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NATURE AND SCOPE OF COST ACCOUNTING INTRODUCTION Cost Accounting is a branch of accounting and has been developed due

to limitations of financial accounting.

LIMITATIONS OF FINANCIAL ACCOUNTING The Following limitations of financial accounting have led to the development of cost accounting: 1. No clear idea of operating efficiency 2. Weakness not spotted out by collective results 3. Not helpful in the price fixation 4. No classification of expenses and accounts 5. No data for comparison and decision making. 6. No control on cost 7. No standards to assess the performance 8. Provides only historical information 9. No analysis of losses 10. 11. Inadequate information for reports No answer for certain questions.

Meaning of Cost Accounting and Cost Accountancy Cost Accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or services, and for the presentation of suitably arranged data for purposes of control and guidance of management. It includes the ascertainment of the cost of every

order, job, contract, process, service or unit as may be appropriate. It deals with the cost of production, selling and distribution. It is thus the provision of such analysis and classification of expenditure as will enable the total cost of any particular unit of production or service to be ascertained with reasonable degree of accuracy and at the same time to disclose exactly how such total cost is constituted (i.e. the value of material used, the amount of labour and other expenses incurred) so as to control and reduce its cost. Cost accountancy is the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost and the ascertainment of profitability. It includes the presentation of information derived therefrom for purposes of managerial decision making.

Meaning of Management Accounting Management Accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and the day to day operation of an undertaking. Thus, it relates to the use of accounting data collected with the help of financial accounting and cost accounting for the purpose of policy formulation, planning, control and decision making by management. Some leading definitions of Management Accounting are given below: Management Accounting is concerned information that is useful to management - R.N.Anthony with accounting

Cost Accounting vs. Management Accounting Cost Accounting and management accounting both have the same objectives of helping management in planning, control and decision making. Both are internal to the organization and use

common tools and techniques like standard costing, variable costing, budgetary control etc. inspite of these similarities there are certain differences between these two.

The Main distinctions between cost accounting and management accounting are given below: Point of Distinctio n 1. Deals with Cost Accounting Management Accounting

It deals with It deals with the effect ascertainment, and impact of costs on allocation, the business apportionment and accounting aspect of costs. It provides a base for It is derived from both management cost accounting and accounting financial accounting. It is helpful in It has greater degree collecting costing data of relevance and for management objectivity as management accountant has a clear idea of the types of costs and items requiring analysis and states the specific problems of business. The status of cost accountant comes after management accountant Management Accountant is senior in position to cost accountant.

2. Base

3. Role

4. Status

5. Outlook

Cost accountant has a Management narrow approach. He Accountant reports the

has to refer to effect of cost on the economic and business along with statistical data for cost analysis. analyzing cost effects. 6. Tools & It has standard Techniq costing, variable ues costing, break even analysis etc. as the basic tools and techniques. Alongwith these, management accountant has funds and cash flow statements, ratio analysis etc. as his accounting tools and techniques. It includes financial and cost accounting, tax planning and tax accounting.

7. Scope

It does not include financial accounting, tax planning and tax accounting.

8. Installati on

It can be installed It needs financial and without management cost accounting as its accounting base for its installation.

Scope of Cost Accountancy It deals with the collection and analysis of expenses, the measurement of production of the different products at the different stages of manufacture and the linking up of production with the expenses. In fact, the varying procedures for the collection of expenses give rise to the different systems of costing as Historical or Actual Costs, Estimated Costs, Standard Costs etc. Again the varying procedures for the measurement of production have resulted in different methods of costing such as Specific Order Costing, Operation Costing etc. For linking up of production with the expenses the different techniques of costing such as Marginal Cost Technique, the Total Cost Technique, Direct Cost Technique etc have been evolved. All the three i.e. systems, methods, and techniques can be used in one concern simultaneously.

It is the process of accounting for cost which begins with recording of expenditure and ends with the preparation of statistical data. It is formal mechanism by means of which costs of products or services are ascertained and controlled. Cost can be ascertained either by following the historical or predetermined system of costing. Cost can be predetermined either by standard costing or estimated costing. If the cost and financial accounts are kept separately then their reconciliation is also to be done in order to verify the accuracy of both sets of accounts. Cost Control is the guidance and regulation by executive action of the costs of operating and undertaking. It aims at guiding the actual towards the line of targets; regulates the actual if they deviate or vary from the targets; this guidance and regulation is done by an executive action. The cost can be controlled by standard costing, budgetary control, proper presentation and reporting of cost data and cost audit.

Costing An Aid to Management Planning, Decision Making and control are three important functions of management. Planning Decision Making Controlling a) Classification and Sub-divisions of Costs b) Control Of Materials, Labour and Overhead Costs. c) Business Policies d) Budgeting

e) Standards for Measuring Efficiency f) Best Use of Limited Resources. g) Instrument of Management Control h) Cost Audit i) Special Factors. j) Price Determination. k) Expansion.

GENERAL PRINCIPLES OF COST ACCOUNTING The following are the main principles of Cost Accounting
1. Cause-effect

Relationship: Cause-effect Relationship should be established for each item of cost. Each item of cost should be related to its cause as minutely as possible and the effect of the same on the various departments should be ascertained. This cost should be shared only by those units which pass through the departments for which such cost has been incurred. should include only those costs which have been actually incurred. For example unit cost should not be charged with selling cost while it is still in factory.

2. Charge of Cost only after its incurrence: Unit cost

3. Cost Accounting should ignore the convention of

prudence: Cost accounting statements should give the factual picture of the profitability of the project. If some contingencies need to be made, it should be shown distinctly and separately.
4. Past Costs should not form part of future Costs: Past

Costs (which could not be recovered in past) should not be recovered from future costs as it will not only affect the true

results of future statements.

period

but

will

also

distort

other

5. Exclusion of Abnormal Costs from Cost Accounts: All

costs incurred because of abnormal reasons (like theft, negligence) should not be taken into consideration while computing the unit cost. If done so, it will distort the cost figures and mislead management resulting in wrong decisions.
6. Principle

of Double Entry should be followed Preferably: To lessen the chances of any mistake or error, cost ledgers and cost control accounts, as far as possible, should be maintained on double entry principles. This will ensure the correctness of cost sheets and cost statements which are prepared for cost ascertainment and cost control.

Cost Unit It is a device for the purpose of breaking up or separating cost into smaller sub-divisions attributable to products and services. It is the unit of product, service or time in relation to which costs may be ascertained. E.g. tone in case of coal. It must be clearly defined and selected before the process of cost finding can be started. It must not be too big or too small and must be so selected that expenditure can be associated with it an is appropriate to the needs of the business. For instance, in case of brick kiln, the unit should not be each brick but 1,000 bricks; normally, it is the same unit by which wholesale transactions are entered into. In case of industries rendering service, usually the unit is a compound of two measures since the single measure may be measure by meaningless. For example, in case of goods transport the unit will be tone-kmthe effort involved in carrying one tone of goods for a distance of one kilometer.

Methods of Costing

The methods to be used for the ascertainment of cost of production differ from industry to industry. It primarily depends on the manufacturing process and also on the methods of costing (as per CIMA Terminology) viz: (i) Specific Order Costing (ii) Job/ Terminal Costing) Specific Order Costing is the category of basic costing methods applicable where the work consists of separate jobs, batches or contracts each of which is authorized by a specific order or contract, job costing, batch costing and contract costing are included in this category. Operation Costing is the category of basic costing methods applicable where standardized goods or services result from a sequence of repetitive and more or less continuous operations or process to which costs are charged before being averaged over units produced during the period.

All these methods are discussed briefly as under:


1. Job Costing: Under this methods, costs are collected and

accumulated for each job, work order or project separately. Each job can be separately identified; so it becomes essential to analyse the cost according to each job. A job card is prepared for each job for cost accumulation. This method is applicable to printers, machine tool manufactures, foundries and general engineering workshops.
2. Contract Costing: When the job is big and spread over

long periods of time, the method of contract costing is used. A separate account is kept for each individual contract. This method is used by builders, civil engineering contractors, constructional and mechanical engineering firms etc.
3. Batch Costing: This is an extension of job costing. A batch

may represent a number of small orders passed through the factory in batch. Each batch is treated as a unit of cost and

separately costed. The cost per unit is determined by dividing the cost of the batch by the number of units produced in a batch. This method is mainly applied in biscuits manufacture, garments manufacture and spare parts and components manufacture.
4. Process Costing: This is suitable for industries where

production is continuous, manufacturing is carried on by distinct and well defined processes, the finished product of one process becomes the raw material of the subsequent process, different products with or without by products are produced simultaneously at the same process and products produced during a particular process are exactly identical. As finished products are obtained at the end of each process, it will be necessary to ascertain not only the cost of each process but also cost per unit at each process. A separate account is opened for each process to which all expenditure incurred thereon is charged. The cost per unit is obtained by averaging the expenditure incurred on the process during a certain period. Hence, this is known as average costing. As the products are manufactured in a continuous process, this is also known as continuous costing. Process costing is generally followed in Textile Industries, Chemical Industries, Tanneries, Paper Manufacture etc.
5. One Operation (Unit or Output) Costing: This is suitable

for industries, manufacture is continuous and units are identical. This method is applied in industries like mines, quarries, oil drilling, breweries, cement works, brick works etc. In all these industries there is natural or standard unit of cost. For example, a barrel of beer in breweries, a tone of coal in collieries, one thousand of bricks in brickworks etc. The object of this method is to ascertain the cost per unit of output and the cost of each item of such cost. Here cost accounts take the form of cost sheets prepared for a definite period. The cost per unit is determined by dividing

the total expenditure incurred during a given period by the number of units produced during that period.
6. Service (or Operating) Costing: This is suitable for

industries which render services as distinct from those which manufacture goods. This is applied in transport undertakings, power supply companies, municipal services, hospitals, hotels etc. This method is used to ascertain the cost of services rendered. There is usually a compound unit in such undertakings e.g., tone-kilometre (transport undertaking), kilowatt-hour (Power Supply) and patient day (hospitals). Types or Techniques of Costing Following are the main types of costing for ascertaining costs:
1. Uniform Costing: It is the use of same costing principles

and / or practices by several undertakings for common control or comparison of costs.


2. Marginal Costing: It is the ascertainment of marginal cost

by differentiating between fixed and variable cost. It is used to ascertain the effect of changes in volume or type of output on profit.
3. Standard Costing: A Comparison is made of the actual

cost with a pre-arranged standard and the cost of any deviation (called variance) is analysed by causes. This permits management to investigate the reasons for these variances and to take suitable corrective action.
4. Historical Costing: It is ascertainment of costs after they

have been incurred. It aims at ascertaining costs actually incurred on work done in the past. It has a limited utility, though comparisons of costs over different periods may yield good results.
5. Direct Costing: It is the practice of charging all direct

costs, variable and some fixed costs relating to operations,

processes of products leaving all other costs to be written off against profits in which they arise.
6. Absorption Costing: It is the practice of charging all costs,

both variable and fixed to operations, processes or products. This differs from marginal costing where fixed costs are excluded.

Costs Analysis, Concepts and Classifications Elements of Cost Mere knowledge of total cost cannot satisfy the needs of management. For proper control and managerial decisions, management is to be provided with necessary data to analyse and classify costs. For this purpose the total cost is analysed by elements of cost i.e., by the nature of expenses. Strictly speaking, the elements of cost are three i.e., materials, labour and other expenses. These elements of cost are further analysed into different elements as illustrated in the following chart:

By grouping the above elements of cost, the following divisions of cost are obtained: 1. Prime Cost = Direct Materials + Direct Labour 2. Works or Factory cost = Prime Cost + Works of Factory Overheads 3. Costs of Production = Works Cost + Administration Overheads 4. Total Cost or Cost of Sales= Cost of Production + Selling and Distribution Overheads. The difference between the cost of sales and selling price represents profit or loss. COST SHEET OR STATEMENT OF COST Cost Sheet is a statement designed to show the output of a particular accounting period alongwith break-up of costs. The date incorporated in cost sheet are collected from various statements of accounts which have been written in cost accounts, either day to day or regular records. There is no fixed form for preparation of a cost sheet but in order to make the cost sheet useful it is generally presented in columnar form. The columns are for the total cost of the current period, per unit for the current period, total cost and per unit cost for a proceeding period and total and per unit cost for the budget period and so on. The information to be incorporated in a cost sheet would depend upon the requirement of management for the purpose of control. The main advantages of a cost sheet are: (1) It discloses the total cost and the cost per unit of the units produced during the given period. (2) It enables a manufacturer to keep a close watch and control over the cost of production.

(3) By providing a comparative study of the various elements of current cost with the past results and standard costs, it is possible to find out the causes of variations in costs and to eliminate the adverse factors and conditions which go to increase the total cost. (4) It acts as a guide to the manufacturer and helps him in formulating a definite useful production policy. (5) It helps in fixing up the selling price more accurately. (6) It helps the businessman to minimize the cost of production when there is a cut throat competition. (7) It helps the businessman to submit quotations with reasonable degree of accuracy against tenders for the supply of goods. Calculate Prime Cost, Factory Cost, Cost of Production, Cost of Sales and Profit from the following Particulars: Rs. Rs. Direct Materials 1,00,0 Depreciation: 00 Direct Wages 30,000 Factory Plant 500 Wages of Foreman 2,500 Office Premises 1,250 Electric Power 500 Consumable Stores 2,500 Lighting: Factory 1,500 Managers Salary 5,000 Office 500 Directors Fees 1,250 Storekeepers Wages 1,000 Office Stationary 500 Oil and Water 500 Telephone Charges 125 Rent : Factory 5,000 Postage and 250 Telegrams Office 2,500 Salesmens Salaries 1,250 Repairs & Renewals: Travelling Expenses 500 Factory Plant 3,500 Advertising 1,250 Office Premises 500 Warehouse Charges 500 Transfer to Reserves 1,000 Sales 1,89,5 00 Discount on shares 500 Carriage outward 375 written off Dividend 2,000 Income-Tax 10,000

The Following figures are extracted from the Trail Balance of Gogetter Co. on 30th September 2001. Rs. Debit Balances Opening Inventories Finished Stock Raw Materials Debit Balances Repairs & Upkeep-Factory 80,000 Heat, Light & Power 1,40,0 Rates and Taxes 00 Work in Progress 2,00,0 Miscellaneous Factory 00 Expenses Office Appliances 17,400 Sales Commission Plant & Machinery 4,60,0 Sales Travelling 00 Building 2,00,0 Sales Promotion 00 Sales Return & Rebates 14,000 Distribution Dept.Salaries&Expenses Materials Purchased 3,20,0 Office salaries & Expenses 00 Freight incurred on 16,000 Interest on Borrowed Funds Materials Direct Labour 1,60,0 Credit Balances 00 Indirect Labour 18,000 Sales Factory Supervisors 10,000 Purchase Returns Rs. 14,000 65,000 6,300 18,700 33,600 11,000 22,500 18,000 8,600 2,000

7,68,0 00 4,800

Further Details are available as follows: (i) Closing Inventories: Finished Goods 1,15,000 Raw Materials 1,80,000 Work-in-Progress 1,92,000 (ii)Accrued Expenses on: Direct Labour 8,000 Indirect Labour 1,200 Interest on Borrowed Funds 2,000 (iii) Depreciation to be provided on: Office Appliances 5% Plant and Machinery 10% Buildings 4% (iv) Distribution of the following Costs:

Heat, Light and Power to Factory, Office and Distribution in the ratio of 8:1:1. Rates & Taxes two-thirds to Factory and One-third to Office Depreciation on Buildings to Factory, Office and Selling in the ratio of 8:1:1. With the help of the above information, you are required to prepare: (i) A statement of cost showing various elements of costs and (ii)A statement of Profit. Cost Concepts Some Concepts which are used in cost accounting are discussed below: (a) Cost: Cost is defined as The amount of expenditure (actual or notional) incurred on or attributable to a given thing or to ascertain the cost of a given thing. The committee on Cost Terminology of the American Accounting Association has defined cost as The foregoing, in monetary terms, incurred or potentially to be incurred in the realization of the objective of management which may be manufacturing of a product or rendering of a service. Thus cost is that which is given or is sacrificed to obtain something. (b) Expenses: Expenses are costs which have been applied against revenue of particular accounting period in accordance with the principle of matching cost of revenue e.g., cost of goods-sold, office salaries of the period in which they are incurred. (c) Loss: It represents diminuation in ownership equity other than from withdrawal of capital for which no compensating value has been received e.g., destruction of property by fire. Thus the central idea of the cost concept is that of giving up, parting with or sacrificing something or value to acquire some other thing or value; expense refer to that portion of such sacrifices which are assigned to a particular accounting period. Loss denotes sacrifice for which there is no corresponding return whereas cost implies sacrifices for the sake of, and accompanied by, the securing of some other value. (d) Cost Centre: A Cost centre is the smallest segment of activity of area or responsibility for which costs are accumulated. Typically cost centres are departments but in

some instances, a department may contain several cost centres. These cost centres are the departments of subdepartments or an organization with reference to which cost is collected for cost ascertainment and cost control. For example, although an assembly department may be supervised by one foreman, it may contain several assembly lines. Sometimes each assembly line is regarded as a separate cost centre with its own assistant foreman. A cost centre can be a location i.e., an area such as department, storeyard or sales area or an item of equipment, e.g., lathe machine, delivery vehicle or a person, e.g., salesman, foreman. (e) Profit Centre: A Profit Centre is that segment of activity of a business which is responsible for both revenue and expenses and discloses the profit of a particular segment of activity. Profit centres are created to delegate responsibility to individuals and measure their performance. Profit centre is different from cost centre.

Cost Classification Cost Classification is the process of grouping costs according to their common characteristics. It is the placement of like items together according to their common characteristics. A suitable classification of costs is of vital importance in order to identify the cost with cost centres or cost units. 1. By Nature or Elements, or Analytical Classification: According to this classification, the costs are divided into three categories i.e., Materials, Labour, and Expenses. There can be further sub-classification of each element; for example, Material into raw material components, spare parts, consumable store, packing material etc. This classification is important as it helps to find out the total cost, how such total cost is constituted and valuation of work in progress. 2. By Function (i.e. Functional Classification): According to this classification costs are divided in the light of the different aspects of basic managerial activities involved in the operation of a business undertaking. It leads to grouping of costs according to the broad divisions or functions of a

business undertaking i.e., Production, Administration, Selling, and Distribution. 3. By Degree of Traceability to the Product (Direct & Indirect): According to this classification, total cost is divided into direct costs and indirect costs. Direct costs are those which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Materials used and labour employed in manufacturing an article or in a particular process of production are common examples of direct costs. Indirect costs are those costs which are incurred for the benefit of a number of cost centres or cost units and cannot be conveniently identified with a particular cost centre or cost unit. Examples of indirect costs include rent of building management salaries, machinery depreciation etc. 4. By Changes in Activity or Volume: According to this Classification, (i) Fixed Cost: Fixed Costs are commonly described as those which remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time. Fixed cost per unit decreases as production increases and increases as production declines. Examples of fixed costs are rent, insurance of factory building, factory mangers Salary etc. These fixed costs are constant in total amount but fluctuate per unit as production changes. These costs are known as period costs because these are dependent on time rather than on output. Such costs remain constant per unit of time such as factory rent of Rs.10,000 per month remaining same for every month irrespective of output of every month. (ii) Variable Costs are those which vary in total in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production. Thus, variable costs fluctuate in total amount but tend to remain constant per unit as production activity changes. Examples are direct material costs, direct labour costs, power, repairs etc. Such costs are known as product costs because they depend on the quantum of output rather than on time. (iii) Semi-Variable Costs are those which are partly fixed and partly variable. For example, telephone expenses

include a fixed portion of annual charge plus variable according to calls; thus total telephone expenses are semi-variable. Other examples of such costs are depreciation, repairs and maintenance of building and plant etc. 5. By Controllability (i) Controllable Costs are those which can be influenced by the action of a specified member of an undertaking, that is to say, costs which are at least partly within the control of management. An organization is divided into a number of responsibility centres and controllable costs incurred in a particular cost centre can be influenced by the action of the manager responsible for the centre. Generally speaking, all direct costs including direct materials, direct labour and some labour and some of the overhead expenses are controllable by lower level of management. (ii) Uncontrollable costs are those which cannot be influenced by the action of a specified member of an undertaking that is to say, which are not uncontrollable. For example, rent of the building is not controllable and so are managerial salaries. Overhead cost, which is incurred by one service section and is apportioned to another which receives the service, is also not controllable by the latter. 6. By Normality: (a) Normal Cost: It is the cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is a part of cost of production. (b) Abnormal Cost: It is the cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is not a part of cost of production and charged to Costing Profit and Loss Account.
7. By Relationship with Accounting Period (Capital And

Revenue): The Cost which is incurred in purchasing an asset either to earn income or increasing the earning capacity of the business is called capital cost, for example, the cost of a rolling machine in case of steel plant. Such

cost is incurred at one point of time but the benefits accruing from it are spread over a number of accounting years. If any expenditure is done in order to maintain the earning capacity of the concern such as cost of maintaining an asset or running a business it is revenue expenditure e.g., cost of materials used in production, labour charges paid to convert the material into production, salaries, depreciation, repairs and maintenance charges, selling and distribution charges etc. 8. By Time: (i) Historical Costs: The costs which are ascertained after being incurred are called historical costs. Such costs are availability only when the production of a particular thing has already been done. Such costs are only of historical value and will help the management to fix the responsibility and to take remedial action to avoid its recurrence in future. 9. According to Planning And Control: Budgeted Costs: Budgeted Costs represent an estimate of expenditure for different phases of business operations such as manufacturing, administration, sales, research and development etc. coordinated in a well conceived framework for a period of time in future which subsequently becomes the written expression of managerial targets to be achieved. Standard Costs: Budgeted Costs are translated into actual operation through the instrument of standard costs. The Chartered Institute of Management Accountants, London defines standard cost as The Predetermined cost based on a technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions. Thus, standard cost is determination, in advance of production of what should be the cost.
10. By

Association with the Product: Under the Classification, cost can be product costs and period costs. Products Costs are those costs which are traceable to the product and are included in inventory valuation. Product costs are inventoriable costs and they become basis for product pricing and cost plus contracts. They comprise direct materials, direct labour and manufacturing overheads

in case of manufacturing concerns. These are used for valuation of inventory and are shown in the Balance Sheet till they are sold because such costs provide income or benefit only after sale. The product cost of goods sold is transferred to the cost of goods sold account. Period Cost are incurred on the basis of time such as rent, salaries etc. these may relate to administration and selling costs essential to keep the business running. Though these are not associated with production and are necessary to generate revenue but cannot be assigned to a product. These are charged to the period in which these are incurred and treated as expense.

11. For Managerial Decision: On this basis, costs may be

classified into the following cost: (i) Marginal Cost: Marginal Cost is the total of variable costs i.e., prime cost plus variable overheads. It is based on the distinction between fixed and variable costs. Fixed costs are ignored and only variable costs are taken into consideration for determining the cost of products and value of work in progress and finished goods. (ii) One of Pocket Costs: This is that portion of the costs which involves payment to outsiders i.e., gives rise to cash expenditure as opposed to such costs as depreciation, which do not involve any cash expenditure. Such costs are relevant for price fixation during recession or when make or buy decision is to be made. (iii) Differential Cost: The Change in costs due to change in the level of activity or pattern or method of production is known as differential cost. If the change increases the cost, it will be called incremental cost. If there is decrease in cost resulting from decrease in output, the difference is known as decremental cost. (iv) Sunk Cost: A Sunk cost is an irrecoverable cost and is caused by complete abandonment of a plant. It is the written down value of the abandoned plant less its salvage value. Such costs are historical costs which

are incurred in the past and are not relevant for decision making and are not affected by increase or decrease in volume. Thus, expenditure which has taken place and is irrecoverable in a situation, is treated as sunk cost. For taking managerial decisions with future implications, a sunk cost is an irrelevant cost. If a decision has to be made for replacing the existing plant, the book value of the plant less salvage value (if any) will be a sunk cost and will be irrelevant cost for taking decision of the replacement of the existing plant. (v) Imputed or Notional Cost: The Chartered Institute of Management Accountants London, defines notional cost as The Value of a benefit where no actual cost is incurred. Even though such costs do not involve any cash outlay but are taken into consideration while making managerial decisions. Examples of such costs are: notional rent charged on business premises owned by the proprietor, interest on capital for which no interest has been paid. Imputed costs or notional costs can also be described as opportunity costs, imputed or notional cost is an hypothetical cost to represent the benefit enjoyed by a firm in respect of which actual expense is not incurred. (vi) Opportunity: It is the maximum possible alternative earning that might have been earned if the productive capacity or services had been put to some alternative use. For example, if an owned building is proposed to be used for a project, the likely rent of the building is the opportunity cost which should be taken into consideration while evaluating the profitability of the project. (vii) Replacement Cost: It is the cost at which there could be purchase of an asset or material identical to that which is being replaced or revalued. It is the cost of replacement at current market price. (viii) Avoidable and Unavoidable: Avoidable costs are those which can be eliminated if a particular product or department with which they are directly related, is discontinued. For example, salary of the clerks employed in a particular department can be eliminated. If the department is discontinued.

Unavoidable cost is that cost which will not be eliminated with the discontinuation of a product or department. For example, salary of factory manager or factory rent cannot be eliminated even if a product is eliminated.

Allocation and Apportionment of Overhead to Cost Centres (Departmentalization of Overhead) When all the items are collected properly under suitable account headings, the next step is allocation and apportionment of such expenses to cost centres. This is also known as departmentalization of overhead. Departmentalization of overheads (products) is the process of identifying production overhead expenses with different production/ service departments or cost centres. It is done by means of allocation and apportionment of overheads among various departments. Thus, it involves (i) allocation and apportionment of overheads among production and service departments and (ii) reapportionment of service departments overheads among production departments. A factory is administratively divided into sub-divisions known as departments for running it smoothly and efficiently. This subdivision is done in such a manner that each department represents a division of activity of the concern such as repairs department, power department, tools department, stores department, cash department, cost department etc. The following factors must be taken into consideration while organizing a concern into a number of departments: (i) Every manufacturing process is divided into its natural divisions in order to maintain natural flow of raw materials from the time of the purchase till its coversion into finished goods and sale. (ii)For ensuring smooth flow of production, the sequence of operations is taken into consideration while determining the location of the various departments. (iii) For physical control on production and maintaining efficiency of the concern, division of responsibility must be taken into consideration while organizing departments. Division of responsibility as far as possible should be clear, without ambiguity and dual control.

Allocation of Overheard Expenses Allocation is the process of identification of overheads with cost centres. An expense which is directly identifiable with a specific cost centre is allocated to that centre. So it is the allotment of whole item of cost to a cost centre or cost unit or refer to the charging of expenses which can be identified wholly with a particular department. For example, the whole of overtime wages paid to the workers relating to a particular department should be charged to that department. Similarly the cost of repairs and maintenance of a particular machine should be charged to that particular department wherein the machine is located. Power if separate meters are provided at each cost centre and fuel oil for boilers are other examples of allocation. So the term allocation means the allotment of the whole item without division to particular department or cost centre. Apportionment of Overhead Expenses Cost apportionment is the allotment of proportions of items to cost centres or cost units on an equitable basis. The term refers to the allotment of expenses which cannot identified wholly with a particular department. Such expenses require division and apportionment over two or more cost centres or units. So cost apportionment will arise in case of expenses common to more than one cost centre or unit. It is defined as the allotment to two or more cost centres of proportions of the common items of cost on the estimated basis of benefit received. Common items of overheads are rent and rates, depreciation, repairs and maintenance, lighting, works managers salary etc. Difference between Cost Allocation and Apportionment The main difference between the cost allocation and apportionment lies in that allocation deals with whole items whereas, apportionment deals with proportion of items of cost. While some costs may be directly allocated whereas apportionment needs a suitable basis for sub-division of the cost by cost centres or cost units. For example factory rent may be allocated to the factory and can be apportioned to products, departments or machines. Further the same cost can be allocated up to a certain level but at further lower levels, if a closer division is necessary, it can be apportioned only. Bases of Apportionment

Suitable bases have to be found out for apportioning the items of overhead cost to production and service departments and then for reapportionment of service departments costs to other service and production departments. The basis adopted should be such by which the expenses being apportioned must be measurable by the basis adopted and there must be proper correlation between the expenses and the basis. Therefore, the common expenses have to be apportioned or distributed over the departments on some equitable basis. The process of distribution is usually known as Primary Distribution. The following are the main bases of overhead apportionment utilized in manufacturing concerns: (i) Direct Allocation: Overheads are directly allocated to various departments on the basis of expenses for each department respectively. Examples are: Overtime premium of workers engaged in a particular department, power (When separate meters are available), jobbing repairs etc. (ii) Direct Labout / Machine Hours: Under this basis, the overhead expenses are distributed to various departments in the ratio of total number of labour or machine hours worked in each department. Majority of general overhead items are apportioned on this basis. (iii) Value of Materials Passing through Cost Centres: This basis is adopted for expenses associated with material such as material handling expenses. (iv) Direct Wages: According to this basis, expenses are distributed amongst the departments in the ratio of direct wages bills of the various departments. This method is used only for those items of expenses which are booked with the amounts of wages. E.g., workers insurance, their contribution to provident fund, workers compensations etc. (v) Number of Workers: The Total number of workers working in each department is taken as a basis for apportioning overhead expenses amongst departments. Where the expenditure depends more on the number of employees than on wages bill or number of labour hours, this method is used. This method is used for the apportionment of certain expenses as welfare and recreation expenses, medical expenses, time keeping, supervision etc. (vi) Floor Area of Departments: This basis is adopted for the apportionment of certain expenses like lighting and heating,

rent, rates, taxes, maintenance on building, air conditioning, fire precaution services etc. (vii) Capital Values: In this method, the capital values of certain assets like machinery and building are used as basis for the apportionment of certain expenses. Examples are: rates, taxes, depreciation, maintenance, insurance charges of the building etc. (viii) Light Points: This is used for apportioning lighting expenses. (ix) Kilowatt Hours: This basis is used for the apportionment of Power Expenses. (x) Technical Estimates: This basis of apportionment is used for the apportionment of those expenses for which it is difficult to find out any other basis of apportionment. An assessment of the equitable proportion is carried out by technical experts. This is used for distributing lighting, electric power, works managers salary, internal transport, steam, water charges etc. when these are used for processes.

Principles of Apportionment of Overhead Costs The determination of a suitable basis is of primary importance and the following principles are useful guides to a cost accountant: (i) Service or Use or Benefit derived: If the service rendered by a particular item of expense to different departments can be measured, overhead can be conveniently apportioned on this basis. Thus, the cost of maintenance may be apportioned to different departments on the basis of machine hours or capital value of the machines, rent charges to be distributed according to the floor space occupied by each department. (ii) Ability to Pay Method: Under this method, overhead should be distributed in proportion to the sales ability, income or profitability of the departments, territories, basis of products etc. Thus, jobs or products making higher profits take a higher share of the overhead expenses. This method is inequitable and is not generally

advisable to relieve inefficient units at the cost of efficient units. (iii) Efficiency Method: Under this method, the apportionment of expenses is made on the basis of production targets. If the target is exceeded, the unit cost reduces indicating a more than average efficiency. If the target is not achieved, the unit cost goes up, disclosing thereby the inefficiency of the department. (iv) Survey Method: In certain cases it may not be possible to measure exactly the extent of benefit which the various departments receive as this may vary from period to period. A survey is made of the various factors involved and the share of overhead costs to be borne by each cost centre is determined. Thus, the salaries of foreman serving two departments can be apportioned after a proper survey which may reveal that 30% of such salary should be apportioned to one department and 70% to the other department. The cost of lighting when not metered may similarly be apportioned on a survey of the number and wattage of light points and the hours of use in each cost centre. What basis would you follow for distribution of the following overhead expenses to departments? (a) Store Service Expenses (b) Employees State Insurance (c) Factory Rent (d) Municipal Rent, Rates and Taxes (e) Insurance on Building and Machinery (f) Welfare Department Expenses (g) Creche Expenses (h) Steam (i) Electric Light (j) Fire insurance Solution 1. 2. 3. 4. Expenses Store Service Expenses E.S.I. Factory Rent Municipal Rent, Rates Taxes Basis of Apportionment Value of Materials Consumed Wages of each department Floor Area and Floor Area Insurable Value

5. Insurance on Building and Machinery 6. Welfare Department Expenses 7. Creche Expenses 8. Steam 9. Electric Light 10. Fire Insurance

Number of Employees Number of Female Employees Potential Demand Calculated Units (i) For Capital Items Value of Capital Items (ii) For Stores Average value of Goods in stock

The Modern Company is divided into four departments: P1, P2, P3 are producing departments and S1 is a service department. The actual costs for a period are as follows: Rs. Rent 1,000 Rs. Supervision 1,500 Repairs to Plant 600 Fire insurance in respect of stock 500 Depreciation of Plant 450 Power 900 Employers liability for insurance 150 Light 120 The following information is available in respect of the four departments: Dept. P1 Area (sq.meters) 1,500 900 500 Number of Employees 20 10 5 Total Wages (Rs.) 6,000 3,000 2,000 Value of Plant (Rs.) 24,000 12,000 6,000 Value of Stock (Rs.) 15,000 6,000 -H.P.of Plant 24 12 6

1,100 15 4,000 18,000 9,000 18

Apportion the costs to the various departments on the most equitable basis.

Reapportionment of Service Department Costs to Production Departments Service department costs are to be reapportioned to the production departments or the cost centres where production is going on. This process of reapportionment of overhead expenses is known as Secondary Distribution. The following is a list of the bases of apportionment which may be accepted for the service departments noted against each: Service Department Cost 1. Maintenance Department 2. Payroll or Time-keeping 3. Employment Department or Personal Basis of Apportionment Hours worked for each department Total labour or machine hours or number of employees in each departments Rate of Labour turnover or number of employees in each department No. of requisitions or value of materials of each department. No. of purchase orders or value of materials for each department. No. of employees in each department. Relative area in each department Weight, value graded product handled, weight and distance travelled. Crane hours, truck hours, truck mileage, truck tonnage, truck tone hours, tonnage handled, number of

4. Store-keeping Department 5. Purchase Department 6. Welfare, Ambulance, Canteen service, Recreation Room expenses 7. Building Service Department 8. Internal Transport Service or Overhead Crane Service 9. Transport Department

10. Power House (Electric Power Cost)

11.

Power House

packages. Wattage, horse power, horse power machine hours, number of electric points etc. Floor area, cubic content.

Methods of RE-apportionment (or Re-Distribution) The following chart depicts the methods of re-distribution of service department costs to production departments: Secondary Distribution of Overhead

Direct Re-Distribution Services Method Method

Step Distribution Method

Reciprocal

Simultaneous Error Equation Method Method

Repeated Distribution Method

Trial and

(i) Direct Re-Distribution Method: Under this method, the

cost of service departments are directly apportioned to production departments without taking into consideration any service from one service department to another service

department. Thus, proper apportionment cannot be done and the production departments may either be undercharged. The share of each service department cannot be ascertained accurately for control purposes. Budget for each department cannot be prepared thoroughly. Therefore Department Overhead rates cannot be ascertained correctly. In a Light engineering factory, the following particulars have been collected for the three months period ended on 31st March 1998. You are required to re-apportion the service departments expenses to production departments.
Production Departments Service Departments

Expenses as per Primary Distribution Summary

P1 8,850

P2 P3 7,16 6,28 5 5

S1 4,515

S2 6,01 0

Apportion the expenses of service department S2 in proportion of 3:3:4 and those of service departments S1 in the Ration of 3:1:1 to departments P1, P2, and P3 respectively. Solution PRODUCTION OVERHEADS DISTRIBUTION SUMMARY For the quarter ending 31st March, 1998
Production Departments Service Departments

P1 Rs. Total Expenses as Primary Distribution Summary Reapportionment Dept.S2(3:3:4) per 8,850 of 1,803 2,709

P2 Rs.

P3 Rs.

S1 Rs. 4,515 (4,515

S2 Rs. 6,010 (6,010 )

7,16 6,285 5 2,404 1,80 903

Reapportionment Dept.S1(3:1:1) Total

of 13,36 2

3 903 9,87 9,592 0

) ----

(ii) Step Distribution Method: Under this method the cost of

most serviceable department is first apportioned to other service departments and production departments. The next service department is taken up and its cost is apportioned and this process goes on till the cost of the last service department is apportioned. Thus, the cost of last service department is apportioned only to the production departments.

A Manufacturing company has two Production Department P1 and P2 and three Service Departments, Time-Keeping, Store and Maintenance. The Departmental Summary showed the following expenses for July, 1998. Production Departments importance) P1 S3 Rs. Rs. 16,000 5,000 Rs. (Time Keeping) (Stores) (Maintenance) Rs. Rs. 10,000 3,000 4,000 P2 S1 Service Departments (in order of their S2

The other information relating to departments were:

Service Departments

Production Departments

S1 S2 (Time (Stores Keeping ) ) No. of Employees --20 No. of Store ----Requisitions ----Machine Hours Solution As per Primary Distributi on System Rs. Rs. 4,000 (-) 4,000 5,000 3,000 16,000 10,000 38,000

S3 (Mainte nance) 10 6 ---

P1

P2

40 24 2,400

30 20 1,600

Department

S1 (TimeKeeping) S2(Stores) S3(Maintenanc e) P1 P2

800 (-) 5,800 400 696 (-) 4,096 1,600 1,200 2,784 2,320 2,458 1,638 22,842 15,158 38,000

Note: Basis of Apportionment: (a) Time Keeping No. of Employees (i.e. 2:1:4:3) (b) Stores Number of Stores Requisitions (i.e. 3:12:10) (c)Maintenance Machine Hours (i.e. 3:2) The most important limitations of this method is that cost of one service centre to other service cost centres is ignored and thus the cost of individual cost centres are not truly reflected.
(iii)

Reciprocal Services Method: In order to avoid the limitation of Step Method, this method is adopted. This method recognizes the fact that if a given department receives service from another department, the department receiving such service should be charged. If two

departments provide service to each other, each department should be charged for the cost of services rendered by the other. There are three methods available for dealing with inter-service departmental transfer: (a) Simultaneous Equation Method (b) Repeated Distribution Method and (c)Trial and Error Method
(a) Simultaneous Equation Method: Under this method, the

true cost of the service departments are ascertained first with the help of simultaneous equations: these are then redistributed to production departments on the basis of given percentage. This method is preferable and is widely used even if the number of service departments are more than two. Due to the availability of computer it is not difficult to solve sets of simultaneous equations. The following illustration may be taken to discuss the application of this method.

A Company has three production departments and two service departments, and for a period the departmental distribution summary has the following totals: Production Departments Rs.500 : P1 Rs.800; P2 Rs.700 and P3

Service Departments : S1 Rs.234 and S2 Rs.300 The expenses of the service departments are charged out on a percentage basis as follows: P1 P2 P3 S1 S2 Service Department S1 10% Service Department S2 --20% 40% 40% 20% 30% 20% --20%

Prepare a statement showing the apportionment of two service departments expenses to Production Departments by Simultaneous Equation Method.

Solution Let x = Total overheads of Department S1 Y = Total overheads of Department S2 Then x = 234 + .2y and y = 300 + .1x

Rearranging and multiplying to eliminate decimals: 10x 2y = 2,340 -x + 10y = 3,000 Multiplying equation (1) by 5, and add result to (2), we get 49x = 14,700 x = 300 Substituting this value in equation (1), we get y = 330 all that now remains to be done is to take these values x = 300 and y = 330 and apportion them on the basis of the agreed percentage to the three production departments; thus: Total Per distribution Summary Service Department S1 (90% of Rs.300) Service Department S2 (80% of Rs.330) Rs. 2,000 270 264 2,534 P1 Rs. 800 60 132 992 P2 Rs. 700 120 66 886 P3 Rs. 500 90 66 656

This method is recommended in more than two service departments if the data is processed with computers and in two service departments only where the data is processed manually.
(b) Repeated Distribution Method: Under this method, the

totals as shown in the departmental distribution summary,

are put out in a line, and then the service department totals are exhausted in turn repeatedly according to the agreed percentage until the figures become too small to matter. By solving Illustration 5 by Repeated Distribution Method, we get the Secondary Distribution Summary which is given as follows:

Secondary Distribution Summary P1 As per Summary Service Department S1 Service Department S2 Service Department S1 Service Department S2 P2 P3 S1 S2 Rs. Rs. Rs. Rs. Rs. 800 700 500 234 300 47 129 14 2 992 94 65 25 2 886 70 65 19 2 656 --(234) 64 (64) 23 (323) 6 (6) ---

(c) Trail and Error Method: Under this method, the cost of

one service department is apportioned to another centre. The cost of another centre plus the share received from the first centre is again apportioned to the first cost centre and this process is repeated till the balancing figure becomes negligible.

By solving Illustration 5 by Trial and Error Method, we get the following: Service Departments S1 S2

Original Apportionment

Rs. 234 (23) 65 (20% of 323) (65) 1 (20% of 7) 300

Total of Positive Figures

Rs. 300 23 (10% of 234) (323) 7 (10% of 65) (7) 330

ABSORPTION OF OVERHEAD Meaning of Absorption After learning the methods to be followed for allocation and apportionment of overhead costs to producing cost centres, now we are required to learn the next step in the accounting of manufacturing overhead i.e. how to recover this cost from the cost of the production. The method of apportionment of overhead expenses to the cost centres or cost units is known as overhead absorption (also referred to as levy, recovery, or application of overhead). It is necessary to charge each unit of production with its share of overhead expenses to ascertain the total cost of each unit. The Charge made to each job to recover indirect cost is known as absorption to overhead. Absorption actually means the distribution of the overhead expenses allotted to a particular department over the units produced in that department. Overhead absorption is accomplished by overhead rates. A Company is having three production departments X, Y, and Z and two service departments boiler house and pump room. The boiler house has to depend upon the pump room for supply of water and pump room in its turn is dependent on the boiler house for supply of steam power for driving the pump. The expenses incurred by the production departments are : X Rs.6,00,00; Y Rs.5,25,000; Z Rs.3,75,000. The expenses for boiler house are Rs.1,75,500 and pump room are Rs.2,25,000. The expenses of the boiler house and pump room are apportioned to the production departments on the following basis:

Expenses of Boiler House Expenses of Pump Room

Departments X Y Z 20% 40% 30% 40% 20% 20%

Boiler Pump House House --10% 20% ---

Show clearly as to how the expenses of boiler house and pump room would be apportioned to X, Y, and Z departments by following: (i) Simultaneous Equation Method and (ii) Repeated Distribution Method. Job Costing Job Costing is a method of Cost accounting whereby cost is compiled for a specific quantity of product, equipment, repair or other service that moves through the production process as a continuously identifiable unit, applicable material, direct labour, direct expenses and usually a calculated portion of overheads being charged to a job order. Features of Job Order Costing (i) The Production is generally against customers order but not for stock. (ii) Each job has its own characteristics and needs special treatment. (iii) There is no uniformity in the flow of production from department to department. The nature of the job determines the departments through which the job has to be processed. The production is intermittent and not continuous. (iv) Each job is treated as a cost unit under this method of costing. (v) Each job is distinctively identified by a production order throughout the production stage. (vi) The cost of production of every job is ascertained after the completion of the job. (vii) The work in progress differs from period to period according to the number of jobs in hand.

Thus cost is ascertained for each job separately. This method is applicable to printers, machine tools manufacturers, foundries and general engineering workshops. The information given below has been taken from the cost records of a factory in respect of Job No.707: Direct Material Wage Details: Department Rs. 4,010. A : 60 hours @ Rs.3 per hour B : 40 hours @ Rs. 2 per hour C : 20 hours @ Rs. 5 per hour

The variable overheads are as follows: Department A : Rs.5,000 for 5,000 hours B : Rs.3,000 for 1,500 hours C : Rs.2,000 for 500 hours Fixed expenses estimated at Rs.20,000 for 10,000 working hours. Calculate the cost of the job No.707 and the price for the job to give a profit of 25% on the selling price. As newly appointed Cost Accountant, you find that the selling price of Job No.1234 has been calculated on the following basis: Rs. Materials Direct Wages 22 hours at 25 paise per hour 5.50 (Department A 10 hours, B 4 hours, C 8 hours) Plus 33 /3 % on Prime Cost 5.86
1

12.08

17.58 23.44 An Analysis of the previous years profit and loss account shows the following: Rs. Materials used 77,500 Factory Overheads

Direct Wages 2,500 A B C 30,000

A 5,000 6,000 4,000 B C Selling Costs 4,000 1,000

You are required to (a) draw up a job cost sheet; (b) Calculate and enter the revised costs using the previous years figures as a basis; (c) Add to the total job cost 10% for profit and give the final selling price. CONTRACT COSTING Contract Costing is that form of specific order costing which applies where the work is undertaken according to customers requirements and each order is of long duration as compared to job costing. The work is generally of constructional and repairs nature. A construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single substantial project. This covers various activities as construction of plants (including site preparation), bridges, roads, dams, ships, buildings, complex pieces of equipment, production of motion pictures etc. That is why this method is used by builders, civil engineering contractors, constructional and mechanical engineering firms etc. These contracts are negotiated in a number of ways. Comparison between Job and Contract Costing There are certain similarities in job and contract costing. Both the methods belong to the category of specific order costing in which work is executed according to the specification of customers. Under both the methods customers come on their own and there is no need of creating demand. Generally quotation price is asked before giving order and production starts only on receipt of order from the customer. In spite of the above similarities there are certain differences between job and contract costing. These are given as under:

1) Size: A Job is small in size but the contract is big in size. 2) Place of Work: Work under job costing is performed in the

3)

4)

5) 6)

7)

workshop of the proprietor but the contract is executed mostly at site. Time for Completion: A Job usually takes less time for completion of work whereas a contract takes more time to complete the work. Payment of Price: The selling price of a job is paid in full after completing the job but in case of a contract, the price is paid in various instalments depending upon the progress of the work. Investment: There is heavy investment on assets initially in case of job costing as compared to contract costing. Nature of Expenses: In job costing, expenses may be direct and indirect but in case of contract costing, most of the expenses are direct in nature. Transfer of Profit: Profit earned on a job is entirely taken to profit and loss account but in case of incomplete contract, only proportionate profit is transferred to profit and loss account depending on the completion stage of the contract.

Types of Contracts Generally there are three types of contracts: (i) Fixed Price Contracts: Under these contracts both parties agree to a fixed contract Price. (ii) Fixed Price Contracts but in some cases Subject to escalation clause (iii) Cost Plus Contracts: Under these contracts no fixed price could be settled. The contractor is reimbursed for allowable or otherwise defined costs plus a percentage of these costs or a fixed fee towards profit. Recording of Value and Profit on Contracts
1. Certificate of Work Done: When a contractor is engaged

on a contract for a considerable time, his financial resources could become severely strained. A large amount of working capital would be required if he did not receive payment until

the completion of the contract. It is a normal practice particularly in the case of large contracts for the contractee to pay the contractor sums of money on account during the period of the contract. These sums will be paid against certificates by surveyors or architects acting for the contractee certifying the value of work so far performed. In may cases, the terms of the contract provide that the whole of the amount shown by the certificate shall not be paid immediately but a percentage thereof shall be retained by the contractee until some time after the contract is completed. The sum retained is called retention money. The object of this retention is to place the contractee in a favorable position, should faulty work arise or penalties become payable by reason of late completion of the contract. If the work has not been certified, the contractee would not make any advance on it. Such work which has been done but not certified is called work uncertified i.e., work done since certification. Work certified and work uncertified will appear on the credit side of the contract account under the heading work in progress. If the work certified is not given, cash received from the contractee and retention money are given, the amount of work certified should be calculated first. For example, if Rs.20,000 is received from the contractee after deducting 20% retention money, work certified will be

2. Profit on Uncompleted Contract: (i) For Contracts which have just started: No profit should

be taken in respect of contracts which have just commenced, as it is impossible to foresee clearly the future position. Generally if the work completed (i.e. completion stage) is th or less than th of the total work, no profit shall be transferred to the Profit and Loss Account. For Contracts which have sufficiently advanced and covered by architects certificate: In this case, notional profit is ascertained by deducting the cost of the contract covered by surveyors certificate from the value of contract certified by the surveyor. A portion of

(ii)

notional profit is taken to profit and loss account and the balance is carried forward in the same contract as a profit in suspense as a provision against future losses, increase in costs and other contingencies. The practice for this is that only 1/3rd of the notional profit is taken, if the completion stage is more than th complete but less than and 2/3 rd, if the completion stand is between 50 and 90 percent. Sometimes, to be more conservative, the amount of profit is further reduced in the ratio of cash received to the value of work certified. Thus the formula for computing the proportion of profit is: For example, the notional profit on the contract comes to Rs.30,000 say the contract is about 2/3rd complete and 75% of the work certified is received in the form of cash. The profit to be transferred to Profit and Loss Account shall be ascertained as below:

(iii)

For the Contracts which are almost complete: if the work is nearing completion say the completion stage is between 91 and 99 percent, the estimated profit is ascertained deducting the aggregate of costs to date and additional expenditure to be incurred to complete the contract from the contract price. A proportion of this estimated total profit is credited to profit and loss account.

A Company undertook a contract for construction of a large building complex. The construction work st commended on 1 April 2000 and the following data are available for the year ended 31st March 2001.
Rs. 000 Rs. 000

Contract Prize

35,00 Plant Hire Charges

1,750

Work Certified Progress Payments Received Materials Issued to Site Planning & Estimating Tools Direct Wages Paid Materials Returned From Site

0 20,00 0 15,00 0 7,500 1,000 4,000 250

Wages Related Costs Site Office Costs Head Office Expenses Apportioned Site Expenses Incurred Work Not Certified

The contractors own a plant which originally cost Rs.20 lacs has been continuously in use in this contract throughout the year. The residual value of the plant after 5 years of life is expected to be Rs.5 lacs. Straight line method of depreciation is in use. As on 31st March, 2001 the direct wages due and payable amounted to Rs.2,70,000 and the materials at site were estimated at Rs.2,00,000.

Surya Construction Ltd., with a paid up share capital of Rs.50Lakhs undertook a contract to construct MIG Apartments. The Work commenced on the contract on 1st April, 2000. The Contract price was Rs.60Lakhs. Cash received on account of the contract upto 31st March 2001 was Rs.18Lakhs (being 90% of the work certified). Work completed but not certified was estimated at Rs.1,00,000. As on 31st March 2001 material at site was estimated at Rs.30,000, machinery at site costing Rs.2,00,000 was returned to stores and wages outstanding were Rs.5,000. Plant and Machinery at site is to be depreciated at 5%. The following were the ledger balances (Dr.) as per trial balance as on 31st March, 2001: Land and Building Plant and Machinery (60%at site) Furniture Materials Fuel and Power Site Expenses Rs. 23,00,000 25,00,000 60,000 14,00,000 1,25,000 5,000

Office Expenses Rates and Taxes Cash at Bank Wages ONE OPERATION (UNIT OR OUTPUT) COSTING

12,000 15,000 1,33,000 2,50,000

This is a method of costing by units of production and is adopted where production is uniform and a continuous affair, units of output are identical and the cost units are physical and natural. The cost per unit is determined by dividing the total cost during a given period by the number of units produced during that period. This method of costing is generally adopted where an undertaking is engaged in producing only one type of product or two or more products of the same kind but of varying grades or quality. The industries where this method of costing is used are collieries, sugar mills, cement works, brick works, paper mills etc. In all these cases work is a natural unit of cost e.g. a tonne of coal, a quintal of sugar, a tonne of cement, 1,000 bricks, 1kg paper and so on. THE ACCOUNTS OF PLEASANT COMPANY LTD., SHOW FOR 2001: Materials Rs.3,50,00; Labour Rs.2,70,000; Factory Overhead Rs.81,000 and Administration Overheads Rs.56,080. What price should the company quote for a refrigerator? It is estimated that Rs.1,000 in material and Rs.700 in labour will be required for one refrigerator. Absorb factory overheads on the basis of labour and administration overheads on the basis of works cost. A profit of 12 % on selling price is required. FROM THE FOLLOWING DATA PREPARE A COST AND PROFIT STATEMENT OF POPULAR STOVES MANUFACTURING CO. FOR THE YEAR 2001:
Rs. Rs.

Stock of Materials on 1-1-

35,0 Establishment Expenses

10,000

2001 Stock of Materials on3112-2001 Purchase of Materials Direct Wages Factory Expenses

00 4,90 0 52,5 00 95,0 00 17,5 00

Completed stock in hand on 1Nil 1-2001 35,000 Completed stock in hand on31- 1,89,0 12-2001 00 Sales

The Number of stoves manufactured during the year 2001 was 4,000. The company wants to quote for a contract for the supply of 1,000 Electric Stoves during the year 2002. The stoves to be quoted are of uniform quality and make the similar to those manufactured in the previous year; but cost of materials has increased by 15% and cost of factory labour by 10% Prepare a statement showing the price to be quoted to give the same percentage of net profit on turnover as was realized during the year 2001, assuming that the cost per unit of overheads will be the same as in the previous year.