of business decisions
li$e ma$e or buy, discontinuance of a particular product, replacement of machines,
6imitations o, *ar0inal Costin0
1. t is di*icult to classify exactly the expenses into fxed and variable cate"ory. ,ome
expenses are neither totally variable nor wholly fxed.
2. Contribution of a product itself is not a "uide for optimum proftability unless it is
lin$ed with the $ey factor.
5. ,ales sta* may mista$e mar"inal cost for total cost and sell at a priceC which will
result in loss or low profts. 9ence, sales sta* should be cautioned while "ivin"
mar"inal cost.
6. @verheads of fxed nature cannot alto"ether be excluded particularly in lar"e
contracts, while valuin" the wor$#in# pro"ress. n order to show the correct position
fxed overheads have to be included in wor$#in#pro"ress.
7. ,ome of the assumptions re"ardin" the behaviour of various costs are not
necessarily true in a realistic situation. -or example, the assumption that fxed cost
will remain static throu"hout is not correct. -ixed cost may chan"e from one period to
another. -or example salaries bill may "o up because of annual increments or due to
chan"e in pay rate etc. The variable costs do not remain constant per unit of output.
There may be chan"es in the prices of raw materials, wa"e rates etc. after a certain
level of output has been reached due to shorta"e of material, shorta"e of s$illed
labour, concessions of bul$ purchases etc.
8. 4ar"inal costin" i"nores time factor and investment. -or example, the mar"inal
cost of two !obs may be the same but the time ta$en for their completion and the cost
of machines used may di*er. The true cost of a !ob which ta$es lon"er time and uses
costlier machine would be hi"her. This fact is not disclosed by mar"inal costin".
Q : Critically discuss the assumptions underlyin) C7P analysis
Cost volume proft (C?') analysis is the analysis of three variables cost, volume and
proft. ,uch an analysis explores the relationship between costs, revenue, activity
levels and the resultin" proft. t aims at measurin" variations in cost and volume.
C?' analysis is based on the followin" assumptions(
1. Chan"es in the levels of revenues and costs arise only because of chan"es in the
number of units produced and sold.
2. Total costs can be separated into two componentsC a fxed component that does not
vary with output level and a variable component that chan"es with respect to output
5. )hen represented "raphically, the behaviour of total revenues and total costs are
linear in relation to output level within a relevant ran"e and time period.
6. ,ellin" price, variable cost per unit, and total fxed costs within a relevant ran"e
and time period are $nown and constant.
7. The analysis either covers a sin"le product or assumes that the proportion of
di*erent products when multiple products are sold will remain constant as the level of
total units sold chan"es.
8. &ll revenues and costs can be added, subtracted, and compared without ta$in" into
account the time value of money.
Q 10 E-./!$n8
(i) @re!>e0en Ch!rt
(ii) Contr$)#t$on @re!>e0en Ch!rt
(iii) ProftD0o/#me Ch!rt
(i) Brea"een C2art( & brea$even chart records costs and revenues on the vertical
axis and the level of activity on the hori+ontal axis. The brea$even point is that
point where the sales revenue line intersects the total cost line. @ther measures
li$e the mar"in of safety and proft can also be measured from the chart.
(ii) Contrib!tion Brea"een C2art: t is not possible to use a brea$even chart to
measure contribution. This is one of its ma!or limitations especially so because
contribution analysis is literally the bac$bone of mar"inal costin". To overcome
such a limitation contribution brea$even chart is used, which is based on the same
principles as a conventional brea$even chart except for that it shows the variable
cost line instead of the fxed cost line. Aines for Total cost and ,ales revenue
remain the same. The brea$even point and proft can be read o* in the same way
as with a conventional chart. 9owever it is also possible to read the contribution
for any level of activity.
The contribution can be read as the di*erence between the sales revenue line and
the variable cost line.
(iii) Pro7t'ol!me C2art: This is also very similar to a brea$even chart. n this
chart the vertical axis represents profts and losses and the hori+ontal axis is drawn at
+ero proft or loss. n this chart each level of activity is ta$en into account and profts
mar$ed accordin"ly. The brea$even point is where this line interacts the .
The loss at a nil activity level is equal to :s. 2,==,===, i.e. the amount of fxed costs.
The second point used to draw the line could be the calculated brea$even point or the
calculated proft for sales of a particular number of units.
Adanta0es o, t2e #ro7t'ol!me c2art: The bi""est advanta"e of the proft#volume
chart is its capability of depictin" clearly the e*ect on proft and brea$even point of
any chan"es in the variables.
Q 11 E-./!$n !n" $//#str!te c!sh )re!>De0en ch!rt
n cash brea$#even chart, only cash fxed costs are considered. .on#cash items li$e
depreciation etc. are excluded from the fxed cost for computation of brea$#even point.
t depicts the level of output or sales at which the sales revenue will equal to total
cash out/ow. t is computed as under(

9ence for example suppose insurance has been paid on 1st Oanuary, 2==8 till 51
0ecember, 2=1= then this fxed cost will not be considered as a cash fxed cost for the
period 1st Oanuary, 2==Q to 51st 0ecember, 2==R.
Q 1'% D$st$n+#$sh )et&een A!r+$n!/ Cost$n+ !n" D$5erent$!/ Cost$n+%
4ar"inal Costin" is defned as the D&scertainment of mar"inal costs and of the e*ect
on proft of chan"es in volume or type of output by di*erentiatin" between fxed costs
and variable costs%.
0i*erential Costin" is defned as the technique of costin" which uses di*erential costs
and<or di*erential revenues for ascertainin" the acceptability of an alternative. The
technique may be termed as incremental costin" when the di*erence is increase in
costs and decremental costin" when the di*erence is decrease in costs.
The main points of distinction between mar"inal costin" and di*erential costin" are as
(i) The technique of mar"inal costin" requires a clear distinction between variable
costs and fxed costs whereas no such distinction is made in the case of di*erential
(ii) n mar"inal costin", mar"in of contribution and contribution ratio are the main
yard stic$s for performance evaluation and for decision ma$in" whereas under
di*erential costs analysis, di*erential costs are compared with the incremental or
decremental revenue (as the case may be) for arrivin" at a decision.
(iii) 0i*erential cost analysis is possible in both absorption costin" and mar"inal
costin", where as mar"inal costin" in itself is a distinct technique.
(iv) 4ar"inal cost may be incorporated in the cost accountin" system whereas
di*erential costs are wor$ed out separately.
B!d0ets and B!d0etar$ Control
Q 1 Defne the terms @#"+et !n" @#"+et$n+ contro/%
<ud)et: & fnancial and<or quantitative statement prepared and approved prior to a
defned period of time of the policy to be pursued durin" that period for the purpose of
attainin" a "iven ob!ective. t may include income, expenditure and employment of
<ud)etary Control: Gud"etary control is the establishment of bud"ets relatin" to the
responsibilities of executives of a policy and the continuous comparison of the actual
with the bud"eted results, either to secure by individual action the ob!ective of the
policy or to provide a basis for its revision.
Q 'D$sc#ss )r$eCy the o);ect$0es o3 )#"+et$n+%
The process of bud"etin" is initiated with the establishment of specifc tar"ets of
performance and is followed by executin" plans to achieve such desired "oals and
from time to time comparin" actual results with the tar"ets of performances<"oals.
3stablishin" specifc tar"ets for future operations is part of the plannin" function of
mana"ement, while executin" actions to meet the "oals is the directin" function of
Plannin0: Gud"etin" supports the plannin" process by requirin" all or"anisational
units to establish their tar"ets for the upcomin" period. The tar"ets, in turn, motivate
individuals and "roups to perform at hi"h levels. 0urin" the plannin" phase of the
bud"et process, all viewpoints are considered, options identifed, and cost reduction
opportunities assessed. This process may reveal opportunities or threats that were not
$nown prior to the bud"et plannin" process.
%irectin0: @nce the bud"et plans are in place, they can be used to direct and
coordinate operations in order to achieve the stated tar"ets. The bud"etary units of an
or"anisation are called responsibility centers. 3ach responsibility center is led by a
mana"er who has the authority over and responsibility for the unit%s performance.
Controllin0( &s time passes, the actual performance of an operation can be compared
a"ainst the planned tar"ets. This provides prompt feedbac$ to employees about their
performance. f necessary, employees can use such feedbac$ to ad!ust their activities
in the future. Comparin" actual results to the plan also helps prevent unplanned
Q / D$sc#ss the com.onents o3 )#"+et!ry contro/ system
Com#onents o, b!d0etar$ control s$stem
The policy of a business for a defned period is represented by the master bud"et the
details of which are "iven in a number of individual bud"ets called functional bud"ets.
The functional bud"ets are broadly "rouped under the followin" heads(
a) 'hysical Gud"ets ; ,ales Hty, 'roduct Hty., nventory, 4anpower bud"et.
b) Cost Gud"ets ; 4anufacturin" Cost, &dministration Cost, sales B distribution
cost, : B 0 Cost.
c) 'roft Gud"et
Q 3 D$sc#ss the s!/$ent 3e!t#res o3 ! )#"+et!ry contro/ system
& bud"etary control system can be defned as .the establishment of bud"ets relatin" to
the responsibilities of executives to the requirements of a policy, and the continuous
comparison of actual with bud"eted results either to secure by individual action the
ob!ective of that policy or to provide a base for its revision.
The salient features of such a system are the followin"(
(i) 0eterminin" the ob!ectives to be achieved, over the bud"et period, and the
policy or policies that mi"ht be adopted for the achievement of these ends.
(ii) 0eterminin" the variety of activities that should be underta$en for the
achievement of the ob!ectives.
(iii) 0rawin" up a plan or a scheme of operation in respect of each class of
(iv) Aayin" out a system of comparison of actual performance by each person,
section or department with the relevant bud"et and determination of causes for
the discrepancies, if any.
(v) 3nsurin" that corrective action will be ta$en where the plan is not bein"
n brief, it is a system to assist mana"ement in ma$in", estimatin" and plannin" for
the future and to facilitate the analysis of the variation between estimated and actual
Q , D$sc#ss the o);ect$0es o3 $ntro"#c$n+ ! @#"+et!ry Contro/ System $n !n
The ob!ectives of a system of bud"etary control are "iven below(
1. 'ortrayin" with precision the overall aims of the business and determinin" tar"ets
of performance for each section or department of the business.
2. Aayin" down the responsibilities of each of the executives and other personnel so
that every one $nows what is expected of him.
5. 'rovidin" a basis for the comparison of actual performance with the predetermined
tar"ets and investi)ation of deviation, if any.
6. 3nsurin" the best use of all available resources to maximise proft or production,
sub!ect to the limitin" factors.
7. Coordinatin" the various activities of the business5
8. 'rovidin" a basis for revision of current and future policies.
F. 0rawin" up lon" ran"e plans with a fair measure of accuracy.
Q. 'rovidin" a yardstic$ a"ainst which actual results can be compared.
Q 1 D$sc#ss )r$eCy the !"0!nt!+es !n" /$m$t!t$ons o3 @#"+et!ry Contro/
Adanta0es o, B!d0etar$ Control S$stem
1. The use of bud"etary control system enables the mana"ement of a business
concern to conduct its business activities in the e*icient manner.
2. t is a powerful instrument used by business houses for the control of their
5. t reveals the deviations to mana"ement, from the bud"eted f"ures after
ma$in" a comparison with actual f"ures.
6. 3*ective utilisation of various resources li$e men, material, machinery and
money is made possible, as the production is planned after ta$in" them into
7. t helps in the review of current trends and framin" of future policies.
8. t creates suitable conditions for the implementation of standard costin" system
in a business or"anisation.
F. t inculcates the feelin" of cost consciousness amon" wor$ers.
6imitations o, B!d0etar$ Control S$stem:
1. Gud"ets may or may not be true, as they are based on estimates.
2. Gud"ets are considered as ri"id document.
5. Gud"ets cannot be executed automatically.
6. ,ta* co#operation is usually not available durin" bud"etary control exercise.
7. ts implementation is quite expensive.
Q 4 D$st$n+#$sh )et&een <#nct$on!/ )#"+ets !n" m!ster )#"+et%
@!nctional b!d0et ' & functional bud"et is one which is related to function of the
business as for example, production bud"et relatin" to the manufacturin" function.
-unctional bud"ets are prepared for each function and they are subsidiary to the
master bud"et of the business. The various types of functional bud"ets to be prepared
will vary accordin" to the si+e and nature of the business. The various commonly used
functional bud"ets are ,ales bud"et, 'roduction bud"et, -actory overhead bud"et,
Cash bud"et, etc. These functional bud"ets are also $nown as schedules to master
*aster b!d0et # )hen all the necessary functional bud"ets have been prepared, the
bud"et o*icer will prepare the master bud"et which may consist of bud"eted proft
and loss account and bud"eted balance sheet. These are in fact the bud"et summaries.
)hen the master bud"et is approved by the board of directors, it represents a
standard for the achievement of which all the departments will wor$.
Q 6 2$st the e$+ht 3#nct$on!/ )#"+ets .re.!re" )y ! )#s$ness%
The various commonly used -unctional bud"ets are(
• ,ales Gud"et
• 'roduction Gud"et
• 'lant Utilisation Gud"et
• 0irect 4aterial Usa"e Gud"et
• 0irect 4aterial 'urchase Gud"et
• 0irect Aabour ('ersonnel) Gud"et
• -actory @verhead Gud"et
• 'roduction Cost Gud"et
Q 7 (h!t "o yo# #n"erst!n" )y the term s!/es )#"+et* =o& $t $s .re.!re"*
,ales forecast is the commencement of bud"etin" and hence sales bud"et assumes
primary importance. The quantity which can be sold may be the principal bud"et
factor in many business underta$in"s. The sales bud"et indicates for each product (1)
the quantity of estimated sales and (2) the expected unit sellin" price. -or estimatin"
the quantity of sales for each product factors li$e bac$lo" of unflled sales orders,
planned advertisin" and promotion, expected industry and "eneral economic
conditions are considered. @nce an estimate of the sales volume is obtained, the
expected sales revenue can be determined by multiplyin" the volume by the expected
unit sales price. The sales bud"et represents the total sales in physical quantities and
values for a future bud"et period.
Q 6 (r$te short notes on the 3o//o&$n+I
(!)C!.$t!/ e-.en"$t#re )#"+et
()) C!sh @#"+et
(a) Ca#ital e8#endit!re b!d0et # The capital expenditure bud"et represents the
planned outlay on fxed assets li$e land, buildin", plant and machinery, etc. durin"
the bud"et period. This bud"et is sub!ect to strict mana"ement control because it
entails lar"e amount of expenditure. The bud"et is prepared to cover a lon" period
of years and it pro!ects the capital costs over the period.
The advanta"es of capital expenditure bud"et are the followin" (
(1) t outlines the capital development pro"ramme and estimated capital
expenditure durin" the bud"et period.
(2) t enables the company to establish a system of priorities. )hen there is a
shorta"e of funds, capital rationin" becomes necessary.
(5) t serves as a tool for controllin" expenditure.
(6) t provides the amount of expenditure to be incorporated in the future
bud"et summaries for calculation of estimated return on capital employed.
(7) This enables the cash bud"et to be completed. )ith other cash commitments
capital expenditure commitment should also be considered for the
completion of the bud"et.
(8) t facilitates cost reduction pro"ramme, particularly when modernisation and
renovation is covered by this bud"et.
(b) Cas2 b!d0et # Cash bud"et represents the cash requirements of the business
durin" the bud"et period. t is the plan of receipts and payments of cash for the
bud"et period, analysed to show the monthly /ow of cash drawn up in such a way
that the balance can be forecasted at re"ular intervals. The cash bud)et is one of
the most important elements of the bud"eted balance sheet. nformation from the
various operatin" bud"ets, such as the sales bud"et, the direct materials purchases
bud"et, and the sellin" and administrative expenses bud"et, a*ects the cash
bud"et. n addition, the capital expenditures bud"et, dividend policies, and plans
for equity or lon"#term debt fnancin" also a*ect the cash bud"et.
Q 7 E-./!$n )r$eCy the conce.t o3 ‘Ce-$)/e )#"+et
@le8ible B!d0et: & /exible bud"et is defned as Sa bud"et which, by reco"ni+in" the
di*erence between fxed, semi#variable and variable cost is desi"ned to chan"e in
relation to the level of activity attainedT. & fxed bud"et, on the other hand is a bud"et
which is desi"ned to remain unchan"ed irrespective of the level of activity actually
attained. n a fxed bud"etary control, bud"ets are prepared for one level of activity
whereas in a /exibility bud"etary control system, a series of bud"ets are prepared one
for the each of a number of alternative production levels or volumes. -lexible bud"ets
represent the amount of expense that is reasonably necessary to achieve each level of
output specifed. n other words, the allowances "iven under /exibility bud"etary
control system serve as standards of what costs should be at each level of output.
Q 4 D$st$n+#$sh )et&een f-e" )#"+et !n" Ce-$)/e )#"+et%
@i8ed B!d0et @le8ible B!d0et
1. t does not chan"e with actual volume of
activity achieved. Thus it is $nown as
ri"id or in/exible bud"et.
t can be recasted on the basis of
activity level to be achieved. Thus it is
not ri"id.
2. t operates on one level of activity and
under one set of conditions. t assumes
that there will be no chan"e in the
prevailin" conditions, which is unrealistic.
t consists of various bud"ets for
di*erent levels of activity.
5. 9ere as all costs li$e # fxed, variable and
semi#variable are related to only one level
of activity. ,o variance analysis does not
"ive useful information.
9ere analysis of variance provides
useful information as each cost is
analysed accordin" to its behaviour.
6. f the bud"eted and actual activity levels
di*er si"nifcantly, then the aspects li$e
cost ascertainment and price fxation do
not "ive a correct picture.
-lexible bud"etin" at di*erent levels
of activity, facilitates the
ascertainment of cost, fxation of
sellin" price and tenderin" of
7. Comparison of actual performance with
bud"eted tar"ets will be meanin"less
specially when there is a di*erence
between the two activity levels.
t provides a meanin"ful basis of
comparison of the actual performance
with the bud"eted tar"ets.