Accounting information is important for every business which will serve the
needs of variety of interested parties. To satisfy the needs of all interested
parties a sound accounting system is very necessary. Accounting may be
divided into three parts i. Financial accounting ii. Cost accounting iii.
Management accounting.
Cost accounting developed to help the internal management in decision
making. The information provided by cost accounting acts as a managerial
tool so that business can utilise the available resources at optimum level.
Meaning of Cost
Cost is the amount of resource given up in exchange for some goods or
services. The resources given up are money or money’s equivalent expressed
in monetary units.
The Chartered Institute of Management Accountants, London defines cost
as “the amount of expenditure (actual or notional) incurred on, or
attributable to a specified thing or activity”.
Costing is the techniques and processes of ascertaining costs. These
techniques consist of principles and rules which govern the procedure of
ascertaining cost of products or services. The techniques to be followed for
the analysis of expenses and the processes of different products or services
differ from industry to industry.
The main object of costing is the analysis of financial records, so as to
subdivide expenditure and to allocate it carefully to selected cost centers,
and hence to build up a total cost for the departments, processes or jobs or
contracts of the undertaking.
Cost Accounting
Cost accounting may be regarded as ``a specialised branch of accounting
which involves classification, accumulation, assignment and control of

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The Costing terminology of C.I.M.A. London defines cost accounting as ``The
establishment of budgets, standard costs and actual costs of operations,
processes, activities or products, and the analysis of variances, profitability
or the social use of funds”.
Cost Accountancy
Cost Accountancy has been defined as “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 there from for the purpose of
managerial decision making”.
Scope of Cost Accounting
The terms ‘costing’ and ‘cost accounting’ are many times used
interchangeably. However, the scope of cost accounting is broader than that
of costing. Following functional activities are included in the scope of cost
1. Cost book-keeping: It involves maintaining complete record of all costs
incurred from their incurrence to their charge to departments, products and
services. Such recording is preferably done on the basis of double entry
2. Cost system: Systems and procedures are devised for proper accounting
for costs.
3. Cost ascertainment: Ascertaining cost of products, processes, jobs,
services, etc., is the important function of cost accounting. Cost
ascertainment becomes the basis of managerial decision making such as
pricing, planning and control.
4. Cost Analysis: It involves the process of finding out the causal factors of
actual costs varying from the budgeted costs and fixation of responsibility
for cost increases.
5. Cost comparisons: Cost accounting also includes comparisons between
cost from alternative courses of action such as use of technology for
production, cost of making different products and activities, and cost of
same product/ service over a period of time.

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6. Cost Control: Cost accounting is the utilisation of cost information for
exercising control. It involves a detailed examination of each cost in the light
of benefit derived from the incurrence of the cost. Thus, we can state that
cost is analysed to know whether the current level of costs is satisfactory in
the light of standards set in advance.
7. Cost Reports: Presentation of cost is the ultimate function of cost
accounting. These reports are primarily for use by the management at
different levels. Cost Reports form the basis for planning and control,
performance appraisal and managerial decision making.
Objectives of cost accounting
There is a relationship among information needs of management, cost
accounting objectives, and techniques and tools used for analysis in cost
accounting. Cost accounting has the following main objectives to serve:
1. Determining selling price,
2. Controlling cost
3. Providing information for decision-making
4. Ascertaining costing profit
5. Facilitating preparation of financial and other statements.
1. Determining selling price: The objective of determining the cost of
products is of main importance in cost accounting. The total product cost
and cost per unit of product are important in deciding selling price of
product. Cost accounting provides information regarding the cost to make
and sell product or services. Other factors such as the quality of product,
the condition of the market, the area of distribution, the quantity which can
be supplied etc., are also to be given consideration by the management
before deciding the selling price, but the cost of product plays a major role.
2. Controlling cost: Cost accounting helps in attaining aim of controlling
cost by using various techniques such as Budgetary Control, Standard
costing, and inventory control. Each item of cost [viz. material, labour, and
expense] is budgeted at the beginning of the period and actual expenses
incurred are compared with the budget. This increases the efficiency of the

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. Facilitating preparation of financial and other statements: Cost accounting helps to produce statements at short intervals as the management may require. sales and operating results. Importance to Management Cost accounting provides invaluable help to management. CRPATNA Page 4 . It is difficult to indicate where the work of cost accountant ends and managerial control begins. This helps in preparation of financial statements. Importance of Cost accounting The limitation of financial accounting has made the management to realise the importance of cost accounting. it is essential for management to have a review of production. (ii) Make or buy a component (iii) Shut down or continue operation at a loss (iv) Continuing with the existing machinery or replacing them by improved and economical machines. semi finished and finished goods. Cost accounting provides daily. Providing information for decision-making Cost accounting helps the management in providing information for managerial decisions for formulating operative policies. The advantages are as follows : Helps in ascertainment of cost Cost accounting helps the management in the ascertainment of cost of process. Ascertaining costing profit: Cost accounting helps in ascertaining the costing profit or loss of any activity on an objective basis by matching cost with the revenue of the activity. etc. accumulated cost with analysis. The importance of cost accounting are as follows: 1. product. In order to operate the business at high efficiency. Cost accounting system provides immediate information regarding stock of raw material. contract. The financial statements are prepared generally once a year or half year to meet the needs of the management. activity. 5.II SEM BCOM COST ACCOUNTING 3. Job. by using different techniques such as Job costing and Process costing. NEW ALLIANCE FIRST GRADE COLLEGE. weekly or monthly statements of units produced. 4. These policies relate to the following matters: (i) Determination of cost-volume-profit relationship.

etc. are in the use of machine equipment and material. As a result both the productivity and earning capacity increases. such as time and expenses etc. Helps in fixing selling Prices It helps the management in fixing selling prices of product by providing detailed cost information. An efficient costing system benefits employees through incentives plan in their enterprise.. work in progress and finished goods. They can base their judgement NEW ALLIANCE FIRST GRADE COLLEGE. Helps in Inventory Control Cost furnishes control which management requires in respect of stock of material. also determine the price of product and cost to the producer does play an important role. investor’s financial institution and other moneylenders have a stake in the success of the business concern and therefore are benefited by installation of an efficient costing system. Cost accounting and creditors Suppliers. 2. 3. Helps in estimate Costing records provide a reliable basis upon which tender and estimates may be prepared. it becomes possible to check the forms of waste. Importance to Employees Worker and employees have an interest in which they are employed. Elimination of wastage As it is possible to know the cost of product at every stage. CRPATNA Page 5 .II SEM BCOM COST ACCOUNTING Aids in Price fixation By using demand and supply. activities of competitors. Helps in Cost reduction Cost can be reduced in the long-run when cost reduction programme and improved methods are tried to reduce costs. Helps in identifying unprofitable activities With the help of cost accounting the unprofitable activities are identified. market condition to a great extent. Helps in checking the accuracy of financial account Cost accounting helps in checking the accuracy of financial account with the help of reconciliation of the profit as per financial accounts with the profit as per cost account. so that the necessary correct action may be taken. The producer can take necessary help from his costing records.

NEW ALLIANCE FIRST GRADE COLLEGE. such as: (a) Whether to make or buy decisions from outside? (b) Whether to shut down or continue producing and selling at below cost? (c) Whether to repair an old plant or to replace it? LIMITATIONS OF COST ACCOUNTING Like other branches of accounting. The limitations of cost accounting are as follows: It is expensive because analysis. allocation and absorption of overheads require considerable amount of additional work. This leads to unnecessary increase in workload. 5. 4. cost accounting is not an exact science but is an art which has developed through theories and accounting practices based on reasoning and common sense. CRPATNA Page 6 . The overall economic developments of a country take place due to efficiency of production. Cost accounting lacks a uniform procedure. Cost accounting can be used only by big enterprises. Data Base for operating policy Cost Accounting offers a thoroughly analysed cost data which forms the basis of formulating policy regarding day to day business. It is unnecessary because it involves duplication of work. There is no stereotyped system of cost accounting applicable to all industries. Some industrial units are functioning efficiently without any costing system. These practices are not static but changing with time. There are widely recognised cost concepts but understood and applied differently by different industries.II SEM BCOM COST ACCOUNTING about the profitability and prospects of the enterprise upon the studies and reports submitted by the cost accountant. Importance to National Economy An efficient costing system benefits national economy by stepping up the government revenue by achieving higher production. Preparation of reconciliation statements frequently is necessary to verify their accuracy. The results shown by cost accounts differ from those shown by financial accounts.

materials by using any Budgetary Control. creditors. only those costs which affect (d) Financial accounting production and sales. 2. CRPATNA Page 7 ..e. Costing. it can control cost without the help of the cost accounting. tax authorities. government. i. and prospective investors. In some cases to of business organizations.e. in order to control NEW ALLIANCE FIRST GRADE COLLEGE. to the reporting mainly to owners. i. This is to be maintained Cost accounting is maintained Obligation compulsorily by higher forms voluntarily. important control techniques (b) It does not control such as Marginal Costing. government has directed some maintain The preparation of accounts companies to maintain cost accounts must be in accordance with accounts to improve efficiency. and classification in order to (c) Financial accounting find out cost per unit.II SEM BCOM COST ACCOUNTING Costing system itself does not control costs. etc. process or operation so as to reveal the areas of profitability. Therefore it is unnecessary. Differences between Cost accounting and Financial accounting Points of Cost accounting Financial accounting Differences 1. incurred.. (b) In financial accounting (b) In cost accounting costs are expenses are recorded in expressed by proper analysis totals. (d) Cost accounting records both historical and estimated costs 4. Analysis Financial accounting Cost accounting shows the of profit discloses profit for the entire profitability or otherwise of business as a whole. according to according to the nature of purpose for which costs are expenditure. 5. 3. mangement of every business. If the management is alert and efficient. records all transactions which (c) Cost accounting records takes place in the business.. the statutory provisions.e. Control (a) It does not make use of (a) It makes use of some any control techniques. records only historical costs. i.. manner. Purpose The purpose of financial The purpose of cost accounting accounting is external is internal reporting. Standard technique. 2. each product. (a) Financial accounting (a) Cost accounting records Recording records transactions in a transactions in an objective subjective manner.



(c) Control over labour is not cost.
(b) It exercises control over
economic order quantity, etc.
(c) Control over labour is
exercised and efforts are taken
to minimise idle time, over time
financial Cost accounting furnishes cost
accounting provides financial data at frequent intervals.
information once a year.
Some reports are daily. Some
are weekly and some monthly
The information provided by The
Evaluation financial accounting is not evaluating the efficiency of the
sufficient to evaluate the businesses.
efficiency of the business.
8. Pricing
the It provides adequate data for
formulation of pricing policy. formulating pricing policy
stock is valued at cost or Stock is always valued of cost
Valuation market price whichever is less price
of Stock


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The different bases of cost classification are:
1. By time (Historical, Pre-determined).
2. By nature or elements (Material, Labour and Overhead).
3. By degree of traceability to the product (Direct, Indirect).
4. Association with the product (Product, Period).
5. By Changes in activity or volume (Fixed, Variable, Semi-variable).
6. By function (Manufacturing, Administrative, Selling, Research and
development, Pre production).
7. Relationship with accounting period (Capital, Revenue).
8. Controllability (Controllable, Non-controllable).
9. Cost for analytical and decision-making purposes (Opportunity, Sunk,
Differential, Joint, Common, Imputed, Out-of-pocket, Marginal,
Uniform, Replacement).
Others (Conversion, Traceable, Normal, Avoidable, Unavoidable,
1. Classification on the Basis of Time
(a) Historical Costs: These costs are ascertained after they are incurred.
Such costs are available only when the production of a particular thing has
already been done. They are objective in nature and can be verified with
reference to actual operations.
(b) Pre-determined Costs: These costs are calculated before they are
incurred on the basis of a specification of all factors affecting cost. Such
costs may be:
(i) Estimated costs: Costs are estimated before goods are produced; these
are naturally less accurate than standards.
(ii) Standard costs: This is a particular concept and technique. This
method involves:
(a) Setting up predetermined standards for each element of cost and each
(b) Comparison of actual with standard to find variation;
(c) pin-pointing the causes of such variances and taking remedial action.
Obviously, standard costs, though pre-determined, are arrived with much
greater care than estimated costs.
2. By Nature or Elements
There are three broad elements of costs:


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(1) Material: The substance from which the product is made is known as
material. It can be direct as well as indirect.
Direct material: It refers to those materials which become a major part of
the finished product and can be easily traceable to the units. Direct
materials include:
(i) All materials specifically purchased for a particular job/process.
(ii) All material acquired and latter requisitioned from stores.
(iii) Components purchased or produced.
(iv) Primary packing materials.
(v) Material passing from one process to another.
Indirect material: All material which is used for purposes ancillary to
production and which can be conveniently assigned to specific physical
units is termed as indirect materials. Examples, oil, grease, consumable
stores, printing and stationary material etc.
(2) Labour: Labour cost can be classified into direct labour and indirect
Direct labour: It is defined as the wages paid to workers who are engaged
in the production process whose time can be conveniently and economically
traceable to units of products. For example, wages paid to compositors in a
printing press, to workers in the foundry in cast iron works etc.
Indirect labour: Labour employed for the purpose of carrying tasks
incidental to goods or services provided, is indirect labour. It cannot be
practically traced to specific units of output. Examples, wages of storekeepers, foreman, time-keepers, supervisors, inspectors etc.
(3) Expenses: Expenses may be direct or indirect.
Direct expenses: These expenses are incurred on a specific cost unit and
identifiable with the cost unit. Examples are cost of special layout, design or
drawings, hiring of a particular tool or equipment for a job; fees paid to
consultants in connection with a job etc.
Indirect expenses: These are expenses which cannot be directly,
conveniently and wholly allocated to cost centre or cost units. Examples are
rent, rates and taxes, insurance, power, lighting and heating, depreciation
It is to be noted that the term overheads has a wider meaning than the term
indirect expenses. Overheads include the cost of indirect material, indirect
labour and indirect expenses. Overheads may be classified as
(a) production or manufacturing overheads, (b) administration overheads,
(c) selling overheads, and (d) distribution overheads.

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4. They are common to several products. salary of a factory manager. For example.g. Whereas Indirect costs have to be apportioned to different products. e. Costs may be direct or indirect with respect to a particular division or department. It is also called common costs. direct labour and manufacturing overheads. Product cost is a full factory cost. CRPATNA Page 11 . These may involve some formula or base which may not be totally correct or exact. cost of wood for making furniture. By Degree of Traceability to the Products Cost can be distinguished as direct and indirect. NEW ALLIANCE FIRST GRADE COLLEGE.II SEM BCOM COST ACCOUNTING 3. Product Costs: Product costs are those which are traceable to the product and included in inventory values. It is also called traceable cost. all the costs incurred in the Power House are indirect as far as the main product is concerned but as regards the Power House itself. It is necessary to know the purpose for which cost is being ascertained and whether it is being associated with a product.g. the fuel cost or supervisory salaries are direct. Direct Costs: The direct costs are those which can be easily traceable to a product or costing unit or cost center or some specific activity. Association with the Product Cost can be classified as product costs and period costs. e. Direct cost can be allocated directly to costing unit or cost center. Indirect Costs: The indirect costs are difficult to trace to a single product or it is uneconomic to do so. department or some activity. In a manufacturing concern it comprises the cost of direct materials. if appropriate measurement techniques are not available.

(ii) It is difficult to apportion these costs to products equitably. (iv) The benefits accruing from these expenses cannot be easily established. therefore. CRPATNA Page 12 . These costs are incurred so that physical and human facilities necessary for business operations. they are not associated with production. It is wrong to say that fixed costs never change. within certain output and turnover limits. property taxes. insurance. Period costs are charged to the period in which they are incurred. 5. Fixed Costs: The Chartered Institute of Management Accountants. variable and semi-variable cost. Period Costs: Period costs are incurred on the basis of time such as rent. Examples are rent. can be provided. tends to be unaffected by fluctuations in the levels of activity (output or turnover)”. Product costs are included in the cost of the product and do not affect income till the product is sold. The net income of a concern is influenced by both product and period costs. The term fixed refer to non-variability related to the relevant range. include many selling and administrative costs essential to keep the business running. supervisors’ salaries etc. etc. Though they are necessary to generate revenue. Selling and administrative costs are treated as period costs for the following reasons: (i) Most of these expenses are fixed in nature. Fixed cost can be classified into the following categories for the purpose of analysis: NEW ALLIANCE FIRST GRADE COLLEGE. defines fixed cost as “ the cost which is incurred for a period. salaries.II SEM BCOM COST ACCOUNTING Product costs are used for valuing inventories which are shown in the balance sheet as asset till they are sold. They arise with the passage of time and not with production and are expressed in terms of time. and which. they cannot be assigned to a product. These costs may vary depending on the circumstances. (iii) It is difficult to determine the relationship between such cost and the product. These costs arise due to contractual obligations and management decisions.. The product cost of goods sold is transferred to the cost of goods sold account. London. They are charged to the period in which they are incurred and are treated as expenses. By Changes in Activity or Volume Costs can be classified as fixed.

g. Because of the variable element. not in terms of time. These costs result from special policy decisions. e. If the conditions upon which variability was determined changes. Semi-variable costs change in the same direction as that of the output but not in the same proportion. (b) Policy and Managed Costs: Policy costs are incurred for implementing particular management policies such as executive development. CRPATNA Page 13 . Management decisions can influence the cost behaviour patterns.g. It is always expressed in terms of units. Functional costs may be classified as follows: (a) Manufacturing/production Costs: It is the cost of operating the manufacturing division of an undertaking. new researches etc.II SEM BCOM COST ACCOUNTING (a) Committed Costs: These costs are incurred to maintain certain facilities and cannot be quickly eliminated. Managed costs are incurred to ensure the operating existence of the company e. (d) Step Costs: Such costs are constant for a given level of output and then increase by a fixed amount at a higher level of output. Depreciation is an example. staff services. they do not change in direct proportion to output... Such costs are often discretionary. and can be eliminated or reduced to a desirable level at the discretion of the management. It should be kept in mind that the variable cost per unit is constant but the total cost changes corresponding to the levels of output. It includes the cost of direct NEW ALLIANCE FIRST GRADE COLLEGE. etc. rent. Functional Classification of Costs A company performs a number of functions.g. direct materials. direct labour. Semi-fixed (Semi-Variable) costs: Such costs contain fixed and variable elements. insurance etc. Variable Cost: Variable costs are those costs that vary directly and proportionately with the output e. 6. for two shifts working the total depreciation may be only 50% more than that for single shift working. The management has little or no discretion in this cost. The concept of variability is relative. the variability will have to be determined again.. They may change with comparatively small changes in output but not in the same proportion. they fluctuate with volume and because of the fixed element. (c) Discretionary Costs: These are not related to the operations and can be controlled by the management. housing.

(b) Administration Costs: They are indirect and covers all expenditure incurred in formulating the policy. the income of a particular period can be correctly determined. products by experiment and implementing such results on a commercial basis. which is not related to research.g. Non-Controllable Cost: It is the cost which is not subject to control at any level of managerial supervision. packing (primary) cost and all overhead expenses relating to production. production. advertisements. (d) Research and Development Costs: They include the cost of discovering new ideas. It is not possible to distinguish between the two under all circumstances. process. They are charged to the cost of future production. (c) Selling and Distribution Cost: Selling cost is the cost of seeking to create and stimulate demand e. warehousing. On the other hand. development.II SEM BCOM COST ACCOUNTING materials. Such costs are termed as pre-production costs and treated as deferred revenue expenditure. 8.g. distribution or selling functions. As and when an asset is written off. CRPATNA Page 14 . directing the organisation and controlling the operation of a concern. revenue expenditure benefits only the current period and is treated as an expense. market research etc. Distribution cost is the expenditure incurred which begins with making the package produced available for dispatch and ends with making the reconditioned packages available for re-use e. 7. cartage etc. capital expenses to that extent becomes cost. Capital expenditure provides benefit to future period and is classified as an asset. Relationships with Accounting Period Costs can be capital and revenue. It includes expenditure incurred in transporting articles to central or local storage. Only when capital and revenue is properly differentiated. There are trial runs. Controllable Cost: The Chartered Institute of Management Accountants defines controllable cost as “cost which can be influenced by its budget holder”. (e) Pre-production Cost: When a new factory is started or when a new product is introduced. certain expenses are incurred. Expenditure incurred in moving articles to and from prospective customers as in the case of goods on sale or return basis is also distribution cost. Controllability Cost can be Controllable and Non-Controlable. direct labour. NEW ALLIANCE FIRST GRADE COLLEGE. direct expenses.

Controllable cost are not totally controllable. It is important in decision making and comparing alternatives. Edwards. The loss of interest and dividend that would be earned is the opportunity cost. A controllable cost can be controlled by a person at a given organisational level. 9. CRPATNA Page 15 . (b) Sunk Costs: A sunk cost is one that has already been incurred and cannot be avoided by decisions taken in the future. all costs can be controlled. (ii) All direct costs are controllable and indirect costs are not. (iii) All long-term costs are controllable. Hermanson and Salmonson define it as “the benefits lost by rejecting the best competing alternative to the one chosen. The authority and responsibility of cost control is delegated to different levels. maintenance cost can be controlled by both the production and maintenance manager.II SEM BCOM COST ACCOUNTING The difference between the terms is very important for the purpose of cost accounting. The National Association of Accountants (USA) defines a sunk cost as “an expenditure for equipment or productive resources which has no economic NEW ALLIANCE FIRST GRADE COLLEGE. It cannot be now invested in shares or debentures. But all costs can be controlled by one or another person.. Another example is when the owner of a business foregoes the opportunity to employ himself elsewhere. It is the amount that can be received if the asset is utilised in its next best alternative. The term “controllable costs” is often used to mean variable costs and noncontrollable costs as fixed. The benefit lost is usually the net earnings or profit that might have been earned from the rejected alternative” Example: Capital is invested in plant and machinery.g. Opportunity costs are not recorded in the books. Proper delegation helps in establishing clear responsibility and controllability. Belkaoni has mentioned the following fallacies about controllable costs: (i) All variable costs are controllable and fixed are not. it is called unavoidable cost. As it refers to past costs. though the managing director is responsible for all the costs. Some costs are partly controllable by one person and partly by another e. cost control and responsibility accounting. Costs for Analytical and Decision Making Purposes (a) Opportunity Costs: Opportunity cost is the cost of selecting one course of action and the losing of other opportunities to carry out that course of action. Sometimes the time factor and the decision making authority can make a cost controllable. If the time period is long enough.

and (d) The selection of an additional sales channel. It has also been defined as the difference between the purchase price of an asset and its salvage value. calculated to assist decision making”. The joint products are not identifiable as different types of product until a certain stage of production known as the split-off point is reached. The former applies to increase in production and is restricted to the cost only. These costs are usually ‘specific purpose costs’ as they are determined for a particular purpose and under specific circumstances. The jointness results from there being more than one product. Joint costs are the costs incurred upto the point of separation. Differential costs is useful in planning and decision making and helps to choose the best alternative. and these multi-products are the result of the methods of production or the NEW ALLIANCE FIRST GRADE COLLEGE. Differential cost is the increase or decrease in total costs resulting out of: (a) Producing and distributing a few more or few less of products. One product may be of major importance and others of minor importance which are called by-products. It helps management to know the additional profit that would be earned if idle capacity is used or when additional investments are made. Bierman and Djckman define it as: “Joint costs relate to a situation in which the factors of production by their basic nature result in two or more products. Incremental cost measures the addition in unit cost for an addition in output. (d) Joint Costs: The processing of a single raw material results in two or more different products simultaneously. It is usually expressed as a cost per unit whereas the differential cost is measured in total. This cost is not useful for decision making as all past costs are irrelevant.II SEM BCOM COST ACCOUNTING relevance to the present decision making process”. This cost need not be the same at all levels of production. CRPATNA Page 16 . (b) A change in the method of production/distribution. (c) Differential Cost: Differential cost has been defined as “the difference in total cost between alternatives. The differential cost between any two levels of production is the difference between the marginal costs at these two levels and the increase or decrease in fixed costs. if any. (c) An addition or deletion of a product or a territory. CIMA defines it as the past cost not taken into account in decision making. whereas the differential cost has a comprehensive meaning and application in the sense that it denotes both increase or decrease.

salaries of owners of proprietorship or partnership. They are not easily related with individual products and hence are generally apportioned. i. Joint costs can be apportioned to different products only by adopting a suitable basis of apportionment.e. costs are classified as fixed and variable. The National Association of Accountants defines it as follows: “Joint costs relate to two or more products produced from a common production process or element-material. gives rise to Cash Expenditure as opposed to such costs as depreciation which don’t NEW ALLIANCE FIRST GRADE COLLEGE. Thus. The National Association of Accountants defines the term as “the cost of services employed in the creation of two or more outputs which is not allocable to those outputs on a clearly justified basis”.II SEM BCOM COST ACCOUNTING nature of raw material and not of a decision by management to produce both”. These costs are known as imputed or notional costs and they do not enter into traditional accounting systems. job.. notional rent etc. Examples: Interest on internally generated funds. Uniform costing signifies common costing principles and procedures adopted by a number of firms. when the cost of replacing an asset is considered. (f) Imputed Costs: Some costs are not incurred and are useful while taking decision pertaining to a particular situation. (e) Common Costs: Common costs are those costs which are incurred for more than one product. It should be kept in mind that management decisions influence the incurrence of common costs e.g. (j) Out of Pocket Cost: It involves payment to outsiders i. territory or any other specific costing object. (g) Uniform Costs: They are not distinct costs as such. prime cost plus variable overheads. (i) Replacement Costs: This is the cost of replacing an asset at current market values e. (h) Marginal Costs: It is the aggregate of variable costs. They are useful in inter-firm comparison. rent of the factory is a common cost to all departments located in factory.g. it means the cost of purchasing the asset at the current market price is important and not the cost at which it was purchased.e. labour or overhead or any combination thereof or so locked together that one cannot be produced without producing the other”. CRPATNA Page 17 .

or process. Often depreciation is also deducted for ascertaining “value added”. or department or batch or the entire concern. CRPATNA Page 18 . (b) Unfavourable cost variances which could have been controlled.II SEM BCOM COST ACCOUNTING involve any cash expenditure. function. Thus cost centre refers to one of the convenient unit into which the whole factory organisation has been appropriately divided for costing purposes. Other Costs (i) Conversion Cost: It is the cost of a finished product or work-in-progress comprising direct labour and manufacturing overhead. Cost centre is the smallest organisational sub-unit for which separate cost collection is attempted. Cost Centre According to the Chartered Institute of Management Accountants. it is not cost. For example. It means the selling price of the product/service less the cost of materials used in the product or the service. (ii) Normal Cost: This is the cost which is normally incurred at a given level of output in the conditions in which that level of output is achieved. (vii) Value Added: Strictly. It is production cost less the cost of raw material but including the gains and losses in weight or volume of direct material arising due to production. The term total cost however. labour and overhead. although an assembly department may be supervised NEW ALLIANCE FIRST GRADE COLLEGE. activity or item of equipment whose costs may be attributed to cost units”. It may also mean the sum total of material. it needs to be made precise by using terms that indicate the elements of cost included. (iv) Avoidable Costs: Avoidable costs are those costs which under the present conditions need not have been incurred. Such costs are relevant for price fixation during recession or when make or buy decision is to be made. is not precise. Each such unit consists of a department or a subdepartment or item of equipment or. COST CENTRE AND COST UNIT A cost accountant has to ascertain cost by cost centre or cost unit or by both. machinery or a person or a group of persons. 10. Example: (a) Spoilage in excess of normal limit. (iii) Traceable Cost: It is the cost which can be easily associated with a product. “a production or service location. (vi) Total Cost: This is the sum of all costs associated to a particular unit. cost centre means. process or department. (v) Unavoidable Costs: Unavoidable costs are those costs which under the present conditions must be incurred. London.

Cost centres may be classified as follows : (i) Productive. and assembly shops are examples of production cost centres in an engineering factory. Each activity may be considered as a separate cost centre and all costs relating to a particular cost centre may be found out separately. it may contain several assembly lines. The determination of a suitable cost centre is very important for ascertainment and control of cost.the raw materials are handled here and converted into saleable products. Take another example. a tool shop serves as a productive cost centre when it manufactures dies and jigs for specific order. Unproductive and Mixed Cost Centres: Productive cost centres are those which are actually engaged in making the products . welding shops. marketing and washing of clothes are performed. Service or unproductive cost centres do not make the products but are essential aids to the productive centres. Examples of such service centres are those of administration. defines a unit of cost as “a unit of product or service in relation to which costs are ascertained”. We may for instance determine the cost per NEW ALLIANCE FIRST GRADE COLLEGE. These smaller sub-divisions are attributed to products or services to determine product cost or service cost or cost of time spent for a particular job etc. An impersonal cost centre is one which consists of a department. The manager in charge of a cost centre is held responsible for control of cost of his cost centre. If a cost centre consists of a continuous sequence of operations it is called process cost centre. sorting. (ii) Personal and Impersonal Cost Centre: A personal cost centre consists of a person or a group of persons. but serves as servicing cost centre when it does repairs for the factory. In such centres both direct and indirect costs are incurred. stores and drawing office departments. Cost Unit The Chartered Institute of Management Accountants. in a laundry. For instance. Mixed cost centres are those which are engaged some on productive and other lines on service works. (iii) Operation and Process Cost Centre: In case a cost centre consists of those machines and/or persons which carry out the same operation is termed as operation cost centre. Sometimes each assembly line is regarded as a separate cost centre with its own assistant foreman. machine shops. London. plant or item of equipment (or group of these).II SEM BCOM COST ACCOUNTING by one foreman. CRPATNA Page 19 . A cost unit is a devise for the purpose of breaking up or separating costs into smaller sub-divisions. repairs and maintenance. activities such as collecting.

II SEM BCOM COST ACCOUNTING ton of steel.Kilometre Chemicals Litre.Kilometre Passenger . It is usually adopted when there is only one main product and all costs almost are incurred for that product only. suitability of the units of centres for cost purposes. length. (iii) Requirements of the costing system i. The information incorporated in a cost sheet would depend upon the requirement of management for the purpose of control.e. The format of cost sheet is as under:Cost Sheet for the Period___________________ Production __________ Units Particulars Amount Amount Opening Stock of Raw Material *** Add: Purchase of Raw materials *** Add: Purchase Expenses *** NEW ALLIANCE FIRST GRADE COLLEGE. weight. time etc. per tonne kilometre of a transport service or cost per machine hour. CRPATNA Page 20 . PREPARATION OF COST SHEET When costing information is set out in the form of a statement. The forms of measurement used as cost units are usually the units of physical measurements like number. gallon. it is called “Cost Sheet”. area. kilogramme. (ii) Conditions of incidence of cost. tonne Steel Tonne Sugar Tonne The selection of suitable cost centres or cost units for which costs are to be ascertained in an undertaking depends upon a number of factors which are listed as follows: (i) Organisation of the factory. value. Unit selected should be unambiguous. Cost sheet is one of the method of unit costing. simple and commonly used. (iv) Availability of information. Following are some examples of cost unit: Industry/Product Cost unit Automobile Number Brick works 1000 bricks Cement Tonne Transport Tonne . (v) Management policy regarding making a particular choice from several alternatives.

Selling and Distribution OH:Sales man Commission Sales man salary Traveling Expenses Advertisement Delivery man expenses Sales Tax Bad Debts Cost of Sales (5) Profit (balancing figure) Sales NEW ALLIANCE FIRST GRADE COLLEGE.Factory Over Heads: Factory Rent Factory Power Indirect Material Indirect Wages Supervisor Salary Drawing Office Salary Factory Insurance Factory Asset Depreciation Works cost Incurred Add: Opening Stock of WIP Less: Closing Stock of WIP Works cost (2) Add:. CRPATNA *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Page 21 .Administration Over Heads:Office Rent Asset Depreciation General Charges Audit Fees Bank Charges Counting house Salary Other Office Expenses Cost of Production (3) Add: Opening stock of Finished Goods Less: Closing stock of Finished Goods Cost of Goods Sold Add:.II SEM BCOM COST ACCOUNTING Less: Closing stock of Raw Materials Raw Materials Consumed Direct Wages (Labour) Direct Charges *** *** *** *** Prime cost (1) Add :.

bars. Hence the total cost of a product can be controlled and reduced by efficiently using materials. strips. Various classes of coding are in practice and the common types are stated below: (a) Alphabetical Scheme: Alphabetics are only used for codification. screws.II SEM BCOM COST ACCOUNTING UNIT-III MATERIALS The materials are a major part of the total cost of producing a product and are one of the most important assets in majority of the business enterprises. There are two steps in the classification and codification of materials – determination of the number of items. office supplies and selling supplies are generally termed as stores. are those materials which are of small value such as nuts. timber. It is therefore. on the other hand. The materials are of two types. etc. glass. Like Mild Steel Sheets are coded as MSS. namely: (i) Direct materials: The materials which can be easily identified and attributable to the individual units being manufactured are known as direct materials. All costs which are incurred to obtain direct materials are known as direct material costs. copper.. Classified into different categories according to their nature or type. brass. mild steel. and do not physically form part of the finished product. angles. It may happen that either one type of material is in excess or another type may be altogether non-existent. other characteristics and classification of the items of comparable nature or type into suitable groups or classes. essential that a proper system of classification and codification. etc. Costs associated with indirect materials are known as indirect material costs. CRPATNA Page 22 . bronze.. viz. and then again within such broad classification into rounds. tool steel. etc. Classification and Codification of Material: In case of large organizations the number and types of materials used is considerable and unless each item is distinguished and stored separately it would be impossible to find them out when they are required for production or any other operation. Factory supplies. These materials also form part of finished products. pins. NEW ALLIANCE FIRST GRADE COLLEGE. (ii) Indirect materials: Indirect materials. their nature.

strips.II SEM BCOM COST ACCOUNTING (b) Numeric Scheme : In this scheme numericals are used instead of alphabets. (c) Codification is a must in the case of mechanisation of the stores accounting.00 mild steel may be coded as 3. for each material code we have to fix the Minimum Level. CRPATNA Page 23 . (c) Decimal Scheme: It is similar to the numeric scheme in which the groups are represented by number and digits after the decimal indicate sub-groups of items. rounds of mild steel may be coded as MS01. where the steel is coded as 3. (e) Combination Scheme : Here the code structure takes in account both alphabetic and numeric schemes and strikes a balance between the two. mild steel bar may be coded as 3112. bars. (d) Block Scheme: In this case block of number are allotted for classification of specific groups such as for material classification the block of number 1 to 999 may be reserved. Re-order Level and Re-order Quantity. For example.11 and mild sheet bar as 3.10 and mild steel sheet can be coded as 3. Advantages of Classification & Codification of materials: (a) The procedure assists in the easy identification and location of the materials because of their classification. 2000 to 2999 for finished goods. NEW ALLIANCE FIRST GRADE COLLEGE. Maximum Level. 1000 to 1999 for stores and spares. It is the storekeeper’s responsibility to ensure inventory of any material is maintained between the Minimum Level and Maximum Level. Mild steel by coded as MS and the sheets. MS04 and so on.12 and so on. MS02. This code is most commonly used because this system has got the advantage of both the alphabetic and numeric systems and is quite flexible in nature. (b) It minimises the recording of the nature/ type of the materials with detailed description on every document relating to the transaction of materials. (d) The method is simple to operate and definitely saves time and money in respect of both physical location/ identification of materials as well as recording of the materials. For example If steel is given main code of 300 mild steel may be coded as 310 and mild steel sheet may be coded as 311. for raw materials. After the material classification and codification is done for all the materials.

and in practice. centralised purchasing department. Maintaining purchasing records and files 11. However. Receiving of quotation 5. department is not always appreciated or understood by top management. Verification of invoices 8. Inspection of incoming materials 9. Assessment of demand or description of need 3. Placing order 6. This disconnection between function and. it can be performed. the purchasing function does not have to be performed in such a manner. The functions of purchasing department are varied and wide which are based upon different approaches. 7. it sometimes is performed by any number of different company officers or departments. directed by a skilled purchasing manager. The purchasing function is usually performed most economically and efficiently by a specialised. Making delivery at the proper time by following up the orders.II SEM BCOM COST ACCOUNTING Functions of Purchasing Department The purchasing department is an organisational unit of a firm whose duties include some part or all of the purchasing function. Receiving indents 2. Selection of sources of supply 4. The purchasing activities may be divided into those that are always assigned to the purchasing department and those that are sometimes assigned to some other department. Meeting transport requirements of incoming and outgoing materials 10. CRPATNA Page 24 . 1. The followings are some of the important functions which are necessary to be performed. Reporting to top management NEW ALLIANCE FIRST GRADE COLLEGE. In theory.

. Receiving indents: The first and foremost function of purchasing is receiving demand/requisition of material from different departments of the organisation. maintenance. Creating goodwill of the organisation in the eyes of the suppliers. stores.. the items are received and these are not acceptable to the user department and it also becomes difficult to convince the suppliers to return the goods in case of faulty supplies. drawing office. packing. In a nutshell. purchasing department must have adequate knowledge of items being purchased to be able to secure full description. The purchasing department should not have such alternative purchases of commodities. Sometimes. needs can be met by transfer of a stock of one department to another department. heat treatment etc. it is recommended that the description of items for purchase on the part of indenter. The real problem arises when the order is placed for want of preciseness in the description of goods needed. such as from production. the reserve stock or the stocks kept in bank can be utilized i. CRPATNA Page 25 .e. After receiving the indent from users’ departments it examines in details and takes action according to the need and urgency of any item. painting. Selection of sources of supply: NEW ALLIANCE FIRST GRADE COLLEGE. purchaser and seller should be quite clear and without ambiguity to promote harmony in an organisation. planning. qualitative as well as quantitative. In other cases. This is called ‘recognition of need’. An improperly described demand can cost heavily money-wise as well as time-wise. 2. Therefore.e.II SEM BCOM COST ACCOUNTING 12. 3. i. Developing coordination among other departments 13. pledged stock with bank. administrative. on their own responsibility or at a lower cost unless and until it gets the consent from the user department. is necessary for the sound and successful purchasing. tool room. which are not available easily. 1. Assessment of demand or description of need: After recognising the need with appropriate description.

like: (a) Catalogues. price lists etc. (d) Quotation letter or tender i. (f) Negotiation between suppliers and the purchase department like catalogue. such as branded or patented item. Receiving of quotation: As soon as the purchase requisition is received in the purchase division. (c) Previous purchase records.e.II SEM BCOM COST ACCOUNTING Most important function of a purchasing department or officer is the selection of the sources for the requisitioned items of stores. Selection of source of supply requires the services of shrewd purchasing officer who can keep pace with policies of the organisation and market from where the materials have to be purchased. NEW ALLIANCE FIRST GRADE COLLEGE. it is being purchased time and again or it is a seldom purchase on non-recurring basis. While selecting the item. Whenever the items are to be bought from single manufacturer. selection of one of the vendors should be made. the order can be placed with the party according to terms and conditions of their sale.. letter of inquiry. there is no difficulty in the selection of the sources of supply. (e) Sample and related price cards. sources of supply will be located. (b) Telephonic quotations. the purchase officer has to see whether the item to be purchased is on a regular basis i. Prices are also ascertained by preparing a comparative statement with the help of either of the following documents supplied either by the supplier or taken from the previous records of advertisements. There are different sources of supply which have no similarity between them. CRPATNA Page 26 . For majority of items. a decision is then taken in respect of the method of tendering/limitation of quotations from prospective suppliers.. 4.e. price lists etc.

All items do not require extensive follow-up. For some less important and low value items follow-up would be costly and wastage of money and time only. Verification of invoices: NEW ALLIANCE FIRST GRADE COLLEGE. it should always be accurate. 5. The purchase order should contain the following particulars: (a) Description and specifications of the material. (d) Name and address of the supplier. It will ensure that prices being paid to the existing vendor are competitive. 6. 7. (b) Quantity order. Placing order: Placing a purchase order is the next function of purchasing officer. (f) Price. (e) Date. Since purchase order is a legal binding between the two parties. (g) Signature of the purchase manager. Even for the items which are being purchased on a regular basis. (h) The name and address of the buyer. the purchasing section should invite tenders and know full well the market price. time and place of delivery. CRPATNA Page 27 . Making delivery at the proper time by following up the orders: Since one of the objectives of successful purchasing is delivery of goods at right time so as to ensure delivery when and where needed? In normal practice. discount and terms of payment.II SEM BCOM COST ACCOUNTING It is in the interest of purchasing department to keep this information up to date. clear and acceptable to both. the responsibility of the purchasing department is upto the time the material is received in the stores and is approved by the inspection department. (c) Transport and packing charges and shipping instructions. Every purchasing department has the responsibility for follow-up of the orders it places on different suppliers.

and even a slight error amounts to delay in consignment required at a particular time. bills. railway receipts. On receipt of the materials from different suppliers. the purchase department can get the correction done or adjustment effected. Maintaining purchasing records and files: Purchasing involves a lot of paper work. If there is any error in the bills. Daily a number of letters. Inspection of incoming materials: The purchasing department should have a close contact with inspection department. 8. 9. quotations.II SEM BCOM COST ACCOUNTING In normal course. the purchase department should have a thorough knowledge of the means of transportation. It should make a correct choice of carriers or routes because otherwise it may entail delay and additional transportation costs. It is a big responsibility. it is also the responsibility of purchase department to check the invoices and accordingly advise the accounts department for clearing the payment to the parties concerned. the experts add that it is part of the responsibility of purchase department that orders are accurately executed and properly filled as per terms and conditions of the contract. the payments of the suppliers also are likely to be delayed. challans. CRPATNA Page 28 . and at the lowest possible cost. If the invoices are checked by the stores or accounts departments. parcel. Some are of the view that invoices should be checked by the purchase department placed by it whereas other suggests that it should go to the accounting department. Meeting transport requirements of incoming and outgoing materials: The purchasing officer must make goods/materials available at the right time they are required. notes. If inspection is delayed. bills of NEW ALLIANCE FIRST GRADE COLLEGE. there may be some delay in attending to the errors. Uninspected materials are a burden on the economy of the organisation. at the place they are needed. way bills. resulting in bad relations between suppliers and purchasers. 10. they are to be inspected as per specifications indicated in the purchase order to verify their quality and quantity. In this regard. In support of this. Contradictory statements have been given as to who should be assigned this function.

11. The materials have to be stored in appropriate places and records the receipts in proper books. lorry receipt. The stores should be maintained properly and cost minimized. The duties and functions of Store-keeper can be summarized as follows: i) Materials should be received. 12. Reporting to top management: It is also an important function of the purchasing department to prepare weekly. quarterly. catalogues. Creating goodwill of the organisation in the eyes of the suppliers: Good vendor relationship has to be maintained and developed to reflect enterprise’s image and goodwill. Worth of a purchasing department can be measured by the amount of goodwill it has with its vendors Storekeeping: Store keeping is a service function. goods received notes. inspection notes have to be dealt with. NEW ALLIANCE FIRST GRADE COLLEGE. The main objectives of store keeping are:i) To protect stores against losses ii) To keep goods ready for delivery/issue iii) To provide maximum service at minimum cost. inspected and then moved to stores. The storekeeper is a custodian of all the items kept in the store. CRPATNA Page 29 . It involves a lot of clerical work. very frequently which makes it imperative to maintain records in appropriate manner. notes. 13.II SEM BCOM COST ACCOUNTING ladings. price lists etc. blue prints. unloaded. Maintaining such relations requires mutual trust and confidence which grows out of dealings between the two parties over a period of time. bi-annually and yearly reports regarding expenditures of this department and send the same to top management along with details of purchases made and suggestions or improvements. Developing coordination among departments: A purchasing department has to fulfill the needs of other departments in the organisation. goods receipt (transport delivery notes). These records are essential for making the day to day purchase. This department has to refer to previous correspondence on purchase orders. monthly. It is the function of purchasing department to work in close coordination and cooperation with other departments of the company. if any.

x) Neatness in stores to facilitate physical verification. rust. conversion ratios etc. iii) The stores should provide maximum protection and safety and accessibility and utilize minimum space. efficiently.date. theft. size of the company. A bin card is a record of the receipt and issue of material and is prepared by the store keeper for each item of stores. In a bin card not only the receipt and issue of material is recorded. heat. xii) Periodical review of various scales. ix) Maintenance of stores at required levels. measuring instruments. dust. moisture and deterioration etc. the organization structure etc. This helps the store keeper to send the material requisition for the purchase of material in time. minimum quantity. weather. vii) Ensure that all transactions are posted in the Bin Card see that the Bin Card is up-to. xi) Co-ordination and supervision of staff in the stores department.II SEM BCOM COST ACCOUNTING ii) The stores records should be maintained in an efficient and orderly manner so that materials can be easily located and information can be obtained for various departments. v) All issues should be properly recorded. iv) The materials should be given special covering to prevent damage due to atmospheric conditions. Suitable storage devices should be installed. vi) The storekeeper is responsible for co-ordination with materials control according to the type of production. promptly and accurately. A bin card is also known as bin tag or stock card and is usually kept in the rack where the material is kept. Stores (or Materials) records In the stores the most important two records kept are bin cards and stores ledger. maximum quantity and ordering quantity are stated on the card. viii) All items should be in its proper place. CRPATNA Page 30 . xiii) Protect stores from fires. All issues should be duly authorized and procedures laid down should be duly followed. erosion. NEW ALLIANCE FIRST GRADE COLLEGE. cold. (a) Bin Card.

This provides the information for the pricing of materials issued and the money value at any time of each item of stores. Difference between Bin Card and Stores Ledger Bin Card Stores Ledger (a) It is a quantity record (a) It is a record of quantity and value. (c) It is maintained by the store keeper (c) It is maintained by the accounts department (d) The postings are done before the (d) The postings are done after the transactions NEW ALLIANCE FIRST GRADE COLLEGE. (b) It is kept inside the stores (b) It is kept outside the stores.II SEM BCOM COST ACCOUNTING (b) Stores Ledger: This ledger is kept in the costing department and is identical with the bin card except that receipts. issues and balances are shown along with their money values. CRPATNA Page 31 .

(e) Cost of storage and insurance. The stock in hand is regulated in such a manner that normally it does not exceed this level. For costly items. (c) Nature and properties of the Store: For instance. (d) Storage facilities that can be conveniently spared for the item without determinant to the requirements of other items of stores. the maximum level should be as low as possible. ensuring that the material is ordered at right time and also avoiding shortage of materials. (g) Financial considerations: Availability of funds and the price of the stores are to be kept in view. NEW ALLIANCE FIRST GRADE COLLEGE. If prices are likely to rise. the following factors are to be taken into consideration: (a) Maximum requirement of the store for production purpose. (b) Rate of consumption and lead time. (f) Economy in prices: For seasonal supplies purchased in bulk during the season. (h) Rules framed by the government for import or procurement. If due to these and other causes materials are difficult to obtain and supplies are irregular the maximum level should be high. the level is pushed up. Fixation of Level: Another important aspect of material procurement is not to purchase too much or too little. a) Maximum Level: The Maximum Level indicates the maximum quantity of an item of material that can be held in stock at any time. Another point to be considered is the future market trend. the maximum level is generally high. The following levels of materials are fixed for achieving objectives like avoiding overstocking. Techniques of inventory control 1. Similarly the timing of the purchase is also important.II SEM BCOM (e) Each transaction is individually posted periodically COST ACCOUNTING Transaction take place (e) Transactions may be posted and in total. CRPATNA Page 32 . the maximum level is necessarily kept low for materials that are liable to quick deterioration or obsolescence during storage. at any point of time. the concern may like to stock-piling for keeping large stock in reserve for long-term future uses and in such a case. While fixing the level. Fixation of levels of materials is done precisely with these objectives in mind.

This applies to other levels also. The basic factors which are taken into consideration in fixing a Re-ordering Level for a store item include minimum quantity of item to be kept. This level is fixed somewhere between the maximum and minimum levels in such a manner that the difference of quantity of the material between the Re-ordering Level and Minimum Level will be sufficient to meet the requirements of production up to the time the fresh supply of material is received. rate of consumption and lead time which are applied for computing of this level. Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption X Minimum Re-Order Period) b) Minimum Level: The Minimum Level indicates the lowest quantitative balance of an item of material which must be maintained at all times so that there is no stoppage of production due to the material being not available. no minimum level is necessary. the re-order point remaining constant. Longer the lead time. the following factors are to be considered:(a) Nature of the item: For special material purchased against customer’s specific orders. Minimum Level=Re-Order level – (Normal Rate of Consumption X Normal Re-Order Period) c) Re-Order Level: When the stock in hand reach the ordering or re-ordering level. CRPATNA Page 33 . In fixing the minimum level.II SEM BCOM COST ACCOUNTING (i) The maximum level is also dependent on the economic ordering quantity. Re-Ordering level= Minimum Level + Consumption during lead time = Minimum Level + (Normal Rate of Consumption × Normal Reorder Period) Another formula for computing the Re-Order level is as below Re-Order level = Maximum Rate of Consumption X Maximum Re-Order period (lead time) NEW ALLIANCE FIRST GRADE COLLEGE. minimum or maximum) of the material. (b) The minimum time (normal re-order period) required replenishing supply: This is known as the Lead Time and are defined as the anticipated time lag between the dates of issuing orders and the receipt of materials. lower is minimum level. store keeper has to initiate the action for replenish the material. (c) Rate of consumption (normal.

The normal lead time cannot be afforded at this stage. the Danger Level is of no significance except that a check with the purchases department may be made as soon as the Danger Level is reached to ensure that everything is all right and that delivery will be made on the scheduled date. Or ½ (Minimum Stock Level + Maximum Stock Level) 2. Since the acquisition cost per unit of material is same whatever is the quantity purchased. This quantity is fixed in such a manner as to minimize the cost of ordering and carrying the stock. The only costs to be taken care of are the ordering costs and carrying costs which vary with the quantity ordered.II SEM BCOM COST ACCOUNTING d) Danger Level: It is the level at which normal issue of raw materials are stopped and only emergency issues are only made. it is usually excluded when deciding the quantity of a material to be ordered at one time. Cost of storage space which could have been utilized for some other purpose. Cost of bins and racks NEW ALLIANCE FIRST GRADE COLLEGE. CRPATNA Page 34 . In such case. if action for purchase of an item was taken when the stock reached the Re-Ordering Level. This is a level fixed usually below the Minimum Level. Carrying Cost: It is the cost of holding the materials in the store and includes: 1. The total costs of a material usually consist of: Total acquisition cost + total ordering cost + total carrying cost. Danger Level = Normal Rate of Consumption × Maximum Re-OrPeriod for emergency purchases f) Average Stock Level The average stock level is calculated by the following formula: Average Stock Level = Minimum Stock Level + ½ of Re-order Quantity. When the stock reaches this level very urgent action for purchases is indicated. 2. Economic Ordering Quantity (EOQ) The quantity of material to be ordered at one time is known as economic ordering quantity. It is necessary to resort to unorthodox hasty purchase procedure resulting in higher purchase cost. The practice in some firms is to fix danger level below the Re-Ordering Level but above the Minimum Level. This presupposed that the minimum level contains a cushion to cover such contingencies.

Cost of maintaining the materials to avoid deterioration. Insurance cost 9. 5. Cost of spoilage in stores and handling. Q= Q = Quantity to be ordered C = Consumption of the material concerned in units during a year. cost of inspection and cost of accounting and making payments. the cost of getting an item into the firms inventory I = Interest payment including variable cost of storing per unit per year i. NEW ALLIANCE FIRST GRADE COLLEGE. 8. ABC System: In this technique. Clerical cost etc. cost of paper work. inspection section and stores accounts department. Ordering Cost: It is the cost of placing orders for the purchase of materials and includes: 1. the cost of carrying will decrease but ordering cost will increase and vice versa. B and C according to their value. Materials are classified as A. Cost of staff posted in the purchasing department. the items of inventory are classifi ed according to the value of usage.e holding costs of inventory.II SEM BCOM COST ACCOUNTING 3. 3. Cost of stationary postage and telephone charges. The ‘A’ items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory. Cost of obsolescence of materials due to change in the process or product. this type of costs includes cost of floating tenders. When the quantity of materials ordered is less. CRPATNA Page 35 . Transportation cost in relation to stock. 6. Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. 4. 2. O = Cost of placing one order including the cost of receiving the goods i. Amount of interest payable on the amount of money locked up in the materials. the cost varies with the number of orders. In other words. cost of comparative evaluation of quotations. 7.e. and postage involved in placing the order. Thus.

CRPATNA Page 36 . The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically. The cost of the abnormal wastage is not charged to the production. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value. NEW ALLIANCE FIRST GRADE COLLEGE. Normal allowance of waste can be fixed with technical assessment and past experience as well as by identifying the special features of materials. the good units should bear the cost of normal wastage. Waste:. In other words it is more than the standard wastage. shrinkage. actual numbers may vary from situation to situation. • Wastage can be controlled by adopting strict quality control measures. It is necessary to take steps to control the material wastage.II SEM BCOM COST ACCOUNTING Items in class ‘B’ constitute intermediate position. Wastages may be visible or invisible. The numbers given above are just indicative. the wastage is divided into the following categories. In other words. about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory. unrecoverable residue etc. It is of paramount importance that there should be rigid control over the material losses failing which it will be very difficult to keep the material costs in check.Any wastage over and above the normal wastage is the abnormal wastage. It is inherent in any production process.This wastage is such that it cannot be avoided.Waste is a loss of material either in stores or in production due to reasons like evaporation. but it is written off to the Costing Profi t and Loss Account. The normal wastage is normally estimated in advance and included in the material cost. • Abnormal Wastage:. The causes for abnormal wastages should be studied in detail and responsibility should be fixed for wastage. Better material handling system will also help in controlling the wastage. chemical reaction. In cost accounting. • Normal Wastage:. Items in class ‘C’ are the most negligible in value. Material Losses: One of the main reasons of rising material costs is the loss of material in the production process. The material losses can be categorized as given below.

the good units should bear the cost of scrap and any income collected will be treated as other income.Scrap is a residual material resulting from a manufacturing process.g. CRPATNA Page 37 . The treatment of scrap in cost accounts is normally as per the following details. negligent handling of material etc. determination of acceptable limits of scrap. the cost of job will be transferred to scrap account and any realization from sale of such scrap will be credited to the job or process account and any unrecovered balance in the scrap account will be transferred to the Costing Profit and Loss Account.II SEM BCOM COST ACCOUNTING Scrap:. • Scrap can be controlled through selection of right type of material.This results from poor quality of raw material. • The cost of normal spoilage is spread over to the good production by charging either to the specific production order or to the product overheads. • If the value of scrap is considerable and identifiable with the process or job. Spoilage:. • The cost of abnormal spoilage is charged to the Costing Profit and Loss Account. • Administrative Scrap:. • If the value of scrap is negligible. It has a recovery value and is measurable. selection of right type of manpower. the amount will be transferred to factory overhead account after deducting the selling cost. The accounting treatment of spoilage is as follows. Rectification can be done at a cost which may not be economic.This is predetermined or anticipated in advance due to experience in manufacturing operations.This results from administrative decisions. it is called as ‘normal’ spoilage and anything exceeding this limit is called as ‘abnormal’ spoilage. change in design of a product or discontinuation of existing product lines. NEW ALLIANCE FIRST GRADE COLLEGE. • Legitimate Scrap:. scrap may be divided into the following categories.Spoilage is the production that fails to meet quality or dimensional requirements and so much damaged in manufacturing operations that they are not capable of rectification and hence has to withdraw and sold off without further processing. and reporting the source of waste. • Defective Scrap:. • Control of Scrap:. e.For the control purpose. If the spoilage is within limits. • If scrap value is quite substantial and it is not identifiable with a particular job or process. This will reduce the cost of production to the extent of the scrap value.

the inventory valuation will be at the older price as material in balance will be from the earlier batches of purchases. material received first is issued first. However the consumption value will be as per the purchases made earlier and hence the latest price may not be charged to the consumption. Therefore the issue should be charged at the latest prices. Hence it is necessary to price the issues by using certain methods. The main advantage of this method is that the issues are priced at the latest prices and hence consumption value is also the latest. But it is not practical as it is virtually impossible to identify the material issued. it is charged to factory overheads. labor and/or processing and made it into saleable condition either as firsts or seconds depending upon the characteristics of the product. Pricing of Issues One of the important aspects of issue control is of pricing of the issues. If it cannot be identified. Cost of abnormal defectives is charged to the Costing Profit and Loss Account. In case of rising prices it will result in charging lower prices while in case of falling price it will result in charging higher prices to the material consumption.II SEM BCOM COST ACCOUNTING Defectives :.The assumption under this method is that the material which is purchased last is issued first to the production. The various methods of pricing of issues are given below. The cost of normal defectives is spread over the good units and the cost of additional processing is charged to a particular department/process if it is identifiable with the same. However the question is that at what price the issue is to be charged. This method is quite logical as the sequence of issue is as per the dates of purchases. Last In First Out [LIFO]:. Thus the material in stock at the beginning of a period is issued firstly and then the issues are made according to the dates of purchases made. The accounting treatment of defectives is the same like that of spoilage.As per this method. However. Valuation NEW ALLIANCE FIRST GRADE COLLEGE. This will make the product cost more realistic. 2. 1.The defectives are part of production units which do not confirm to the standards of quality but can be rectified with additional application of materials. First In First Out:. Material is issued to production and it is necessary to find out the consumption value of the material. CRPATNA Page 38 . The closing stock will be shown at the latest prices as the material purchased towards the end of the period will remain the stock. Obviously the answer is that the issues should be priced at the same price at which they are purchased.

15. The weighted average price will be calculated as shown below.10 × 1. For example.11.600 = Rs.12 × 1. NEW ALLIANCE FIRST GRADE COLLEGE.000 + Rs. Weighted Average Method:. The issue is charged at prices arrived at according to this calculation.200 + Rs. if three consignments of materials are purchased at prices of Rs.10.11 × 1.10.400. The subsequent issue will be charged at this price. CRPATNA Page 39 .200 and 1.II SEM BCOM COST ACCOUNTING of inventory according to this method is not accepted for inventory valuation in the preparation of financial statements.14. Rs.400 = Rs.400 + Rs.800 / 3.05.This method takes into consideration the prices as well as the quantities of materials purchased. 000 + Rs. 3.12 and Rs. Rs.39. 1.11 and the quantities involved are respectively 1.000.400 = Rs. The main advantage of this method is that it evens out the price fluctuations and reduces the number of calculations to be made. Thus weighted average is computed after each receipt by dividing the total amount by the total quantity.

Importance of Labour Cost Control Labour is of two types (a) direct labour. Labour is the most perishable commodity and as such should be effectively utilized immediately. CRPATNA Page 40 . watchmen etc. workers. The cost of indirect labour cannot be conveniently allocated to a particular job. To reduce the labour turnover. ascertaining the cost of every product. cleaners. office. Management is interested in the labour costs due to the following reasons. if percentage of direct labour cost to overhead is to be used as a method of absorption of overhead. process or article. selling and distribution expenditure according to the nature of the time spent by the indirect worker. sweepers. Hence control of labour cost is an important objective of management and the realization of this objective NEW ALLIANCE FIRST GRADE COLLEGE. (b) indirect labour. order. For example labour engaged in spinning department can be conveniently allocated to the spinning process. Indirect Labour is that labour which is not directly engaged in the production of goods and services but which indirectly helps the direct labour engaged in production. The examples of indirect labour are supervisors. The distinction between direct and indirect labour must be observed carefully because payment of direct labour is a direct expenditure and is a part of prime cost whereas payment of indirect labour is an item of indirect expenditure and is shown as works.II SEM BCOM COST ACCOUNTING UNIT IV LABOUR Labour cost is a second major element of cost. The control of labour cost and its accounting is very difficult as it deals with human element. Direct Labour is that labour which is directly engaged in the production of goods or services and which can be conveniently allocated to the job. t labour cost as a basis for absorption of overhead. or process. order. time-keepers. process or commodity or process.

They are the manual methods and the mechanical methods. Time keeping Time-keeping will serve the following purposes: 1. Methods of Time-keeping There are two methods of time-keeping. This method is simple and inexpensive and can be used in small firms where the number of workers is not large. Preparation of Pay Rolls in case of time-paid workers. The manual methods of time keeping are as follows: a) Attendance Register Method. early leaving. the time of arrival and departure. These boards can be maintained separately for each department so that the workers can remove NEW ALLIANCE FIRST GRADE COLLEGE. CRPATNA Page 41 . A board is kept at the gate with pegs on it and all tokens are hung on this board. The timekeeper records the name of the worker. each worker is allotted a metal disc or a token with a hole bearing his identification number.II SEM BCOM COST ACCOUNTING depends upon the co-operation of every member of the supervisory force from the top executive to foremen. late attendance. Metal Disc Method Under this method. 5. Recording of each worker’s time ‘in’ and ‘out’ of the factory making distinction between normal time. they may make a record of time themselves in the presence of a time-keeper or foreman. 2. Meeting the statutory requirements. the department in which he is working. the worker’s number. 4. overtime. the rate of wages. 3. and b) Metal Disc Method Attendance Register Method This is the traditional method where an attendance register or muster roll is kept at the time office near the factory gate or in each department. normal time and overtime. However recording the time of workers who work at customers’ premises and places which are situated at a distance from the factory is not practical in this method. If the workers are literate. Whichever method is used it should make a correct record of the time and the method should be cost effective and minimize the risk of fraud. For overhead distribution when overheads are absorbed on the basis of labour hours. Ensuring discipline in attendance.

Under this method. It has a dial with number of holes (usually about 150) and each hole bears a number corresponding to the identification number of the worker concerned.II SEM BCOM COST ACCOUNTING the token without delay and put it in a tray or box kept near the board. There is one radial arm at the centre of the dial. The sheet on which the time is recorded provides a running account of the worker’s time and it can calculate the number of hours and prepare the wage sheets. NEW ALLIANCE FIRST GRADE COLLEGE. The tokens or disc left on the board will represent the absentee workers. return from lunch and time of leaving the factory in the evening. puts it in the time recording clock which prints the exact time of arrival in the proper space against the particular day. the box is removed and the latecomers will have to give their tokens to the timekeeper and their exact time of arrival is recorded. Immediately after the scheduled time for entering the factory. a dial time recorder machine us used. CRPATNA Page 42 . Later the timekeeper records the attendance in the attendance register and subsequently it is passed on to the Pay Roll Department. However. he is to press the radial arm after placing it at the hole of his number and his time will automatically be recorded on roll of a paper inside the dial time recorder against the number. This procedure is repeated for recording time of departure for lunch. the high installation cost of the dial time recorder and its use for only a limited number of worker are the drawbacks of this method. As a worker enters the factory gate. he picks up his card from the tray. Dial Time Records Under this method. Mechanical Methods The mechanical methods that are generally used for the recording of time of workers may be as follows: (a) Time Recording Clocks (b) Dial Time Records Time Recording Clocks The time recording clock is a mechanical device which automatically records the time of the workers. each worker is given a Time Card which is kept in a tray near the factory gate and as the worker enters the gate. Late arrivals and overtime are recorded in red to attract the attention of the management.

the wastage of which cannot be avoided and. But every effort should be made to reduce it to the lowest possible level. Weekly Time Sheets 3. it is necessary to make the comparison of actual time taken with time allowed for completing a particular task. time between the NEW ALLIANCE FIRST GRADE COLLEGE. 5. Job cards are used to keep a close watch on the time spent by a worker on each job so that the labour cost of a job may be conveniently ascertained. Idle Time There is always a difference between the time booked to different jobs or work orders and the time recorded at the factory gate. To ascertain unproductive time or idle time so as to make efforts to keep it in limit. the employer must bear the labour cost of this time. Following documents are generally used for time booking: 1. 3. CRPATNA Page 43 . To know the efficiency of workers. To ascertain the labour cost of each individual job or work order. therefore. Job Tickets or Job Cards. 4.II SEM BCOM COST ACCOUNTING Time Booking Time booking is the recording of time spent by the worker on different jobs or work orders carried out by him during his period of attendance in the factory. Examples of normal idle time are: time taken in going from the factory gate to the department in which the worker is to work and back at the end of the day. The objects of time booking are: 1. time taken in picking up the work for the day. Daily time sheets are given to each worker where he records the time spent by him on each job or work order. (a) Normal Idle Time (b) Abnormal Idle Time Normal Idle Time: This represents the time. 6. To ensure that time spent by a worker in a factory is properly utilized on different jobs or work orders. To know the time taken to complete a particular job so that bonus can be paid as per the incentive schemes. Idle time is of two types. This difference is known as idle time. Weekly time sheets record the same particulars for a week and hence one card is required for a week. To provide a basis for the apportionment of overhead expenses over various jobs or work orders when the method for the allocation of overheads depends upon time spent on different jobs. 2. Daily Time Sheets 2.

Overtime is done at late hours when workers have become tired and efficiency will it be as much as during the normal working hours. strikes or lock-outs in the factory. machine set-up time etc. time taken for personal needs like tea or toilet. Overtime should be recorded separately and thoroughly investigated to see that it is incurred only when genuinely required. The cost of normal idle time can be treated as an item of factory expenses and recovered as an indirect charge or added to labour cost. On the other hand if overtime arises due to any abnormal reason like breakdown of machinery or power failure. 3.It is the work done beyond the normal working period in a day or week. waiting for tools and raw materials. CRPATNA Page 44 . shortage of materials. the workers are given double the wages for the overtime done. 1. For overtime done. Over Time: . Example: time wasted due:. Overtime is paid at higher rate. printouts. The additional amount paid on account of overtime is known as overtime premium. waiting for instructions. then the overtime wages is added to the cost of labour.II SEM BCOM COST ACCOUNTING completion of one work and the start of another work. Workers will develop the habit of working slowly during normal hours and complete the work using overtime to earn more wages. Hence it is debited to Costing Profit and Loss Account. cost of supervision. overtime premium is excluded from the cost of production and is debited to the Costing Profit and Loss Account NEW ALLIANCE FIRST GRADE COLLEGE. then normal wages is charged to labour cost for the overtime also but if it is a rush job. The treatment of overtime depends on the situation. Abnormal Idle Time: It is that time the wastage of which can be avoided if proper precautions are taken.to breakdown of machinery on account of inefficiency of the works engineer. If overtime is incurred for because of the sequence of jobs. time taken for machine maintenance. failure of the power supply. and wear and tear of machines will increase disproportionately. time taken for waiting for instructions. 2. Overtime increases the cost of production and should not be encouraged as it has the following disadvantages. It is a principle of costing that all abnormal expenses and losses should not be included in costs and as such wages paid for abnormal idle time should not form part of the cost of production. Expenses like lighting. Normal Idle Time is unavoidable cost as such should be included in cost of production. 4.

7. 4. 2. daily. Where the speed of work is beyond the control of the workers. It will encourage a tendency among workers to go slow so as to earn overtime wages. This method is highly suitable for following types of work: 1. This payment is made according to the time worked irrespective of the work done. (ii) Payment on the basis of the work done irrespective of the time taken by the worker. the worker is paid at an hourly. artistic goods 3. Where quality of goods produced is of extreme importance eg. The disadvantages of this method are: 1. Strict supervision is necessary to get the work done. Other methods called premium plans or bonus and profit sharing schemes are used with either of the two principal methods of wage payment. Efficient workers will become inefficient in the long run as all of them get same wages. 2. Workers are not motivated. Inefficiency results in upsetting the production schedule and increases the cost per unit. 4. This method is called piece rate system.. Where highly skilled and apprentices are working. NEW ALLIANCE FIRST GRADE COLLEGE. 5. Employer finds it difficult to calculate labour cost per unit as it varies as production increases and decreases. Where close supervision of work is possible. The system of wages should result into higher production. 6. CRPATNA Page 45 . 3. There are two principal wage systems: (i) Payment on the basis of time spent in the factory irrespective of the amount of work done. weekly or monthly rate.II SEM BCOM COST ACCOUNTING Methods of remuneration / System of Wage Payment System of Wage Payment There is no single method of wage payment which is acceptable both to the employers and the workers. improved quality of output and a contented labour force. Workers will get payment for idle time. Thus this method does not establish a proportionate relationship between effort and reward and the result is that it is not helpful in increasing production and lowering labour cost per unit. 5. Time Wage System Under this method of wage payment. This method is known as time wage system. Where output cannot be measured.

NEW ALLIANCE FIRST GRADE COLLEGE.II SEM BCOM COST ACCOUNTING Piece Rate System (payment by result) Under this system of wage payment. payment is made according to the quantity of work done no consideration is given to the time taken by the workers to perform the work. 5. Another method is piece rate with guaranteed time rate in which the worker is given time rate wages if his piece rate wages is less than the time rate. 6. Disadvantages 1. The employer knows his exact labour cost and hence can make quotations confidently. 4. 7. Thus. There are four variants of this system. Fixing of piece work rate is difficult as low piece rate will not induce workers to increase production. job completed or an operation performed. Haste makes waste. 3. CRPATNA Page 46 . Quality of output will suffer because workers will try to produce more quickly to earn more wages. 2. Workers use their tools and machinery with a greater care so that the production may not be held up on account of their defective tools and machinery. Increased production leads to decreased cost per unit of production and hence profit per unit increases. Workers are motivated to increase production to earn more wages. a) Straight piece rate system b) Taylor’s differential piece rate system c) Merrick’s multiple piece rate system d) Gant’s task and bonus plan (a) Straight piece rate system Payment is made as per the number of units produced at a fixed rate per unit. Inefficient workers are motivated to become efficient and earn more wages by producing more. because of the efforts of workers to increase the production. Thus there will be more wastage of material. Idle time is not paid for and is minimized. a fixed rate is paid for each unit produced. 8. Wages are linked to output so workers are paid according to their merits. There may not be an effective use of material. 2. 3. Advantages 1. Less supervision is required because workers get wages for only the units produced.

there may be increased wastage of materials. 6. Time cards are maintained so that workers are punctual and regular so that production may not slow down (b) Taylor’s Differential Piece Rate system This system was introduced by Taylor. tools and machines are sufficiently available to cope with the possible increase in production. may spoil their health. The system is flexible and rates can be adjusted to changes in price level. he is paid a higher piece rate and if he does not complete the work within the standard time. CRPATNA Page 47 . Increased production will not reduce the labour cost per unit because the same rate will be paid for all units. so that if a worker performs the work within or less than the standard time.II SEM BCOM COST ACCOUNTING 4. Workers have the fear of losing wages if they are not able to work due to some reason. Quantity of output can be measured. three piece rates are applied for workers NEW ALLIANCE FIRST GRADE COLLEGE. Taylor advocated two piece rates. The system will cause discontentment among the slower workers because they are not able to earn more wages. Workers may work at a very high speed for a few days. On the other hand. Workers may work for long hours to earn more wages. 10. The work is of a repetitive type. the father of scientific management to encourage the workers to complete the work within or less than the standard time. increased production will reduce the labour cost per unit under the time wage system. he is given a lower piece rate. 5. When there is increased production. It is possible to fix an equitable and acceptable piece rate 5. 2. Workers in the habit of producing quality goods will suffer because they will not get any extra remuneration for good quality. 9. 3. Under this method. 4. 6. This method can be successfully applied when: 1. upsetting the uniform flow of production. Quality of goods can be controlled. 7. and thus. c) Merrick’s Multiple Piece Rate System This method seeks to make an improvement in the Taylor’s differential piece rate system. Materials. earn good wages and then absent themselves for a few days. high cost of supervision and inspection and high tools cost and hence cost of production might increase. 8. 7.

a standard time is fixed for the completion of a specific job or operation at an hourly rate plus wages for a certain fraction of the time saved by way of a bonus. so it is helpful in reducing labour cost per unit. The plan is also known as incentive plan because a worker has the incentive to earn more wages by completing the work in less time. T the time taken. The standard time for doing each job or operation is fixed. It guarantees time wages to workers. Under a premium plan. 1. CRPATNA Page 48 . Thus if S is the standard time. The wages of time saved are shared by both employers and workers. Wages are paid at ordinary piece rate to those workers whose performance is less than 83% of the standard output. R the labour rate per hour. The following are some of the important premium plans. the worker gets full payment for time saved whereas in a premium plan both the worker and the employer share the labour cost of the time saved. 110% of the ordinary piece rate is given to workers whose level of performance is between 83% and 100% of the standard and 120% of the ordinary piece rate is given to workers who produce more than 100% of the standard output. This method is not as harsh as Taylor’s piece rate because penalty for slow workers is relatively lower. 2. It motivates efficient workers to work more as there is increasing incentive to efficient workers. worker does not get any reward for the time saved and in piece work system. total earnings of the worker will be: T x R + % (S-T) R The advantages of the Halsey Premium Plan are: It is simple to understand and relatively simple to calculate. In time wage system. This system of wage payment is in between the time wage system and piece work system. Premium and Bonus Plan The object of a premium plan is to increase the production by giving an inducement to the workers in the form of higher wages for less time worked. the worker is given wages for the actual time taken and a bonus equal to half of wages for time saved. 3. NEW ALLIANCE FIRST GRADE COLLEGE. In practice the bonus may vary from 33⅓ % to 66⅔ % of the wages of the time saved. (i) Halsey Premium Plan: Under this method.II SEM BCOM COST ACCOUNTING with different levels of performance. and % the percentage of the wages of time saved to be given as bonus.

4. CRPATNA Page 49 . Disadvantages 1. nature of the industry. Workers criticize this method on the ground that the employer gets a share of wages of the time saved. 2. Fixed overhead cost is reduced with increase in production. 5. Labour Turnover Labour Turnover of an organisation is change in the labour force during a specified period measured against a suitable index.II SEM BCOM COST ACCOUNTING 4. its size. Total Earnings = T x R + S-T x T x R S Advantages 1. one very efficient and the other not so efficient. 3. The rate of Labour Turnover in an industry depends upon several factors such as. may get the same bonus. NEW ALLIANCE FIRST GRADE COLLEGE. Labour cost per unit is reduced because wages of time saved are shared by employer and employee. he is induced to provide the best possible equipment and working conditions. Disadvantages 1. The Rowan plan is criticized by workers on the ground that they do not get the full benefit of the time saved by them as they are paid bonus for a portion of the time saved. Quality of work suffers because workers are in a hurry to save more and more time to get more and more bonus. So. Under this method also the workers are guaranteed the time wages but the bonus is that proportion of the wages of the time taken which the time saved bears to the standard time allowed. location and composition of the labour force. Fixed overhead cost per unit is reduced with increase in production. 2. The employer is able to reduce cost of production by having reduction in labour cost and fixed overhead cost per unit. The Rowan plan suffers from another drawback that two workers. It guarantees time wages to workers 2. The quality of work does not suffer as they are not induced to rush through production as bonus increases at a decreasing rate at higher levels of efficiency. (ii) Rowan Plan: The difference between Halsey plan and Rowan Plan is the calculation of the bonus. A controlled level of Labour Turnover is considered desirable because it helps the firm to adjust the size of its labour force in response to needs such as for seasonal changes or changes in technology.

These circumstances are: (a) Retrenchment due to seasonal trade. (b) Low pay and allowance. The above causes may also be classified in a different manner under three heads. (g) Lack of amenities like recreational centres. e. (a) Dislike for the job. (f) Lack of transport.II SEM BCOM COST ACCOUNTING Causes of Labour Turnovers: The causes giving rise to high labour turnover may be broadly classified under the following the heads: (i) Personnel Causes: Workers may leave employment purely on personal grounds. may be grouped the causes which need the attention of the management most so that the turnover may be kept low by taking remedial measures. In all such cases. (c) Discharge due to continued or long absence.g. shortage of any material and other resources. (b) Discharge on disciplinary grounds. locality or environments. accommodation. (c) Change of line for betterment.. NEW ALLIANCE FIRST GRADE COLLEGE.. (d) Retirement due to old age and ill health. personal factors count the most and employer can practically do nothing to help the situation. slack market for the product. etc. (d) Unhappy relations with co-workers and unsatisfactory behaviour of superiors. etc. (e) Dispute between rival trade unions. medical and other factors. schools. Social and Economic Causes and Psychological Causes relating to human relationship. (e) Death. (iii) Avoidable Causes: Under this head. CRPATNA Page 50 . (ii) Unavoidable Causes: In certain circumstances it becomes obligatory on the part of the management to ask some of the workers to leave. (b) Domestic troubles and family responsibilities. (c) Unsatisfactory working conditions. viz. The main reasons for which workers leave are: (a) Unsuitability of job. Financial Causes.

The turnover can also be computed by taking replacements and separations also. number of employees added during a particular period is taken into consideration for computing the Labour Turnover. CRPATNA Page 51 . Computation is done as per the following methods. instead of taking the number of employees added. This is necessary for having an idea about the turnover in the organisation and also to compare the Labour Turnover of the previous period with the current one. Labour Turnover=(Number of additions/Average number of workers during the period) ×100 (b) Separation Method: In this method. The following methods are available for measurement of the Labour Turnover:(a) Additions Method: Under this method. The number of employees replaced is taken into consideration for computing the Labour turnover. number of employees left during the period is taken into consideration. The method of computation is as follows. Labour Turnover = ½ [Number of additions + Number of separations] /Average number of workers during the period X100 Labour Turnover = ½ [Number of replacements + Number of separations] /Average number of workers during the period X 100 NEW ALLIANCE FIRST GRADE COLLEGE. Labour Turnover = Number of separations/Average number of workers during the period)×100 (c) Replacement Method: In this method neither the additions nor the separations are taken into consideration. The method of computing is as follows.II SEM BCOM COST ACCOUNTING Measurement of Labour Turnover: It is essential for any organisation to measure the Labour Turnover. Labour Turnover = (Number of replacements/Average number of workers during the period)×100 (d) Flux Method: Under this method Labour Turnover is computed by taking into consideration the additions as well as separations.

It is necessary to identify the indirect expenses and the above NEW ALLIANCE FIRST GRADE COLLEGE. Collection of Overheads: . In other words. as cannot be conveniently charged direct to specific cost centres or cost units. Overhead Accounting The ultimate aim of overhead accounting is to absorb them in the product units produced by the firm. Classification and Codification of Overheads :I. A. In view of this. it becomes necessary to charge them to the product units on some equitably basis which is called as ‘Absorption’ of overheads. Collection. Purchase Orders and Invoices v. CRPATNA Page 52 . Absorption of Overheads. as overheads are all indirect costs. Other Registers and Records For the purpose of overhead accounting. it becomes difficult to charge them to the product units. etc. indirect labour and such other expenses. Classification and Codification of Overheads B. Stores Requisition ii. collection of overheads is very important.) are associated with individual jobs or products. A. Absorption of overhead means charging each unit of a product with an equitable share of overhead expenses. Allocation. Journal Entries vi. Collection. i. Wages Sheet iii. materials or services which cannot be economically identified with a specific saleable cost unit”. The important steps involved in overhead accounting are as follows.II SEM BCOM COST ACCOUNTING UNIT V OVERHEADS Overhead may be defined as the cost of indirect material.Overheads collection is the process of recording each item of cost in the records maintained for the purpose of ascertainment of cost of each cost center or unit. London defines overhead as “Expenditure on labour. It should be noted that direct costs (materials. CIMA. Cash Book iv. they represent the cost of the facilities required for carrying on the operations. Indirect expenses or overheads are not associated with individual jobs or products. including services. The following are the source documents for collection of overheads. Apportionment and Reapportionment of overheads C. labour.

indirect materials used in production etc. Accurate classification of all items is actually a prerequisite to any form of cost analysis and control system.Overheads can also be classified according to their functions. Proper collection of overhead expenses will help to understand accurately the total overhead expenses. factory power. depreciation of factory machinery and other fixed assets. office rent. electricity used in the office. workers who are not directly engaged on the production are examples of indirect wages. II. • Indirect Expenses :. ‘the arrangement of items in logical groups having regard to their nature ( subjective classification ) or the purpose to be fulfilled. similarly thread used to stitch clothes is also indirect material. factory insurance. electricity. insurance. The classification is done as per the following details.II SEM BCOM COST ACCOUNTING mentioned source documents are used for this. For example. This classification is done as given below. ii. printing and stationery. Classification is made according to following basis. salaries of administrative staff etc. lubricants used in a machine is an indirect material. i. It should be noted that such expenditure is incurred for manufacturing but cannot be identified with the product units. • Indirect Materials :.Materials which cannot be identified with the given product unit of cost center is called as indirect materials. works manager’s salary.Indirect expenses incurred for running the administration are known as Administrative Overheads. • Indirect Labor :. For example. Classification of Overheads :. i.According to this classification overheads are divided according to their elements. ( Objective classification ) In other words.e. • Manufacturing Overheads :. Classification according to Elements :. classification is the process of arranging items into groups according to their degree of similarity. power. office telephone.Expenses such as rent and taxes. office salaries. Examples of such overheads are.Wages and salaries paid to indirect workers. printing and stationery. Functional Classification :.Classification is defined by CIMA as. Small nuts and bolts are also examples of indirect materials. NEW ALLIANCE FIRST GRADE COLLEGE.Indirect expenses incurred for manufacturing are called as manufacturing overheads. marketing and selling expenses etc are the examples of indirect expenses. • Administrative Overheads :. CRPATNA Page 53 .

According to this classification. it decreases. On the other hand.These types of overheads remain constant over a relatively short range of variation in output and then are abruptly changed to a new level.Variable overheads are those which go on increasing if production volume increases and go on decreasing if the volume decreases. are some of the examples of fixed costs. Codification of Overheads: .It is always advisable to codify the overhead expenses. for a given period of time.Overheads incurred for getting orders from consumers are called as selling overheads. Classification according to Behavior :.In the modern days. In other words. depreciation of fixed assets. Variable overheads are generally considered to be controllable as they are directly connected with the production. Similarly. Total fixed costs remain same irrespective of changes in volume of production but per unit of fixed cost is variable. advertising expenses etc. fi re insurance are also semi-variable overheads. transportation of outgoing goods. Variable Overheads :. they start increasing. firms spend heavily on research and development. supervisor’s salary is treated as fixed but if a decision is taken to operate a second shift. It increases if production decreases while if production increases.Fixed overheads are commonly described as those that do not vary in total amount with increase or decrease in production volume. CRPATNA Page 54 . maintenance expenditure. Salaries. iii. property taxes. III. There are numerous items of overheads and a code NEW ALLIANCE FIRST GRADE COLLEGE. Semi-variable Overheads :. • Research and Development Overheads :. sales promotion expenses. Examples of selling overheads are. overheads are classified as fixed. Examples of distribution overheads are warehouse charges. variable and semi-variable. overheads incurred for execution of order are called as distribution overheads.II SEM BCOM COST ACCOUNTING • Selling and Distribution Overheads :. This indicates that it is a semi-variable overheads. commission of middlemen etc. For example. Expenses incurred on research and development are known as Research and Development overheads. additional supervisor may have to be appointed which results into increase in the salary of the supervisor. salesmen’s salaries and commission. Fixed Overheads :. Such increase or decrease may or may not be in the same proportion. These concepts are discussed below. packing. they remain same up to a certain level of output and after crossing that level. may be a year. marketing expenses. Codification helps in easy identification of different items of overheads.

the next step is allocation and apportionment of such expenses to cost centres. depreciation. repairs and maintenance. works manager’s salary etc. lighting. Codification can be done by allotting numerical codes or alphabetical codes or a combination of both. partly producing departments. Service department. Whatever system is followed.II SEM BCOM COST ACCOUNTING number to each one will facilitate identification of these items easily. CRPATNA Page 55 . NEW ALLIANCE FIRST GRADE COLLEGE. The electricity charges of a department if separate meters are there should be charged to that particular department only. it should be remembered that the system is simple for understanding and easy to implement without any unnecessary complications. Basis of Apportionment Suitable bases have to be found out for apportioning the items of overhead cost to production and service departments and then for reapportionment of service departments costs to other service and production departments. The basis selected should be correlated to the expenses and the expense should be measurable by the basis. An expense which is directly identifiable with a specific cost centre is allocated to that centre. Allocation of Overhead Expenses Allocation is the process of identification of overheads with cost centres. If a cost is incurred for two or more divisions or departments then it is to be apportioned to the different departments on the basis of benefit received by them. This is also known as departmentalization or primary distribution of overhead. Common items of overheads are rent and rates. For example the total overtime wages of workers of a department should be charged to that department. Apportionment of Overhead Expenses Cost apportionment is the allotment of proportions of cost to cost centres or cost units. Thus it is allotment of a whole item of cost to a cost centre or cost unit. This process of distribution of common expenses over the departments on some equitable basis is known as ‘Primary Distribution’. Allocation and Apportionment of Overhead to Cost Centres (Departmentalisation of Overhead) When all the items are collected properly under suitable account headings. A factory is administratively divided into different departments like Manufacturing or Producing department.

g.:.no. Re-apportionment of Service Department Costs to Production Departments Service department costs are to be reapportioned to the production departments or the cost centres where production is going on. Under this basis. of employees in each service. 7. of employees in each department. Employment or Personnel . Expenses which are booked with the amounts of wages e. (i) Direct Labour/Machine Hours. Example overtime premium of workers engaged in a particular department. 4. (ii) Value of materials passing through cost centres. Maintenance Department -Hours worked for each department 2. (iii) Direct wages. overheads are directly allocated to the department for which it is incurred. Payroll or time-keeping -Total labour or Machine hours or department number of employees in each department 3. Building service department -Relative are in each department 8. CRPATNA Page 56 . This process of re-apportionment of overhead expenses is known as ‘Service Distribution’. Are distributed amongst the departments in the ratio of wages.II SEM BCOM COST ACCOUNTING The following are the main bases of overhead apportionment utilized in manufacturing concerns: Direct Allocation. ambulance. value graded product NEW ALLIANCE FIRST GRADE COLLEGE. Welfare. -no. The following is a list of the bases of apportionment which may be accepted for the service departments noted against Service Department Cost Basis of Apportionment 1. overhead expenses are distributed to various departments in the ratio of total number of labour or machine hours worked in each department. worker’s compensation etc.worker’s insurance. of purchase orders or value of 5. their contribution to provident fund. Purchase Department materials 6. of requisitions or value of materials of each department. Majority of general overhead items are apportioned on this basis. This basis is adopted for expenses associated with material such as material handling expenses. repairs of a particular department etc. power. recreation room expenses. department.Rate of labour turnover or number Department. Under direct allocation. Store keeping department . canteen -No. Internal transport service or -Weight.

truck tonnehours. 10. This process is called secondary distribution of overheads. number of electric points etc. truck mileage. both are not the same. truck hours. truck tonnage. where as apportionment needs a suitable basis for sub-division of the cost. Allocation deals with the whole items of cost and apportionment deals with proportion of items of cost. The basis for secondary distribution is dependent on:(i) The nature of service given e. but depends on the relation with the cost centre or cost unit to which it is to be charged. tonnage handled. The products actually do not pass through the service departments.e to identify or allot the costs to the cost centres or cost unit. (ii) Measurement of service based on surveys or analysis. as there may not be a direct linkage between services and production activity.g.II SEM BCOM COST ACCOUNTING overhead crane service handled. horse power. weight and distance travelled. So does it mean that the service cost is not a part of cost of production? It very much is the part of production cost! Hence the loading of service costs onto the production departments is necessary. Transport Department -crane hours. horse power cost) machine hours. the next step is to redistribute the service department costs over the production departments. Allocation is direct process of departmentalization of overheads. This also needs to be done on some suitable basis. (iii) General use indices Methods of Secondary Distribution NEW ALLIANCE FIRST GRADE COLLEGE. Secondary Distribution of Production Overheads After the primary distribution as shown above is over. CRPATNA Page 57 . number of packages. i. Distinction between Allocation & Apportionment Although the purpose of both allocation and apportionment is identical. Whether a particular item of expense can be allocated or apportioned does not depends on the nature of expense. Power House (Electric power –wattage. it may be maintenance department or stores. 9.

the true cost of the service departments are ascertained first with the help of simultaneous equations. Reciprocal Services method a. CRPATNA Page 58 .II SEM BCOM COST ACCOUNTING The following are the various methods of re-distribution of service department costs to production departments. the cost of most serviceable department is first apportioned to other service departments and production departments. This method recognizes the fact that if a given department receives service from another department. Thus. Trial and Error Method (a) Simultaneous Equation method Under this method. each department should be charged for the cost of services rendered by the other. Department Overhead rates cannot be ascertained correctly. Trial and Error Method Direct re-distribution method Under this method. proper apportionment cannot be done on the assumption that service departments do not serve each other and as a result the production departments may either be overcharged or undercharged. Simultaneous Equation Method b. If two departments provide service to each other. these are then redistributed NEW ALLIANCE FIRST GRADE COLLEGE. the cost of last service department is apportioned only to production departments. the costs of service departments are directly apportioned to production departments without taking into consideration any service from one service department to another service department. Therefore. There are three methods available for dealing with inter-service departmental transfer: a. The next service department is taken up and its cost is apportioned and this process goes on till the cost of the last service department is apportioned. 1. Repeated Distribution Method c. the department receiving such service should be charged. Reciprocal Services Method In order to avoid the limitation of Step Method. Direct re-distribution method 2. Simultaneous Equation Method b. Step Distribution Method Under this method. this method is adopted. Step distribution method 3. Repeated Distribution Method c. Budget for each department cannot be prepared thoroughly. Thus. The share of each service department cannot be ascertained accurately for control purposes.

There is a basic similarity between the machine hour and the direct labour hour rate methods. the cost of one service department is apportioned to another centre. In respect of departments or operations. (b) Repeated Distribution Method Under this method. NEW ALLIANCE FIRST GRADE COLLEGE.II SEM BCOM COST ACCOUNTING to production departments on the basis of given percentage. Machine Hour Rate. Machine hour rate is the cost of running a machine per hour. are put out in a line. What is needed for computing the machine hour rate is to divide overhead expenses for a specific machine or group of machines for a period by the operating hours of the machine or the group of machines for the period. It is calculated as follows: Machine hour rate = Amount of overheads ---------------------------------------------Machine hours during a given period The following steps are required to be taken for the calculation of machine hour rate: 1) Each machine or group of machine should be treated as a cost centre. The cost of another centre plus the share received from the first centre is again apportioned to the first cost centre and this process is repeated till the balancing figure becomes negligible. (c) Trial and Error Method Under this method. This is generally the case for operations or processes performed by costly machines which are automatic or semi-automatic and where operators are needed merely for feeding and tending them rather than for regulating the quality or quantity of their output. In such cases. the machine hour rate is more appropriate. The following illustration may be taken to discuss the application of this method. the machine hour rate method alone can be depended on to correctly apportion the manufacturing overhead expenses to different items of production. The choice of one or the other method depends on the actual circumstances of the individual case. It is one of the methods of absorbing factory expenses to production. the totals are shown in the departmental distribution summary. and then the service department totals are exhausted in turn repeatedly according to the agreed percentages until the figures become too small to matter. in which machines predominate and the operators perform a relatively a passive part. CRPATNA Page 59 . in so far as both are based on the time factor.

Repairs – Cost of repairs spread over its working life. 3. Miscellaneous Expenses – Equitable basis depending upon facts.. Power – Actual consumption as shown by meter readings or estimated consumption ascertained from past experience. 5. Some of the bases which may be adopted for apportioning the different expenses for the purpose of calculation of machine hour rate are given below. Activity Based Costing NEW ALLIANCE FIRST GRADE COLLEGE. switchgears etc. Some of the expenses and the basis of apportionment are given below. Insurance – Insurable value of each machine 6. less residual value spread over its working life. Supervision – estimated time devoted by the supervisory staff to each machine.The number of points used plus cost of special lighting or heating for any individual machine.II SEM BCOM COST ACCOUNTING 2) The estimated overhead expenses for the period should be determined for each machine or group of machines. Heating and Lighting . Depreciation – cost of machine including cost of stand-by equipment such as spare motors. 4. 3. 2.. Rent and Rates . fixed or standing charges and variable or machine expenses. 4) Standing charges are estimated for a period for every machine and the amount so estimated is divided by the total number of normal working hours of the machine during that period in order to calculate an hourly rate for fixed charges.Floor area occupied by each machine including the surrounding space. 2. alternatively according to floor area occupied by each machine. CRPATNA Page 60 . For machine expenses. an hourly rate is calculated for each item of expenses separately by dividing the expenses by the normal working hours. 5) Total of standing charges and machines expenses rates will give the ordinary machine hour rate. Machine Expenses 1. Lubricating Oil and Consumable Stores – On the basis of past experience. 1. 3) Overheads relating to a machine are divided into two parts i.e.

To help in decision making by accurately computing the costs of products and services. IDENTIFY COST OBJECTS ABC provides profitability by one or more cost object. products and services. To identify various activities in the production process and further identify the value adding activities. To identify the opportunities for improvement and reduction of costs. IDENTIFY ACTIVITIES Activities represent the work performed in an organization. By determining the actual activities that occur in various departments it is then possible to more accurately relate these costs to customers. ABC links these cost to products. STAGES IN DEVELOPING ACTIVITY BASED COSTING SYSTEM Step 1. These are the same costs that are represented in a traditional accounting. Defining outputs to be reviewed is an important step in a successful ABC implement action. setting up.’ Objectives of Activity Based Costing The objectives of Activity Based Costing are discussed below. ‘the collection of financial and operational performance information tracing the significant activities of the firm to product costs. Step 4.II SEM BCOM COST ACCOUNTING Meaning :. DETERMINE RESOURCE DRIVERS Resource drivers provide the link between the expenditure of an Organisation and activities performed within the Organisation. To distribute overheads on the basis of activities.CIMA defines Activity Based Costing as. Cost object profitability is utilized to identify money losing customers to validate separate divisions or business units.g. ABC accounts for the costs based on what activities caused them to occur. Step2.’ One more definition of Activity Based Costing is. ‘cost attribution to cost units on the basis of benefit received from indirect activities e. NEW ALLIANCE FIRST GRADE COLLEGE. IDENTIFY RESOURCES Resources represent the expenditure of an organization. Step 3. CRPATNA Page 61 . ordering. customers or services. assuring quality. To focus on high cost activities. To remove the distortions in computation of total costs as seen in the traditional costing system and bring more accuracy in the computation of costs of products and services. To eliminate non value adding activities.

Due to the increasing accuracy of output costs. ABC information enables managers to make better decisions on product. . We can summarise the importance of ABC as under: 1. To assist managers in budgeting and performance measurement 6. the Cost Driver 2. To provide the links between the activities. ASSIGN COSTS TO THE COST OBJECTS We can use following formula for assigning costs to the cost objects Costs = Resources Consumed × Activity Cost Driver Rate IMPORTANCE OF ACTIVITY BASED COSTING (ABC) ABC provides information for decision making about product costs and product-line profitability. more accurate costing. CRPATNA Page 62 . To link the cost to its causal factor – i. It is also used to advocate for strategic decisions. better allocation of overhead. Activity Cost Driver Rate = Total Cost of Activity(Cost pool ) Activity Cost Driver Step 6. To overcome the inherent limitations of traditional absorption costing and use of blanket overhead rates 5.II SEM BCOM COST ACCOUNTING Step 5. It can lead product designers to decisions on tradeoffs between minimizing cost and desired performance and it provides the cost information of diverse designs that product designers can compare moreover. Cost drivers trace or links the cost of performing certain activities to cost objects. the organizational acts and the resources consumed. using product costing techniques at the design stage can be combined with target costing since product costs can determine the mix of products to manufacture and to sell and can evaluate profitability by product group or customer type. improved cost control and cost management. Implementation of ABC will emphasis on more precise profit analysis. and illustrate the differences between resource consumption and resource provision NEW ALLIANCE FIRST GRADE COLLEGE. To ascertain product costs with greater accuracy by relating overheads to activities 4. such as performance measurement. market segments and customer mix.e. It supports the manager in operating decisions. such as customer profitability and pricing and product mix. product design and process improvement. To identify costs of activities rather than cost centres 3. process improvement. DETERMINE COST (ACTIVITY) DRIVERS Determination of cost drivers completes the last stage of the model. product design.

(e) Providing a model prospect on value-adding organizational transactions and activities USES OF ACTIVITY BASED COSTING The areas in which activity based information is used for decision making are as under: 1. CRPATNA Page 63 . product return handling. Activity costs: ABC is designed to track the cost of activities. Make or buy: ABC enables the manager to decide whether he should get the activity done within the firm or outsource the same. To furnish many significant benefits over traditional costing techniques (a) Most accurate data about product cost. Distribution cost: Organisation uses a variety of distribution channels to sell its products. Customer profitability: Though most of the costs incurred for individual customers are simply product costs. ABC is an excellent feedback tool for measuring the ongoing cost of specific services as management focuses on cost reduction. If not. 8. and cooperative marketing agreements. product lines. distributors. 5. This analysis may result in some unprofitable customers being turned away. To help in cost control and cost reduction. there is also an overhead component. Most of the structural cost of maintaining a distribution channel is overhead. To provide valuable economic information to support a company’s operational improvement and customer satisfaction programs. we can determine the margins of various products. such as unusually high customer service levels. An ABC system can sort through these additional overhead costs and determine which customers are actually providing a reasonable profit. 9. so if we can make a reasonable determination of which distribution channels are using overhead. 4. Outsourcing may be done if the firm is incurring higher overhead costs as compared to the outsourcer or vice-versa. so we can use it to see if activity costs are in line with industry standards. 3.II SEM BCOM COST ACCOUNTING 7. or more emphasis being placed on those customers who are contributing more in profits. as well as improved profitability. (d) More potential for sensitivity analysis. or even to drop unprofitable channels. (b) More comprehensive cost information for performance measurement. and mail order catalogs. Internet. we can make decisions to alter how distribution channels are used. and entire NEW ALLIANCE FIRST GRADE COLLEGE. 2. (c) Relevant data for management’s decision-making. Margins: With proper overhead allocation from an ABC system. such as retail.

one for internal use and one for preparing external reports. which is costly to maintain. 4. This can be quite useful for determining where to position company resources to earn the largest margins. so we can compare the costs of production between different facilities.II SEM BCOM COST ACCOUNTING subsidiaries. 6. depending upon the circumstances under which products are being sold. Minimum price: Product pricing is really based on the price that the market will bear. However activity based costing has certain Limitations or disadvantages which as are under: 1. NEW ALLIANCE FIRST GRADE COLLEGE. 7. In small organisation mangers are accustomed to use traditional costing systems to run their operations and traditional costing systems are often used in performance evaluations. Activity based costing data can be easily misinterpreted and must be used with care when used in decision making. CRPATNA Page 64 . 2. ABC is very good for determining which overhead costs should be included in this minimum cost. in order to avoid selling a product that will lose a company money on every sale. an organization involved in activity based costing should have two cost systems . Implementing an ABC system requires substantial resources. Consequently. Reports generated by this systems do not conform to generally accepted accounting principles (GAAP). Production facility cost: It is usually quite easy to segregate overhead costs at the plant-wide level. Activity Based Costing is a complex system which need lot of record for calculations. LIMITATIONS OF ACTIVITY BASED COSTING Activity based costing help managers in decision making. Managers must identify which costs are really relevant for the decisions at hand. 3. 5. but the marketing manager should know what the cost of the product is.