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Cost Accounting
(For : CA - IPCC)
Chapter

Page No.

1-

Basic Concepts

2-15

2-

Cost Sheet

16-26

3-

Reconciliation of Cost & Profit

2730

4-

Integrated & Non Integrated Accounts

3132

5-

Material

33-38

6-

Labour

39-43

7-

Overhead

44-47

8-

Job & Batch Costing

48-49

9-

Contract

49-51

10- Process

52-54

11- Joint & Bye Product

54-56

12- Inter Firm / Uniform Costing

57-59

13- Marginal Costing

60-61

14- Standard Costing

62-63

15- Budgetary Control

64-67

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Chapter: Basic Concepts


Cost - Cost represents the amount of expenditure (actual or notional) incurred on or attributable to a given thing. It
represents the resources that have been or must be sacrificed to attain a particular objective.
Pre-determined cost - It is the cost which is computed in advance, before the production starts, on the basis
of specification of all the factors affecting the cost.
Standard cost - It is a pre-determined cost which is arrived at, assuming a particular level of efficiency in
utilisation of material, labour and other indirect services. It is the planned cost of a product and is expected
to be achieved under a particular production process under normal conditions. It is often used as a basis for
price fixing and cost control.
Estimated Cost - It is an approximate assessment of what the cost will be. It is based on past data adjusted
to anticipated future changes.
Cost Accountancy
The Institute of Cost and Management Accountants of England defines Cost Accountancy as follows:
"The application of costing and cost accounting principles, methods and techniques to the science, art
and practice of cost control and the ascertainment of profitability. It includes the presentation of
information, derived therefrom for the purpose of managerial decision making."
Thus cost accountancy is a very comprehensive term.
Cost Accounting:
Cost accounting is accounting for cost, aimed at providing cost data, statements and reports for the purpose of
managerial decision making. Cost Accounting is the application of costing and cost accounting principles, methods
and techniques to the science, art and practice of cost control and ascertainment of profitability. It includes the
presentation of information derived there from for the purpose of managerial decision-making.
The term costing and cost accounting are many times used interchangeably. However, the scope of cost accounting
is broader than that of costing which merely focuses on cost ascertainment. Following functional activities are
included in the scope of cost accounting:
1.

Cost Book- keeping : It involves maintaining complete record of all costs incurred from their incurrence to their
charge to departments, products and services.

2.

Cost System : Systems and procedures are devised for proper accounting for costs.

3.

Cost Analysis : It involves an investigation into the causes of actual costs varying from the planned costs and fixation
of responsibility for cost increases.

4.

Cost Comparisons : Cost accounting also includes comparisons between cost from alternative technologies, cost of
different products and activities, and cost of same product or service over a period of time.

5.

Cost Control : An important function of cost accounting is utilization of cost information for exercising control. This
involves an examination of each cost in the light of benefit derived from incurrence of the cost.

Importance and Advantages of Cost Accounting


The primary advantages of Cost Accounting System are as under:
(a)

Profit Measurement and Analysis: Costs should be accurately ascertained and matched with revenues to measure
profits of a firm. Further, Cost Accounting is useful for identifying the exact causes for decrease or increase in the
profit / loss of the business.

(b)

Cost Reduction: The application of cost reduction techniques, operations research techniques and value analysis
techniques , helps in achieving the objective of economy in concerns operations. Continuous efforts are being made
by the business organization for finding new and improved methods for reducing costs

(c)

Cost Comparison and Cost Control: Cost comparison helps in cost control. Such a comparison may be made from
period to period by using the figures in respect of the same firm or of several units in an industry by employing
uniform costing and inter- firm comparison methods.

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(d)

Identification of losses and inefficiencies: A good Cost Accounting System helps in identifying unprofitable
activities, losses or inefficiencies in any form, so that appropriate actions are taken. The use of Standard Costing and
Variance Analysis techniques points out the deviations from pre- determined level and thus demands suitable action to
eliminate its recurrence. The cost of idle capacity can be easily worked out, when a concern is not working to full
capacity,

(e)

Financial Decision Making: Managers can obtain relevant information from the Cost Accounting System, to serve
as guides in making decisions involving financial considerations. Guidance may also be given by the Cost Accountant
on various decision making issues viz. whether to purchase or manufacture a given component, whether to accept
orders below cost, which machine to purchase when a number of choices are available. The use of Marginal Costing
techniques helps managers in taking short-term decisions.

(f)

Price Determination: Cost Accounting is quite useful for price fixation. It serves as guide to test the adequacy of
selling prices. The price determined may be useful for preparing estimates or filing tenders.

(g)

Dispute and Issue-solving: A good cost accounting system provides cost figures for the use of Government, Wage
Tribunals and other bodies for dealing and solving issues like price taxation, price control tariff protection, wage level
fixation.

Limitation of Cost Accounting


(1)

Cost accounting prepares cost records and reports in different depths, detail and form. Even assumptions made
regarding lacks uniformity. Different organizations various costs differ.

(2)

There is arbitrariness in apportionment of overheads, allocation controllable and non- controllable, determination of
joint costs, division of costs between of overhead absorption rates.

(3)

Cost accounts are prepared in addition to financial accounts. There are. number of costs, e.g. notional costs and
decision making costs which do not appear in financial accounts. This necessitates reconciliation of financial profits
and cost profit.

(4)

Cost accounting is only one of the means of achieving cost control, efficiency improvement and motivation. It does
not by itself achieve these objectives.

(5)

Cost accounting has only a limited use in projecting future costs. It needs to be supplemented by various statistical
tools.

List the objectives of Cost Accounting.


The primary objective of study of cost is to contribute to profitability through Cost Reduction and Cost Control. The following
objectives of Cost Accounting can be identified:
(1)

Ascertainment of cost: This involves collection of cost information, by recording them under suitable heads of
account and reporting such information on a periodical basis.

(2)

Determination of selling price: Selling Prices are influenced by a no of factors. However, prices cannot be fixed
below cost, save in exceptional circumstances. Hence cost accounting is required for determination of proper selling
price.

(3)

Cost Control and Cost Reduction: In the long run, higher profits can be achieved only through Cost Reduction and
cost Control. These terms are discussed in detail ion a separate Chapter.

(4)

Ascertaining the profit of each activity: Profit of each department/ activity / product can be determined by
comparing its revenue on an objective basis.

(5)

Assisting management in decision-making: Business decisions are taken after conducting Cost- Benefit Analysis.
Hence cost and benefits of each option are analyzed and the Manager chooses the least cost option. Thus Cost
Accounting and reporting system assists managers in their decision making process.

The essential features of a good cost Accounting system


To be successful, a good Cost Accounting System should possess the following essential features.
(a)

Simple and easy to operate: The system should be tailor-made, practical, simple and capable of meeting the
requirement of a business concern.

(b)

Accuracy of data: The data to be used by Cost Accounting System should be accurate. Otherwise it may distort the
output of the system

(c)

Relevance of data: The system should handle and report relevant data for use of managers for decision making. It
should not sacrifice its utility by introducing meticulous and unnecessary, details

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(d)

Managements Role: The top Management should have a faith in the costing system and should also provide a
helping hand for its development and success.

(e)

Participative Role of executives: Necessary cooperation and participation of executives from various departments
of the concern is essential for developing a good system of cost Accounting.

(f)

Cost-effective: The cost of installing and operating the system should justify the results. The benefits from the
system should exceed the amount to be spent on it.

(g)

Smooth implementation: The system should be effectively implemented. A carefully phased programme should be
prepared by using network analysts for the Introduction of the system.

Eight factors that you will consider before installing a costing system.
The eight factors which must be considered before installing a Costing System are listed below:
(1)

Nature of business: The system of costing to be introduced should suit the general nature of business.

(2)

Layout aspects: The size and layout of the organization should be studied by the system designers.

(3)

Methods and procedures in vogue: The system designers should also study various methods and procedures for the
purchase, receipts, storage and issue of material. They should also study the methods of wage payment.

(4)

Managements expectations and policies: The system of costing should be designed after a careful analysis of the
organizational operations, managements expectation and the policies of the concern.

(5)

Technical aspects: The technical aspects of the business should be studied thoroughly by the designers. They should
also make an attempt to seek the assistance and support of the supervisory staff and workers of the concern for the
system.

(6)

Simplicity of the system: The system of costing to be installed should be easy to understand and simple to operate.
The procedures laid down for operating the system should be easily understood by operating system.

(7)

Forms standardization: Various forms to be used by the costing system for various data/ information collection and
dissemination should be standardized as far as possible.

(8)

Accuracy of data: The degree of accuracy of data to be supplied by the system should be determined.

Steps involved in installing a costing system in a manufacturing unit. What are the essentials of an effective costing
system
The main steps involved in installing a costing system in a manufacturing unit may be outlined as below:
(1)

The objectives of installing a costing system in a manufacturing concern and the expectation of the management from
such a system should be identified first. The system will be a simple one in the case of a single objective but will be
an elaborate one in the case of multiple objectives.

(2)

It is important to ascertain the significant variables of the manufacturing unit which are amenable to control and affect
the concern. For example, quite often the production C3sts control may be more important than control of its
marketing cost.. Under such a situation, the costing system should devote greater attention to control production costs.

Pre- requisites for installation of Cost Accounting System.


A cost accounting system is a set of plans, programmes, procedures and documentation designed to accumulate costs,
assign them to products, processes and jobs, and report cost information to management at all levels. It assists
management in planning, control, performance appraisal, analysis of product profitability and optimum utilization of
physical and financial resources for achieving organizational objectives.
The following considerations should be specifically taken into account:
1.

Design in suit specific needs The system should be designed as to serve the specific needs of the organization.

2.

In depth examination of production details: Before installing the system, management should make an, in-depth
study of nature of products and processes, technologies, plant layout, nature of material used, so that cost accounting
system is tuned to the requirements of the business,

3.

Cost Benefit analysis: The benefit from the proposed cost accounting system should far exceed the cost involved.
The best system, if cost benefit, becomes useless.

4.

Location of cost office: Costing department obtains basic data mainly from accounts department. Most of this data is
related to production activity.

5.

Codification: All costs relating to all products of all departments should preferably be coded. This will increase speed
in handling and processing of costs. Codification also facilitates computerization of costing system.

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6.

Continuous Monitoring: Operation of cost accounting system should be continuously monitored so that deficiencies
do not creep in, methodical work is not replaced by short- cuts, and the system is always kept up-to-date.

Cost Control and Cost Reduction:


Cost Control and Cost Reduction are two different concepts.
Cost Control aims at maintaining the costs in accordance with established standards. It involves the following
steps a.

Determination of target cost

b.

Measurement of actual cost

c.

Analysis of variation with respect to target cost

d.

Initiation of corrective action.

Cost Reduction on the other hand aims at improvement established targets. It is defined as "the
achievement of real and permanent reduction in the unit cost of goods manufactured or services
rendered without impairing their suitability for the use intended or diminution in the quality of the
product."
The difference between Cost Cost Control and Cost Reduction can be summarized as under:
Cost Control
1. It represents efforts made ds towards achieving a
target or a goal.
2. The process of cost control is to Set-up a target,
investigate the variations and take remedial action.
3. It assumes existence of norms or Standards which
are not challenged.
4. It is preventive function.
5. Sometimes, it lacks a dynamic approach.

Cost Reduction
1. It represents achievement of reduction of cost .
2. Cost reduction is not contended merely with the
maintenance of performance with standards.
3. It assumes that the standards can be improved.
4. It is a corrective function.
5. It is continuous process of analysis of all the
factors affecting cost.

Difficulties in Installing Cost accounting System


1.

Lack of enthusiasm and support from top management because they are not fully convinced about the benefits from
such system.

2.

resistance from production staff and people at different levels in other departments because they fear getting subjected
to additional controls.

3.

Resistance from accounting staff as they believe that their work would increase.

4.

Shortage of trained and well- qualified staff.

5.

Over enthusiasm to have an unnecessary detailed costing structure or keeping it too simple due to too much concern
for cost.

6.

High cost of installing the system.

7.

Failing to keep the system up-to-date,

Cost Accounting And Financial Accounting :


Financial Accounting is concerned with the preparation of financial statements, which summarise the results of operations for a
selected period of time and show the financial position of the organisation as at a particular date. It helps to assess the overall
progress of an organisation, its strength and weakness. It facilitates effective control over the assets of the organisation.
However, there are serious limitations of financial accountancy from the point of view of the management. It is on account of
these limitations that "Costs Accounting" has been developed for the purpose of management control and internal reporting.
The limitations of financial accounting together with procedures that over come the limitations are given below:

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1.
2.
3.

Limitations of Financial Accounting


Overcome By Cost Accounting
Forecasting and Planning
Financial accounts cannot provide information required for future Budget technique of cost accounting overcomes this
planning.
hurdle.
Decision-making
Day-to-day decision making like The technique of marginal costing overcomes the
Which product mix is the most profitable ?
decision-making limitation. The management can make
When to shut down the activity ?
accurate decisions by analysis of the cost incurred / to be
When will the break-even point be achieved?
incurred.
Cannot be facilitated by financial accounting.

Control and Assessment


Financial accounting does not provide management with the The techniques of budgeting and standard costing enable
information required to assess the performance of various
management to perform this function.
departments / persons.
Thus the important limitations of financial accountancy namely, lack of analysis of data and absence of yardsticks is very well
overcome by cost accountancy.
Cost Accounting and Management Accounting :
The scope of management accounting is broader than that of cost accounting. In cost accounting, the main emphasis is on cost
and it deals with its collection, analysis, relevance, interpretation and presentation for various problems of the management.
Management accountancy utilizes the principles and practices of financial accounting in addition to other modern management
techniques for efficient operation of the organisation. The main emphasis in management accountancy is towards determining
policy and formulating plans to achieve the desired objective of the management.
Management accountancy has been defined by CIMA as under :
"An internal part of concerned with identifying, presenting and interpreting information used for:
a.
Formulating strategy
b.
Planning and controlling activities
c.
Decision making
d.
Optimising the use of resources
e.
Disclosure to shareholders and others external to the entity
f.
Disclosure to employees
g.
Safeguarding assets".
Cost Classifications
On the basis of Time Period
On the basis of Time Period: Costs are classified into:
(1)

Historical Costs- Costs relating to the past time period: Cost which has already been incurred.

(2)

Current Costs- Costs relating to the present period.

(3)

Pre determined Costs- Costs relating to the future period; Cost which is computed in advance, on the basis of
specification of all factors affecting it.

On the basis of Behavior/ Nature/ Variability


On the basis of Behavior/ Nature/ Variability: Costs are classified into:
(1)

Variable Costs- These are costs which tend to vary or change in relation to volume of production. They increase in
total as production increases and vice-versa e.g. cost of raw materials, direct wages etc. However, variable costs per
unit are generally constant for unit of the additional output.

(2)

Fixed Costs- these are costs which remain constant at various levels of production. They are not affected by volume
of production e.g. factory rent, Insurance etc. Fixed Costs per unit decreases and vice- versa. Sometimes, these are
also known as Capacity Costs or Period Costs.

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(3)

Semi- Variable Costs- These are costs which are partly fixed and party variable. These are fixed upto a particular
volume of production and become variable therefore for the 1 next level of production. Hence, they are also called
Step Costs. Some examples are Repairs and Maintenance, Electricity, Telephone etc.

On the basis of Elements


On the basis of elements: Costs are classified into:
(1)

Materials- Cost of tangible, physical input used in relation to output/ production: e.g., costs of raw materials,
consumable stores, maintenance items etc.

(2)

Labour- Cost incurred in relation to human resources of the enterprise; e.g, wages to workers, Salary to Office Staff,
Training Expenses etc.

(3)

Expenses- Cost of operating and running the enterprise, other than materials and labour; this is the residual category of
costs, E.g, Factory Rent, Office Maintenance, Salesman Salary etc.

On the basis of Relationships


On the basis of Relationship : Costs are classified into:
(1)

Direct costs- Costs which are directly related to / identified with / attributable to a Cost Center or a Cost unit. E.g.
Cost of basic raw material used in the finished product, wages paid to site labour in a construction contract etc

(2)

In direct Costs- Costs which are not directly identified with a cost centre or a cost unit. Such costs are apportioned
over different cost centers using appropriate basis e.g, Factory Rent incurred over various departments; Salary of
supervisors engaged in overseeing various construction contracts etc.

On the basis of Controllability


On the basis of Controllability: Costs are classified into:
(1)

Controllable Costs- Costs which can be influenced and controlled by managerial action. However, Controllability is
a relative term and is subject to the following factors.

a.

Time- Certain costs are controllable in the long run and not in the short run.

b.

Location- certain costs are not influenced and decided at a particular location / cost center. If rent agreements of all
factory premises are executed centrally at the head Office, factory Managers cannot control the incurrence of cost.

c.

Product Output- Certain costs are controllable by reference to one product or market segment and not by reference to
the other. For example, cost of common raw material input for exports is lower than that of domestically sold goods
since excise duty concession / duty drawback is available for export sales.

(2)

Non - Controllable Costs-* These are costs that cannot be influenced and controlled by a specific member of the
organization. The line of difference between controllable and non- controllable costs is thin.

NOTE: No cost is uncontrollable. Controllability is subject to the factors laid down above.
On the basis of Normality
On the basis of Normality: Costs are classified into:
(1)

Normal Cost: Costs which can be reasonably expected to be incurred under normal, routine and regular operating
conditions.

(2)

Abnormal Cost: Costs over and above normal cost; which is not incurred under normal operating conditions e.g,
fines and penalties.

On the basis of Functions.


On the basis of Functions: Costs are classified as under;
(1)

Production Cost: The cost of the set of operations commencing with supply of materials, labour and services and
ends with the primary packing of product. Thus it is equal to the total of Direct Materials, Direct labour, Direct
Expenses and Production Overheads.

(2)

Administration Cost: The cost of formulating the policy, directing the organization and controlling the operations of
the undertaking, which is not directly related to production, selling, distribution, research or development activity or
function. Some examples are Office rent, Accounts Department Expenses, Audit and Legal expenses, Directors
Remuneration etc.

(3)

Selling Costs; The cost of seeking to create and stimulate demand and of securing orders. These are sometimes called
marketing costs. Some examples are Advertisement, Salesmen remuneration, Show-room Expenses, Cost of samples
etc.

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(4)

Distribution Cost: The cost of the sequence of operations which begins with making the packed product available for
dispatch and ends with making the reconditioned returned empty package, if any, available for re- use. Some
examples are Distribution packing (secondary packing), carriage outwards, maintenance of delivery vans, expenditure
incurred in transporting articles to central or local storage, expenditure incurred in moving articles to and from
prospective customers(as in sale or Return) etc.

(5)

Research Cost: The cost of the process which begins with the implementation of the decision to produce a hew or
improved products, new application of materials or improved methods.

(6)

Development Cost: The cost of the process which begins with the implementation of the decision to produce a new or
improved product, or to employ a new or improved method and ends with commencement of formal production of
that product of by that method.

(7)

Pre production Cost; The part of development cost incurred in making a trial production run prior to formal
production.

(8)

Conversion Cost: The sum of direct wages, direct expenses and overhead cost of convening raw materials to the
finished stage or converting a material from one stage of production to the other.

Period Costs and Product Costs.


On the basis of atributability to the Product: Costs are classified into:
(1)
Period Costs: These are costs which are not assigned to the products but arc charged as expenses against the revenue
of the period in which they are incurred. Non - manufacturing costs e.g. Selling and Distribution Costs are generally
recognized as expenses against the revenue of the period in which they are incurred. Non- manufacturing costs. These
costs are not included in inventory : valuation.
(2)

Product Costs: These are costs which are assigned to the product and are included in inventory valuation. These are
also called as Inventorable costs. Under absorption costing, total manufacturing costs are regarded product costs under
marginal costing, total manufacturing costs are regarded product costs while under marginal costing, only variable
manufacturing costs are considered. The purposes of computing product costs are as under:

a.

Preparation of Financial Statements- Focus on inventory valuation and reporting profits.

b.

Product Pricing- Focus on costs assigned and incurred on the product till it is made available to the customer/ user.

c.

Cost- plus- Contracts with Government Agencies- Focus is on reimbursement of costs specifically assigned to the
particular job / contract.

On the basis of relevance to decision making (Decision- Making Cost).


On the basis of Relevance to decision making: Costs are classified into:
(a)

Relevant Costs viz. Marginal Costs, Differential Costs, Opportunity Costs etc.

(b)

Irrelevant Costs viz. Absorbed fixed Costs, Sunk Costs, Committed Costs etc.

(A)

Relevant Costs: These are costs which are relevant and useful for decision-making purpose.

(1)

Marginal Cost- Marginal cost is the total variable cost i.e. prime cost plus variable overheads. It is assumed that
variable cost varies directly with production whereas fixed cost remains fixed irrespective of volume of production.
Marginal cost is a relevant cost for decision- making as this cost will be incurred in future for additional units of
production.

(2)

Differential Cost- It is the change in costs due to change in the level of activity or pattern or method of production.
Where, the change results in increase in cost it is called incremental cost, whereas if costs are reduced due to decrease
of output, the difference is called decremented costs.

(3)

Opportunity Cost- This refers to the value of sacrifice made or benefit of opportunity foregone in accepting an
alternative course of action, For example, a firm may finance its expansion plan by withdrawing money from its bank
deposits. In such a case the loss of interest on the bank deposit is the opportunity cost for carrying out the expansion
plan. Opportunity cost is a relevant cost where alternatives are available. However, opportunity cost does not find any
place in formal accounts and is computed only for decision making and analytical purposes,

(4)

Out- of- pocket Costs- These are costs which entail current or near future outlays of cash for the decision at hand as
opposed to costs which do not require any cash outlay such as depreciation. Such costs are relevant for decisionmaking, as these will occur in near future. It is that portion of total cost which involves cash outflow. This cost
concept is a short- run concept and is used in decisions relating to fixation of selling price in recession, make or buy,
etc. Out of pocket costs can be avoided or saved if a particular proposal under consideration is not accepted,

(5)

Replacement Cost- It is the cost at which there could be purchase of an asset or material identical to that which is
being replaced or revalued. It is the cost of replacement at current market price and is relevant for decision- making.

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(6)

Imputed Costs- These are notional costs appearing in the cost accounts only e.g, notional rent charges, interest on
capital for which no interest has been paid. Where alternative capital investment projects are being evaluated, it is
necessary to consider the imputed interest on capital before a decision is arrived at, as to which is the most profitable
project.

(7)

Discretionary costs- These are escapable or avoidable costs. These can be avoided if a particular course of action
is not chosen. In other words, these are costs, which are essential for the accomplishment of a managerial objective.

(B)

Irrelevant Costs: These are costs which are not relevant for decision-making.

(1)

Sunk Cost- It is a cost which has already been incurred or sunk in the past. It is not relevant for decision- making and
is caused by complete abandonment as against temporary shut- down. Thus, if a firm has obsolete stock of materials
amounting to Rs. 10,000 which can be sold as scrap for Rs. 2,000 or can be, utilized in a special job, the value of
opening stock of Rs. 10,000 is a sunk cost and is not relevant for decision- making.

(2)

Committed Cost- A cost which has been already committed by the management is not relevant for decision- making.
This should be contrasted with discretionary costs, which are avoidable costs.

(3)

Absorbed Fixed Cost- Fixed costs which do not change due to increase or decrease in activity is irrelevant for
decision- making. Although such fixed costs are absorbed in cost of production at a normal rate, they are irrelevant for
managerial decision making. However if fixed costs are specific, they become relevant.

Short notes on Explicit and Implicit Costs.


(a)

Explicit Costs- These are also known as out of pocket costs they refer to costs involving / immediate payment of
cash. Salaries, wages, postage and telegram, printing and stationary, interest on loan etc. are some examples of
explicit cost involving immediate cash payment.

(b)

Implicit Costs- These costs do not involve any immediate cash payment. They are not recorded in the books of
account. They are also known as economic costs or imputed costs.

Define the terms (a) Estimated Costs, (b) Shut Down Costs and (c) Absolute Costs.
(a)

Estimated Cost- Kohler defines estimated cost as the expected cost of manufacture or acquisition, often in terms of
a unit of product computed on the basis on information available in advance of actual production or purchase.
Estimated costs are prospective costs they refer to prediction of costs.

(b)

Shut down costs- These are costs which continue to be incurred even when a plant is temporarily shut down, e.g. rent,
rates, depreciation, etc. These costs cannot be eliminated with the closure of the plant. In other words, all fixed costs
which cannot be avoided during the temporary closure of a plant will be known as shut down costs.

(c)

Absolute cost- These costs refer to the cost of any product, process or unit in its totality. When costs are presented in
a statement form, various cost components may be shown in absolute amount or as a percentage of total cost or as per
unit cost or all together. Here the costs depicted in absolute in absolute amount may be called absolute costs and are
base costs on which further analysis and decisions are based.

Write Short notes on Direct Expenses or Chargeable Expenses


These are the Expenses which can be charged directly to Jobs, Product, Processes, Cost Units. These are also known
as Direct Expenses. Depending on the Situation, the same item of expenses may be treated as a chargeable Expenses
or an indirect Cost.
For example, the rent charges of a machine specifically hired to complete a particular job will be a direct charge on
the job. But if the same machine is used for various purposes, then the rent charges will be treated as indirect cost and
are apportioned to concerned cost centers on an equitable basis.
Nature of Direct Expenses
(1)

These are expenses other than Direct materials and Direct Labour

(2)

These are either allocated or charged completely to cost centers or cost units.

(3)

These are included in the prime Cost of a Product.

Examples
(1)

Hire charges in respect of special machinery or plant.

(2)

Cost of special Moulds, design and Patterns,

(3)

Payment of royalties

(4)

Architects, Surveyors and other consultants fees.

(5)

Traveling expenses to site.

(6)

Freight inward on special material.

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Direct Costs are sub-classified on the basis of elements into Materials, Labour and Expenses.

Indirect Costs (Overheads) are sub-classified on the basis of functions.

Cost Period
The period to which the Cost relates is called Cost Period. It is also called the control period since cost ascertainment is
for the purpose of control. Generally, the cost period is shorter than the financial period used for reporting purposes.
For example, if the production process for converting raw material into finished product requires 15 days, it may be
considered as a Cost Period.
Cost Unit. Give suitable illustrations.
Cost Unit: It is a unit of production, service or time or combination of these, in relation to which costs may be
ascertained or expressed. It should be one with which expenditure can be most readily associated.
An appropriate cost unit should be selected keeping in view the following:
1.

Cost units should suit the business.

2.

It should be most natural to the business.

3.

Cost unit should be readily understood and accepted by all concerned.

4.

Cost unit should be uniformly maintained over a period of time and should be same

or similar products.

Cost Units differ from one business to the other. They are usually units of physical measurement like number, weight,
area, volume, time, length and value. Some illustrations of cost units are as under:
Examples of cost Units and Methods of Costing in Various industries
Industry

Cost Unit

Methods of costing

Bricks

Per 1,000 bricks

Unit costing

Cement

Per ton

Process costing

Road construction

Per k.m or per mile

Job costing

Advertising

Each job

Job

Interior decoration

Each job

Job

Made to order

Number

Job costing

Readymade

Number

Batch costing

Tyres and tubes batch

Each

Batch costing

Toy

Each batch

Batch costing

Pharmaceuticals

1000 Nos., tablets, strips, capsules

Batch costing

Water supply

Per 1000 litre

Operating costing

Bus service

Passenger-kilometer

Operating costing

Education

Per student hour

Operating costing

Electricity

Per kilowatt-hour

Operating costing

Hotel

Per guest per day or per guest per meal etc.

Operating costing

Bridge construction

Each contract

Contract costing

Ship building

Each ship

Contract costing

Mining

Per ton

Process costing

Petrochemicals

Tons, gallons litres

Process costing

Steel

Per ton

Process costing

Textiles

Per meter

Process costing

Sugar

Per tonne

Process costing

Paper

Per kg/tonne

Process costing

Chemical

Per kg/litre/tonne

Process costing

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Fertilizer

Per tonne

Process costing

Oil refinery

Per gallon

Process costing

Automobile

Number

Process costing

Colliery

Per tonne

Output

Bicycle manufacturing

Number

Multiple costing

Examples - A few typical examples of cost units are given below :


Industry

Cost Unit Basis

Automobile

Number

Bicycle

Number

Transport

Tonne-kilometer or

Furniture

Each article

Bridge construction

Each contract

Interior decoration

Each job

Advertising

Each job

Nursing home

Bed or day

Power

Kilowatt hour

Bricks

Number

Cement

Tonne, bag

Steel

Tonne

Chemical

Litre, gallon, tonne,kilogram

Sugar
Coal

Tonne
Tonne

Passenger-kilometer

Responsibility Centre? What are its types?


Meaning:

It is an activity centre of a business organization entrusted with a special task.

It is a unit of function of a business organization headed by an executive responsible for its performance:

Types of Responsibilities Centres


Particulars

Cost Centres

Meaning

A centre for which a


standard amount of cost
is pre-determined and
used for control.

Primary
responsibility
Performance
evaluation

Cost reduction
and cost control
Standard cost less
actual cost

Other points

Control of cost is
subject to1, Time
2. Location
3. Product

Revenue
Centres
A centre devoted
to raising revenue
(no responsibility
for production)

Generation of sale
revenue
Budgeted revenue
less actual
revenue
Also responsible for
some
expenses
related with marketing of products.

11

Profit Centres
A centre whose
performance
is
measured in terms
of income earned
and cost incurred
(profit earning)
Profit earning
Budgeted profits
less actual profits
It may mean that one
division sells its
output to another
division within the
organization

i.e.inter-divisional

Investment
Centres
A centre responsible for
earning profits and also
for asset utilization.

Earning return of
Investments.
Budgeted ROI
less actual ROI

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transfer pricing.
Short note on Cost Centre? Discuss the various types of Cost Centres.
Cost Centre:
A cost centre refers to a section, segment or subdivision of an organization of which costs are charged. A cost centre
is location, person or its of equipment (or group of these) for which costs may be ascertained and used for the
purpose of control. For example a cost centre may be
(i)

Allocation e.g., departments sales territories etc.

(ii)

A person e.g., engineers salesmen, machine operators, etc.

(iii)

An item of equipment, e.g., machines delivery vans, etc. Classification: Cost Centres can be classified as under:

(a) Based on Type:


Personal Cost Centre

Impersonal cost Centre

It consists of a person or group of persons.

it consists of a location or an item of equipment (or


group of these)

(b) Based on Role:


Personal Cost Centre
It is a cost centre where raw material is processed and
converted into finished product
Here both direct and indirect costs are incurred

Machine shops, welding shops and assembly shops


are examples of production Cost Centres,

Service cost Centre


It is a cost centre which serves as an ancillary unit and
renders services to a production cost centre.
Here only indirect costs are incurred. There are no
direct costs as there is no measurable and saleable
output.
Power-house, gas production shop, material service
centres, plant maintenance centres are examples of
since cost centres.

(c) Based on Activity:


Operational Cost Centre

Process cost Centre

It consists of machines and / or persons, carrying our


similar operations.

It consists of machines and / or persons, engaged on


a specific process or a continuous sequence of
operation.

All machines/operators performing the same operation are


brought together under a Cost Centre, the purpose being
ascertainment of cost of each operation irrespective of its
location inside the factory.

Cost is analysed and related to. a series of


operations in sequence. Generally, these constitute a
single location, as in oil refineries and other process
industries

Write short notes on the various methods of costing. Or Discuss the different Methods of costing along with their
applicability to concerned Industry?
Business vary in their nature and in the type of products or services they produce. Hence different methods of cost
ascertainment are used in different business. The output has to be costed, so that costing methods to be employed are
also determined with due regard to the method of production and the unit of cost used. The various methods of costing
can be summarized as under:

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COSTS

Materials

Direct

Labour

Indirect

Direct

Expenses

Indirect

Direct

Indirect

Overheads

Prime Cost

Job Costing: Under this method, the cost of each job is ascertained separately. It implies that the direct cost of each job is
traceable and identifiable. It is suitable in all cases where work is undertaken on receiving a customers order / assignment,
Some examples are; printing press, motor workshop etc.
Batch Costing: It is an extension of job costing. It is used where the output under a particular work order consists of similar
units. . It may not be economically feasible to ascertain cost per unit. Hence a collection or lot of units called a batch is taken
for cost ascertainment purposes. Each batch is treated as a unit of cost, and thus separately costed. Here cost per unit is
determined by dividing the cost of the batch by the number of units produced in the batch. Examples: Pharmaceuticals,
Production of component parts like cycle rims, TV monitor screens etc. in bulk for subsequent assembly.
Contract Costing- A larger job is called a contract. Generally, execution of work is distributed over two or more financial
years. Hence) the cost of each contract is ascertained separately. It is suitable for firms engaged in the construction of bridges,
roads, buildings etc.
Single or Output Costing - Cost is ascertained for a product, the product being the only one produced like bricks, coals, etc.
Process Costing and Operation Costing- The cost of completing each stage of work is ascertained, like cost of making pulp
and cost of making paper from pulp. In mechanical operations, the cost of each operation may be ascertained separately; the
name given is operation costing.
Operating or Service Costing: Ascertainment of cost of rendering or operating a service is called Service Costing or
Operating Costing. It is used in the case of concerns rendering services like transport, cinema, hotels, etc., where there is no
identifiable tangible cost unit
Multiple Costing- It represents a combination of two or more methods of costing outlined above. For example, if a firm
manufactures bicycles including its components; the parts will be costed by batch costing system but the cost of assembling the
bicycle will be computed by the Single or output costing method. This whole system of costing is known as multiple costing.
The following table summarises the various methods of costing applied in different industries
Nature of Output
Method
Cost Ascertainment
Examples of Industries
Customer
Job Costing
For each order/
Automobile workshop/
Specifications: Single
assignment/ job
Interior Decoration
Unit
Number of similar units
Batch Costing
For each batch/ lot of
Printing Press- for
units produced
Cards, invitations etc/
Pharmaceuticals,
Execution of work
Contract Costing
For each contract
Civil Construction/ Ship
building

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Similar units of a single


product produced by:
Single process
A Series of processes

Unit or Output or
single costing

Consisting of multiple
varieties of activities
and process
Rendering of Services

Multiple costing

Process Costing or
Operation Costing

Operating Costing

For the entire


activity, but averaged
for the output
For each process or
operation
Combination of any
of the methods listed
above.
For every type of
Service

Quarries, Brickworks,
Colliery, Paints etc,
Oil Refining,
Breweries, Chemicals
etc.
Bicycle Assembly

Transport, Hotels,
Cinema

What do you mean by Techniques of Costing.


In addition to the above methods of costing there are certain techniques of costing which are used along with any of the above
method. These techniques serve the special purpose of managerial control and policy. Some of the important techniques are as
follows:
1.

Standard Costing

It is a valuable technique of cost control

2.

Budgetary Control

It is also a technique that is used to control costs.

3.

Marginal Costing

It is a special technique to help the


management in decision-making and profit planning. In this technique, only
variable costs are charged to products and fixed costs are treated as period
costs and transferred to P & L A/c.

4.

Absorption Costing

5.

Uniform costing

As against marginal costing in this technique total


cost, i.e. fixed and variable is charged to products.
It is a system whereby several undertaking uses the
same costing principles and practices so as to make cost data comparable.

Types of cost ascertainment


For ascertaining cost, following types of costing are usually used:
(1)

Uniform Costing: When a number of firms in an industry agree among themselves to follow the same system of
costing, by adopting common technology for various items and processes they are said to follow a system of uniform
costing. Such a system of cost ascertainment facilitate s inter-firm comparison, determination of true costs of the
industry.

(2)

Marginal Costing: It is defined as the ascertainment of marginal cost by differentiating between fixed and variable
costs. It is used to ascertain effect of changes in volume or type of output on profit. It is a tool of decision-making on
various management issues, Under this method, stocks are valued at variable cost. Fixed Costs are treated as Period
Costs and are not included in Stock Valuation.

(3)

Absorption Costing: It is the practice of charging all costs, both variable and fixed to operations, processes or
products. Stocks are valued at total cost, inclusive of proportionate amount of fixed cost. This differs from marginal
costing where fixed costs are excluded.

(4)

Direct Costing: It is the practice of charging all direct costs to operations, processes or products leaving al! indirect
costs to be written off against profits in which they arise. It may be distinguished from Marginal Costing, where only
variable costs are identified with products.

(5)

Standard Costing: It is the name given to the technique whereby actual costs are compared with already set
standards. It is thus a technique of both cost ascertainment and cost control. This technique may be used along with
any method of costing. It is especially suitable where the manufacturing method involves production of standardized
goods of repetitive nature,

(6)

Historical Costing: It is the ascertainment of costs after they have been incurred. This type of costing has limited
utility.

Difference between Cost estimation and Cost ascertainment.


Cost estimation: Cost estimation is the process of predetermining the cost of the certain product or Job. This
predetermination of cost is based upon budgetary control, standard costing and variance analysis. Cost estimation is
made to take the decision regarding buy/make or to fix the sale price of the product etc.
Cost ascertainment: Cost ascertainment is the process of determining the cost on the basis of actual data. Hence,

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computation of historical cost is called Cost ascertainment. Cost estimation and ascertainment are interrelated and
very important to-the management to have a sound costing system, The ascertainment of cost greatly helps in cost
estimation of future period.
The term cost centre is defined as a location, person.or an item of equipment or a group of these for which costs may
be ascertained and used for the purposes of cost control. Cost centres can be personal cost centres, operation cost
centres and process cost centres.
Distinction between Cost Unit and Cost Centre
The term Cost Unit is defined as a unit of quality of product, service or time (or a combination of these) in relation to
which costs may be ascertained or expressed, It can be for a job, batch, or product group.
Cost Unit The term cost unit is defined as a unit of product, service or time (or a combination of these) in relation to which
costs may be ascertained or expressed. It can be for a job, batch, or product group.
Industry

Method of costing

Unit of cost

(1) Nursing Home

Operating

Per Bed per week or per day

(2) Road transport

Operating

Per Tonne Kilometer or per mile

(3) Steel

Process

Per Tonne

(4) Coal

Single

Per Unit

(5) Bicycles

Multiple

Each Unit

(6) Bridge

Construction Contract

Each contract

(7) Interior Decoration

Job

Each Job

(8) Advertising

Job

Each Job

(9) Furniture

Multiple

Each unit

(10) Sugar company

Process

Per Quintal / Ton

having its own sugar-cane fields


The term Cost Centre is defined as a location, person or an item of equipment or a group of these for which costs may be
ascertained and used for th0 purposes of Cost Control. Cost Centers can be personal Cost Centers, impersonal Cost Centers,
operation cost and process Cost Centers.
Thus each sub-unit of an organization is Known as a Cost Centre, if cost can be ascertained for it. In 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.
Distinction between Cost Centre and Profit Centre
A Cost Centre is the smallest segment of activity or the area of responsibility for which costs are accumulated. A
Profit Centre is that segment of activity of a business which is responsible for both revenue and expenses and
discloses the profit of a particular segment of activity.
Important points of distinction between Cost Centre and Profit Centre are as below:
(a)

Cost Centers are created for accounting convenience of costs and their control where a profit centre is created because
of decentralization of operations.

(b)

A Cost Centre does not have target costs but efforts are made to minimize costs, but e; profit centre has a profit target
and enjoys authority to adopt such policies as necessary to achieve its targets.

Distinction between Bill of Material and Material Requisition Note


Bill of Material: It is a comprehensive list of materials with exact description \ specifications, required for a job or
other production units. This also provides information at required quantities so that if there is any deviation from the
standards, it can easily detected. It is prepared by the Engineering or Planning Department in a standard form.
Material requisition Note: It is a formal written demand or request, usually from the production department to store
for the supply of specified materials, stores etc. It authorizes the storekeeper to issue the requisitioned materials and
record the same on bin card.
The purpose of bill of material is to act as a single authorization for the issue of all materials and stores items
mentioned in it. It provides an advance intimation to store department about the requirements of materials. It reduces
paper work. It serves as a work order to t production department and a document for computing the cost of material
for a particular job work order to the cost department. The purpose of material requisition note is to draw material
from the store by concerned departments.

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CHAPTER :- COST SHEET


What is a Cost Sheet? What are its uses
Meaning: A Cost Sheet is a statement which shows the break- up and build - up of costs. It is a document which provides for
the assembly of the detailed cost of a cost center or a cost unit.
Uses: The following are the uses of the Cost Sheet.
(a)

Presentation of Cost information.

(b)

Determination of Selling Price.

(c)

Ascertainment of profitability.

(d)

Product - wise and Location - wise cost Analysis.

(e)

Inter- firm and Intra- firm Cost Comparison.

(f)

Preparation of Cost Estimates for submitting tenders/ quotations.

(g)

Preparation of Budgets.

(h)

Disclosure of operational efficiency for Cost Control.

Proforma of the Cost Sheet


The proforma of the Simple Cost sheet i.e. without stocks, is as under:
Direct Materials
Direct Labour
Direct Expenses
Prime Cost
Add: Factory Overheads ( Works OH / Manufacturing OH / Production OK)
Factory Cost / Works Cost
Add: Administration Overheads
Cost of Production
Add: Selling and Distribution Overheads
Cost of Sales
Add: Profit / Loss ( Balancing Figure)
Sales
The proforma of the Comprehensive Cost Sheet, i.e, with stocks, is as under;
Opening Stock of Raw Materials
Add: Purchases (including Carriage Inwards, Transit Insurance etc.)
Less: Closing Stock of Raw Materials
Direct Materials Consumed
Direct Labour
Direct Expenses
Prime Cost
Add: Factory overheads ( Works OH / Manufacturing OH / Production OH )
Add: Opening Stock of Work in progress
Less; Closing Stock of Work in Progress
Factory Costs / Works Cost

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Add; Administration Overheads


Cost of Production
Add: Opening Stock of Finished Goods
Less: Closing Stock of Finished Goods
Cost of Goods Sold
Add: Selling and Distribution Overheads
Cost of Sales
Add: Profit / Loss (Balancing Figure)
Sales

Cost Sheet may be prepared weekly, fortnightly, monthly, quarterly, half- yearly or yearly.
Distinguish between Production/ Manufacturing Account and a Cost Sheet.
Production / Manufacturing Account

Cost Sheet

It is prepared on the basis of double entry system of


book keening.

It is only a statement and hence double entry system is not


applicable.

The primary objective of preparation is Reporting.


It has two part- one showing the cost ofManufacture and
the other part showing Sales and Gross Profit.

The primary objective is decision- making.


It is a step by step presentation of total and shows Prime
Cost. Works Cost. Cost of Production. Cost of Goods.
Sold, Cost of Sales and Net Profit.

Total Cost is shown in aggregate. Product wise or


location wise analysis is not given.

Cost Sheet shows costs in a detailed and analytical manner,


which facilitates cost Comparison

This is not useful for preparing tenders

Estimated Cost Sheets can be prepared based on past


experience, and useful for submitting quotations.

Examples:
(a)

Where only one electric meter is installed in a factory, the common electricity charges should be apportioned to all the
departments on the basis of no. of light points or floor area.

(b)

Factory Rent is incurred for the factory a whole and benefits all the departments in the factory. Hence, it should be
apportioned to all the departments on the basis of floor area occupied

Meaning of Cost Absorption


Absorption of cost is charging cost from cost centre to products or services by means of absorption rate which is
calculated as follows:

Cost Absorption Rate

Total cos t of the cos t centre


Totalquantum of the base

Q. Classification of cost by element

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COSTS

Materials

Direct

Labour

Indirect

Direct

Expenses

Indirect

Direct

Indirect

Overheads

Prime Cost

Material The term materials refer to all commodities supplied to an undertaking. For costing purposes, materials may be
classified into two broad categories (a) Direct Materials (b) Indirect Materials.

(a) Direct Materials


1. Meaning

Direct materials are those materials which can be conveniently identified with and can
be directly allocated to a particular product; job or process.

2. Features

The main features of direct materials are; (a) It can be easily identified with a specific
job, contract or work order. (b) It varies directly with the volume of output.

3. Examples

Some examples of direct materials are as follows;


Basic Raw- Materials

Primary Packing Materials

(a) Timber in furniture

(a) Can for tinned food and drink

(b) Cloth in Garments

(b) Bottles for water, wine & whisky

(c) Milk & cream in ice cream

(c) Plastic packing for Milk, Ghee & oil

(d) Paper in Books

(d) Tin packing for Ghee & Oil

(e) Gold/ Silver in Jewellery

(e) Card board box for drinks like


fruity, Real juice

(f) Bricks or Cement in Building

(f) Bag for Cement

Construction
4.Treatment

Direct Material Cost forms part of prime cost.

(b) Indirect materials


1. Meaning

Indirect materials are those materials which can not be conveniently identified with

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and cannot directly allocated to a particular product, job or process.


2. Features

The main features of direct Materials are: .


(a) It can be easily identified with a specific job, contract or

work order,

(b) It may or may not vary directly with the volume of output.
3. Examples

Some examples of indirect materials are as follows:


(a) Stores used for maintaining machines such as lubricant oil & grease, cotton
waste, consumable stores etc.
(b) Stores used by service departments like power house,

boiler house,

(c) Materials of small value which can not be conveniently


identified with
particular product, job or process. For example, nails used in furniture, thread used
in stitching garments.
4. Treatment

Indirect Material Cost is treated as part of overheads.

2. Labour
Labour is an essential factor of production. It is a human resource and participates in the process of production. Labour cost is
a significant element of cost of a product or service. For costing purposes, labour may be classified into two broad categories:
(a) Direct Labour and, (b) Indirect Labour.
(a) Direct Labour
1. Meaning

Direct labour is that labour which can be readily identified with a specific job, contract
or work order. It includes(a) all labour directly engaged in converting raw materials into finished goods or in
altering the construction, composition or condition of the product,
(b) any other form of labour which is incurred wholly or specifically for any particular
job, contract or work order

2. Features

The main features of direct labour are:


(a) It can be easily identified with a specific job, contract or work order.
(b) It varies directly with the volume of output.

3. Examples

Some examples of direct labour are:


(a) Weaver in weaving unit
(b) Carpenter in furniture unit
(c) Tailor in readymade wears unit
(d) Baker in Baking unit
(e) Halwai in confectionery unit
(f) Washer in Dry cleaning unit
(g) Labour employed on construction contract

4. Treatment

Wages paid to direct labour are termed as direct labour cost and form part of prime
cost.

(b) Indirect labour


1. Meaning

Indirect labour is that labour which cannot be readily identified with a specific
job, contract or work order. It includes all labour not directly engaged in
converting raw- materials into finished goods or in altering the construction,
composition or condition of the product.

2. Features

The main features of indirect labour are:


(a) It can not be easily identified with a specific job, contract or work order
(b) It may or may not vary directly with the volume of output.

3. Examples

Some examples of indirect labour are;

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4. Treatment

(a)

Labour employed in Personnel Department

(b)

Labour employed in Engineering & Work Study Department

(c)

Labour employed in Time- keeping Department

(d)

Labour employed in Pay-roll Department

(e)

Labour employed in Cost Accounting Department

(f)

Labour employed In Repairs & Maintenance Department

(g)

Labour employed in Stores Department

(h)

Labour employed in Power House Department

(i)

Labour employed in Security Department

(j)

Labour employed in Machine Shop such as tools setters, cleaners

Wages paid to indirect labour are termed as indirect labour cost and are treated as
part of overheads.

3. Expenses
All costs other than material costs and labour costs are termed as expenses. For costing purposes, expenses may be classified into
two broad categories: (a) Direct Expenses, and (b) Indirect Expenses.

(a) Direct Expenses


1. Meaning

All direct costs other than direct material costs and direct labour costs are
termed as direct expenses. These can be readily identified with and thus, can
be directly allocated to a particular product, job or process. Thus, Direct
expenses= Direct Costs- Direct Material Cost- Direct Labour Cost

2. Features

The Main features of direct expenses are:


(a) It can easily be identified with a specific job , contract or worK order,
(b) it varies directly with the volume of output.

3. Examples

Excise Duty based on output produced Royalty based on output produced.


Job Processing Charges Cost of special Moulds, designs and pattered Hiring
Charges for machines, tools and equipments

4. Treatment

Direct expenses from part of prime cost.

(b) Indirect Expenses


1. Meaning

All indirect costs other than indirect material costs and indirect labour costs
are termed as Indirect expenses. These can not be readily identified with and
thus, can not be directly allocated to a particular product, job or process.
Thus,
Indirect Expenses= Indirect Costs- Indirect Material Cost- Indirect Labour
Cost

2. Features

The main features of Indirect expenses are;


(a) It can not be easily identified with a specific job, contract or work order,
(b) It may or may not vary directly with the volume of output.

3. Examples

Rent, Rates and taxes of Building Repairs, Insurance and Depreciation of


Building, Plant and Machinery, Furniture Telephone Expenses Lighting ,
heating and Cleaning Expenses

4. Treatment

Indirect expenses are treated as part of overheads

Overheads or On Cost or Indirect Cost


All material, labour and expenses which cannot be readily identified with a particular product, job or process are termed as

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Indirect costs. The three elements of indirect cost, viz, indirect materials, indirect labour and indirect expenses are collectively
known as Overheads or On costs or Burden. Thus,
Overheads = Indirect Materials Cost + Indirect Labour Cost + Indirect Expenses
Overheads are grouped into following three broad categories:

Overheads (or Indirect Costs)

Production
Overheads

Indirect
Material

Indirect
Expenses

Administration
Overheads

Indirect
Material

Indirect
Labour

Indirect
Expenses

Selling & Distribution


Overheads

Indirect
Material

Indirect
Labour

Indirec
t
Expens
es

Indirect
Labour

Production / Manufacturing / Factory Overheads


Meaning: Production overheads represents all the indirect costs incurred in connection with the production of products or
services. These represents the aggregate of indirect material cost, indirect labour cost and indirect expenses incurred by
production department.

Examples:
(a) Indirect Materials Cost

(b) Indirect labour cost

(a)

Cost of consumable stores and supplies like cotton


waste, lubricating oil etc.

(b)

Cost of printing, Postage & Stationary used in


Production Deptt.

(a)

Salary of supervisor, works manager and departmental


superintendents.

(b) Contribution to ESI, P.P., leave pay,


(c) Indirect Expenses

maternity pay

(a)

Rent, rates& taxes of factory building

(b)

Repairs, insurance & depreciation of factory building,


plant & machines and furniture

(c)

Factory telephone expenses

(d)

Lighting, heating & cleaning of factory

(2) Administration Overheads


Meaning: Administration overheads represents the cost of formulating the policy, directing the organization and
controlling the operations of an undertaking which is not related directly to production, selling, distribution, research, or
development activity or function. These represents the aggregate of material cost, labour cost and expenses incurred by
Administration Department for the general management of an organization.

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Examples
(a) Materials Cost

(a)

Cost of printing, postage & stationery used in


Administration department

(b) Cost of dusters, brusher etc, for cleaning


(b) Labour Cost

(c) Expenses

(a)

Salary of managing director, whole time director,


general manager, finance manager, accounts
manager, secretary, legal manager and other
staff working in Administration department.

(b)

Remuneration of internal & statuory cost &


financial auditors, Legal Advisors.

(a)

Rent, rates & taxes of office building

(b)

Repair, insurance & depreciation of office


building, equipment and furniture

(c) Administration office telephone expenses


(d) Lighting, heating & cleaning of Administration
office.
(3) Selling Overheads
Meaning: Selling overheads represents the cost of seeking to create and stimulate demand and of securing order. Thus, this
is the cost of promoting sales and retaining customers. These represent the aggregate of materials cost, labour cost and
expenses incurred by sales department for the sales management of an organization.
Examples:
(a) Materials Cost

(a)

Cost of printing, postage & stationary used


insales department. (b) Cost of catelogues,
list prices etc.

(b) Labour Cost

(a)

Salary of sales director, sales manager, sales


officers, salesmen and other staff working in
sales department.

(c) Expenses

(c)

Commission to agents

(a)

Rent, rates & taxes of sales office/ showroom

(b)

Repairs, insurance & depreciation of sales office


building, equipment and furniture

(c)
(d)

Sales office telephone expenses


Lighting, heating & cleaning of sales office

(e)

Advertising

(f)

Bad Debts

(g)

Debt Collection charges

(h)

Salesmens traveling expenses

(i)

Entertainment expenses on customer

(4) Distribution Overheads


Meaning; Distribution overheads, represent the cost of the sequence of operations which begins with making the packed
product available for dispatch and ends with making the reconditioned returned empty package, if any, available for re-use.
There also include expenditure incurred in moving in moving articles to central or local storage, or in moving articles to
and from prospective .customers as in the case of goods on sale or return basis. In the gas, electricity and water
industries Distribution means pipes, mains and service which may be regarded as equivalent to packing and
transportation. These represent the aggregate of materials cost, labour cost and expenses incurred by distribution
department for the distribution management of the organization.
Examples:
(a) Materials

(a)

Cost of printing, postage & stationary


used in distribution office
(b) Cost of secondary packaging

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(c)

Cost of materials used in reconditioning


of the empty containers returned by
customers for re-use.
(a) Salary of staff attached to distributionoffice like,
packers, despatch(staff)
(b) Salary of distribution vehicle driver.
(a) Rent, rates & taxes of distributing office/ godown
/storage / warehouse
(b) Repair, insurance & depreciation ofdistribution
office Building, equipment & furniture,
delivery van of distribution office
(c)
Distribution office telephone expenses
(d) Lighting, heating & cleaning of distribution office
(e)
Depreciation, repair & running expenses of
delivery vans
(f) Freight & carriage outward
(g) Insurance of finished stock in godown

(b) Labour

(c) Expenses

Q.7 Classification of costs by relation to cost centre


Cost
1. Direct Cost

2. Indirect Cost

Meaning
It is the cost which can be
conveniently identified with and
directly allocated to a cost object in an
economically feasible way. It
represents the aggregate of
(a) Direct Material Cost
(b) Direct Labour Cost
(c) Direct Expenses
It is the cost which can not be
conveniently identified with and
directly allocated to a cost centre or
cost object in an economically feasible
way. It is apportioned to various cost
centres on some equitable basis. It is
also known as overhead. It represents
the aggregate of
(a) Indirect Material Cost
(b) Indirect Labour Cost
(c) Indirect Expenses

Example
Cost of cloth in a shirt Wages
paid to tailor to shirt a shirt
Excise duty on production

Lubricating oil for machine


Salary of supervisor. Repairs,
Insurance & Depreciation of
machines

Q.8. Special Costs Used for Managerial Decision Making


Special Costs

Meaning

Example

1. Relevant Costs

These are those future costs which


differ under different alternatives.
These can be changed by the
decision of the management.
These are those costs which are not
relevant, These cannot be changed
by the decision of the management.

In case of a decision relating


to the replacement of an old
machine, dismantle cost of an
old machine is a relevant cost.
In case of a decision relating to
the replacement of an old
machine, depreciated book
value of old machine is
irrelevant cost.
In case of decision relating to
the replacement of an old
machine, depreciated book
value of old machine is sunk
cost.
Rent, insurance and
depreciation of Building

2. Irrelevant Cost

3. Sunk Costs

4. Shut- down Costs

5, Out of Pocket Cost

These are the historical or past costs


incurred by a past decision. Since
sunk costs can not be changed by
later decision, these are not relevant
for decision- making.
These are those fixed costs which
continue to be incurred even when a
plant is temporarily shut down.
These are those costs which involve

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6. Opportunity costs

7. Imputed costs

8. Differential costs

9. Marginal cost

10. Replacement cost

cash outlay. These can be avoided or


saved. These are used In decisions,
relating to fixation of selling price
during depression, make or buy etc.

Materials, Rent & Insurance of


Building,

It is the value of sacrifice made in


accepting an alternative course of
action.
These are the notional costs which
do not involve any cash outlay.
These costs are similar to
opportunity costs.
It is the increase or decrease in total
Cost ( variable & fixed ) due to
change in activity level, technology,
process or method of production etc.
It is termed as incremental cost
when the cost increases and as
decrement cost when the cost
decreases.
It is the amount at any given volume
of output by which aggregate costs
are changed if the volume of output
is increased or decreased by one
unit. In practice this is measured by
the total variable cost attributable to
one unit.
It is the cost at which an asset
identical to that which is to be
replaced, could be currently
purchased. In other words, it is the
current purchase price of an identical
asset.

Likely Rent of owned building


proposed to be used for a new
project.
1. Rent of owned building.
2. Interest of owned capital.

11. Conversion cost

It is the cost of converting a raw


material into a finished product. It is
the aggregate of direct labour cost,
direct expenses and production
overheads.

12. Committed costs

These are those costs which can


not be avoided in the short run
once the decision to incur them,
has been taken.
These are those costs which can
be avoided by managerial decisions.

13.Discretionary costs

Total cost under alternative 1=


Rs 1,00,000, Total cost under
alternative 11= Rs 1,20,000
Differential cost= Rs 20,000

Direct Material Cost Rs 400,


Direct Labours Cost Rs 300,
Direct Expenses Rs 200,
Variable Overhead Rs 100,
Marginal Cost is Rs 1,000

An old machine purchased for


Rs 1,00,000 in the year 2,000
is to be replaced in the year
2005 by a new machinery of
the same type which could be
purchased for Rs 2,00,000.
Here replacement cost of old
machine is Rs 2,00,000.
Direct Material Cost Rs. 400,
Direct Labour Cost
Rs 300,
Direct Expenses
Rs 200,
Production overheads Rs 100,
Conversion Cost is
Rs 600
Depreciation of plants
equipment.

Advertising costs, Research


Development Costs.

Q.9. Items excluded from Cost Accounts


The following items of income and expenditure are normally included in financial accounts and not in cost accounts.
Their inclusion in cost accounts might lead to unwise managerial decisions. These Items are:
1. Incomes

2. Expenditures

(a) Profit on sale of Fixed Assets


(b) Profit on sale of investments
(c) Interest Income
(d) Dividend Income
(e) Rental Income
(f) Transfer fees
(a) Loss on sale of fixed assets
(b) Loss on sale of Investments
(c) Interest on mortgage and loans

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3. Appropriations

(d) Preliminary expenses written off


(e) Goodwill written off
(f) Underwriting commission and debenture discount written off
(g) Fines and penalties
(a) Income tax
(b) Dividend Distribution tax
(c) Transfer to General Reserves
(d) Transfer to Special Reserves like Dividend Equalisation Reserve etc.

Q.10 Components of total cost


The various components of total cost are as follows:
Component
How to calculate component
=
Direct Material Cost* Direct Labour Cost + Direct expenses Note: Direct
1. Prime cost
Material Cost = Opening Stock of raw materials + Net purchases (e.g.,
carriage/ freight inward)- Closing Stock of raw- materials.
=
Prime Cost + works/ factory / production overloads* opening WIP-closing
2. Works cost or factory
WIP Note: Work-in-progress represents those units on which some
cost
work has been done but which are not yet complete. When work-inprogress is valued at factory cost, it is adjusted as shown above,
=
Works Cost + Administration Overheads
3. Cost of production or
cost of goods produced
Cost of goods produced + Opening Stock of finished goods - Closing
4. Cost of goods sold
stock of finished goods
Cost of goods sold + Selling & Distribution Overheads
5. Cost of sales

Q.11 Format of Statement of Profit or Loss


There is no prescribed form of production statement. It may very from industry to industry. A specimen of the general
statement of profit or loss is given below;
Statement of profit or loss
Particulars
Total (Rs.)
A. Direct Material Cost
Opening Stock of Materials .....;..
Add: Purchases ........
Add: Expenses on Purchases .......
Less: Purchase Returns ........
Less: Closing Stock of Materials ........
Less; Net value of Normal Scrap of Direct Materials .
........
B. Direct Labour Cost Paid
Add: Outstanding at the end ..........
Less: Prepaid at the end .......
C. Direct Expenses (e.g. Royalty on Production)
D. Prime Cost [A + B + C+]
E. Works Overheads / Factory
Overheads / Production Overheads .......
Less: Net value of Normal Scrap of Indirect Materials
.......
Adjustment on account of Stock of WIP
Add: Opening Stock of Work-in-progress ....
Less: Closing Stock of Work-in-progress
F. Works Cost [ D + E ] ........
G, Add: Office & Administration Expenses
H. Cost of Goods Produced [F + G]
I. Adjustment on Account of Stock of Finished Goods:
Add: Opening Stock of Finished Goods ......
Less: Closing Stock of Finished Goods
= Cost of goods produced

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J. Cost of Goods Sold [H + l]


K. Add: Selling & Distribution Expenses
L. Cost of Sales [J + K]
M. Add: Profit
N. Sales [L + M]
1.

These amounts are ascertained by dividing the respective total by the number of units produced.

2.

These amounts are ascertained by dividing the respective total by the number of units sold.

Tutorial Notes:
(1)

Unless otherwise stated, closing stock of finished goods should be valued at current cost of production assuming that
the first-in-first out method of inventory valuation is in use.

(2)

Items of financial nature like Income Tax, Cash Discount, Interest on Capital/ Bank
Overdraft, Donations, Dividend, Preliminary Expenses/ Goodwill w/o, Provision for Doubtful Debts, T/f to reserves,
etc. are ignored while preparing Cost Sheet/ Production Statement/Account.

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Chapter : RECONCILIATION OF COSTING AND FINANCE PROFIT


Reconciliation of cost and financial accounts in the modern computer age is redundant. Comment
In the modern computer age the use of computer knowledge and accounting software has helped the field of Financial and cost
accounting in a big way. In fact, computers work at a very high speed and can process voluminous data for generating
desired output in on time. Output produced is precise and accurate. Computers can work for hours without any
figures. They can bring out different financial accounting and cost accounting statement and Reports accurately in a
presentable form. Financial accounts and cost accounts show their results accurately and precisely, when maintained
on a computer system, but the profit shown by one set of books may not agree with that of the other set.
The main reasons for the disagreement of the profit figures shown by the two set of books is the absence of certain
items which appear in financial books only and are not recorded in cost accounting books. Similarly there may be
some items which appear in cost accounts but do not find a place in the financial books. Some examples which affect
it are as follows :
(i)

Loss/profit on sale of fixed assets.

(ii)

Expenses on stamp duty, discount and other expenses relating to the issue and transfer of shares and
debentures.

(iii)

Fee received on issue and transfer of shares etc.

(iv)

Interest received on bank loan, mortgage etc.

(v)

Interest received on bank deposits and other investments.

(vi)

Fines and penalties

(vii)

Dividend received on investments in shares.

(viii)

Rental income etc.

(ix)

Under or recovered expenses.

(x)

Difference due to varying basis of valuation of stock or in the matter of charging depreciation.

Under the situation of different profit figures shown by financial and cost accounts, it is necessary to reconcile the
results (profit / loss) shown. Such a reconciliation proves arithmetical accuracy of data, explains reasons for the
different in the two sets of books affords reliability to them. Hence, the reconciliation of cost and financial accounts is
essential and not redundant even in the modern age of computer.

Reasons for disagreement of profits as per financial accounts and cost accounts.
Reasons for disagreement of profit as per Financial accounts and cost account are as below. There are certain items which are
included in Financial accounts but not in cost accounts. Likewise there are certain items which are in cost.
(i)

Accounts but not in financial accounts.


Examples of financial charges which appear only a financial books are :-

(i)

Loss on sale of fixed assets and investment.

(ii)

Interest on bank loans, mortgage etc.

(iii)

Expenses relating to the issue and transfer of share and debentures like stamps duty expenses; discount on
share and debentures etc.

(iv)

Penalties and fines.


Examples of incomes which are recorded in the financial books only are :-

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(i)

Profit on sale of investment and fixed assets.

(ii)

Interest received on investment and bank deposits.

(iii)

Dividend received on investment in shares.

(iv)

Fees received on issues and transfer of shares etc.

(v)

Rental income

There are abnormal or special items of expenditure and income which are not included in the cost production. Their
inclusion in cost of production would result into correct cost ascertainment. Different bases of charging depreciation
also accounts for the disagreement of profits as per financial and cost accounts. Different methods of valuation of
closing stock adopted in cost and financial accounts will also account for the difference in profit under financial and
cost accounts.

Reasons for disagreement of profits as per cost accounts and financial accounts.
The various reasons for disagreement of profit shown by the two sets of books viz., cost and financial may be listed be below:
1.

Items approaching only in financial accounts.


The following items of income and expenditure are normally included in financial accounts and not in cost
accounts. Their inclusion in cost accounts might lead to unwise managerial decisions. These items are :

(i)

(ii)

(iii)

Income :(a)

Profit on sale of assets

(b)

Interest received

(c)

Dividend received

(d)

Rent receivable

(e)

Share Transfer fees

Expenditure
(a)

Loss on sale of assets

(b)

Uninsured destruction of assets

(c)

Loss due to scrapping of plant and machinery

(d)

Preliminary expenses written off

(e)

Goodwill written off

(f)

Underwriting commission and debenture discount written off

(g)

Interest on mortgage and loans

(h)

Fines and penalties

Appropriation
(a)

Dividends

(b)

Reserves

(c)

Dividend Equalization fund, Sinking fund etc.

2.

Items appearing only in cost accounts


There are some items which are included in cost accounts but not in financial accountants. These are :
(a)

Notional interest on Capital;

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(b)
3.

Notional rent on premises owned

Under or over absorption of overhead


In cost accounts overheads are charged to production at pre determined rates whereas in financial accounts
actual amount of overhead is charged, the different gives rise to under or over absorption; causing a
difference in profits.

4.

Different bases of stock valuation


In financial books, stocks are valued at cost or market price, whichever is lower. In cost books, however,
stock of material may be valued on FIFO or LIFO basis and work in progress may be valued at prime cost
or works cost. Differences in stock valuation may thus cause a difference between the two profits.

5.

Depreciation
The amount of depreciation charge may be different in the two sets of books either because of the different
methods of calculating depreciation or the rates adopted. In cost accounts, for instance, the straight line
method may be adopted whereas in financial accounts it may be the diminishing balance method.

Why is it necessary to reconcile the profits between cost accounts and financial accounts?
(a) Need for reconciliation: when cost and financial accounts are maintained separately, the profit shown by one set of books
may not agree with that of the other set. In such a situation, it becomes necessary toe reconcile the results (profit /
loss) shown by two sets of books.
Cause for difference between profit shown by cost and financial accounts
(1)

There are certain items which appear in financial books only and are not recorded in cost accounting books
e.g. loss on sale of fixed assets; expenses on stamp duty; interest on bank loan etc. Similarly, there may be
some items which appear in cost accounts only and do not find a place in the financial books e.g., notional
interest etc.)

(2)

In cost accounts, overheads are generally absorbed on the basis of predetermined overhead rate, whereas in
financial accounts actual expenditure on overheads is recorded, this will also cause a difference between the
figures of profit shown under financial and cost accounts.

(3)

Different methods of valuation of closing adopted in cost and financial accounts will also cause a difference
in the results shown by the two sets of books. In financial accounts the method generally followed is cost or
market price, whichever is less whereas in cost accounts different methods of pricing of material issues such
as LIFO, FIFO average etc are used.

(4)

Use of different methods of depreciation is also responsible for the variation of profit shown by two sets of
books. In financial accounts, depreciation may be charged according to written down value method whereas
in cost accounts it may be charged on the basis of the life of the machine.

(5)

Abnormal items not included in cost accounts also cause a difference in profit. If such items of expenses are
included, cost ascertained will not be correct.

Under non-integrated system of accounting, cost accounts and financial accounts are separately maintained. In such a
system, profit and loss shown by costing books may not agree with that shown by financial books. Therefore, it
becomes necessary that profit or loss shown by the two sets of accounts is reconciled.
Need for Reconciliation
1.

Reconciliation reveals the reasons for difference in profit and loss between cost and financial accounts.

2.

It also helps in checking the arithmetical accuracy of the costing data.

Reasons for Difference in Costing and Financial Profit / Loss


1.

Items shown only in financial accounts. There are a number of items which appear in financial accounts and
not in cost accounts. These items are classified into three categories as under :
(a)

Purely financial charges. The examples are as follows :

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(b)

(c)

(i)

Loss on the sale of capital assets.

(ii)

Discount on bonds, debentures, etc.

(iii)

Losses on investments.

(iv)

Expenses of companys transfer office.

(v)

Interest on bank loans and mortgages, etc.

(vi)

Fines and penalties.

(vii)

Damages payable under law.

Purely financial incomes. The examples are as follows :


(i)

Profit arising from the sale of capital assets.

(ii)

Rent receivable.

(iii)

Dividend and interest received on investments.

(iv)

Interest received on bank deposits.

(v)

Transfer fees received.

Appropriations of profit. The examples are as follows :


(i)

Dividends paid.

(ii)

Transfer to reserves.

(iii)

Charitable donations.

(iv)

Income tax.

(v)

Amounts written off goodwill, discount on debentures, preliminary expenses, etc.

(vi)

Any other items which appears in Profit and Loss Appropriation Account.

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Chapter : Integrated & Non Integrated Accounts


Integrated Accounts:- It is the name given to a system of accounting whereby cost and financial accounts are kept in
the same set of books. This system avoids the need for separate sets of books for financial and costing purpose.
Integrated accounts provides or meets out fully the information requirement for costing as well as financial accounts.
The main advantage of integrated accounts, are as follows:(i)

Due to the use of one set of books, there is a significance extent of saving in efforts made.

(ii)

No delay is caused in obtaining information as it is provided from books of original entry.

(iii)

The question of reconciling costing profit and financial profits does not arise, as there is one figure of profit
only.

(iv)

The accounting procedures can be simplified.

Essential pre- requisites for integrated accounts are :(1)

A suitable coding system must be developed to serve the purpose of both financial and cost accounts.

(2)

An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, other adjustment
necessary for the preparation of interim accounts be lad down.

(3)

Perfect coordination should exist between the staff responsible for the financial and cost aspect of the
accounts.

Cost Ledger control accounts


This control account is also popularly known as 'General ledger adjustment statement accounts is opened is cost ledger to
complete double entry. All items of income and expenditure taken from financial accounts and all transfers from
cost accounts to financial books are recorder in this account. Since the purpose of this account is to complete double
entry in the cost ledger, therefore all transactions in the cost ledger must be recorded through the cost ledger control
account. The balance in this account will always be equal to the total of all the balance of the impersonal accounts.
Distinguish between Integrated and non integrated systems of accounting.
Non integral system of accounting :- Under this system, cost and financial accounts are kept separately under two sets of
accounts books. In other words, cost accounts are kept independent of financial accounts. At the end of the year cost
accounting profit is reconciled with the profit as per financial accounts.
Integral system of accounting : - Under this accounting system. Both the cost accounts as well as financial accounts are
maintained in one and the same set of books. It means 'the merger or integration of both financial and cost accounts
thus maintaining only one integrated ledger containing both financial as well as costing records.'
Other wise, in non- integrated accounting system, cost accounts and financial accounts are kept separately. Under this
system, however, certain inter locking accounts may be maintained so as to ensure integration. This is known as
inter locking of the two accounts.
Under integrated accounting method, there is no need to reconcile the results of cost accounts with those of the
financial accounts. It is so because in case of integrated accounting system both accounts are preferred as part of a
single comprehensive accounting method.
What are the essential pre-requisites of integrated accounting system?
The essential pre-requisites of integrated accounting system including the following :
1.

The management's decision about the extent of integration of the two sets of books. Some concerns find it useful to
integrate upto the stage of primary cost or factory cost while other prefer full integration of the entire accounting
records.

2.

A suitable coding system must be made available so as to serve the accounting purposes of financial and cost
accounts.

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3.

An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, other adjustment
necessary for preparation of interim accounts.

4.

Perfect coordination should exist between the staff responsible for the financial and cost aspects of the accounts and
an efficient processing of accounting documents should be ensured.
Under this system there is no need for a separate cost ledger. Of course, there will be a number of subsidiary ledgers;
in addition to the useful Customers Ledger and the Bought Ledger, there will be : (a) Stores Ledger; (b) Stock Ledger
and (c) Job Ledger.

Advantages of integrated accounting


Integrated Accounting is the name given to a system of accounting whereby cost and financial accounts are kept in the
same set of books. Such as system will have to afford full information required for Costing as well as for Financial Accounts. In
other words, information and date should be recorded in such a way so as to enable the firm to ascertain the cost (together with
the necessary analysis) of each product, job, process, operation or any other identifiable activity. For instance, purchases are
analysed by nature of material and its endues. Purchases account is eliminated and direct postings are made to Stores Control
Account, Work-in-Progress account, or Overhead Account. Payroll is straightway analysed into direct labour and overheads. It
also ensures the ascertainment of marginal cost, variances, abnormal losses and gains. In fact all information that management
requires from a system of Costing for doing its work properly is made available. The integrated accounts give full information
in such a manner so that the profit and loss account and the balance sheet can be prepared according to the requirements of law
and the management maintains full control over the liabilities and assets of its business.
The main advantages of Integrated Accounting are as follows :
(i)

Since there is one set of accounts, thus there is one figure of profit. Hence the question of reconciliation of costing
profit and financial profit does not arise.

(ii)

There is no duplication of recording of entries and efforts to maintain separate set of books.

(iii)

Costing data are available from books of original entry and hence no delay is caused in obtaining information.

(iv)

The operation of the system is facilitated with the use of mechanized accounting.

(v)

Centralization of accounting function results in economy.

What do you understand by integrated accounting system? State its advantages and pre-requisites.
Ans.
Integrated (or Integral) Account is the name given to a system whereby cost and financial accounts are kept in the
same set of books. Obviously, then there will be no separate sets of books for Costing and Financial purposes. Integrated
Accounts will have to afford full information required for Costing as well as for Financial Accounts. In other words,
information and data should be recorded in such a way as to enable the firm to ascertain the Cost (together with the necessary
analysis) of each product, job, process, operation or any other identifiable activity. For instance, purchases are analysed by
nature of material and its endues. Purchase accounts are eliminated and direct postings are made to Stores Control Account,
Work-in-Progress Account, or Overhead Account. Payroll is straightway analysed into direct labour and overheads. It also
ensures the ascertainment of marginal cost, variances, abnormal losses and gains in fact, all information that management
requires from a system of Costing for doing its work properly. The integrated accounts give full information in such a manner so
that the profit and loss account and the balance sheet can be prepared according to the requirements of law and the
managements maintains full control over the liabilities and asserts of its business.
The main advantages of Integrated Accounts are as follows:
(1)

Since there is one set of accounts, thus there is one figure of profit. Hence the question of reconciliation of costing
profit and financial profit does not arise.

(2)

There is no duplication of recording of entries and efforts in the separate set of books.

(3)

Costing data are available from books of original entry and hence no delay is caused in obtaining information.

(4)

The operation of the system is facilitated with the use of mechanized accounting.

(5)

Centralization of accounting function results in economy.


The essential pre-requisites for integrated accounts include the following steps.

1.

The management's decision about the extent of integration of two sets of books. Some concerns find it useful to
integrate upto the stage of primary cost or factory cost while others prefer full integration of the entire accounting
records.

2.

A suitable coding system must be made available so as to serve to accounting purposes of financial and cost accounts.

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3.

An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, and other adjustments
necessary for preparation of interim accounts.

4.

Perfect co-ordination should exist between the staff responsible for the financial and cost aspects of the accounts and
an efficient processing of the accounting documents should be ensured.

Chapter MATERIAL
Write short notes on: ABC analysis.
ABC Analysis It is a system of inventory control. It exercise discriminating control over different items of stores classified on
the basis of the investment involved. Usually the items are divided into three categories according to their importance,
namely, their value and frequency of replacement during a period.
(i)

A category of items consists of any small percentage i.e. about 10% of the total items handled by the stores
but requires heavy investments about 70% of inventory value, because of their high prices and heavy
requirement.

(ii)

B category of items are relatively less important; they may be 20% of the total items of material handled
by stores. The percentage of investment required is about 20% of the total investment in inventories.

(iii)

C category of items do not require much investment; it may be about 10% of total inventory value but they
are nearly 70% of the total items handled by store.

A category of items can be controlled effectively by using a regular system which ensures neither overstocking nor storage
of materials for production. Such a system plans its total materials requirements by making budgets. The stocks of materials are
controlled by fixing certain levels like, maximum level, minimum level and re order level. A reduction in inventory
management costs is achieved by determining economic order quantities after taking into account ordering cost and carrying
cost. to avoid shortage and to minimize heavy investment in inventories, the techniques of value, analysis reduction,
standardization, may be used.
In the case of B category of items, as the sum involved is moderate, the same degree of control as applied in A category of
items is not warranted. The orders for the items, belonging to this category may be placed after reviewing their situation
periodically.
For C category of items, there is no need of exercising constant control. Orders for items in this group may be placed either
after six months or once in a year, after ascertaining consumption requirements. In this case the objective is to economics is to
economics on ordering and handling costs.
The advantages of ABC analysis are the following:
(i)

It ensures that, without there being any danger of interruption of production for want of materials or stores, minimum
investment will be made on inventories of stock of materials or stocks to be carried.

(ii)

The cost of placing orders, receiving goods and maintaining stocks is minimized specially if the system is coupled
with the determination of proper economics order quantities.

(iii)

Management time is saved since attention need be paid only to some of the items rather than all the items as would be
the case if the ABC system was not in operation.

(iv)

With the introduction of the ABC system, much of the work connected with purchases can be systematized on a
routine basis to be handled by sub ordinate staff.

Write notes on: Bill of Material


In most of the manufacturing units a list of materials required for a particular work or job order is prepared. Such a list is usually
prepared either by the engineering or production planning department. This list is known as a bill of material. Bill of
material has code; description and quantity of material and other stores items required for carrying out a particular
work or job order. It also acts as an authorization for the issue of materials and stores items mentioned in it. Use of
Bill of Materials save paper work and also ensures requisition of the exact quantity of material. It also saves the
botheration of stores people of preparing and issuing a number of material requisition slips. It also acts as an advance
intimation to stores and purchase departments about the requirements of materials.
Generally four copies of it are prepared, one for each of the following departments

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(a)

Stores departments

(b)

Production departments

(c)

Cost accounts departments

(d)

Production planning departments

Distinguish between : Perpetual Inventory and continuous Stock taking.


Perpetual inventory is a system in which a continuous record of receipt and issue of materials is maintained by the stores
department. In this system the stock control cards, bin cards and stores ledger show the receipts, issue and balance of
each item at any point of times after each transaction. The stocks alas per dual records namely Bin card and stores
ledger are reconciled on a continuous basis. The system facilitates planning and control.
Continuous stock taking is a system of physical verification of stocks of each item on continuous vases. The actual quantity on
the bin card is compared with bin valances. Such a verification is conducted round the year such that all items of stocks are
verified 3 to 4 times in a year. Any discrepancies are investigated and reported for corrective action. It also serves as a moral
check on stores staff and acts as deterrent to dishonesty. A perpetual inventory system in usually supported by continuous stock
taking. it calls for up-to-date writing up of stores ledger and bin cards and stock control cards. The balances as per bin card and
stores ledger are compared when every receipts or issue is posted. The physical balance on continuous stock taking is also
compared with the bin card or ledger balances. Thus monthly accounts can be prepared with confidence.
Distinguish clearly Bin cards and Stores Ledger.
Both bin cards and stores ledger are perpetual inventory records. None of them is a substitute for the other.
These two records may be distinguished from the following point of view:
(a)

Bin card is maintained by the store keeper, while the stores recording document whereas the stores ledger is an
accounting records.

(b)

Bin card is the stores recording documents whereas the stores ledger is an accounting record.

(c)

Bin card contains information with regard to quantities i.e. their receipt, issue and balance while the stores ledger
contains both quantitative and value information in respect of their receipts, issue and balance.

(d)

In the bin card centuries are made at the time when transactions takes place. But in the stores ledger entries are made
only after the transactions has taken place.

(e)

Inter departmental transfers of materials appear only in stores ledger.

(f)

Bin cards records each transactions but stores ledger records the same information in a summarized form.

Economics Order Quantity.


Economics order quantity :- Economics order quantity represents the size of the order for which both order, ordering and
carrying costs together are minimum. If purchases are made in large quantities, inventory carrying cost will be high. If
the order size is small, ordering cost will be high. Hence, it is necessary to determine the order quantity for which
ordering and carrying costs are minimum. The formula used for determining economics order quantity is a s follows:

EOQ

2AO
C

Where,

A is the annual consumption of material in units.


O is the cost of placing an order (ordering cost per unit)
C is the cost of interest and storing one unit of material for the one year (carrying cost per unit per annum).
How does a bill of material differ from a material requisition notes? Explain the purpose of each.
Bill of material :- It is a list of material required either for a particular job or for a work order. It cotains the description; code
and quantity of materials and other stores items required for a particulars job or work order. It serves as an advance
intimation to stores department about the requirement of materials. It acts as an authorization for the issue of all
materials and stores items mentioned in the bill of materials. Its use reduce pupae work and assures requisition of the
exact quantity of material to the user departments.

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Material requisition note :- It is a formal request, for the supply of specified materials, stores etc. to the production
departments for a specific job or work order. it authorizes the issuing departments to draw from stores the
requisitioned materials. Such notes contains information about the description, code and quantity of materials needed.
It also has job/work order number for which the material has been requisitioned. This note is signed by the foreman of
the concerned departments.
To be able to calculate a basic EOQ certain assumptions are necessary. List down these assumptions.
The computation of economics order quantity is subject to the following assumptions.
(i)

Ordering cost (per order) and carrying cost (per unit! annum) are known and constant.

(ii)

Anticipated usage (in units) of material for a period is uniform and known.

(iii)

Cost per unit of the material (to be purchased) is known and it is constant.

What is a purchase requisition? (Give a specimen form of a purchases requisition?


(a)

A purchase requisition is a form used for making a formal request to the purchasing department to purchase
materials. Purchase requisitions are usually initiated by

(i)

A store department for regular and standard items held in the stock.

(ii)

The production control department for special material required for specific jobs.

(iii)

The maintenance department for maintenance equipment and items of capital expenditure.

(iv)

The heads of departments for office equipments.

The aforesaid arrangement is only a matter of convenience. In some concerns distinction is made between regular indents and
special indents, depending upon whether the items are needed for replacing stocks or for special orders. But both types of
indents are initiated by the stores department. Irrespective of the difference regarding the procedure for initiating purchase
requisition, the purchase manager should have with him a list of the persons authorised to requisition materials.
Each purchase requisition should clearly state the quantity, quality and other specifications in the appropriate column of the
given specimen form along with the purpose for which materials are required. It should also indicate the date by which such
materials are needed.
Depending upon the procedure to be followed appropriate number of copies of the purchase requisitions may be prepared and
used accordingly. A specimen form of purchase requisition is given below:

A Specimen form of purchase requisition


Date___________ For Stock

Date of requirement_________

Req. No._________
Sl.No.

Code No. Description

Dept. or work order No.________


Quantity Grade

Remarks

----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------Requisitioned by _______Checked by _____ Approved by_________


For Purchase Department use
Purchase Order No.______________ Date of Purchase____________
Name of Supplier _____________ Expected date of delivery___________
Just in Time (JIT) purchase? What are the advantages of such purchases?
Just in time (JIT) purchases means the purchase f goods or materials such that delivery immediately precedes their use.
Advantages of JIT purchases:
Main advantages of JET purchases are as follows:
1.

The suppliers of goods or materials co-operates with the company and supply requisite quantity of goods or materials
for which order is placed before the start of production.

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2.

JIT purchases results in cost savings for example, the costs of stock out, inventory carrying, materials handling and
breakage are reduced.

3.

Due to frequent purchases of raw materials, its issue price is likely to be very close to the replacement price.
Consequently the method of pricing to be followed for valuing material issues becomes less important for companies
using ITT purchasing.

4.

JIT purchasing are now attempting to extend daily deliveries to as many areas as possible so that the goods spend less
time in warehouses or on store shelves before they are exhausted.

What is material handling cost? How will you deal it in cost accounts?
Material handling over : It refers to the expenses involved in receiving, storing, issuing and handling materials. To deal with
this cost in cost accounts there are two prevalent, approaches as under:
First approach suggests the inclusion of these costs as part of the cost of materials by establishing a separate material
handling rate e.g. at the rate of percentage of the cost of material issued or by using a separate material handling rate
which may be established on the basis of weight of materials issued.
Under another approach these costs may be included along with those of manufacturing overhead and be charged over
the products on the basis of direct labour or machine hours.
At the time of physical stock taking, it was found that actual stock level was different from the clerical or computer records.
What can be possible reasons for such differences? How will you deal with such differences?
Possible reasons for differences arising at the time of physical stock taking may be as follows when it was found that actual
stock level was different from that of the clerical or computer records:
(i)

Wrong entry might have been made in stores ledger account or bin card.

(ii)

The items of materials might have been placed in the wrong physical location in the store.

(iii)

Arithmetical errors might have been made while calculating the stores balances on the bin cards or store ledger when
a manual system is operated.

(iv)

Theft of stock.

When a discrepancy is found at the time of stock taking, the individual stores ledger account and the bin card must be adjusted
so that they are in agreement with the actual stock. For example, if the actual stock is less than the clerical or computer record
the quantity and value of the appropriate store ledger account and bin card (quantity only) must be reduced and the differences
in cost be charged to a factory overhead account for stores losses.
MATERIAL LOSSES:

Material losses take the form of waste, scrap, spoilage or defectives from the accounting points of view, all such losses may be
divided in to two categories-normal and abnormal loss.
Accounting and control of waste, scrap, spoilage and defectives
WASTE
a. It represents the portion of basic raw materials lost in processing having no recoverable value.
b. Waste may be visible - remnants of basic raw materials or invisible - disappearance of basic raw materials through
evaporation, smoke etc.
c. Shrinkage of material due to natural causes may also be a form of a material wastage.
Accounting treatment
d. Waste may be classified into Normal and Abnormal Waste.
e. Normal waste is absorbed in the cost of net output, whereas abnormal waste is transferred to the Costing Profit and
Loss Account.
Control
f. For effective control of waste, normal allowances for yield and waste should be made from past experience,
technical factors and special features of the material process and product.
g. Actual yield and waste should be compared with anticipated figures and appropriate actions should be taken where
necessary.
h. Responsibility should be fixed on purchasing, storage, maintenance, production and inspection staff to maintain
standards.
A systematic procedure for feedback of achievement against laid down standards should be established.

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SCRAP
Meaning: It has been defined as the incidental residue from certain types of manufacture, usually of small amount and low
value, recoverable without further processing.
Accounting treatment
Scrap may be treated in cost accounts in the following ways (a). Other Income: Where the value of scrap is negligible, such value may be excluded from costs. Hence, the cost of
scrap is borne by good units. Income I Receipt from Scrap Reallsation is treated as Other Income.
(b). NRV of Scrap: The Net Realisable Value (NRV) of Scrap, i.e. Sales Value less Selling and Distribution cost, is
deducted from Overheads. Alternatively, the NRV can be reduced from Materials Cost. This method is followed
when scrap cannot be aggregated job or process-wise.
(c). Specific Identification: When scrap is identifiable with a particular job or process and its value is significant, the
Scrap Account is charged with full cost. The credit is given to the job or process concerned. The profit or loss in the
Scrap Account, on realisation, will be transferred to the Costing Profit and Loss Account.
Control
a. Control of scrap really means the maximum effective utilisation of raw material.
b. Scrap control does not, therefore, start in the production department; it starts from the stage of product designing.
c. A standard allowance for scrap should be fixed and actual scrap should be collected, recorded and reported indicating
the cost centre responsible for it.
d. A periodical scrap report would serve the purpose where two or more departments or cost centres are responsible for
the scrap; the reports should be routed through the departments concerned.
SPOILAGE
Meaning: Spoilage refers to materials which are badly damaged in manufacturing operations, and they cannot be rectified
economically, and hence taken out of process to be disposed of in some manner without further processing
Classification: For accounting purposes, Spoilage is classified into Normal and Abnormal, and dealt as under (a) Normal Spoilage Costs (i.e. which is inherent in the operation and hence unavoidable) are included in costs either charging
spoilage loss to the Job I Process or by charging it to Production OH so that it is spread overall products. Any value realised
from spoilage is credited to Job /Process a/c or OH a/c, as the case may be.
(b) Costs of Abnormal Spoilage (i.e. arising out of causes not inherent in manufacturing process) are charged to the Costing
P&L Account. When spoiled work is the result of rigid specification, the cost of spoiled work is absorbed by good production
while the cost of disposal is charged to Production OH.
DEFECTIVES
1. Meaning: Defective Work signifies those units of production which can be rectified and turned out as good units by the
application of additional material, labour or other service, e.g. duplication of pages or omission of some pages in a book
2. Reasons: Defectives arise due to sub-standard materials, bad supervision, improper planning, poor workmanship, inadequate
equipment and careless inspection. To some extent, defectives may be unavoidable, but with proper care it is possible to avoid
defect in the goods produced.
3. Reclamation of loss from defective units: In the case of articles that have been spoiled, it is necessary to take steps to
reclaim as much of the loss as possible. For this purpose (a). All defective units should be sent to a place fixed for the purpose,
(b). These should be dismantled,
(c). Goods and serviceable parts should be separated and taken into stock,
(d). Parts which can be made serviceable by further work should be separated and sent to the workshop and taken into
stock after the defects have been removed, and
(e). Parts which cannot be made serviceable should be collected in one place for being melted or sold.
4. Treatment of Defectives: Defectives are generally treated in two ways (a) They can be brought upto the standard by incurring further costs - additional material and labour,
(b) They can be sold as inferior products (seconds) at lower prices, where possible.
5. Control over Defectives: Control of defectives may cover the following two areas (a) Control over defectives produced.
(b) Control over re-working costs.
For exercising effective control over defectives produced and the cost of re-working, standards for normal percentage of
defectives and reworking costs should be established.
6. Spoilage vs Defectives: Spoilage cannot be repaired or re-conditioned. However, Defectives can be either, rectified and
transferred into standard production or sold as seconds.

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Accounting treatment for rectification costs of defective work


The costs of rectification or re-work may be treated in the following ways 1. When Defectives are normal and inherent in the process, they are (a). Charged to good products: The loss is absorbed by good units. This method is used when "seconds" have a normal
value, and defectives rectified into "seconds" or "first" are normal.
(b). Charged to Jobs: When defectives are normal and are easily identifiable with specific jobs, the work costs are
debited to the job
(c). Charged to General Overheads: When the defectives caused in one department are reflected only on further
processing, the rework costs are charged to general overheads
(d). Charged to the Department Overheads: If the department responsible for defectives can be identified then the
rectification costs should be charged to that department
2. When Defectives are Abnormal: If defectives are abnormal and are due to causes beyond the control of the Firm, the work
cost should be charged to Costing Profit and Loss Account.
LOSSES DUE TO OBSOLETE STORES
Meaning: Obsolescence is defined as the loss in the intrinsic value of an asset due to its supersession.
Situations: Materials may become obsolete under any of the following circumstances:
1. where it is a spare part or a component of a machinery used in manufacture and that machinery becomes obsolete
2. Where it is used in the manufacture of a product which has become obsolete
3. Where the material itself is replaced by another material due to either improved quality or fall in price.
Accounting treatment:
1. In case of obsolescence, steps should be taken for immediate disposal of such stores at the best possible price.
The net loss arising out of Obsolete Materials (i.e. Cost of Materials less NRV obtained, if any) is an Abnormal loss and does
not form part of the cost of manufacture.

Indicate whether the following statement are True of False, giving reason in one in one or two lines.
(1)

According to LIFO method of pricing, issues are close to current economics values.

(2)

Perpetual inventory system means continuous stocks taking.

(3)

Under the ABC analysis of material control, A stands for the highest.

Ans.

(i)

True, Issue of materials are made from the latest purchases.

(ii)

False, Continuous stock taking is a part of perpetual inventory system.

(iii)

False, A stands for highest value items.

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Chapter LABOUR
Write short notes on: Labour Turnover.
Labour Turnover: - Leaving and coming of workers in business organization gives rise to the phenomenon of labour
turnover. Labour turnover of an organization is the rate of change in its labour force during a specified period. This
rate of change is compared with an index which acts as there meter 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. A higher labour turnover reflects that the workers in the organization are new and inexperienced,
and it is a matter of concern to the organization. Also it accounts for an increase in cost of production end even
disturbs the even flow of production in the market.
To measure labour turnover, the following three methods, viz., (i) Separation method; (ii) Replacement method and
(iii) Flux method are available. Each method emphasizes on different aspects. But it is expected from business
concern that a particulars method may be used consistently to facilitates comparison of data from year to year. Labour
turnover may be calculated by using any one of the following formulae:Number of employees replaced
Labour turnover =

----------------------------------------- x 100
Average number of employees on roll
OR
Number of employees left

Labour turnover =

------------------------------------ x 100
Average number of employees on roll
OR
Number of Joining plus number of leaving

Labour turnover = -------------------------------------------------------- x 100


Average number of employees on roll

Causes of Labour turnover :- the main causes of labour turnover in an organization/ industry can be broadly classified under
the following heads:
(a)

Personal causes

(b)

Unavoidable causes

(c)

Avoidable causes

Remedial steps to minimize labour turnover. The following remedial steps are useful in minimizing labor turnover.
(a)

Exit Interview

(b)

Job analysis and evaluation

(c)

Scientific system of recruitment, selection, placement and promotion.

(d)

Enlightened attitude of management

(e)

Use of committee.

Discuss the two types of cost associated with labour turnover


Two types of cost which are associated with labour turnover are :-

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(1)

Preventive costs :- These include costs incurred to keep the labour turnover as a low level i.e., cost of
medical schemes. If a company incurs high preventive cost. The rate of labour turnover is usually low.

(2)

Replacement costs :- These are the costs which arise due to high labour turnover. If men leave soon after
they acquire the necessary training and experience of work, additional costs will have to be incurred on new
workers, i.e. cost of advertising, recruitment, selection, training and induction etc. caused due to the
inefficiency and inexperienced new workers.

It is obvious that a company will incur very high replacement costs if the rate of labour turnover is high. Similarly,
only adequate preventive costs can keep labour turnover at a low level. Each company must, therefore, workout the
optimum level of labour turnover keeping in view its personnel politics and the behavior of replacement costs and
preventive costs at various levels of labour turnover rates.
Impact of 'Labour Turnover' on a manufacturing organization's working.
Labour turnover refers to the rate of change in the composition of labour force of a concern during a specified period
of time. The impact of labour turnover on a manufacturing organisation's working is manifold.
(a)

Even flow of production is disturbed.

(b)

Cost of recruitment and training increases.

(c)

Breakage of tools, wastage of material increases.

(d)

Overall production decreases due to the time lost between the leaving recruitment of new workers.

(e)

Reduction in sales accounts for loss of contribution and goodwill consequently.

Distinguish Between Job evaluation and Merit rating.


Ans.

Job evaluation and merit rating :The main points of distinction between job evaluation and merit rating are as follows :(1)

Job evaluation is the ascertainment of the relative of jobs within a company and merit rating is the assessment of
the relative worth of the man behind a job. In other words, merit rating rates employees on their job while job
evaluation rates the jobs.

(2)

Job evaluation and its accomplishments are meant to set up a rational wage and salary structure whereas merit
rating provides a scientific basis for determining fair wages for each worker based on his ability and
performance.

(3)

Job evaluation simplifies wage administration by bringing a uniformity in wage rates. On the other hand, merit
rating is used to determine fare rate of pay for different workers on the basis of their performance.

Distinguish between Casual worker and outworker.


Casual worker and outworker :A worker who is appointed for a short duration to carry on normal business activities in place of regular but
temporarily absent worker. Such a worker is also known as daily wager or 'bad lies'. A casual worker do not enjoy the facilities
available to a regular worker.
A worker who does not work in the factory premises but either he works in his home or at a site outside the factory is
known as an outworker. An outworker who works in his home is usually compensated on the basis of his home is usually
compensated on the basis of his output. He is supplied with raw materials and tools necessary for carrying out the job. An
outworker (outside the factory) is usually on specialized jobs/contract work
Explain the meaning of and the reasons for "idle Time" and discuss its treatment in cost accounts.
Idle time refers to the labour time paid for but not utilized on production. It, in fact, represents the time or which wages are paid,
but during which no output is given out by the workers. This is the period during which no output is given out by the
workers. This is the period during which workers remain idle.
Reasons for idle time:- According to reasons, idle time can be classified into normal idle time and abnormal idle
time. Normal idle time is the time which cannot be avoided or reduced in the abnormal course of business.
The main reasons for the occurrence of normal idle time are as follows :2.

time taken by workers to travel the distance between the main gate of factory and the place of their work.

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3.

time lost between the finish of one job and starting of next job.

4.

time spent to overcome fatigue.

5.

time spent to meet their personal needs like taking lunch, tea, etc.

The main reasons for the occurrence of abnormal idle time are :1.

Due to machine break downs, power failure, non availability of raw materials, tools or waiting for jobs due to
defective planning.

2.

Due to conscious management policy decision to stop work for some time.

3.

In the case of seasonal goods producing units, it may not be possible for them to produce evenly throughout the
year. Such a factor too results in the generation of abnormal idle time.

Treatment in cost accounting :- Idle time may be normal or abnormal


Normal idle time :- It is inherent in any job situation and thus it cannot be eliminated or reduced.
The cost of normal idle time should be charged to the cost of production. This may be done by inflating the labour rate. It may
be transferred to factory overheads for absorption, by adopting a factory overhead absorption rate.
Abnormal idle time :- It is defined as the idle time which arises on account of abnormal causes e.g. strikes, lockouts; floods;
etc. such an idle is uncontrollable.
The cost of abnormal idle time due to any reason should be charged to costing profit and account.
Discuss the objectives of time keeping and time booking.
Objectives of time keeping and time booking :- Time keeping has the following two objectives
(a)

Preparation of Payroll:- Wages bills are prepared by the payroll departments on the basis of information provided by
the time keeping departments.

(b)

Computation of cost :- Labour cost of different jobs, departments or cost centers are computed by costing
departments on the basis of information provided by the time keeping department.
The objectives of time booking are as follows :(a)

To ascertain the labour time spent on the job and the idle labour hours.

(b)

To ascertain labour cost of various jobs and products.

(c)

To calculate the amount of wages and bonus payable under the wage incentive scheme.

(d)

To compute and determine overhead rates and absorption of overheads under the labour and machine
hour method.

Overtime premium. Explain the treatment of overtime premium in cost accounting. Suggest steps for controlling
overtime.
Overtime premium :- Overtime is the amount of wages paid for working beyond normal working hours as specified by
Factories Act by a mutual a agreements between the workers union and the management. According to Factories Act
of 1948, a worker is entitled for overtime at double the rate of his wages (including allowances) if he works beyond 9
hour in a day or 48 hours in a week. Even where the act is not applicable, the practice is to pay for overtime work at
higher rates usually in accordance with a standing agreement between the employer and the workers. Hence, payment
of overtime consists of two elements, the normal wages i.e., the usual amount, and the extra payments i.e. the
premium. This amount of extra payments paid to a workers under overtime is known as overtime premium.
Treatment of overtime premium in cost accounting
(a)

If the overtime is restored to at the desire of the customer, then the entire amount of overtime including
overtime premium should be charged to the job directly.

(b)

If it is due to a general pressure of work to increase the output, the premium as well as overtime wagers may
be charged wages may be charged to general overheads.

(c)

If it is due to the negligence or delay of workers of a particular departments, it may be charged to the
concerned department.

(d)

If it is due to circumstances beyond control, it may be charged to costing profit and loss account.

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Steps for controlling overtime:Important steps for controlling overtime work are as follows:(1)

Entire overtime work should be duly authorized after investigating the reasons for it.

(2)

Overtime cost should be shown against the concerned departments. Such a practice should enable proper
investigation and planning of production in future.

(3)

If overtime is a regular features, the necessity for recruiting more men and adding shift should be
considered.

(4)

If overtime is due to lack of plant and machinery or other resources, steps may be taken to install more
machines, or to resorts to sub contracting.

What do you mean by time and motion study? Why is to so important to management?
Time and motion study :- it is study of time taken and motions (movements) performed by workers while performing their
jobs at the place of their work. Time and motion study has played a significance role in controlling and reducing
labour cost. Time study is concerned with the determination of standard time required by a person of average ability to
perform a job. Motion study on other hand, is concerned with determining the proper method of performing a job so
that there are no wasteful movements, hiring the worker unnecessarily. However, both the studies are conducted
simultaneously. Since materials, tools equipment and general arrangements of work, all have vital bearing on the
method and time required for its completion. Therefore, their study would be uncompleted and would not yield its full
benefit without a proper consideration of these factors.
Time and motion study is important to management because of the following features:1.

Improved methods, layout, and design of work ensures effective use of men, materials and resources.

2.

Unnecessary and wasteful methods are pin pointed with a view to either improving them or criminating them
altogether. This leads to reduction in the work content of an operation, economy in human efforts and reduction
fatigue.

3.

Highest possible level of efficiency is achieved in all respect.

4.

Provides information for setting labour standards a steps towards labour costs control and cost reduction.

5.

Useful for fixing wage rates and introducing effective incentive scheme.

Discuss the effect of overtime payment on productivity.


Overtime work should be restored to only when it is extremely essential because it involves extra cost. The overtime payments
increase the cost of production in the following ways.
1.

The overtime premium paid is an extra payment in addition to the normal rate.

2.

Time and thus the output during normal output.

3.

In order to earn more the workers may not concentrate on work during normal time and thus the output during normal
hours may also fall.

4.

Reduction output and increased premium of overtime will bring about an increase in costs of production.

State the circumstances in which in which time rate system of wage payment can be preferred in a factory.
Circumstances in which time rate system of wage payment can be preferred:
In the following circumstances the time rate system of wage payment is preferred in a factory:
(a)

Persons whose services cannot be directly or tangibly measured, e.g. general helpers, supervisory and
clerical staff etc.

(b)

Workers engaged on highly skilled jobs or rendering skilled services, e.g. tool making, inspection and
testing.

(c)

Where the pace of output is independent of the operator, e.g. automatic chemical plants.

How are payments to workers in respect of over-time work and set-up time treated in cost Account?

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Overtime Wages. Sometimes workers work for an extra time over and above the normal hours of work. According to the
Indian Factories Act 1948, overtime is the time worked for more than nine hours per day or 48 hours per week.
Usually, for overtime has to be paid double the normal rate of payment. This coupled with the fact that overtime
comes at the end of the day, when fatigue has set in, should make it clear that the jobs done in overtime are rather
costly. This is because of higher rate of wage payment, low productivity and additional expenses on lighting etc. The
Production manager or some higher authority should authorize the overtime because there is a danger that workers
may develop that as a habit.
The following treatment should be given to overtime wages in the following cases :
-

Overtime required because of some abnormal conditions like floods, earthquakes etc. should be charged to
Costing Profit & Loss A/c.

Overtime when required for seasonal pressure should be taken as an item of factory overheads.

When overtime is direct i.e. can be identified with individual jobs, it should be charged entirely to that particular
job or work/order concerned.

When Overtime is required to make with any shortfall in production due to some fault of management or some
unexpected development, it should be charged to Costing Profit & Loss A/c.

Indicate whether the following statements are True or False:

Ans.

(i)

Overtime premium paid to all factory workers is usually considered direct labour.

(ii)

Period costs are invariable and re expenses out as and when the inventory is sold.

(iii)

Idle facility and idle time are the same.

(i)

False

(ii)

False

(iii)

False

State the purpose served by the Time Keeping and Time booking records of a factory.
Time keeping and Time booking records serve the following purposes:
(i)

It completes the attendance records of the company

(ii)

It helps in calculating the wage/salaries of workers.

(iii)

Labour cost of each job can be easily calculated.

(iv)

It helps in exercising control on labour time and productivity.

Normal Idle Time.


The Normal idle time is almost unavoidable and the employer has to bear its cost. This is the time lost in
-

coming from the gate of the factory to the department in which the worker is engaged; or

going from one job to another; or

getting from the department to the factory gate at the closing times or intervals; or

personal needs and tea-breaks

Such normal idle time is calculated by comparing the time card with the job card and it may be treated in any these
two ways :
-

It may be treated as an overhead expense because no particular job has benefited out of it; or

The jobs should be charged at a rate higher than the actual rate paid to the worker in order to recover the cost of
the normal idle time.

Out of these the second method is better. It is so because under the first method if the wages paid for idle time are
treated as overheads then even those jobs, which have not used this class of workers, have to bear a part of the
overheads.
Abnormal Idle Time.

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Such abnormal idle time arises because of the following causes :


-

Strikes

Lock-outs

Machinery break-down or power failure

Non-availability of jobs or materials

The abnormal idle time may be treated as a loss rather than a cost. Hence, it may be charged to the Closing Profit &
Loss Account.

Chapter Overheads
Meaning of overhead

Overhead costs are the operating costs of a business enterprise which cannot be traced directly to a
particular unit of output.

Overhead may be defined as the cost of indir ect materials, indirect labour and such other expenses
including services as cannot conveniently be charged direct to specific cost units.

C.I.M.A., London, Terminology gives a very simple definition of overhead as an aggregate of indirect
materials, indirect wages and indirect expenses.

Difference between allocation and apportionment of overheads.


Allocation of overheads:Allocation is the process of charging the full amount of overhead costs to a particular cost centre. This is
possible when the nature of expenses is such that it can be easily identified with a particular cost centre. For
example, the salary paid to a foreman of a particular production department can be directly identified with that
department and therefore it will be directly charged t o that department.
Apportionment of overheads:It is process of splitting up an item of overhead cost and charging it to the cost centers on an equitable basis.
This is done in case of those, overhead items which cant allocated to a particular department . For example
salary paid to the works manager of the factory cannot be charged wholly to a particular production department
but will have to be charged to all departments of the factory on an equitable basis.
Give some bases of Allocation & Apportionment of O/H.
1.

Overhead Costs

Bases of Apportionment

2.

Rent

Flora area

3.

Repair and maintenance of building

Flora area

4.

Heating and lighting

Flora area

5.

Air conditioning

Flora area

6.

Indirect material

Direct material

7.

Depreciation

Asset Value

8.

Insurance

Asset Value

9.

Repair and maintenance of plant

Asset Value

10.

Supervision

Number of workers

11.

Supervision

Number of workers

12.

Canteen expenses

Number of workers

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13.

Employee welfare expenses

Number of workers

14.

Personnel overheads

Number of workers

15.

Indirect Labour

Direct Labour /Wage Bill

16.

Employers contribution to PF & ESI

Direct Labour /Wage Bill

17.

Workmen compensation

Direct Labour / Wage Bill

18.

Stores overhead

Number of material requisition

19.

Misc. expenses

Direct material or direct labour or prime cost

20.

Crane expenses

Number of hours crane worked in departments

21.

General overheads

labour hours or machine hours

22.

General machine expenses

Value of plant & machinery

23.

Power

Horse power of machine or


H.P x hours worked

24.

Leave with pay

Direct Labour / Wage bill

25.

Gratuities

Direct Labour /Wage Bill

Service Department

Bases of Apportionment

1.

Stores Deptt.

No.of material requisitions

2.

Personal Deptt.

No. of employees

3.

Purchase Deptt.

Value of materials purchased or No.of purchase orders

4.

Welfare Deptt.

No. of employees

5.

External transport

Ton miles, truck miles, no. of package

6.

Tool room expenses

Direct labour hours

8.

Inspection expenses

Hours spent on inspection or value of output

Treatment of interest on capital in cost accounts.


Arguments for the inclusion of interest on capital in cost accounts.
(A)

Interest is the cost of capital as wages are the reward for labour. Both are factors of production
and, therefore should not be treated differently in co st accounts. While determining the total
cost, interest like wages should be included in the cost of production.

(B)

The exclusion of interest from cost accounts, particularly in businesses where raw material is
used in different states of readiness would distort costs and render their comparison a difficult
one.

(C)

Profit on different jobs/operation requiring different periods for completion may not be
comparable if interest on capital is not included in their total cost.

(D)

Sometime exclusion of interest cost may lead the management to take wrong decisions.

(E)

The significance of time value of money is recognized only when interest is treated as in
element of cost

What is notional rent of a factory building? Give one reasons why it may be included in c ost accounts.
Notional Rent :- It is a reasonable charges raised in the cost accounts for the use of owned premises. One
reason for the use of such a nominal charge is to enable comparison between the cost of items made in
factories which are owned and in rented factories. However, it may be noted that the case of owned
factory cost for the same is accounted for by means of depreciation.

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How do you deal with the following in cost accounts?


(i)

Research and Development Expenses

(ii)

Fringe Benefits.

Ans.(i) Reasons and development Expenses: - Research and development expenses is the expenses incurred for
searching new or improved products, production methods/ techniques or plants/equipments. Research
expenses may be incurred for carrying basic or applied r esearch. Both basic and applied research relates
to original investigations to gain from new scientific or technical knowledge and understanding, which
is not directed towards any specific practical aim (under basic research) and is directed towards a
specific practical aim or objective (under applied research).
Treatment in cost accounts :- expenses of basic research (if it is a continuous activity) be charged to the
revenues of the concern. It may be spread over a number of years if research is not a cont inuous activity
and amount is large. Expenses of applied research, if relates to all existing products and methods of
production then it should be treated as a manufacturing overheads of the periods during which it has
been incurred and absorbed. Such expenses are directly charged to the product, if it is solely incurred
for it.
If applied research is conducted for searching new product or methods of production etc., then the
research expense treatment depends upon the outcome of such research.
Development expenses begins with the implementation of the decision to produce a new or improved
product or improved method. The treatment of development expenses is same as that of applied
research.
(ii)

Fringe benefits :- In every organization, workers are paid some benefits in additional to their normal
wage or salary. These additional benefits are popularly called benefits. They include:
(a)

Housing

(b)

Children education allowances

(c)

Holiday pay

(d)

Leave pay

(e)

Leave travel concession to home town or any place in India etc.

Expenses incurred on factory workers should be treated as factory overheads and apportioned among the
production and services departments on the basis of number of workers in each department.
Fringe benefits to office and selling and distribution staff be treated as administration overheads and
selling and distribution overheads respectively and recovered accordingly.

Blanket overheads rate. In which situations, blanket rate is to be used any why?
Blanket overheads rate is one single overheads absorption rate for the whole factory. It may be computed by
using the following formulae:
Blanket overhead rate

- overhead costs for the whole factory


Total units of the selected base

Situations for using blanket rate:The use of blanket rate may be considered appropriate for factories which produces only one major
product on a continuous basis. It may also be used in those units in which all products utilize same
amount of time in each department. If such conditions do no t exist, the use of blanket rate will give
misleading results in the determination of the production cost, specially when such a cost ascertainment
is carried out for giving quotations and tenders.
How do you deal Bad Debts in cost accounts?
Bad Debts:- There is no unanimity among various author about the treatment of bad debts. Some authors believe
that bad debts are financial losses and therefore should not be included in the cost of a particulars
product or job. Another view is that, bad debts are a part of selling and distribution overheads,
especially where they arise in the normal course of trading. Therefore they should be treated in cost

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accounts in the same way as any other selling and distribution expenses.
Training costs.
Training costs:- these costs comprises of wages and salaries of the trainees or learners, pay and allowances of
the training and teaching staff, payments of fees etc. for training or for attending courses of studies
sponsored by outside agencies and cost of materials, tools and equipments used for training, costs
incurred for running the training department, the losses arising due to the initial lower production, extra
spoilage etc. occurring while providing training facilities to the new recruits. All these costs are booked
under separate standing order numbers for the various functions. Usually there is a service cost center,
known as the training sections, to which all the training costs are allocated. The total cost of training
section is thereafter apportioned to production c enters.
Single and multiple overheads rates.
Single overhead rate :- it is one single overhead absorption rate for the whole factory. It may be computed as
follows:
Single overhead rate = Overhead costs for the entire factory
Total quantity of the base selected
The base can be total output, total labour hours, total machines hours etc. The single overhead rate may
be applied in factories which produces only one major product on a continuous basis. It may also be
used in factories where the work perform in each department is fairly uniform and standardized.
Multiple overheads rates:- it involves computations of separates rates for each production department,
services departments, cost center and each product for both fixed and variable overheads, it may be
computed as follows:Overhead allocated / apportioned to each departments cost center or product
Multiple overheads rate:- -

Corresponding base

Under multiple overhead rates, jobs or products are changed with varying amount of factory overheads
depending on the type and number of departments through which they pass. However the number of
overheads rates which a firm may compute would depend upon two opposing factories viz., the de gree
of accuracy desired and the clerical cost involved.
Fixed cost does not charge in the same proportion in which output changes (T / F) .
True. Total fixed cost does not change when output changes.

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CHAPTER JOB AND BATCH COSTING


Distinguish betw een Job costing and process costing .
Job Costing

Process Costing

1. Job costing is specific order costing.

1. Process costing is a method of costing used


to ascertain the cost of a product at each
process or stage of manufacture.

2. Cost here is determined on job basis.

2. Costs are accu mulated for each process


separately for a given period of time.

3. Each job needs special treatment and no two


jobs are like.

3. Finished products of one process becomes


the raw materials for the next process.

4. The cost of each job is compiled separate ly


by adding materials, labour and overheads
costs.

4. The unit cost here is the average cost of the


process for a given period. Its correct
computation requires the measurements of
production at various stages of manufacture.

5. Costs are computed when j ob is completed.

5. Costs are computed for each process at the


end of each period.

6. As each job is distinct or is of different


nature, more detailed supervision and control
and necessary

6. As the processes operations are standardized,


accumulation of c osts and supervision and
control are comparatively easier.

Describe job costing and batch costing giving examples of industries w here these are used.
Job costing : It is a method of costing which is used when the work is undertaken as per the customers
special requirements. When an inquiry is received form the customers costs expected to be incurred on
the job are estimated and on the basis of the estimate, a price is quoted to the customer. Actual cost of
materials, labour and overheads are accumulate d and on the completion of job, these actual costs are
compared with the quoted price and thus the profit or loss on it is determined. Job costing is applicable
in printing press, hare ware, ship -building, heavy machinery, foundry etc.
Batch costing : It is variant of job costing. Under batch costing, a lot of similar units which comprises
the batch may be used as a unit for ascertaining cost. In the case of batch costing separate cost sheets are
maintained for each batch of products by assigning a batch nu mber. Cost per unit in a batch is
ascertained by dividing the total cost of batch by the number of units produced in that batch. Such a
method of costing is used in the case of pharmaceutical or drug industries, readymade garments
industries, industries ma nufacturing electronics parts of T.V. and radio sets etc.
Nature of accounting proble ms associated w ith job costing.
Job costing : Job costing is used in that type of production where work is done against orders and
instructions from customers. To asce rtain the cost of each job, a separate account is prepared for each
job to ascertain its cost and profit. For this purpose each job is given one job number. Direct materials
and wages are charged to each job on actual costs basis while overheads are charge d on a pre -determined
rate by one of the methods of absorption of overhead. In this wa y total cost of a job is ascertained. This
total cost is compared with the sale price of the job to ascertain profit or loss on the job.
Batch costing.
This is a va riation of job costing. While job costing is concerned with costing of jobs made to a
customers particular requirements, batch costing is used when production involves limited repetition
work and a definite number of articles are manufactured in each batc h to be held in stock for sale to
customers generally. Thus a batch is cost unit consisting of a group of identical items.
Batch costing is applied in the manufacture of shoes, toys, readymade garments, components parts of,
cars, radios, watches, etc.
Concept of Economics Batch Quantity (EBQ).

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Ans.
Economics batch Quantity : production is usually done in batches and each batch can have any
number of units of a components in it. The optimum quantity for a batch is that quantity for which the
setting up and c arrying costs are minimum. Such an optimum quantity is known as Economic batch
quantity. The formula used to determine the economic batch quantity (EBQ) is :

Economic Batch Quantity

2.U.S.
C

where,
EBQ = Economics batch quantity
U = Demand of the componen ts in a year
S = Setting up cost per batch
C = Carrying cost p.u. per annum.
*********

CHAPTER CONTRACT COSTING

What is contract costing?


Meaning of Contract Costing
Contract costing is that form of specific order costing under which each contract is treated as
cost un it and costs are accumulated and ascertained separately for each contract.
Basic Features of Contract Costing

(a)

Each contract is treated as cost unit.

(b)

All costs are accumulated and ascertained for each contract.

(c)

A separate Contract Account is pr epared for each contract and is assigned a certain
number by which the contract is identified.

(d)

Work on contracts is usually executed at the site of the contract.

(e)

Direct costs usually constitute a major portion of the total cost of the contract.

(f)

Indirect costs usually constitute a small portion of the total cost of the contract.

(g)

The numbers of contracts undertaken by a contractor at a time is not usually very large.

In w hich industries contract costing is applied


Contract costing is applied in :(a)

Industries engaged in the construction of building, roads, bridges or other construction


work

(b)

Industries undertaking engineering projects.

Number of parties involved in a contract


There are two parties involved in a contract viz.
(a)

The contractor the person who undertakes the contract and

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(b)

The contractee the person who assigns the contract.

Distinction betw een job costing and contract costing


Basis of Distinction

Job Costing

Contract costing

1 . Cost unit

Each job is treated as a


unit.

2. Execution of w ork

Job work is executed


factory pre mises.

cost

Each contract is treated as a


cost unit.

in

Contract work is executed at


the site of contract.

3. Indirect costs

Indirect costs are higher that


those under contract costing.

Indirect costs are low er than


those under job costing.

4. Pricing

Pricing
is influenced by
individual
condition
and
general
policy
of
the
organization.

Pricing is influenced by the


specific
clauses
of
the
contract.

5. Size

Size of a job is s maller than


that of a contract.

Size of a contract is larger


than that of a job.

6. Number

The numbers
usually large.

The
number
of
contracts
undertaken are usually s mall.

of

jobs

are

Meaning of w ork certified


Work certi fied is that portion of the work completed which has been certified / approved by the
contractees architect or surveyor. It is valued in in terms of contract price.
Meaning of w ork uncertified
Work uncertified is that portion of the work completed which has not been certified / approved
by the contractees architect or surveyor. It is valued at cost.

Short notes on Escalation clauses


This clause is always provided in a contract to safeguard the interest of the contractor against
any rise in price of materials and rates of labour and their increased utilization. If the prices of
materials and rates of labour increase during the period of the contract beyond a certain defined
level, the contractor will be compensated to the extent of a portion thereof. The contractor has to
satisfy the contractee about his claim for compensation in respect of prices and utilization of
material and labour.

Write notes on Cost Plus Contracts


M ain features of cost - plus - contracts:
The main features of cost - plus contracts are as follows: 1.

This method is adopted in the case of those contacts where the probable cost of the
contracts can not be ascertained in advance with a reasonable accuracy.

2.

These contracts are preferred when the cost of material and labour is not steady and the
contract completion may take number of years.

3.

The different costs to be included in the execution of the contract are mutually agreed,
so that no dispute may rise in future in this respect. Under such type of contracts
contractee is allowed to check or scrutinize the concerned books, documents and
accounts.

4.

Such a contract offers a fair to the contractee and also a seasonal profit to the
contractor.

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5.

The contactor price here is ascertained by adding a fixed and mutually pre - decided
component of profit to the total cost of the work.

Principles to be follow ed w hile taking credit for profit on incomplete contracts.


Principal to be followed while taking credit for profit on incom plete contacts: The portion of profit, to be cr edited to, profit and loss account should depend on the stage of
completion of the contact. This stage of completion of the contract should refer to the credited
work only. For this purpose, uncertified work should not be considered as far as possible. For
determining the credit for profit, all the incomplete contracts should be classified into the
following four categories.
(1)

Contract less than 25% categories.

(2)

Contract between 25% and 50% complete.

(3)

Contracts between 50% and 90% complete

(4)

Contracts nearing completion, any between 90% and 100% complete.

(a)

Contract less than 25% c ategories : If the contract has just started or it is less than
25% complete, no profit should be taken into account.

(b)

Contract betw een 25% and 50% complete : In this case one thir d of the national profit
reduced in the ratio of cash received to work certified, may be transferred to the profit
and loss account. The amount of profit to be transferred to the profit and loss account
ma y be determined by using the following formula:

1 Cash received
Or alternative National profit
3 Work certified
(c)

Contracts betw een 50% and 90% c omplete : In this case, two third of the notion
profit, reduced by the portion of cash received to work certified may be transferred to
the profit and loss account. In this case the formula to be used is as under :

2 Cash received
Or alternative National profit
3 Work certified
(d)

Contracts nearing comple tion, any betw een9% and 100% complete : When a contact
is nearing completion or 90% or more work has been done on a contract. The amount of
profit to be certified to profit and lo ss account may be determined by using any one of
the following formula:

Estimated Pr ofit

Work certified
Contract price

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CHAPTER : PROCESS COSTING


What is Process Costing?
Meaning of Process Costing
Process Costing is a method of costing under which the all costs are accumulated for each stage of production (also
called process of production) and the cost per unit of product is ascertained at each stage of production by dividing the
total cost of each process by the normal output of that process.
CIMA, London, defines process costing as that form of operation costing which applies where standardized goods
are produced.
Basic Features of Process Costing
(a)

The production is continuous

(b)

The product is homogenous

(c)

The processes are standardized

(d)

The output of one process becomes the input of another process

(e)

The output of the last process is transferred to Finished Stock Account

(f)

Costs are collected process wise

(g)

Cost per unit is calculated at the end of period by dividing the total process cost by the normal output produced

In which Industries Process Costing is applied


Process Costing is applied in those industries where manufacturing activity is carried on continued by means of two or
more processes and the output of one process becomes the input of the following process till completion. It is
generally applied in :

(a)

Paper Industries

(b)

Chemicals Industries

(c)

Textiles Industries

(d)

Sugar Industries

(e)

Crude oil Refineries

Distinction between job costing and process costing


Basis of Distinction

Job Costing

Process Costing

1. Specific orders

Job is performed against specific


orders

Production is continuous

2. Nature

Each job may be different

Product
is
standardized

3. Cost centre

The cost centre is a job.

The cost centre is a process

4. Cost Ascertainment

Costs are collected and ascertained


for each job separately

Cost are collected and ascertained for


each process separately.

5. When cost are calculated?

Job costs are calculated only when a


job is completed.

Process costs are calculated at the


end of each period.

6. WIP

There may or may not be work-inprocess

There is always some work in


process because of continuous
production.

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7. Degree of control

Higher degree of control is required


because of heterogeneous jobs.

Lower degree of control is required


because of homogenous products and
standardized process.

8. Transfer

There are usually no transfers from


one job to another unless there is
some surplus work.

The output of one process is


transferred to another process as
input.

The percentage of wastage in each case is computed on the basis of Number of units entering the process concerned.
The wastage of each process has a scrap value. The wastage of process A and B is sold at Rs. 1 per unit and that of
process C at Rs.4 per unit.

Procedure for valuation of work-in-process.


Definition of Cot Adult : It is defined as the verification of cost accounts and a check on the adherence of Cost Accounting plan.
It in fact comprises of :
(i)

The verification of cost accounting records such as accuracy of the cost accounts, cost reports, cost statements, cost
data, costing techniques.

(ii)

Examining cost accounting records to ensure that they adhere to the cost accounting principles, plans, procedures and
objectives.
In other words, the Cost Auditor ensures that the cost accounting plan is in accordance with the objectives established
by the management and in conformity with the appropriate system of cost accounting. Broadly, the purpose of cost
audit can be classified as (i) Protective and (ii) Constructive.
Protective purpose : It examines that there is no undue wastage or losses and the costing system brings out the correct
and realistic cost of production or processing.
Constructive purpose : It provides management with information useful in regulating production, choosing
economical methods of operation, reducing operations costs and reformulating plants etc.

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CHAPTER

JOINT PRODUCT / BY PRODUCT

MEANING OF JOINT PRODUCT


Joint Products represent two or more products of almost equal importance which are produced in natural proportions
simultaneously from the same material in the same process. These products may be saleable without further
processing or after further processing.
Features of Joint Products
(a)

Joint products are of almost equal importance. In other words, no single one of them can be regarded as the main
product.

(b)

These are produced in natural proportions. In other words, proportion of such products can not be changed at the
will of the management.

(c)

These are produced simultaneously from the same material.

(d)

These are produced simultaneously in the same process.

Examples of Joint Products


Industry

Job Product

(a) Oil refining

Gasoline, petrol, diesel, paraffin wax, coal tar, kerosene etc.

(b) Flour mill

White flour, brown flour, animal feeding stuff

Meaning of co-products
Co-products represent two or more products which are contemporary but are not necessarily produced in natural
proportions from the same material in the same process. For example, wheat and grain produced in two separate farms
with separate processing of cultivation. Similarly, timber boards made from different trees are co-products.
Distinction between joint products and co-products
Joint products can be distinguished from co-products in the following respects:
Basis of distinction

Joint products

Co-products

(a) Proportion

These are produced in natural

These are not produced in

proportions which can not be

natural proportion. Proportion

changed by the management

of such products can be


changed by the management.

(b) Material

These are produced from the

These need not necessarily be

same material.

produced from the same


material.

(c) Process

These are produced

These need not necessarily be

simultaneously in the same

produced in the same process.

process.
(d) Importance

These are of almost equal

These need not necessarily be

Importance

of equal importance.

Meaning of By-Products

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By-Products are products of relatively small value which emerges incidentally in the course of manufacturing the
main product.

Features of By-Products
(a)

By products are of relatively small value.

(b)

These emerge incidentally in the course of manufacturing the main product.

Examples of By-Products
Industry

Main Product

By-Products

1. Sugar

Sugar

Malasses, Bagasse

2. Cotton

Cotton

Cotton Seed

3. Rice Mill

Rice

Husk

Distinction between Joint Products and By-Products


Basis of Distinction
1. Value

2. Production

Joint Products

By-Products

These are of almost equal

These are of relatively small

Value

value

These are produced

These emerge incidentally in

simultaneously

the course of manufacturing


the main product

Tutorial Notes :
(i)

The management may decide to treat all products produced as joint products or one product as main product and other
products as By-Products

(ii)

The same product may be a joint product in one industry and a By-Products in another industry.

METHODS OF APPORTIONING JOINT COSTS OVER JOINT PRODUCTS


The various methods of apportioning joint costs over joint products are as follows:
(1)

Physical Unit Method

(2)

Average unit cost method

(3)

Survey method / point values method

(4)

Contribution margin method

(5)

Market value at separation point method

(6)

Market value after further processing method

(7)

Net relisable value method

(8)

Reverse cost method

(1)

Physical unit method : Joint costs are apportioned on the basis of physical volume of the joint products at the split
off point. Any processing loss is also apportioned over the products on the same basis.

(2)

Average unit cost method : Joint costs are apportioned on the basis of average cost per unit which is obtained by
dividing the total joint costs by total number of units of joint products produced.

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Average cost per unit

Total Joint Costs


Total No. of Units of Joint Pr oducts

(3)

Survey / method / point values method : Joint costs are apportioned on the basis of point values/ percentages
assigned to the products according to their relative importance. The point values / percentage are based on the
technical survey of all the factors affecting the production and distribution of joint products.

(4)

Contribution margin method :


(1) The variable portion of total joint cost is apportioned on the basis of physical volume of products produced ratio.
(2) The fixed portion of total joint cost is apportioned on the basis of contribution margin ratio.
Contribution margin is the difference between the total sales value and total variable cost.

(5)

Market value at separating point method : Joint costs are apportioned in the ratio of market value of joint products
at the separation point.

(6)

Market value after further processing method : Joint costs are apportioned in the ratio of market value of the joint
products after further processing.

(7)

Net Realizable value method : Joint costs are apportioned in the ratio of net realizable values of the joint products at
the separation point. Net realizable value is computed as follows:

A Sales value after further processing

--

B Less : Further processing costs

--

C Net realizable value (A-B)

--

(8)

Reverse cost method : Joint costs are apportioned in the ratio of net values of the joint products at the separation
point. Net value is computed as follows:

A Sales value after further processing

--

B Less Estimated profit

--

C Total cost of sales (A-B)

--

D Less : Selling and distribution expenses

--

E Total cost of goods sold (C-D)

--

F Less : Further Processing Costs

--

G Net Value (E-F)

--

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CHAPTER : Inter-firm Comparision


Meaning of Inter-firm Comparison :
Inter-firm comparison consists of voluntary exchange of information pertaining to the various aspects of the
participating firms (like costs, productivity, profitability etc.) among the firms engaged in a similar business, so as
to increase the efficiency of the firms concerned and the overall efficiency of the industry.
Inter-firm comparison is a technique of evaluating the performances, efficiencies, costs and profits of a firm with
those of other firms in the industry. The process of evaluation is carried out by a neutral body, like a trade association.
It enables the participating firm to compare its performance with that of the most efficient firm.
Inter-firm comparison follows the principle of "comparing like to like" and this is possible only a uniform costing
system in use. Thus, uniform costing system is a pre-requisite to inter-firm comparison.
Procedure for Inter-firm Comparison:
The following procedure is adopted for inter-firm comparison :
i.

Information is collected from the participating firms by a central body like a trade association.

ii.

The information so collected is analysed and presented in such a manner that the secrecy of the information
supplied by the partcipating firms is maintained.

iii.

Only relevant information is provided to a participating firm so that, that firm can use the information to
improve it's efficiency.

Pre-requisites for Inter-firm Comparison :


i.

Uniform costing system - As discussed earlier, a good uniform costing system is a pre-requisite to inter-firm
comparison. For developing such a system, active co-operation is required from all the participating firms.

ii.

Central Body for inter-firm comparison - The responsibility of collecting, analysing and disseminating
information from the participating firms needs to be entrusted to a neutral body. In India, this responsibility
is entrusted to trade associations, manufacturing associations, Chamber of Commerce and Industry and
National Productivity Council. Besides collecting and supplying information, such an entity also undertakes
research and development activities for the common benefit of all the firms. It also conducts various
training programmes for its member firms.

iii.

Varied membership - For a purposeful and successful inter-firm comparison, it is essential that firms of
different sizes become members of the Central Body.

iv.

Nature and extent of information to be collected - Though there is no limit to collecting information, the
extent of information required to be collected depends upon the demand for such information, comparative
value of the information and the efficiency of the central body. Collection of mass data or irrelevant data
should be avoided as otherwise it will give rise to confusion and additional cost to the member firms.
Though there is no standard list of information to be collected, normally, the following data is procured by
the central body from it's member firms :
a.

Information pertaining to costs and cost structures

b.

Raw material consumption

c.

Labour efficiency and utilisation

d.

Machine efficiency and utilisation

e.

Method of production

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f.

Inventory control

g.

Technical aspects

h.

Return on capital employed

i.

Return on net worth

j.

Reserves and appropriation of profits

k.

Liquidity position

l.

Debtors and Creditors etc.

v) Method of collection and presentation of information - The methodology for collection and dissemination of
information should be clearly laid down. Normally, the central body collects the information at fixed intervals, like
quarterly, half-yearly or annually. This information is collected via specific forms or questionnaires. The information
to be supplied by the member firms is normally in ratios. Absolute figures are not collected so as to safeguard the
secrecy of the data supplied by the member firms. Such information collected is analysed and presented in the form of
a report. This report is made available only to member firms.
Advantages of Inter-firm Comparison :
i.

The standing of each member in the industry is ascertained. The weaknesses and the reasons for the same
are highlighted. This facilitates the management to take remedial action and improve the efficiency of their
firm.

ii.

By ranking the members, an atmosphere of healthy competition is created, whereby each member tries to
better it's competitor's achievement.

iii.

Healthy competition in turn benefits the consumers.

iv.

Inter-firm comparison promotes cost-consciousness among the members of the industry.

v.

It helps the Government in price regulation.

vi.

It enables the Government to grant protection/concession to the industry, if necessary.

vii.

Since the evaluation of the participating firms is done by a neutral body, the report generated is unbiased.

Limitations of Inter-firm Comparison :


i.

The information may not be forthcoming from the members due to lack of organisational secrecy.

ii.

Even the data submitted by the members may not be fully accurate due to the above-mentioned reason.

iii.

In absence of a uniform costing system, inter-firm comparison is meaningless.

iv.

Non-availability of a suitable basis of comparison poses a problem for the introduction of a system of interfirm comparison.

Uniform Costing
Meaning of Uniform Costing :
Uniform Costing is not a specific method of costing. It is only a system where several undertakings use a common set
of costing principles, practices and procedures. The main objective of uniform costing is that the different
undertakings in an industry should adopt a common method of costing and apply uniformly, the same principles and
techniques so as to facilitate better cost comparison and cost control.
CIMA defines uniform costing as "the use by several undertakings of the same costing system, i.e., the same basic
costing methods, principles and techniques."

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Applications of Uniform Costing :


The need for application of uniform costing arises in the following circumstances :
i.

When a single undertaking has a number of factories located at different locations and produces similar
products or performs similar operations - Though the products manufactured / processes performed are
identical, the cost of products / processes is bound to vary due to difference in location. Unless uniform
costing is applied, it will be very difficult to compare the costs of products / processes at different factories.

ii.

When a number of undertakings are members of a trade association Members of the association are required to maintain uniform costing records. This ensures that cost data
submitted by members is comparable and consistent. It also enables the trade association to fix common
prices for the whole industry and measure the operating efficiency of the members.

Objectives of Uniform Costing :


The main objectives of uniform costing are summarised as follows :
i.

To generate reliable cost data for inter-unit or inter-firm cost comparison.

ii.

To improve the operational efficiency of individual units by comparing the efficiency of units with each
other / overall performance of the industry.

iii.

To facilitate control on fixed costs.

iv.

To provide relevant cost data to the Government for fixing and regulating the prices of the products.

v.

To eliminate unhealthy competition among the different units.

vi.

To bring about standardisation in the operations of different units.

vii.

To reveal lines of individual products which have been discovered to be unprofitable.

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CHAPTER : Marginal Costing

The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively
small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the
decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them
in the short term.
Marginal costing - definition Marginal costing distinguishes between fixed costs and variable costs as conventionally
classified.
The marginal cost of a product is its variable cost. This is normally taken to be; direct labour, direct material, direct
expenses and the variable part of overheads.
Marginal costing is formally defined as:
the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full
against the aggregate contribution. Its special value is in decision making. (Terminology.)
The term contribution mentioned in the formal definition is the term given to the difference between Sales and Marginal cost.
Thus
MARGINAL COST = VARIABLE COST DIRECT LABOUR
+
DIRECT
MATERIAL
+
DIRECT
EXPENSE
+
VARIABLE OVERHEADS
CONTRIBUTION = SALES - MARGINAL COST
Note Alternative names for marginal costing are the contribution approach and direct costing
Marginal cost means the cost of the marginal or last unit produced. It is also defined as the cost of one more or one less unit
produced besides existing level of production. In this connection, a unit may mean a single commodity, a dozen, a gross or any
other measure of goods.
For example, if a manufacturing firm produces X unit at a cost of Rs 300 and X+1 units at a cost of Rs 320, the cost of an
additional unit will be Rs 20 which is marginal cost. Similarly if the production of X-1 units comes down to Rs 280, the cost of
marginal unit will be Rs 20 (300280).
Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown
separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like
process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of
management which tries to find out an effect on profit due to changes in the volume of output.
The principles of marginal costing
The principles of marginal costing are as follows.
a. For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the
level of activity is within the relevant range). Therefore, by selling an extra item of product or service the following
will happen.

b.

Revenue will increase by the sales value of the item sold.

Costs will increase by the variable cost per unit.

Profit will increase by the amount of contribution earned from the extra item.

Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the
item.

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c.

Profit measurement should therefore be based on an analysis of total contribution. Since fixed costs relate to a period
of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a
share of fixed costs.

d.

When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed
costs are unaffected, and no extra fixed costs are incurred when output is increased.

Features of Marginal Costing


The main features of marginal costing are as follows:
1. Cost
Classification
The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost
on the basis of which production and sales policies are designed by a firm following the marginal costing technique.
2. Stock/Inventory
Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the
total unit cost under absorption costing method.
3. Marginal
Contribution
Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution
is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products
or departments.
Advantages and Disadvantages of Marginal Costing Technique
Advantages
1. Marginal costing is simple to understand.
2.

By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.

3.

It prevents the illogical carry forward in stock valuation of some proportion of current years fixed overhead.

4.

The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken
would yield the maximum return to business.

5.

It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate
overhead recovery rate.

6.

Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be
concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management.

7.

It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs.
Comparative profitability and performance between two or more products and divisions can easily be assessed and
brought to the notice of management for decision making.

Disadvantages
1. The separation of costs into fixed and variable is difficult and sometimes gives misleading results.
2.

Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is
gained by marginal costing.

3.

Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories
affect profit, and true and fair view of financial affairs of an organization may not be clearly transparent.

4.

Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost
data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.

5.

Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over
absorption of the same.

6.

Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should
not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed
costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.

7.

In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of
marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.

Presentation of Cost Data under Marginal Costing and Absorption Costing


Marginal costing is not a method of costing but a technique of presentation of sales and cost data with a view to guide

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management in decision-making. The traditional technique popularly known as total cost or absorption costing technique does
not make any difference between variable and fixed cost in the calculation of profits. But marginal cost statement very clearly
indicates this difference in arriving at the net operational results of a firm.

CHAPTER : Standard Costing


You know that management accounting is managing a business through accounting information. In this process, management
accounting is facilitating managerial control. It can also be applied to your own daily/monthly expenses, if necessary. These
measures should be applied correctly so that performance takes place according to plans. Planning is the first tool for making
the control effective. The vital aspect of managerial control is cost control. Hence, it is very important to plan and control costs.
Standard costing is a technique which helps you to control costs and business operations. It aims at eliminating wastes and
increasing efficiency in performance through setting up standards or formulating cost plans.
Meaning of Standard
When you want to measure some thing, you must take some parameter or yardstick for measuring. We can call this as standard.
What are your daily expenses? An average of Rs50! If you have been spending this much for so many days, then this is your
daily standard expense. The word standard means a benchmark or yardstick. The standard cost is a predetermined cost which
determines in advance what each product or service should cost under given circumstances.
Definition
The CIMA, London has defined standard cost as a predetermined cost which is calculated from managements standards of
efficient operations and the relevant necessary expenditure. They are the predetermined costs on technical estimate of material
labor and overhead for a selected period of time and for a prescribed set of working conditions. In other words, a standard cost
is a planned cost for a unit of product or service rendered.
The technique of using standard costs for the purposes of cost control is known as standard costing. It is a system of cost
accounting which is designed to find out how much should be the cost of a product under the existing conditions. The actual
cost can be ascertained only when production is undertaken. The predetermined cost is compared to the actual cost and a
variance between the two enables the management to take necessary corrective measures.
Advantages
Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also
helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of
this system, some of the advantages of this tool are given below:
1.

Efficiency measurement-- The comparison of actual costs with standard costs enables the management to evaluate
performance of various cost centers. In the absence of standard costing system, actual costs of different period may be
compared to measure efficiency. It is not proper to compare costs of different period because circumstance of both the
periods may be different. Still, a decision about base period can be made with which actual performance can be
compared.

2.

Finding of variance-- The performance variances are determined by comparing actual costs with standard costs.
Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance. It is
possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by
standard cost system.

3.

Management by exception-- The targets of different individuals are fixed if the performance is according to
predetermined standards. In this case, there is nothing to worry. The attention of the management is drawn only when
actual performance is less than the budgeted performance. Management by exception means that everybody is given a
target to be achieved and management need not supervise each and everything. The responsibilities are fixed and
every body tries to achieve his/her targets.

4.

Cost control-- Every costing system aims at cost control and cost reduction. The standards are being constantly
analyzed and an effort is made to improve efficiency. Whenever a variance occurs, the reasons are studied and
immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system.

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5.

Right decisions-- It enables and provides useful information to the management in taking important decisions. For
example, the problem created by inflating, rising prices. It can also be used to provide incentive plans for employees
etc.

6.

Eliminating inefficiencies-- The setting of standards for different elements of cost requires a detailed study of
different aspects. The standards are set differently for manufacturing, administrative and selling expenses. Improved
methods are used for setting these standards. The determination of manufacturing expenses will require time and
motion study for labor and effective material control devices for materials. Similar studies will be needed for finding
other expenses. All these studies will make it possible to eliminate inefficiencies at different steps.

Limitations of Standard Costing


1.

It cannot be used in those organizations where non-standard products are produced. If the production is undertaken
according to the customer specifications, then each job will involve different amount of expenditures.

2.

The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required
to be undertaken for this purpose. These studies require a lot of time and money.

3.

There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed
do not remain static. With the change in circumstances, if the standards are not revised the same become
impracticable.

4.

The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable
variances. Standard costing is applicable only for controllable variances.

For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or
revise the standards. A frequent revision of standards will become costly.

CHAPTER : Budgeting & Budgetary Control


Introduction:
Finance is the life blood of a business. Therefore, financial planning is of utmost significance to a businessman. Financial
planning is concerned with raising funds and their effective utilization with a view to maximize the wealth of the company.
In spite of good financial plan, the desired results may not be achieved if there is no effective control to ensure its
implementation. A budget is an important tool for financial planning and control. The budget represents a set of yardsticks or
guidelines for use in controlling internal operations of an organization. The management, through budget, can evaluate the
performance of every level of the organization. The discrepancy between planned performance & actual performance is
highlighted through budgets.
Budgeting: Meaning:
A budget is a plan expressed in quantitative, usually monetary term, covering a specific period of time, usually one year. In
other words a budget is a systematic plan for the utilization of manpower and material resources. In a business organization, a
budget represents an estimate of future costs and revenues. Budgets may be divided into two basic classes: Capital Budgets and
Operating Budgets. Capital budgets are directed towards proposed expenditures for new projects and often require special
financing. The operating budgets are directed towards achieving short-term operational goals of the organization, for instance,
production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental of functional
budgets.
The main characteristics of a budget are:
1. It is prepared in advance and is derived from the long-term
2. It relates to future period for which objectives or goals have already been laid down.

strategy

of

the

organization.

It is expressed in quantitative form, physical or monetary units, or both. Different types of budgets are prepared for different
purposed e.g. Sales Budget, Production Budget, Administrative Expense Budget, Raw-material Budget etc. All these sectional
budgets are afterwards integrated into a master budget, which represents an overall plan of the organization.
Advantages of Budget A budget helps us in the following ways:
1.

It brings about efficiency and improvement in the working of the organization.

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2.

3.
4.
5.
6.
7.
8.

It is a way of communicating the plans to various units of the organization. By establishing the divisional,
departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes the possibilities of buck passing
if the budget figures are not met.
It is a way or motivating managers to achieve the goals set for the units.
It serves as a benchmark for controlling on-going operations.
It helps in developing a team spirit where participation in budgeting is encouraged.
It helps in reducing wastage and losses by revealing them in time for corrective action.
It serves as a basis for evaluating the performance of managers.
It serves as a means of educating the managers.

Budgetary control:
Budgeting is closely connected with control. The exercise of control in the organization with the help of budgets is known as
budgetary control. The process of budgetary control includes:
1.
2.
3.

Preparation of various budgets


Continuous comparison of actual performance with budgetary performance
Revision of budgets in the light of changed circumstances

A system of budgetary control should not become rigid. There should be enough scope of flexibility to provide for individual
initiative and drive. Budgetary control is an important device for making the organization more efficient on all fronts. It is an
important tool for controlling costs and achieving the overall objectives.
Choice between fixed and flexible budgets: A budget may be fixed or flexible. A fixed budget is base on a fixed Volume of
activity. It may lose it s effectiveness in planning and controlling if the actual capacity utilization is different from what was
planned for any particular unit of time e.g., a month or a quarter. The flexible budget is more useful for changing levels of
activity as it considers fixed and variable costs separately fixed costs as you are aware, remain unchanged over a certain range
of output. Such costs change when there is a change in capacity level.
The variable costs change in direct proportion to output. If flexible budgeting approach is adopted, the budget controller can
analyses the variance between actual costs and budgeted costs depending upon the actual level of activity
Chart : Classification of Budgets
Time
Long Term
Short Term
Current
Rolling

Function
Sales
Production
Cost of Production
Purchase
Personnel
Research
Capital Expenditure
Cash
Master

Flexibility
Fixed
Flexible

Rolling Budget: Some organizations follow the practice of preparing a rolling or progressive budget In such organizations, a
budget for a year in advance will always be there. Immediately after a month, or a quarter, passes, as the case may be, a new
budget is prepared for a twelve months. The figures for the month/quarter, which has rolled down, are dropped and the figures
for the next month/quarter are added.
Capital Expenditure Budget: The budget provides guidance as to the amount of capital that may be needed for procurement of
capital assets during the budget period. The budget is prepared after taking into account the available productive capacitates
probable reallocation of existing assets and possible improvement in production techniques. If necessary separate budgets may
be prepared for each item o assets, such a building budget, a plant and equipment budget etc.
Research and Development Budget: Research and development costs are to be incurred so that the products or the methods of
the concern do not become out of date. The research and development budget is a forecast of all such expenses.
Sales budget: Sales budget generally forms the fundamental basis on which all other Budgets are built. The budget is based on
projected sales to be achieved in a budget period. The sales manager is directly responsible for the preparation and execution of
this budget. He usually takes into consideration the following organizational and environmental factors while preparing the sales
budget.
It is desirable to break up the entire sales budget on the basis of different products, time periods and sales areas or territories.
Production Budget :This budget provides an estimate of the total volume of production Distributed product-wise with

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scheduling of operations by days, weeks and months, and a forecast of the inventory of finished products. Generally, the
production budget is based on the sales budget. The responsibility for the overall production budget ties with works manager
and that of with departmental works managers.
Production budget may be expressed in physical or financial terms or both in relation to production. The production budgets
attempt to answer questions like
I.
II.
III.
IV.

What is to be produced?
When is to be produced?
How is to be produced?
Where it is to be produced?

The production budget envisages the production program for achieving the sales target. It serves as a basis for preparation of
related cost budgets, e.g., materials cost budget, labor cost budget, etc. it also facilities the preparation of a cash budget. The
production budget is prepared after taking into consideration several factors like Inventory policies, sales requirements,
production stability, plant capacity, availability of materials and labor, time taken in production process etc.
Cash budget
The cash budget is a summary of the firms expected cash inflows and outflows over a particular period of time. In other words,
cash budget involves a projection of future cash receipts and cash disbursements over various time intervals.
A cash budget helps the management in:

Determining
the
future
cash
Planning
for
financing
Exercising control over cash and liquidity of the firm.

needs
of

of

the
those

firm.
needs.

The overall cash budget can be prepared by any of the following methods :
1.
2.
3.

Receipts and payments method


The adjusted profit and loss method
The balance sheet method

Receipts and payments method: In case of this method the cash receipts from various sources and the cash payments to
various agencies are estimated. In the opening balance of cash estimated cash receipts are added and from the total, the total of
estimated cash payments are deducted to find out the closing balance.
The adjusted profit and loss method: In case of this method the cash Budget is prepared on the basis of opening cash and
bank balances, projected profit and loss account and the balances of the various assets and liabilities.
The balance sheet method: With the help of budgeted balances at the End except cash and bank balances, a budgeted balance
sheet can be prepared and the balancing figure would be the estimated closing cash/bank balance. Thus, under this method,
closing balances other than cash/bank will have to be found out first to be put in the budgeted balance sheet. This can be done,
by adjusting the anticipated transactions of the year in the opening balances.
Budgetary control: Objectives:
To provide a detailed plan of action for a business over a period of time.
To coordinate the different units & activities of the organization with a view to utilize the resources judiciously.
To revise the budgets in the light of changed circumstances.
To exercise control and on cost through comparison of actual results with the budgeted one.
Master & Financial Budget:
A budget is a statement, which shows forecasts of the financial activities of a business to achieve a specific purpose. A budget is
basically an estimate of receipts and payments of revenue and capital items in future.
Master Budget:
Master budget (also known as summary budget or finalised profit plan) combines all the budgets for a period into one
harmonious unit and thus, it show the overall budget plan. As profit planning is the main objective of a budget program, it is but
natural that all the subsidiary budgets should be co-ordinated and projected into a master or summary budget, which should
show the final projected results of the plan. The master budget incorporates all the subsidiary functional budgets and the
budgeted Profit and Loss Account and Balance Sheet. Before the budget plan is put into operation, the master budget is
considered by the top management and revised if the -position of profit disclosed therein is not found to be satisfactory. After
suitable revision is made, the master budget is finally approved and put into action.

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Another view regards the budgeted Profit and Loss Account and the Balance Sheet as the master budget. The Profit and Loss
Account is built up from the other budgets already set, and no fresh estimates are necessary. The budgeted cost of production is
deducted from the budgeted sales revenue in order to arrive at the budgeted gross profit. The operating profit is obtained by
further deduction of the budgeted selling and distribution expenses. Addition and subtraction of other budgeted income and
expenditure items give the budgeted net profit.
Fixed & Flexible Budget:
Fixed Budget: A fixed budget is designed to remain unchanged irrespective of the level of activity. This budget is prepared on
the basis of a standard or fixed level of activity. This budget becomes an unrealistic yardstick in case the level of activity
actually attained does not conform to the one assumed for budgeting purposes. Due to the limitations of fixed budgeting, firms
whose sales and production cannot be accurately estimated have given up the practice of fixed budgeting.
Flexible Budget: A budget that is designed to change in accordance with the level of activity attained is called a flexible
budget. This budget is prepared after considering the fixed and variable elements of cost and the changes that may be expected
for each item at various levels of operations. Flexible is desirable in the following cases:

Sales are unpredictable, e.g., luxury or semi-luxury products.


The venture is new & it is difficult to foresee the demand, e.g., fashion products.
Where the business is subject to the vagaries of nature, such as soft drinks.
Government interference, e.g., cigarettes, liquor, etc.

Zero-based budgeting:
The technique of zero base budgeting provides a solution for overcoming the limitations of traditional budgeting by enabling top
management to focus on priorities, key areas and alternatives of action throughout the organisation. .
Some of the problems, which top management has to face are:
1.
2.
3.
4.
5.
6.

Programs and activities involving wasteful expenditure are not identified, resulting in avoidable financial and other
costs.
Inefficiencies of a prior year are carried forward in determining subsequent years levels of performance.
Managers are not encouraged to identify and evaluate alternative means of accomplishing the same objective.
Decision-making is irrational in the absence of rigorous analysis of all proposed costs and benefits.
Key problems and decision areas are not highlighted. Thus, no priorities are established throughout the organisation.
Managers tend to inflate their budget requests resulting in more demand for funds than their availability. This results
in recycling the entire budgeting process.

The technique of zero base budgeting suggests that an organisation should not only make decisions about the proposed new
programs, but, should also review the appropriateness of the existing programs from time to time. Such a review should
particularly be done of such responsibility centers where there is relatively high proportion of discretionary costs. Costs of this
type depend on the discretion or policies of the responsibility center or top managers. These costs have no direct relation to
volume of activity. Hence, management discretion typically determines the amount budgeted. Some examples are expenditure
on research and development, personnel administration, legal advisory services.
Zero base budgeting, as the term suggests, examines or reviews a program or function or responsibility from scratch, The
reviewer proceeds on the assumption that nothing is to be allowed. The manager proposing the activity has, therefore, to justify
that the activity is essential and the various amounts asked for are reasonable taking into account the outputs or results or
volume of activity envisaged. No activity or expense is allowed simply because it was being allowed or done in the past. Thus,
according to this technique each program, whether new or existing, must be justified in its entirety each time a new budget is
formulated. It involves:
i.
ii.
iii.

dealing with practically all elements of managers budget requests


critical examination of ongoing activities along with the newly proposed activities
providing each manager a range of choices in setting priorities in respect of different activities and in allocating
resources

Process of Zero-Base Budgeting


The following steps are involved in zero base budgeting:
Determining the objectives of budgeting: The objective may be to effect cost reduction in staff overheads or it may be to drop,
after careful analysis, projects which do not fit into achievement of the organizations objectives etc.
Deciding on scope of application: The extent to which the zero base budgeting is to be introduced has to be decided, i.e.
whether it will be introduced in all areas of the organizations activities or only in a few selected areas on trial basis.

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Developing decision units: Decision units for which cost benefit analysis is proposed have to be developed so as .to arrive at
decisions whether they should be allowed to continue or be dropped. Each decision unit, as far as possible should be
independent of other units so that it can be dropped if the cost analysis proves to be unfavorable for it.
Developing decision packages: A decision package for each unit should be developed. While developing a decision package,
answers to the following questions would be desirable:
i.
ii.
iii.
iv.
v.

Is it necessary to perform a particular activity at all? If the answer is in the negative, there is no need to proceed
further.
How much has been the actual cost of the activity and what has been the actual benefit both in tangible as well as
intangible forms?
What should be the estimated cost of the level of activity and the estimated benefit from such activity?
Should the activity be performed in the way in which it is being performed and what should be the cost?
If the project or activity is dropped, can the unit be replaced by an outside agency?

After completing decision packages for each unit, the units are ranked according to the findings of cost-benefit analysis.
Essential projects are identified and given the highest ranks. The last stage is that of implementing the decisions taken in the
light of the study made. It involves the selection and acceptance of those projects which have a positive cost-benefit analysis or
which are capable of meeting the objectives of the organisation.
Advantages of zero base budgeting
1.
2.
3.
4.
5.
6.

It provides the organisation with a systematic way to evaluate different operations and programs undertaken. It
enables management to allocate resources according to priority of the programs.
It ensures that each and every programme undertaken by managers is really essential for the organisation, and is being
performed in the best possible way.
It enables the management to approve departmental budgets on the basis of cost-benefit analysis. No arbitrary cuts or
increases in budget estimates are made.
It links budgets with the corporate objectives. Nothing will be allowed simply because it was being done in the past.
An activity may be shelved if it does not help in achieving the goals of the enterprises.
It helps in identifying areas of wasteful expenditure and, if desired, it can also be used for suggesting alternative
courses of action.
It facilitates the introduction and implementation of the system of management by objectives. Thus, it can be used
not only for fulfillment of the objectives of traditional budgeting, but also for a variety of other purposes.

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