Cost & Management Accounting

April 2021 Examination

Q1. Kabir Khanna is the MD of Al Farid Supermarkets and has hired you as a
Management accountant to reduce costs for his business.
Post your review of the overall business costs, and you prepared the Cost sheet for Kabir
and his Management Team.
Please assist them in understanding the classification of cost basis behavior briefly (Fixed,
Variable, Semi-variable, and Stepped costs) and advise the treatment of the following items
in the Cost Sheet:

 Value of Scrap

 Bad Debts

 Trade Discount

 Packing charges

 Interest on Capital (10 Marks)

ANS 1.

INTRODUCTION:

The cost that a company or a business incurs daily for its activities is either a direct cost or
indirect cost. These direct and indirect costs can be further categorized as a fixed cost, variable
cost, or semi-variable cost. All the costs are incurred while carrying out the business's operation,
and hence together, these costs are termed as Business Cost or Business Expenses. It includes the
payment of obligations and the depreciation costs on both plant and equipment.

Concept and application

Costs can be classified in a number of different ways:
 By their behavior: Do they increase as an organization gets busier or do they tend to stay
the same? This is important when it comes to budgeting as it is essential to be able to
predict how costs are likely to change.
  By their location: Where in the organization are they incurred? For example, costs
incurred in the factory are relevant to working out the cost of production. However, costs
incurred in storing and delivering finished goods are not relevant to production.
 By their function: For example costs related to research and development, marketing,
training, manufacturing.
 By the person responsible for their control: All costs need to be controlled and there
should be a clearly identified person who is responsible for the control of each cost. For
example, the managers of a branch might be held responsible for the costs incurred there.
 By their type: For example, material, labour, other production expenses, such as the cost
of running machinery.
 By their traceability: Are they direct or indirect? Direct costs are closely related and
traceable to each item produced. Indirect costs are not so easy to relate and trace to each
unit of production.

Classification of costs
 Variable Cost: A variable cost is a corporate expense that changes in proportion to
production output. Variable costs increase or decrease depending on a company's
production volume; they rise as production increases and fall as production decreases.
Examples of variable costs are sales commissions, direct labor costs, cost of raw materials
used in production, and utility costs. The total variable cost is simply the quantity of
output multiplied by the variable cost per unit of output. Variable costs are usually viewed
as short-term costs as they can be adjusted quickly.
 Fixed Cost: Fixed Cost refers to the cost or expense that is not affected by any decrease
or increase in the number of units produced or sold over a short-term horizon. In other
words, it is the type of cost that is not dependent on the business activity, rather it is
associated with a period of time.
It can be seen as expenses that are incurred by a company irrespective of the level of
business activity, which may include the number of units produced or sales volume
achieved. Fixed cost is one of the two major components of the total cost of production.
The other component is the variable cost. Examples are monthly rental paid for
accommodation, salary paid to an employee, etc. However, please note that such cost is
not permanently fixed, but it changes over the period
 Semi Variable Cost: A semi-variable cost, also known as a semi-fixed cost or a mixed
cost, is a cost composed of a mixture of both fixed and variable components. Costs are
 fixed for a set level of production or consumption, and become variable after this
production level is exceeded. If no production occurs, a fixed cost is often still incurred.
For example, the semi-variable cost may include the following cost such as:

Commission to the salesperson: The company will pay a fixed amount to the employees
who work in the sales department. But it will increase to a new level when sales increase a
certain level.
Monthly Telephone charge: The phone company charge us $10 per month and allow us
to make a call of 100 minutes. If we use more than 100 minutes, we will be charged $ 0.2
per minute.
Indirect Labor: indirect labor such as security guards who ensure safety in the factory and
prevent any theft or burglar. The company will pay a fixed salary to them, however, if the
factory expands, we need to increase the number of security guards too.
Repair & maintenance: The machinery usually requires to pay the fixed costs on a
monthly basis to operate them efficiently. However, the cost will increase when the
machine breaks down.
 Stepped Cost: A step cost is a cost that does not change steadily with changes in activity
volume, but rather at discrete points. The concept is used when making investment
decisions and deciding whether to accept additional customer orders. A step cost is a fixed
cost within certain boundaries, outside of which it will change. When stated on a graph,
step costs appear to be incurred in a stair step pattern, with no change over a certain
volume range, then a sudden increase, then no change over the next (and higher) volume
range, then another sudden increase, and so on. The same pattern applies in reverse when
the volume of activity declines.
For example, a facility cost will remain steady until additional floor space is constructed,
at which point the cost will increase to a new and higher level as the entity incurs new
costs to maintain the additional floor space, to heat and air condition it, insure it, and so
forth.

a) Treatment of Scrap
 Nominal sales price realized out of negligible scrap is treated as other income in cost
account.
 A scrap account is opened with the full amount of the scrap of the process or job if such a
scrap value is significant. Process account or job account is given credit by the value of
 scrap. The scrap account is closed by the balance either of profit or loss to the profit or
loss account.
 Net sales value of scrap after deduction of selling and distribution costs is deducted either
from the overhead amount or from the material cost. Deduction out of overheads is made
to adjust the overhead ratio if scrap is not possible to identify in relation to a process or a
job.
b) Treatment of bad debt: As per accounting, Bad debts are treated as an expense in the
Income statement; while provision for doubtful debts needs to be recorded as an expense in
the Income statement in the first year of trading. On the other hand, in the following year,
the business would calculate whether there has been an increase compared to the previous
year or business experienced a reduction in the value of doubtful debts; if there is an
increase in the provision, then the business would treat it as an expense; while a reduction in
the allowance will be considered as an income in the Income statement.
c) Treatment of Trade Discount: It is a discount which is given on the listed price and no
entry is made for this type of discount. Journal entry is made after deducting the amount of
trade discount from the listed price of goods purchased or sold.
d) Treatment of Packing Charges: Cash payment or Bank payment or Journal vouchers are
prepared as per the nature of transactions. If the cost of packing is related to goods then the
packing charges will be shown in expenses side of trading account otherwise it will be
shown in expenses side of profit and loss account.
e) Treatment of interest on capital: The amount of interest charged on capital is an indirect
expense of the business and on the other hand, it is an income of the owner. Interest on
Capital has the following two effects on final accounts:
 It is an expense of the business, therefore; it will be recorded on the debit side of Profit
and Loss Account.
 On the other hand, it is an income of the owner, therefore; it will be added in the Capital
Account in Balance Sheet.

Conclusion:
Cost classification has simplified the work of the management, accountants, economists,
researchers and many others. It facilitates the process of cost control, cost reduction and cost
management.
Q2. Modern Biscuit co has more than 8 items in its product suite. Many times, there is an
issue faced inappropriately allocating Fixed costs to all the biscuit variants. As a
consequence, the company finds it difficult to assess the correct cost of each product.

They hire Progressive partners as their Management consultants and are advised to
introduce standard costing in their company.

As a team member of Progressive partners, please advise Modern Pharma on the benefits of
Standard Costing (any 5) and 3 primary differences between Standard Costing and
Budgetary control.(10 Marks)
ANS 2.

INTRODUCTION:
Standard costing is a method of costing by which the standard cost is allocated. The way of
substituting the expected cost for an actual cost in the records of costing and accounting is called
Standard Costing. It requires the estimation of cost, and that is only called the standard costing.
Variance is the difference between the actual cost incurred and the expected cost, which was to
have occurred.

Concept and application

Standard Costing:
Standard costing is a perfect system of controlling the costs and measuring efficiency and its
development. It is a technique of cost reduction and cost control. It helps to provide valuable
guidance in several management functions such as formulating policies, determining price level,
etc.

As a team member of Progressive partners, I will advise these benefits of Standard Costing:
 The essence of standard costing is to set objectives and targets to achieve them, to
compare the actual costs with these targets. Standard Costing is used to ascertain the
standard cost under each element of cost, i.e., materials, labours, overhead.
 Standard Costing can eliminate all kinds of waste. Through the application of this costing
it can be ascertained whether or not the activities of production are going on according as
the pre‐determined plan.
 The use of standard costs is a key element in a management by exception approach. If
costs remain within the standards, Managers can focus on other issues. When costs fall
 significantly outside the standards, managers are alerted that there may be problems
requiring attention. This approach helps managers focus on important issues.
 Standards that are viewed as reasonable by employees can promote economy and
efficiency. They provide benchmarks that individuals can use to judge their own
performance.
 Standard costs can greatly simplify bookkeeping. Instead of recording actual co0sts for
each job, the standard costs for materials, labor, and overhead can be charged to jobs.
 Standard costs fit naturally in an integrated system of responsibility accounting. The
standards establish what costs should be, who should be responsible for them, and what
actual costs are under control.

The following are the major differences between standard costing and budgetary control:

 Standard Costing is a cost accounting system, in which performance is measured by

comparing the actual and standard costs. Budgetary Control is a control system in which
actual and budgeted results are compared continuously in order to achieve the desired
result.
 Standard Costing is limited to, cost data, but Budgetary Control is related to cost as well
as economic data of the enterprise.
 Standard costing is a unit concept, unlike budgetary control is a total concept.
 Standard Costing has a restricted scope, limited to production costs only, whereas
Budgetary Control, has a comparatively wider scope as it covers all the operations of the
whole organization.
 In Standard Costing variances are revealed and reported however in budgetary control, as
the control are being exercised at the same time, the variances are not disclosed.
 In Standard Costing the comparison is made between actual cost and standard cost of
actual output. On the other hand, in Budgetary Control the comparison is made between
the actual and budgeted performance.

Conclusions
Both Standard Costing and Budgetary Control are the techniques which provide a yardstick to
judge the performance and analyze disagreement of the actual and estimated figures. Budgetary
Control makes side by side comparisons, and that is why periodic revisions are made in the
budgets, and that is why there is no need for reporting the variances, which is absent in Standard
costing
Ques3a. Roy & Saha Ltd. has made a contract with Sharma Ltd. to supply 4,800
microwaves per annum.
It is estimated that the carrying cost per microwave per annum will be Rs. 12/- and that the
set-up cost per batch is Rs. 648. Find out:
(a) Economic Batch Quantity.
(b) The time interval between two consecutive optimum runs
(c) The minimum inventory holding cost.(5 Marks)
ANS 3a.

INTRODUCTION:
Economic Batch Quantity (EBQ) is used for the determination of the size of a production run
during the manufacturing period. It is known as the optimum size of the production quantity. It
helps in minimizing the total cost of production. EBQ is suitable for determining the batch size of
the production.

Concept and Application

1. Calculation of optimum run size for piston manufacturing:

Optimum run size = 2AB/CS

where A the annual supply of pistons is 4800, B the setup cost per production run is Rs. 648, C
the annual holding cost per piston Rs. 12

Optimum run size = 2 x 4800 x 648/12

= 5,18,400
= 720 microwaves

2. The time interval between two consecutive optimum runs

Number of production per annum = 4800/720

= 6 times
Interval between two consecutive runs = 365/6
= 61 Days
3. Minimum inventory cost per annum:
Production run cost = 06 x 648
= 3,888
Carrying cost = ½ x 720 x12
= 4320

Minimum inventory cost p.a.= 8208

3.b. Exotica Exports Ltd. has three divisions, each of which makes a different product. The
budgeted data for the next year is as follows: Divisions A BC Rs. Rs. Rs. Sales 1,12, 000 56,
000 84, 000 Direct material 14, 000 7, 000 14, 000 Direct labor 5, 600 7, 000 22, 400 Variable
overhead 14, 000 7, 000 28, 000 Fixed cost 28, 000 14, 000 28, 000 Total cost 61, 600 35, 000
92, 400 The management is considering closing down division C. There is no possibility of
reducing variable costs. Advice whether or not division C should be closed down.

Particulars Product A Product B Product C

Sales 1,12,000 56000 84000
Direct Material 14,000 7000 14000
Direct Labour 5,600 7000 22400
Variable Overheads 14,000 7000 28000
Fixed Cost 28,000 14000 28000
Total Cost 61,600 35000 92400

The Management is considering closing down Division C. There is no possibility of a

reduction in Variable costs in any division as they are at optimum capacity. Advise whether
or not Division C should be shut down.(5 Marks)

Ans 3 b.
2INTRODUCTION:

When a company records all its costs and analyzes these recorded costs to form a report, it is
called Cost Accounting. It deals with every type of costs (variable costs, fixed costs, semi-
variable costs) included or incurred during the units' production. Cost accounting helps in making
the best decisions for the production of the units in an organization.
Concept and Application
Cost accounting is used by a company's internal management team to identify all variable and
fixed costs associated with the production process. It will first measure and record these costs
individually, then compare input costs to output results to aid in measuring financial performance
and making future business decisions. There are many types of costs involved in cost accounting,
which are defined below.

Types of Costs
 Fixed costs are costs that don't vary depending on the level of production. These are
usually things like the mortgage or lease payment on a building or a piece of equipment
that is depreciated at a fixed monthly rate. An increase or decrease in production levels
would cause no change in these costs.
 Variable costs are costs tied to a company's level of production. For example, a floral
shop ramping up its floral arrangement inventory for Valentine's Day will incur higher
costs when it purchases an increased number of flowers from the local nursery or garden
center.
 Operating costs are costs associated with the day-to-day operations of a business. These
costs can be either fixed or variable depending on the unique situation.
 Direct costs are costs specifically related to producing a product. If a coffee roaster
spends five hours roasting coffee, the direct costs of the finished product include the labor
hours of the roaster and the cost of the coffee beans.
 Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster
example, the energy cost to heat the roaster would be indirect because it is inexact and
difficult to trace to individual products.

Cost Accounting vs. Financial Accounting

While cost accounting is often used by management within a company to aid in decision-
making, financial accounting is what outside investors or creditors typically see. Financial
accounting presents a company's financial position and performance to external sources
through financial statements, which include information about its revenues, expenses, assets,
and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting
and in setting up cost control programs, which can improve net margins for the company in
the future.

Types of Cost Accounting

  Standard Costing: Standard costing assigns "standard" costs, rather than actual costs,
to its cost of goods sold (COGS) and inventory. The standard costs are based on an
efficient use of labor and materials to produce the good or service under standard
operating conditions, and they are essentially the budgeted amount. Even though
standard costs are assigned to the goods, the company still has to pay actual costs.
Assessing the difference between the standard (efficient) cost and actual cost incurred
is called variance analysis.
 Activity-Based Costing: Activity-based costing (ABC) identifies overhead costs from
each department and assigns them to specific cost objects, such as goods or services.
The ABC system of cost accounting is based on activities, which is any event, unit of
work, or task with a specific goal, such as setting up machines for production,
designing products, distributing finished goods, or operating machines. These
activities are also considered to be cost drivers, and they are the measures used as the
basis for allocating overhead costs.
 Lean Accounting: The main goal of lean accounting is to improve financial
management practices within an organization. Lean accounting is an extension of the
philosophy of lean manufacturing and production, which has the stated intention of
minimizing waste while optimizing productivity. For example, if an accounting
department is able to cut down on wasted time, employees can focus that saved time
more productively on value-added tasks.
 Marginal Costing: Marginal costing (sometimes called cost-volume-profit analysis)
is the impact on the cost of a product by adding one additional unit into production. It
is useful for short-term economic decisions. Marginal costing can help management
identify the impact of varying levels of costs and volume on operating profit. This type
of analysis can be used by management to gain insight into potentially profitable new
products, sales prices to establish for existing products, and the impact of marketing
campaigns.

Conclusion: Cost accounting can be seen as a self-assessment tool in the hands of management.
It acts as a source of information like closing inventory, capital expenditure, direct and indirect
cost, etc. for the preparation of financial accounts of an organization.

The concept of service costing is widely applied for determining the expenses incurred in
business activities carried out in the service organizations. It helps in applying cost accounting in
the service industries.