Product

Moong dal 1 kg Green 1

Moong dal 1 kg Yellow 1
Chana dal 1 kg 1900 1
Udad dal 1 kg 1900 1
Toor dal 1 kg 2000 1
Rajma 1 kg 2200 1
Red chilli powder 1 kg 5000 1
Coriander powder 1 kg 5000( Everest) 1
Turmeric Powder 1 kg 4000 1
Jeera seed 100 gm 600 1
Rai 100 gm 400 1
Lipton Tea Sachat 1
Tomato ketchup 500 gm 2000 1
Rice 5 kg ( india gate rozzana ) 1
Poha 1 kg - thik 1
Kabuli chana 1
MAGGI tomato sauce 1
ajwaine/ ajamo 1
Besan 1 kg 1
Suji 500 gm 1800 1
Chick peas 1 kg 2200 / Kala chana 1
Green dal 1 kg 2000 1
Ghee 1 kg 8000 1
Everest masale 1100 1
Clover 50 gm 900 1
Elaichi 50 gm 2800 1
Custard powder Big- vanila300 gm 1
faluda packet 1
Hingh50 gm 1
Vermicili Sev 120 gm 1
Green chili sauce 680 gm 1
Red chilli sauce 680gm 1
soya sauce 700 gm 1
Bread fresh sliced 400 gm 1
GITS- gulabjambun- big200 gm 1
Ratlami SEV big 250 gm 1
Nescoffee gold blend 1
Mag dal sliced - yellow 1 kg 1
Mag dal sliced - green 1 kg 1
Sambhar masala 1
pav bhaji Masala 1
chole masala 1
Chicken Masala 1
Meat Masala 1
Fish masala 1
Rice flour if available 500 gm 1
Pickle - khata mango 1
Rice 50 KG 1
 15,000 2 30,000 50,000
1590000 15,000 2 30,000 50,000
928000 15,000 2 30,000
100000 15,000 2 30,000
112000
112000
181000
171000 25,000 27 922.50923
125000 25,000 49 513.34702

3319000
50,000
50,000
 2,500.00
2,500.00
2,500.00
74.00 7,500.00 555,000.00
1,465,000.00
865,000.00
200,000.00
181,000.00
151,000.00
125,000.00
100,000.00
300,000.00

3,942,000.00 65,700.00
(1) Units of Output Method
Absorption of the factory overhead occurs based on the number of units manufactured. Dividing the overhead expenses by th
Formula

Overhead rate = factory overhead of the department / number of units of output.

Example
If the factory overhead for department ‘A’ for a particular period amounts to $10,000 and the department manufactures 2,00
This simple, direct method only applies to single output industries manufacturing one product or a few grades of the same pro

(2) Direct Material Cost Method (Percentage on Direct Material Cost)

Here, the overhead absorption occurs based on the direct materials consumed. This method expresses the overhead rate as a
Calculate the overhead rate by dividing the factory overhead for a particular period by the cost of the direct materials used in
Formula

Overhead rate = (factory overhead cost of direct materials used) x 100.

Example

If the monthly amount or factory overhead for department ‘A’ amounts to $10,000 and the cost of direct material consumed a
A job carried out by the department involving direct material costing $200 means the job absorbs $80 (40% of $200) and Rs. (4
This simple, equitable method uses the same type of material in all the manufactured articles, and the price of such material d

Disadvantages

1. Considerable fluctuations, unaccompanied by similar fluctuations in the factory overhead, affect the cost of materials and
2. Ignores the time factor involved in production.
3. A job’s consumption of expensive materials does not justify supposing that charging the factory overhead to it would be p
4. Factory expenses result from the cost of materials and the type of workers. However, this method makes no distinction be

(3) Direct Labor Cost Method (Percentage on Direct Wages)

Under this method, the overhead absorption occurs based on direct wages. 

Obtain the overhead rate, expressed as a percentage on direct wages, by dividing the factory overhead for a particular period

Formula

Overhead rate = (factory overhead / direct wages) x 100.

Example
If the factory overhead cost for department ‘A’ for a particular month amounts to $10,000 and the total labor cost amounts to

A job carried out by department ‘A’ involving a payment of $200 by way of direct wages absorbs $100 (50% of $200) by way o

Advantages

1. Automatic consideration of the time factor because wages are paid based on time.
2. Wage rates show more constancy than material prices, meaning this method provides a stable basis for overhead absorpti
3. Factory expenses can depend on the number of employees, making this basis more equitable.

Disadvantages

1. No consideration of skilled and unskilled workers’ wage rates. 

2. No distinction between the efforts of hand workers and machine workers. 
3. No consideration of the time element if the workers receive payment based on piece work and not the basis of time.

(4) Prime Cost Method (Percentage on Prime Cost)

This method absorbs the overhead based on the prime cost and assumes that both materials and labor give rise to the  overhe

Formula

Overhead rate = (factory overhead / prime cost) x 100.

Example

If the factory overhead for department ‘A’ for a particular month amounts to $10,000 and the prime cost amounts to $40,000
If the prime cost of a job done by the department amounts to $300, the job will absorb $75 (25% of $300) by way of overhead
This simple method assigns equal weight to materials and labor.

(5) Direct Labor Hour Rate Method

Absorption of the overhead reflects the number of hours involving direct labor. 
Calculate the direct labor hour rate of the overhead by dividing the factory overhead for a given period by the total number of
Formula
Overhead rate = factory overhead / number of direct labor hours.

Example

If the factory expenses for department ‘A’ for a particular period amount to $10,000 and the direct labor hours during the sam
A particular job carried out during the period involving 50 hours of direct labor absorbs $100 (50 hours x $2) by way of overhe
The direct labor hour rate is a time rate. Most factory overhead items vary with time, meaning this method provides a basis fo
This method also assumes the predominance of direct labor and ignores all other production factors.
(6) Machine Hour Rate Method
Overhead absorption occurs based on the cost of operating machinery. Highly organized engineering works relying heavily on
The hourly cost of operating a machine, otherwise known as the machine hour rate, represents the overhead rate.  
Obtain the machine hour rate by dividing the factory expenses connected with a machine for a given period by the number of

Formula
Overhead rate = factory overhead (relating to a machine) / number of machine hours.

Example
If the factory expenses relating to Machine No. 15 installed in department ‘A’ for a particular period amount to $5,000 and sai
A particular job executed by Machine No. 15 taking 30 hours absorbs $150 (30 hours x $5) by way of the factory overhead.
In mechanized factories, the machine hour rate method provides the most scientific basis for absorbing the overhead.  

However, this complicated method involves too many mathematical calculations and requires accurate records of the machin

(7) Dual Hour Rate Method

This method combines the direct labor rate and the machine hour rate. It classifies the overheads into two categories related
The labor hour rate absorbs the first category of overheads and the machine hour rate absorbs the second category of overhe

Illustration
The following information relates to a Manufacturing Co., for the year ending 31 March 2019:

Materials used $60,000.

Direct labor $30,000.
Factory overhead $18,000.
Direct labor hours 12,000.
Machine hours 10,000.
The following information relates to Job No. 75:
Materials used $1,200.
Direct labor $650.
Direct labor hours 265.
Machine hours 255.

Enumerate four different methods of absorbing factory overheads and prepare a statement showing the total cost of Job No.

Solution

The four primary methods of absorbing the factory overhead may involve:

1. A percentage of direct materials.

2. A percentage of the direct labor cost.
 3. The direct labor hour rate method.
4. The machine hour rate method.

First Method

The overhead rate as a percentage on the direct materials cost comes to 30%, calculated as follows:

= (18,000 / 60,000) x 100.

The factory cost of the job will be as follows:

Second Method

The overhead rate as a percentage on direct labor cost comes to 60%, calculated as follows:

= (18,000 / 30,000) x 100.

The factory cost of the job will be as follows:

Third Method

The direct labor hour rate of the overhead comes to $1.50, calculated as follows:

= ($18,000 / 12,000 hours).

The factory cost of the job will be as follows:

Fourth Method

The machine hour rate of the overhead comes to $1.80, calculated as follows:

= $18,000 / 10,000 hours.

The factory cost of the job will be as follows:

Choice of Overhead Absorption Method

Different methods can absorb the factory overhead: direct material cost, direct labor cost, direct labor hour rate, and machine

Consider the following factors when selecting a method:

1. The type of industry — whether job order or continuous production.

2. Nature of the manufacturing process — whether manual or mechanical.
3. The primary constituents of the overhead and their nature — whether fixed or variable.
4. The organizational setup of the undertaking into departments and cost centers.
5. Capacity at which the factory works — full-capacity or under-capacity.
6. Management policy.

Requisites of a Good Method of Absorption

1. A simple, convenient application that does not require unnecessary clerical records.
2. It ensures the recovery of the overhead which is more or less equal to the actual amount of the overhead.
 3. It considers the time factor involved in production.
4. It distinguishes between the work of skilled workers and unskilled workers.
5. It makes a proper distinction between manual labor and machine labor.
6. It should prefer multiple rates (determined in relation to the work of different departments) rather than the blanket rate o

Frequently Asked Questions

What Is A Factory Overhead?

Factory overhead or factory burden refers to all the costs involved in operating an organization's factory, apart from direct ma

What Is The Purpose Of Absorption Of Factory Overhead?

The main purpose of absorption of factory overheads is to allocate all the indirect costs of running a factory to individual prod

What Are The Different Methods Of Absorption Of Factory Overhead?

There are four common methods of absorption of factory overheads: percentage of direct materials cost, percentage of direct

How Is The Overhead Rate Calculated In The First Method?

The overhead rate as a percentage on the direct materials cost comes to 30%, calculated as follows: = (18,000 / 60,000) x 100.

How Is The Overhead Rate Calculated In The First Method?

The overhead rate as a percentage on the direct labor cost comes to 18%, calculated as follows: = (18,000 / 100,000) x 100.

Related Posts

Factory Overhead: Practical Problems and Solutions

Calculating the Machine Hour Rate
How to Compute Various Overhead Cost Variances
Overhead Absorption
Job Costing
g the overhead expenses by the number of units of output obtains the overhead rate.

epartment manufactures 2,000 units, the overhead rate per unit amounts to $5 ($10,000 + 2,000 units). Each unit will bear $5 by way of th
r a few grades of the same product.

aterial Cost)
presses the overhead rate as a percentage of the direct material cost.
of the direct materials used in the same period and then multiplying it by 100.

of direct material consumed amounts to $25,000, the overhead rate is 40% on the direct material cost (10,000 / 25,000) x 100.
bs $80 (40% of $200) and Rs. (40% 01′ Rs. 2()()) by way of overhead.
nd the price of such material does not respond to fluctuations.

ffect the cost of materials and render this basis unstable.

ory overhead to it would be proportionately higher.

ethod makes no distinction between skilled and unskilled workers.

erhead for a particular period by the direct wages paid during that period and multiplying it by 100.
he total labor cost amounts to $20,000, the overhead rate will be 50% on direct wages (10,000 / 20,000) x 100.  

$100 (50% of $200) by way of overhead.

ble basis for overhead absorption.

nd not the basis of time.

d labor give rise to the  overhead. The overhead rate is expressed as a percentage of the prime cost.

rime cost amounts to $40,000, the overhead rate will be 25% on the prime cost (10,000 / 40,000) x 100.
% of $300) by way of overhead.

period by the total number of direct labor hours for the same period.

ect labor hours during the same period amount to 5,000, the direct labor hour rate will be $2 ($10,000 / 5,000 hours).  
hours x $2) by way of overhead.
his method provides a basis for overhead absorption.
ering works relying heavily on machines tend to apply this method.
the overhead rate.  
given period by the number of hours worked by the machine during that period.

riod amount to $5,000 and said machine works 1,000 hours during the period, the machine hour rate amounts to $5 ($5,000 + 1,000 hours
ay of the factory overhead.
sorbing the overhead.  

ccurate records of the machines and repairs and maintenance costs.

ds into two categories related to manual work and machine work.  

he second category of overheads.

wing the total cost of Job No. 75 under each of the four methods referred to above.
t labor hour rate, and machine hour rate. Failing to choose the most equitable and suitable method can result in misleading  costing result

the overhead.
 rather than the blanket rate or the overall overhead rate of the entire factory.

s factory, apart from direct materials and direct labor. In other words, it means indirect cost. Factory overhead may include ,but not limited

ng a factory to individual products or services. This is done in order to determine the cost of each product or service and thereby ascertain

rials cost, percentage of direct labor cost, direct labor hour rate and machine hour rate.

ows: = (18,000 / 60,000) x 100.

= (18,000 / 100,000) x 100.

h unit will bear $5 by way of the overhead cost.

00 / 25,000) x 100.
nts to $5 ($5,000 + 1,000 hours).  
lt in misleading  costing results. 
ad may include ,but not limited to: indirect material costs such as lubricants, cleaning materials used for production line, etc. Indirect labor

service and thereby ascertain whether a business is making profits or losses on specific items.
duction line, etc. Indirect labor costs such as supervisors, quality control personnel, etc. Factory rent or lease, utilities (electricity, water), D
, utilities (electricity, water), Depreciation on factory building and equipment, insurance, taxes.
According to the Oxford Dictionary, cost means “the price paid for something.” 

However, in management terminology, cost refers to expenditure and not to price. A cost represents a sacrifice or a release o

The Institute of Cost and Management Accountants, London, has defined cost as “the amount of expenditure (actual or notion

For instance, cost items in the manufacture of cotton fabrics comprise the expenditure involved in the purchase of cotton yarn

Elements of Cost
One of the primary objects of cost accounting involves analyzing the total cost of production and providing the most helpful in

The analysis and classification of costs refer to the factors resulting in expenditure. Otherwise known as the elements of cost,

The elements of cost comprise:

Material cost
Labor cost or wages
Expenses

Material Cost

Material cost refers to the commodities supplied to an undertaking, such as the cost of yarn and dyes engaged in manufacturi

Further subdivisions of material costs include:

(a) Direct material cost: The cost of materials identifiable with and allocated to cost centers or cost units, such as the cost of w

(b) Indirect material cost: The material cost that cannot be allocated but can be apportioned to or absorbed by cost centers o

Labor Cost (or Wages)

The cost of remunerating the employees of an undertaking, e.g., wages, salaries, and commission. 

Further subdivisions include:

(a) Direct labor cost (or direct wages): The labor cost identifiable with and allocated to cost centers or cost units.

Direct labor cost includes the remuneration paid to convert raw materials into finished products or alter the construction, com

Direct labor cost also includes the wages paid to those who directly carry out or operate a service, such as a driver and conduc

(b) Indirect labor cost (or indirect wages): The labor cost or wages that cannot be allocated but can be apportioned to or abso
Expenses

The cost of services provided to an undertaking and the notional cost of using owned assets (i.e., depreciation of an owned fa

Subdivisions of expenses include:

(a) Direct expenses (or chargeable expenses): The expenses (other than direct material cost and direct labor cost) identifiable

One example is octroi paid on the purchases of imported direct materials (if not added to their purchase price).

(b) Indirect expenses: Expenses that cannot be allocated but can be apportioned to or absorbed by cost centers or cost units,

The aggregated direct material cost, direct labor cost, and direct expenses result in the direct cost. The aggregated indirect ma

(i) Factory overhead or works overhead: All the indirect costs incurred in manufacturing operations: indirect materials, indirec

(ii) Office and administration overhead: All the indirect costs relating to the direction, control, and administration of an under

(iii) Selling and distribution overhead: All indirect costs incurred for promoting sales, retaining customers, and delivering good

Components of Cost
The cumulation or aggregate of different elements of cost. Aggregating or grouping the various elements obtains the following

(a) Prime cost: The aggregate of the direct material cost, direct labor cost, and direct expenses. Otherwise known as flat cost,

(b) Factory cost: Results from the prime cost plus the factory overhead (or works overhead) and comprises the aggregated dir

Factory cost is also known as works cost, production cost, or manufacturing cost.

(c) Office cost: Results from the factory cost plus the office and administrative overhead. Otherwise known as gross cost or co

(d) Total cost: Made up of the cost of production plus the selling and distribution overhead. Comprises all elements of cost or

Selling Price

The selling cost (or the total cost or the cost of sales) plus profit.

Simplified Formulas

Direct material cost + Direct wages + Direct expenses = Prime cost

Prime cost + Factory overhead = Factory cost
Factory cost + Office and administration overhead = Office cost
Office cost + Selling and distribution overhead = Total cost
 Total cost + Profit = Selling price

Frequently Asked Questions

What Is A Cost?

According to the oxford dictionary, cost means “the price paid for something.”

What Are The Elements Of Cost?

The elements of cost comprise: Material Cost, labor cost or wages, and expenses

What Is The Analysis And Classification Of Costs?

The analysis and classification of costs refer to the factors resulting in expenditure. Otherwise known as the elements of cost,

What Is A Material Cost?

Material Cost refers to the commodities supplied to an undertaking, such as the cost of yarn and dyes engaged in manufacturi

What Is Meant By Labor Cost (Or Wages)?

The cost of remunerating the employees of an undertaking, e.G., Wages, salaries, and commission.

Related Posts

Methods of Factory Overhead Absorption

Classification of Cost
How to Compute Various Overhead Cost Variances
Overhead Absorption
Cost
sents a sacrifice or a release of something of value. 

f expenditure (actual or notional) incurred on or attributable to a given thing.”

in the purchase of cotton yarn, wages paid to weavers, factory foreman salaries, depreciation on machinery, notional rent of owned facto

d providing the most helpful information. 

nown as the elements of cost, these costs may also refer to smaller costs of identical nature.  

dyes engaged in manufacturing cloth.

ost units, such as the cost of wood in the case of furniture. Direct materials enter into and form part of the finished product.

or absorbed by cost centers or cost units. These materials cannot be traced as part of the product, and their cost is distributed among the

ters or cost units.

or alter the construction, composition, or condition of the product manufactured by an undertaking.

e, such as a driver and conductor of a bus in the transport business.

can be apportioned to or absorbed by cost centers or cost units, such as the salary paid to a factory manager.
 ., depreciation of an owned factory building). 

d direct labor cost) identifiable with and allocated to cost centers or cost units.

purchase price).

by cost centers or cost units, such as rent, rates, taxes, insurance of the factory building, factory lighting, repairs, and so forth.  

st. The aggregated indirect material cost, indirect labor cost, and indirect expenses are known as the  indirect cost or overhead, which can

ons: indirect materials, indirect labor, and all other indirect expenses, such as wages, factory rent, factory rates, repairs, and so forth.

nd administration of an undertaking, such as office rent and staff salaries.

ustomers, and delivering goods after their manufacture, such as advertising, salesmen salaries, commission on sales, carriage on sales, and

elements obtains the following components or types of cost:

Otherwise known as flat cost, first cost, and direct cost.

comprises the aggregated direct material cost, direct labor cost, direct expenses, and factory overhead.

wise known as gross cost or cost of production.

mprises all elements of cost or items of expenditure up until the sale of the commodity. Otherwise known as the selling cost or cost of sales
nown as the elements of cost, these costs may also refer to smaller costs of identical nature.

d dyes engaged in manufacturing cloth.

, notional rent of owned factory building, and so forth.

finished product.

cost is distributed among the cost centers or cost units on an equitable basis.  
pairs, and so forth.  

t cost or overhead, which can be classified into:

tes, repairs, and so forth.

on sales, carriage on sales, and packing charges.

the selling cost or cost of sales.

All direct expenses are recorded on the debit side of the Trading Account. This article provides a detailed explanation of vario

Opening Stock or Opening Inventory

In a trading business, opening stock consists of different types of finished goods. By contrast, in a manufacturing business, op

Unsold closing stock from the last year is the opening stock of the current year. However, a newly established business has no

Therefore, the cost of opening stock will be the expense of the current year. It is recorded on top of the debit side of Trading A

Purchases
This direct expense is the balance of the Purchases Account that appears on the debit side of the  Trial Balance. It shows the to

Purchases are recorded on the debit side of the Trading Account. If there are any purchase returns in the Trial Balance, these m

Carriage Inward

or Carriage In or Carriage Inwards or Carriage on Purchases or Transportatio

Carriage inward is also known as carriage, carriage on purchases, or transportation inward. Carriage inward refers to the expen

Generally, the term “carriage” is used to refer to the expenses paid to transport goods from one city to another city within the

Students should remember that carriage paid on goods sold is called carriage outward. It is not a direct expense and should n

Cartage
Cartage is another term used to refer to the expenses incurred to bring the purchased goods to the factory, godown, shop, or

Generally, the term “carriage” is used for the expenses paid to move goods from one place to another within the same city. Th

Students should remember that carriage paid on goods sold is not a direct expense and should not be recorded in the Trading

Freight or Freight Inward

These expenses are paid as a fare to the ship or aircraft operator that transports goods purchased from abroad. Given that the

Insurance in Transit
These are the charges paid to the insurance company to cover losses that may occur during the transit of goods purchased.
Since these expenses are incurred in connection with the purchase of goods, they are considered direct and are recorded on t

Packing Charges
Certain types of goods cannot be sold without packing. In such cases, the packing becomes part of the product and is treated a

These types of packing charges are debited to the Trading Account. However, other types of packing that are not direct expen

Landing and Wharf Charges or Dock Charges

These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with the goo

Clearing Charges
Some imported goods must be cleared at ports and airports. Any expenses paid for the clearance of purchased goods are trea

Import Duty, Excise Duty, and Customs Duty

The government imposes different taxes on the import of goods from abroad, each with different names (e.g., import duty, cu

When these taxes are paid on bought goods, they are considered direct expenses and are debited to the Trading Account.

Octroi Duty
This tax is charged by the municipal corporation of a city when commercial goods enter its territory. When bought goods are b

If this tax is paid on bought goods, it is considered a direct expense and debited to the Trading Account.

Wages and Salaries

In trading concerns, wages are the remuneration paid to the workers for loading and unloading the goods, as well as other tas

If these wages are paid in connection with the goods bought, then these are treated as direct expenses and debited to the Tra

In manufacturing concerns, wages are paid to the workers who are directly engaged in the manufacturing process. These are a

Productive wages are treated as direct expenses and should be debited to the Trading Account.

Factory Rent, Factory Expenses, Factory Insurance, Factory Rates, and Facto
All expenses incurred in the process of manufacturing goods, including factory rent, factory insurance, and factory lighting and

Given that all these expenses are related to the production of goods, they are considered direct expenses and are debited to t

Motive Power
Motive power expenses include the fuel, gas, water, and other energy incurred to run the machines used for production. They

Students should remember that the electricity used in the administrative and sales departments should be debited to the Profi

Consumable Stores
Consumable stores such as lubricating oils (engine oils), grease, and cotton waste are used to keep machinery in proper workin

As this machinery is used in the production of goods, the value of any consumable stores that are consumed is treated as a dir

Raw Materials
Some raw materials are directly used in the production of goods, such as tallow used in the fabrication of lubricants, soap, and

As these materials are directly used in production, the expenses incurred on them are considered direct expenses and are deb

Royalty
Royalty is essentially a form of rent that is paid to use certain rights. A manufacturer or producer pays a royalty to receive the

For example, a publisher pays a royalty to the author of a book to get the rights to publish it.

Similarly, a company may pay a royalty to their landlord to secure the right to drill for oil and gas in a particular area. As anoth

Royalties may be paid on a production basis or on a sales basis. If paid on a production basis, then the royalty is considered a d

However, if the royalty is paid on a sales basis, then it is debited to the Profit and Loss account. If, however, nothing is specific

Frequently Asked Questions

Direct Expenses Are Recorded On What Side Of The Trading Account?

Debit side

This Refers To The Expenses Incurred To Bring The Purchased Raw Materials Or Goods To T

Carriage inward
What Is A Royalty?

Is essentially a form of rent that is paid to use certain rights. A manufacturer or producer pays a royalty to receive the rights to

Royalties May Be Paid Using The 2 Bases. What Are These?

Production basis or on a sales basis

If Royalties Are Paid On A Production Basis Then It Is Considered What?

A direct expense and debited to the Trading Account.

Related Posts

Methods of Factory Overhead Absorption

Trading Account
Direct and Indirect Expenses
Ledger Accounts
Rules of Debit and Credit
a detailed explanation of various direct expenses.

a manufacturing business, opening stock consists of raw materials, work-in-progress, and finished goods.

ly established business has no opening stock at the beginning of the first year because the last year’s unsold closing stock is sold in the cur

p of the debit side of Trading Account.

e  Trial Balance. It shows the total purchases made by the business during the accounting year. It includes both cash and credit purchases.

ns in the Trial Balance, these must be deducted from the purchases. Only net purchases should be recorded on the debit side of the Tradi

es or Transportation Inwards
age inward refers to the expenses incurred to bring the purchased raw materials or goods to the factory, godown, shop, or workplace.

city to another city within the same country. These expenses are recorded on the debit side of the Trading Account.

a direct expense and should not be recorded in Trading Account; rather, it is recorded in the Profit and Loss Account.

the factory, godown, shop, or workplace.

nother within the same city. These expenses are recorded on the debit side of the Trading Account.

ot be recorded in the Trading Account; instead, it is recorded in the Profit and Loss Account.

ed from abroad. Given that these expenses are connected with the purchase of goods, they are recorded on the debit side of the Trading A

transit of goods purchased.

d direct and are recorded on the debit side of the Trading Account.

of the product and is treated as a direct expense. For example, ink cannot be sold without a bottle or sachet.

king that are not direct expenses (e.g., safety-promoting packing such as carton packing for medicine) are debited to the Profit and Loss A

aid in connection with the goods purchased are considered direct expenses and are debited to the Trading Account.

e of purchased goods are treated as direct expenses and recorded on the debit side of the Trading Account.

nt names (e.g., import duty, customs duty, and excise duty). #

ed to the Trading Account.

ory. When bought goods are brought from the jurisdiction of one municipal corporation to another, then this type of tax is paid.

the goods, as well as other tasks.

penses and debited to the Trading Account.

ufacturing process. These are also known as  productive wages, manufacturing wages, and factory wages.

y Rates, and Factory Lighting and Heating

rance, and factory lighting and heating, are called manufacturing expenses.

expenses and are debited to the Trading Account.

nes used for production. They are considered direct expenses because they are directly related to the production of goods, and they are d

should be debited to the Profit and Loss Account.

ep machinery in proper working condition.

e consumed is treated as a direct expense and debited to the Trading Account.

cation of lubricants, soap, and candles. Similarly, oilseeds are used in the production of edible oils and Banaspati Ghee.

d direct expenses and are debited to the Trading Account.

r pays a royalty to receive the rights to produce certain articles that belong to others.

s in a particular area. As another example, manufacturers pay royalties to  patent-holders to use their intellectual property.

en the royalty is considered a direct expense and debited to the Trading Account.

f, however, nothing is specific in an exam question, then you should debit the royalty to the Trading Account.

aterials Or Goods To The Factory, Godown, Shop, Or Workplace

royalty to receive the rights to produce certain articles that belong to others.
 closing stock is sold in the current year.

oth cash and credit purchases.

on the debit side of the Trading Account.

down, shop, or workplace.

the debit side of the Trading Account.

ebited to the Profit and Loss Account.

s type of tax is paid.

uction of goods, and they are debited to the Trading Account.

spati Ghee.

ctual property.
Definition of Factory Overheads
Factory overheads are the aggregate of indirect materials, labor, and other costs that cannot be identified conveniently with t

The benefits arising from these costs cannot be associated with a specific cost unit. Instead, they are apportioned across the c

Overheads are an element of cost but they are a supplementary cost and cannot be directly added to a particular job.

Explanation
The main cost of a product consists of direct materials, direct labor, and direct expenses.

Besides these expenses, there are certain indirect expenditures that cannot be conveniently identified with the article produc

The factory overhead is the total of all costs (other than direct costs) incurred to maintain and run the production facility or fa

Examples of Factory Overheads

Examples of items included in factory overheads include:

Factory expenses (e.g., rent, rates, insurance, water, heat, and electricity)
Factory maintenance (e.g., cleaning, servicing, repairs, oiling, and greasing)
Depreciation of factory plant and machinery and buildings
Wages and salaries (other than direct labor) of persons engaged in the factory (e.g., foremen, supervisors, maintenance staff
Consumable stores and all forms of indirect material (i.e., material that cannot be traced as part of the finished product, suc

Steps Needed for Proper Accounting of Factory Overheads

Since overheads cannot be allocated to cost units directly, the following steps are necessary for its proper accounting:

Allocation of expenses to production

Allocation of expenses to service departments
Appropriation of expenses to the production unit(s) and service departments that cannot be conveniently allocated
Re-appropriation of expenses related to service departments so as to include them in the production cost
Absorption of expenses of each department over the job, process, or product completed during the period in the departmen

Problems With Factory Overheads

Several problems associated with factory overheads are stated as follows:

Factory overheads cannot be conveniently allocated to cost units, which gives rise to the apportioning problem
It is not possible to decide whether a cost incurred is beneficial or detrimental
It is not possible to know whether a certain overhead can help in achieving better value for money, which is because the ben
 It is not possible to reduce or eliminate such a cost that has been incurred; an extension is undertaken and the step cannot e
Factory overheads have a tendency to grow with increasing business complexity

Expenses Usually Included in Factory Overheads

Wages of indirect workers (e.g., repairmen, labor used on cleaning shop floor, men employed in moving work-in-progress an
Salaries and allowances for work manager and supervisory staff
Workers welfare, canteen expenses, medical charges, and compensation
Contribution to social security schemes, educational schemes, and old-age pension contributions
Carriage inward on purchased materials
Indirect materials and materials of small value
Buying and store-keeping expenses
Normal losses of time and materials
Factory rent and rates, property tax, and so on
Power, oil, and gas expenses
Factory lighting
Insurance of factory premises, plant, and machinery
Depreciation
Stationery, telephone, and clerical salaries.
Repair and maintenance expenses
Time-keeping expenses
Factory transport expenses
Expenses of service departments (e.g., boiler room, electricity supply, water supply, inspections, and tool room)
Other miscellaneous expenses related to production shops not listed above

Classification of Factory Overheads

Factory overheads may be classified based on the following:

By Nature

Indirect materials
Indirect labor
Indirect expenses

By Normality

Normal factory overheads

Abnormal factory overheads

By Controllability

Controllable
 Uncontrollable

By Variability

Fixed
Variable
Semi-variable

List of Possible Expenditures Treated as Factory Overheads

Under normal circumstances, the following expenditures are included in and treated as factory overheads:

Indirect Materials

Cost of consumable stores

Cost of stationery used in the factory

Indirect Labor

Salary paid to the factory manager

Salary paid to other officers of the company who are involved in some form of manufacturing
Proportionate salary of the director(s) devoting time to factory problems
Holiday pay for workers
Paid sickness leave for workers
Storekeeper salary and salaries of other staff in the stores department
Contribution to provident fund of the factory employees
Contribution to social welfare activities
Expenditures, other than contributions, to social and other welfare activities
Contribution to social security scheme (e.g., premiums for group insurance, state insurance corporation, and so on)
Overtime wages
Wages for normal idle time (if not charged directly)

Indirect Expenses

Rent of factory land and buildings

Insurance of factory buildings, plant and machinery, stock of raw materials, and so on
Municipal taxes and rates
Expenses of canteen, educational facilities, and recreation clubs
Experimental and research expenditure
Design expenditure
Power and fuel
Stores handling expenditure
Factory lighting and heating charges
Carriage inward
 Factory telephone expenditures

Other Chargeable Items

Depreciation on plant and machinery

Expenses on removal and erection of machinery
Provision for obsolescence
Cost of defective work
Interest on capital
Development costs
Royalties and patent fees
Maintenance and repairs
Annual bonuses
Benefits (e.g., prizes)
Training expenses
Township maintenance costs

Frequently Asked Questions

What Are Factory Overheads?

Factory overheads are the aggregate of indirect materials, labor, and other costs that cannot be identified conveniently with t

What Are The Main Costs Of A Product?

It consists of direct materials, direct labor, and direct expenses.

What Are The Examples Of Factory Overheads?

It includes factory expenses and maintenance, depreciation of factory plant and machinery and buildings, wages and salaries c

What Are The Classifications Of Factory Overheads?

By nature, normality, controllability and variability

What Are The Possible Expenditures Treated As Factory Overheads?

These are indirect materials, indirect labor, indirect expenses and other chargeable items.

Related Posts

Methods of Factory Overhead Absorption

Classification of Cost
Elements and Components of Cost
Overhead Absorption
Cost
 identified conveniently with the articles produced or services rendered.

y are apportioned across the cost units on an equitable basis.

ed to a particular job.

ntified with the article produced. These expenditures cannot be allocated to a particular job, process, or item of production. Such expendi

un the production facility or factory. These are also referred to as production overheads or works overheads.

supervisors, maintenance staff, factory administrative or clerical staff, testers, and examiners)
rt of the finished product, such as oils and greases, small tools,  cleaning materials, and minor spare parts for repairs)

its proper accounting:

onveniently allocated

g the period in the department concerned

rtioning problem

ney, which is because the benefits achieved cannot be measured easily

ertaken and the step cannot easily be re-traced

n moving work-in-progress and financial goods)

s, and tool room)

rporation, and so on)
identified conveniently with the articles produced or services rendered.

buildings, wages and salaries consumable stores and all forms of an indirect material.
m of production. Such expenditures are known as  factory overheads.
Cost: Definition
Cost is the sacrifice made that is usually measured by the resources given up to achieve a particular purpose. It is a sacrifice m

Costs are not always expenses

Some costs are assets, others are expenses
Expenses are expired (used up) costs

Eventually, costs will become expenses.

Cost: Explanation
Cost measurement and allocation are significant aspects of financial and management accounting. Cost measurement and allo

In accounting, the term cost has a variety of meanings. Furthermore, various cost concepts and measurement techniques are

The purpose of this article is to analyze the cost classifications and behavior patterns that are widely used in management acc

Types of Cost
Cost can be defined as the amount (measured in terms of money) paid for goods and services received (or to be received).

Accountants and managers use many different concepts of cost, each usually for a different purpose. It is the classification of c

Important types of costs are explained below.

Product Cost

Product costs are assigned to goods either purchased or manufactured for resale; they are incurred to produce or purchase a

Inventoriable Cost

Inventoriable cost is another name for product cost. It is stored as the cost of inventory until the goods are sold. Inventoriable

Period Cost

Period costs are expensed during the time period in which they are incurred. They are costs that are treated as expenses of th

Expense

An expense refers to the consumption of assets for the purpose of generating revenue.

Direct Cost

A direct cost is a cost that can be traced to specific segments of operations.

Indirect Cost

An indirect cost is a cost that cannot be identified with specific segments of operations. Common costs are shared by multiple

Example
Segments = Plastic chairs (P) & Wood chairs (W)

Manufacturing Cost

Product costs consist of:

Direct material (DM)

Direct labor (DL)
Manufacturing overhead (MOH, OH)

The formula for manufacturing cost is the following:

Manufacturing costs = DM + DL + MOH

Direct material (DM): Raw materials that are physically incorporated into the finished product.
Direct labor cost: The cost of salaries, wages, and fringe benefits for personnel who work directly on the manufactured produ
Manufacturing overhead: Manufacturing costs other than direct material and direct labor costs.

Indirect material
These are required for the production process but do not become an integral part of the finished product.

Indirect labor
Indirect labor refers to the cost of personnel who do not work directly on the product, but whose services are necessary for

Conversion Cost
Conversion costs are direct labor costs plus manufacturing overhead costs.

Prime Cost

These are the costs of direct material and direct labor.

Non-manufacturing Cost

Period costs (expenses) incurred in and due to administrative activities.

Variable Cost

A variable cost changes in direct proportion to a change in the level of activity.

Fixed Cost

These costs do not change in total as activity changes.

Marginal Cost

Marginal costs are additional costs incurred in producing extra units.

Incremental Cost

These types of costs are the difference between costs for the corresponding items under each alternative being considered. Fo

Difference Between Marginal and Incremental Cost

The main difference is that marginal cost represents the additional cost of one extra unit of output, whereas incremental cost

Sunk Cost

These costs are created decisions made in the past that cannot be changed by any decision that will be made in the future. Wr

Opportunity Cost

This cost refers to the opportunity that is lost or sacrificed when the choice of one course of action requires that an alternative

If no alternative use of resources exists, then the opportunity cost is zero.

Cost of Goods Sold

This is the expense measured by the cost of the finished goods sold during a specific period.
Work in Process

Partially completed products that are not yet ready for sale.

Finished Goods

Completed goods available for sale.

Elements of Cost
The elements of cost are categorized under:

Material
Labor
Factory overhead

1. Materials

These are the principal substances used in production.

Materials are transformed into finished goods through the addition of labor and factory overhead. The cost of materials may b

(a) Direct Materials

Direct materials are those that can be identified in the product, which can be conveniently measured and directly charged to t

Direct materials can be identified with the product, easily traced, and represent a major material cost associated with produci

(b) Indirect Materials

All materials involved in the production of a product that are not direct materials are indirect materials.

For example, nails and glue used in the manufacturing of a table are examples of indirect materials. In other words, indirect m

2. Labor

Labor is the physical or mental effort expended in the production of a product. Labor costs may be divided into direct and indi

(a) Direct Labor

Direct labor is all labor directly involved in producing a finished product; that can be easily traced to the product; and that rep

(b) Indirect Labor

All labor involved in producing a product that is not considered direct labor is classed as indirect labor. For example, the work
3. Factory Overhead

Factory overhead refers to all costs other than direct materials and the direct labor required to produce a product. This follow

Indirect materials and indirect labor are also included in factory overhead. This is because they can not be identified with a spe

Other examples of factory overhead costs, aside from indirect materials and indirect labor, include rent, utility bills, and  depre

Factory overhead costs can be further classified as fixed, variable, and semi-variable costs.
By grouping the above elements of cost, the following equations showing the relationships between costs are obtained:

1. Prime cost = Direct material + Direct labor

2. Conversion cost = Direct labor + Factory overhead
3. Factory cost = Direct materials + Direct labor + Factory overhead

Frequently Asked Questions

What Is A Cost?

Cost is the sacrifice made that is usually measured by the resources given up to achieve a particular purpose. It is a sacrifice m

What Are The Types Of Cost?

Cost can be defined as the amount paid for goods and services received. Important types of costs includes:- product cost- inve

What Is The Difference Between A Marginal And A Incremental Cost?

The main difference is that marginal cost represents the additional cost of one extra unit of output, whereas incremental cost

What Are The Elements Of A Cost?

The elements of cost are categorized under:- material (the principal substances used in production)- labor (the physical or men

What Are The Equations Under The Elements Of A Cost That Shows The Relationships Betw

By grouping the above elements of cost, the following equations showing the relationships between costs are obtained:1. Prim

Related Posts

Methods of Factory Overhead Absorption

Classification of Cost
ular purpose. It is a sacrifice made in order to obtain some goods or services.

ng. Cost measurement and allocation techniques are used not only to assign incurred costs to products or services but also to plan future a

measurement techniques are needed for internal planning and  control.

dely used in management accounting. Such an analysis will help management accountants when supplying information for planning and d

ceived (or to be received).

pose. It is the classification of cost that indicates to managers how the term is being used and whether they can do anything about the cos

red to produce or purchase a product. Product costs are initially identified as part of the inventory on hand (i.e., moving from raw materia

goods are sold. Inventoriable costs become expenses (cost of goods sold) when the product is sold.

are treated as expenses of the period in which the costs are incurred.
n costs are shared by multiple segments.

y on the manufactured products.

ed product.

ose services are necessary for the manufacturing process.

ternative being considered. For example, incremental cost increasing output from $1 000 to $1 100 units per week is the additional cost o

ut, whereas incremental cost represents the additional cost resulting from a group of additional units of output.

will be made in the future. Written down values of any asset previously purchased are an example of sunk costs.

on requires that an alternative course of action be given up. Notably, opportunity cost only applies to resources that have some alternativ
d. The cost of materials may be divided into direct and indirect materials as follows:

ured and directly charged to the product.

l cost associated with producing the product. Examples of direct materials include wood in furniture, iron in fans, clay in bricks, leather in

als. In other words, indirect materials cannot be directly identified.

be divided into direct and indirect labor as follows:

d to the product; and that represents a major labor cost of producing the product. The work of machine operators in a manufacturing conc

labor. For example, the work of a plant supervisor in a manufacturing concern would be considered indirect labor.
produce a product. This follows from the fact that the cost of any product equals the cost of direct materials, direct labor, and factory over

an not be identified with a specific product.

de rent, utility bills, and  depreciation of factory equipment.

een costs are obtained:

ular purpose. It is a sacrifice made in order to obtain some goods or services.

s includes:- product cost- inventoriable cost - period cost - expense cost - direct cost - indirect cost - manufacturing cost - conversion cost

ut, whereas incremental cost represents the additional cost resulting from a group of additional units of output.

on)- labor (the physical or mental effort expended in the production of a product)- factory overhead (refers to all costs other than direct m

he Relationships Between Costs Obtained?

een costs are obtained:1. Prime cost = direct material + direct labor2. Conversion cost = direct labor + factory overhead3. Factory cost = d
rvices but also to plan future activities.

nformation for planning and decision-making purposes.

can do anything about the cost or not.

i.e., moving from raw materials to work-in-process to finished goods).

r week is the additional cost of producing an extra 100 units per week.

rces that have some alternative uses.

fans, clay in bricks, leather in shoes, and wheat in flour.

rators in a manufacturing concern would be considered direct labor.

 direct labor, and factory overhead.

cturing cost - conversion cost - prime cost - non-manufacturing cost- variable cost - fixed cost - marginal cost - incremental cost - sunk cos

to all costs other than direct materials and the direct labor required to produce a product)

y overhead3. Factory cost = direct materials + direct labor + factory overhead

t - incremental cost - sunk cost - opportunity cost - work in process - finished goods
There is no standard definition for the terms debit and credit.

Historically, the word “debit” derives from the Latin word debere, which means “to owe.” In accounting, this has been shorten

Similarly, the word “credit” has its historical roots in the Latin word credere, meaning “to believe.” In accounting, this is often

In spite of all the discussion surrounding these terms, we can also say that they are the fundamental operators of  accounting,

Debit and credit represent two sides (columns) of an account (i.e., a Debit column and a Credit column). Debit (Dr.) involves m

Today, accountants adopt practices like the use of these columns to keep records that are used on a long-term basis. They are

Rules of Debit and Credit

Debit and credit are financial transactions that increase or decrease the values of various individual accounts in the ledger. Th

Rules for Asset Accounts

Assets are recorded on the debit side of the account. Any increase to an asset is recorded on the debit side and any decrease i

For example, the amount of cash in hand on the first day of the accounting period is recorded on the debit side of the cash in

Whenever an amount of cash is paid out, an entry is made on the credit side of the cash in hand account.

Rules for Liability Accounts

Liabilities are recorded on the credit side of the liability accounts. Any increase in liability is recorded on the credit side and an

For example, the amount payable to United Traders on the first day of the accounting period is recorded on the credit side of

If more goods are bought from United Traders (thereby incurring an additional liability to United Traders), an entry would be m

If an amount is paid to United Traders (thereby reducing the liability to United Traders), an entry is made on the debit side of U

Rules for Capital Accounts

Capital is recorded on the credit side of an account. Any increase is also recorded on the credit side. Any decrease is recorded

For example, the amount of capital of Mr. John on the first day of the accounting period will be shown on the credit side of Joh

If he introduces any additional capital, an entry will be made on the credit side of his capital account. If he takes any money or

Notice that the rules of debit and credit for asset accounts are exactly the opposite of the rules of debit and credit for liability
Rules for Expense Accounts
An expense is a loss and therefore results in a reduction in capital. Since a reduction in capital is recorded on the debit side of

Hence, when salaries is paid to workers, we make an entry on the debit side of the salaries account. Usually, but not always, n

Rules for Income or Revenue Accounts

An income or revenue results in an increase in capital. Since increases in capital are recorded on the credit side of the capital a

Hence, when receiving funds from any business activity, we make an entry on the credit side of the relevant income or revenu

Summary
We can now summarize the rules of debit and credit for various ledger accounts as follows:

Example
Mr. John made the following transactions during January 2016:

January 04: Received cash $1,350 from Sam (a debtor)

January 10: Bought a new delivery van for $6,000 from Deluxe Motors Inc. on credit
January 15: Paid cash $1,520 to United Traders (a creditor)
January 21: Mr. John introduced an additional capital of $1,400

Required: How would the rules of debit and credit be applied to record the above transactions in ledger accounts?

Solution

Receipt of cash from Mr. Sam, a debtor

1. An increase in cash (an asset); must be recorded on the debit side of the cash account
2. A decrease in the amount due from Mr. Sam (an asset); must be recorded on the credit side of Mr. Sam’s account
Purchase of new delivery van from Deluxe Motors Inc.

1. An increase in delivery van (an asset); must be recorded on the debit side of the delivery van account
2. An increase in the amount payable to Deluxe Motors (a liability); must be recorded on the credit side of the Deluxe Motor

Payment of cash to United Traders

1. A decrease in the amount payable to United Traders (a liability); must be recorded on the credit side of the United Traders
2. A decrease in cash (an asset); must be recorded on the credit side of the cash account

Cash taken by John for his personal use

1. An increase in John’s capital; must be recorded on the credit side of John’s capital account
2. An increase in cash (an asset); must be recorded on the debit side of the cash account

Learn the Basics

Mastering the rules of debit and credit is foundational to every accounting process. Finance Strategists connects you to a trust

Frequently Asked Questions

What Is The Formula For Calculating Debit And Credit Balance Of An Account?

Debit balance = assets - liabilities + capital credit balance = capital - liabilities + assets

Does The Debit Side Of Any Account Always Increase When There Is An Entry On The Credi

No. The debit and credit sides of accounts can both go up or down depending on the nature of transactions recorded in such a

Can A Company Make An Entry On Its Cash Account?

Yes, but only if it would result in a debit balance.

What Are The Two Types Of Accounts Into Which Transactions Are Recorded?

Revenue/income accounts and capital accounts are classified as income or revenue account , while proprietorship, Partnership

How Does The Formula For Debit Balance Change In Revenue/Income Accounts?

The formula for debit balance in revenue or income accounts is assets - liabilities + capital. This indicates that if revenue accou

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Single Entry System in Accounting
ounting, this has been shortened to “Dr.”

e.” In accounting, this is often abbreviated as “Cr.”

ntal operators of  accounting, which underpin the subject.

olumn). Debit (Dr.) involves making an entry on the left side and Credit (Cr.) involves making an entry on the right side.

on a long-term basis. They are also useful for the management in promoting effective decision-making.

dual accounts in the ledger. The following rules of debit and credit are applied to record these increases or decreases in individual ledger

e debit side and any decrease is recorded on the credit side of its account.

n the debit side of the cash in hand account. Whenever an amount of cash is received, an entry is made on the debit side of the cash in ha

rded on the credit side and any decrease is recorded on the debit side of a liability account.

ecorded on the credit side of the United Traders Account.

d Traders), an entry would be made on the credit side of United Traders Account.

y is made on the debit side of United Traders Account.

ide. Any decrease is recorded on the debit side of the respective capital account.

shown on the credit side of John’s Capital Account.

ount. If he takes any money or goods from the  business for his personal use, that will reduce his capital and therefore an entry will be mad

of debit and credit for liability and capital accounts.

recorded on the debit side of an account, all expenses are also recorded on the debit side of the relevant account.

unt. Usually, but not always, no entries are made on the credit side of the accounts kept for expenses.

the credit side of the capital account, all  incomes are also recorded on the credit side of the relevant account.

the relevant income or revenue account. Usually, but not always, there will be no entries made on the debit side of the accounts kept for i

n ledger accounts?

of Mr. Sam’s account

redit side of the Deluxe Motors account

edit side of the United Traders account

tegists connects you to a trusted  financial advisor in New Orleans, LA for all the help you may need. For a list of other areas we cover, see

Account?

An Entry On The Credit Side?

ransactions recorded in such accounts.

ecorded?

hile proprietorship, Partnership , trusts, unincorporated organizations etc. Are capitalized, so they fall under the capital account category.

e Accounts?

ndicates that if revenue account has a credit balance, the amount of credit will be added to capital. Therefore, if there is any increase it w
decreases in individual ledger accounts.

he debit side of the cash in hand account.

therefore an entry will be made on the debit side of his account.

side of the accounts kept for income and  revenue.
st of other areas we cover, see our financial advisor page.

the capital account category.

re, if there is any increase it will lead to an increase in capital.

What Is Meant by Closing Stock?
For trading businesses, closing stock consists of different types of finished goods. For manufacturing businesses, closing stock

The unsold closing stock of the current year is the opening stock of the next year. Given that the current year’s unsold closing

For this reason, any closing stock is entered on the credit side of the trading account.

Application of Convention of Conservatism

The convention of conservatism states that whenever closing stock and other current assets (e.g., short-term investments in m

As such, the convention lays down a rule: “Don’t expect to make a profit, but expect that you will make possible losses.”

Example 1
At the end of 2019, suppose that closing stock appears in the books at a cost price of $25,000, but the market price at that tim

Therefore, anticipated profit will not be considered and closing stock will be recorded at the cost price of $25,000, which is low

Example 2
Suppose that closing stock appears in the books at a cost price of $25,000 at the end of 2019, but its market price at that time

Although this loss will occur in the next year when the stock will be sold, it is a “possible loss.” Therefore, it should be recorde

This is consistent with what the convention of conservatism requires in terms of providing for all possible losses rather than as

Reason for Recording Closing Stock on Credit Side of Trading Account: Appli
To calculate gross profit or gross loss, direct expenses are matched with direct revenues. All direct expenses are recorded on

Closing stock is also recorded on the credit side of the trading account, which is the revenue side. Is closing stock revenue? No

The cost of opening stock and purchases is charged as an expense to the trading account by recording them on the debit side

Expenses of a certain number of units should be matched against the revenue generated by the sale of the same number of un

Therefore, their cost is deducted by recording them on the credit side. The following example will demonstrate the concept eff

Example 3
Suppose that 100 units of goods were purchased at $50 per unit. The total purchase of $5,000 (100 x 50) will be shown on the

Now suppose that all of the units have been sold at $80 per unit. These sales of $8,000 (100 x 80) will be recorded on the cred

The gross profit is $3,000 (8,000 – 5,000). Here, we are matching the expense (purchase price) of 100 units with the revenue (

Example 4
In Example 3, suppose that only 80 units are sold at $80 per unit. The resulting sales of $6,400 (80 x 80) will be recorded on th

If the closing stock of 20 units is not recorded on the credit side of the trading account, the gross profit will be $1,400 (6,400 –

This gross profit is not accurate because, in this case, we are matching the expense (purchase price) of 100 units with the reve

According to the matching concept, the only expenses that are matched against the revenue are those that are incurred to pr

In this regard, the expense (purchase price) of 80 units only should be matched against the revenue (sales price) of 80 units. H

Here, we are matching the expense (purchase price) of 80 units against the revenue (sales price) of 80 units, which is logical. T

Frequently Asked Questions

What Is Meant By Closing Stock?

Closing stock is the number of goods that remain unsold when a business closes down at the end of its financial year.

What Is The Treatment Of Closing Stock?

The unsold closing stock of the current year is the opening stock of the next year. Given that the current year’s unsold closing

What Is The Conservatism Principle?

The convention of conservatism states that whenever closing stock and other current assets are recorded, they should be reco

How Is The Conservatism Principle Applied When Valuing Closing Stock?

The convention lays down a rule: “don’t expect to make a profit, but expect that you will make possible losses.” At the end of

What Does Closing Stock Represent In Terms Of Revenue?

Closing stock represents sales made in an earlier accounting period (such as in the current month, quarter, or year). For examp

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Marginal Costing: Practical Questions and Solutions
Trading Account
Ledger Accounts
Rules of Debit and Credit
uring businesses, closing stock consists of raw materials, work-in-progress, and finished goods.

current year’s unsold closing stock will be sold in the next year, its cost is not an expense of the current year; instead, it is an  expense of t

g., short-term investments in marketable securities) are recorded, they should be recorded at cost price or net realizable value (market va

ll make possible losses.”

ut the market price at that time is $30,000. The excess amount, $5,000, is profit based on the expectation that it will be earned when the s

t price of $25,000, which is lower than the market price or net realizable value. As the convention says, don’t expect to make a profit.

ut its market price at that time is $22,000. When the stock is actually sold in the next year, there will be a loss of $3,000 (25,000 — 22,000)

herefore, it should be recorded in the current year and the closing stock will be recorded at the market price of $22,000 (which is lower th

possible losses rather than assuming profits will be made.

ing Account: Application of the Matching Concept

ect expenses are recorded on the debit side of the trading account, while direct revenues are recorded on the credit side.

e. Is closing stock revenue? No! Closing stock is not revenue. It is recorded on the credit side of the trading account only due to the applica

ording them on the debit side of the trading account. Revenue generated by selling them is matched against them by recording  sales on th

sale of the same number of units. If, however, there are some unsold units, their cost must not be charged to the trading account.

ill demonstrate the concept effectively.

100 x 50) will be shown on the debit side of the trading account.

0) will be recorded on the credit side of the trading account.

f 100 units with the revenue (sales price) of 100 units, which is quite logical.

80 x 80) will be recorded on the  credit side of the trading account.

s profit will be $1,400 (6,400 – 5,000).

ice) of 100 units with the revenue (sales price) of 80 units.

e those that are incurred to produce such revenue.

nue (sales price) of 80 units. Hence, the expense of 20 unsold units will be recorded on the credit side of the trading account to reduce the

of 80 units, which is logical. The true gross profit on sale of 80 units will be $2,400 (6,400 + 1,000 – 5,000).

d of its financial year.

current year’s unsold closing stock will be sold in the next year, its cost is not an expense of the current year; instead, it is an expense of t

recorded, they should be recorded at cost price or net realizable value, whichever is less.

possible losses.” At the end of 2019, suppose that closing stock appears in the books at a cost price of $25,000, but the market price at tha

h, quarter, or year). For example, if goods are sold during may but not all of them are sold until june, these goods should still be recorded a
r; instead, it is an  expense of the next year (when it will be sold).

et realizable value (market value), whichever is less.

at it will be earned when the stock is sold in the next year.

t expect to make a profit.

s of $3,000 (25,000 — 22,000).

of $22,000 (which is lower than the cost price).

he credit side.

ccount only due to the application of  the matching concept.

them by recording  sales on the credit side of trading account.

o the trading account.

trading account to reduce the expense of 20 unsold units.

r; instead, it is an expense of the next year (when it will be sold). For this reason, any closing stock is entered on the credit side of the Trad

0, but the market price at that time is $30,000. The excess amount, $5,000, is profit based on the expectation that it will be earned when

oods should still be recorded as revenue of may. However, if the business closes down at the end of may and some unsold goods remain i
on the credit side of the Trading Account.

n that it will be earned when the stock is sold in the next year. Therefore, anticipated profit will not be considered and closing stock will b

d some unsold goods remain in the warehouse or showroom, they will be included as closing stock and not revenue for june.
idered and closing stock will be recorded at the cost price of $25,000, which is lower than the market price or net realizable value. As the c

evenue for june.

r net realizable value. As the convention says, don’t expect to make a profit.
 PNB- Near SBI SBI Sayaji
Keep with you SBI NRE ICICI Bank
NEOMI MUJMAHUDA Gunj

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Corporation/ BANK OF
BOB AKOTA BOB OP ROAD
UNION bank INDIA

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1660
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