COMILLA UNIVERSITY

Department of Accounting & Information Systems

Term paper on- Cost Accounting

Course Title: Cost Accounting Course Code: 314

Submitted To-
Arupa Sarker
Assistant Professor
Department of AIS
Comilla University

Submitted By- Invincible- X

REG. NO. Name of the students Remarks
11806001 Sabeconnahar Linda
11806007 Md. Rani Miah (Leader)
11806010 Md. Akram Hossain
11806013 Md. Shahneawj Tuhin
11806027 Lutfur Nahar
11806034 Md. Abu Taher
11806041 Md. Borhan Uddin
11806043 Mahmuda Akter
11806052 Salma Jahan
11806053 Omme Habiba Chumki

Date of Submission: 15th September, 2020

 Table of Content
SL. No. Title Page No.

LETTER OF TRANSMITTAL 03

EXECUTIVE SUMMARY 04
ACKNOWLEDGEMENT 05

01. INTRODUCTION 06

02. Cost Concepts, Classification and Preparation of Cost Sheets 26

03. Costing & Control of Materials

A) Purchasing and storing materials 30

B) B) IAS 2 — Inventories 42

4. REFERENCE 46

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 LETTER OF TRANSMITTAL

15th September 2020

To,
Arupa Sarker (Assistant Professor)
Department of Accounting & Information Systems
Comilla University
Subject: - Submission of term paper on “Cost Accounting.”

Madam,
With due respect and humble submission, we, would like to inform you that,
there is the dissertation term paper on Cost Accounting.
This was assigned to us to submit under the program. It was a great pleasure
for us to do the assigned job. We made every endeavor to prepare this paper
accurately & try our level best to accumulate relevant and insightful
information. It helps us to gather theoretical knowledge in Unemployment &
International trade.

In finally, we are very grateful to you for your kind and generous guidance to
make the term paper successfully.
Sincerely Yours,

Md. Rani Miah

(On behalf of the group members)
BBA- ID: 11806007
Department of accounting and information systems
Comilla University

3
 EXECUTIVE SUMMARY

Cost Accounting System is a branch of managerial accounting concerned with

accumulating manufacturing costs for financial reporting and decision-making
purposes. It is a process that aims to capture a company's costs of production
by assessing the input costs of each step of production as well as fixed costs
such as depreciation of capital equipment. The report assemblage involves
understanding the significance of applying cost accounting system to the
costing techniques. In the process we have come across certain issues that
demand special attention as the selection of valuation techniques among the
options available. We also verify how smoothly the establish standards and
norms comply with the overall cost accounting process of the company.

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 ACKNOWLEDGEMENT

The special thank goes to our helpful course instructor, Arupa Sarker the
supervision and support that he gave truly help the progression and
smoothness of the paper. The co-operation is much indeed appreciated.

As a team and as a new experience in working environment, this challenges us

in every minute. The whole assignment really brought us together to
appreciate the true value of friendship and respect of each other.

Finally yet importantly, we would like to thank our friends especially those
who helped us for the wise idea throughout the project.

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 Chapter one
1. INTRODUCTION

Manufacturing Concerns

Definitions:
MANUFACTURING CONCERN is an entity that derives its products for sale, thereby
revenue, through the direct manufacture of those products. It is the process of making
items from raw materials. An example of manufacture is the making of automobiles in
factories.
Three common types of manufacturing production processes are-
Make to stock (MTS),
Make to order (MTO) and
Make to assemble (MTA).

Characteristics:
Income comes from sales: The first characteristic of a manufacturing company is the
income comes from sales. The company sells a range of products from semi-finished
products to finished products such as household appliances, food, and beverages, to
household cleaning products. Manufacturing companies get the main revenue from the
sale of products.
Have a Physical Inventory: Manufacturing companies sell physical products that can be
seen and touched. So, you need physical inventory. Inventories in manufacturing
companies can be in the form of finished goods that is ready to sell, raw materials or semi-
finished materials. Manufacturing companies apply a recording system with certain
methods to calculate the purchase and the use of raw materials because the product
inventory is not small.
Companies must pay attention to records because the company's income comes from the
sale of products and goods, so if there is a mistake in recording the products or there are
lost items, it will harm the company.
Manufacturing Activity: Manufacturing activities that are usually done are processing raw
materials or raw products into semi-finished products or finished products that are ready
to sell to consumers or customers. If there is no production in a manufacturing company, it
is impossible for a manufacturing company to run.

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Production Costs (Raw Material Cost, Labor Cost, and Overhead Cost): The cost of raw
materials is the cost of using raw products as the main material which then goes through
the production process stage. Furthermore, labor cost is the cost incurred for the work of
all employees involved in the production process, both operational employees and
managerial employees.
The last is factory overhead costs (BOP) is the costs incurred for the use of auxiliary
materials or other indirect costs. The company still need to charge BOP or factory overhead
costs because these costs support the production process, even though the cost is not
absorbed directly on the product. The examples of factory overhead costs or BOPs are the
costs of factory machine maintenance, communication costs, electricity costs, and other
costs.
Well, those are four characteristics of manufacturing company:
Manufacturing Activity:
Manufacturing Activity means those activities associated with the production, manufacture
or processing of Licensed Products, and the filling, finishing, packaging, labeling, shipping
and storage of such Licensed Products, including without limitation quality assurance and
quality control, that are performed by Globe Immune, its contractors under this
Agreement, the Supply Agreement or any quality agreement relating to the manufacture or
supply of Licensed Products.
Manufacturing Vs Non-manufacturing Costs
Manufacturing Costs: Manufacturing costs refer to those that are spent to transform
materials into finished goods. Manufacturing costs include direct materials, direct labor,
and factory overhead.
Direct materials - Cost of items that form an integral part of the finished product. They
refer to the major parts or ingredients. Examples include wood in furniture, steel in
automobile, water in bottled drink, fabric in shirt, etc.
Direct labor - Cost of labor expended directly upon the materials to transform them into
finished goods. Direct labor refers to salaries and wages of employees who work to convert
the raw materials to finished goods.
Factory overhead - also called manufacturing overhead, refers to all costs other than direct
materials and direct labor spent in the production of finished goods. Factory overhead
includes indirect materials such as cost of nails, thread, glue, etc.; indirect labor such as
salary of the supervisor; and factory expenses such as rent of the factory space,
depreciation of factory equipment, utilities expense of the factory, factory supplies, etc.
Manufacturing costs are also known as factory costs or production costs.
Non-manufacturing Costs: Non-manufacturing costs refer to those incurred outside the
factory or production department. These are costs are not needed in transforming

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materials into finished goods. Non-manufacturing costs include: selling expenses and
general expenses.
Selling Expenses - also called Selling and Distribution Expenses. Examples include
advertising costs, salaries and commission of sales personnel, storage costs, shipping and
delivery, and customer service.
General Expenses - also called General and Administrative Expenses. Examples are:
executive salaries, salaries of administrative staff, accounting expenses, legal expenses,
research and development, and other costs related to general administration of the
organization.
EXAMPLES
Factory supplies
Salary of production supervisor
Legal expense
Freight-out (delivery expense)
Marketing samples
Glue used in production
Wood in producing furniture
Salary of the company president
Advertising
Administrative office rent
Salary of factory workers
Depreciation of factory building
Depreciation of office equipment
Depreciation of display racks inside the store
Freight-in

Organization Structure

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Definition: An organizational structure is a system that outlines how certain activities are
directed in order to achieve the goals of an organization. These activities can include rules,
roles, and responsibilities.
The organizational structure also determines how information flows between levels within
the company. For example, in a centralized structure, decisions flow from the top down,
while in a decentralized structure, decision-making power is distributed among various
levels of the organization.
An organizational structure outlines how certain activities are directed to achieve the goals
of an organization. Successful organizational structures define each employee's job and
how it fits within the overall system. A centralized structure has a defined chain of
command, while decentralized structures give almost every employee receiving a high level
of personal agency.
Types of Organizational Structures
Functional Structure: The first and most common is a functional structure. This is also
referred to as a bureaucratic organizational structure and breaks up a company based on
the specialization of its workforce. Most small-to-medium-sized businesses implement a
functional structure. Dividing the firm into departments consisting of marketing, sales, and
operations is the act of using a bureaucratic organizational structure.
Divisional or Multidivisional Structure: It’s Called the divisional or multidivisional
structure, a company that uses this method structures its leadership team based on the
products, projects, or subsidiaries they operate. A good example of this structure is
Johnson & Johnson. With thousands of products and lines of business, the company
structures itself so each business unit operates as its own company with its own president.
Matrix Structure: The fourth and final organizational structure is a matrix structure. It is
also the most confusing and the least used. This structure matrixes employees across
different superiors, divisions, or departments.

Producing Departments
Definition: A production department is a group of functions within a business that is
responsible for the manufacture of goods. The production department can be the largest
organization within a business. It may employee mechanics, machine setup specialists,
maintenance personnel, and machine operators.

Service Departments

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Definition: A service department is a cost center that provides services to the rest of a
company. The services provided by a service department are then allocated to the other
departments of a business that use these services. Some of the costs of a service
department may not be allocated elsewhere, due to cost overages that cannot be passed
through to other departments.
Examples of service departments are:
Maintenance department: Bills the production department for labor and equipment
consumed during the maintenance of machinery. Costs are commonly accumulated by
individual maintenance job for each machine.
Janitorial: Bills all departments for cleaning services, frequently on a square footage basis.
Purchasing: Bills a variety of departments for its efforts in procuring goods and services for
them. The allocation may be based on total dollars purchased or the number of purchase
orders placed.
Information technology: Bills departments for their use of IT storage, bandwidth, by user,
or some other reasonable method of allocation.

Chart of Accounts
A chart of accounts is a listing of the names of the accounts that a company has identified
and made available for recording transactions in its general ledger. A company has the
flexibility to tailor its chart of accounts to best suit its needs, including adding accounts as
needed.
Balance Sheet Accounts
Assets
Liabilities
Owner's (Stockholder’s) Equity
Income Statement Accounts
Operating Revenues
Operating Expenses
Non-operating Revenues & Gains
Non-operating Expenses & Losses

Manufacturing concern

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Financial Statement of a Manufacturing concern:
Manufacturing companies have several different accounts compared to service and
merchandising companies. These include three types of inventory accounts—raw
materials, work-in-process, and finished goods—and several long-term fixed asset
accounts.
A manufacturing company uses purchased raw materials and/or parts to produce a
product for sale. At a point in time, the company's inventories consist of raw materials,
those materials and parts waiting to be used in production; work-in-process, all material,
labor, and other manufacturing costs accumulated to date for products not yet completed;
and finished goods, the cost of completed products that are ready to be sold. The value of
each type of inventory is disclosed in a company's financial statements. The amounts may
be shown individually on the face of the balance sheet or disclosed in footnotes. In the
long-term asset section of a manufacturing company's balance sheet, one would expect to
find factory buildings and equipment and possibly a small tools account. A manufacturer
often has patents for its products or processes.
The capitalized costs associated with a patent would be included in the intangible asset
section of the balance sheet. The income statement for a manufacturing company is similar
to that prepared for a merchandising company. In calculating cost of goods sold, only the
finished goods inventory account is used, as shown.

A model of decision -making

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Financial statements may be use as a guide to identify what financial statements elements
are directly affected by a specific decision. This approach is not commonly used, but
because it is helpful in understanding how decision affect the various items to financial
statements. For example, every item on the balance sheet such as accounts receivable or
inventory is the result of the execution of one or more identifiable decision. That a primary
purpose of management is to manage assets, liabilities, capital, revenue, and expenses. To
clarify the above statement, the following financial statements of the V.K.Gadget Company
are prescribed in terms of decision and required information:

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Cost accounting
Definition of cost accounting: Cost accounting is defined as "a systematic set of
procedures for recording and reporting measurements of the cost of manufacturing goods
and performing services in the aggregate and in detail. It includes methods for recognizing,
classifying, allocating, aggregating and reporting such costs and comparing them with
standard costs."

Objectives of cost accounting

Main objectives of cost accounting can be described as follows:

1. Ascertainment of Cost

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This is the key objective of cost accounting to track and analyze the per unit cost of the
product produced by the company. It helps to ascertain cost of each activity such as
process, operation, job etc.
2. Fix Selling Price
Cost accounting provides base for determination of selling price of company's product by
ascertaining the cost of each product. It helps the management to fix the selling price of
products and services.
3. Cost Control
Cost accounting helps the organization to control the cost of production by taking
necessary steps to reduce wastage of materials, time and expense while carrying out the
operation.
4. Assisting In Decision Making
Cost accounting helps management in decision making such as make or buy decision, drop
or continue decision, future expansion policies etc. It helps to make a choice out of two or
more courses of action.
5. Ascertainment of Profit
Cost accounting helps in tracking and ascertaining profitability of the product by preparing
profit and loss account and balance sheet periodically.
6. Formulating Policies
Cost accounting plays important role to formulate policies of the organization. It provides
necessary information and data to the top level management which are essential for
framing marketing policies of the company.
7. Basis of Financial Statement
Cost accounting is the foundation for the preparation of different financial statements
(profit and loss account, balance sheet, trial balance etc.) of the company.

Limitations of Financial Accounting:

Financial accounting is the only branch of accounting and it is not perfect. There are large
numbers of limitations which open new way to use other tools of accounting. To know
what are the main limitations of financial accounting. It is very necessary for accountants.
Accountants are often blind to these limitations. So, I am covering its limitation a lot of
ground.

The major limitations are as follows:

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 1. Financial accounting is of historical nature
Net effect of transactions are recorded in financial accounting which has happened in past.
These accounts is just postmortem of all events of business in past .These record does not
help for future planning and other managerial decisions. Financial accounting shows the
profitability of business but it is failure to tell that is it good or bad. Financial accounting is
also failure to know the reasons of low profitability position.
2. Financial accounting deals with overall profitability
Accounts of business are made by a way which shows only overall profitability .It does not
shows net profit per product , or per department or according to job . Thus to find difficult
to all activities which do not give profit. So, it creates inefficiency in business activities.

3. Absence of full disclosure of facts

In financial accounting we record only those activities and transactions which we can show
or describe in money. There are many other facts of business which are non-financial and
non-monetary like efficient management, demand of products of firm, good relations in
industry, good working environments which cannot be known by financial accounting.

4. Financial reports are interim report of business

Financial statements made by financial accounting is the interim report of firm’s all
business work but financial position and profitability which are shown in it is not fully true .
Due to adopting cost concept, all transactions are recorded on it real cost but by changing
in the time; it is the need of time to adjust cost of assets and liabilities according to
inflation of market. Because, financial accounting does not records according to inflation so
its result does not show true position of business.

5. Incomplete knowledge of costs

From cost point of view, financial accounting is incomplete. In financial accounting,
accountant does not calculate each and every product’s total cost. So, financial accounting
does not help to determine the price of product of business.

6. No provision of cost control

Financial accounting does not help business organization for controlling the cost. Because,
there is no provision of controlling cost in it. In financial accounting, we write cost, if we
paid any expenses. Thus there is no provision of improvement in financial accounting.
Except this, there is no any other way to inspect all expenses.
7. Financial statements are affected from personal judgment
Many events of financial statements are affected from personal judgement of accountant.
Method of calculating depreciation, rate of provision of doubtful debts and stock valuation
method are decided by accountant. Thus, financial statements do not show true and fair
view of business.

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mportance of cost accounting

Some of the importance of cost accounting to the management of an organization,

1 Classification of Costs
Cost is a very generic term, it needs to be classified to be of further use. Cost accounting
involves the recording and classification of such costs. Some costs are prime cost, direct
cost, factory cost, selling cost etc. Such classification allows the management to control the
costs and ascertain the profitability of any such processes and activities. It also helps in
calculating efficiency.
2. Cost Control
An efficient business focuses on controlling the cost of inventory, labor, and various other
overhead costs. Cost accounting allows them to do so.
For example to achieve maximum efficiency in their inventory management the can adopt
the EOQ technique which is a costing technique.
Similarly, by analyzing costs of labor and capacity of machinery their efficiency can be
improved also. Cost accounting also classifies overheads into fixed, variable or controllable,
uncontrollable to achieve cost control.

3 Price Determination
Cost accounting makes the basic distinction between fixed and variable costs. This is then
used by management to fix the prices of products, according to the costs of the product.
This allows the management to find the most ideal price for the product or the service, not
too high and not too low. Take for example a case where the economy suffers depression.
The businessman has to lower the prices of his products to survive these circumstances. So
he can begin by trying to control his variable costs allow him to fix his prices.
4 Fixing of Standards
Organizations use standards to make estimates and budgets for the future. They use these
as a basis to measure the actual efficiency of the process or department.
There is an entire branch in cost accounting known as Standard Costing dedicated to this
process.

Importance of Cost Accounting to Others

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Workers: One of the biggest uses of cost accounting is that it helps us calculate efficiency.
This will help the company come up with an incentive scheme for workers who show
efficiency in their work, and thus they will be awarded accordingly. It is also an incentive for
workers with lower efficiency to do better.
Government: Costing helps the government when assessing for income tax or any other
such government liabilities. It also helps set industry standards and helps with price fixing,
tariff plans, cost control etc.

Customers: The main aims of costing are cost control and improvement in efficiency. Both
of these are very beneficial to the company. And ultimately this benefit passes on to the
customers of the products or services.

Cost Accounting vs Financial Accounting

The basis of comparison Cost Accounting Financial Accounting

between cost accounting vs
Financial accounting

Nature Records the information Records information which is

regarding the cost incurred in financial in nature alone.
the production activities
including labor, overhead and
material cost.

Cost -type Records historical (eg:a cost Records only historical cost
of acquiring assets) as well as (accrued during the specified
forecasted cost (eg:sales ) time).

Objective To find out per unit cost of a To assess the profitability and
project, fixing the selling Price financial position of the
of a product. company.
End-users Cost accounting is used by the Financial accounting is used
management including by the external parties
employees, directors, including shareholders lending
managers, among others for and prospective investor’s

17
 their internal assessment and credit rating agencies in the
management. market.
Information Monetary as well as non- Only monetary transactions
monetary transactions are are recorded.
recorded such as units.
Frequency It is prepared and reported to It is prepared at the end of
the management as and when the accounting periods which
required. is usually one year.
Coverage Analyses operations divided Analyses the operations of a
by segments (operational or company as a whole.
geographical), division,
contacts etc.
Measurement of profit It measures the profit for a It measures the profit for the
product or process. whole entity for a combined
entity.
Reporting It is not mandatory to prepare Public companies are obliged
any statements for public. to announce results prepared
As a part of financial
accounting.
Forecasting Cost accounting is It is not possible to forecast
forecasted using financial accounting.
budgeting technique.
Format No specific format is used, the There are formalized
intention is to record all the principles such as GAAP and
important information. IFRS designed and controlled
by independent agencies.
Reports Variance analysis, marginal Profit &loss balance sheet,
cost, break-even analysis. cost flow statement.
Stock The stock is valued at cost. The stock is valued at market

Cost accounting vs management accounting

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The basis for comparison Cost Accounting Management Accounting
cost accounting vs
management accounting

1.Inherent meaning Cost accounting revolves Management accounting

around cost computation cost helps management make
control and cost reduction.
Effective decisions about the
business.

2.Application Cost accounting prevents a Management accounting

business from incurring costs Offers a big picture of how
beyond budget. management should
strategize.
3.Scope-cost accounting vs The scope is much narrow. The scope is much broader.
management accounting

4.Measuring grid Quantitative Quantitative and qualitative.

5.sub -set Cost accounting is one of the Management accounting

many sub-sets of itself is pretty vast.
management accounting.

6.Basis of decision making Historic information is the Historic and predictive

basis of decision making. information is the basis of
decision making.

7. Statutory requirement cost Statutory audit of cost The audit of management

-accounting vs management accounting is a requirement accounting has no statutory
accounting. in big business houses. requirement.

8.Dependence Cost accounting is not Management accounting is

dependent on management dependent on both cost &
accounting to be successfully financial accounting for
implemented. successful implementation.
Evaluation of Cost Accounting

The origin of cost accounting, along with the origin of bookkeeping itself, is unknown.
Attempts to keep manufacturing accounts have been traced to the time of Henry all and to
the Medici the account books of Christophe Planting, a ‘French publisher, showed some

19
understanding of job lot accounting before the 16th century. Manuals for double-entry
bookkeeping before the 19th century were common, but little or no mention was made of
manufacturing or costing methods until Charlie Babbage in England (approximately 1830)
presented a paper that emphasized the need for serious cost accounting. The French, led
by Ansel me Pagan and Louis Meniere’s, were active in the early part of the 19th century
and in 1841 Armand Milo won a prize of 1000 furfur his manual of agriculture for primary
schools.

In the period from 1870 to1900 engineers took the lead in developing cost accounting
methods and in 1900 Alexander Hamilton Church, president of the Institute of cost and
works Accountants, set forth the modern approach to production centers and idle capacity
charges. Fixed-variable analysis of business costs in credited to Dionysius Lardner (1850)
and was developed in France by C.Adolphe Guilbault about 1865,in Great Britain by John
Manger Fells (1877) and Alfred Marshall (1890) and in Germany by Eugen Schanalenbach
(1900). Attempts to set and use standards were made in the textile industry by G. P. Norton
(1889), but developed standards date from F. Taylor (shop management, 1903) John
Whitmore (1905) and Harrington Emerson (1909). Fells presented profit charts and modern
flexible budgeting in 1903.
It is generally conceded that the structure of modern factory cost accounting was
established before World War I. Beginning about 1930 businessmen and economists
became impressed with the magnitude of the costs of distribution and cost Accountants
therefore began to extend their factory techniques to cover the control of distribution
activities. Costs are accumulated and compared for size of order, method of delivery, line
of distribution, customer call, ton warehouse and a myriad of office activities.
Relationship of cost accounting with Mathematics:
Mathematics is a subject which can be defined as the science of numbers and their
operations, generalizations, interrelations, combinations, abstractions, measurements and
transformations. The definition of accounting is given as the measurement,
communications and processing of financial information about the entities of economics
like business and corporations. Accounting is also known as the language of business. The
relationship between mathematics and
Accounting. It is given that accounting is an application of elementary arithmetic which is a
part of mathematics. Accounting is nothing but a comprehensive discipline of measuring,
identifying and communicating a business’s economic health. Accounting equation is
actually used to express the core concept of accounting. Some accounting calculations like
determination of loan instalment, computation of depreciation, determination of cash
prize, etc. requires mathematical techniques
Economics broadly is the study of how resource allocation decisions are made by
individuals and societies, and using that knowledge to suggest what would be welfare

20
maximizing. So the field is largely driven by both theoretical investigation and empirical
research. Statistics are useful in Economics, as they are a strong tool in assessing the
empirical research. Economists largely have to deal with observational data where the
knowledge of both statistics and economics are important to get valid, reliable and efficient
estimates. A sub discipline with that focus is known as Econometrics. Statistical methods
are also sometimes used in evaluating experiments in Economics. Ultimately, statistics are
useful in any type of academic research that makes use of sample data, as it is a specific
characteristic of the sample that helps us infer something about population parameters of
interest. Economics happens to be one of the fields that use it a lot how finance is crucial
for accounting as it is the fundamental of accounts.

Techniques of Cost Accounting

Historical Absorption Costing:
It’s the ascertainment of costs after they have been incurring. It defines as the practice of
charging all costs, both variable and fixed, to operations, process or products. It also knows
as traditional costing. Its ascertainment of costs after they have been incurring. It aims at
ascertaining costs incurred on work done in the past. It has a limited utility, though
comparisons of costs over different periods may yield good results. Since costs are
ascertaining after they have been incurring, it does not help in exercising control over
costs. However, it is useful in submitting tenders, preparing job estimates, etc.
Differential Costing:
Differential cost is the difference in total cost between alternatives-evaluate to assist
decision making. This technique draws the curtain between variable costs and fixed costs.
It takes into consideration fixed costs also (unlike marginal costing) for decision making
under certain circumstances.
This technique considers all the revenue and cost differences amongst the alternative
courses, of action to assist management in arriving at an appropriate decision.

Standard Costing:
It refers to the ascertainment and use of standard costs and the measurement and analysis
of variances. Standard cost is a predetermining cost that computes in advance of
production based on a specification of all factors affecting costs. A comparison makes of
the actual cost with a pre-arranged standard cost and the cost of any deviation (called
variances) analyzes by causes.
Marginal Costing:

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It refers to the ascertainment of costs by differentiating between fixed costs and variable
costs. In this technique, fixed costs are not treated as product costs. They are recovering
from the contribution (the difference between sales and variable cost of sales. The
marginal or variable cost of sales includes direct material, direct wages, direct expenses,
and variable overhead. It is the ascertainment of marginal cost by differentiating between
fixed and variable costs.
Methods of Costing
Job costing:
Job costing uses where production is not repetitive and is done against orders. The work
usually carries out within the factory. Each job treats as a distinct unit, and related costs
are recording separately. This type of costing is suitable for printers, machine tool
manufacturers, job foundries, furniture manufactures, etc.
Batch costing:
Where the cost of a group of product ascertains, it calls “batch costing”. In this case, a
batch of similar products treats as a job. Costs are collecting according to batch order
number and the total cost divide by the numbers in a batch to find the unit cost of each
product. Batch costing generally follows in general engineering factories that produce
components in convenient batches, biscuit factories, bakeries, and pharmaceutical
industries.
Operating Costing:
This method is applicable where services are rendering rather than goods produce. The
procedure is the same as in the case of unit costing. The total expenses of the operation
are divide by the units and cost per unit of service arrives at. This follows in transport
undertakings, municipalities, hospitals, hotels, etc.
Departmental Costing:
When costs are ascertaining department by department, such a method calls
“departmental costing“. Where the factory divides into several departments, this method
follows. The total cost of each department ascertains and divides by the total units
produced in that department to obtain the cost per unit. This method follows
departmental stores, publishing houses, etc.

Characteristics of An ideal system of cost Accounting:

1. Simplicity

22
Costing system should be simple to operate and easy to understand. The facts, figures and
other information revealed by cost accounts should be so presented as to make them
easily graspable. As such the needless elaboration of costing records should be avoided.
2. Suitability to the Business
A costing system should be so devised as to suit the conditions, requirements, nature and
size of the business. A costing system which serves the purposes of the business and
supplies necessary information for running the business successfully is an ideal system for
that business.
3. Economy
In order that the system of costing may become a profitable investment of the business,
the cost of installing and operating the system must be within the financial capacity of the
business.
4. Elasticity
The system of costing should be elastic and capable of adapting itself to altered conditions
and must not be rigid. It should, in particular, be suitable to handle a large volume of work
as also to deal with changes in the nature of business.
5. Accuracy
An ideal system of costing is that which ensures accuracy of the records to be maintained.
If the costing records maintained are not correct and accurate, the results or conclusions
drawn therefrom are bound to be inaccurate and misleading.
Installation of a Cost Accounting System:
Step 1 - Objectives to be achieved:
The objective to be achieved should be very clear so that a thrust is given to that aspect. If
the main objective is to expand production then the costing system should give more
attention to production aspect, if the emphasis is to improve marketing of products then
that area should be cared well.
Step 2 Study the Product:
The study of the product is very essential. The nature of the product determines the type
of costing system to be used. A product requiring high costs on materials will need a
costing system giving main emphasis on pricing, storing, issuing and controlling of material
cost.
On the other hand, if the product requires high labor cost then efficient system of time-
recording and wage payment will be essential and the same will be true of overhead cost
too.

23
Installation of a Costing System:
Step 3 Study the Organization:
An effort should be there to introduce the costing system in the existing organizational set
up. As for as possible, the organization should be least disturbed.
It becomes, therefore, necessary to see the nature of the business and of the operations,
the extent of authority and responsibility, the methods of dealing with wastages of
materials, the system of wage’ payment, the sources from which the cost accountant has
to derive information etc. Installation of a Costing System:
Step 4 Selecting the Cost Rates:
A decision is required for the allocation of various expenses among different products.
What expenses are direct and what expenses are indirect? From indirect expenses an
allocation is made among factory, office and selling and distribution overheads. This
division of expenses will help in determining the cost rates.
Installation of a Cost Accounting System:
Step 1 - Objectives to be achieved:
The objective to be achieved should be very clear so that a thrust is given to that aspect. If
the main objective is to expand production then the costing system should give more
attention to production aspect, if the emphasis is to improve marketing of products then
that area should be cared well.
Installation of a Costing System:
Step 2 Study the Product:
The study of the product is very essential. The nature of the product determines the type
of costing system to be used. A product requiring high costs on materials will need a
costing system giving main emphasis on pricing, storing, issuing and controlling of material
cost.
On the other hand, if the product requires high labor cost then efficient system of time-
recording and wage payment will be essential and the same will be true of overhead cost
too.

Installation of a Costing System:

Step 3 Study the Organization:

24
An effort should be there to introduce the costing system in the existing organizational set
up. As for as possible, the organization should be least disturbed. It becomes, therefore,
necessary to see the nature of the business and of the operations, the extent of authority
and responsibility, the methods of dealing with wastages of materials, the system of wage’
payment, the sources from which the cost accountant has to derive information etc.
Installation of a Costing System:
Step 4 Selecting the Cost Rates: A decision is required for the allocation of various
expenses among different products. What expenses are direct and what expenses are
indirect? From indirect expenses an allocation is made among factory, office and selling
and distribution overheads. This division of expenses will help in determining the cost
rates.
Modern Trends in Cost Accounting:
Just-in-time inventory is the first trend we will discuss. It focuses on reducing inventory
costs by keeping only what inventory you need available when you need it. The importance
of cost accounting to this type of inventory system is that businesses must be able to
forecast consumer demand. Let's look at Flipper Boats. Cost accounting helps Flipper Boats
find the most reliable and cost efficient suppliers of raw materials when they are needed.
After all, the company continuously tracks supplier data. This makes it easier to find profits
when inventory and demand fluctuate.

25
 Chapter two
2. Cost Concepts, Classification and Preparation of Cost Sheets
Basic concept of cost
Costs: The term cost refers to the monetary value of expenditures. Costs represent the
resources that have been or must be sacrifice to attain a particular objects. We can define
it as an amount paid or spent to acquire an asset (fixed asset) or paid towards the creation
of an asset.
Expense
Expense in its broadest sense includes all expired costs which are deductible from
revenues. In income statements, distinctions are often made between various types of
expired costs by captions or titles including such terms as cost, expense, or loss, e.g., cost
of goods or services sold, operating expenses, selling and administrative expenses , and
loss on sale of property.
Loss
Loss is the excess of expenditure incurred over revenue earned by a business for a given
accounting period. It reduces the total capital invested in the business.
Costing: System of computing cost of production or of running a business, by allocating
expenditure to various stages of production or to different operations of a firm.
Cost accounting: It is a process via which we determine the costs of goods and services. It
involves the recording, classification, allocation of various expenditures, and creating
financial statements. This data is generally used in financial accounting.
This helps us calculate the costs of the various goods. It also involves a suitable
presentation of this data for the purposes of cost control and guidance to the
management.
It deals with the cost of every unit, job, process, order, service, etc., whichever is applicable
and includes the cost of production, cost of selling and cost of distribution.
Cost accountancy: Cost accountancy is 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 as well as the presentation of information for the purpose of
managerial decision making.
Cost Accountancy, as is clear from the definition, is a science as well as an art. It is a science
because it is a body of systematic knowledge having certain principles. It is an art because
it requires the ability and skill in the application of the principles of cost accountancy to
various managerial problems. It is also a practice since it requires a continued effort of a

26
cost accountant in the field of cost accountancy. One has to have sufficient practical
training so as to develop insight and know the intricacies
Classification of cost:
Cost Classification refers to a complete and transparent idea of separation of expenses in
the different sector as like manufacturing cost, product cost, sunk cost, variable cost, direct
cost, and indirect cost etc. Classifications of cost are a vital part of a company. It is almost
impossible to operate a business without understanding it properly. Cost may be classified
on the basis of element, function, controllability and normality.
Classified on the basis of identifiability Direct Costs: So these are the costs which are easily
identified with a specific cost unit or cost centers. Some of the most basic examples are the
materials used in the manufacturing of a product or the labor involved with the production
process. Indirect Costs: These costs are incurred for many purposes, i.e. between many
cost centers or units. So we cannot easily identify them to one particular cost center. Take
for example the rent of the building or the salary of the manager. We will not be able to
accurately determine how to ascertain such costs to a particular cost unit.
Cost classified as depending on behavior: Variable cost: Variable cost is such a cost which
proportion is changing with the amount of production. Such as direct material and
changeable costs Fixed cost: This cost won’t change with the proportion of production. It is
maximum time fixed. But it is notable that this cost may be changed after a long time. For
example, office rent, insurance, and hospital.
Other concept of costs: Prime cost: Prime cost is the adjustment of the direct material,
direct labor, and direct costs. It is actually the result of these three elements. Product cost:
It means the factory cost with administrative and office overheads Factory cost: Factory
cost is also known as work cost. It is combined with work cost and work expenses relevant
cost: Which cost can be by making a new decision is called relevant cost. Occasionally there
may have many relevant costs. This cost is not fixed from before. Opportunity cost:
Opportunity cost is the system of getting some extra advantages from the existing things of
a factory like land, money and time etc. Someone can rent his office for another purpose of
advantages. Moreover, they can rent their other things also. It is actually an extra benefit
for a company. Standard cost: Standard cost is fixed from the previous experience. It was
fixed according to the specific budget, the volume of an industry. The actual cost is also
included with this cost. Controllable cost: Which cost can be controlled by management is
called controllable cost. The manager can control some cost. Sunk cost: It is known as a
historical cost. Sunk cost effect is most important for a company. It is such a cost which is
already lost and can’t be undone anymore. If a company is paid their monthly rent than we
can say this rent cost is sunk cost. Manufacturing cost: Manufacturing cost refers to the
total cost of a product from the raw materials to finish the product. It is mainly the
combination of direct material cost, labor cost, and manufacturing overheads.

27
Cost unit
A unit cost is a total expenditure incurred by a company to produce, store, and sell one unit
of a particular product or service. Cost unit vary from industry to industry and from one
concern to another within the same industry. An enterprise which have more than one
product of different types of product, may have more than one cost unit.
Cost Centre
The word center is defined as, Department area or function to which cost and other
revenues are charge. A cost center is thus a location (production or service) function or
activity or an item of equipment in respect of which cost are accumulate.

Cost Accounting Cycle

The cost accounting cycle is a process performed during the accounting period in recording
data, classifying, determining total cost, determining product cost, determining selling
price, controlling cost and decision making.
1. Recording cost data at the first step of cost accounting, it ascertains and records the
element of cost for determining of cost of production.
2. Classification of cost at the second step according to function, nature, and behavior cost
accounting classifies the cost.
3. Determining total cost in this step under cost accounting cost of goods sold of a product
is calculated. The cost of goods sold means the sum of all items of expenditure incurred in
production for the goods which are sold.
4. Unit cost in the fourth step, the Unit cost is obtained dividing the cost of goods sold
divided by the total number of units sold.
5. Selling price Selling price is obtained by adding a profit margin with the cost of sales.
6. Cost control and decision making at the last step of cost accounting by using standard
costing and budget and budgetary control system cost accounting control cost and make a
decision.

Income Statement
An income statement is one of the three important financial statements used for reporting
a company's financial performance over a specific accounting period, with the other two
key statements being the balance sheet and the statement of cash flows. Also known as
the profit and loss statement or the statement of revenue and expense, the income

28
statement primarily focuses on the company’s revenues and expenses during a particular
period.
Income Statement Structure: Mathematically, the Net Income is calculated based on the
following:
Net Income = (Revenue + Gains) – (Expenses + Losses)
To understand the above details with some real numbers, let’s assume that a fictitious
sports merchandise business, which additionally provides training, is reporting its income
statement for the most recent quarter.

29
 Chapter three
3. Costing & Control of Materials
A) Purchasing and storing materials
Purchase order is an agreement between the buyer and supplier of materials. It is a
request made by the purchaser to the supplier to supply a specific quantity and quality of
goods in accordance with the terms and conditions laid down in the agreement.
In a manufacturing concern there is a separate purchase department under the control of
purchasing officer. The main functions of purchase department are to purchase required
quantity of materials in time so that the store can feed the production departments with
the continuous supply of materials, to purchase better quality of materials at reasonable
price.
The purchase officer has to play an important role since much money can be saved or lost
by him. He requires a good technical knowledge of the industry and a large measure of
administrative ability. He should also be aware of the policy of the management and the
financial resources of the concern.
Classification of Materials
‘Classification ‘refers to the systematic division, grouping or categorization of materials or
store items with reference to some common characteristic. Classification of materials can
be made on different bases namely nature, manufacturing process, value, purpose etc.
For identification of materials being purchased and stored it is necessary that they should
be properly classified. The store incharge should make a close study of the materials during
the process of storage for the purpose of their (i) safe custody, (ii) meticulous handling and
storing, and (iii) protection from damages, fire, pilferage, spoilage, etc. He is responsible for
the classification of the materials.

The broad classification according to the materials (i) nature, (ii) use, and (iii) service can be
done in the following, classes:
(i) Raw Materials
(ii) Consumable Stores
(iii) Machinery and Plant
(iv)Equipment: Factory and office
(v) Inflammable Stores

30
(vi) Chemical
(vii) Furniture and Fixtures
(viii) Scrap Materials
(ix) Packaging Materials
(x) General Stores.

Accounting for materials:

1. Materials control includes physical control of materials and control over the investment
in materials. Effective physical control of materials involves limiting the access to stored
materials, segregating the duties of employees who handle materials and materials
reports, and establishing an accurate recording system for materials purchases and issues.
Only authorized personnel should be permitted in material storage areas, and procedures
for moving materials into and out of these areas should be well established. The following
functions of materials control should be segregated to minimize opportunities for
employee misappropriation: purchasing, receiving, storage, use, and recording. To ensure
the accurate recording of purchases and materials issues, inventory records should
document the determination of inventory quantities on hand, and cost records should
provide the data needed to assign a cost to inventories to be used in the preparation of
financial statements.
2. Controlling the materials inventory investment requires analysis and planning to
determine when orders should be placed and the number of units to be ordered. The point
at which the predetermined minimum level of inventory is reached, requiring the item to
be ordered, is called the order point. Calculating the order point is based on the following:
 Usage—The anticipated rate at which the materials will be used.
 Lead time—The estimated time interval between placing the order and
receiving the materials ordered.
 Safety stock—The estimated minimum level of inventory needed to protect
against stock outs.
The order point can be calculated as follows:
(Expected Daily Usage × Lead Time) + Safety Stock
3. The optimal quantity of materials to order at one time, called the economic order
quantity, is the order size that minimizes the total costs of placing orders and of carrying
inventory in stock. Order costs include purchasing, receiving and inspection salaries and
wages, communication costs, and record keeping. Carrying costs include storage and
handling; interest, insurance, and property taxes on inventories; and losses due to theft,

31
spoilage, or obsolescence. Annual order costs decrease when order size increases while
annual carrying costs increase with increases in order size.

The economic order quantity is the point where order total costs equal total carrying costs,
unless there is a provision for safety stock.
4. Materials control personnel include (a) the purchasing agent who is responsible for
purchasing the materials needed at the most economical price; (b) the receiving clerk who
is responsible for supervising incoming shipments of material; (c) the storeroom keeper
who is responsible for storing and maintaining the goods received; and (d) the production
department supervisor who is responsible for supervising the operations of a particular
department and who prepares or approves material requisitions.
5. The supporting documents used in the procurement process include (a) the purchase
requisition, which is prepared by the storeroom keeper to notify the purchasing agent that
additional materials should be ordered; (b) the purchase order, which is prepared by the
purchasing agent describing the materials ordered, stating terms and prices, and fixing the
date and method of delivery; (c) the vendor’s invoice, which the purchasing agent
compares to the purchase order to verify description of materials, price, terms of payment,
method of shipment, and delivery date; (d) the receiving report, which is prepared by the
receiving clerk who counts and identifies the materials received and records the shipper,
the date of receipt, the materials received, and the number of the purchase order
identifying the shipment; and (e) the debit-credit memorandum, which is prepared when
the type, quantity, or quality of goods ordered differs from that which was shipped and
adjustments must be made to the vendor’s invoice. If goods are to be returned, the
purchasing agent will prepare a return shipping order.
6. After materials have been ordered, received, and transferred to the storeroom, they
must be protected from unauthorized use. Materials should not be issued from the
storeroom without written authorization in the form of a properly approved materials
requisition. The materials requisition should identify the specific job or department to
which the materials are issued. Occasionally materials are returned to the storeroom
because, for example, more materials were requisitioned than were actually needed for
production or perhaps the wrong type of material was issued. Returned materials should
be accompanied by a returned materials report.
7. All purchases of material should be recorded in the general ledger as a debit to
Materials. The materials account is a control account supported by a subsidiary materials
ledger. The individual accounts in the materials ledger are designed to show the quantity of
each material on hand and its cost. When materials receipts and issues are posted to the
materials ledger accounts, the balance is extended after each entry so that it may be
determined when stock is falling below minimum requirements. Most companies now have

32
automated inventory systems that utilize online information processing, such as bar coding
and optical scanning technology, to update inventory records on a “real time” basis.
8. There are several acceptable ways of assigning costs to materials as they are issued.
Under the first-in, first-out (FIFO) method of costing, the materials issued are costed at the
earliest prices paid for the materials in stock, and the ending inventories are costed at the
most recent purchase prices. Under the last-in, first-out (LIFO) method of costing, the
materials issued are costed at the most recent purchase prices, and the ending inventories
are costed at the prices paid for the earliest purchases. Under the moving average method,
an average unit price is computed each time a new lot of materials is received, and the new
unit price is used to cost all issues until another lot is received and a new unit price is
computed. In choosing an inventory costing method, the method selected should
accurately reflect the income for the period in terms of current economic conditions.
Under conditions of rising prices, the LIFO method is sometimes selected because the
higher priced materials are charged against the increasingly higher sales revenue, resulting
in a more representative earnings picture and a lower income tax liability. The FIFO method
is simpler and less expensive clerically and fairly depicts profits under stable price
conditions. Many companies have adopted the middle-of-the-road position represented by
the moving average method, especially now that computer programs do the computations.
9. All materials issued to production and those returned to stock during a period are
recorded on a summary of materials issued and returned. At the end of the period, the
summary provides the information necessary to record the cost of materials. The total cost
of direct materials requisitioned is recorded by debiting Work in Process and crediting
Materials. The total cost of indirect materials requisitioned is recorded by debiting the
appropriate factory overhead account and crediting materials. Unused materials returned
from the factory to the storeroom are recorded by debiting Materials and crediting Work in
Process (direct materials) or Factory Overhead (indirect materials). Any materials returned
to vendors should be recorded by debiting Accounts Payable and crediting Materials. The
balance of the Materials account may be proven by comparing it to the total of the
individual materials ledger account balances.
10. Periodically, the materials on hand should be physically counted and compared to the
individual materials ledger accounts by someone other than the storeroom keeper or
materials ledger clerk.
11. A just-in-time inventory (JIT) system, also known as a lean production system,
significantly reduces inventory-carrying costs by requiring that raw materials be delivered
only when they are ready to be used and by eliminating inventory buffers of raw materials
between manufacturing cells. Many manufacturing functions that were performed in
individual departments in a traditional manufacturing system are combined into work
centers and manufacturing cells in a JIT system. A JIT system can significantly reduce
throughput time, the time that it takes a unit of product to make it through the

33
manufacturing process, and increase velocity, the speed with which units are produced in
the system. Successful JIT systems require a high degree of coordination with both
suppliers and customers and among work centers.
12. Scrap or waste materials may result from the production process. If the expected sales
revenue from scrap is small, no entry is made for the scrap material until it is sold. At the
time of sale, Cash or Accounts Receivable is debited and Scrap Revenue, Work in Process,
or Factory Overhead is credited depending on whether or not the scrap can be identified
with a specific job or department. If the revenue from scrap is expected to be substantial
and the market value is known, Scrap Material should be debited and Scrap Revenue
should be credited at the time the scrap is inventoried. Scrap Material is credited when the
materials are subsequently sold.

Inventory planning and controlling

Inventory planning and control are functions relating to inventory management. Inventory
planning includes creating forecasts to determine how much inventory should be on hand
to meet consumer demand. Inventory control is the process by which managers count and
maintain inventory items in the business.
Business owners pay close attention to inventory as it usually represents the second largest
expense in their businesses. Inventory planning includes creating forecasts to determine
how much inventory should be on hand to meet consumer demand. Inventory control is
the process by which managers count and maintain inventory items in the business.

Facts
Business owners usually create internal policies and procedures for inventory planning and
control. Managers and employees must follow these policies and procedures when
handling the company’s inventory. Policies and procedures outline who can order
inventory, how inventory flows through the company and accounting policies for valuing
inventory and procedures to deal with obsolete goods. Inventory planning and control has
several benefits for companies who derive the majority of their revenue sales from
inventory.
Better Cash Flow inventory planning and control
Inventory planning and control can help companies manage cash flow. Small businesses do
not have large capital balances for purchasing copious amounts of inventory. Business
owners implement policies and procedures to limit the amount of money spent on
inventory. Cash flow improvements also come from purchasing the lowest cost inventory

34
available in the business environment. Not only does low-cost inventory save the company
money, but it also allows companies to develop a cost advantage in the economic market.
Higher Profits
Business owners can use inventory planning and control to generate higher profits.
Purchasing the right type of inventory to meet consumer demand often leads to higher
business profits. Companies who sell through their entire inventory multiple times each
year also increases business profits. Inventory planning and control procedures can also
limit the amount of obsolete inventory in the company. Obsolete inventory must be
disposed of and written off by the company. Writing off obsolete inventory creates a loss
on the income statement.

EOQ
Economic order quantity (EOQ) is the ideal order quantity a company should purchase to
minimize inventory costs such as holding costs, shortage costs, and order costs. This
production-scheduling model was developed in 1913 by Ford W. Harris and has been
refined over time. The formula assumes that demand, ordering, and holding costs all
remain constant.
EOQ formula
Formula and Calculation of Economic Order Quantity (EOQ)
The formula for EOQ is:

Q=

Where:
Q=EOQ units
D=Demand in units (typically on an annual basis)
S=Order cost (per purchase order)
H=Holding costs (per unit, per year)

Safety Stock
What is safety stock?

35
Safety stock is an extra quantity of a product which is stored in the warehouse to prevent
an out-of-stock situation. It serves as insurance against fluctuations in demand
Importance of safety stock
Safety stock helps eliminate the hassle of running out of stock. If you hold sufficient safety
stock, you needn’t rely on your suppliers to deliver quickly or turn away customers because
of depleted inventory levels. Safety stock covers you until your next batch of ordered stock
arrives. Let’s see how safety stock is important for your business.
How to calculate safety stock
To get the benefits of keeping safety stock, you need to know how much safety stock to
keep. This is because too much safety stock can lead to higher holding costs, and too little
safety stock results in loss of sales. Using a formula will help you calculate the optimal
amount of safety stock for your business.
Each method of calculating safety stock uses slightly different details, but they all require
you to know your lead time, which is the time between the initiation of an order and the
completion of the delivery process.
There are several different methods to calculate safety stock:
Fixed safety stock
Time-based calculation
The general formula
Heizer Render’s formula
Greasley’s method
Safety stock = (max daily sales * max lead time in days) – (average daily sales * average
lead time in days)

Reorder Point
A set inventory level where, if the total stock on hand plus on order falls to or below that
point, action is taken to replenish the stock. The order point is normally calculated as
forecasted usage during the replenishment lead time plus safety stock.
Calculate! Reorder Quantity = ADU x ALT
1. ADU = 10 units.
2. ALT = 29 days.
3. reorder quantity is equal to 290
ADU = Average daily usage
ALT = Average lead time

Material control methods

Material control is a systematic control over the purchasing, storing and using the material
to minimizing the possible cost. Material cost may be defined as the level of material

36
maintenance so as to ensure uninterrupted production and minimizing the investment of
funds.
Impact of JIT on inventory Accounting
The just-in-time (JIT) inventory system is a management strategy that aligns raw-material
orders from suppliers directly with production schedules. Companies employ this inventory
strategy to increase efficiency and decrease waste by receiving goods only as they need
them for the production process, which reduces inventory costs. This method requires
producers to forecast demand accurately.
The JIT inventory system contrasts with just-in-case strategies, wherein producers hold
sufficient inventories to have enough product to absorb maximum market demand.
Just-in-Time (JIT) Inventory System Advantages
JIT inventory systems have several advantages over traditional models. Production runs are
short, which means that manufacturers can quickly move from one product to another.
Furthermore, this method reduces costs by minimizing warehouse needs. Companies also
spend less money on raw materials because they buy just enough resources to make the
ordered products and no more.
Disadvantages of the Just-in-Time System
The disadvantages of JIT inventory systems involve potential disruptions in the supply
chain. If a raw materials supplier has a breakdown and cannot deliver the goods in a timely
manner, this could conceivably stall the entire production process. A sudden unexpected
order for goods may delay the delivery of finished products to end clients.
Materials requirement planning System (MRP)
Material requirements planning (MRP) is a computer-based inventory management system
designed to improve productivity for businesses. Companies use material requirements-
planning systems to estimate quantities of raw materials and schedule their deliveries.

How MRP Works

MRP is designed to answer three questions: What is needed? How much is needed? When
is it needed?" MRP works backward from a production plan for finished goods, which is
converted into a list of requirements for the subassemblies, component parts, and raw
materials that are needed to produce the final product within the established schedule.

37
By parsing raw data—like bills of lading and shelf life of stored materials—this technology
provides meaningful information to managers about their need for labor and supplies,
which can help companies improve their production efficiency.
Types of Data Considered by MRP
 Name of the final product that's being created. This is sometimes called
independent demand or Level "0" on BOM.
 What and when info. How much quantity is required to meet demand? When is it
needed?
 The shelf life of stored materials.
 Inventory status records. Records of net materials available for use that are already
in stock (on hand) and materials on order from suppliers.
 Bills of materials. Details of the materials, components, and sub-assemblies
required to make each product.
 Planning data. This includes all the restraints and directions to produce such items
as routing, labor and machine standards, quality and testing standards, lot sizing
techniques, and other inputs.

Material Requisition
 A material requisition, also known as a materials requisition form, or a material
request, is a document used by the production department to request materials
they need to complete a manufacturing process. It is used to authorize and keep a
record of the components used so that an appropriate inventory can be stocked to
keep production moving.
 Information on the requisition is used to update the stores record card, also known
as the bin card, and the stores ledger. It’s also used to determine the direct
materials used on various jobs or products, along with the indirect materials used
by various cost centers.
 The bin card is a paper or computer record used to keep track of inventory for each
stock item held in storage. The card details the amount of stock received and
issued, the amount of stock reserved to meet current production orders, and any
residual balance free for future use.
 The production manager generally fills out the materials requisition form and
delivers it to either the materials or storage department where all the raw materials
are located. Then, the materials manager approves the request and has the raw
materials moved from the storage area to the production floor
 The person who is requesting the materials will keep a copy of the form, as will the
warehouse staff. An additional copy goes along with the picked goods to their
eventual destination. If any items listed on the form are not in stock, another copy
may go to the purchasing department so they can create a purchase requisition and
purchase order to obtain the necessary materials.

38
 Materials Requisition Information
 Typically, this form has the job number, the date of the request, the date the items
are needed by, material description, item number, quantity, and proper
management signatures for approval.
 “Depending on the size of the organization, these forms may be filled out daily,
weekly, or even hourly.”
 Example Materials Requisition Usage
 Because the form lists the items to picked from inventory and used in either the
production process or in the provision of a service to a customer for a specific job,
the form generally has three purposes:
 To pick items from stock.
 To relieve inventory records of the items picked
 To charge the targeted job the cost of items requisitioned
 You can also use it as a basis for ordering any inventory items that are currently out
of stock.
 For example, when your company orders goods, they are delivered to your
warehouse or storage facility, where the appropriate forms are filled out. This
provides an audit trail that shows both when goods were purchased and when they
were received.
 When the production floor needs more materials, it can request them from the
storage area with the material request form. This adds to the audit trail because it
shows when the goods were moved from your warehouse to production and gives
managers the documentation, they need to support ordering more materials to
prevent them from running out of stock.
 If managers see goods sitting in the warehouse for months before making it into
production, they know they can order less often, or fewer quantities when they do
place an order. If managers notice stock is moving more quickly than usual, they can
start to place orders more frequently, or look for volume discounts and place larger
orders.
 The requisition form is also used to allocate production costs to goods in process,
since not all inventories in process will finish in the current year. As you’ll always
have goods in the production process, the forms help allocate costs and values to
these materials so you can keep an eye on your bottom line.
 You, however, will not see a material requisition form used in a computerized
planning production environment. That’s because the picking information is sent to
the warehouse as an electronic message in the system rather than making use of
the form.
 Some organizations may refer to a material requisition form as a purchase
requisition form, however, there are some differences. A purchase requisition form
can be used for any type of purchase, while the material form is only used
throughout the production process.

39
 With Purchase Control, you can easily manage how much inventory you have on
hand with each of your suppliers.

 Issue of Materials: Basic Requirement and Methods

 Issue of Materials -Basic Requirement:
 Since large sums of money remain blocked in materials, it is essential for the
custodian of materials to ensure that the issue of materials is made only under
proper authorization. In fact, authorization of stores is very vital.
 Moreover, for efficient operation, the following points to be considered:
 (a) Authorization of issues
 (b) Identification of requirements
 (c) Timing of issues.
 Authorization of Issues: Since materials represents money, for the issue of materials
there must be some authorization by responsible officers nominated by the
management. Such authorization should be given clearly in the form of a directive
circular.
 The object is to avoid misunderstanding and unpleasantness that may arise due to
the refusal by the storekeeper to issue materials. In many industries, the
designation of the person authorized to draw materials along with their specimen
signature are sent to the stores for verification.
 The request for issue of materials is invariably made in written form or documents
for proper authorization. It is the primary responsibility of the storekeeper to verify
all such documents for proper authorization before the materials are issued.
 Even though certain persons are authorized to draw goods from the stores,
management normally imposes a few restrictions for drawl of the goods beyond a
certain level of consumption. In all such cases, a clear directive must be given to the
stores department.
 Identification of Requirement: Largely due to ignorance, in several cases the correct
description of the items is not given by the user department. Often the code
number given may not tally with the description of the goods, and vice versa. Hence
an experienced store-keeper should use his intelligence to identify the mistake and
suggest to the indenter the correct item.
 Details about materials requirements such as part number, code number, etc.
ensure that it is supplied without delay and unnecessary correspondence.
 Timing of Issue: The store’s manager should ensure that the indenting departments
are fully aware of the timing of issues. However, there may be sudden rush during
the peak hours. This may put undue pressure on the stores department and may
lead to sudden stoppage of production, in case of undue delay.
 So, our intelligent store-keeper should study carefully the requirements of various
departments and stagger (spread) the timings in such a way that each department
can draw their requirements without loss of time.

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Issue of Materials-Methods
Issues from stores must be efficiently organized so that the requirements of the
production/operations department can be met.
1. Issue on request: This is the most orthodox way of issue wherein the indenting
department normally sends a man and collects the materials from stores.
2. Issue per schedule: In a batch production unit sometime, the requisition for issue of
stores is sent well ahead indicating when, i.e., the time and date it is required. The stores
department will collect all the materials and keep them ready.
Then it will intimate the indenting department about this. Depending on the prevailing
practice of the industry either they are collected from stores or delivered at the shop floor.
This is desirable in order to prevent any loss of man-hour caused by sudden absenteeism of
a worker in the production department.
3. Impress issues: In this system a list of certain items especially for tools and components
and in specified quantities is approved. The list is then held in a sub-store or tool kit near
the shop floor.
4. Replacement issue: In most engineering industries a large number of workshop
machines are used. So, there will be considerable requirements of tools and gauges. When
a fresh issue has to be made the machine shop operator may be asked to return the old
ones to the stores and obtain new one for replacement. This is done without issue notes
and the storekeeper has to maintain proper records of such replacement.
5. Loan issues: The issue of stores on loan should, as far as possible, be discouraged.
Situations often arise where some amount of spares; electrical fitting, etc. are required on
emergency basis due to some breakdowns. In such cases the materials are to be issued on
a loan basis. However, the storekeeper is to maintain a separate record and ensure that
they are returned before year-ending when annual stock-taking begins.
6. Stock records: In a store-house where thousands of transactions take place some
amount of records are too maintained. This makes it possible for the storekeeper to make
an entry of all transactions.

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 B) IAS 2 — Inventories

IAS 2 Inventories contains the requirements on how to account for most types of inventory.
The standard requires inventories to be measured at the lower of cost and net realizable
value (NRV) and outlines acceptable methods of determining cost, including specific
identification (in some cases), first-in first-out (FIFO) and weighted average cost.

Objective of IAS 2
The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides
guidance for determining the cost of inventories and for subsequently recognizing an
expense, including any write-down to net realizable value. It also provides guidance on the
cost formulas that are used to assign costs to inventories.
Scope Inventories include assets held for sale in the ordinary course of business (finished
goods), assets in the production process for sale in the ordinary course of business (work in
process), and materials and supplies that are consumed in production (raw materials). [IAS
2.6] However, IAS 2 excludes certain inventories from its scope: [IAS 2.2] Work in process
arising under construction contracts (see IAS 11 Construction Contracts)
Financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
Biological assets related to agricultural activity and agricultural produce at the point of
harvest (see IAS 41 Agriculture).
Also, while the following are within the scope of the standard, IAS 2 does not apply to the
measurement of inventories held by: [IAS 2.3]
producers of agricultural and forest products, agricultural produce after harvest, and
minerals and mineral products, to the extent that they are measured at net realizable value
(above or below cost) in accordance with well-established practices in those industries.
When such inventories are measured at net realizable value, changes in that value are
recognized in profit or loss in the period of the change

Measurement:
Inventories shall be stated at the lower of cost and net realizable value. To the extent that
service providers have inventories, they measure them at the costs of their production.
These costs are primarily the costs of labor directly engaged in providing the service,
including supervisory personnel, and attributable overheads. The cost of inventories of
items that are ordinarily interchangeable and have not been produced and segregated for
specific projects is determined by using the first-in, first-out (FIFO) or weighted average

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cost formula. The same cost formula shall be adopted for all inventories having a similar
nature and use to the entity. Inventories are usually written down to NRV on an item by
item basis, unless it is more appropriate to group similar or related items.
Cost of inventories
All costs incurred in bringing the inventories to their present location and condition,
including the costs of purchase and conversion. - Costs of purchase of inventories comprise
the purchase price (less trade discounts, rebates and similar items), irrecoverable taxes,
and transport, handling and other costs directly attributable to their acquisition. - Costs of
conversion include costs directly related to the units of production, such as direct labor and
systematically allocated fixed and variable production overheads incurred in producing
finished goods.
Cost of formulae: Specific identification methods: FIFO (FIRST IN FIRST OUT METHOD) First-
In- First-Out (FIFO) is one of the methods commonly used to estimate the value of
inventory on hand at the end of an accounting period and the cost of goods sold during the
period. This method assumes that inventory purchased or manufactured first is sold first
and newer inventory remains unsold. Thus cost of older inventory is assigned to cost of
goods sold and that of newer inventory is assigned to ending inventory. The actual flow of
inventory may not exactly match the first-in, first-out pattern. First-In, First-Out method
can be applied in both the periodic inventory system and the perpetual inventory system.
The following example illustrates the calculation of ending inventory and cost of goods sold
under FIFO method:
Example Use the following information to calculate the value of inventory on hand on Mar
31 and cost of goods sold during March in FIFO periodic inventory system and under FIFO
perpetual inventory system. Mar 1 Beginning Inventory 68 units @ $15.00 per unit 5
Purchase 140 units @ $15.50 per unit 9 Sale 94 units @ $19.00 per unit 11 Purchase 40
units @ $16.00 per unit 16 Purchase 78 units @ $16.50 per unit 20 Sale 116 units @ $19.50
per unit 29 Sale 62 units @ $21.00 per unit Solution FIFO Periodic Units Available for Sale =
68 + 140 + 40 + 78 = 326 Units Sold = 94 + 116 + 62 = 272 Units in Ending Inventory = 326 −
272 = 54 Cost of Goods Sold Units Unit Cost Total Sales From Mar 1 Inventory 68 $15.00
$1,020 Sales From Mar 5 Purchase 140 $15.50 $2,170 Sales From Mar 11 Purchase 40
$16.00 $640 Sales From Mar 16 Purchase 24 $16.50 $396 272 $4,226 Ending Inventory
Units Unit Cost Total Inventory From Mar 16 Purchase 54 $16.50 $891
FIFO Perpetual Date Purchases Sales Balance Units Unit Cost Total Units Unit Cost Total
Units Unit Cost Total Mar 1 68 $15.00 $1,020 5 140 $15.50 $2,170 68 $15.00 $1,020 140
$15.50 $2,170 9 68 $15.00 $1,020 114 $15.50 $1,767 26 $15.50 $403 11 40 $16.00 $640
114 $15.50 $1,767 40 $16.00 $640 16 78 $16.50 $1,287 114 $15.50 $1,767 40 $16.00 $640
78 $16.50 $1,287 20 114 $15.50 $1,767 38 $16.00 $608 2 $16.00 $32 78 $16.50 $1,287 29
38 $16.00 $608 54 $16.50 $891 24 $16.50 $396

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WEIGHTED AVERAGE METHOD
The Weighted Average Cost (WAC) method of inventory valuation uses a weighted average
to determine the amount that goes into COGS and inventory. The weighted average cost
method divides the cost of goods available for sale by the number of units available for
sale. The WAC method is permitted under both GAAP and IFRS accounting. The formula for
the weighted average cost method is as follows: The bundling of costs is referred to as the
cost of goods available for sale. The costs of goods available for sale are either allocated to
COGS or ending inventory. Allocating the costs of goods available for sale is referred to as a
cost flow assumption. There are several cost flow assumptions such as: Using the weighted
average cost method yields different allocation of inventory costs under a periodic and
perpetual inventory system.
In a periodic inventory system, the company does an ending inventory count and applies
product costs to determine the ending inventory cost. COGS can then be determined by
combining the ending inventory cost, beginning inventory cost, and the purchases
throughout the period. A perpetual inventory system keeps continual tracking of
inventories and COGS. The perpetual inventory system provides more information for the
management of inventory levels. However, this method of inventory
Tracking can be costly for a company. In a perpetual inventory system, the weighted
average cost method is referred to as the “moving average cost method”.
Weighted Average Cost (WAC) Method Formula: Costs of goods available for sale is
calculated as beginning inventory value + purchases. Units available for sale are the
number of units a company can sell or the total number of units in inventory. RETAIL
METHOD: The retail inventory method is used by retailers that resell merchandise to
estimate their ending inventory balances. This method is based on the relationship
between the cost of merchandise and its retail price. The method is not entirely accurate,
and so should be periodically supplemented by a physical inventory count. Its results are
not adequate for the year-end financial statements, for which a high level of inventory
record accuracy is needed.
Retail Inventory Method Calculation: To calculate the cost of ending inventory using the
retail inventory method, follow these steps: 1. Calculate the cost-to-retail percentage, for
which the formula is (Cost ÷ Retail price). 2. Calculate the cost of goods available for sale,
for which the formula is (Cost of beginning inventory + Cost of purchases). 3. Calculate the
cost of sales during the period, for which the formula is (Sales × cost-to-retail percentage).
4. Calculate ending inventory, for which the formula is (Cost of goods available for sale -
Cost of sales during the period). For example, Milagros Corporation sells home coffee
roasters for an average of $200, and which cost it $140. This is a cost-to-retail percentage
of 70%. Milagros’s beginning inventory has a cost of $1,000,000, it paid $1,800,000 for
purchases during the month, and it had sales of $2,400,000. The calculation of its ending

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inventory is: Beginning inventory $1,000,000 (At cost) Purchases + 1,800,000 (At cost)
Goods available for sale = 2,800,000 Sales - 1,680,000 (Sales of $2,400,000 x 70%) Ending
inventory $1,120,000
The retail method uses the cost to retail price ratio to estimate the value of the inventory.
To calculate the value of ending inventory, you need to follow these steps: 1. Maintain a
comprehensive record of purchases and on-hand goods at cost price and retail price 2.
Calculate a cost-to-retail ratio Formula = Cost price x 100 / Retail price 3. Estimate the
ending inventory at retail prices by subtracting the retail price of goods sold from the retail
price of goods in inventory 4. Convert the estimated inventory at retail price to cost price
by applying the cost-to-retail percentage
NET REALIZABLE VALUE
Definition of Net Realizable Value: Net realizable value (NRV) is the cash amount that a
company expects to receive. Hence, net realizable value is sometimes referred to as cash
realizable value. We often find the term net realizable value being associated with the
current assets accounts receivable and inventory. While these two assets are initially
recorded at cost, there are occasions when the company will collect less than the cost.
When that occurs, the company must report the lower of 1 cost, or 2 the net realizable
value. In the case of accounts receivable, net realizable value can also be expressed as the
debit balance in the asset account Accounts Receivable minus the credit balance in the
contra asset account Allowance for Uncollectible Accounts. In the context of inventory, net
realizable value is the expected selling price in the ordinary course of business minus any
costs of completion, disposal, and transportation.
Examples of Net Realizable Value: Net realizable value (NRV) is the amount by which the
estimated selling price of an asset exceeds the sum of any additional costs expected to be
incurred on the sale of the asset. NRV may be calculated for any class of assets but it has
significant importance in the valuation of inventory. Both GAAP and IFRS require us to
consider the net realizable value of inventory for valuation purposes. Under GAAP,
inventories are measured at lower of cost or market provided that the market value must
not exceed the NRV of inventory. Under IFRS, inventories must be valued at lower of cost
and NRV.
Formula Net Realizable Value = Sale Value – Cost to Make Sale Where, Sale value is the
estimated selling price of inventory in the ordinary course of business; and Cost to make
sale is the sum of any additional costs expected to be incurred to make the sale including,
but not limited to, the costs of finishing, repair, advertising expenses directly related to
inventory and transportation costs borne by the owner etc. if any.
Example Calculate the net realizable value of inventory having following particulars: Total
Units 19,000 Estimated Selling Price per Unit 35 Units Damaged (Included in Total Units 700
Cost to Repair each Damaged Unit $6 Other Selling Costs per Unit $2.

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Solution: Good Damaged Estimated Price per Unit $35 $35 – Repair Cost 6 – Other Selling
Costs 2 2 NRV per UN
NRV per Unit $33 $27 × Units 18,300 700
Net Realizable Value $603,900 $18,900
Total Net Realizable Value $622,800
RECOGNITION AS AN EXPENSE
When inventories are sold, the carrying amount of those inventories should be recognized
as an expense in the period in which the related revenue is recognized. Any losses of
inventories and the amount of any write-down to net realizable value shall be recognized
as expense in the period in which the loss or write-down occurs.
Any reversal of any write-down of inventories that resulted from an increase in the net
realizable value shall be recognized as a reduction in the inventory expense in the period in
which the reversal occurs.
DISCLOSURE:
The following shall be disclosed in the financial statements - the accounting policies for
inventories - the total carrying amount of inventories and the carrying amount in
classifications appropriate to the entity - the carrying amount of inventories carried at fair
value less costs to sell - the amount of inventories recognized as an expense during the
period.

Reference:

Books:
COST ACCOUNTING: PRINCIPLE & PRACTICE BY S.P.IYENGER

Websites:
Www.Investopedia.Com
Www.Accountingcoach.Com
Www.Investiganswer.Com
Www.Toppr.Com
Www.Freshbooks.Com
Www.Accountingedu.Org

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