SUCM301 Cost Accounting

SUCR 301 / SUCC 301/ SUCM 301
UNDERGRADUATE COURSE
B.COM.- CORPORATE SECRETARYSHIP
B.COM.- COMPUTER APPLICATION
B.COM.- GENERAL
THIRD YEAR
FIFTH SEMESTER
CORE PAPER - IX / CORE PAPER - XI

[B.COM - CS] [B.COM - CA & G]
COST ACCOUNTING
INSTITUTE OF DISTANCE EDUCATION

UNIVERSITY OF MADRAS
B.COM.- CORPORATE SECRETARYSHIP CORE PAPER - IX /
B.COM.- COMPUTER APPLICATION CORE PAPER - XI
B.COM.- GENERAL COST ACCOUNTING
THIRD YEAR - FIFTH SEMESTER
WELCOME
Warm Greetings.
It is with a great pleasure to welcome you as a student of Institute of Distance

Education, University of Madras. It is a proud moment for the Institute of Distance education
as you are entering into a cafeteria system of learning process as envisaged by the University
Grants Commission. Yes, we have framed and introduced Choice Based Credit
System(CBCS) in Semester pattern from the academic year 2018-19. You are free to
choose courses, as per the Regulations, to attain the target of total number of credits set
for each course and also each degree programme. What is a credit? To earn one credit in
a semester you have to spend 30 hours of learning process. Each course has a weightage
in terms of credits. Credits are assigned by taking into account of its level of subject content.
For instance, if one particular course or paper has 4 credits then you have to spend 120
hours of self-learning in a semester. You are advised to plan the strategy to devote hours of
self-study in the learning process. You will be assessed periodically by means of tests,
assignments and quizzes either in class room or laboratory or field work. In the case of PG
(UG), Continuous Internal Assessment for 20(25) percentage and End Semester University
Examination for 80 (75) percentage of the maximum score for a course / paper. The theory
paper in the end semester examination will bring out your various skills: namely basic
knowledge about subject, memory recall, application, analysis, comprehension and
descriptive writing. We will always have in mind while training you in conducting experiments,
analyzing the performance during laboratory work, and observing the outcomes to bring
out the truth from the experiment, and we measure these skills in the end semester
examination. You will be guided by well experienced faculty.
I invite you to join the CBCS in Semester System to gain rich knowledge leisurely at
your will and wish. Choose the right courses at right times so as to erect your flag of
success. We always encourage and enlighten to excel and empower. We are the cross
bearers to make you a torch bearer to have a bright future.
With best wishes from mind and heart,
DIRECTOR
(i)
B.COM.- CORPORATE SECRETARYSHIP CORE PAPER - IX /
B.COM.- COMPUTER APPLICATION CORE PAPER - XI
B.COM.- GENERAL COST ACCOUNTING
COURSE WRITER
Mr. R. SURESH
Faculty in Commerce
M.K.U. College
Andipatti, Theni District
EDITING
Dr. R. PANCHALAN Dr. P. HEMAVATHY

Professor in Commerce Assistant Professor in Commerce (T)
Institute of Distance Education Institute of Distance Education

University of Madras,
University of Madras,
Chennai - 600 005.
Chennai - 600 005.
© UNIVERSITY OF MADRAS, CHENNAI 600 005.
(ii)
B.COM.- GENERAL
COST ACCOUNTING
SYLLABUS
UNIT I
Definition, meaning and objectives- Advantages and Importance- Distinction between Cost
and Financial Accounting - Elements of Cost and Preparation of Cost Sheets and Tenders.
UNIT II MATERIALS
Stores record- purchase records- purchase order- Goods received note- Bin card- Stores
Ledger - Inventory Control- ABC Analysis – Economic Ordering Quantity – Maximum,
Minimum and Reordering levels – Methods of Pricing Issues - Perpetual Inventory System.
UNIT III LABOUR
Importance of Labour Cost Control- Various Methods of Wage Payments - Calculation of

Wages - Methods of Incentives (Bonus) Schemes - Recording Labour time- Treatment of
“OVER TIME” and “IDLE TIME”- Labour Turn Over (L.T.O)
UNIT IV OVERHEADS: (Factory, Administration, Selling and Distribution)
Definition and Meaning of Overheads – Classification – Apportionment of Overheads –

Redistribution (Secondary Distribution) – Absorption of Overheads including “Machine Hour
Rate”.
UNIT V METHODS OF COSTING
Unit Costing – Job Costing ( Excluding Contract Costing )– Process Costing – Simple
Process Accounts ( Excluding Inter Process Profits and Equivalent Production, Joint
Product) – Operation and Operating Costing.
(iii)
REFERENCE BOOKS
1. B.K.Bhar – Cost Accounts
2. Jain & Narang – Cost and Management Accounts
3. S.N.Maheshwari – Cost & Management Accounts
4. S.P.Iyengar – Cost and Management Accounting
5. T.S. Reddy and Y. Hari Prasad Reddy – Cost Accounting
(iv)
B.COM.- GENERAL
COST ACCOUNTING
SCHEME OF LESSONS
Sl.No. Title Page
1. Fundamentals of Cost Accounting 001
2. Cost Analysis 014
3. Output Costing 022
4. Reconciliation of Cost and Financial Accounts 044
5. Materials - Purchase Control 058
6. Materials - Inventory Control 077
7. Materials - Issue Control 100
8. Materials - Lossess 128
9. Labour Cost Computation 139
10. Labour - Remuneration and Incentives 167
11. Overheads 191
12. Overheads (Contd.) 223
13. Costing Methods 242
(v)
1
LESSON - 1
FUNDAMENTALS OF COST ACCOUNTING
Learning Objectives
After studying this lesson, you should be able to:
• Understand the objectives of cost accounting
• Highlight the essentials of good costing system
• Describe the installation of good costing system in a firm.
Structure
1.1 Introduction
1.2 Meaning
1.3 Essentials of Good Costing System
1.4 Installation of Good Costing System in a Firm
1.5 Summary
1.6 Key Words
1.7 Review Questions
1.8 Answers to Check Your Progress
1.1 Introduction
At present, business activity exists as a dynamic one. Every business person is in a position to
face tough challenges, competitions, uncertainty and risks related to his business on its day to
day operations, because of technological changes, economic situations, political conditions,
availability of resources and increase in population, which makes him to think about the product
cost. This cost consciousness led to the necessity of cost accounting. The discipline cost
2
accounting is a recently developed one in the accounting world. During the First World War
(1914-1918), the industrialists became more and more conscious. This was due to growing
competitions and increasing government control over pricing policy. During the First World War
period the cost plus system was followed. Many legislations which had an effective control over
pricing policy was brought down by the government during the second world war period, which
became imperative to the manufacturers. The blanket cover over prices is
a) to take constant effort to improve the quality of the products.
b) to trace the accurate cost related to the job or product completed or manufactured.
c) to control costs.
1.2 Meaning
1.2.1 Cost
Generally the term cost stands with the meaning of expenditure whether paid or payable either
actual or notional incurred, or attributable to, a product or service. It is the yardstick to make
measurement, in monetary terms, of the amount used for some specific purpose. AICPA defines
the cost as “the amount, measured in money, of cash expended or other property transferred,
capital stock issued, services performed or liability incurred, in consideration of goods or services
received or to be received”
The term is also represents that the resources that have been, or must be sacrificed to attain
particular objective.
1.2.2 Cost Accountancy
It is the application of costing and cost accounting principles, methods and techniques to the
science, art and practice of cost control and the ascertainment of profitability and the derived
details supports the management in decision-making process.
3
Scope of Cost Accountancy
The scope of cost accountancy is very wide and it includes the following.
1) Cost ascertainment: 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 production with the expenses.
2) Cost accounting: It begins with recording of expenditure and ends with preparation of
statistical data. Cost can be ascertained either by following historical or predetermined
system of costing. Cost either can be predetermined by standard costing or estimated
costing.
3) Cost control : 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 regulations are done by
an executive action. It is to be controlled by standard costing, budgetary control, proper
presentation, and reporting of cost data and cost audit.
4) Budgetary control : slt is the establishment of budgets relating to the responsibilities

of executives to the requirements of a policy and the continuous comparison of actual
with budgeted results either to secure by individual action the objective of that policy or
to provide a basis for its revision.
5) Cost audit: It is the verification of the correctness of the cost records and a check on
the adherence to the cost accounting plan. It is to verify that cost accounting rules and
principles are followed correctly or not.
1.2.3 Cost Accounting
Cost accounting came into existence to fulfil the needs of management of business concerns
for detailed information about the cost controllability on product and service and to ascertain
true cost of every operation, through a close watch - cost analysis and allocation which is
purely a managerial decision-making process.
The Institute of Cost & Works Accountants of U.K. defines that “cost accounting as the application
of costing and cost accounting principles, methods and techniques to the science, art and
practice of cost control and ascertainment of profitability. It includes the presentation of information
derived there from for the purpose of managerial decision making”.
4
The institute of Cost & Works Accountants of India defines “cost accounting is the technique
and process of ascertainment of costs. It is the process of accounting for costs which begins
with recording of expenses or the bases on which they are calculated and ends with preparation
of statistical data”.
Cost accounting may also be defined as the body of concepts, methods and cedures used to
measure, analyse or estimate the costs, profitability and performance Individual products,
departments and other segment’s of a company’s operations, for either internal or external use
or both, and to report on these questions to the interested parties.
We can understand from the above item that, the main divisions of cost accounting are
a) cost ascertainment
b) cost presentation and
c) cost control and reduction
Objectives of Cost Accounting
a) Cost ascertainment: Cost accounting helps the management to ascertain the cost of
a product, job, and contract, service, which help to develop the cost standard. This may
be done under different circumstances, using one or more types of costing principles
such as standard costing, marginal costing, uniform costing etc.
b) Determination of selling price : After ascertainment of cost, the management can fix
the selling price of a product, job, contract and service with the help of the cost accounting.
c) Cost control : One of the important objectives of cost accounting is cost control. It is
minimising the cost of manufacturing. With the help of cost accounting, the management
will enter into an investigation to adapt correct action to eliminate any adverse effect
arising after comparing the actual cost with standard cost.
d) Matching cost with revenue : The determination of profitability of each product, ce

department etc. is also an important object of the cost accounting.
e) Special studies & investigations on cost : The cost accounting supports the
management to make some policy decisions like pricing of new products, expansion of
business, close down and continuance of a department, product mix, price reduction in
depression, determination of CVP relationship, to make or to buy etc.
5
f) Facilitates preparation of financial and other statements : Cost accounting helps

to prepare Cost Profit and Loss Account and Balance Sheet periodically, once in a year
or half yearly or on the basis of necessity which supports the management under the
following cases:
1) to operate the business at a high level of efficiency.
2) to have a frequent review of production, sales and operating results
3) to see the volume of units produced and its accumulated costs
Advantages of Cost Accounting
a) Advantages to the management
1) Helps in price fixation
2) Helps in the periods of trade depression and trade competitions
3) Helps to channel the products on the right way
4) Helps in making estimates and decisions
5) Helps to eliminate wastage during and after production
6) Helps in making comparison with past experience to take action against unprofitable
activities
7) Provides details for periodical P&L accounts
8) Helps in determining an enhancing efficiency
9) Helps in inventory control
10) Helps to prevent fraud
b) Advantages to the employees
1) It helps to fix a sound wage policy.
2) It helps the employee to measure their efficiency and to give higher bonus plans.
3) It helps to distinguish between the efficient and inefficient workers.
4) It helps to get security of job after measuring the above three items.
6
c) Advantages to creditors
1) It helps the lenders of the firm to get a correct understanding about the firm.
d) Advantages to the government
1) It helps in preparation of national, economical development plans.
2) It helps in making policies related to taxation, import & export, price ceiling and granting
of subsidy etc.
e) Advantages to the public
1) It enables the consumers to get goods at better quality in cheap rates.
2) It makes the public to feel that costing system facilitates the customers to pay fair price.
3) Development and prosperity of industries will create employment opportunities.
4) Cost reduction helps in curbing inflationary trends in economy.
Disadvantages of Cost Accounting
1) It is an expensive system, which is suitable only to the very large industries in size.
2) It is a tedious work, because routine forms and statements are to be prepared which is
an unnecessary paper work.
Cost Accounting Vs Financial Accounting
Cost Accounting Financial Accounting
1. Transactions are recorded with costs 1. Transactions are recorded for a definite
units Period
2. Transactions are recorded completelv. 2. Transactions are recorded partially

viz. manufactures, sales, services etc.
3. It aims to guide the management for 3. It aims to show the final result for a
proper planning, control and particular period to owners & outsiders
decisionmaking.
7
4. It analyses the expenditure under 4. It analyses the expenditure under

different heads of performance as different types of expenses.
distinct from types of expenses.
5. It analyses the profitability and non 5. It analyses the overall performance of

profitability factors of each department the firm.
so as to take corrective measures
on non-profitability factors.
6. It provides a proper system of 6. It does not provide such a system of

Inventory control. inventory control, since the figures are
available in aggregative.
7. It depends upon the financial 7. It does not depend upon cost

accounting for data. accounting.
8. Reconciliation of cost profit with 8. No such a reconciliation is necessary.

financial profit is essential to
find out correct profit.
9. It is a positive as well as normative 9. It is a positive science.

science.
10. Wastages, Spoilages etc. are 10. There are no such categories.
categorised into normal and
abnormal to eliminate abnormal items.
11. It deals with internal transactions. 11. It deals with external transactions.
12. It deals partially with actual facts and 12. It deals with only actual facts.
partially with estimates.
13. It makes clear distinction of costs. 13. It does not make any distinction of
costs.
14. Stock are valued at cost. 14. Stocks are valued at cost price or
market price whichever is less.
15. It provides information for all operation 15. It does not do so.
and can be compared with standard cost.
16. It is kept to meet the requirements of 16. They are kept compulsorily under
the management. Now it is obligatory Company’s Act and Income Tax Act.
to keep such records.
8
1.2.4 Costing
It is the technique and process of ascertaining costs. It is referred to as classifying, recording

and proper allocation of expenditure for the determination of the costs of products or services.
The term technique used in costing consist of principles and rules to be Tollowed while
ascertaining the cost of a product or service. Harley observes, costing is a study of the expenses
incurred in manufacturing a product and conducting a business in such a manner that the
expenses are analysed and classified so as to enable the actual cost of any particular process
or unit of production to be determined with a minimum of error”.
Institute of Cost & Management Accountants of England (ICMA) defined costing as “the technique
and process of ascertaining costs.” This technique of costing involve’s four steps namely,
a) Collection of expenditure
b) Classification of expenditure according to the cost elements
c) Allocation of expenditure to the cost centres or cost units, and
d) Apportionment of expenditure to the cost centres or cost units
To inculcate the above items, costing is the classifying, recording, and appropriate allocation of
expenditure for the determination of the costs of products or services; the relation of these
costs to sales values, and the ascertainment of profitability.
Methods of Costing
Costing
A) Specific Order Costing B) Operation Costing
1) Job Costing
2) Contract Costing
3) Batch Costing
4) Process Costing
5) Single Output/Unit Costing
6) Service Costing
7) Multiple Costing
9
1) Job costing : ICMA of London defines as that form of specific order costing, which
applies where work is undertaken to customer’s special requirements.
2) Contract costing : For a large job in size and in duration, this method is applied.
3) Batch costing : A batch contains a number of small orders passed in batches through
the factory. ICMA defines batch costing as “that form of specific order costing, which
applies where similar articles are manufactured in batches either for sale or for use
within the undertaking”. In most cases, the batch costing is similar to job costing.
4) Process costing : This method is applied in the factories where raw material is
processed in different stages to get a final product.
5) Single output/unit costing : Under this method, production is continuous and units
are identical.
6) Service costing : It is suitable for the firms that render service rather than product,
such as railway, road transport operation, hospital, canteens etc.
7) Multiple costing : It is a combination of two or more of the above methcds. This system
is adopted in the manufacturing concerns, which produces the parts of a product
separately and assemble it for a final product.
Types of Costing
The following are the types of costing
1) Uniform costing : Using of same costing principles and practicing by several

undertakings for common control
2) Standard costing : To identify the positive or adverse effect raised and the cause for it,
by comparing the actual cost with standard cost.
3) Marginal costing : To ascertain the marginal cost by differentiating the fixed cost with
variable cost
4) Historical costing : It is the ascertainment of costs after they have been incurred. It
aims at ascertaining costs actually incurred on work done in the past.
10
5) Direct costing : Under this practice, all direct costs i.e. variable costs and some fixed
costs relating to operations, processes or products (leaving other costs to be written off
against profits) are charged.
6) Absorption costing : Under this type, the practice of charging all costs irrespective of
its types is followed.
1.3 Essentials of a Good Costing System

Before installing costing system we must verify that, if it possess the below mentionen
characteristics which brings all advantages to the firm
1) It should be simple, flexible, adaptable to the changing conditions, and easy to understand
by the entire firm.
2) The system should be economically suitable to the firm.
3) It should facilitate the management to make comparison with experiences and or with
other concerns.
4) No disturbance or fewer disturbances is acceptable at the time of installation.
5) Uniformity in maintenance of forms and statements should be followed.
6) It should possess less clerical work.
7) It should have efficient material and labour control.
8) It should have proper and sound plans for the growth of the firm.
9) The systems of cost and financial accounting must be facilitated to reconcile them in
the easiest manner.
10) Cost accountant’s duties, liabilities, and responsibilities should be defined clearly under
good costing system.
1.4 Installation of Costing System

Before, installation of good costing system in a concern, the cost accountant should make
preliminary investigation that the system has the quality and relates to the
11
1. Objectives of good costing system
2. Business
3. Product manufactured
4. Organisation
5. Manufacturing methods
6. Standard method of form to be followed in clerical work
7. Proper system of communication to be prepared to the management
8. Accounting system followed / to be followed
9. Economical condition of the firm
10. Cost records.
Check Your Progress
1. Define : cost accounting.

According to the institue of cost and work accountants UK - Cost accounting is the application of cost
accounting principles, methods and techniques
to the art, science and practice of cost control and ascertainment of profitabiltiy and providing details
derived to the management decision making process.
2. What do you mean by cost audit?
3. What is Marginal Costing?

12
4. State Whether True or False.
a) Cost Accounting provide information for ascertaining the financial position as on a

particular date.
b) The scope of Cost Accounting includes cost ascertainment, cost presentation, and
cost control.
c) Cost Accounting is an instrument of management
d) Cost Accounting is the post-mortem of past costs.
e) Cost Accounting helps in the ascertainment of cost before hand.
1.5 Summary
From the above items, it is clear that the hierarchy of cost is, cost ’! costing ’! cost accounting
cost accountancy. It is possible to ascertain the per unit cost easily with the cost related items.
It also reveals how to prepare plans and budgets from the experience. Proper control is possible
to reduce the cost. It is clear that cost accounting helps the management to make a right
decision for future. The cost, costing, cost accounting, and cost accountancy takes various
forms and it has its own objectives and scope for the support of the management for decision-
making process.
1.6 Key Words

Cost : The expenditure whether paid or payable either actual or notional incurred, or attributable
to see a product or service
Costing : Classifying, recording and proper allocation of expenditure for the determination of
the costs of products or services.
Cost Accounting : The application of costing and cost accounting principles, methods and
techniques and presentation of information derived there from for the purpose of managerial-
decision making.
Cost Accountancy : The application of costing and cost accounting principles, methods and
techniques and practice of cost control and the ascertainment of profitability and the derived
details supports the management in decision-making process.
13
Cost audit : It is the verification of the correctness of the cost records and a check on the
adherence to the cost accounting plan. It is to verify that the cost accounting rules and principles
are followed correctly or not.

1. What are the objectives of Cost Accounting?
2. Explain the advantages of Cost Accounting.
3. State the scope of Cost Accounting.
4. Differentiate: Cost Accounting and Financial Accounting
5. Explain the methods of Costing.
6. What are the types of Costing?
7. What are the essentials of a good costing System?
8. Write a note on the responsibilities of a Cost Accountant before installing Cost System
in a firm.
1.8 Answers to Check your Progress

4) a) False b) True c) True d) False e) True
14
LESSON - 2
COST ANALYSIS
Learning Objectives
* Explain the cost concept
* Explain the classification of cost.
Structure
2.1 Introduction
2.2 Cost Concepts
2.3 Analysis of Costs
2.4 Classification of Costs
2.5 Summary
2.6 Key Words
2.1. Introduction
In the previous chapter, you have learnt the history, meaning, scope, objectives, advantages &
disadvantages of costing, what is cost accountancy and what is financial accounting, methods
and types of cost accounting, essential factors of good costing system and how to install a good
costing system in a firm. This chapter will make you to learn the cost concepts, how the cost is
classified based on its characteristics.
15
2.2 Cost Concepts

In the previous chapter, we saw that cost means "the amount of expenditure (whether payable
or paid and actual or notional) incurred to produce a product or service. The cost must be
studied in relation to its purpose and conditions in total. A cost accountant is mainly concerned
with the following concepts.
1) Total cost : The sum of expenses incurred (whether it is paid or not) in the production,
sale or distribution or in rendering of a service to a customer.
2) Marginal cost: The amount by which the total cost varies if there is an increase or
decrease of one unit in production.
3) Standard cost: The predetermined or target cost set to maintain the standard in the
operation condition of a firm.
4) Conversion cost : The cost of producing partly or fully finished products excluding the
cost of direct material but including gains & losses in weight or volume of direct material
raised out of production.
5) Direct cost: The total of marginal cost and a portion of fixed cost that can be traced
allocated to products.
6) Cost centre : Acost centre is a location, person or item of equipment for which cost
may be ascertained and used for the purpose of cost control. The following are the sub-
division of cost centres.
a) Personal & impersonal cost centre: Personal cost centre consist of a person or
a group of persons like works-manager, sales-manager, storekeeper etc., and
impersonal cost centre consists location of the factory, items of equipments.
b) Operating cost centre : It consists of machines and / or persons carrying out

similar operations.
c) Process cost centre: It consists of specific process or a continuous sequence of

operation.
7) Profit centre : A profit centre is that segment of activity of a business, which is responsible
for both revenue and expenses discloses the profit of a particular activity. This is
responsible to measure the performance of the individuals.
16
2.3 Analysis of Cost

When the cost elements classified on the basis of its nature is called as the cost analysis. The
total cost is classified under three headings as elements of cost such as material, labour and
overheads. Further it is classified on the basis of directability as direct material, labour & overhead
and indirect material, labour and overheads.
2.4 Classification of Costs

The cost classification is the process of grouping cost according to their common characteristics.
It is essential to classify the cost to identify the cost centres or cost units. The cost can be
classified on the basis of the following factors
1) Elements / Nature : The items which are directly related to the product and forms the
product are called the elements and expenditure related to the elements are the
elements of cost. They are
a) Materials : The raw material directly required for the production.
b) Labour : The labour directly required for the production process.
c) Overheads : The expenses other than the above two, which are directly related
to the production process.
2) Function: The costs, which are divided in the light of the different aspects of basic
managerial activities, see involved in the operation of a business.
a) Production cost : Total cost incurred from the production
b) Administration cost : Cost incurred for formulating policy, directing the organisation,
and controlling the operation of a firm, which is not related to R&D, production and
selling function.
c) Selling cost : The expenditure related in seeking of demand and stimulating the
demand (e.g. Advertisement etc.)
d) Distribution cost : The cost related to packing of product available for despatch
and the cost incurred for the returned empty containers if any. (e.g. carriage outwards
etc.)
17
3) Variability : Under this, cost is classified according to their behaviour in relation to the
changes in volume of production.
a) Fixed cost : A cost which tends to be unaffected by variations in volume of output

(e.g. Rent, Depreciation, Insurance etc.)
b) Variable cost: A cost which tends to vary directly with the volume of output. (e.g.
Direct material, Labour & overheads)
c) Semi-fixed and Semi-variable cost : The cost, which is partly fixed and partly
variable, is semi-fixed and semi-variable cost. (e.g. Telephone charges etc.)
4) Controllability: The costs, which are classified according to whether cr not they are
influenced by the action of a given person of the firm.
a) Controllable cost : The cost, which is influenced, by the action of a given person of
the firm is controllable cost.
b) Uncontrollable cost : The cost, which is not influenced, by the action of a given
person of the firm is uncontrollable cost.
5) Normality : The classification is made according to whether or not they are normal
costs, which are normally incurred at a given level of output in the conditions in which
that level of output is normally attained.
a) Normal cost : The normal cost that is normally incurred at a given level of output in
the conditions in which that level of output is normally attained is normal cost.
b) Abnormal cost: The costs which are not normally incurred at a given level of output
in the conditions in which that level of output is normally attained is abnormal cost
6) Capital & Revenue
a) Capital cost : The cost that is incurred in purchasing of asset either to cash income
or to increase the earning capacity is the capital cost.
b) Revenue cost : Any expenditure is done in order to maintain the earning capacity of
the concern is the revenue cost.
18
7) Time: Under this, the cost is classified based on experience, present condition, and
plan.
a) Historical cost: It is the ascertainment of costs after they have been incurred. It
aims at ascertaining costs actually incurred on work done in the past.
b) Predetermined costs : These are the estimated costs, which is used to make
comparison with the actual to identify whether there is a favourable or adverse effect.
8) Planning and controlling : Under this, the classification based on the execution of
plans and to have control on it.
a) Budgeted costs: It is an estimate of expenditure for different phases of business

operations, co-ordinated in a well-conceived framework for a period in future, which
subsequently becomes the written expression of managerial targets to be achieved.
b) Standard cost: The predetermined cost based on a technical estimate for material,
labour and overhead for a selected period and for a prescribed set of working
conditions is called standard cost.
9) Managerial Decision : Under this, the costs that are purely used for managerial decision-
making process are put together.
a) Marginal cost : The difference between fixed cost and variable cost.
b) Out of pocket costs : This is that portion of the cost which involves payment to the
outsiders, which do not involve any cash expenses.
c) Sunk costs : It is an irrecoverable cost and is caused by complete abandonment of

a project in a firm, which excludes the salvage or scrap value.
d) Differential cost : The change in cost due to change in the level of activity is called
as differential costing, which are known as incremental and decremenal costs.
e) Imputed / normal cost : The costs, which appear only in the cost accounts, are
imputed cost.
f) Opportunity cost: The possible maximum alternative earning that might have been
obtained if the productive goods, services or capacity have been applied to some
alternative use.
19
g) Replacement costs: It is the cost of replacement at current market price. It is the

cost at which there could be purchase of an asset, which is identical to that which is
being replaced.
h) Avoidable and unavoidable costs : The cost, which can be eliminated if a particular
product or department with which they are directly related to is avoidable cost. The
cost which cannot be eliminated if a particular product or department with which
they are indirectly related is unavoidable cost. It is also called as shut down cost.
i) Traceable costs : A cost, which can be easily identified with cost unit / cost centres.
j) Conversion cost : It refers to the cost of changing or converting the direct materials
into partly or fully finished products from one stage to next.
k) Research & Development cost: It is the cost incurred in seeking of improved and
sophisticated technologies in production to face the hectic competitions in the
market.
l) Policy cost: It is the cost, which is additional to normal requirements incurred or

spent in accordance with the policy laid down by the management.
m) Postponable cost: The costs, which can be shifted to a future date without affecting
the efficiency of current operations, when there is any economical crisis etc., are
called as postponable costs.
Check Your Progress
1. What do you mean conversion cost?
2. Define fixed cost

20
3. What is opportunity cost?
4. Fill in the blanks.
1. The cost comprising of all expenses is_______________
2. _______________ cost are partly fixed and partly variable in relation to output.
3. An opportunity cost is_______________
4. Out of pocket cost involve payment to______________
5. Fixed cost______________irrespective of the level of output.
6. Men / machine carrying the similar work are included in______________
7. The______________are shifted to future periods.
8. The cost of alternative asset for existing one in current market price is______________
2.5 Summary
The cost of a product is ascertained by using the various concepts of cost. The expenses
incurred for them are classified based on its nature and common characteristics, which help
see the management for proper decision-making for future prospects of the concern.
2.6 Key Words

Cost concepts: A study about cost in relation to Lts purpose and condition in total.
Fixed cost : The expenditure which remains unchange irrespective of the level of output
Production cost : The cost incurred from the production process.
Cost centre : It is a location, person or items of equipment for which cost is to be axertained
and used for the purpose of cost control.
21

1. Explain the Cost concepts.
2. Chart out the classification of costs and explain them.
3. Write a short note on Avoidable & unavoidable cost.

1) Total cost
2) Semi variable & Semi fixed
3) The advantage of foregone
4) Outsiders
5) Remains constant
6) Operation cost centre
7) Postponable costs
8) Replacement cost
22
LESSON - 3
OUTPUT COSTING
Learning Objectives
• Explain the meaning of the cost sheet
• Discuss the purpose of the cost sheet
• List out the components of the cost sheet
• Explain how a cost sheet is prepared
• Explain what is tender / quotation and how it is prepared
Structure
3.1 Introduction
3.2 Cost Sheet
3.3 Tenders and Quotations
3.4 Summary
3.5 Key Words
3.8 Suggested Readings
3.1 Introduction
In the previous chapter, you have learnt how the costs are classified according to their charac-
teristics, and how they are treated. It has also made you to learn how a cost accountant is
mainly concerned with the cost concepts. This chapter attempts to show how cost sheet or
statement of cost is prepared and how they get form as cost component.
23
3.2 Cost Sheet

The expenses relating to the finished product are extracted from financial accounts. These
expenses are analysed and tabulated in a form of statement. This statement is called as cost
sheet. Bigg defines it as "the expenditure which has been incurred upon production for a period
is extracted from the financial books and the stores records, and set out in a memorandum or a
statement" is called as cost sheet.
Purpose of the Cost Sheet
a) It gives the break up figures of the total cost under different elements.
b) It gives the total cost and cost per unit.
c) It facilitates comparisons to have cost control.
d) It helps in preparation of cost estimates.
e) It helps in fixing the selling price.
Preparation of Cost Sheet
The expenses which is related to production either directly or indirectly are put together which
forms the total cost of a product. In the cost sheet the total cost of the products are bifurcated,
based on the cost classification.
The following will make you to understand the components of a cost sheet
1) Direct Material + Direct Labour + Direct Expenses = Prime Cost.
2) Prime Cost + Production / Works = Works / Factory / Production / Manufacturing Cost.
3) Works Cost + Office administration = Office cost / Total cost of production.
4) Office cost + selling and distribution = Cost of sales / Total cost.

24
The following format shows you, how a statement or cost / cost sheet is prepared.
[SPECIMEN OF COST SHEET)
1) Cost sheet for the period ...
Particulars Amount Total No. of Cost

cost Units per unit
Direct Material
Opening Stock XXXX
(+) Purchase of Raw Material XXXX
(+) Carriage inwards XXXX
XXXX
(-) Closing Stock of Raw Material XXXX
Cost of Direct Material XXXX
Direct Labour / Wages XXXX
(+) Outstanding, (-) Prepaid (if any) XXXX
XXXX
Direct Expenses XXXX XXX
PRIME COST XXXXX XXX
Add Factory Expenses
Indirect Labour XXX
Indirect Material XXX
Indirect Expenses XXX
Factory Supervisor's salary XXX
Repairs XXX
Up keep of factory XXX
Light, Heat, Power, Coal, Gas,
Oil, Water, Lubricants etc. XXX
Factory Rent & Rates XXX
Factory expenses XXX
25
Depreciation on factory
Plant XXX
Building XXX
Premises XXX
Loose tools written off XXX
Haulage XXX
Consumable Stores XXX
Research & Experimental XXX
expenses XXX
Wastage of materials XXX
Drawing office expenses XXX
Works Stationary XXX
Factory Insurance XXX
Works Manager's salary XXX XXXX XXX
GROSS WORKS COST XXXX
(+) Opening work-in-progress XXX
XXX
(-) Closing work-in-progress XXX
WORK COST XXXX XXX XXX
Add Administration Expenses
Office Salaries XXX

Office Lighting & Power XXX
Office Rent & Rates XXX
Office Insurance XXX
Printing costs XXX
Postage costs XXX
Office Manager's salary XXX
Director's fees XXX
Audit fees XXX
Repairs and Renewals XXX
26
Telephone charges XXX

Cleaning charges XXX
Legal charges XXX
Bank charges XXX
Depreciation on
Office Buildings XXXX
Furniture & Equipments XXXX
Premises XXXX
XXXX
COST OF PRODUCTION XXXX XXX XXX
(+) Opening Finished goods XXXX
XXXX
(-) Closing Finished goods XXXX
COST OF GOODS SOLD XXXX
XXXX
Add Selling and Distribution
Expenses
Advertisement XXXX
Salesmen salaries XXXX
Samples and free gifts XXXX
Sales office rent XXXX
Sales promotion expenses XXXX
Packing and demonstration XXXX
Commission to salesmen XXXX
Travelling expenses XXXX
Warehouse Rent & Rates XXXX
Repairs and up keep of
delivery vans XXXX
Carriage out wards XXXX
Distribution department salaries XXXX
Bad debts XXXX
XXXX
COST OF SALES XXXX

27
Illustration 1
Calculate the Prime cost, Factory cost. Total cost of production and Cost of sales from the
following particulars:
Particulars Rs. Rs.
Raw materials consumed 40,000
Wages paid to labourers 10,000
Directly chargeable expenses 2,000
Oil & Waste 100
Wages of Foremen 1,000
Store keeper's wages 500
Electric Power 200
Lighting : Factory 500
Office 200 700
Rent : Factory 2,000
Office 1,000 3,000
Repairs & Renewals:
Factory Plant 500
Machinery 1,000
Office Premises 200 1,700
Depreciation :
Office Premises 500
Plant & Machinery 200 700

28
Consumable stores 1,000
Manager's salary 2,000
Directors' fees 500
Office Printing & Stationery 200
Telephone charges 50
Postage & Telegrams 100
Salesmen's commission & Salary 500
Travelling expenses 200
Advertising 500
Warehouse charges 200
Carriage outwards 150
Solution
Cost Sheet for the period ending. . ....
Rs. Rs.
Direct material : Raw materials consumed 40,000
Direct labour: Wages paid to labourers 10,000
Direct expenses: Directly chargeable expenses 2,000
Prime Cost 52,000
Add Factory Overheads
Indirect material:
Consumable stores 1,000
Oil and waste 100
Indirect labour :
Wages of Foremen 1,000
Storekeeper wages 500

29
Indirect Expenses :
Electric power 200
Factory lighting 500
Factory rent 2,000
Repairs & Renewals :
Plant 500
Machinery 1,000
Depreciation :
Plant & Machinery 200
7,000
Factory or Works Cost 59,000
Add Office or Administrative
Indirect materials:
Office printing and
stationery 200
Indirect labour :
Manager's salary 2,000
Director's fees 500
Indirect Expenses :
Office lighting 200
Office rent 1,000
Repairs and renewals-premises 200
Dep. On premises 500
Telephone charges 50
Postage and telegrams 100 4,750
Total Cost of Production 63,750
Add Selling & Distribution
Indirect labour :
Salesmen's commission and salary 500
Indirect Expenses :
Travelling expenses 200
Advertising 500
Warehouse charges 200
Carriage outward 150 1,550
Cost of Sales 65,300
30
Illustration 2
The following figures are extracted from the Trial Balance of Jeyasuras & Co. on 304
September, 1991.
Particulars Rs. Rs.
Inventories:
Finished Stock 60,000
Raw Materials 1,60,000
Work-in-Progress 1,80,000
Office Appliances 17,400
Plant & Machinery 4,60,500
Buildings 2,00,000
Sales 8,00,000
Sales Return and Rebates 14,000
Materials Purchased 3,20,000
Freight incurred on Materials 12,000
Purchase Returns 4,800
Direct Labour 1,40,000
Indirect Labour 18,000
Factory Supervision 10,000
Repairs and Upkeep-Factory 14,000
Heat, Light and Power 65,000
Rates and Taxes 6,300
Miscellaneous Factory Expenses 18,700
Sales Commission 33,600
Sales Travelling 11,000
Sales Promotion 22,500
Distribution Dept.-Salaries and Expenses 18,000
Office Salaries and Expenses 8,600
Interest on Borrowed Funds 2,000
31
Further details are available as follows:

(i) Closing Inventories:
Finished Goods 1,15,000
Raw Materials 1,20,00
Work-in-Progress 1,62,000
(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 8:1:1.
Rates and Taxes two-thirds to Factory and
one-third to Office.
Depreciation on Buildings to Factory, Office and
Selling in the ratio 8:1:1..
With the help of the above information, you are
required to prepare :
(i) a statement of cost showing various elements of cost, and
(ii) a statement of profit.
Solution
I) Statement of Cost For The Period Ending..........
Rs. Rs.
Add Opening Raw Material Inventory 1,60,000
Materials purchased 3,20,000
Freight on Material 12,000
4,92,000
32
33
3.3. Tenders and Quotations

Usually a manufacturer is compelled to quote the price of a product to be supplied by him when
a customer demands it, to place order with him. To quote the competitive price the manufacturer
has to prepare a statement, which is called as tender or quotation. The price, at which the
supplier offers his goods for sale, is known as tender or quotation. This tender/quotation have to
be prepared very carefully and must be competitive as the receipt of orders depends upon the
acceptance of price supplied. To prepare a tender the following factors are to be carefully
considered. They are
1) Cost of materiale
2) Cost of labour and chargeable expenses

34
3) Cost of factory overheads

4) Cost of office overheads
5) Cost of selling & distribution overheads and
6) Estimated profit
Utmost care is to be taken while estimating the different elements of cost: material cost is
estimated on the basis of cost per unit of preceding period subjec fluctuations in the market
price for the estimated output of the future period. Direct Labour Cost is to be estimated by
taking into account of proposed increase in wage rates. Overheads are to be estimated based
on experience and current trends.
Practically, they are estimated as percentage. For example
% of factory overheads to direct wages = (F.O.H / Direct wage) *100
% of office overheads to works cost = (Office O.H/Works cost) *100
% of selling overheads to works cost = (Selling O.H/Work cost) * 100
Illustration 3
The following figures relate to the costing of a tarpaulin manufactured in respect of certain type
of sheet for a period of three months.
Details Rs.
Stock of materials, 1st January 6,000
Stock of materials, 31st March 4,000
Factory wages 85,000
Materials purchased 80,000
Sales 1,80,000
Indirect expense's 15,000
Completed stock. 1st January 10,000
Completed stock. 31st March 30,000
The number of sheets manufactured during three months 2,500 and the price is to be quoted for
700 sheets, in order to realise the same percentage of profits as for the period under review,
assuming no alteration in rates of wages and cost of materials
Prepare a statement of cost for the manufacture of 2500 sheets and quotation for 700 sheets.
35
Solution
Statement of Cost for the Period Ending 31* March 19.....

(Output 2,500 Sheets)
36
Illustration 4
From the following data, prepare a cost and production statement of Popular Stove Manufacturing
Company for the year 2020.
Rs.
Stock of materials on 1-1-2020 35,000
Purchase of materials 52,500
Factory expenses 17,500
Establishment expenses 10,000
Completed stocked in hand on 1-1-2020 Nil
Completed stocked in hand on 31-12-2020 35,000
Sales 1,89,000
The number of stoves manufactured during the year 4,000.
The company wants to quote for a contract for the supply of 1,000 electric stoves during the
year 1995. The stoves to be quoted are of uniform quality and make, and are similar to those
manufactured in the previous year, but the cost of material 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 realised during the year 2020 assuming that the cost per unit of overhead
charges will be the same as in the previous year.
37
Solution
Statement showing Cost of 4,000 Stoves for the year ending 2020.
(Output: 4,000 Stoves)
38
Check Your Progress
1) What are the purposes of Cost sheet?
2) What is a Cost sheet / Statement of cost?

39
3) In a Cost sheet, on what basis are the expenses incurred relate production process
shown?
4) Fill in the blanks
a) Direct Material, direct labour and direct expenses comprises___________
b) Prime cost plus works overheads is equal to___________
c) Cost of production includes ___________
d) Cost of sales is derived from ___________
3.4 Summary
The cost sheet helps in ascertainment of cost per unit. This single or output costing is employed
in case of industries where
i) The production is uniform and a continued affair
ii) The units of production are identical, and
iii) The cost units are physical and natural.
This system is also suitable to make estimates for future and to prepare tenders and quotations
in competitive price to succeed in the competitive market. It is possible to prepare the tenders
and quotations because the costs incurred to the finished product are recorded based on its
classification.
3.5 Key Words

Cost Sheet
Prime cost
Works Cost
40
Total cost
Tender

1) How a cost sheet is prepared?
2) What is a tender / quotation?
3. The Directors of a Manufacturing business require a statement showing the production

results of the business for the month of March. The accounts reveal the following
information:
you are required to construct a statement to show:
a) The value of materials consumed,
b) The total cost of production

41
c) The cost of goods sold, and
d) The net profit for the month
4) The following data have been extracted from the books of M/s Moonshine Industries for
the calendar year 2020 Details
The Managing Director's remuneration is to be allocated as Rs.4,000 to the Factory. Rs. 2000 to
the office and Rs.6,000 to the selling departments. From the above information prepare
(a) Prime cost (b) Works cost (c) Cost of production (d) Cost of sales and (e) Net profit.
42
5) From the following data prepare a cost and production statement of Nathan Stoves
Manufacturing Co. for the year 2020.
Details Rs.
Purchase of materials 52,500
Factory expenses 17,500
Establishment expenses 10,000
Completed stock in hand on 1-1-2001 Nil
Completed stock in hand on 31-12-2001 35,000
Sales 1,89,000
The number of stoves manufactured during the year 2020 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 and 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 realised during the year 2020, assuming that the cost per unit of overhead
charges will be the same as in the previous year.
6) On 314 July, 2020 a carpet manufacturer desired to quote for contract for the supply of
2,000 carpets. From the following particulars, prepare a statement showing the price to
be quoted to give the same percentage of net profit on the turnover as was realised
during the six months ending 30th June, 2017
43
Details Rs.
Stock of materials on 1st January, 2017 2,00,000
Stock of materials on 30th June, 2017 28,000
Purchase of materials during six months 3,00,000
Factory wages during six months 6,00,000
Indirect wages during six months 1,00,000
Sales during six months 10,80,000
Stock of finished carpets on 1-1-2017 Nil
Stock of finished carpets on 30-6-2017 2,00,000
The number of carpets manufactured during the six months was 24,000 including those sold
and those in stock at the close of the period. The carpets to be quoted are of uniform size and
quality and similar to those manufactured during the six months to 30% June 2017. As from 1st
July 2017, the cost of factory labour has increased by 10% and of materials by 5%.

4) a) Prime Costa
b) Works Cost
c) Works cost & office overheads
d) Cost of production and selling and distribution expenses.

44
LESSON - 4
RECONCILIATION OF COST AND

FINANCIAL ACCOUNTS
Learning Objectives
• Explain what is cost accounting and financial accounting
• Discuss what is reconciliation of cost accounts and financial accounts
• List out what are the reasons for disagreements, while making comparison of cost ac-
counting with financial accounting
• Explain the necessity of preparing a reconciliation statement and why it is prepared.
Structure
4.1 Introduction
4.2 Reconciliation of Cost and Financial Accounts - Variations
4.3 Preparation of Reconciliation Statement
4.4 Summary
4.5 Key Words
4.1 Introduction
From the previous chapter, you have learnt that expenses, which are merely in cost nature, are
recorded in the cost accounting, but at the same time the cost nature and financial nature items
of expenses are recorded in the financial accounts in large business concerns. Naturally, while
45
integrating the cost accounting and financial accounting of these large concerns the cost profit
will not agree with financial profit. To identify and rectify these disagreements the reconciliation
statement is to be prepared.
4.2 Reconciliation of Cost and Financial Accounts - Variations

The business concerns, which are large, will maintain separate set of books for cost nature and
financial nature items. While closing these set of books the profit or loss arrives. Mostly the
profit or loss of cost accounts will not agree with financial books, because the items of incomes
and expenses in cost nature will be recorded only in the cost books, where both the cost and
financial nature incomes and expenditures will be recorded in the financial books. Sometimes
there are chances of omission of expenses or income or both in the cost and or in the financial
books. These are the reasons for disagreement of profit/ loss. To identify the reasons for dis-
agreement, the reconciliation statement is to be prepared. If the integral accounting system is
not followed, preparation of reconciliation statement becomes necessary..
Reasons for Variations
a) Items included in the cost accounts but not included in the financials accounts and vice-
versa.
b) Matters of financial nature which will appear only in the financial books, such as
Financial Charges
1) Loss on sale of fixed assets
2) Interest and dividend paid
3) Expenses of capital nature Expenses of capital man
4) Donations, discount on shares and debentures
5) Stamp duties, fines, penalties
6) Damages payable, loss due to machinery scrap
7) Cash discount
46
Financial Incomes
1) Interest on bank balances
2) Profit on sale of fixed assets
3) Interest on loan, share transfer fees
4) Rent on sublet
5) Dividends on investments
6) Discount or commission received
7) Brokerage received
Appropriation of Profits
1) Sinking funds
2) Dividends paid
3) Interest paid on debentures
4) Taxes
5) Amounts written off
c) Matters shown in cost account only but not in financial accounts such as notional rent,
interest on capital employed in production.
d) Under-or-over absorption of overheads in cost accounts or in financial accounts
e) Abnormal losses and gains recorded in the financial accounts but not in the cost ac-
count.
f) Over or under valuation of opening, closing stock in the cost accounts or in the financial
accounts
g) Omission of recording expenses or incomes either in one book or in both books.

47
4.3 Preparation of Reconciliation Statement

Method-1 (Vertical form)
[Specimen)
Reconciliation Statement
48
49
IIlustration 1
The net profit of A Co. Ltd. appeared at Rs.60, 652 as per financial records for the year ending 31
March 1995. The Cost Books, however, showed a net profit of Rs.86, 200 for the same period.
A scrutiny of the figures from both the sets of accounts revealed the following facts:
Details Rs.
Works overhead under-recovered in costs 1,560
Administrative overheads over-recovered in costs 850
Depreciation charged in financial accounts 5,600
Depreciation recovered in costs 6,250
Interest on investments not included in cost accounts 4,000
Loss due to obsolescence charged in financial accounts 2,850
Income-tax provided in financial accounts 20,150
Bank Interest and transfer fee in financial books 375
Stores Adjustment (credit in financial books) 237
Value of opening stock in :
Cost accounts 24.800
Financial accounts 26,300
Value of closing stock in :
Cost accounts 25,000
Interest charged in cost accounts 2,000
Goodwill written off 5,000
Loss on the sale of furniture 600
Prepare a statement showing the reconciliation between the figure of net profit as per Cost
Accounts and the figure of net profit as shown in the Financial Books.
50
Solution
51
Illustration 2
From the following summary of Trading and Profit and Loss Account which appears in the
financial accounts of X. Ltd., and the additional information given, you are required to prepare
detailed statement reconciling the profit of Rs.60,570 as disclosed by the Financial Accounts
with the figure of profit i.e. Rs.54,650 as disclosed in Cost Accounts.
Summary of Trading and Profit and Loss A/C

52
Note
(a) In the Cost Accounts (i) works expenses are charged at a rate of 5 paise per product
produced (ii) selling expenses are charged at a rate of 12 per cent on sales (ili) admin-
istration expenses are charged at a fixed sum of Rs.25,000 per annum, which includes
financial expenses Rs. 13,000.
(b) Items of non-revenue value are not included in the Cost Accounts.
(c) In the Cost Accounts, stock is valued at direct cost (Materials and Labour) but infinancial
accounts, it includes an allowance for overheads.
(d) Opening Stock-5,000 units
Rs.
Valued: Materials 3,100
Labour 1,100
Overheads 800
5,000
(e) Closing Stock - 8000 units
Rs.
Valued: Materials 5,300
Labour 1,700
Overheads 1,500
8,500
Sales were 2, 10,000 units at Rs.1.50 per unit.

53
Solution
54
Check Your Progress
1) What do you mean by reconciliation statement?
2) How will you deal with under or over valuation of stocks in cost accounting while preparing
reconciliation statement?
3) State whether True / False
Indicate whether the following statements are true or false.
i) Cost and financial accounts are reconciled under non-integral accounting.
ii) Rent on owned building is not included in cost accounts.
iii) Costing Profit and Loss Account includes all items of financial nature (like interest) which
are not included in cost ascertainment.
iv) Dividend received but not included in cost accounts is to be added back to costing profit
in reconciling profit with financial profit.
v) Income tax is provided in cost accounts only. iseen
vi) Over absorption of production in cost accounts are deducted to costing profit to recon-
cile it with profit as per financial book.
4.4 Summary
The manufacturing concerns those who are not maintaining separate cost and financial
accounts, the disagreement between cost account balance and financial account balance do
not arise. But in the concerns those who maintain separate books it is imperative that accounts
are to be reconciled. The reconciliation statements are prepared due to the following reasons;
55
1) To identify the reasons for the difference in the profit or loss in cost and financial
accounts.
2) To ensure the mathematical accuracy and reliability of cost accounts in order to have
cost ascertainment, cost control and to have a check on the financial accounts.
4.5 Key Words

Reconciliation : Cross checking of inter related two books and identifying the reasons for
disagreement of balances available in those books.
Under-absorption : Recording less (value) than the actual
Over-absorption: Recording more (value) than the actual

1) Explain the methods, in which the reconciliation of cost & financial account statements
are prepared.
2) State briefly the causes of difference between profits shown by Financial Accounts and
by Cost Accounts.
3) A Company's Trading and Profit and Loss Account was as follows:
The profit as per cost accounts was only Rs.19, 770. Reconcile the financial and cost profits
using the following information:
56
a) Cost accounts value of closing stock: Rs.4, 280.
b) The works expenses in the cost accounts were taken as 100 per cent of direct wages.
c) Selling and administration expenses were charged in the cost accounts at 10 per cent of
sales and Rs.0.10 per unit respectively.
d) Depreciation in the cost accounts was Rs.800.
[Hints. Add: Profit on sale of land Rs.2, 340. Over absorption of selling expenses 400/ -
Discount Received Rs.260. Less : Over-valuation of closing stock in cost accounts
Rs.200, under-absorption of Works Expenses Rs.1,630 Administration Expenses
Rs.340, undercharge of Depreciation in cost accounts Rs.300 ]
4) From the following figures prepare a Reconciliation Statement:
Rs.
Net Loss as per costing records 1,72,400
Works overhead under-recovered in costing 3,120
Administrative overhead recovered in excess 1,700
Depreciation charged in financial records 11,200
Depreciation recovered in costing 12,500
Interest received not included in costing 8,000
Obsolescence loss charged in financial records 5,700
Income-tax provided in financial books 40,300
Bank interest credited in financial books 750
Stores adjustments (credit ) in financial books 475
Value of opening stock in :

57
Value of closing stock in:
Interest charged in cost accounts but not in financial accounts 6,000
Preliminary expenses written off in financial accounts 800
Provision for doubtful debts in financial accounts 150
Ans. [Net Loss as per financial records Rs. 2, 08,045]

3) i) True ii) False ii) False iv) True v) False vi) False
58
LESSON - 5
MATERIALS - PURCHASE CONTROL
Learning Objectives
• Explain the necessity of materials control
• Discuss the objectives and aspects of material control
• List out the essentials of material control
• Explain purchase control and purchase department
• Chart out the meaning, advantages and disadvantages of centralised purchasing
• Discuss the functions of purchasing department and forms used.
Structure
5.1 Introduction
5.2 Materials
5.3 Material Control
5.4 Purchase Control
5.5 Receiving and Inspecting Materials
5.6 Checking and Passing of Bills for Payment
5.7 Summary
5.8 Key Words

59
5.1 Introduction
One of the main elements of cost is material. In a production, oriented industry without material,
production process is not possible. Because it is the first and most important element of cost.
This chapter will make you to acquaint, how the materials play a vital role in production-oriented
concern, and how they are controlled.
5.2 Materials
A finished product purchased by one is fully made from its required raw materials. So that we
are saying that, it is the first and most important element of cost. The materials account for
nearly 60 per cent of the cost of production. The following table enables to get an idea, to what
percentage the materials occupy in the cost of production.
Table -1
Average Materials Expenditure
Average expenditure of Types of Industries

materials (in percentage)
40-45 Aircraft, Newspaper, Fertilizer, Steel products
46-50 Pharmaceuticals
51 - 55 Electricity, Cement, Chemicals, Tyre, Machine,

Tools, Ship-building.
56-60 Non-Ferrous, Engineering.
61 - 65 Bread, Cotton Textiles.
66 & above Cotton yarn, earthmoving equipment, sugar, wool,

jute, fabrications
According to the Indian Association of Materials Management, in one rupee of the cost, 64 paise
is the cost spent on material, 16 paise for labour and 20 paise for overheads.
60
5.3 Material Control

A comprehensive framework for the accounting and control of material cost designed with the
object of maintaining material supplies at a level so as to ensure uninterrupted Production, but
at the same time minimising investments of funds is called as material
TOI. It is a systematic control over purchasing, storing and using of material so as to have the
minimum possible cost of materials. The material control covers three stages viz., purchase,
storing and issuing control.
The authors Matz, Curry & Frank, say that "because materials constitute such a significant part
of product cost and since this cost is controllable, proper planning, purchasing, handling and
accounting are of great importance". An effective material control requires the systematic
preparation of period summaries and reports.
Material Control - Levels
Material control consists of two levels. They are
a) Quantity or Unit control
b) Rupee or Financial control
Quantity or unit control are suitable to the production executives and store keepers who deal
only with the quantity or unit, but the second one is suitable only for the financial executives to
verify, how far the investment in materials is utilised.
The main objectives of the levels of material control are
a) Maintenance of sufficient quantity of every item of material for efficient operations, and
b) Maintenance of inventory that is not detrimental financially.
Material Control - Aspects
Under two aspects, the material control is followed. They are
a) Accounting aspect: It is concerned with maintenance of documentary evidence of

movement of materials at every stage.
b) Operation aspect : It is concerned with the maintenance of material supplies at a level

so as to ensure that materials are available for use in production and production services
as and when required by minimising investment in materials.
61
Obiectives of Material Control
The objectives of material control are:
1) To make available all types of materials and stores of right quality without any
interruption.
2) To make purchase of material at required quality according to the budget.
3) To make the purchase an economical one
4) To make adequate investment to avoid over-stocking by fixing maximum stock level.
5) To eliminate or to curtail losses such as wastage, leakage, spoilage etc.
6) To avoid obsolescence by adopting better method of issue of materials.
7) To provide the management with information of raw materials cost and its availability
etc.
8) To ensure proper storage and utilisation of materials.
Essentials of Material Control
The following are the essential factors in material control to achieve the maximum managerial
control
1) There should be co-operation and co-ordination among the departments dealing with
materials.
2) Expert who has been well trained should make centralised purchasing.
3) Materials should be properly codified, classified, and standardised.
4) Proper material storage should be executed to avoid unnecessary losses such as theft,
pilferage, wastage, spoilage, evaporation, decay, deterioration.
5) Store control measures such as ABC, VED analysis should be followed.
6) Levels of stock should be introduced to avoid, shortage and over-stocking of materials.
7) Proper formats should be followed to record all receipts and issues of materials.
8) Economical purchasing procedure should be introduced to reduce the ordering and

carrying costs.
62
9) Stocks must be priced on a suitable basis in order to ensure reliable costs.
10) Inspection at the time of receipt and issue of materials should be made.
11) Regular reports containing all details of materials should be submitted to the management
Advantages of Material Control
The following are the advantages of a good material control procedure.
1) It eliminates unnecessary losses.
2) It reduces risks.
3) Availability of right quality of material in right time.
4) It eliminates over stocking and shortage.
5) It leads to economical buying procedure.
6) Quick and accurate data availability relating to stores.
7) It avoids unnecessary delays.
5.4 Purchase Control

Correct cost, quality and volume plus proper time delivery are the effective purchase control
techniques. Very low-cost material may reflect more wastage, and high cost of sub-standard
product. Lack of proper purchase interrupts the production. Purchase control is one of the aspects
of material control. Purchase control starts with initiation of purchase requisition and ends with
receipt of materials by the stores and payment of the bill. This will be followed by the management
if it is a small concern. In case of large concerns, a separate purchase department is to take
care of the purchase control.
Purchasing Department
Purchasing is the most important function. This department is managed and headed by the
purchase manager who is also known as Chief Buyers. The following are the objectives of the
purchase department:
1) To make continuous availability of materials for uninterrupted production
2) To make wise purchase of materials at competitive and economical prices

63
3) To purchase proper quality of materials to reduce wastage during production
4) To make purchase at optimum level according to the requirement
5) To maintain good relationship with suppliers for uninterrupted supply of materials
6) To have an alternative to purchase materials when an existing supplier fails to supply

materials
7) To adopt most advantageous method of purchase to ensure smooth delivery, and to

avoid unnecessary risks, disputes and financial losses
8) To serve as an information centre regarding materials
To achieve the above objectives, Centralised purchasing is suitable for the separate purchase
department.
Centralised Purchasing
Centralised purchasing means, "all purchases should be made by the purchasing department."
Advantages of Centralised Purchasing
1) More trade discounts can be received, transportation charges is jet reduced.
2) It is possible to have economical as well as quality materials purchase because persons

possessing specialised knowledge and skill are engaged when separate purchase
department is formed.
3) Better control on purchasing is possible.
4) All records with regard to purchases are kept at one place under the supervision of
purchase officer. This results in economy, both in compilation and consultation of records.
5) Better layout of stores is possible.
Disadvantages of Centralised purchasing
1). Chances are there for delayed supply of materials.
2) In centralised purchasing branches at different places cannot take advantage of localised

purchasing.
64
3) There are chances of misunderstanding between the branch that requires the materialand
purchasing department with the result that wrong purchases can be made
4) It may lead to high initial cost while setting up of separate purchasing department.
From the above facts we may get concluded that the manufacturing concerns which have
branches or production units at different places, they should not follow the centralised purchasing
procedure.
Functions of Purchasing Department
The following are the functions of effective purchase to be followed by the purchase department.
1) Receiving purchase requisition
2) Exploring the sources of supply and choosing supplier and execution of purchasing
orders
3) Receiving and inspecting materials.
4) Checking and passing of bills for payment.
1) Indenting Materials / Purchase Requisition
A form in triplicate used as a formal request to the purchasing department to purchase material
is called as purchase requisition. Usually it is prepared by the store-keeper when it is a regular
purchase or by the department head for special (or) occasional purchase. The regular purchase
requisitions are prepared, when the items of materials reach at the ordering level to avoid shortage
of material and to give materials for uninterrupted production. The regular purchase requisitions
prepared by the store-keeper will be approved by the plant superintendent or works manager.
From this triplicate copy, original copy will be sent to purchasing department, the store-keeper
will keep the duplicate copy, and the triplicate cody will be sent to the authorising executive.
The specimen form of purchase requisition is given below for better understanding.
JEYASURAS COMPANY LTD. Purchase Requisition Regular / Special.
Date:---- Date by which Materials are required----
SI.No
65
2) Exploring the sources of supply and choosing the supplier
After receiving the purchase requisition, the sources of supply of material is to be selected.
Usually the purchase department will have the list of suppliers. The quotations will be called for,
by keeping in view the benefits to the concern such as lowest price, better quality, quick delivery
etc. After receiving the quotations, the tenders should be opened at the prescribed time. On
seeing the tenders a separate comparative statement is to be prepared to identify the quotation
suitable to the organisation. The suitable tenders, usually the lowest quoted will be selected and
the purchase order will be placed with them. The purchase order is to prepared in five copies
out of which original is to be sent to the supplier, second copy to the receiving department, third
copy to the accounting department, fourth copy to the initiating department and the fifth copy is
to be retained with the purchase department for reference.
The following are the specimen copies for better understanding.

66
67
The following illustration shows, how comparative statements are prepared.
Illustration 1
1) After inviting tenders, two quotations are received as follows:
Supplier 1) Rs.8.40 per unit
Supplier 2) Rs. 8.00 per unit plus Rs.4,000 fixed charges to be added irrespective of
units ordered.
68
With whom the order will be placed ?
Solution
For these types of quotations we have to identify the equal point of units to be ordered to these
two quotations by considering the fixed cost & difference in cost per unit.
Difference in price = (8.40 - 8.00)
= 0.40 paise.
Break event point in units = 4,000 / 0.40 paise
= 10,000 units (Equal point to order / Break Even point)
The quotation will be equal at 10,000 units i.e.
Supplier 1) 10,000 * 8.40 = 84,000
Supplier 2) 10,000 * 8.00 = 80,000
(+) Fixed charges = 4,000
84,000
Therefore
a) Orders can be placed with supplier 1 when purchase is less than 10,000 units.
b) If the requirement is more than 10,000 units supplier 2 is suitable.
Illustration 2
When tenders were invited for a store, quotations were received as under:
Supplier A
a) Rate Rs.2 each
b) Trade discount 10%
c) Cash discount 5%-if bills are paid within a fortnight after receipt
d) Transport charges Re.1 per 100 units.

69
Supplier B
a) Rate Rs.1.80 each (up to 1,000 units)

Rs.1.60 each (for orders above 1,000 units)
b) 6% interest per annum will be added if bills are not paid within a fortnight after receipt of
the materials
c) Transport charges Rs.3 per 100 units.
Assuming about 5,000 units are required every month and that quality and other conditions of
supply are the same, offer your comments as to whom purchase order can be issued. The
factory pays 50% of its total monthly bills every fortnight.
Solution
Comparative Statement of Cost Materials of Two Quotations

70
The purchases order should be issued to supplier B because of the lower cost of material.
5.5 Receiving and Inspectina Materials

After receiving the goods ordered in the factory door, the clerk concerned should verify the
goods received with the help of the Delivery Note and Copy of the purchase order. The quantity
and quality of materials should be checked carefully before passing them to the store. The
delivery note in duplicate should be signed by the receiving department. One copy should be
returned to the supplier and the second copy is to be retained. In huge concerns this will be done
by the inspector concerned for which he will give an inspection report. The following are the
specimen of the goods received report and inspection report.
Note: The above statement is to be prepared in three copies
- One to purchase department
- One to accounting department
- One to initiating department

71
Note: The above statement is to be prepared in four copies.
- Purchase department
- Receipt department
- Stores department
- Office copy
5.6 Checking and Passing of Bills for Payment

With the help of Goods Received Note, Purchase Order and Inspection Report, the bill of supply
of materials is checked. Arithmetic accuracy is also verified. To verify the material cost items
like invoice price freight, sales tax, excise duty, cost of containers whether it is returnable at full
cost or returnable at reduced cost or non-returnable are checked thoroughly. Having checked all
these items, the bill is passed and sent to the accounts section, which makes the payment by
accepting a stamped receipt.
72
Check Your Progress
a) Material control should meet two conflicting objectives: 1) the maintenance of sufficient
quantity of every item of material for efficient operations, and 2) maintenance of an
inventory, that is -
b) Material control aims at achieving effective _________
c) Material control covers three stages_________
d) Two levels of material control exist_________
e) There are two aspects, namely_________ of material control.
2) State whether True / False
a) Purchase order is prepared by the purchasing department.
b) Purchase requisition is sent by the purchasing department.
c) Original copy of the purchase order is retained by the purchasing department.
d) Purchase control is exercised by the storekeeper.
e) Tender form is issued by the purchasing department.
f) Goods received note is prepared by the goods receiving clerk.
3) Explain Material Control.
4) What are the levels of material control ?

73
5) What are the aspects of material control?
6) Differentiate: Regular purchase and special purchase.
5.7 Summary
It is essential to all large concerns to have a proper purchase control to avoid unnecessary
wastages and loss of investments, because materials occupy a minimum of 40% and a maximum
of 65% to 70% in a finished product cost.
5.8 Key Words

Material: A basic requirement of them to produce a new product, which is the first basic element
of cost.
Centralised purchasing : Purchase making to all departments in hrm by one department

headed by an effieicent person.
Purchase Requisition: Written details regarding the requirement of material

1. What do you understand by 'Material Control? How is it planned and organized ?
2. List out the broad objectives of material control. Explain the important requirements to
attain these objectives.
3. Outline the steps in the purchasing procedure from the time a need for material is
determined until the material is sorted and paid for.
4. State the functions of the purchase department in any factory.

74
5. The following quotation is received from a supplier in respect of Material X:
Rate per kg.
Rs.
Lot price - 1,000 kg 5.00
5,000 kg 4.50
10,000 kg 4.00
Trade discount 20% and cash discount 5% if payment is made within 15 days. One container is
required for every 1,000 kg of the material and containers are charged at Rs. 100 each but
credited Rs.90 if returned within 3 months.
Transport charges for one order
Stores charges
Calculate the material cost for 5,000 kg of material when the purchase decides to purchase
5,000 kg. of material, assuming containers are returned in due course.
[Ans. Material cost Rs.18,700; Per unit Rs.3.74]
6. A lorry load of material of mixed goods was purchased for Rs.1,00,000. Later on these
were sorted out into the following categories:
Category A 1,000 units Selling price Rs.20 per unit
Category B 2,000 units Selling price Rs.22.50 per unit
Category C 2,400 units Selling price Rs.25 per unit
Find the purchase rate per unit of each category of the material assuming that all grades yield
same rate of profit.
[Ans. Category A-Rs. 16; Category B - Rs.18; Category C - Rs.20]
7. After inviting tenders, two quotations are received as under:
Supplier A- Rs.2.20 per unit
Supplier B- Rs.2.10 per unit plus Rs.2,000 fixed charges irrespective of units ordered
75
Calculate the order quantity for which the purchase price per unit will be the same. Considering
all factors regarding production requirements and availability of finance, the purchase officer
wants to place an order for 15,000 units. Which supplier should be selected?
[Ans. 20,000 units; Supplier A]
8. The particulars relating to 1,200 kgs of a certain raw material purchased by a company
during June were as follows:
a) Lot prices quoted by supplier and accepted by the company for placing the purchase
order:
Lot up to 1,000 kgs @ Rs.22 per kg
Between 1,000 - 1,500 kgs @ Rs.20 per kg F.O.R Supplier's Factory
Between 1,500 -2,000 kgs @ Rs.18 per kg
b) Trade discount 20%
c) Additional charge for container @ Rs. 10 per drum of 25 kgs
d) Credit allowed on return of containers @ Rs.8 per drum
e) Sales tax @ 10% on raw materials and 5% on drums
f) Total freight paid by the purchaser Rs.2.40
g) Insurance @2.5% (on net invoice value) paid by the purchaser
h) Stores overhead applied @ 5% on total purchase cost of materials.
The entire quantity was received and issued to production. The containers are returned in due
course. Draw of the statement to show
a) Total cost of material purchased and
b) Unit cost of material issued to production
[Ans. i) Rs.23,122 ii) Rs.19.27]

76
5.10 Answers to Check Your Progress.

1) a) Not detrimental financially
b) Material management
c) Purchase of materials, storing of materials and issue of materials
d) Quantity control and financial control
e) Accounting aspect and operational aspect
2) a) True b) False c) False d) False e) True f) True

77
LESSON - 6
MATERIALS - INVENTORY CONTROL
Learning Objectives
• Explain what is inventory control.
• Discuss the stores layout and location
• List out the types of stores, its advantages and disadvantages
• Give brief note on classification and codification
• Fix the stock levels of a store keeping department
• Make ABC and VED analysis
• Say the salient features of ABC analysis
• Chart out the inventory system & the forms used in the stores department
Structure
6.1 Introduction
6.2 Stores Control / Inventory Control
6.3 Stores Layout and Location
6.4 Classification and Codification
6.5 Stock Level Fixation
6.6 Method of Inventory Control
6.7 Inventory System
6.8 Stores Records
6.9 Summary
6.10 Key Words

78
6.1 Introduction
In the previous chapter, you have learnt the meaning, objectives and aspects of material control.
It also made you to know about the purchase department in the large concerns, how they are
functioning regarding the purchase of materials required for production. In this chapter, you can
learn in detail the stores control, its layout and location, coding and classification of materials,
how they maintain the levels of stock, stores records and how they are following inventory
control systems.
6.2 Stores Control / Inventory Control

To strengthen further the materials control, purchase control is followed. It is necessary to follow
inventory (or) stores control along with purchase control to avoid losses from misappropriation,
damages, deterioration, evaporation and carelessness, because investment in materials
constitutes a major portion of current assets. So it is necessary to have a separate stores
control in stores department.
6.3 Stores layout and location

To facilitate prompt receipt and issue of materials, a perfect plan is to be made to assign each
and every item, and to assign a definite place. The stores should be placed near to the material
receiving department and production department in order to reduce the transportation charges.
A well planned location of store will facilitate easy movement of materials. The stores should be
divided into rooms, and further divided into small rooms and small racks. These small racks are
called as 'Bins'. One item of material is to be kept in one bin. All bins are to be numbered serially.
Proper attention must be given to the storage of materials, which are liable to be affected, by
evaporation or leakage.
Types of Stores
According to the size and policy of the industry the types of stores are decided. The following
are the types of stores:
1) Centralised Stores
2) Decentralised Stores
3) Hybrid Stores / Central Stores with sub-stores

79
1) Centralised Stores
When one stores department deals with purchase and issue of materials, then it is called as
centralised stores.
Advantages
a) Better layout and control is possible.
b) Better supervision is possible.
c) Less space is required, as stores are kept at minimum.
d) Low investment in stores is possible.
e) Better forecasting of requirements is possible.
f) Economical one.
g) Maximum advantage on purchase can be achieved.
h) Timely flow of materials is facilitated.
i) Frequent, constant and easy stock-taking is possible.
j) Sophisticated techniques can be adopted.
k) Possible to follow uniform coding system and specification.
l) Better safety and security.
m) Minimum wastage of materials.
n) Simplified procedures for issue.
Disadvantages
a) Cost of material handling may increase.
b) Chances for unnecessary delay.

c) Greater risk of loss due to fire.
d) Over crowding of materials may affect storing and control.
e) Break down of transport will adversely affect production.
80
2) Decentralised Stores
Under this type, each and every department will have its own stores. Through this. the
disadvantages on centralised stores are eliminated.
3) Hybrid Stores / Central Stores with sub-stores
This system is also known as imprest system of stores control. In large factories, when stores
department is situated at a distant place, a sub-store is formed near the production department
to reduce the transportation charges. A fixed quantity of materials is issued by the central stores
to sub-stores, at the beginning of the period. At the end of the period, the sub-stores will make
requisition to get materials from the central stores for the materials issued by them to the
production department.
Advantages
a) It reduces the demerits of centralised stores.
b) It offers services to meet the special needs of individual departments.
c) It relieves the central stores of the burden of sundry issues.
d) It avoids unnecessary delay and facilitates easier location of any discrepancies in stores.
6.4 Classification and codification

Good classification and codification are the important objectives of efficient storekeeping. Basically
the materials should be classified initially on the basis of its nature and types. Further it should
be sub-grouped on the basis of its size, colour or shape. Next it is necessary to use symbols or
code numbers for easy identification.
1. Methods of Codification
The materials can be codified on the following types:
1) Alphabetical method.
2) Abbreviation/Mnemonic method
3) Numerical method
4) Alpha Numerical method

81
1) Alphabetical method
An alphabet is used to identify a particular material.
E.g. A for bolt
B for nut
C for screw etc
This system is not flexible, not expansible. This system is unfit when large numbers of items are
in store.
2) Abbreviation / Mnemonic method
In this system the first sound of the name of the materials is used as its code.
E.g. Silver plate - S.P., Copper wire - C.W., etc.
This is a suitable method, where materials can be easily identified without referring to the index.
3) Numerical method
When a number is assigned to each material, it is called numerical method. Number coding can
be made either in straight numbering (01,02) or block numbering (1-10,01-20).
4) Alpha - numerical method
It is the combination of mnemonic method and numerical method.
Eg. Silver plate - SP1
6.5 Stock Level Fixation

The stock level is to be followed to avoid under or over-stocking which creates problems such
as-interruption in production and idle investment or blocking up the capital To avoid this, stock
level is to be maintained properly. The stock levels are:
a) Minimum stock level
b) Maximum stock level
c) Re-order stock level.

82
d) Danger stock level
e) Average stock level
a) Economic-ordering quantity Minimum stock level: It is also known as safety and

buffer stock level below which stock of materials is never to fall. If the stock goes below
this level, there is every possibility that the production may be held up for want of materials.
This level is decided based on rate of consumption, the lead-time, availability of substitute
and reorder level.
Minimum Stock Level=Reorder Level-(Normal ConsumptionXNormal Reorder Period)
b) Maximum Stock Level: It is the stock level above which stock should not be allowed to
rise. This is the maximum quantity of stock of raw materials which can be had in the
stock. If it goes above, it will be over stocking.
Maximum Stock Level=(Reorder Level+Reordering Quantity)-(Minimum Consumption

X Minimum Reorder Period)
The demerits are given below :
1) Capital is blocked.
2) More space is needed
3) Deterioration of stocks is possible.
4) There will be loss due to obsolescence.
5) There is the danger of depreciation in value.
The Maximum level is fixed by considering the following:
1) Availability of capital
2) Space available in stores
3) Rate of consumption
4) Reorder level.
5) Delivery time to obtain fresh stock
6) Changes of price
83
7) Cost of maintaining the stock.
8) Possibility of change in fashion
9) Seasonal nature of supply
10) Restrictions imposed by governments.
11) Economic order quantity
c) Re-order Level: It is the point to initiate purchase for fresh supply. It lies between
minimum level and maximum level. The level depends upon the lead time, rate of
consumption and economic order quantity.
Reorder Level= (Maximum Consumption X Maximum re-order period)
d) Danger Level: It is the level below the minimum level which may lead to stoppage in
production. During this time the normal issues are stopped.
Danger Level=(Average Consumption X Maximum Re-order period for emergency

purchase)
e) Average stock level : This level indicates the average stock held by the firm.
Average Stock Level = ((Minimum Level + Maximum Level)/2)
(Or)
= (Minimum Level + (1/2 X Re-order Quantity)
Illustration 1
Calculate the minimum stock level, maximum stock level and re-ordering level from the following
information:
i) Minimum consumption = 100 units per day
ii) Maximum consumption = 150 units per day
iii) Normal Consumption = 120 units per day
iv) Re-order period = 10 - 15 days

84
v) Re-order quantity = 1,500 units
vi) Normal re-order period = 12 days
Solution
Re-ordering level = Maximum Consumption * Maximum Re-order Period
= 150 units * 15 days = 2,250 units
Minimum stock level = Re-ordering level - (Normal consumption - Normal Re-order

Period)
= 2,250 - (120 * 12) = 810 units
Maximum stock level = Re-ordering level + Re-ordering Quantity - (Minimum

Consumption * Minimum Re-order Period)
= 2,250 + 1,500 – (100 * 10) = 2,750 units.
Illustration 2
In manufacturing its products, a company uses three raw materials, A, B and C, in respect of
which the following apply.
Weekly production varies from 175 to 225 units. averaging 200. What would you expect the
quantities of the following to be ?
a) Minimum stock of A,
b) Maximum stock of B,
c) Re-order level of C, and
d) Average stock of A
85
Solution
a) Minimum Stock of A
= Re-order level – (Normal consumption Normal re-order period)
8,000 - ( 2,000 2 ) = 4,000 lbs
Normal production per week = ( 175 + 225)/2 = 200 units.
Normal usage of material per unit = 10 lbs
Therefore Normal consumption of material per week = 200* 10 = 2,000 lbs
Normal re-order period = (Minimum delivery period + Maximum delivery period)/2
(1 week + 3 weeks 12) = ( 4 weeks /2) = 2 weeks
b) Maximum Stock of B
= Re-order level + Re-order Quantity - (Minimum Consumption. Minimum Re-order

Period)
4,750 + 5,000 - ( 700 * 3 ) = 7,650 lbs.
Minimum production per week = 175 units
Usage per unit of product = 4 lbs
Therefore Minimum consumption of material per week = 1754=700 lbs.
c) Re-Order Level of C
= Maximum consumption. Maximum Re-order period
1,350 * 4 = 5,400 lbs.
Maximum production per week = 225 units
Usage per unit = 6 lbs.
Therefore Maximum consumption of material C 225 6 = 1,350 lbs.
d) Average Stock Level of A
= Minimum stock level of A+ 1/2 Re-order quantity of A
4,000 + 1/2* (10,000) = 9,000 lbs.

86
e) Economic Order Quantity : It is the quantity of inventory, which can be reasonably

ordered at a time and purchased economically. It is also known as standard order quantity,
optimum quantity or economic lot size. It means that the total cost is at minimum. The
problem is, how much to buy at a time. In case, large quantities are to be purchased, the
cost of carrying the inventory is high. This includes interest on investment, obsolescence,
overstocking, losses, space costs etc. On the other hand, for frequent purchases, in
small quantities, the cost is high-short of materials, loss of sales, increased buying
expenses such as stationery, postage etc. Therefore, the quantity to be ordered depends
upon two factors, i.e., the acquisition cost and the cost of possessing materials. When
order for material is placed, it must facilitate more trade discount, economy in transport
etc., and at the same time it should not incur heavy charges on account of storage,
insurance etc. The E.O.Q. can be calculated as under.
EOQ =
E.O.Q = Economic order quantity
A= Annual consumption
B = Buying cost per order ordering cost
C = Cost per unit
S = Storage and carrying cost
Illustration 3
A factory requires 1,500 units of an item per month, each costing Rs.27. The cost per order is
Rs. 150 and the inventory carrying charges work out to 20 per cent of the average inventory.
Find out the Economic Order Quantity and the number of orders per year.
Solution
Annual consumption = 1,500 * 12 = 18,000 units

87
= 1,000 units
No. of orders per year = ( 18,000 units / 1,000 units ) =18 orders per year
Illustration 4
Calculate the Economic Order Quantity from the following information. Also state the number of
orders to be placed in a year.
Consumption of materials per annum 10,000kg
Order placing costs per order Rs. 50
Cost per kg. of raw materials Rs.2
Storage costs 8% on average in inventory.
Solution
= 2,500 kg.
Number of orders to be placed in a year:
Total quantity required per year /Economic order quantity = 10,000 12,500
= 4 orders per year
6.6 Methods of Inventory Control

Now, let us discuss about various methods of inventory control in detail.
It is the control according to values. It is also known as Proportional part Value Analysis. Under
this system efficient control of store is required to give more care on costlier items. On that
basis, items are grouped into three categories.
88
1) High priced materials as A
2) Medium priced materials as B
3) Low priced materials as c
It is clear that materials are listed in descending order based on money value of consumption.
The ABC analysis measures the cost of significance of each item of materials. It concentrates
on important items, so it is also known as control by importance and exception (CIE).
The report of the Indian Productivity Team on Stores and Inventory Control in the USA, Japan
and West Germany gives the following example of ABC analysis
Group Percentage of items Percentage of Costs
A 8% 75%
B 25% 20%
C 67% 5%
100% 100%
Advantages of ABC
1) Closer control on the basis of investment
2) Development of scientific inventory control
3) Saving the time of management, as attention is given to high va! a materials
4) Ensuring minimum cost

89
Salient Features of ABC Analysis

90
Vital, Essential and Desirable (VED) Analysis
This VED analysis is primarily used to control spare part items. The spare parts can be divided
into three categories viz. vital, essential and desirable - keeping in view the criticality to production.
The stock-out of spares which are for a short time will stop production Tor a quite time and
where the cost of stock-out is very high, are known as vital spares. The absence of which
cannot be tolerated for more than a few hours or a day and the cost of last production is high and
which are essential for the production to continue, are known as essential spares. The desirable
spares are those spares which are needed but their absence for even a week will not lead to
stoppage of production. Some spare items though negligible in monetary value, may be vital for
the production to continue and require constant attention. Such spares may not receive the
attention they deserve if they are maintained according to ABC analysis because their
consumption is small. So it is clear that VED analysis is made to get the effective results.
Input - Output Ratio
It is the ratio of raw materials put into production and the standard raw materials content of the
actual output. It enables in determining whether the usage of materials is favourable or
unfavourable. This comparison ratio facilitates to know the performance of the firm by comparing
the actual with standard which shows the favourable or adverse position of materials. The ratio
can be calculated as under
= Standard Cost of actual quantity / Standard Cost of a standard quantity
Inventory Turn Over Ratio
To measure the inventory performance this ratio is used. It is a ratio of the value of materials
consumed during a period to the average value of inventory during the ratio. A high inventory turn
over ratio is an indicator of fast moving stock. A low ratio indicates that locking of working capital
in undesirable items. This can be calculated as under
Materials Turn Over ratio = Cost of materials used / Average Stock
6.7 Inventory System

Normally the book balance of materials must agree with physical balance of materials during
the time of stock verification. There are two systems of stock verification. They are
91
1) Periodic Inventory System
2) Perpetual Inventory System
1) Periodic Inventory System: Under this system, the stocks are checked and verified
only at the end of the financial year.
2) Perpetuai Inventory System : Under this system the available stock are counted daily
or at frequent interval, so this system is also known as continuous stock taking (or)
automatic inventory system. The ICMA defines perpetual inventory system as "a system
of records maintained by the controlling department which reflects the physical movement
of stocks and their current balances". According to Wheldon's Cost Accounting "Perpetual
inventory system is a method of recording stores balances after every receipt and issue,
to facilitate regular checking and to obviate closing down for stock taking".
Advantages
1) While stock-taking is conducted, not necessary to stop production.
2) The long and costly stock-taking is avoided.
3) Discrepancies are detected easily and quickly.
4) Bin cards and stores ledger give ready figures.
5) It facilitates the preparation of final accounts even at short notice.
6) Stock levels can be revised from time to time in order to avoid under or over stocking.
7) Thorough and reliable check on the stores is facilitated.
8) Since it is a regular work, persons possessing special knowledge in material handling

are appointed.
9) Unnecessary losses such as deterioration, obsolescence etc are avoided.
10) The correct balances of stock are kept always.
Discrepancies in Physical Stocks
The disagreement between book balances and physical stock balances shows that
discrepancies in physical stock is present. However, discrepancies appear owing to many
reasons and they must be rectified. The reason of discrepancies are divided into two categories,
such as
92
a) Avoidable causes.
b) Unavoidable causes.
The avoidable causes are
1) Clerical error while recording
2) Theft, Pilferage
3) Placing of stores in wrong bins
4) Careless material handling
5) Short or excess issue of materials due to negligence
6) Making mistakes in identifying items
The Unavoidable causes are
a) Evaporation, Shrinkage etc
b) Loss due to breaking the bulk or cutting to sizes
c) Loss due to fire, riot etc.
d) Loss due to approximate estimation
6.8 Stores Records

The bin cards and stores ledger are the two main records kept in the stores department.
Bin Cards
Bin is a small area allotted to keep the materials in the form of rack or cup-board. To each bin a
card is attached to show the stock position of the bin. This card is called as "Bin Card”. In this
card only quantity of stores is recorded. It contains the stores in terms of quantity received,
issued and closing balances. The following specimen reveals the content in the bin card.
93
Double Bin System
When the bin is divided into two parts-smaller and larger, it is called as double bin system. In the
smaller part, the minimum quantity is kept and in the larger part the remaining quantity. The
quantity in the smaller part is not issued as long as the other part has materials. When the
bigger part are finished, further issue will be made from the smaller parts, which is the signal to
the store-keeper to know the position of stock to make fresh purchase.
Stores Ledger
It is the ledger maintained by the stores department to record the quantity and the rupee value of
the material. The following specimen reveals us, how the stores ledger is modelled.
94
Stores Ledger
Difference Between Bin Card and Stores Ledger
Bin Card Stores Ledger
1. Quantity only recorded Quantity and its Money value are recorded
2. Maintained by the store keeper Maintained by the cost clerk
3. It is with the bin It is kept in the office
4. Postings are made before transaction Postings are made after transaction
Check Your Progress
I) Fill in the blanks
i) ____________represents the quantity of material which is normally ordered when a

particular material reaches ordering level.
ii) Stores ledger is maintained in the____________
iii) Stock verification sheets are maintained to record the results of ____________
iv) Bin Card is a record of only____________
v) The quantity of material to be ordered at one time is known as ____________

95
2) State whether the following statements are True / False
i) Material turnover ratio is calculated by dividing the cost of materials consumed by cost
of average stock held.
ii) Bin cards make a record of the quantity and value of materials kept in the stores.
iii) The perpetual inventory system means a continuous stock-taking system. iv) Under the
ABC analysis of material control, 'A' stands for high value items.
v) The perpetual inventory system enables the management to ascertain stock without
physical verification.
3) How do standardisation and simplification help in controlling the size of materials?
4) What the difference between classification and codification?
5) What do you mean by the imprest system of stores control?
6.9 Summary
It is evident that the materials take place more in a finished product, for which all the uracturing
concerns must have proper material control. The inventory control is a part of an efficient material
control. This stores control can be implemented on the basis of its layout and location. The
firms will have any one of the types of stores out of three types. Proper coding and classification
of materials should be made for easy identification. To avoid unnecessary problems, stock
96
levels should be followed strictly. Various methods of material control such as ABC, VED analysis,
material input-output ratio and inventory turnover ratios should be used to measure the efficient
usage of materials. For documentary evidence, all production-oriented firms should follow proper
forms of documents of inventory system.
6.10 Key Words

Codification : Grouping or indexing the products
Minimum Level: It is the safety and buffer stock level below which stock of materials is never to
fall
Maximum Level : It is the stock level above which stock should not be allowed to use
Re-ordering Level : It is the point to initiate fresh purchase
E.O.Q. : Inventory ordering in resonable, time and in economical way to reduce unworked, can
of un depends in
BIN: The small asked alloted to keep materials in the form of rack or cup-board.

1) Explain the meanings of minimum level, maximum level and re-ordering level with regard
to the maintenance of stock. What are the factors that govern the fixing up of these
levels ?
2) What is 'Economic Order Quantity' ? How is it calculated ?
3) Enumerate the advantages and disadvantages of a centralised stores system.
4) What do you mean by ABC analysis ? What are its advantages ?
5) 'The Perpetual Inventory System is an integral part of Material Control. Discuss this
statement by bringing out briefly the salient features and advantages of this system.
6) Write short notes on the following:
a) Classification of stores
b) Codification of materials
97
c) Inventory control.
7) What is a Bin Card ? Give a specimen form of it; and discuss its utility.
8) From the following particulars, calculate the economic order quantity and tabulate your
results:
9) Annual requirements: 1,600 units
Cost of material per unit Rs.40
Cost of placing and receiving one order: Rs.50
Annual carrying cost of inventory: 10% of inventory value. [Ans. 200 units]
10) A manufacturer buys a certain equipment from outside suppliers at Rs.30 per unit. Total
annual needs are 800 units. The following further data are available:
Annual return on investments, 10%
Rent, insurance, taxes per unit per year, Re. 1.
Cost of placing an order, Rs.100.
Determine the economic order quantity.
[Ans.200 units]
11) Calculate maximum level, minimum level and reordering level from the following data:
Re-order quantity 1,500 units
Re-order period 4 to 6 weeks
Maximum consumption 400 units per week
Normal consumption 300 units per weeks
Minimum consumption 250 units per week
[Ans. Maximum Level 2,900 units; Minimum Level 900 units; Ordering level 2,400 units]
98
12) Two components A and B are used as follow:
Normal usage 50 units per week each
Minimum usage 25 units per week eac
Maximum usage 75 units per week each
Re-order quantity A: 300 units
B: 500 units
Re-order period A: 4 to 6 weeks
B: 2 to 4 weeks
Calculate for each component:
a) Re-order level, b) Minimum level, c) Maximum level, and d) Average stock level.
[Ans. a) A-450 units, B-300 units; b) A-200 units, B-150 units; c)A-650 units, B750 units; and d)
A-350 units, B-400 units]
13) Two materials X and Y are used as follow:
Minimum usage - 50 units per week each;
Maximum usage - 150 units per week each:
Normal usage - 100 units per week each;
Ordering quantity: X-600 units
Y-1,000 units
Delivery period: X-4 to 6 weeks
Y-2 to 4 weeks
Calculate for each material :
a) Minimum level, b) Maximum level and c) Ordering level.

99
[Ans.
X (units) Y (units)
(a) 400 300
1,300 1,500
900 600]

1. i) Re-orde rquantity
ii) Cost accounting department
iii) Physical verification
iv) Quantities
v) Economic order quantity
2. i) True ii) False iii) False iv) True v) True

100
LESSON - 7
MATERIAL - ISSUE CONTROL
Learning Objectives
After studying this lesson, you should be able to :
• Highlight about the issue of material
• Brief how the surplus of materials are treated
• Explain the methods of pricing.
Structure
7.1 Introduction
7.2 Issue of Material
7.3 Material Issue Analysis Sheet
7.4 Methods of Valuing Materials Issues
7.5 Summary
7.6 Keywords
7.8 Answer to Check your Progress
7.1 Introduction
In the previous chapter, you have learnt how the stock control is executed in the store-keeping
department, where the stores are to be located, and how the layout of stores is to be designed.
The previous chapter discussed the types of stores, its advantages, and disadvantage, how the
materials are classified, and how codifications made; suitable methods in codification are used.
It was also discussed the advantages in codification. Discussion was made on stock level
101
fixation, EOQ, ABC and VED analysis. Inventory system and various forms used in a store were
also discussed. This chapter attempts to acquaint knowledge on issue control followed in stores
department, because one of the main objectives of cost accounting is to ascertain the accurate
cost. This ascertainment of accurate cost is fully dependent upon the correct valuation of mate-
rials. The valuation of materials is made on a) Valuation of materials received and b) Valuation of
materials issued.
7.2 Issue of Material

The storekeepers will issue the raw materials required for manufacturing process from the
stores after receiving the material requisition. The requisition slip/form will be given in duplicate
out of that one will be sent for accounting purpose and the second copy will be retained with the
store keeper for his reference. The following specimen shows the model of a requisition slip.
Treatment of Surplus Materials
Sometimes materials may be issued in excess of the requirements of a particular job/ work
order to facilitate convenient handling. Under this case, regarding excess issue of materials, the
following treatment will be made, as
102
a) Return of surplus
b) Transfer of surplus
a) Return of Surplus : When excess materials are returned to stores a "Material Return
Note" or "Stores Debit Note" or "Shop Credit Note" will be prepared and signed by the
store keeper. It is prepared in triplicate. One copy will be returned to the section con-
cerned, one copy will be sent to the cost office for recording purpose and the last copy
will be retained in the stores for reference. The following is the specimen of Material
Return Note. The values of these materials are made either in same price at which it
was issued or current price of issue whichever is suitable.
b) Transfer of Surplus : Sometimes, it happens that the excess material may be trans-
ferred from one department to another department. It is known as interdepartmental
transfer. Such transfers should be avoided, because it creates complication in ascer-
taining the cost of materials. In this case a "Material Transfer Note" will be prepared in
duplicate. One is to the store keeper and the other copy for transferring department.
Given below is the specimen of material transfer note.
103
7.3 Material Issue Analysis Sheet

Analysis of various requisitions, materials returned notes and material transfer notes are made
frequently and periodically. From the analysis the value of materials consumed in each job is
ascertained. This analysis in the statement form is known as Materials Issue Analysis Sheet /
Materials Abstract. The ruling of the abstract is given below.
104
7.4 Methods of Valuing Material Issues

At the time of receipt, issue, return or transfer of the cost of material is to be recorded. This cost
includes a) the invoice price less trade discount b) freight, cartage, octrai and insurance on
incoming materials c) expenses of purchase, receiving, storing, record keeping, and carriage
from the stores up to the process plant.
7.4.1 Pricing of Materials
When the materials are issued for any production work or any job, they have to be valued in the
costing department. Generally the purchase of raw materials is made on anticipation rather
than necessity. The prices of materials change on the prevailing condition of the market. The
price will differ at the time of purchase made in different days, some stock lying in the stores
consists of many purchases at different rates. While issuing, create problems. To put an end to
this problem pricing of materials is made.
105
The following are the methods of pricing of materials.
Methods of Pricing
I) Cost Price Method II) Market Price Method III) Standard Price Method
1) Replacement Price Method 2) Realisable Value Method
A) Actual Price Method B) Average Price Method
1) First in First 1) Simple Average

out (FIFO) Method Method (SAM)
2) Last in First 2) Weighted Average

out (LIFO) Method Method (WAM)
3) Specific Price Method

Identical Cost Method
4) Base Stock Method C) Inflated Price

Method
5) Highest in First
out (HIFO) Method.
1) Current Standard 1) Basic Standard

Price Method Price Method
106
A suitable system of pricing materials is to be selected by considering the following points.
1. This system of pricing materials must recover the cost price of the materials.
2. It must be as far as possible mere to the market or current price.
3. Adopt a good system, to remove the unnecessary fluctuation in the price.
4. Policy of the management
5. Reduced clerical work.
I Cost Price Method
A) Actual Price Method
1) First in First out (FIFO) Method
Under this system, materials are issued on the basis of the priority of the receipt. On first come
first served basis the materials are issued in FIFO method, as a result the closing stock value
will be at the latest price.
Advantages
1) Simple and easiest to operate
2) Closing stock will reflect latest purchase.
3) Suitable for slow moving material
4) During price fall, it gives better result.
5) Logical system "First Come First Serve" is followed.
6) Deterioration and obsolescence can be avoided
Disadvantages
1) When prices fluctuate, Calculation becomes complicated.
2) Complicated calculation will invite clerical errors.

107
3) Under fluctuating prices, materials charged to different but similar jobs vary, leading to
non-comparison.
4) When prices fall, jobs are charged with higher price of earlier materials; the quotations
are less competitive.
5) When materials are returned to the store, they are treated as new purchases, for the
purpose of next issue.
Illustration 1
The stock in hand of a material as on 1st September was 500 units at Rs. 10 per unit. The
following purchases and issues were subsequently made. Prepare the Stores Ledger Account
showing how the value of the issues would be recorded under FIFO method.
Purchases
6th September 100 units at Rs. 11
27th September 400 units at Rs.13
13th October 1,000 units at Rs.14
20th October 500 units at Rs. 15
17th November 400 units at Rs.16
Issues
9th September 500 units
22nd September 500 units
304 September 500 units
15th October 500 units
22nd October 500 units
11th November 500 units

108
Solution
Stores Ledger (FIFO Method)
Name of Article: Folio:

Code: Maximum level:
Bin Card No. Minimum level:
Units: Reordering level:
Reordering quantity:
109
Value of stock in hand Rs.9,400 or 200 * Rs. 15 + 400 * Rs. 16 = Rs.9,400
Illustration 2
Record the following transactions in Stores Ledger, pricing the materials under FIFO method.
May 1 Balance 50 units at Rs.25 per unit
May 3 Received 300 units at Rs.30 per unit
May 5 Issued 200 units
May 8 Received back 10 units (issued on 7th May)
May 10 Returned to Vendor 15 units purchased on 3rd May
May 15 Received 200 units at Rs.32
The stock verifier found a shortage of 10 units on 20th and left a note
110
Solution

Value of Stock: 15 units @ Rs.32 = Rs.480

111
2) Last in First out (LIFO) Method

The opposite approach of FIFO method is Last in first out method. The priority during the time of
issue goes to the latest price product received recently. This method is not in chronological
order.
Advantages
1) Cost of material issued represent current price.
2) It facilitates complete recovery of material cost.
3) There is a better matching of cost and revenue.
4) It is suitable when prices are rising.
Disadvantages
1) Due to variation of prices, comparison of cost of similar jobs is non-comparable.
2) It consists of considerable clerical work.
3) Income tax authorities do not accept this system.
4) Stock of materials shown in the balance sheet will not reflect market prices.
IIlustration 3
The stock in hand of a material as on 1st September was 500 units at Rs. 10 per unit. The
following purchases and issues were subsequently made. Prepare the Stores Ledger Account
showing how the value of the issues would be recorded under LIFO method.
Purchases
13th October 1,000 units at Rs. 14
20th October 500 units at Rs. 15
17th November 400 units at Rs.16
Issues
22nd September 500 units
15th October 500 units

112
22nd October 500 units
11th November 500 units
Solution

113
Value of stock in hand Rs.8,600 viz. 100 units @ Rs. 10, 100 units @ Rs.12 and 400 units @
Rs.16
Illustration 4
From the following particulars write up the priced Stores Ledger under Last-in-first out:
Dec. 1 Stock in hand 500 units at Rs.20
Dec. 3 Issued 200 units
Dec. 3 Purchased 150 units at Rs.22
Dec. 5 Purchased 200 units at Rs.25
Dec. 6 Returned to Store 10 units (Issued on 4th Dec.)
On 10th Dec, it was noticed that there is a shortage of 10 units.

114
Solution
Stores Ledger Account (FIFO Method)

Value of stock: 100 units @ Rs.20 = Rs.2,000.

115
3) Specific Price Method
This is the price paid in actual for the materials for a particular job or work or contract. In this
method, materials purchased for specific jobs are kept separately. While issuing the job is
charged with the actual price. So that, it is also called as identical cost method. This method is
suitable for individual jobs. contracts against specific orders.
Advantages
1) Actual price is charged.
2) This method is suitable when the items are costly.
Disadvantage
1) It involves more clerical work because separate records are to be kept.
4) Base Stock Method
When the issue of materials is made after keeping "Safety stock" as base stock it is known as
base stock method. This base stock is valued at a price at which the first lot of materials is
received. This base stock will not be issued until emergency arises. Considering the advan-
tages and disadvantages of those two methods, the quantity in excess of base stock will be
issued suitably either in FIFO or LIFO Method.
Illustration 5
Prepare Store Ledger Account from the following information
Jan. 1 Purchased 500 kg. at Rs.20 per kg.
Jan. 15 Issued 600 kg.
Jan. 20 Purchased 400 kg at Rs.22 per kg.
Adopt the Base Stock Method of issue and ascertain the value of closing stock. Base
Stock 200 kg.
116
Solution
Stores Ledger Account (Base Stock - FIFO Method)

Value of closing stock: 600 kg of Rs. 12,400 (or) 200 kg * Rs.20 + 400 kg * Rs.21 = Rs. 12,400
5) Highest in First out (HIFO) Method
In this method materials, of the highest price are issued in descending order until. exhaustion.
According to this method the closing stock will be of the minimum price or as low as possible.
This method is suitable for cost plus contracts, but is not common. It rather operates similar to
FIFO and LIFO method.
B) Average Price Method
1) Simple Average Method (SAM)
The prices of raw materials are taken for issue, considering the issue quantity and the availability
of received quantity. Under this system usually FIFO method is adopted.
117
For Example
The quantity available is 200 kg. @ Rs.10,
300 kg @ Rs.12, and 100 kg @ Rs. 15.
a) If 300 kg of materials are issued. The simple average price will be, out of 300 kg issue
200 kg @ Rs. 10 and 100 kg @ Rs. 12.
Therefore Average Price (simple) = (10 + 12)/2 = 22 12 = Rs. 11.
b) If 550 kgs of materials are issued.
The simple average price will be = ( Rs. 10 + Rs.12 + Rs. 15)/3 = 37/3 = Rs. 12.33.
Advantages
1) Easy to operate.
2) Reduced clerical work.
3) At the time of slight fluctuation in price, it gives good results.
Disadvantages
1) Generally not accepted method
2) Costs are not fully recovered
Illustration 6
The following particulars have been extracted in respect of material X. Prepare ledger account
showing the receipts and issues, pricing the materials issued based on Simple Average Method.
Receipts
3rd Oct. Purchased 500 units at Rs.4.00 per unit
13th Oct. Purchased 900 units at Rs.4.30 per unit
Issues
50h Oct. issued 400 units
15th Oct. issued 600 units

118
Solution
Stores Ledger Account (Simple Average Method)
Final Stock: 400 Materials: Rs.1,630

(Rs.4 + Rs.4.30)/2 = Rs.4.15 (Rs.4.30 + Rs.3.80)/2 = Rs.4.05
2) Weighted Average Method (WAM)
This method gives importance to both price and quantity. Under this method issue price is
ascertained by dividing the total amount value of total quantity available by total quantity after
putting the various quantities in various price together.
WAP = Value of materials available / quantity of materials available.
WAP = Weighted Average Price.
Advantages
1. It will smooth out the fluctuations
2. It facilitates the recovery of the cost paid for materials
3. Commonly accepted method
Disadvantages
1. When a large number of purchases is made at different rates, the calculation is tedious.
119
Illustration 7
The following particulars have been extracted in respect of material X. Prepare ledger account
showing the receipts and issues, pricing the materials issued based on Weighted Average
Method.
Receipts
13th Oct. Purchased 900 units at Rs.4.30 per unit
Issues
5th Oct. issued 400 units 15th Oct. issued 600 units

Solution
Stores Ledger Account (Simple Average Method)
Final Stock: 400 Materials: Rs.1,594

120
C) Inflated Price Method

While issuing materials, if the issue price gives coverage to all expenses and losse related to
the material, then the price quoted is called as "Inflated Price". The Inflated Price includes the
cost of material purchased plus the expenses made at the time of purchase. expenses after
purchase such as, storing, preservation expenses, and unavoidable losses like evaporation,
deterioration in quantity, shrinkage, loss in weight etc.
Illustration 8
Write up the priced Store Ledger card adopting the standard price method at the rate of Rs.2 per
unit and draw your conclusion regarding the utility of the method:
Dec. 5 Purchased 150 units @ Rs.2.20 per unit.
Solution
Stores Ledger Account (Standard Price: Rs.2)
Bin Card No. Folio:
Name of Material Maximum level:
Material Code No. Minimum level:
Reordering level:
Reordering quantity
Units:
121
Note: Actual cost of purchases (500 units) = Rs.1,185
Standard Price of Issue (500 Units) = Rs. 1,000
Rs. 185(Adverse)
This reflects the inefficiency of the purchasing department. Material price variance shows payment
of Rs.185 more than the standard price of issue.
II) Market Price Method
In this method issues price are fixed either in replacement price or in realisable price. The
replacement price is used in case of the items which are held in stock for use in production
while realisable price is used in respect of the items which are kept in stock for sale. Replacement
price is followed for issuing materials. This method is suitable, while quotations are prepared.
This method discloses whether the buying is efficient or inefficient. This method does not recover
cost price of the materials from production because materials are issued at the market price,
which may be more or less than the cost price.
III) Standard Price Method
Under this method, the price is predetermined for the receipts and issues of materials. This
price is neither cost price nor market price. This method is followed by the concerns which are
following Standard Costing. The difference between the actual price and standard price will be
charged to an account known as "Purchase Price Variance Account".
This standard price is classified into two types namely i) Basic Standard Price ii) Current Standard
Price. The basic standard price is the ideal standard price fixed for long periods so as to help
forward planning where as the current standard is the basic standard price which has been
adjusted to provide for permanent changes in cost on account of prevailing trends in the market.
Illustration 9
The standard price of a material is fixed at Rs. 10 per unit. Prepare the Stores Ledger Account
showing how the cost of materials issued and value of balance in stock will be recorded under
the standard price method from the following purchases and issues made during January, 1982.
122
Date Particulars Quantity Rate

January 2 Received 2,000 units 11
January 5 Received 1,000 units 10
January 10 Issued 1,200 units -
January 18 Received 800 units 9
January 25 Issued 900 units -
January 29 Received 500 units 12
January 30 Issued 1,500 units -
Also find out the efficiency of purchasing materials.
Solution
Stores Ledger Account

(When materials are issued according to standard price method)
All issues have been valued at the standard price of Rs. 10 per unit.
Efficiency of Purchasing Material can be ascertained by calculating price variance as follows:
Price Variance = Actual Quantity of Receipts * Standard Price - Actual Cost of Receipts
= 4,300 units * Rs. 10 - Rs.45,200
= Rs.43,000 - Rs.45,200 = Rs. 2,200 unfavourable.

123
So, there is inefficiency in purchases of materials to the extent of Rs.2,200.
The efficiency in purchase of materials can also be ascertained by comparing actual value of
closing stock with the standard value of stock as follows:
Standard value of closing stock:1,100 units @ Rs. 10 Stand= Rs. 11,000
Less: Actual value of stock as per Stores Ledger Account = Rs. 13,200
Difference (unfavourable) = Rs. 2,200
Check Your Progress
a. Material should be issued by the storekeeper against_____________
b. Last in first out method is suitable in times of_____________
c. Inflated price method of valuing material issue is suitable when_____________
d. Market price method is considered to be the best method when _____________
e. Material abstract is also known as_____________
f. First in first out method of valuing material issues is suitable in times of_____________
g. Average cost method of valuing material issues is suitable when_____________
h. Specific price method of valuing material issue is used when_____________
2) State True / False
a. Bose Stock method of valuing material issues works with some other method of valuing
issues.
b. According to LIFO method of pricing, issues are close to current economic values.
c. Weighted average cost method of valuing material issues involves adding all the different
prices and dividing by the number of such prices.
d. A material returned note is prepared when excess material is returned to stores.

124
e. First in first out method of valuing material issues is suitable in times of rising prices.
f. Under the average cost method of valuing material issues, new issue price is determined
after each purchase.
7.5 Summary
Issue of materials are made by the store-keeper to the production department after receiving an
appropriate material requisition from them. Sometimes to facilitate convenient handling, materials
are issued in excess to the requirement. These excess issues will be returned by the production
department to the stores or transferred to the other department for production for which a material
return note or transfer note is maintained. To know the position of materials, analysis about
materials is made in a statement which is known as ateriais Abstract". During the time of issue,
the price of issuing materials is made on the suitable basis. The methods of pricing is basically
classified as actual price method, market price metod and standard price method. Further,
these items are subdivided into ten methods.
7.6 Key Words

Materials Return note : A written document prepared and signed by the store keeper regarding
return of materials insured in excess to a job / work order.
Materials Abstract: A statement containing the details about analysis mode from the maknals
requistion, returned and transfer nores which shown the closry balance of nations
Safety Stock : Stock kept as base stock to be used at the time of emergency.

1. Describe the various methods of pricing issues of materials. Which method would you
recommend for adoption in a case where prices of raw materials seldom change
2. Explain FIFO and LIFO methods of valuation of material issues. Discuss the effects of
rising prices and falling prices on these two methods of pricing of material issues.
3. Define (i) Replacement Price, and (ii) Standard Price. Discuss the objectives of these
methods of pricing of materials and state the circumstances in which they are used.
125
4. Prepare the Stores Ledger Account from the following information pricing the issued
material on FIFO Method.
Receipt of Material
1st January, 2020 300 tons @ Rs.8 per ton

7th January, 2020 200 tons @ Rs.8.20 per ton
23rd January, 2020 400 tons @ Rs.7.50 per ton
Issue of Materials
5th January 140 tons; 8th January 60 tons; 15th January 120 tons;
18th January 210 tons; 24th January 200 tons; 25th January 150 tons:
29th January 240 tons.
[Ans.: Issue Price: 5th January 140 tons @ Rs.8; 8th January, 60 tons @ Rs.8; 15th January,
100 tons @ Rs.8 and 20 tons @ Rs.8.20; 18th January 180 tons @ Rs.8.20 and 30 tons @
7.90; 22nd January, 200 tons @ Rs.7.90; 25th January, 20 tons @ Rs.7.90; and 130 tons @
Rs.7.50; 29th January, 240 tons @ Rs.7.50; value of closing stock Rs.1,765 (i.e. 30 tons @
Rs.7.50 and 200 tons @ Rs.7.70)]
5. The stock in hand of a material as on 1st September 2020, was 500 units at Re. 1 per
unit. The following purchases and issues were subsequently made. Prepare the Store
Ledger Account showing how the value of the issues would be recorded under Simple
Average Methods.
Purchased Issued
Sept 6 100 units at Rs.1.10 Sept 9 500 units

Oct. 13 1,000 units at Rs.1.40 Oct. 15 500 units
Oct. 20 500 units at Rs.1.50 Oct. 22 500 units
Nov. 17 400 units at Rs.1.60 Nov. 11 500 units
126
6. The following transactions occur in the purchase and issue of a material:
Jan. 2 Purchased 4,000 units @ Rs.4.00 per unit

Jan. 2 Purchased 5,000 units @ Rs.5.00 per unit
0
Feb. 5 Issued 2,000 units
Feb. 1 Purchased 6,000 units @ Rs.6.00 per unit
0
Feb. 1 Issued 4,000 units
March 2 Issued 1,000 units
March 1 Purchased 4,500 units @ Rs.5.50 per unit
5
a) by adopting FIFO method of charging material issued, and b) by adoption of the LIFO
method, what would be the value of stock in hand at the end of the period according to
each of these two methods ?
Ans.. Value of stock in hand: a) Rs.16,500 i.e. 3,000 units @ Rs.5.50 per unit, b) Rs.14,250 i.e.
1,500 units @ Rs.5.50 per unit + 1,500 units @ Rs.4.00 per unit]
7. Manufacturing Company uses copper wire which is purchased from the market as and
when necessary. The following purchases and issues were made during the month of
January, 2020:
Jan. 1 Opening balance 300 kg. at Rs.25 per kg.
Jan. 3 Purchased 500 kg. at Rs.26.20 per kg.
Jan. 4 Issued 220 kg. (Material Requisition No.201)
Jan.10 Issued 440 kg. (Material Requisition No. 202)
Jan.20 Purchased 449 kg. at Rs.23 per kg. (Purchase Order No.102)
Jan.25 Issued 300 kg. (Material Requisition No.203)
Jan.26 Surplus 20 kg. returned to store out of quantity issued on January 4 (Material
Returned 1 Note No.20)
127
Prepare Stores Ledger Account for the above transactions according to 'LIFO method of pricing
issue of materials.
Ans.: Value of Stock Rs.8,402 (i.e. 140 units @ Rs.25 + 20 units @ Rs.26.60 +190 units @
Rs.23]
8. Prepare the Stores Ledger Account for the following transactions according to Weighted
Average method of pricing issue of materials.
Jan. 1 Received 1,000 kg. at Rs.20 per kg.
Jan. 10 Received 260 kg. at Rs.21 per kg.
Feb. 5 Received 400 kg. at Rs.25 per kg.
Feb. 21 Received 300 kg. at Rs.23 per kg.
March 16 Issued 620 kg.
April 12 Issued 240 kg.
May 10 Received 500 kg. at Rs.22 per kg.
May 25 Issued 380 kg.
1. a. Material requisition
b. Rising prices
c. materials are subject to natural wastage
d. Quotations have to be sent
e. Material issue analysis sheet
f. Falling prices
g. Prices fluctuate considerably
h. Materials are purchased for specific job or work order;
2. a. True b. True c. False d. True e. False f. True

128
LESSON - 8
MATERIAL - LOSSES
Learning Objectives
• Discuss the bill of material and its specimen
• Describe the meaning of wastage, scrap, spoilage and defectives
• Discuss the treatment of wastage, scrap, spoilage and defectives
• List out the treatment of wastage, scrap spoilage and defectives.
Structure
8.1 Introduction
8.2 Material Handling
8.3 Bill of Materials
8.4 Wastage, Scrap, Defectives, and Spoilage
8.5 Summary
8.6 Key Words
8.1 Introduction
From the previous lesson, you have learnt that material issue control is highly essential in material
control. Proper system of pricing is to be followed for material issued to the production department.
For this purpose all manufacturing oriented concerns establish separate store keeping
department, where raw materials used for production process are kept. The store keeper is
responsible to take care of the stores. Issue of materials is made by the store keeper by following
any one of the methods of pricing suggested by the management after receiving the materials
129
requisition form from the production department. From this chapter you can learn material handling,
treatment of material handling charges bill of materials, wastage, scrap, defectives, spoilages
and control measures on them and the items related to materials.
8.2 Material Handling

Material handling is concerned with handling of raw materials from the source to the place of
production. It is the scientific study of handling, movement and storing of materials. The material
handling charges incurred in the handling, movement and storing of materials will reflect a hike
in the cost of a product without increasing its value. The scientific material handling keeps the
cost of production in control. This scientific materials handling involves the following principles.
1) Elimination of unnecessary movements and handling to increase the output and lower
the cost of production.
2) Standard methods and equipment of materials handling are determined which have
maximum flexibility and are made available easily.
3) Avoiding re-loading of materials by laying down a scientific layout of the factory and plant
4) Analysis should be made on all materials handling operations for the improvement handling
5) Arrangement of materials and storing methods should be in proper manner, according

to its nature and viability
Advantages of Scientific Material Handling
1) Reduction in labour cost of handling when materials are received stored and despatched
2) Reduction in transportation cost by eliminating unnecessary movements.
3) Increased industrial safety due to scientific movement.
4) It leads to increased productivity, reduction in cost and increased profit.
Treatment of Materials Handling Charges
These expenses are generally treated as an item of works overhead. These can be recovered
as a percentage of the value of materials issued i.e. X% of material handling charges on total
value of materials issued during that month to various jobs.
130
8.3 Bill of Materials

The bill which gives a complete list of all materials required for a particular job. Order or Process
is called bill of materials. This will be done by the production department in a single document
about the materials requirement to various jobs, order or process. This is to be prepared if the
job is of non-standardised nature, so that reasonable estimate of all materials required may be
made by the production department before the job is started. The Following is the specimen of
bill of materials
Advantages of Bill of Materials
1) It serves the purpose of an authority for the production department to place requisition
for materials.
2) It serves as an indent or purchase requisition upon the purchase officer for the purchase
of materials required for a particular job.
3) It helps the storekeeper at the time of issue of materials.
4) Costing of jobs becomes easier because costing department can use bill of material for
calculating the cost of materials issued.
5) Control over use of materials in case of non-standard jobs.
6) This bill of material facilitates planning for procurement of materials.

131
7) It saves time which otherwise would have been wasted for preparing separate requisition
for different materials.
8.4 Wastage, Scrap, Defectives, and Spoilage

It is natural in all manufacturing concerns, for the chance of occurrence of wastage, scrap,
defective items and spoilage, so there will be the difference between the quantity of materials
issued and the output of the process. Efforts should be taken to reduce the wastage, scrap,
defective items and spoilage which has the negative impact in the cost of production. From the
cost accounting point of view, it is necessary to know not only the nature of these losses but
also the method of their treatment.
Wastage
"The portion of basic raw material lost in the processing, having no value to be recovered" is
called as wastage. It is different from scrap. Wastage is a complete loss. This wastage is
classified into two types viz.
a) Normal waste
b) Abnormal waste
a) Normal Waste: It is that which is unavoidable and is bound to arise, because of the
nature of the material. Evaporation, shrinkage, breaking in bulk etc. are the suitable
examples of the normal waste. Considering the nature of the materials and the type of
operations, through a careful study, the amount of normal waste can be determined.
For example, a manufacturing operation needs 100 kgs of raw material, but when the
material content is weighed it is only 99 kas in weight. This difference of one kg is called
normal wastage, because during the process, it ought to occur an unavoidable. According
to costing rule the value of the normal loss will be borne by the good items. The normal
wastage is treated as a part of cost; i.e., the rate per un gets inflated to recover such a
normal loss.
b) Abnormal wastage: It is avoidable and controllable. Fire accident loss, theft, pilferage
and improper handling of materials are the suitable examples for abnormal wastage
This loss cannot be a part of manufacturing cost. This loss will be transferred to costing
profit and loss account. These losses are recovered from the insurance claims.
132
Scrap
It is the incidental residue from certain types of manufacture, usually of small quantity and low
value, recoverable without further processing.
The I.C.M.A. London defines scrap as it is discarded material having some value which is usually
either disposed of without further treatment; i.e., other than reclamation and handling; or is
introduced into the production process in the place of raw material". The small pieces usually
not wanted raised due to turning, boring, punching, sawing, shaving, moulding of metals are the
suitable examples, which will be sold to the industries for melting in furnaces.
These Scrap Occurs because of
a) Poor manufacturing methods
b) Faulty planning of processes.
c) Raw Materials of low quality.
d) Inadequate and unconditional machines and tools.
e) Defective inspection system.
Control of Scrap is made effective through
1) Setting up standard.
2) Keeping proper records of scraps.
3) Fixing responsibility.
These scraps are classified into three types
1) Legitimate Scrap : These types of scraps are unavoidable and such losses are bound
to arise during production process. These losses in almost all the cases, are
predetermined or anticipated. These are normal in nature.
2) Administrative Scrap : These types of scraps arise due to poor administration. Scrap
resulting from obsolescence of design, inferior quality of materials, poor workmanship,
unsuited machines and tools are the suitable examples. These are abnormal in nature.
133
3) Defective Scrap : This type of scrap is abnormal loss because of inferior quality of
materials or bad workmanship.
Accounting Treatment of Scrap
The realisable value of normal scrap may be credited to profit and loss account like other income.
This method of treatment is suitable when the scrap is of very little value. This method is also
known as treatment by neglect. This method is not suitable for effective control. Excess of
scrap cannot be identified because detailed records of scrap are not kept, and scrap cost is not
shown as an element of cost in the cost sheet.
1) The sale value of scrap may be deducted from the cost of materials consumed or from
the factory overheads. This method is suitable when several production orders are
commenced at a time and it is not possible to find scrap for each other.
2) When the actual scrap is in excess of the pre-determined quantity, the cost of the excess
scrap is transferred to costing profit and loss account after deducting there from the
sale proceeds of such excess scrap.
3) The cost of defective scrap after deduction there from the sale proceeds of scrap is
transferred to costing profit and loss account because it is an abnormal loss.
Defective Items
These are that portions of product which is in the process of manufacturing, developed some
imperfection and which can be rectified at an extra cost of operation on it. Defective work is to
be distinguished from spoiled work. There is some imperfection which can bring up the standard
by additional material or labour. But the spoiled work cannot be reconditioned and the units must
be sold as scrap or second or third grade products.
Defectives occur because of
1) Poor workmanship and poor quality of raw materials
2) Improper maintenance of machines.
3) Faulty design of products.
4) Wrong setting of tools.

134
5) Lack of supervision.
6) Lapse of time.
7) Unsound working condition.
8) Management failure and poor manufacturing condition.
Accounting Treatment
1) The cost of rectification work, if identical, can be charged to the particular job
2) If the rectification work was not identical, the cost will be charged to the general factory
overheads.
3) If the cost of rectification is due to abnormal reasons, it will be transferred to costing

profit and loss account.
Spoilage
I.C.M.A., London defines spoilage as "units of output which fail to reach the required standard of
quality or specification. Such faulty units may be capable of rectification; and they may be so
corrected that the cost of doing so is less than the loss in value from allowing the fault to remain
uncorrected. When it is uneconomic to rectify the fault, the article may be sold as sub-standard.
If it is still functioning sound; otherwise it may be disposed of as scrap". This spoilage arises
when goods are so damaged in the course of manufacturing process. Generally, spoilage is
irreparable or non-rectifiable. This spoilage is classified into two types viz. normal spoilage and
abnormal spoilage. The cost of spoilage due to normal reason is loaded in the good units of
product, in case of abnormal spoilage: the cost of spoilage is transferred to costing profit and
loss account.
Control of Wastage, Scrap, Spoilage, and Defectives
It is necessary to all production-oriented concerns to have a control over wastage, scrap, spoilage,
and defectives. Efforts should be taken to reduce the cost of production by exercising control on
wastage, scrap, spoilage and production of defective items.
135
The following steps may be taken in this regard.
1) Reports related to the wastage, scrap, spoilage and defects should be prepared in time
to locate the reasons, to take corrective measures.
2) These losses should be standardised by following the standard costing system to make
comparison of actual loss with standard loss to spot out the reason when it gives adverse
effect. There is no chance to put an end to these losses, which are in normal nature in all
types of production process, because normal losses will occur without our knowledge.
We can predetermine these types of losses through standard costing system. The items,
which exceed the normal loss, are the abnormal losses, which are to be controlled to
reduce the cost of production.
3) Good quality of materials should be used. Better quality of materials will result less on no
wastage, scrap, spoilage and defectives.
Check Your Progress
a) A bill of material serves the purpose of –
b) A bill of material is prepared in case of a- job.
c) Normal wastage – part of cost of production
d) Abnormal wastage-part of cost of production
e) Material losses due to abnormal reasons should be transferred to
f) Defectives are that portion of production which can be - at some extra cost of re-operation.
g) Scrap represents- of materials that are left from certain types of manufacture.
2) State whether the following statements are true or false
a) Normal wastage is avoidable.
b) A bill of material gives a complete list of all materials required with quantities for a particular
job.
136
c) Wastage can be realised whereas scrap cannot be realised.
d) Abnormal wastage should be a part of the cost of production.
3) How will you treat material handling charges ?
4) How does a bill of materials serve the purpose of a purchase requisition?
5) What is the difference between wastage and scrap ?
8.5 Summary
In all types of manufacturing concerns it is not possible to eliminate the losses Olin nature.
These types of losses-wastage, scrap, spoilage and defectives which are normal in nature
should be planned before production from the experien through standard costing system. The
actual losses occurred should be compared planned losses. Any losses in excess of standard
loss is to be treated as abnormal loss items. These wastage, scrap, defective and spoilage
which are abnormal in nature should be eliminated, because these will affect the cost of
production. The management and production department should spot out the reasons for
abnormal losses and they should immediately take corrective measures.
8.6 Key words

Material Handling : It is concerned with heading of raw materials from the source to the place
of production.
137
Bill of materials : The bile which gives a complete list of all materials required for a particulars
job.
Wastage: The portion of basic raw material lost in the processing, having no value to be recovered.
Scrap : The discarded materials having some value disposed of without further treatment or
introduced again in production process.
Spoilage : The Materials which foul to reach the required standard of quality, which are capable
for rectification if needed and sold as sub-standard item.
Defectives : The portion of material in developed some importion and rectious with an extra
cost and sold as second third grade product.

1) What do you understand by normal and abnormal waste of materials during the process
of manufacture ? State how each should be treated in cost accounts.
2) When scrap, spoilage and defectives are high in an organisation how will you, as a Cost
Accountant, go about and take remedial measures to control them?
3) What is meant by Bill of Materials ? When will you recommend drawl of stores under Bill
of Materials as opposed to individual requisition ?
4) Distinguish between spoilage and defectives in a manufacturing company. Discuss their

treatment in cost accounts and suggest a procedure for their control.
5) Draw a proforma of "Bill of Materials". List down the advantages of using the same.
6) What is meant by material losses? What are the items constituting such losses? How
are these accounted for ?
7) How would you treat the following in Cost Accounts ?
a) Normal wastage.
b) Abnormal wastage.
c) Off cuts and broken pieces in the production of main product being used for
production of other articles.
138
1. a) material requisition
b) non-standardised job
c) forms
d) does not form
e) Costing Profit and Loss Account
f) rectified
g) fragments or remnants.
2. a) False b) True c) False d) False

139
LESSON - 9
LABOUR COST COMPUTATION
Learning Objectives
• Explain what is labour and labour cost
• Discuss the types and classification of labour cost
• Express how the labour costs are controlled
• Discuss the steps to have control over labour costs.
Structure
9.1 Introduction
9.2 Meaning
9.3 Summary
9.4 Key Words
9.1 Introduction
The previous chapters made you learn how materials play a vital role in the cost of a finished
product, how they are controlled, what are the factors affecting the cost of production, how the
factors affecting cost of production are eliminated. This chapter will make you to analyse how
labour cost is taking part in the cost of a finished product and how to compute the labour cost
and the way to have control over the labour cost.
140
9.2 Meaning
1. Labour : Engagement of manpower to complete a targeted work is called At present
sophisticated technologies are available. Even though they are available they cannot be
executed without manpower. This will make you to formulate that work can be executed
without human resources.
2. Labour Cost : The compensation by way of cash or kind given by the employer to the
manpower engaged by him to extract a particular required work is known as labour cost.
This labour cost is the second major element of cost. Under the presen political and
economic conditions with a restive labour in organised industry, it is very difficult to
reduce the labour cost. As far as material is concerned, rigid policies or control can be
executed. But it is not possible in case of labour. Moreover, materials can be easily
stored to be used as and when required, but labour is as like as a perishable item, which
should be used in time, if not, it is a waste and ultimately the cost of production will be
increased. This labour cost is divided into two types. They are
a) Direct labour cost
b) Indirect labour cost
a) Direct labour cost : I.C.M.A. defines direct labour cost as "cost is that cost which can
be identified with an allocated to cost centres or cost units”, “the Cost of remuneration
for employee's effect and skills is applied directly to a product or a saleable service”. Eg.
Engagement of work force in the production process.
b) Indirect labour cost: I.C.M.A. defines indirect labour cost as "cost other than direct
wages cost”, “therefore, indirect labour cost is the amount of wages paid to workmen
who are not engaged in the production of goods or services, but at the same time indirectly
help the direct labour.
This labour cost offered as compensation to the work extracted from the labour by the employer
includes
a) Monetary benefits.
b) Fringe benefits.
141
a) Monetary benefits : This type of benefit is direct benefit which is represented by way of
cash, such as i) basic wages. ii) dearness allowance. iii) employer's contribution to
provident fund. iv) employer's contribution to Employees State Insurance. V) production
bonus, vi) profit bonus. vii) old age pension. viii) retirement gratuity etc.
b) Fringe benefits : This type of benefit is indirect in nature represented by way of kind,
such as i) subsidised food. ii) subsidised housing and education to the children of the
workers etc.
3. Control Over Labour Costs : Labour cost is very essential for all production oriented
organisation. Engaging unfit persons in the factory, results in poor output at high cost
Hoe of production, less profit, more wastage etc and unfair practices in labour
engagements etc. Therefore proper utilisation of labour is essential. To have control
over labour E cost the following steps must be taken.
1. The scientific methods of selection of personnel
2. Imparting training to them
3. A good system of incentives
4. Production planning made in advance.
5. Time and motion studies which help to determine standards of time required for
each job.
6. A proper system of job evaluation
7. Introducing mechanical devices in labour costing
8. A good system of control over idle time and over-time
9. Control over labour turnover ratio.
10. Co-ordination and co-operation among the workers of the concern. To carry out
all the aimed schemes mentioned above, and to have a good effect from the
functional point of view.
In a large concern, the following departments are involved:
1. The personnel department
2. The engineering department

142
3. The rate or time and motion study department
4. The time-keeping department
5. The cost accountancy department
6. The pay-roll department
Personnel Department
The personnel department is headed by a personnel Manager. He is a responsible person, who

deals with employment discharge and transfer of the employees. He has to follow the policies
and directions laid down by the Board of Directors or the Executive Committee. The personnel
officer should be acquainted with the labour laws in force, labour policies, production programme
of the firm and the needs and problems of the employees. The important functions of this
department are selection, training and placing them on the job to which they are suited or best
fitted. Different departments to this personnel department send requisition for placement of
workers and the department proceeds for action in selecting personnel, locally or calling for
applications through advertisement or employment exchange. Labour placement requisition
proforma is given below.
On receipt of the labour placement requisition, the personnel department takes initiative to appoint
143
the applicants through tests, interview etc. by the personnel officer or the committee; and if
satisfied, appointment orders are issued, giving copies to the appointee, requisitioned and the
pay-roll department. The personnel department will have to keep a personnel record card or
employee's history card. In it full and relevant records of the employee have to be written. The
proforma of the employee's history card is given below
Engineering Department
This department helps in maintaining control over production methods and working conditions.
This department is headed by a technically qualified person who is well conversant with the
programme of planning production, processes and performance of the factory product. In brief,
the functions are:
1. To prepare plans and specification for each job schedule for production.
2. To maintain an efficient working condition.
3. To conduct researches and experimental work.

144
4. To make job analysis and job studies.
5. To conduct work studies – motion study, time study etc.
6. To set price - rates and time wages on the basis of work-study.
7. To make job evaluation.
8. To reduce labour turnover rates.
Time and Motion Study Department
Gilbreth defines this as, “The science of eliminating wastefulness resulting from unnecessary,
ill-directed and inefficient motions”. In other words, it is the study of the movements of an employee
(or a machine) in doing an operation for the purposes of eliminating unnecessary and inefficient
motions (Movements). The workers are studied at their performance and all the movements are
noted. They are carefully analysed to eliminate the useless motions. The object of this study is
to improve the system of working by economising efforts and reducing fatigue. The system
standardises the operation of a worker or a machine.
"Time study may be defined primarily as the art of observing and recording the time required to
do each detailed element of an industrial operation". It facilitates in fixing a “standard time" for a
job. It is the basis on which wage rates, incentive schemes etc., are fixed. To be effective, an
average worker may be studied, and not fast or slow workers.
Advantages
1. Fair incentive wage plans can be established.
2. Idle time to men and machines can be known.
3. Work method can be improved.
4. Labour cost control can be easily exercised.
5. Labour cost budget can easily be prepared.
6. Percentage of spoiled work can be reduced.
7. Lower direct and indirect cost.

145
8. Increased morale of employees
9 Lower labour turnover.
10 Better control of production.
11 Adds to capacity to face competition
12 Standard time for a job can be determined.
Illustration 1
A work measurement study was carried out in a firm for 10 hours and the following information
was generated:
Units produced 350
Idle time 15%
Performance rating 120%
Allowance time 10% of standard time
What is standard time for the task ?
Solution
Unit produced 350
Time spent 10 hours
Idle time 15%
Therefore, observed time per unit minutes
(10 * 60 * (85 / 100))/350 = 1.457.
Time per unit is 1.457 minutes when performance rating is 120%. Therefore, normal time per
unit at 100% performance rating is
Normal time = 1.457 * (120/100) =1.748 minutes
Allowance time = 10% of standard time

146
Therefore, standard time = 1.748 * (110/100) = 1.923 minutes
Alternatively, standard time may be calculated as follows:
1.748 * ( 100/90 )= 1.942 minutes
Job Evaluation
Job evaluation is to determine by studying and assessing, the relative worth of each job in order
to ascertain its comparative labour worth. It is studied on the basis of job description and job
analysis comparing one job with another. The labour value of each job is calculated by considering
skill, educational qualifications, responsibility, risk involved etc. All these characteristics are given
point value and the total of all these points is the relative value of the job. Wages are fixed and
paid on this basis.
Advantages
1. It helps in job classification and work simplification.
2. It helps in bringing uniformity in wage structure.
3. It facilitates cost control.
4. It simplifies wage administration by bringing about uniformity in wage rates.
5. There develops a good relationship between employee and the employer as no scope is
left for personal bias of the employer.
6. It helps in avoiding anomalies, confusions, unrest etc.
Job Analysis
Job analysis is to determine a list of qualifications needed to workers to perform the work
satisfactorily in each job.
It is defined as "the process of determining, by observation and study and reporting pertinent
information relating to the nature of a specific job. It is the determinate of the tasks which comprise
of the job and the skills, knowledge, abilities and responsibilities required of the worker for
successful performance and which differentiates the job from all others".
147
Advantages
a) It helps in fixing suitable rates for different jobs.
b) It affords no scope for personal prejudices in establishing rates to favour certain

employees.
c) It facilitates right recruitment, selection and placement of workers.
d) It assists training and development programme to workers for the development of their
skills related to their job.
e) It gives knowledge to workers about the work and work conditions.
Merit Rating
It aims at evaluating the workers performance. The purpose of merit rating is to reward the
workers on the basis of their merit, because it is a scientific tool. Under this, the following are
measured as the good qualities of a good employee.
a) Knowledge, skill, and experience
b) Interest on the work given
c) Quantity and quality of the work done.
d) Attendance and punctuality.
e) Reliability and integrity.
n) Supervisions qualities like leadership, initiative, self confidence and sense of judgement
g) Adjustability, Co-operation and discipline in usual and unusual circumstances
Importance of Merit Rating
a) It helps the supervisor in evaluating the performance of his subordinates.
b) It lists out the defects of the workers engaged to improve their performance.
c) It helps at the time of wage increase and promotion.
d) It reveals the weakness of the workers and the necessity of training in that particular
weakness.
e) It develops the sense of confidence.

148
Time-keeping Department
Time - keeping is the recording of the time of entry into and exit from the factory in respect of
every worker so that duration of work putforth by him may be assessed.
The Objectives of Time - Keeping are
a) to have a correct record of attendance for meeting statutory requirements.
b) to prepare the pay rolls.
c) to enforce discipline in attendance.
d) Overhead distribution when overheads are absorbed based on labour hours.
Methods of Time - Keeping
The methods of time keeping is broadly classified as
a) Manual methods.
b) Mechanical methods.
a) Manual Methods
These methods are generally used for recording the attendance. They are
1) Muster Roll / Attendance Register : It is a register containing the names of workers,

where they put signature in it during that arrival and exit time. In this the labours should
sign along with their time of their entry and exit. This is an orthodox system. Chances
are there for proxy. This register will be in the custody of the time - keeper.
2) Check Token or disk method : Under this method identical number are allotted to the
workers, known as token numbers in a metal disk. These disks are hung on a board with
book at the entrance of the factory. On arrival, the workers take their respective disks
and piace them in a tray or box, kept inside the factory. When the schedule time is over,
the tray or box is removed and another tray will be placed for late - comers. This tray is
also removed after the prescribed time.
b) Mechanical Methods
To overcome the defects of manual methods, mechanical devices are used in large concerns.
They are
149
1. Time recording clocks : It ensures great accuracy and avoids all types of disputes. It is
a mechanical device and it automatically records the time of workers. For this. every
worker is provided with a time card which contains all relevant information. These cards
are serially arranged in a tray. When they arrive, they take their respective cards and put
them in the time recording cards which will print the time. The same process is repeated
for departure also. Late arrivals and departure, overtime are printed in red colour. It is
very easy to prepare wage bill. Under this method there is a chance for mischief in
clerical work.
2. Dial time recorder : This device has a number of holes bearing numbers to the
corresponding token. There, a radial arm is mounted at the centre. Each worker entering
the gate has to turn the arm and press the same into the hole bearing his number. This
automatically prints the arrival and departure time on a paper kept inside the machine.
This can be used as a pay roll. This system has two types namely dial time recorder and
card time recorder.
Time booking
Time booking is to ascertain the time spent by a worker to complete a job or an operation. Time
booking is different from time keeping. The objectives of time booking are
a. to ascertain labour cost of every job.
b. to ascertain the work on which a worker is employed.
c. to have control over wastage of time.
d. to provide suitable apportionment of overhead expenses.
Methods of time booking
a) Daily Time Sheets : In small type of concerns each worker is provided with a daily time
sheet. The particulars of time spent on each job are recorded daily in this sheet. After
filling the sheet, the employee will hand over this to the supervisor for verification and
signature.
150
Merits
1) It is a record prepared by worker..
2) It is simple to understand and easy to operate.
3) It provides information, job wise and work wise.
4) There is a close check up, as the foreman verifies every day.
Demerits
1) Paper work becomes more voluminous.
2) The correctness depends upon the supervisor.
b) Weekly Time Sheets : It is similar to the daily time sheet, but similar recording are
made for a week. It will have separate columns for each day. Different colour sheets are
used for different departments. The following is the specimen of weekly time sheet.
151
Merits
1) It is more suitable for intermittent jobs.
2) It reduces clerical work.
Demerits
1) Accuracy depends upon supervision.
2) Irregularity in filling the sheet is common.
3) This method will not work successfully, when one has to do a number of jobs in a week.
Job Cards
Under this system a separate card is allotted for each job of operation. Whenever a worker
takes úp a particular job, to enter this card- the time of starting the job and completion of the job.
The entries are made either manually or through mechanical devices. After completion, the
worker will hand over the card to the foreman, who sends it to costing department. The job
cards are of four types:
a) Simple iob card / Job card for each worker.
b) Job card for each job.
c) Combined time and job cards.
d) Piece - work card.

152
a) Simple job card : In this system, a card is allotted to each worker, at the beginning of
each day or week. The time of starting and finishing the job is recorded. The form of this
simple job card is as like as weekly time sheet.
Merits
1) It helps to identify the idle time.
2) The total hours can be known.
3) The amount payable is known.
b) Job card for each job: Under the system only one card is issued for each job. This type
of card is used where the number of jobs to be done is large and each job has to pass
through different workers to complete it. The total labour cost of each job can be found
out easily.
Merits
1) The total cost can be known at a glance.
2) The reverse side may be used for material consumption.
c) Combined Time and Job Cards : This type of card has dual purpose. It shows the time
- keeping and time booking. Though this card, the attendance and the time spent on jobs
can be known. This card is used when the number of workers employed few.
153
d) Piece work card : The factories that pay wages on piece work basis use this piece
work card. Under this time taken or standard time is not important. The aim is a number
of quantities are produced by the workers. This output is measured to each worker. The
work done by each worker is checked and verified as to its quality by the inspector, who
may reject it, if the product is of substandard.
Idle Time
The time booked for jobs must agree with the time taken by the workers for the job. Normally the
time booked for jobs does not agree with the gate time; because of waiting for materials, machine
break down, waiting for instruction, power failure etc. Reconciliation of gate time with time booked
is facilitated by preparing an idle time card, which has been lost and the reasons thereof. Idle
time is that for which the employer pays without any benefit to him. Idle time is classified into two
types, viz. normal idle time and abnormal idle time. Normal idle time is the time wasted by a
worker which is unavoidable. Time taken by employee to the production department from gate,
tea break, time for tool setting etc. are the suitable examples for normal idle time. Abnormal idle
time is the time wasted which can be avoided. Machine breakdowns, waiting for work and
instruction, power failure, shortage of materials, strikes, lock out etc. are suitable examples for
abnormal idle time.
Control Over Idle Time
The following steps are to be taken to control idle time.

154
a) Vigilance must be exercised to control and eliminate idle time.
b) The instructions to the workers should be given in advance so that workers need not
wait.
c) Proper maintenance should be exercised on plant and machineries.
d) Root causes of idle time should be identified and removed properly.
e) Perfect supply of raw materials must be facilitated.
Accounting Treatment of Idle Time
1. Normal Idle Time: The cost of labour of normal idle time can be treated in two ways.
a) A worker has to work for 8 hours a day; but he actually puts in on 7 12 hours on job and
half an hours is wasted. The labour cost of half an hour will be charged with 7 22 labour
hour cost.
b) The hourly rate may be raised and the cost of complete labour (i.e. 8 hours ) may be
charged to the job concerned. This method is preferable.
2. Abnormal Idle Time : The abnormal idle time expenses or cost should not be included
in cost. It may be debited to costing profit and loss account.
Overtime
When a worker works above his normal hours for additional production, he is said to be working
overtime, for which the wage will be paid at double the normal rate as per the Factories Act,
155
1948. If a worker works more than 9 hours on any day or 48 hours in a week, the worker is
entitled for overtime payment. Usually a worker is to do overtime, when he completes his normal
hours. If the Factory Act does not apply instead of double the normal rate, 1 22 times of the
normal rate will be given as overtime wages.
However, overtime work should not be encouraged because
a) When a worker works more than his normal hours, he may not be having concentration
on production where the quality of output may be affected.
b) Additional monetary burden to the firm, which may be a loss to the firm.
C) Workers are tempted to earn more amounts without completing a job in normal working
hours.
d). Overhead expenses will also increase.
But at the same time, overtime work may be permitted.
a) During the peak season.
b) When there is failure of power or break down of machines.
c) To finish a job in time.
Illustration 2
Calculate the normal and overtime wages payable to a worker from the following data:
Days Hours Worked
Monday 8 hrs.
Tuesday 10 hrs.
Wednesday 9 hrs.
Thursday 11 hrs.
Friday 9 hrs.
Saturday 4 hrs.
Total 51 hrs.
Normally working hours 8 hours per day
Normal rate Re. 1 per hour

156
Overtime rate : Up to 9 hours in a day at single rate and over 9 hours in a day at double rate; or
up to 48 hours in a week at single rate and over 48 hours at double rate whichever is more
beneficial to the workmen.
Solution
Rs.
Normal Wages for 44 hours @ Re. 1 = Rs.44
Overtime Wages:
At single rate for 4 hours @ Re. 1 =Rs.4
At double rate for 3 hours @ Rs.2 =Rs.6
Rs.10
Total Wages Rs.54
Or alternatively
Normal Wages for 48 hours @ Rs.1 per hour = Rs.48
Overtime Wages for 3 hours @ Rs.2 per hours= Rs. 6
Total Wages Rs.54
Therefore, whichever method is followed, the amount of the wages payable to the worker is
Rs.54.
Labour Turn Over
It is the percentage of change in the labour force of an organisation. It is the rate of placement of
labour employed in an organisation. It is normal that some workers may leave their jobs and
157
some worker may take their place. This change in labour force is called as labour turnover. A
high labour turnover is not desirable..
The labour turnover is calculated under three methods.
1) Separation Method : The labour turnover is measured by dividing the total number of
separations during a period by the average number of workers employed in that period.
L.T.O= (No.of Separtion in a period / Avg no.of workers in a period) * 100
2) Replacement Method : By dividing the number of replacements during period with

average number of workers for that period. Labour turnover is calculated under this
method. Following the below given formula
L.T.O. = (No. of replacements in a period / Average no.of workers in a period ) * 100
3) Flux Method : Under flux method both separation and replacement in a particular period
are taken into account.
L.T.O. = (No. of Separations + No. of replacements) / Average no.of workers in a period)*

100
Illustration 3
From the following information, caiculate the labour turnover rate and labour flux rate
Number of workers at the beginning of the year 4,800
Number of workers at the end of the year 5,200
During the year 80 workers leave while 240 workers are discharged. 800 workers are required
during the year, of these 250 workers are recruited because of leavers and the rest are engaged
in accordance with an expansion scheme.
Solution
Average number of workers during the year = (4,800 +5,200)/2 = 5,000
Labour Turnover Rate
= (No. of workers replaced during the year/Average No. of workers during the year) * 100 = ( 250
/ 5000 ) * 100 = 5%
158
Labour Flux Rate
= (No. of additions+No.of separations during the year/Average no. of workers during the year) *
100
= (( 800 + 80 +240) / 5,000 )* 100 = 22.4%
Labour flux rate denotes total change in the composition of labour force due to additions and
separations of workers.
Reason for Labour Turnover
The causes of labour turnover may be of
a) Avoidable reasons
b) Unavoidable reasons
a) Avoidable reasons
i) Job dissatisfaction.
ii) Low wages.
ii) Poor working conditions.
iv) Bad planning.
v) Odd hours of work.
vi) Bad recruitment policy.
vii) Lack of incentives and promotional plans.
b) Unavoidable reasons
i) Death, retirement.
ii) Domestic reasons.
iii) Marriage.
iv) Personal betterment.
v) Transport and housing facility,

159
Cost of Labour Turnover
Cost of labour turnover is divided into two heads as
i. Preventive costs
ii. Replacement costs
1. Preventive Costs
It includes
a) Personnel administration cost.
b) Cost incurred on provision of medical services.
c) Cost of providing labour welfare facilities.
d) Cost of maintaining pension, provident fund and Old Age Benefit Schemes.
Treatment of Turnover Costs
Preventive Cost of labour turnover are treated as overhead expenses and should be apportioned
to different departments in the ratio of no. of persons engaged in each department.
Replacement cost of labour turnover should be charged directly to the departments.
Cost Accounting Department
The responsible department in a concern for the accumulation and classification of all labour
cost is cost accounting department. This department uses time cards, job cards, pay roll wages
abstract, wage analysis book for the purpose of labour costing. The following illustration makes
you to realise how the labour cost per man-day is calculated.
Illustration 4
From the particulars given below, prepare labour cost per man-day of 8 hours:
(a) Basic Salary Rs.3 per day
(b) Dearness Allowance 30 paise per every point over 100 cost of living index
for working class. Current cost of living index is
700 points.
(c) Leave Salary 10% of (a) and (b)

160
(d) Employer's contribution to 7.5% of (a), (b) and (c)

Provident Fund
(e) Employer's contribution to 3.5% of (a), (b) and (c)
State Insurance
(f) Expenditure on amenities
to labour Rs.25 per head per month
(h) Number of working days
In a month 30 days of 8 hours each.
Statement of Labour Cost

(per man day of 8 hours)
Pay - Roll Department
This department is responsible to prepare the pay roll. The main activities of the pay -roll
department is listed below.
i) To maintain a record of the job classification department
1. To verify and to summarise the time of each worker as shown on the time cards.
2. To calculate the wage due to the worker.

161
3. To prepare pay roll, wage sheet of each department.
4. To disburse the salary and wages.
5. To remit the deductions made from the wages to the appropriate authorities such as
income tax, P.F. authority etc.
6. Preparation and issue of earnings certificate to the workers as an when demanded.
After preparation of wage sheets, this will be handed over to the cashier so that he may withdraw
the amount from the bank and make the payment to the workers. The following is the specimen
of the wage sheet.
Pay Roll/Wage Sheet
Department Week Ending
The wage, sheet is to be prepared very carefully in order to eliminate the chance of fraud. The
most common frauds are the inclusion of dummy or ghost workers in the pay roll, marking the
absent workers as present. Necessary steps are to be taken to eliminate these frauds by following
the below mentioned steps.
i) More number of persons should be engaged during the preparation of wage sheet and
wages disbursement time.
ii) The persons engaged for preparing wage sheet should sign after preparation for its
correctness.
iii) Recording of times of arrival and departure should be properly controlled.
iv) Each and every worker should be issued an identity card containing all details.
162
v) The persons working on pay roll department should prepare the details related to the
worker's wages.
vi) Envelopes indicating the names of workers and amount contained there in should be
prepared.
vii) The cashier should withdraw the exact amount from the bank for wage payment.
vii) At the time of wage payment, the workers should be compelled to produce their identity
card.
ix) Wages to the absentees should be paid on a fixed date.
x) Wages should be paid to the workers concerned before some responsible official and
the unclaimed wages should be enquired into and reasons established. Such amount
should be transferred to an unpaid wage account.
Check Your Progress
1) State whether True or False
a) The pay-roll department, conducts time and motion study.
b) Labour once lost cannot be recouped.
c) A copy of the appointment letter should be sent to the time and motion study department.
d) In merit rating system, a number of traits are measured to know an employee's worth.
e) Job evaluation and job analysis are the same.
f) Metal disc method is a manual method of recording time of workers.
g) Time keeping is the recording of time spent by a worker on the different jobs or work
orders carried out by him during his period of attendance in the factory.
a) Labour cost is a______________major element of cost.
b) The Heart_______________ in labour makes difficult the control of labour cost where-
as materials, being inanimate in nature could be subjected to a rigid control.
c) Job evaluation is a method of evaluating the job in terms of its______________
d) There are two types of methods of time keeping, i.e.______________
e) Job analysis is the making of analysis of each job to determine a list of______________
needed by workers to perform the work satisfactorily.
163
f) Job card for each worker is maintained to know how the worker's time shown by the
time card is spent on______________
g) Idle time cards are prepared to know the reasons of ______________
h) Labour turnover according to replacement method is______________
i) Two types of idle time are______________
j) Cost of abnormal idle time is transferred to ______________
k) Two types of cost of labour turnover are ______________
1) The workers who are sent to the premises of the customers are known
as______________
m) The payment of idle time arises only when workers are paid on______________basis.
9.3 Summary
It is evident that labour cost plays a second major role in the cost of production. When this
labour cost is not controlled properly. It will affect the cost of production which may reflect price
hike in this cost of finished goods, wastage of raw materials etc. To eliminate these unnecessary
losses, labour control is essential to all types of manufacturing concern. This labour cost takes
form as direct and indirect cost. In an industry labour turnover should be avoided. For the
betterment of any concern labour cost and labour turnover should be controlled effectively.
9.4 Key Words

Labour Cost: The comparisation to the man power used to a particular job by way of cash or
kind.
Fringe Benefits : Benefit by way of kind such as subsidised God etc.
Job Analysis: List of qualifications needed to workers to perform the work satisfactory in each
job
Merit Rating: A method to ascertain the time spent by a worker to complete a job or an operation.
Time Booking: A method to ascertain the time spent by a worker to completea job or an
operation.
164
Idle Time : The time worked by the worker for which he gets wages
Over time : Additional hours worked by the worker than her normal hours.
Labour Turnover: It is the percentage of change in the labour force fo an organisation.

1) Describe briefly the functions of the following departments in relation to labour:
a. Personnel Department;
b. Time and Motion Study Department; and
c. Engineering Department.
2) Describe briefly the items of expenses that are generally included in 'Direct Labour Cost'.
3) Distinguish between:
a. Time keeping and Time Booking;
b. Job Evaluation and Job Analysis; and
c. Time Study and Motion Study
4) Explain the methods and records of time-keeping. What are the functions of timekeeping
records?
5) Define job evaluation and distinguish it from merit rating. Explain the methods and
advantages of job evaluation.
6) Describe briefly the functions of the following departments of manufacturing company in

relation to labour:
a. Pay-roll Department, and
b. Cost Accounting Department.
7) What do you understand by labour turnover ? How is it measured ? Why is high labour
turnover a matter of serious concern to the management? What steps should be taken
to check the increasing rate of labour turnover?
8) What do you understand by Idle Time ? What are its causes ? How it is treated in Cost
Accounts ?
9) A work measurement study was carried out in a firm for 8 hours and the following
information was available:
165
Unites produced 40
Performance rating 80%
Idle time 10%
Allowance time 10% of standard time
What is standard time for task ?
(Ans. 9.5 or 9.6 minutes per unit)
10) From the following data prepare a statement showing the cost per man-day of oight
hours.
a) Basic salary and dearness allowance R3,300 per month,
b) Leave salary to the workman six per cont of the basic and D.A.
c) Employer's contribution to Provident Fund 6% of (a) plus (b)
d) Employee's contribution to PF 6% of (a) and (b)
e) Pro-rata expenditure on amenities to labour Rs 25 per head per month,
f) Number of working hours in a month 200.
(Ans. Rs.14.48)
11) A worker is paid Rs. 300 per month in addition to dearness allowance Rs.75 per month.
He is entitled to bonus @ 10% on wages. Employer's contribution is 81/3 % of wages
towards contributory provident fund to which worker also contributes an equal amount.
The contribution for E.S.I. is 1 % for employer and % % for worker. The employer maintains
a canteen where subsidised tea and lunch are provided to workers and a monthly subsidy
of Rs.3,000 is provided to the canteen. The total number of employees who take advantage
of the canteen is 400. Normal idle time amounts to 20%. The worker is entitled to 15
days' earned leave during the year, The number of working days in a year should be
taken to be 300 of 8 hours each.
Find out the labour cost per hours.
Ans. Rs. 2.00]

166
12) From the following data calculate total monthly remuneration of 3 workers X,Y,Z:
i) Standard production per month per worker is 1,000 units.
ii) Actual production during a month :
X-800 units
Y – 700 units
Z-900 units
iii) Piece - work rate per unit of actual production 15 paise.
iv) D.A. Rs.40 per month(fixed)
v) House rent allowance : Rs.20 per month (fixed)
vi) Additional production bonus at the rate of Rs.5 for each percentage of actual
production exceeding 75% actual production over standard.
[Ans. Worker A-Rs.205; Worker B - Rs. 165; Worker C- Rs.270]

1. a) False b) True c) False d) True e) False f) True g) False
2. a) second; b) human element;
c) money value; d) manual methods and mechanical methods;
e) qualifications; f) various jobs;
g) idle time; h) (No.of workers replaced during the period Average no.of
workers during the period)*100
i) normal and abnormal; j) costing profit and loss account;
k) preventive costs and replacement costs;
l) outworkers; m) time
167
LESSON - 10
LABOUR - REMUNERATION AND INCENTIVES
Learning Objectives
• Explain remuneration and incentive
• List out the essential of good wage system
• Discuss the system of wages payment
• Describe the advantages and disadvantages of various wage payment system.
Structure
10.1 Introduction
10.2 Remuneration and Incentives
10.3 System of Wage Payment
10.4 Premium and Bonus Plans
10.5 Summary
10.6 Key Words
10.1 Introduction
From the previous chapter, you have learnt how the labour cost takes part in the cost of production,
how it affects the cost of production. It also discussed that poor administration of labour would
affect an increase in cost of production. It was also made us to understand how the labour costs
168
are controlled and the ways used for the labour cost control. This chapter attempts to reveal
what is remuneration and incentives?. How does they take part in labour cost? How they are
calculated?
10.2 Remuneration & Incentives

Remuneration is the consideration payable to the workers for the service rendered by them. It
includes wages, salaries, fees or allowances etc. However, incentive is the stimulation of effort
and effectiveness by offering monetary inducement of extra facilities. It includes premiums,
bonus, prizes, promotion plans, training schemes etc.
The remuneration to the labour are fixed on the basis of the following factors such as
a) Demand and supply of local labour
b) Trade Union's strength in the industry
c) Ability of the employer to pay without incurring loss
d) The improvement in productivity
e) Cost of living
f) The role of government
g) Wage level prevailing in the surrounding areas
Essential Features of a Good Wage System
1) The system should be fair to both the employer and employee.
2) The worker should be assured of a guaranteed minimum wage at satisfactory level

irrespective of the work done by him.
3) Under the scheme, efficiency should be rewarded by paying more wages comparing
with unskilled workers.
4) The pay should be paid in equal for equal work,
5) The wage level should be optimum and equal to the industries in the surrounding areas.
169
6) The system should be such, which should boost up the morale of the workers and .
should minimise the labour turnover, absenteeism, and late attendance.
7) The system should not violate any local or national trade union's agreement.
8) In order to protect the real wages from erosion, the level of money wages should adjusted
to price changes.
9) The system should be flexible to allow necessary changes, which may become inevitable
at a later stage.
10) The workers and workers union should informed properly about the procedures used to
establish wage rates, so that there may be no cause of suspicion in the minds of workers.
11) The wage calculation method should be simple where the workers can easily understand.
10.3 System of Wage Payment

By following the below mentioned principles the wages are paid. They are
a) Time Rate System
b) Piece Rate System
a) Time Rate System
In this method wages are paid to the workers for the hours engaged. The wages are paid
irrespective of the quantity of the work done. The wage is paid by applying the below given
formula
Wages = Hours worked * Rate per hour.
This time rate system is classified into five types. They are
i) Flat time rate / time rate at ordinary.
ii) High day rate / time rate at high wage level.
iii) Measurad day rate
iv) Graduated time rates
v) Differential time rate

170
Advantages
i) It is easy to calculate the earnings under this system. It does not involve much calculation
and worker can calculate wage on his own.
ii) Time wages result in better quality of output since workers are in no hurry to complete
the job.
iii) This system is generally preferred by the trade unions because uniform rate is given to
workers irrespective of difference in efficiency. Therefore, it maintains unity of workers.
iv) This system is economical, record of labour are simple and less detailed. This means
saving in over-heads.
v) Speeding is eliminated due to the security of job ensured to the workers. Speeding results
in poor health of the workers and wastage of raw materials.
vi) The workers are assured of stable earnings and sense of security.
Disadvantages
i) This system is unfair since wages and productivity are not correlated. In this, more
efficient worker gets no reward for his efficiency.
ii) This system may cause discontent among the more efficient workers and they may
leave the organization.
iii) It makes the workers lazy and dull and they sit idle because they will also get wages for
idle time.
iv) Efficient workers become inefficient because they may feel that they were not rewarded
for their efficiency.
v The cost of supervision may be high since the workers may not shrink their work.
vi) Cost accounting is difficult because labour cost per unit depends upon the rate at which
the men work.
b) Piece Rate System
Under this method, the wage is paid based on per unit produced by the worker. irrespective of
the time engaged. An equitable piecework rate should be fixed to give an inducement to the
workers to produce more. The rate is fixed with the help of time, motion study and job analysis.
171
There are four variants of this system, each differing only as far as the fixation of the piece wage
is concerned. They are
i) Straight Piece Rate System
ii) Taylor's Differential Piece Rate System
iii) Merrick's Multiple Piece Rate System
iv) Gant's Task and Bonus plan
i) Straight Piece Rate System
The simplest method of payment of wage is followed under this system. The wage is calculated
as under.
Wages = No. of Units (or) Pieces Produced * Rate per piece
Advantages
• Efficient workers are rewarded and bad workers are penalised.
• It maximises the level of output
• Cost of supervision is less. The workers works in their own interest
• The quantum of idle time is minimised.
• The workers may become innovative and improves their efficiency.
Disadvantages
• This system ignores the quality of output
• Fixation of an appropriate and satisfactory piece rate is very difficult.
• The trade unions do not favour this system as this encourages rivalry among workers
and weakens their hold over them.
• Workers waste more materials in their anxiety to speed up production and earn more.
• More clerical work is involved.
ii) Taylor's differential piece rate system
F.W. Taylor, 'the father of scientific management', introduced this system in the year 1880. It
was the first systematic attempt at rationalising the incentive. Under this system, standard time
and standard production of units are fixed. When the production of a worker is below the standard
the piece rate will be given at 80% of the standard piece rate and the level of output of a worker
is equal or more than the standard, 120% of piece rate will be given.
172
The following illustration will make you to understand, how the wages are paid under straight
piece rate and Taylor's differential piece rate system.
Illustration 1
Based on the following information, calculate the time rate, straight piece rate and Taylor's
differential piece rate of the workers Saravanan & Sivaraman.
Standard production 12 units per hour
Normal time rate Re.0.75 per hour
Differentials to be applied
80% of the piece rate below standard
120% of the piece rate at and above standard.
In an 8 hours day, Saravanan produces 85 units and Sivaraman produces 108 units.
Solution
Wages under time rate system
Saravanan = 8 hrs. * Re.0.75 per hr = Rs.6/=
Sivaraman = 8 hrs. * Re.0.75 per hr = Rs.6/=
In this problem we have been provided with time rate only.
We can also calculate the piece rate from the given information.
Piece rate = Time rate per hour / No. of pieces produced per hour
= Re.0.75/12 = Re.0.06257=
Wages under straight piece rate system
Saravanan = 85 units * Re.0.0625 per piece =Rs.5.317=
Sivaraman =108 units * Re.0.0625 per piece =Rs.6.75/=
Wages Under Taylor's Differential Piece Rate System
To calculate wages under this, system we have to calculate the standard output for | the standard
time.
173
Standard output = No. of pieces per hour * Total working hours
= 12 pieces * 8 hrs = 96 pieces.
Therefore, Saravan is below the standard output...
The wages are to be calculated to him at 80% of the standard piece rate.
Wages of
Saravanan = 80% * 0.0625 * 85 units =Rs.4.527=
Sivaraman's production is more than the standard production, so he will be paid at 120%
of the piece rate.
= 120% * 0.0625 * 108 units = Rs.8.10/=
Advantages
• Easy to understand
• It gives incentives to workers to increase production.
• It is advantageous to employer as it helps to increase production.
• Increased production reduces the cost per unit.
Disadvantages
• Even a slight fall will considerably affect the wage rate.
• It does not provide minimum wage.
• It imposes a very heavy penalty on a worker who fails to attain the standard by a narrow
margin.
iii) Merrick's Multiple Piece Rate System
It is an improved system of Taylor's differential piece rate system.
The following table will makes you to understand how the wages are calculated under merrick's
multiple piece rate
174
Performance / Efficiency Wage Rate on Ordinary

of Output on Standard Output Piece Rate
<83% of the standard output Ordinary piece rate
>= 83% and <= 100% of the standard output 110% of the ordinary piece rate
>100% of the standard output 120% of the piece rate
Illustration 2
Calculate the earnings of workers A,B and C under straight piece rate system and Merrick's
multiple piece rate system from the following particulars
Normal rate per hour Rs.1.80
Standard time per unit 1 minute
Output per day is as follows:
Worker A: 384 units
Worker B: 450 units
Worker C: 552 units
Working hours per day are 8.
Solution
Standard output per minute = 1 units
Standard production per hour = 60 units
Standard production per day of 8 hours = 480 (i.e. 60 * 8 ) units
Normal rate per hour = Rs.1.80
Normal output per hour = 60 units
Therefore Normal piece rate = Rs. 1.80 / 60 = 3 paise (0.03)
Calculation of level of performance
Standard output per day =480 units (calculated above)
Worker A's output per day =384 units

175
Worker A's level of performance = (384 / 480) * 100 = 80%
Worker B's output per day . =450 units
Worker B's level of performance =( 450 / 480 ) * 100 = 93.75%
Worker C's output per day =552 units
Worker C's level of performance =( 552 / 480 ; * 100 = 115%
Earning of Worker A
Under straight piece rate system:
For 384 units @ 3 paise per unit = 384 * (0.03) = Rs. 11.52
Under Merrick's multiple piece rate system:
Normal piece rate has been applied because worker A's level of performance is 80% which is
below 83%.
Earning of Worker B
For 450 units @ 3.3 paise per unit = 450 * (0.033) = Rs. 14.85 (0.03 x 110%)
Worker B's level of performance is 93.75% which is between 83% and 100% so he is entitled to
get 110% of normal piece rate (i.e. 110% of 3 paise or 0.033 paise per unit)
Earning or worker C
For 552 units @3 paise per unit = 552 * (0.03) = Rs. 16.56
For 552 units @ 3.6 paise per unit = 552 * (0.036) = Rs.19.87
Worker C's level of performance is 115% which is more than 100% of standard output so he is
entitled to get 120% of normal piece rate (i.e. 120% of 3 paise or 0.036 paise per unit)
176
iv) Gants Task and bonus plan
This method is a combination time, bonus and piece rate wages using the differential piece rate
principle. The remuneration payable under this plan is as follows:
Out put Wages
1) Below standard Guaranteed wage
2) Equal to standard Guaranteed wage + Bonus 20% on it
3) Above standard Piece rate wage + Bonus 20% on it
This system is also known as “progressive Rate System".
Advantages
i) It provides security to less skilled worker and incentives to the efficient workers.
ii) It is simple to understand.
iii) It is suitable when fixed overhead and machine
Disadvantages
i) If the standards are high, very few workers may earn bonus. This may result frustration.
ii) Due to wage scheme units of labour may get affected.
Illustration 3
From the following data, calculate monthly remuneration of three workers X, Y and Z under
Gant's Task and Bonus Scheme.
i) Standard production per month per worker is 1500 units.
ii) Actual production during the month
X-1000 units Y-1500 units Z-1800 units
iii) Piece work rate - 0.90 paise per unit.
Solution
Standard production per month is 1500 units and piecework rate is 0.90 paise per units; so
guaranteed payment is Rs. 1350/- (i.e. 0.90 paise * 1500 units).
177
Level of Performance of Workers
X = ((1000 / 1500) *100 ) = 66.67%
Y = ((1500 / 1500) * 100 ) = 100%
z = ((1800 / 1500) * 100 ) = 120%
Therefore earning of worker X; His level of performance is below 100%, so he will get the
guaranteed wage of Rs.1350/-.
Earning of worker Y; His level of performance is at standard, so he will get the guaranteed wage
plus 20% bonus on it.
Therefore Rs.1350 + 20% of Rs.1350% = Rs. 1620/=
Earning of worker Z; His level is above the standard, he will get the high piece rate plus 20%
Bonus on it.
Therefore Actual 1800 * 0.90 = Rs. 1,620
(+) Bonus at 20% on the above = Rs. 324
= Rs. 1,944
10.4 Premium and Bonus Plan

The purpose of an incentive wage plans is to induce the worker to produce more and thereby to
secure higher earnings from him when there is increased production, there will be saving in total
production cost per unit. The incentive may be of monetary or non-monetary benefits or both.
The main objectives of any incentive plans are as follows:
j) Rewarding efficiency
ii) Reducing per unit cost of overhead
iii) To increase the overall productivity
Essential of Good Incentive Plans
i) It should be simple and easy to understand..
ii) It should be commonly acceptable one by all workers.
iii) Standard time should be determined based on time and motion study.
178
iv) A minimum and adequate wage should be assured.
v) It should be flexible so that necessary changes may be introduced quickly.
vi) It should result increase in production and decrease in cost of production.
vii) Schemes of reward should be prompt.
viii) It should provide a better supervision and production control.
ix) The cost of operating of these schemes should be economical.
The following are some schemes introduced under good incentive plans. They are
a) Individual premium plans
i) Halsey premium plans.
ii) Rowan premium plan
iii) Emerson Efficiency Plan (or) Empiric System.
iv) Barth premium plan.
v) Bedeaux point premium plan.
b) Group premium plan
i) Priestman's Production Bonus
ii) Scanlon Plane
iii) Towne Plans
a) Individual Premium Plans
i) Halsey Premium Plan
F.A. Halsey founded this system. Under this plan, time rate is considered. Standard time and
work are determined in advance. The worker will get wages for the time taken plus 331/3% to
662/3% as bonus for the time saved by him, normally 50%.
WH = Time Taken * Rate per hr. + % (Std. Time - Time taken) * Rate per hr.
= (TT *R) + % (S-TT) * R

179
Illustration 4
Rate per hour = Rs.3.50 per hour
Time allowed for job = 20 hours
Time taken = 15 hours.
Calculate the total earnings of the worker under the Halsey Plan.
Solution
S = 20 hours
TT = 15 hours
R = Rs.3.50
WH = (TT * R ) + 50% ( S- TT)* R.

= (15.* 3.5) + 50/100 *( 20 - 15) * 3.5
= Rs.52.50 + 8.75
= Rs.61.25/=
Advantages
• It is simple to understand and simple to operate.
• It guarantees time wages to workers.
• The wages of time saved is shared between the employer and employee, which help In
reducing labour cost per unit. the enginee rs It differentiates officient and inefficient workers.
• Fixed overhead cost per unit is reduced with increase in production.
Disadvantages
• Quality of the work suffers because workers are in a hurry to save more time to get
incentive.
• Workers criticise this method on the ground that the employer gets a share of wages of
the time saved.
180
ii) Rowan Plan
This plan was introduced by J.Rowan. Under this plan bonus is the proportion of the wages of
the time saved bears to the standard time.
Bonus = ( Std. Time - Time Taken / Std. Time ) * Time Taken * Rate per hour
Total Earnings = Time Taken * Rate Per Hour + Bonus
Consider the problem given in the Halsey Plan.
Standard Time = 20 Hours
Time Taken = 15 Hours
Rate per Hour = Rs.3.50/=
WR = ( 15 * 3.50 ) +(((20 -15) / 20) * 15 * 3.50)
= 52.50 + 13.13
= Rs.65.63/=
Advantages
• It guarantees minimum wages.
• It gives incentives to workers to save more time and earn more bonuses.
• The quality of work does not suffer much.
• The employer is also benefited, as he gets larger in share in saving achieved.
iii) Emerson's Efficiency Plan
Emerson introduced this plan. It is the combination of time and piece rates. Minimum daily
wages are guaranteed. Standard output is determined based on time and motion study. Under
this method the earnings are calculated as under.
Earnings = Hrs. worked * Rate per hr. plus Emerson's percentage * hrs. worked rate per hour
181
Bonus rates under this plan
The following table exhibits the bonus percentage increase

182
Illustration 5
Standard output per day of 8 hours is 16 units. Actual output of a worker for 8 hours is 20 units.
Rate per hour is Rs.2.50/=. Calculate the wages payable to the worker according to the
Emerson's Efficiency Plan.
Solution
Level of Performance = (Actual output / Standard output) * 100
= (20 units / 16 units) * 100 = 125%
Therefore, Bonus payable is calculated as given below.
Out of 125% up to 100% for the balance 25% ->20% of time wages
Efficiency 1% of bonus for each 1% of efficiency up to 25% - >25% of time wages
Total Bonus Payable 45%
Therefore Wages =
Time wages for 8 hrs @ Rs.2.50 per hour Rs.20
(+) 45% on Rs.20% of time wages Rs. 9
Total wages payable Rs. 29
iv) Barth Premium Plan
This method is suitable for beginners and apprentices, Wages are to be calculated as given
below. This method does not guarantee time wages to the workers.
Therefore Total Earning = Rate per hour* vStd. hrs * Actual hrs,
V) Bedeaux Point Premium Plan
In this plan every operation or job is expressed in terms of so many standard minutes, which are
called "Bedeaux Points" or "B's". Each B representing one minute through time and motion
study. Up to 100% performance, the worker gets part time wages without any premium for
efficiency. If the actual performance exceeds the standard performance in terms of B's, then
75% of the wages of time saved is paid to the workers as bonus and 25%. is earned by the fire-
fighter. This method ensures time wages to the workers and has the novel feature of distributing
the wages of time saved among workers and foremen. It serves as a strong incentive for workers
for improving their performance above 100% of the standard.
183
b) Group Premium Plans
The bonus schemes, previously discussed are individual premium plans. A bonus scheme for a
group of worker's can be introduced where:
• It is necessary to have teamwork.
• It is required to reward not only the direct workers but also the indirect workers who
assist the direct workers.
• It is difficult to measure the output of the individuals.
Advantages
• It creates team spirit and high output.
• It eliminates wastage of materials.
• It guarantees time wage to the member of a group.
• Flow of production will be maintained by the group to get group bonus.
• Supportive system to indirect labours on their wages
• It greatly reduces the number of rates to be negotiated.
• It is easier to manage the scheme.
Disadvantages
• Inefficient workers in the group will get the same benefit.
• Its net effect is lesser than the individual premium plan for individual.
• It may by difficult to obtain agreement on the proportions of the bonus, which group
members will receive.
For a satisfactory group bonus system should have the following characteristics.
• The degree of skill required of the workers of the group should not vary widely.
• The number of the members of a group should not be very large.
• The production of a group should be independent of any other group.
The following are some group premium plans.

184
Preiestman's Production Bonus
In this scheme the workers of a group is assured with guaranteed time wages. When the
production of the group exceeds the standard, the group will get bonus in proportion to the
increase in output.
Scanlon Plan
A constant proportion of the benefit of output is paid to the workers who are responsible for the
addition of the value. The added value is the change in market value (including profit) resulting
from an alteration in the form, location or availability of a product (or) service, excluding the cost
of purchased materials or services used in production.
Towne Plan
The objective of this plan is to encourage cost reduction by supervisors and workers. However,
bonus is paid upon a reduction in labour cost alone. A standard cost per unit for a particular
period is determined and if actual labour cost per unit is less than the standard labour cost, 50%
of the saving in labour cost is distributed among workers and supervisors in proportion to their
wages.
Illustration 6
Ten men are working as a group on a particular manufacturing project. When the weekly
production of the group exceeds a standard number of pieces per person-hour, each man in the
group is paid a bonus for the excess production, in addition to his wages at hourly rates. The
amount of bonus is computed by first determining the percentage by which the group's production
exceeds the standard. One-half of this percentage is then applied to a wage rate of Rs.8 to
determine an hourly bonus rate, irrespective of the variation in individual hourly wage rates.
Each man in the group is paid, as a bonus, this bonus rate applied to his total hours worked
during the week. The rate of production before a bonus can be earned=200 pieces per person-
hour.
Based on production records stated below, compute:
i) The rate and amount of bonus for the week
ii) The total wages of 'A' who worked 40 hours at a base rate of Rs.6 per hour and of 'B'
who worked 39 1/2 hours at a base rate of Rs.9 per hour.
185
Man-hour worked Production
Monday 72 17,680
Tuesday 72 17,348
Wednesday 72 18,000
Thursday 72 18,560
Friday 71.5 17,888
Saturday 40 9,600
399.5 99,076
iii) How much is the labour bonus cost to be attached to each unit of the week's production?
Solution
i) Actual rate of production for the group per person-hour

= ( 99,076 / 399.5 ) =248 pieces
Standard rate = 200 pieces per man-hour
Actual rate exceeds the standard
=( 248 - 200 200 ) * 100 = 24%
Thus, Bonus rate per hour = 8 * (1/2) * ( 24/ 100 ) = Re.0.96.
Total amount of bonus for the week
=Re.0.96 * 399.5 = Rs.383.5
ii) Total Wages
A= 40 * Rs.6 + 40 * Re.0.96 = Rs.278.40

B= 39.5 * Rs.9 + 39.5 * Re.0.96 = Rs.393.42
iii) Total production for the week = 99,076

Total bonus for the week = Rs.383.50
Thus, Labour bonus cost per unit
= Rs.383.50 / 99,076 = 4 paise (Approx.)
186
Check Your Progress

a) In time wage system, wages are paid according to the__________
b) Under piece rate system of wage payment, payment is made according to the__________
c) For a work order, standard time and time taken are 20 hours and 15 hours respectively.
Time rate being Rs.2 per hour total wages payable under Rowan Premium Plan will
be__________
d) Taylor's differential piece rate system provides for higher rate to__________workers.
e) __________is most suitable when quality of work is of prime importance.
f) Formula of calculation of wages under Halsey Premium System is__________
g) Under Merrick's multiple piece rate system, 110% of the ordinary piece rate is given to
workers whose level of performance is between __________of the standard output.
h) In Taylor's differential piece rate system,__________piece rates are set for each job.
2. State whether True / False
a) Low time wages do not necessarily mean low cost of production and high wages mean
high cost of production.
b) There are two principal wage system:
1) time wage system and 2) piece rate system.
c) Piece rate system is suitable when quality of goods produced is of extreme importance.
d) Time wage system is suitable where output cannot be measured
e) Piece rate system cannot be successfully applied when the work is ofsuffers in the
Rowan Plan.
f) The Halsey Plan, the quantity of work does not suffer much as it suffers in the Rowan
Plan.
g) The Halsey Plan protects workers against loose premium rate setting.
187
3. Choose the correct answer
a) Which of the following methods of wage payment is most suitable wherethe speed of
production is beyond the control of worker?
i). Time rate system
ii) Piece rate system
iii) Halsey premium system
b) Which of the following methods of wage payment does not guarantee wages on time
basis ?
i) Halsey premium system
ii). Rowan premium system
iii) Piece rate system
10.5 Summary
We can recognise that the remuneration to workers is the most complex problem in the
democratic countries. It is fact that wages will affect the cost of production. The employer offers
the wages by following various reasonable methods. Apart from wages, bonus and incentives
are offered to encourage the workers. The bonus and incentives are given by following various
methods in individual premium plan for individuals, for group of workers by following group plans.
These awards are issued after bifurcating the efficient and inefficient workers.
10.6 Key Words

Remuneration : Consideration payable to the workers for the service rendered by them.
Incentives : It is the stimulation of effort and effectives by offering monetary inducement of

extra facilities
Progressive Rate : Order exent task & bonus plan the bonus paid based on output percentage
188

1. What are the factors to be taken into account before adopting a particular system of
wage payment?
2. What are the essential characteristics of a good system of wage payment ? and Describe
the time rate and piece rate systems of wage payment.
3. What are the merits and demerits of time rate and piece rate systems of wage payment?
State the situation in which each system is effective and useful.
4. State two differences between the Halsey and the Rowan systems of incentive schemes.
5. Using the following data, calculate the wage payable to a workman under the Rowan
Premium Bonus Plan and the Halsey Premium Bonus Plan.
Time allowed : 40 hours
Time taken : 32 hours
Rate per hour : Rs.5.00
[Ans. Rs.192.00 (Rowan) Rs. 180.00(Halsey)]
6. Using the following data, discuss and illustrate any three methods of incentive bonus
plans, bringing out their comparative merits and demerits.
[Ans. Halsey :Rs.220.00
Halsey-Weir :Rs.212.00
Rowan :Rs.233.30]
7. Standard time allowed for a job is 20 hours and the rate per hour is Rs.5 plus a dearness
allowance of Rs.1.50 per hour worked.
The actual time taken by a worker is 15 hours. Calculate the earnings under i) Time
Wage System ii) Piece Wage System iii) Halsey Plan iv) Rowan Plan.
[Ans. a) Rs.97.50; b) Rs. 122.50; c) Rs.110; d) Rs. 116.25 ]
8. Calculate the earnings of A and B under straight piece rate basis and Taylor's differential
piece rate system from the following information:
Standard Production : 10 Units per hour

189
Factory day : 8 hours : 8 hours
Normal time rate : Rs.5
Differential rates to be applied
80% of piece rate below standard
120% of piece rate at or above standard.
Mr.A produced 70 units in a day.
Mr.B produced 85 units in a day.
[Ans. Under Straight Piece Rate: A gets Rs.35 and B gets Rs.42.50 and under Taylor's
differential system, A gets Rs.28 and B gets Rs.51 ]
9. In a manufacturing concern the daily wages guaranteed for workers is Rs.20. The standard
output for the month is 1,000 articles representing 100% efficiency. The rate of wages is
paid without bonus to those workers who show-up to 662/3% efficiency. Beyond this,
bonus is payable in a graded scale:
Efficiency Bonus
90% 10%
100% 20%
Further increase of 1% of bonus for every 1% further rise in efficiency. Calculate the total
earnings of A,B;C and B who have worked 26 days in a month, and their output was 500,
900, 1,000 and 1,200 articles respectively.
[Ans. A B C D
Efficiency % 50 90 100 120
Earnings: Rs.520 Rs.572 Rs.624 Rs.728]
10. From the particulars given below, prepare the labour cost per man day of 8 hours:
a) Basic salary Rs.55 per day
b) Dearness Allowance: Re.0.50 per every point over 100 cost of living index for
working class Current cost of living index is 700 points.
190
c) Leave salary: 10% of (a) and
d) Employer's contribution to P.F. of (a).+ (b)+(c).
e) Employer's contribution to State Insurance: 2.5 % of (a) + ( b ) + (C).
f) Expenditure on amenities to labour: Rs.20 pe head p.m
g) Number of working days in a month 25 days of 8 hours [Ans. Rs.82.20 )...

1. a) time worked;
b) quantity of work done;
c) Rs.37.50;
d) efficient;
e) time wage system;
f) T* R + % (S-T) R; g)
g) 83% and 100%;
h) two
2. a) True; b) True; c) False; d) True; e) False; f) False; g) False
3. a) (i); b) (iii)
191
LESSON - 11
OVERHEADS
Learning Objectives
• Differentiate between direct and indirect expenses
• Say how they are codified
• Brief the steps involved in overhead accounting
• Discuss the difference between allocation and apportionment
• List out the bases of apportionment and principles of apportionment of overheads
• Explain what is secondary distribution
• Describe how overhead rates are calculated.
Structure
11.1 Introduction
11.2 Meaning
11.3 Methods of Codification
11.4 Steps Involved in Overhead Accounting
11.5 Re-Apportionment
11.6 Absorption of Overheads by Production Units
11.7 Summary
11.8 Key Words

192
11.1 Introduction
From the previous chapters, you have acquainted knowledge that in the cost of woduction of a
product, material and labour occupy the first and second places respectively. Therefore, it was
discussed that the control is necessary on those two items. It was explained in the previous
chapters, how the materials and labour costs are controlled, and the methods and objectives of
the control techniques. Next to the items material and labour, expenses occupy the third place.
The expenses are specially incurred on behalf of a particular job, and therefore they may be
charged on the job.
11.2 Meaning
The expenses related to the production other than material and labour is classified
into two categories viz.
a) Direct expenses / Chargeable expenses
b) Indirect expenses / Overhead expenses
a) Direct expenses : The direct expenses that are also called as chargeable expenses
mean the expenditure which can be identified with and allocated to cost centres or cost
units. I.C.M.A. London defines "as costs, other than material and wages, which are
incurred for a specific product or saleable service." These expenses can be allocated to
particular job, because they are identical with the particular job.
The following are the suitable examples for direct expenses / chargeable expenses.
i) Hiring a plant or machinery for a particular job / cost of components and spares bought
for a specific job.
ii) Royalties payable based on production
iii) Research and experimental cost of expenditure on models and pilot schemes.
iv) Cost of special pattern, designs, tools etc.
v) Travelling and other expenses in securing a particular contract work and to the work site
vi) Architect's, surveyor's and other consultant's fees

193
vii) Freight and carriage inwards on the special material
viii) Packing materials required for a job.
In some cases, the direct expenses, which are meagre, will not be treated as direct expenses
because it will be small or a negligible value. At that time, these minor direct expenses are
treated as indirect expenses. The following are some examples for these types of expenses.
They are nuts & screws, sewing cotton thread, handling labour etc.
b) Indirect expenses / Overhead expenses : The expenses, which cannot be apportioned

to or absorbed by cost centres or cost units are known as indirect expenses. All these
expenses are called as overheads and need apportionment. These expenses are also
known as overhead cost, overhead charges, non-productive cost, burden, loading and
on cost.
I.C.M.A. defines overhead as "total cost of indirect materials, wages, and expenses”. According
to Wheldon "overhead may be defined as the cost of indirect materials, indirect labour and such
other expenses including services as cannot conveniently be charged to a specific unit." According
to Blocker and Weltmer, “overhead costs are operating costs of a business enterprise, which
cannot be traced directly to a particular unit of output. Further such costs are invisible or
unaccountable.”
The overheads are classified based on i) function ii) behaviour iii) element-wise and iv) nature.
Production overheads, administrative overheads, selling, and distribution overhead are the
overheads classified based on its function. Fixed overheads, variable overheads, semi fixed
and semi-variable overheads are the overheads classified based on its nature. The segregation
of semi-variable overheads into fixed and variable overheads is very important for correct cost
ascertainment, cost control and decisionmaking.
The following methods may be used for this purpose.
i) Graphical presentation method
ii) Least Square method
iii) High or Low points methods.
iv) Methods of Averages
v) Equation method
194
vi) Analytical method
The classification of overhead into fixed and variable are
i) to fix the selling price.
ii) to frame the budget.
iii) to have effective cost control.
iv) to help the management for decision-making.
v) to prepare break even charts and marginal costing.
vi) to identify the method of absorption of overheads.
The element-wise classification is made based on its nature and source as indirect material,
indirect labour and indirect expenses. Stores used in maintenance of machinery building etc.,
stores used by service departments, lubrication oil and, tools used are some suitable examples
for indirect material. Charge-hands and supervisors, maintenance workers, departmental coolies
employed in service department, clerical staff engaged are some suitable examples for indirect
labour. Rent, rates and insurance, municipal tax, general manager's salary, canteen and welfare
expenses, power and fuel, cost of training the employee etc. are some suitable examples for
indirect expenses. According to the nature, the expenses are classified and codified. Coding is
a technique of intelligently describing in numbers or letters or a combination of both the length
description of numerous cost accounting heads for ease of recording and controlling of a cost
data generated.
11.3 Methods of Codification

There are three types of codification generally accepted. They are
i) Mnemonic Method : Under this method symbols are so allotted as to assist memory.
The symbol itself suggests the name of the items.
Eg. SAL - for Salary, RE- for Repairs, RET- for Rent, MA- for Maintenance. AD - for
Administration.
ii) Decimal Code Method : The whole numbers are used to indicate the master group
and the decimals to indicate primary, secondary and other groups.
195
Eg.
1.1 Indirect Materials
1.1.1 Lubricant oils
1.1.2 Consumable stores
1.1.3 Spare parts
1.2 Indirect labour
1.2.1 Stores
1.2.2 Internal transport
1.2.3 Inspection
iii) Field Method Numerical Code : This method is used in the concerns which are working
under mechanised system with punched card accounting. The nine-digit punched card
is divided into four barrels as under: 10/120/01/05
In these four barrels, first barrel containing two digits (i.e. 10) represents kind or class of overheads.
E.g. fixed or variable. The second barrel of three digits represents head of expenses. Third
barrel with two digits stands for the analysis of expenses. The last barrel of two digits shows the
cost centre number. This method is suitable for large business concerns.
11.4 Steps Involved in Overhead Accounting

The total cost of a product is ascertained by adding overheads with the prime cost. The
overheads which cannot be specifically related to cost units, are to be apportioned to various
departments and then to cost centres or production units. The following steps are involved in
this procedure:
• Collection of overheads
• Classification of overheads
• Allocation and apportionment of overheads
• Re-apportionment of service departments' expenses to production department.
• Absorption of overhead by production units

196
1. Collection of Overheads : The production overheads are collected under separate

standing order numbers provided from the following documents such as
i) Stores Requisition
ii) Wages Analysis Sheet
iii) Invoice / Purchase Vouchers
iv) Cash Book
v) Subsidiary Books
2. Classification of Overheads : The classification overheads has been already discussed

in detail.
3. Allocation and Apportionment of Overheads to Cost Centres Departmentalisation

of Overheads : The overheads are collected properly under suitable account heading.
The next step is allocation and apportionment of such expenses to cost centres. This is
known as departmentalisation of overheads. For this, departments are classified into
three types viz.
i) Manufacturing departments
ii) Service departments
iii) Partly producing departments
Allocation of Overhead Expenses: Allocation has been defined by I.C.M.A. London as “the
allotment of whole items of cost to cost centres or cost units”. Allocation of overhead is the
function of identifying overhead items with particular cost centres or production and service
departments. Allocation is the process of charging the full amount of overhead costs to a particular
cost centre. It is possible when the nature of expenses is such that it can be easily identified with
a particular cost centre.
Apportionment of Overhead Expenses: Apportionment has been defined by I.C.M.A. London

as "the allotment of proportions of cost to cost centres or cost units”. It is the process of distributing
those items of overhead. This cannot be allocated to a cost centre or department, between cost
centres or departments on an equitable basis. It is the process of splitting up an item of overhead
197
cost and charging it to the cost centres on an equitable basis. That is, where the expenses are
a common one and it is to be allotted to different cost centres proportionately on an approximate
basis. It is known as apportionment of overhead expenses.
Differences Between Allocation and Apportionment: Allocation is the allotment of whole

items of cost to cost centres and cost units, but apportionment is allotment of proportion of cost
to cost centres or cost units. The allocation of expenses can be done directly but for the
apportionment, suitable basis is to be followed. For example
a) Factory rent can be allocated to factory, but can be apportioned to the departments.
b) The maintenance of cost of production shop can be allocated to the shop directly; but it
can be apportioned to various machines of the shop, based on machine-hour or value of
the machines.
Bases of Apportionment
As discussed earlier, the apportionment can be made by following suitable basis to production
and service departments and then the total cost of the service departments should be re-
apportioned among the production department. The first step of allocating the cost to the
production and service department is called as primary distribution. The following are the main
bass of overhead apportionment utilised in manufacturing concerns.
i) Direct allocation.
ii) Direct labour hours.
ii) Direct wages.
iv) Number of workers.
v) Relative areas of departments
vi) Capital value of the assets.
vii) Number of lighting points used.
viii) Kilowatt-hours
ix) Technical estimates

198
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 / Use / Benefit Derived : If the service rendered by a particular item of expense
to different departments can be measured, overhead can be convoniently apportioned
on this basis. For example, rent charges are distributed on the floor space occupied
basis and the cost of maintenance are distributed to the different departments based on
the machine's capital value or machine hours.
ii) Ability to Pay Method : Under this method, overheads are distributed in proportion to
the sales ability, profitability of the departments. This method is inequitable. This method
is not advisable.
iii) Efficiency method : The apportionment of expenses is made on the basis of the
production targets under this method When the actual exceeds the target production.
the unit cost reduces indicating a more than average efficiency. It the target is not achieved,
the unit cost goes up, indicating the inefficiency
iv) Survey method : In some cases, it is not 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 overheads to be borne
by each cost centre is determined. For example the electricity is consumed and it is not
metered the total electric charges will be apportioned after taking the survey of the number
and wattage of light points and hours used.
11.5 Re-Apportionment
Service department's cost is to be transferred to the production department by following suitable
methods. This is known as re-apportionment of service department costs to production
department or secondary distribution of service departments costs to production department.
The following is the list of bases for the secondary distribution.
199
Service Department Cost Basis of Apportionment
1. Maintenance department Hours worked for each department
2. Pay-roll or time-keeping Total labour or machine hours or number of

employees in each department
3. Employment or personnel Rate of labour turnover or number of employees

department in each department.
4. Store-keeping department No. of requisitions or value of materials of each

department
5. Purchase department No. of purchase orders or value of materials for

each department
6. Welfare, ambulance, canteen No. of employees in each department.

service, recreation room
expenses
7. Building service department Relative area in each department
8. Internal transport service or Weight, value graded product handled, weight and
overhead crane service distance travelled.
9. Transport Department Crane hours, truck hours, truck mileage, truck

tonnage, truck t?nne hours, tonnage handled
number of packages.
10. Power House (Electric Wattage, horsepower, horsepower machine hours,

power cost) number of electric points etc
11. Power House Floor area, cubic content
1. Methods of Re-apportionment or Redistribution : The following are the methods for

redistributing the service department's costs to production departments.
i. Direct Redistribution method
ii. Step method
iii. Reciprocal Service method

200
i) Direct Redistribution 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 overcharged or undercharged. The share
of each service department cannot be ascertained accurately for control purposes.
Illustration 1
In a light engineering factory, the following particulars have been collected for the three months'
period ended on 31st December, 2020. It is required to prepare Production Overheads Distribution
Summary showing clearly the basis of apportionment where necessary.
The expenses for the period were:
Motive Power Rs.550; Lighting Power Rs. 100; Stores Overheads Rs.400; Amenities to Staff
Rs.1,500; Depreciation Rs. 15,000; Repairs and Maintenance Rs.3,000; General Overheads
Rs.6,000; and Rent and Taxes Rs.275.
Apportion the expenses of service department E in proportion of 3:3:4 and those of service
department D in the ratio of 3:1:1 to departments A, B and C respectively.
201
Solution
Production Overheads Distribution Summary
For the quarter ending 318 December, 2020
ii) Step Method : The cost of most serviceable department is first apportioned to other.
service departments and production departments. The next service department is taken
up, its cost is apportioned, and this process goes on until the cost of the last service
department is apportioned. Thus, the cost of last service department is apportioned only
to the production departments.
Illustration 2
The Departmental Summary showed the following expenses for July.

202
The other information relating to departments were:
Note : Basis of apportionment:
a) Time-keeping - No. of employees (i.e. 2:1:4:1)
b) Stores - Number of stores requisition (i.e. 3 : 12 : 10)
c) Maintenance - Machine hours (i.e. 3 : 2)
iii) Reciprocal Service Method : In order to avoid the limitation of Step Method, this method
is adopted. This method recognizes the fact that if a given department receiving such
service from another department, 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:
203
a) Simultaneous Equation Method
0) Repeated Distribution Method
C) Trial and Error Method
a) Simultaneous Equation Method : The true cost of the service departments are
ascertained first with the help of simultaneous equations; these are then redistributed to
production departments based on given percentage. The following illustration may be
taken to discuss the application of this method.
Illustration 3
A company has three production departments and two service departments, and for a period
the departmental distribution summary has the following totals:
Rs.
Production Departments:
P1 – Rs.800; P2 - Rs.700 and P3 - Rs.500 2,000
Service Departments:
S1 - Rs.234 and S2 - Rs.300 534
2,534
The expenses of the service departments are charged out on a percentage basis as follows:
P1 P2 P3 S1 S2
Service Department S1 20% 40% 30% - 10%
Service Department S2 40% 20% 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 departments S2
Then
x=234 + 2y
y=300 + 1x
204
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
Therefore 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
based on the agreed percentage to the three production departments; thus:
This method is not recommended where there are more than two service departments as each
creates an additional unknown.
b) Repeated Distribution 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 percentages until the figures become too small
to matter. By solving illustration 3 by Repeated Distribution Method, we get the Secondary
Distribution Summary that is given as follows:
205
c) Trial and Error 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 until the balancing figure
becomes negligible. By solving Illustration 3 by Trial and Error Method, we get the following:
2. Advantages of Departmentalisation of Overhead Expenses
It facilitates control of overhead cost. It facilitates control of the uses made of the services
rendered to respective departments. It facilitates for the ascertainment of cost of respective
departments It enables for the calculation of the correct cost of work-in-progress.
The following illustration will make you to learn clearly how the allocation, apportionment, and re-
apportionment is made.
Illustration 4
Modern Manufacturers Ltd. Have three Production Departments P1, P2, and P3 and two Service
Departments S1 and S2, the details pertaining to which are as under:
The following figures extracted from the Accounting records are relevant: Rent and Rates Rs.5,
000, General Lighting Rs.600, Indirect Wages Rs. 1, 939; Power Rs. 1,500; Depreciation on
Machines Rs. 10,000 and Sundries Rs.9,695.
The expenses of the Service Departments are allocated as under:

206
Find out the total cost of a product which is processed for manufacture in Department Pipe and
P3 for 4.5 and 3 hours respectively, given that its Direct Material cost is Rs. 50 and Direct
Labour Cost Rs.30
Solution
Overhead Distribution Summary
Cost of Product "X"
Direct Material Cost 50.00

207
Direct Labour Cost 30,00
P14 x 3.01 = 12.04
P2 5 x 2.02 = 10.10
P3 3 x 5.03 = 15.09 37.23
117.23
11.6 Absorption of Overheads by Production Units.

It is necessary to learn the next step in the accounting of manufacturing overheads, that is how
to recover this cost from the cost of production after learning the principles to be followed for
allocation and apportionment of overhead costs to producing cost centres. The method and
procedure of spreading of overhead expenses to the cost centres or cost units is known as
overhead absorption. It also referred to as levy, recovery or application of overhead. Actually,
absorption means the distribution of the overhead expenses allotted to a particular department
over the units produced in that department. The overhead related to suitable bases/ factors
must be determined in order to absorb the overhead in costs of jobs, processes or products.
This is called as overhead Rate. It will be calculated as given below:
Overhead Rate = Overhead expenses / Total quantity or value Therefore
Overhead absorbed in a product = (Overhead rate * Units of the base contained in the product)
The overhead absorption rate computed may be either based on i) actual cost or on the basis of
ii) estimated cost / predetermined rate. iii) Moving average rate. & iv) Blanket and multiple rates.
i) Actual Rate : This rate is derived by dividing the overhead expenses incurred during the
period by actual quantity or value produced during the period. Actual Overhead rate =
(Actual overhead expenses during the period) / (Actual quantity or value of the products
produced during the period).
ii) Predetermined Rate : It is determined in advance of the actual production and is

computed by dividing the budgeted overheads by the budgeted production of units (or)
by its value for the accounting period. Predetermined Rate = Budgeted overhead expenses
for the period / Budgeted base for the period. These predetermined rates are used as
yard-stick against which actual rates may be watched and the variances are worked
out. The only limitation of such rate is that it may give rise to over or under absorption of
overheads.
208
iii) Moving Average Rate : This rate is a compromise between the actual rate and
predetermined rate. This rate is generally calculated on monthly basis and is computed
by dividing the average of the past twelve or six months average actual overhead by the
estimated base for the following months. This rate removes to some extent the
shortcomings of the overhead rate fixed on actual basis by equating the wide fluctuations
but it cannot avoid them. Overhead expenses may increase or decrease because of
change in the production activity and recovery on the basis of actual rate would result in
excess or less charging of overhead to cost of production, the estimated expenses for
the period are not taken into consideration.
iv. Blanket and multiple rates : When a single overhead rate is computed for the factory
as a whole, it is called as single or blanket rate. It will be calculated by following the
below given formula. Blanket Rate = Overhead cost for entire factory / Total quantity of
the base selected. When different rates are computed for each producing department,
service department, cost centre, each product or product line, each production factor
and or fixed & variable overhead, then it is called as multiple rate. The formula is
Multiple rate = Overhead cost allocated and apportioned to each cost centrel Corresponding
base
The blanket rate is used in small concerns where multiple rate is used in large concerns.
Methods of Absorption of Overheads
The below mentioned methods are main methods for the absorption of manufacturing overheads.
(For the discussion purpose estimated cost is assumed)
i) Rate Per Unit of Production : The very simplest direct and easiest method followed by
mining and other extractive industries, foundries, brick laying industries where the output
is measured in terms of physical units like number of items produced, weight, volume
etc, is rate per unit of production method. The rate is calculated as under:
Overhead rate = Budgeted overhead expenses / Budgeted production
ii) Direct Labour Cost/Direct Wages Method : This method is as like as rate per unit of
production method. But in this budgeted overhead expenses are divided by "Direct Labour
Cost" instead of Budgeted Production. The formula is:
209
Overhead rate = Overhead expenses / Direct labour cost.
This method is suitable, only for those concerns where the direct labour constitutes a major
proportion of the total cost of production. Where the production and labour employed and types
of work performed are uniform, where the ratio of skilled and unskilled labour is constant, and
where there are no variations in the rates of pay, that is the rates of pay and methods are the
same for the majority of the workers in the concern.
iii) Direct Labour Hour or Production Hour Method : From the below given formula this
overhead rate is obtained.
Overhead rates = Overhead expenses / Direct labour hours.
For example, when overhead expenses per day is Rs.40,000 and no. of workers in a day
is 5,000 and their working hours is 8 hours per day, then the overhead rate is .
=Rs.40,000 / (5,000* 8hrs) = 40,000 / 40,000 = Re. 1.
Re. 1 will be the overhead labour cost
This rate is suitable where labour constitutes the major factor of production and where
the job is labour oriented, it is desired to take into consideration the time factor which is
uniform in nature and the rate may not be affected by the method of wage payment or
the grade or the rate of workers.
iv) Machine hour rate : The overhead costs of production may also be absorbed based on
machine hour rate where the cost of machinery forms a greater element of total cost
and the use of machinery influences production as well. Here the overheads mostly
relate to the operating of the machines. For the purpose of computation of machine or a
group of similar machines. All expenses, either factory general expenses or machine
running expenses, are, then, allocated or apportioned to the machine cost centres, on
equitable basis. Afterwards, the machine hour rate is calculated by dividing the estimated
total overhead for the machine cost centre by the expected machine hours.
The formula is machine hour rate = Overheads / Machine hours for the period.
There are two methods of computation of machine hour rate namely
a) Ordinary machine hour rate and
b) Composite, comprehensive, or blanket rate

210
Calculation of Machine Hour Rate
Let us consider the steps to be followed in the calculation machine hour rate.
1. The machine cost centres are to be fixed first to identify overheads relating to such
machine or group of machines taken as cost centre and to allot or apportion them
accordingly.
2. The next step is to classify the overheads relating machine into two categories viz.
i) Fixed or standing charges and
ii) Machine running expenses or variable expenses.
i) Standing charges : Standing charges are not related to the machine operation time
and they are constant in nature. Examples of such expenses are supervision, rent and
rates, heating and lighting, Insurance, shop cleaners, consumable stores etc.
ii) Machine expenses : Machine expenses are generally related to the machine operating
time, such expenses as depreciation of machines, power, fuel, repairs, etc.
3. Now the standing charges classified are estimated for the given period for each machine
and then divided by total no. of normal working hours of the machine for the period to
arrive at the machine hour rate for standing charges. But for machine expenses, hourly
rate, for each item of expenses is computed separately, but dividing each of them by the
total norrnal machine working hours. Of course, the total normal working hours for this
purpose will not include the hours required for maintenance of machine, setting up, or
setting off.
4. Then we get the ordinary or simple machine hour rate by adding the standing charges
rate with the machine expenses rates.
5. Sometimes the machine operator's wages will also be included in overheads for computing
machine hour rate, when he attends a number of machines at the same time. Such
machine hour rate is known as composite of comprehensive machine hour rate. This
method helps to compare the relative efficiency and cost extent of the preference of
machines to man.
The following bases may be adopted for the apportionment different expenses to individual
machines.
211
Expenses Basis
1. Standing Charges
a) Supervision Machine hours devoted by supervisory staff of each

machine.
b) Rent and Rates Floor area occupied by each machine.
c) Heating and lighting No. of light points used and cost of specia lighting
or heating for any machine or Floor area used by
each machine or number of operators.
d) Insurance on building Floor area occupied by each machine.
e) Shop cleaners Machine hour.
f) Consumable stores Machine hour or on the basis of past experience
2. Machine Expenses
a) Depreciation Asset value i.e. cost of machine including, cost of

stand by equipment like spare motors, switch gear
etc. less residual value spread over its working life.
b) Power, steam Horsepower of the motor driving the machine or

actual consumption as per metre reading for each
machine.
c) Repairs Cost of repairs spread over in working life.
d) Insurance on Machinery Asset value or insurance value of each Machine
e) Lubricating Oils As per stores, requisition slips or the standard

lubricating schedules.
Illustration 5
(A) Compute comprehensive machine hour rate from the following data
212
a) Total of machine to be depreciated Rs.2.70,000: Life 15 years; Depreciation on Straight

line.
b) Departmental overheads (annual):
Rs.
Rent 60,000
Heat and Light 40,000
Supervision 1,30,000
c) Departmental Area 80,000 square metres
Machine Area 2,500 square metres
d) 26 machines in the department
e) Annual cost of reserve equipment for the machine = Rs. 1,500
f) Hours run on production = 2,000
g) Hours for setting and adjusting = 200
h) Power cost Rs.0.50 per hour of running time.
i) Labour:
1) When setting and adjusting, full time attention.
2) When machine is producing, one man can look after 3 machines.
j) Labour rate Rs.6 per hour.
B) Using the machine hour rate as calculated value work out the amount of factory overhead to
be absorbed on the following
Total hours Production time Hours Setting up time hours
Job No.605 100 80 20
Job No.595 100 70 30

213
Solution
A) Computation of Machine Hour Rate
Note: It is assumed that there is no power cost when the machine is being set or adjusted.
b) From the machine hour rate calculated in A, adopted the overheads absorbed over the
various jobs will be
Job No. 605=16.19* 80 = Rs.1,295.20
Job No. 595=16.19* 70 = Rs.1,133.30
Advantages
i. It helps to compare the relative efficiencies and cost of operating different machines.
ii. It brings to light the existence and extent of idle time of machines.
iii It enables the management to decide how far the use of machine work is preferable to
manual work.
iv It is most scientific, practical, and accurate method of recovery of manufacturing

overheads.
v cost reports prepared with the help of such rate are dependable and can help the
management in decision-making.
vi It provides useful data for estimating cost of production, setting standard and for fixing
selling prices for quotations.
214
vii. It provides ready method for measuring the cost of idle machines if separate rates for
fixed and variable overhead rates are calculated. When hourly rate is fixed based on
anticipated running hours of the machine there is under absorption of fixed overhead
expenses, if actual running hours are less than the estimates.
Disadvantages
i. It involves additional work in assessing the working hours of machines and thus it is a
costly method.
ii. It does not take into account expenses that are not proportional to the working hours of
machines.
iii. It gives inaccurate results if hand labour is equally important.
iv. it is difficult to estimate the machine hours especially when production programme is
not available in advance.
v Blanket rate cannot be used and it makes the method more costly.
v) Direct material cost method : In this method, percentage of factory expenses to value
of direct materials consumed in production is calculated to absorb manufacturing
overheads. The formula is
Overheads rate = Budgeted overhead expenses / Budgeted Direct material cost.
This method is suitable where output is uniform, where the prices of materials are stable
and the proportion of overhead to total cost is significant.
vi) Prime cost method : The recovery rate is calculated in this method by dividing the
budgeted overhead expenses by the aggregate of direct material and labour cost of all
the products of a cost centre. The formula to calculate overhead recovery rate is
= Budgeted overhead expenses / Anticipated direct material & labour
This method is not usually used because
• The cost of materials is predominating item of prime cost and adequate consideration is
not given to the time factor.
• No distinction is drawn between the production of hand workers and machine workers.
• No distinction is drawn between fixed and variable expenses.
• It comprises of short-comings of direct material and direct labour methods.

215
vii) Sale price method : This method is more suitable for the application of administration,
selling and distribution, research and development, cost to cost of product. It can also
be used with advantage for the preparation of Joint product costs. In this method overhead
rate is calculated as under
Overhead rate = Budgeted overhead expenses / Sale price of the units of production.
This method is arbitrary and recovery made by this method is inequitable because
overhead costs have practically no relationship with the sale price of the products. The
apportionment is made on the basis of benefits rather than on their ability to bear the
costs.
Check Your Progress
1. Fill in the blanks
a) Cost pertaining to a cost centre may be broadly divided into two portions i.e._________
b) Anexpenditure over and above prime cost is known as_________
c) Overhead cost is the aggregate of indirect material cost, indirect wages and_________
d) Basis of apportionment of stores service expenses is_________
e) Basis of apportionment of welfare department expenses is_________
f) Under step method of re-apportionment of costs of service departments, the cost of last
service department is apportioned only to the_________
g) Machine hour rate is obtained by dividing the total running expenses of a machine during
a particular period by the _________ the machine is estimated to work during the period.
2. State whether the following Statements, are True or False
a) Variable overhead cost is a period cost.
b) Fixed overhead cost is an output cost.
c) Fixed overhead cost is a committed cost.

216
d) Fixed expenses will move up by jumps if the output exceeds the capacity.
e) Depreciation is a semi-variable expense.
f) Variable overhead cost is a discretionary cost.
g) Basis for apportionment of cost of steam is wages of each department.
h) Basis of apportionment of depreciation of plants is values of plants in each department.
i) Predetermined rate of absorption of overhead helps in quick preparation of cost estimates

and quoting prices.
j) The time factor is ignored when the cost of material is used as the basis for absorption
of overhead.
k) Direct labour hour rate of absorption of overhead is suitable where most of the production
is done by using machines.
11.7 Summary
The expenses made for the production process occupy the cost of production next to materials
and labour. These expenses are classified as direct and indirect expenses. The direct and
indirect expenses play a vital role in the cost of production. These expenses are codified for the
purpose of classification. Proper steps are followed while accounting these overhead expenses
because direct expenses are charged directly to the job where the indirect expenses, which are
also called as overheads expenses, are allocated, apportioned, and re-apportioned by suitable
basis. Finally these overhead expenses are absorbed by production units, which take part in the
cost of production.
11.8 Key Words

Chargeable expenses : Direct Expenses
Overhead expenses : Indirect Expenses
Allocation : The allotment of whole items of cost to cost centres or cost units. o Apportionment:
The allotment of proportions of cost to cost centres or cost units.
217
Overhead rate: Percentage of overhead expenses obsorbed for a total quantity or value.
Blanket rate: Single overhead rate

1) Explain the methods involved in codification.
2) Briefly explain the steps involved in overhead accounting.
3) What are principles the of apportionment of overhead cost and what are the bases of
Apportionment?
4) Explain Absorption of overheads by production units.
5) The following data were obtained from the books of Light Engineering Company for the
half year ended 304 September, 2020
The expenses for 6 months were: Stores Overhead Rs.400; Motive Power Rs.1,500; Electric
Light Rs.200; Labour Welfare Rs.3,000; Depreciation Rs.6,000; Repairs and Maintenance
Rs.1,200; General Overheads Rs. 10,000; Rent & Taxes Rs.600.
You are required to prepare Primary Overhead Distribution Summary for the department showing
clearly the basis of apportionment where necessary.
(Ans. A-Rs.8,340; B-Rs.6,220; C-Rs.5,100; X-Rs.4,100; Y-Rs.3,640 ]

218
6. A company's production for the year ending 30-6-2020 is given below:
General Expenses: Rent Rs. 12,500; Insurance Rs.1,050; Depreciation 15% of value of
machinery; Power Rs.3,800; Light Rs.1,250.
You are required to prepare an overhead analysis sheet for the departments showing clearly the
basis of apportionment where necessary.
[Ans. P1-Rs.22,268; P2-Rs.29,780; P3-Rs.30,302]

219
7. From the following information work out the production hour rate of recovery of overhead
in departments P1, P2 and P3:
Expenses of Service Departments S1 and S2 are to be apportioned as under:
P1 P2 P3 S1 S2
S1 30% 40% 20% - 10%
S2 10% 20% 50% 20% -
[Ans. P1-Rs.1.66; P2-Rs.1.04; P3-Re.0.96]
8. PH Ltd. Is a manufacturing company having three production departments. 'A', 'B' and 'C'
and two service departments 'X' and 'Y'. The following is the budget for December 1984.
220
A technical assessment for the apportionment of expenses of service departments is as under:
A B C X Y
Service Dept. 'X' 45% 15% 30% - 10%
Service Dept. 'Y' 60% 35% - 5% -
1. A statement showing distribution of overheads to various departments
2. A statement showing re-distribution of service departments' expenses to production

departments.
[Ans. i) A-Rs.2,700; B-Rs.3,700; C-Rs.6,000; X-Rs.4,750: Y-Rs.5,350 ii) ARs.8,482; B-

Rs.6,505; C-Rs.7,513 ]
9. Calculate Machine Hour Rate from the following:
i) Cost of Machine Rs. 19,200.
ii) Estimated scrap value Rs. 1,200.
iii) Average Repair and Maintenance charges per month Rs. 150.
iv) Standing charges allocated to machine per month Rs.50.
v) Effective working life of machine 10,000 hours.
vi) Running time per month 166 hours.
vii) Power used by machine: 5 units per hour @ 19 paise per unit.
10. Calculate Machine Hour Rate of A Machine

Rs.
Consumable Stores 600 for A Machine
Consumable Stores 1,000 for B Machine
Repairs 800 for A Machine
Repairs 1,200 for B Machine
Heat and Light 360
Rent 1,200
Insurance of Building 4,800
Insurance of Machines 800
Depreciation of Machine 700
221
Room Service 60
General Charges 90
Additional Information:
Working Hours Area (sq. metre) Book Value (Rs.)
A Machine 10,000 100 12,000
B Machine 25,000 500 20,000
[Ans. 30 Palse ]
11. From the following information relating to the machine, "Kempress” installed in a factory,
work out the Machine Hours Rate:
Purchase price of the machine with scrap value of zero Rs.90,000
Installation and incidental charges incurred on the machine Rs. 10,000
Life of the machine is 10 years of 2,000 working hours each.
Repairing charges-50% of depreciation.
Machine consumes 10 units of electric power pe hour @ 10 P. per unit.
Oil expenses @ Rs.2 per day of eight hours.
Consumable stores @ Rs. 10 per day of eight hours.
The operators are engaged on the machine @ Rs.4 per day of eight hours. [Ans. Rs.10 ]
12. Compute the Machine Hour Rate from the following data;
222
The machine occupies 1/4 th of the total area of the shop. The supervisor is expected to devote
1/5th of his time for supervising the machine. [Ans. Rs. 7.95]

1. a) direct and indirect;
b) overhead;
c) indirect expenses;
d) value of materials consumed;
e) number of employees;
f) production departments;
g) number of hours.
2. a) False; b) False; c) True; d) True; e) True;
f) False; g) False; h) True; i) True; j) True; k) False

223
LESSON - 12
OVERHEADS (Contd.)
Learning Objectives
• Explain what is administrative expenses, and how they are accounted and controlled
• Explain what is selling and distribution expenses, and how they are accounted and
controlled
• Explain what are the other types of expenses included in the miscellaneous expenses
and how they are accounted and controlled.
Structure
12.1 Introduction
12.2 Administrative Overheads
12.3 Selling and Distribution Overheads
12.4 Miscellaneous Items of Overheads
12.5 Summary
12.6 Key Words
12.1 Introduction
The previous chapter discussed, what is expenses, how it is classified on the basis of directability,
how the expenses are allocated and apportioned to the various departments of the manufacturing
concerns, how these overheads are classified, what are the steps involved in overhead accounting
and what are the advantages and disadvantages on the methods of allocation, apportionment
224
and re-apportionment of production overheads. This chapter attempts to discuss how the
administration, selling, distribution and miscellaneous items of overheads are discussed.
12.2 Administrative Overheads

In all types of business concerns administrative department plays a vital role, and it is large in
size which is responsible for hamming and control of the organisation. It lays down policies to
be followed and ensures through proper direction that these policies are effectively carried out.
The expenses related to the administration work are called as administrative overheads.
It is defined by the I.C.M.A., London as "the cost of formulating the policy, directing the Organisation
and Controlling the operations of an undertaking which is not related directly to the production,
selling, research and development activity or function”. From this, it is clear that the administrative
overhead may be indirect expenses, which arise in connection with the management and
administration of an enterprise. The cost of these are of general nature. To have an effective
control first the administrative overheads are to be departmentalised among general office,
secretarial department, legal department, accounting department, personnel department etc.
The following are some examples of administrative overheads. i) Office rent & rates ii) Insurance
iii) Office lighting, heating and cleaning iv) depreciation on office buildings, furniture & fittings and
buildings etc. V) Staff salary vi) Postage, Printing, Stationary, Telegram vii) Salary to directors,
audit fees, legal charges etc.
1. Treatment of Administrative Overhead : The administrative overhead expenses are

absorbed by one of the following methods viz.
i) Transferring it to profit & loss account (or)
ii) Apportioning to production and selling (or)
iii) Adding separately with cost of production.
Normally the rates are predetermined and the works cost base is a suitable basis for
absorption of administrative overheads.
Rate = Total administrative Overheads / Base selected (works cost)
2. Control of Administrative Overhead : Expenses of this type are generally fixed. These
overheads are incurred as a result of the management policy. A major part of the overhead
is non-controllable. Therefore, some control should be exercised under the following
methods.
225
i) By making analysis and comparison of overheads
ii) By preparing budgets and comparing it with actual. If any negative variation arises making
enquiry into that and taking remedial measures.
iii) By fixing standards
12.3 Selling and Distribution Overheads

Due to technological developments automations etc. the cost of production has been curtailed
to a considerable extent. As such it must be true that the cost of production will come down.
Thus mass production takes place and at the same time, there arises a growing competition in
selling out the products consequently, the costs of selling and distribution are increased to a
great extent. Therefore, a good control is essential, there arises the need for a proper accounting
of the two categories-selling overheads and distribution overheads. If these expenses are
excluded and neglected the exact cost of sales cannot be known. Therefore, for the following
reasons, they must be included:
1. To arrive at the cost of sales, and to know the profits accurately these expenses are
added to the cost of production.
2. The correct price fixation cannot be done in the absence of these expenses.
3. At the present stage of competition, the selling and distribution overheads are very
important; and as the cost is increasing, cost control is essential.
4. To adopt suitable policies for sales in different markets, different methods, different
conditions etc., are included.
Selling overhead Distribution overhead
Advertisement Carriage out
Brokerage Transport expenses
Market research Packing
Sales office expenses Insurance of finished goods

226
Salaries of salesmen and agents Warehouse expenses
Bad Debts Salary of van-men
Cost of entertainment of customers Salary of ware-house keeper
Show room expenses
Preparation of tenders
Samples
Cost of price lists, catalogue, etc. Cost of after sale service
The cost, which cannot be allocated, has to be apportioned through some reasonable bases. A
few are:
Expenses Possible basis
Remuneration Direct allocation
Credit and collection Number of invoices, number of orders or number

of transactions
Depreciation Value of assets
Transport Weight of packages
Advertisement Sales value
1. Control of Selling and Distribution Overhead : It is a difficult task to have control

over selling and distribution expenses, because it depends upon the external factors of
the business organisation, such as distance of market place extent of competition etc.
are beyond management's control. The main problems are
1. It is difficult to exercise control over competitors.
2. It is difficult to determine the capacity of market.
3. It is difficult to control customers and their choice.

227
4. Data relating to market operations are difficult to obtain.
5. Staff employed outside are not susceptible to control due to lack of supervision.
6. Control of selling and distribution overhead would mean control over the
customers.
7. There is difficulty to define the capacity of sales organisation.
8. Market price may be established without reference to cost or producono individual

business.
Selling cost is the cost of seeking to create and stimulate demand and securing orders.
Distribution cost is the cost of the sequence of operations which begins with making the packed
product available for despatch and ends with making the reconditioned returned empty packages,
if any, available for re-use.
It is clear that the selling cost is the cost of:
a) Trying to create demand, it is immaterial whether the demand has been created or not;
b) Trying to stimulate demand, or the cost of marketing
c) Securing orders.
All expenses incurred either to create or stimulate demand, for examples, advertisement,
salesmen's expenses, showroom expenses, price lists etc. and the expenses of securing orders
are the selling costs. The area of selling costs or overheads ends here. After this, the area of
distribution begins. The cost of packing, transportation warehousing etc. belong to distribution.
This Selling and Distribution costs are absorbed based on
i) Rate per unit
ii) A percentage in sales
iii) A percentage to works cost
The following illustration will make you to understand this in details.

228
Illustration 1
A company is producing 3 types of products A, B and C. The sales territory of the company is
divided into 3 areas X,Y and Z.
The estimated sales for the year are as under:
The budgeted advertising cost is as under:
X Rs. Y Rs. Z Rs. Total Rs.
Local cost 3,200 4,500 4,200 11,900
General - - - 5,800
You are required to find advertising cost per cent on sales for each product and territory showing
how you will present the statement to management.
Solution
Apportionment of Advertising Cost

229
The advertising cost of each territory is apportioned among the products (percentage
of the estimated sales)
The percentage of general
Advertising cost = (5,800 * 100)/2,90,000 = 2%
2% on Rs.80,000 (territory X) =1,600
2% on Rs.90,000 (territory Y) =1,800
2% on Rs.1,20,000 (territory Z) =2,400
Total 5,800
Advertising cost % on sales for territory-wise :
X territory = ( 4,800 * 100 ) / 80,000 = 60%
Y territory = (6,300 * 100 )/90,000 = 7%
Z territory = (6,600 * 100 ) /1,20,000 = 5.5%
The total advertising cost of each territory is apportioned amongst the products (estimated
sales)
Territory X@ 6% on Rs.50,000 = 3,000 for A

on Rs.30,000 = 1,800 for B
230
Territory Y @7% on Rs.20,000 = 1,400 for A

on Rs.70,000 = 4,900 for C
Territory Z@ 5.5% on Rs.80,000 = 4,400 for B

on Rs.40,000 = 2,200 for C
12.4 Miscellaneous Items of Overheads

We have to come across certain items of expenses in the process of costing of a unit of a
product or service, for which a particular attention is needed. It was already discussed that
direct expenses are expenses which can be allocated to a cost centre or cost units and indirect
expenses which are also known as overhead expenses will be apportioned to or absorbed by
cost centres or cost units. But, for some expenses, in cost accounting special treatment is to
be followed. The following are some expenses, which have special attention.
1. Depreciation : It is a gradual diminution in the intrinsic value of an asset due to use and
/ lapse of time. Depreciation is the result of two factors – usage of asset and lapse of
time. The depreciation should be accounted for, because of the following reasons:
i) When a machine is used in production, the value of the asset falls which is equal to an
expenditure. If it is not taken into account, correct profit can be arrived at.
ii) Everything has a fixed lifetime. After the expiry of the life-time, it becomes useless, and
the full value has to be written off, if no depreciation is written off. This is against business
principles.
iii) The value of asset, when depreciation is not accounted, will be a boosted figure and true
values are overstated in the balance sheet.
iv) If depreciation is not accounted for it may be possible that dividends will be paid out of
capital.
Obsolescence
It is different from depreciation. It is generally used to indicate a sudden loss in the value of an
asset not due to wear and tear. It arises because a machine has to be discarded in favour of one
better adopted to its purpose and giving better result. It is also called external depreciation as the
asset has to be withdrawn before the end of its useful life owing to the operation of external
factors like technological improvements in the existing machines.
The following methods may be used for accounting of obsolescence.

231
i) The rate of depreciation should be increased in order to include the element of

obsolescence provided, it can be foreseen and predicted.
ii) The loss resulting from obsolescence may be written off to profit and loss account of
that particular year, provided the amount is small. If the amount is large it may be splitted
for several years to write off.
iii) A suitable amount should be credited to Obsolescence Reserve Account and the loss
arising from the discarding of asset is to be debited to Obsolescence Reserve Account
Methods of Charging Depreciation
i) Straight Line / Fixeu instalment / Original cost method : Under this method, a fixed
percentage on the basis of its life period, its original cost is written off every year so as to
reduce the asset value to nil or to its scrap value. The depreciation is calculated as
under
Depreciation = (Cost price of the asset - Scrap value ) / Estimated life of the asset.
Therefore Rate of Depreciation = ( Depreciation / cost price ) * 100
The advantage of this method is that it makes calculation of depreciation on simple and
can write down an asset to zero at the end of the year.
ii0 Reducing Balance / Diminishing balance / written down value method : Amethod of
providing for depreciation by means of fixed pel ventage, written off every year on the
diminished book value until the asset is reduced to scrap value, is known as Reducing
Balance Method or Diminishing Balance Method,
Depreciation = Written down balance on asset * Fixed percentage
= 1-n RIC
iii) Production Unit Method : This is a method of providing for depreciation by means of a
fixed rate per unit of production, calculated by dividing the value of assets by the estimated
number of units to produced during its life.
Depreciation rate per unit = (Asset cost-Scrap value / Estimated production units during
life)
The production units will be multiplied by the calculated rate in order to get the amount of
depreciation.
232
iv) Production Hour Method : Charging depreciation by means of fixed rate per hour of
production, calculated by dividing the value of the assets by the estimated number of
working hours of its life. Depreciation per hour = ( Cost of assets – Residual value ) /
Estimated Production hours during life.
v) Repair Provision Method : This is a method of providing for aggregate of depreciation

and maintenance cost by means of periodic charges, each of which is a constant
proportion of the aggregate of the cost of the assets depreciated and the expected
maintenance cost during its life.
Depreciation = (Cost of assets + Estimated repair cost during life) / Estimated Life.
vi) Annuity Method : This method takes into account the interest on the money invested in
the acquired assets; that means the amount spent for acquisition of assets is regarded
as capital investment. If it is employed otherwise, it will fetch interest. As such, the
depreciation charge is made to include an interest charge also. A certain rate of interest
is calculated on the diminishing balance of the assets and is debited. to the asset account.
The amount of depreciation is calculated with the help of the
Depreciation Annuity Tables.
Depreciation = (Asset cost + Interest charged during life ) / Estimated life.
vii) Sinking Fund Method / Depreciation Provision Method / Amortisation Fund Method /
Redemption Fund Method : In this method the amount of depreciation is invested every
year in some securities; interest received thereon is again invested so as to raise sufficient
money to purchase a new asset, when the asset becomes useless. The amount is set
outside securities as a provision for replacement. This method includes not only
depreciation, but also the provision for replacement of the asset. When the asset
becomes useless the investments are sold away, and thus new asset can be acquired.
Depreciation = (Asset cost - Interest received during life ) / Estimated life.
vill) Endowment Policy Method : This method provides for depreciation by means of fixed
periodic charges equivalent to the premiums on an endowment policy for the amount
required to provide at the end of the life of the asset a sum equal to its cost. Depreciation
equals premium charged by insurance company. The insurance companies determine
the amount of premium.
233
ix) Revaluation Method : This method provides for depreciation by means of periodic
charges, each of which is equivalent to the difference between the values assigned to
the asset at the beginning and at the end of the period. This method is used in case of
bottles, corks, crates, loose tools, packages, patterns, trade marks, live stock, plant in a
contract etc.
x) Sum of the Digits Method : This is variant of the reducing instalment or diminishing
balance method. Under this method, depreciation is calculated by the following formula:
Depreciation = Amount to be written off
No. of years of the remaining life of the asset including the current year
The total of the digits representing the Life of the asset (in year)
Rates of Depreciation
There are three rates:
a) Single rate
b) Composite rate
c) Accelerated rate
a) Single Rate : Under this method, the depreciation is calculated for every machine
separately with reference to the estimated life of the asset.
b) Composite rate : “In composite rate depreciation, rate is calculated by dividing the
aggregate of the individual depreciation charges in any one period of all the assets
concerned, by the aggregate of the cost of those assets”. Composite rate is used when
processes are continuous. It is also used when the assets concerned are engaged on
the same job or product or service.
c) Accelerated Rate Depreciation : Sometimes there is abnormal usage of assets, i.e.,

when assets are employed on overtime work, double or triple shifts etc. For example,
double shift working leads to increased rate of depreciation. To eradicate (overcome)
this drawback the depreciation rate is increased according to the increased usage of
the asset. This is the accelerated rate which increases the depreciation rate.
234
2. Interest on Capital : Interest on capital may be of two types:
a) Interest on capital borrowed such as debentures and bank overdraft.
b) Notional interest on capital owned and not actually payable
3. Rent: It is similar to the case of interest, it is also a debatable point. Of course rent paid
is an item for fixed overhead and is allocated on a suitable basis. When the firm owns
the premises, no rent is payable. Then the point is
235
Whether the unpaid rent of owned premises is to be included or not in cost accounts in order to
ascertain the correct cost of product. The argument is that it is akin to depreciation, and therefore
should be included in the cost accounts.
4. Royalty : Royalty is payable for the right to make use of a patent process or component
in the course of manufacture and is a direct charge to the production. It is included in
prime cost. If it is payable on the basis of the number of units sold, then it is a selling
overhead. When the royalty is for both production and sale, the amount may be apportioned
between the two. At the same time, the expenditure incurred for registration or renewal
of patents is treated as administrative overheads.
5. Research and Development Costs : The cost searching for new or improved products,
new applications of materials or improved methods is known as research cost. After the
research, there may be further expenditure essential to implement the decision to produce
the improved product on commercial basis; this falls under development cost. Research
cost may be treated as production overhead or administrative overhead or selling
overhead based on the field covered.
6. Advertising Expense : This expense includes advertisements in journals, cinema slides,

radio, posters, show-room expenses, free samples, gifts, etc. If these expenses relate
to a particular product, they will be charged to the product, under selling overheads. If
they are of a general nature, then such costs are apportioned to all products.
7. Bad Debts and Loss or Wastage of finished stock: Bad debts within a reasonable
limit, can be treated as selling overhead. If it is an abnormal amount, it is better not to
include it in cost. Finished Stock Waste and Loss. Unavoidable waste or loss, for example,
evaporation, shrinkage etc., of finished products can be treated as distribution cost.
Again if the waste is of an avoidable nature, and if the amount is small, it can also be
treated as distribution cost. But if the loss is of an abnormal nature, for example
obsolescence, loss under fire etc., it is not to be included in cost.
8. Dismantling of Plant : The cost of dismantling is added to the asset. The cost can be
set off against the sales of the dismantled asset.
9. Material Carriage Handling and Storage : The cost of the carriage can be regarded
as a part of the cost of the material. Sometimes, expenses of carriages, handling and
storage are accumulated and later apportioned on percentage basis.
236
10. Costing Department Expenses : All the departments enjoy a separate department for
the benefit of the cost office. As such the expenses can be treated as administration
overhead. It is sometime, apportioned to production, administration and selling and
distribution departments on the basis of benefit received by each department.
11. Medical Service Cost : Medical expenses are collected under a standing order number
and distributed to all departments on the basis of the number of employees working in
each department. And where the expense is high, it can be treated as a separate cost
centre and the total expenses are finally distributed to other departments on a suitable
basis, for example, number of workers, benefit received etc.
12. Fringe Benefit: Leave pay, sick pay, P.F., E.S.I. contribution and H.R.A. etc., are the
fringe benefits enjoyed by the workers. These are collected under different standing
order numbers and treated as departmental overhead. In certain cases, they are treated
as direct wages through a supplementary rate.
13. Tabulation Expenses : This expense may be met by the division of the concern as a
whole; and thus this expense is apportioned to all divisions manufacturing, administration,
and selling and distribution, on a suitable basis, i.e., number of cards punched or number
of tabulation hours. In case, the expense relates to a particular department, it may be
allocated to the department.
14. Bonus to Workers : Bonus paid out of profit is an ex-gratia payment and as such
generally not included in cost. As far as India is concerned, bonus to workers is
compulsory, and as such it can be included in cost. Bonus payable to direct workers,
can be charged to the cost of job, by inflating the wage-rate. In the case of indirect
workers, it can be included in factory overhead. High rate of bonus may be excluded
from costs.
15. Subscription : General subscriptions and donations can be excluded from cost, because
no benefits are received by the workers. In the case of subscriptions to journals, the
benefit is received by the workers and it can be treated as a part of production.
16. Canteen Expenses : There are two types of canteens - one on no-loss-no-profit basis
and the other on a subsidised basis. In the former, the amounts spent or received are
excluded from cost. In the later case the subsidy is a charge to overheads and is
apportioned on the basis of the number of workers employed in each department
237
17. Incentive Bonus : This type of bonus is given to the workers in order to induce them to
improve the productivity. Therefore, it is a part of wages, in the case of direct workers. It
is treated as an overhead and charged to departments, in the case of indirect workers.
18. Transit Insurance : The cost is met in connection with distribution, and is chargeable
on the basis of the sales amount. If the expense is included in the customer's order, it is
added to the cost of sales. If it is met at the time of despatch to branch, it is debited to the
branch.
19. Post Sales Services : Some concerns offer 'continue free services' during a stipulated
guarantee period after sales. This includes replacement of parts and repairs which are
necessary to maintain the product in working. The expenditure on this account includes
cost of spare parts and materials, salaries, wages and travelling expenses of the service
staff etc. Such expenses are treated as selling overheads.
20. Transport : Freight or carriage inwards on the purchase of raw materials forms a part
of material cost. Carriage outwards is a part of selling and distribution overhead. The
cost of internal transport for moving materials from stores to production department or
from department to departments, forms a part of manufacturing overhead to be
apportioned to the products or departments on the basis of distance or weight.
21. Periodical Exhibition Expenses : Periodical exhibition expenses should be treated as

selling overheads. In case the interval between two exhibitions is more than one year
and it is felt that the benefit of the expenditure will accrue over the whole of the interval,
the expenses may be apportioned like a deferred revenue expenditure over the number
of years during which the benefit will be received.
22. Packing Expenses : Prime packing materials, i.e. materials which are necessary for
the product are charged to the cost of the product as an element of prime cost. Secondary
packing materials are needed while delivering or transporting the products and such
expenses are treated as distribution overhead. Special packing material expenses if
required by the customer, are charged directly to the job or product. Fancy packing
expenses to attract customers are selling overhead. The overhead costs of the packing
department should be apportioned to different products on some suitable basis such as
labour cost, sale value of the product, if they cannot be charged directly to the product.
238
23. Idle Capacity : Maximum capacity is the capacity for which a department can work
without loss of operating time. In other words, a factory is said to be operating at maximum
capacity when it is able to sell all the goods that it can produce. This notion is only
theoretical; this can never be attained, because it is usual that time is lost due to repairs,
maintenance, minor breakdowns, lost time etc. Practical capacity is the capacity for
which a factory can work, taking into account the repairs, maintenance etc. The practical
capacity is less than the ideal capacity. Normal capacity is the capacity available or use
after giving considerations to normal delays and normal idle time. It is the capacity of the
enterprise which is available for utilisation in normal period. Idle capacity is the capacity
specified or designed by the manufacturer and is attainable under idle conditions. Idle
capacity is the difference between practical capacity and capacity based on expected
sales. This unused capacity is known as idle capacity. The cost of idle capacity includes
rent for floor area, depreciation, maintenance etc. The cost may be obtained by using
the following formula.
Idle capacity cost = ( Idle capacity / Practical capacity ) * Total cost
Thus, this method determines the cost of idle capacity and distributes the same over products.
In another method.
Recovery rate: = ( Total cost / Utilised capacity )
Under this method, the idle capacity cost is merged and applied to production. As such, separate
treatment is not needed. But at the same time, for the purpose of comparison and control, this
method is unsuitable.
Check Your Progress
a) The cost of formulating the policy, directing the organisation and controlling the operation
is_____________
b) Office rent, insurance_____________
c) expenses are excluded from cost._____________
d) Such expenses which are included (even though they are not incurred) for taking
managerial decisions are called_____________
239
e) Semi-variable expenses are variable and _____________ fixed.
f) Unsuccessful research expenditure should be from cost accounts._____________
g) Salary paid to the general manager is an item of _____________ expenses.
h) That basis of apportionment of overheads, which takes into account the profitability of
the various departments, is called_____________
i) Fancy Packing is an illustration of_____________ expenses.
j) Telephone expense is._____________expense as part of it depends on time and another

on number of calls.
k) Depreciation is the diminution in the value of a fixed asset mainly due to

_____________and lapse of time.
l) Obsolescence is _____________ depreciation.
m) Depreciation according to the sum of the digit methods is: Amount to be written off *
_____________ The total of all the digits representing the life of the Asset (in years)
n) Theoretical capacity is _____________possible capacity.
0) Normal capacity is the capacity _____________ possible capacity.
2) Say whether the following statements are True or False
a) Basis of apportionment of cost of steam is wages of each department.
b) Basis of apportionment of depreciation of plants is values of plants in each department.
c) Predetermined rate of absorption of overhead helps in quick preparation of cost estimates

and quoting prices.
d) The time factor is ignored when the cost of material is used as the basis for absorption
of overhead,
e) Direct labour hour rate of absorption of overhead is suitable where most of the production
is done by using machines.
240
f) Factory overhead includes all production costs other than direct materials, direct labour
and depreciation.
g) Indirect expenses and overheads mean the same thing.
h) Obsolescence arises when a machine has to be discarded in favour of on better adopted

to its purpose and giving better result.
i) The volume of production achieved in a specified period is called practical capacity.
12.5 Summary
The cost of a product is arrived by adding the total cost incurred for production process and the
expenses incurred for the product after production before sales. It is a fact that the direct expenses
incurred for production will be charged directly against the cost centres and cost units, but the
indirect expenses are apportioned or absorbed through the cost centres and cost units. The
indirect expenses should be closely watched while charging into the account. The expenses
such as administration, selling and distribution, depreciation rent, advertisement expenses are
to be charged in the account according to its nature of occurrence, value expended.
12.6 Key Words

Depreciation : Gradual decrease in the intrinsic value of an asset due to use and or lapse of
time.
Obsolescence : It is a sudden loss in the asset value
Residual value: Scrap value : Final realisable value.
Royalty: An amount payable to one person for getting the right to are his property
Incentive Bonus : A can emolument paid to labour in addition to wages to induce their productivity.

1. What is depreciation ? Explain the various methods of charging depreciation in respect
of the fixed assets, indicating the effect and relevance for the purpose of costing.
241
2. What is idle capacity ? How does it arise ? How will you compute the cost of idle capacity
and in what manner will you treat this in costing?
3. Define “Administration Cost”. Give a few examples and indicate how they may be dealt
with in cost accounts and how best they may be controlled.
4. What are selling and Distribution Overheads ? Describe a scheme of controlling Selling
and Distribution Costs.
5. Discuss
a) Interest on capital
b) Research & Development expenses
c) Bad debts & Loss or Wastage
d) Medical Service Cost

1. a) administration cost b) administration cost
c) Abnormal d) notational
e) Partly, partly f) excluded
g) fixed h) ability to pay
i) selling j) semi-variable
k) use l) external
m) number of years of the remaining life of the asset including the current year
n) maximum 0) available for utilisation
2. a) False b) True c) True d) True e) False
f) False g) False h) True j) False

242
LESSON - 13
COSTING METHODS
Learning Objectives
After reading this lesson, you should be able to:
 Describe the features of process costing
 Prepare the process, normal loss, abnormal loss and abnormal gain accounts
 Compute the value of work in progress and equivalent production statement using the
average cost and first in first out methods of valuing work-in-progress
 Describe the accounting treatment of joint products and by products
 Explain Inter - Process profit method.
Structure
13.1 Introduction
13.2 Process Costing
13.3 Advantages and Limitations of Process Costing
13.4 Distinction between Job Costing and Process Costing
13.5 Recording of Cost Under Process Costing
13.6 Treatment of Process Losses and Abnormal Gain
13.7 Inter Process Profit
13.8 Equivalent Production
13.9 Joint Product and By Product
13.10 Summary
13.11 Key Terms

243
13.1 Introduction
There are various methods of costing among which job order costing is appropriate
when each unit of product, or “batch” of production, is manufactured to different specifications.
Many companies, however, produce a continuous stream of identical units, such as bottles of
soft drinks, gallons of gasoline, or kilowatt hours of electricity. When identical products are
produced in a continuous stream, there are no distinct “jobs”. Therefore, companies engaging
in mass production often use process costing rather than job order casting. Mass production
usually involves a series of specific steps, or manufacturing processes. Process costing
measures separately the cost of performing each process and then allocates these costs to
the units processed during the month. Process costing serves two related purposes. First, it
measures the cost of goods manufactured on both a total and per-unit basis. This information
is used in valuing inventories and in recording the cost of goods sold. But process costing also
provides management with information about the per-unit cost of performing each step in the
production process. This information is useful in evaluating the efficiency of production
departments and often draws attention to potential cost savings.
Methods of Costing
The methods used for the ascertainment of cost of production primarily depend on the
manufacturing process and the methods of measuring the departmental and finished goods.
Basically, there are two methods of costing: ,
Specific Order Costing : This method is applicable where the work consists of separate jobs,
batches or contracts authorized by a specific order. Job costing, batch costing and contract
costing belongs to this category.
Operation Costing: This method is applicable where standardized goods or services result
from a sequence of repetitive and more or less continuous process or operation, to which
costs are charged. These costs are averaged over the units produced during the period. Process
costing, services costing can be included in this category.
1. Job Costing
A type of specific order costing where work is undertaken as an identifiable unit and
manufacturing is according to customer’s specific requirement is known as Job Costing. Under
job costing method cost of an individual job or work order is ascertained separately. Job costing
244
is ideal where the products are dissimilar and non-respective in nature. It is suitable for ship
building, printing, interior decoration and advertising industries. The main objective of job costing
are to establish the profit or loss on each job and to provide a valuation of WIP.
Advantages of Job Costing
The various advantages of job costing may be listed as under
 Job costing facilitates the determination of profitability job-wise. It enables the management
to distinguish profitable and unprofitable jobs.
 Job costing helps in making detailed analysis of cost of materials, wages, overheads
which enables management to determine the operating efficiency of the different factors
of production.
 Job costing helps in identifying spoilage and defective work with each job and, hence,
responsibility may be fix on persons or departments.
 Job costing facilitates the preparation of estimates for similar jobs for the purpose of
submitting quotations.
 Job costing facilitates the application of cost plus pricing for contracts.
 System of budgetary control can also be introduced since the overheads are recovered
on the basis of pre - determined rates.
Disadvantages of Job Costing
The weaknesses of job costing are as follows
Job costing involves a great deal of clerical work, hence, it is very much expensive.
Job costing ascertains the cost of a job after it has been manufactured. In this way, job costing
is a historical costing and suffers from all defects of historical costing.
Job costing does not facilitate control of cost unless it is used with standard or estimated
costing
245
Job Cost Card / Sheet
Job cost card or job cost sheet is the most important document used in the job costing. A
separate job cost sheet is prepared for each job. the main idea of preparing job cost sheet is to
show in detail the cost components of the total cost of executing a job. Job cost sheet is used
to record direct material direct wages and overheads applicable to the job concerned. A specimen
of job cost sheet is given as under.
Summary
Estimated cost (Rs) Actual cost (Rs) Variance (+) (-)
Material
Labour
Overhead
Total
Explanation of Variance
Date ------ Prepared by -----
Remarks ----- Checked by -----
Job cost sheet facilitates the determination of profit or loss on each job. Estimated
costs are also recorded on the job cost card which facilitate comparison of actual costs with
the estimated cost and variation in the cost is known.
246
2. Batch Costing
This is a form of job costing. Under job costing, executed job is used as a cost unit,
whereas under batch costing, a lot of similar units which comprises the batch may be used as
cost unit for ascertaining cost. In the case of batch costing separate cost sheets are maintained
for each batch of products by assigning a batch number. Cost per unit in a batch is ascertained
by dividing the total cost of a batch by number of items produced in that batch. Such a method
of costing is used in the case of pharmaceutical or drug industries , readymade garments,
industries manufacturing electronics parts of T.V., ratio sets etc.
Illustration 1
Following information relates to the manufacturing of a component X - 005 in a cost centre:
Cost of materials 6 paise per component
Operator’s Wages 72 paise per hour
Machine-hour rate Rs. 1.50
Setting up time of the machines 2 hours and 20 minutes
Manufacturing time 10 minutes per component.
Prepare a cost sheet showing both production and setting up costs total and per unit, when the
batch consists of 100 components.
Solution
Cost Sheet for the Batch of 100 Components
Setting up costs Per unit Total (Rs.)
Operator’s wages for 2 hrs. 20 mts.
@ 72 Paise an hour 1.68
Machine overhead for 2 hrs. and
20 mts. @ Rs. 1.50 an hour 3.50
Total setting up costs: 0.05 5.18

247
Production Costs:
Material Cost for 100 units @ paise
6 per unit 0.06 6.00
Wages of the operator for 1,000 mts.
@ 72 paise an hour 0.12 12.00
Machine overheads for 1,000 mts
@ Rs. 1.50 an hour 0.25 25.00
Total 0.48 48.18
13.2 Process Costing

According to C.I.M.A. London, “process costing is that form of operation costing where
standardized goods are produced”. According to Charles T. Horngren, “process costing deals
with the mass production of like units that usually pass in continuous fashion through a series
of production steps called operations or processes”. Kohler, in his book, “Dictionary for
Accountants”, defines process costing as “a method of cost accounting whereby costs are
charged to processes or operations and averaged over units produced”
Process costing is an accounting methodology that traces and accumulates direct costs,
and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually
in a large batch, which might include an entire month’s production. Eventually, costs have to be
allocated to individual units of product. It assigns average costs to each unit, and is the opposite
extreme of Job costing which attempts to measure individual costs of production of each unit.
Process costing is usually a significant chapter. It is a method of assigning costs to units of
production in companies producing large quantities of homogeneous products..
Features of Process Costing
 The plant has various divisions, and each division is a stage of production.
 The production is carried out continuously, by way of the simultaneous, standardized and
sequential process.
248
 The output of a process is the input of another.
 The production from the last process is transferred to finished stock.
 The final product is homogeneous.
 Both direct and indirect costs are charged to the processes.
 The production may result in joint and by-products.
 Losses like normal and abnormal loss occur at different stages of production which are also
taken into consideration while calculating the unit cost.
 The output of one process is transferred to another one at a price that includes the profit of
the previous process and not at the cost.
 At the end of the period, if there remains the stock of finished goods, then it is also expressed
in equivalent completed units. It can be calculated as:
Equivalent units of semi-finished goods or WIP = Actual number of units in process ×

Percentage of work completed
Process costing is employed by the industries whose production process is continuous and
repetitive, as well as the output of one process is the input of another process. So, chemical
industry, oil refineries, cement industries, textile industries, soap manufacturing
industries, paper manufacturing industries use this method.It is convenient and easy to
compute the cost of different processes as well as finished product at short intervals, say,
daily, weekly or monthly.
13.3 Advantages and Limitations of process costing

Due to the simplicity of cost records, process costing involves less efforts and expenses on
accounting.
Production activity in process costing is standardized. Hence, managerial control and supervision
become easier.
In case of process costing, it is possible to allocate expenses to different processes on rational

basis. This results into more accurate costing.
249
In process costing, the products are homogeneous. As a result, cost per unit can be easily
computed by averaging the total cost and price quotations become easier.
In process costing, products and processes are standardized. Hence, it is easy to apply standard
costing.
Limitations of Process Costing
Process accounting suffers from certain limitations. The limitations of process costing are
summarised below :
The cost obtained at the end of the accounting period is historical in nature and is of little use for
effective managerial control.
Since process cost is the average cost, it may not be accurate for analysis, evaluation and
control of the performance of various departments.
Once an error is committed in one process, it is carried over to the subsequent processes.
Value of work-in-progress is computed on the basis of estimates which results in further

inaccuracies.
13.4 Distinction between Job Costing and Process Costing

Process costing and job costing are two principal methods of cost accounting. The
main points of distinction between job costing and process costing may be listed as
under:Distinction between Job Costing Process Costing
250
13.5 Recording of Costs Under Process Costing

For the introduction of process costing, productions activity of a factory is divided into
departments or processes. The following costs are recorded under process costing.
Material of the Process : The cost of raw material debited to the process account is determined
on the basis of documents like material requisition slips and consumption reports.
Wages for the Process : Wages to workers for a particular process is debited to that process
account. When workers are engaged in more than one process, the wages relating to a process
251
are determined with reference to time spent on that particular process. Time tickets of workers
can form a reliable basis for determining wages relating to a particular process.
3. Direct Expenses : If expenses can be identified to a particular process, these expenses

should be debited to that process account.
4. Overheads : Overhead relating to a process should be debited to that process account. For
distribution of expenses relating to more than one process, suitable basis is determined with
reference to available data. Some industries prefer to use predetermined overhead rates to
apply overheads to the process.
In process costing a separate account is kept for each process. The process account
is debited with the value of material, labour and overheads relating to the process. The value of
by-products and scrap, if any, is credited to the account and the balance of this account
representing the cost of partially worked out product is transferred to the next process so one
until the final product is completed. Thus the finished product of one process becomes the raw
material of the next process.
13.6 Treatment of Process Losses and Abnormal Gain
In process industries certain losses cannot be completely prevented. For instance, in oil refinery
industries the loss due to evaporation of petroleum cannot be completely avoided. Similarly,
sometimes some losses can arise due to abnormal reasons. Now we can discuss treatment
of process loss.
1, Normal Loss : Loss which is unavoidable because of the inherent nature of production
process is called normal loss. For example, weight losses in processes due to evaporation,
burning and melting, etc. Normal loss can be estimated in advance on the basis of past
experience and data available relating to industry. The normal process loss is recorded only in
terms of quantity and the cost per unit of normal output is increased accordingly. If scrap fetches
some value, the process account is credited with such value.
2. Abnormal Process Loss : Any loss caused by abnormal conditions such as plant breakdown,
carelessness, accidents, etc. or loss in excess of the margin anticipated for normal process
loss should be regarded as abnormal process loss. The value of units representing abnormal
loss is debited to a separate account known as abnormal loss account. The sale proceeds of
252
the units representing abnormal loss, if any should be credited to abnormal loss account. The
balance in the abnormal loss account after considering the above adjustments should be
transferred to profit and loss account.
3. Abnormal Gain : Normal loss is provided for in the production on the basis of estimates.
Situations where the actual losses are less than the normal losses, an abnormal gain results.
In other words, when the actual production is more than normal production, abnormal gain
occurs.
13.7 Inter Process Profit

Sometimes the transfer price from one process to another process intludes an element
of profit. The practice of including profits in the transfer pricing is resorted to because of the
following reasons:
To show the cost of production in relation to the market price.
To make each process stand on its own efficiency and economics.
This practice induces competition in different processes which ultimately leads to cost
control.
This system is complicated and time consuming. For balance sheet purpose, the closing
balances of inventories have to be adjusted as it includes unearned profit. To avoid this
complication a provision must be created to reduce the stock to actual cost price.
13.8 Equivalent Production

When work done in a process includes unfinished units, equivalent completed units or
equivalent production is calculated for work done on unfinished units. Equivalent production
represents the production of a process in terms of completed units. The following points have
to be considered for preparation of Statement of Equivalent Production.
Equivalent completed units are not calculated for normal loss because it is shared by
good production in the process.
Units representing abnormal loss and abnormal gain should be treated like “units finished
and transferred to next process” for the preparation of statement of equivalent production.
253
Valuation of work-in-progress: For the valuation of work-in-progress following three

methods are available:
First-in-First Out (FIFO) method.
Last-in-First Out (LIFO) method.
Average Cost Method (or weighted average cost method).
First-In-First-Out Method : Under this method the units completed and transferred include
completed units of opening work-in-progre’ss and subsequently introduced units. Proportionate
cost to complete the opening work-in-progress and that to process the completely processed
units during the period are derived separately. The cost of opening work-in-progress is added to
the proportionate cost incurred on completing the same to get the complete cost of such units.
Complete cost of such units plus cost of units completely processed constitute the total cost of
units transferred.
Last-in-first-out method : According to this method units lastly entering in the process are the
first to be completed. This assumption has a different impact on the costs of the completed
units and the closing inventory of work-in-progress. The completed units will be shown at their
current cost and the closing inventory of work-in-progress will continue to appear at the cost of
the opening inventory of work-in-progress.
Average method : This method is useful when prices fluctuate from period to period. Cost of
opening inventory is added to cost incurred during the process and an average rate is ascertained
which tends to even out the price fluctuations.
13.9 Joint Products and By-Products

Agricultural product industries, chemical process industries, sugar industries, and
extractive are some of the industries where two or more products of equal or unequal importance
are produced either simultaneously or in the course of processing operation of a main product.
In all such industries, the management is faced with the problems such as, valuation of inventory,
pricing of product and income determination, problem of taking decision in matters of further
processing of by-products and / or joint products after a certain stage etc. In fact the various
problems relate to (i) apportionment of common costs incurred for various products and (ii)
aspects other than mere apportionment of costs incurred upto the point of separation. Before
taking up the above problems, we first define the various necessary concepts.
254
Joint Products : Joint products represent “two or more products separated in the course of
the same processing operation usually requiring further processing, each product being in
such proportion that no single product can be designated as a major product”. In other words,
two or more products of equal importance, produced, simultaneously from the same process,
are known as joint products. For example, in the oil industry, gasoline; fuel oil, lubricants, paraffin,
coal tar, asphalt and kerosene are all produced from crude petroleum. There are known as joint
products.
Co - Products : Joint products and co-products are used synonymously in common parlance,
but strictly speaking a distinction can be made between two. Co-products may be defined as
two or more products which are contemporary but do not emerge necessarily from the same
material in the same process. For instance, wheat and gram produced in two separate farms
with separate processing of cultivation, are the co-products. Similarly timber boards made
from different trees are co-products.
By-Products : There are defined as “products recovered from material discarded in a main
process, or from the production of some major products, where the material value is to be
considered at the time of severance from the main product”. Thus by-products emerges as a
result of processing operation of another product or they are produced from the scrap or waste
of materials of a process. In short a by-product is a secondary or subsidiary product which
emanates as a result of manufacture of the main product. Examples of by-products are molasses
in the manufacture of sugar, tar, ammonia and benzole obtained on carbonization of coal and
glycerin obtained in the manufacture of soap.
Distinction between Joint-Product and By-Product: The main points of distinction as

apparent from the definitions of Joint Products and By-Products are:
(i) Joint products are of equal importance whereas by-products are of small economic value,
(ii) Joint products are produced simultaneously but the by-products are produced incidentally in
addition to the main productsAccounting for Joint Products : Accounting for joint products implies
the assignment of a portion of the joint costs to each of the joint products. Unless the joint costs
are apportioned reasonably to different joint products, the product cost determination will not be
correct. As a result the valuation of inventory, pricing of products and profitability of different
products will also be affected. The following methods are commonly used for apportionment of
joint costs to different products.
255
Average Unit Cost Method : Under this method the total cost up to the point of separation is
ascertained and it is divided by the total units produced to arrive at the average cost per unit of
production. This method can be used when the processes are common and inseparable for
the joint products and where the resultant products can be expressed in the same common
unit. This method is not suitable when the products are of different grades and cannot be
expressed in some common unit.
Physical Unit Method: A physical base like raw material weight in physical output quantity is
taken as basis for apportioning the joint costs to joint products. This method is simple and
technically sound. This method is not suitable when the output consists of different types of
units such as liquids and solids unless they can be equated. This method presupposes each
product as equally valuable, which is not the case in practice.
Survey Method: All the important factors such as volume, selling price, marketing process,
etc. affecting the costs are ascertained by means of extensive survey. Points value or
percentages are given to individual products according to their relative importance. The joint
costs are apportioned on the basis of the total points. This method of costs apportionment is
more accurate and equitable because a combination of related factors is considered. The main
disadvantage of this method is that the weights are allocated arbitrarily.
Standard Cost Method : If standard costing is in operation, it may be possible to apportion the
joint costs on the basis of standard costs set for the respective joint products. It has the advantage
of measuring efficiency or otherwise of processes in producing joint products.
Contributory Margin Method : Under this method the joint costs are divided into fixed and
variable costs. The variable costs are apportioned on the basis of the weight or quantity of each
product and fixed costs on the basis of contribution made by the various products. Contribution
is the difference between the sales and variable costs.
Market Value Method : Under this method the joint costs are apportioned in the ratio of selling
prices of individual products. This method is widely supported, as under this method the product
with the higher sales value is allocated a larger proportion of the joint cost then the products
with lower sales value. This method is not suitable in situations where the selling prices of
some joint producers are fairly stable, while others fluctuate.
256
Variants of this method commonly used are as follows :
Market value at the point of separation: Under this method, the joints costs are apportioned
in the ratio of the market value of products at the point of separation (split - off point). This
method is useful where further processing of products incurs disproportionate costs. But it is
difficult to ascertain the market value at this stage.
Market value after further processing : This method is easy to operate as the selling price
of the various joint products after further processing that is, in their final state are readily available.
The cost of completing the individual joint products will not be the same in all cases. Therefore,
the market values of individual joint products cannot be an accurate indicator of costs incurred
in their manufacture up to the point of separation.
Market values less cost to complete the individual joint product after split - off point:
This method is used whenever there is no ready market price for individual joint products at
split - off point. This method is very simple. Production in terms of sales values is taken for
individual joint products and cost beyond split - off point is reduced from it to arrive at cost at
split - off point.
Net value method : Under this method, the estimated net profit, direct selling expenses if any,
and the cost of processing after split - off point are deducted from the sales value of individual
joint products to arrive at the net realizable value. The joint costs are apportioned on the basis
of net realizable value of joint products. This method appeals to reason, but it is very difficult to
use in practice. One will have to decide whether benefits after these detailed analysis justify the
costs incurred.
By-Product Accounting
The methods of apportionment of costs of by-products can be classified as follows:
I. Non - Cost or Sale Value Methods
Other income or miscellaneous income method : Under this method, the sales value of by-
products which is negligible is credited to the profit and loss account treating it as other or
miscellaneous income. This method is suitable forthe industries where the value of by-product
is negligible and where the carrying of by-product with the main product does not entail any
difference in the cost of main product. The value of unsold by-products is shown as nil in the
balance sheet. This vitiates the valuation of closing stock. Accounting under this method is
inaccurate because there is a time lag between the sales and production.
257
Total sales less total costs : The total costs incurred on main products and byproducts is

deducted from the total sales value of the main products and by-products. This method is
adopted in cases where the value of by-products is very less or where it is sold in the market in
the same state.
Total costs less sales value of by-products : Sales value of by-products is deducted from
the cost of production. This method is favoured because, like waste and scrap, by-products
revenue reduces the cost of major products. Under this method, the fluctuating cost of the by-
products affect the costs of the main products.
Total cost less net yield of by-products : Under this method cost incurred on byproducts

after the point of separation and selling and distribution overheads of byproducts are deducted
from the sales value of by-product. The net realization is deducted from the total cost of the
main product.
Reserve cost method : Under this method an estimated profit from the sale of byproducts,

Selling and distribution expenses and further processing costs after split- off points are deducted
from the sales value of by-products and the net amount is deducted from the cost of the main
product.
II. Cost Methods
Replacement or opportunity cost method : When the by-products are utilized in the same
undertaking, the by-product is valued at opportunity cost or replacement cost i.e. the cost which
would have been incurred, had the by-product been purchased from outside. The process
account is credited with the value of by-products so ascertained.
Standard cost method : Under this method the by-products are valued at a standard rate
determined for each product. The standard cost of by-product is credited to the process account
of main product. As the standard price remains stable, the cost of the main product would
reflect changes if any, due to operational factors.
Joint cost proration : Under this method the joint costs are apportioned between the main
product and by-product on a suitable acceptable basis. This method does not differentiate
between joint products and by-products.
258
Operation and Operating costing: Operation costing refers to the cost of renderring services.
It is cost of producing and rendering a service. Operating cost is a method of costing which is
designed to ascertain and control the cost of undertaking which do not produce products but
render services.
Check you Progress

1. What is batch costing?
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
2. What is job cost card?
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
3. What do you mean operation costing?
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
13.10 Summary
The job costing system is applicable in the case of a single item or batch. It is also
applicable both to manufacturing and service activities. The procedure of determining cost
according to this method is to trace/ attach costs of the specific job by means of a cost sheet
set up for each job. Direct materials and direct labour cost are traced directly to the specific
jobs; indirect manufacturing costs are applied to jobs by means of predetermined overhead
application rate.
259
A variant of job costing is contract costing. The cost accumulation in this system of
costing is done through a contract account. The difference between the contract price and
various direct and indirect costs incurred in completing the contract is the profit or loss. Although
the profit on a contract can be known only when the contract is fully complete. Conventionally,
profits are estimated for intervening years also for contracts which extend beyond one year.
The variables having a bearing on the determination of profits on incomplete contracts are : (i)
The extent of completion of the work; (ii) The extent of work certified by the architect of the
contractee; and (iii) Cash received from the contractee. The difference between the profit
estimated and transferred represents for future contingencies.
The process costing system measures the cost of products under conditions of
continuous production, sequential processing and homogeneous output. The procedure under
such a system of costing essentially involves averaging the total costs of a process or a
department. The cost is accounted for in the form of a production cost report or process account.
The computation of the average cost is expressed in terms of equivalent output units processed
or produced during the period and an equivalent unit is based on the assumption that a number
of partially completed units are the cost - equivalents of a proportionately smaller number of
fully completed units and vice - versa. The apportionment of the total production cost between
current output and closing work-in-process inventory is commonly determined on the basis of
weighted average cost or first -in-first out (FIFO) method.
Wastage of some units occurs during the manufacturing process, if the wastage is
inherent unavoidable and uncontrollable, it is know as normal spoilage. Any wastage excess of
normal wastage is referred to as abnormal spoilage. The cost of production of normal spoiled
units is treated as product cost and is recovered from the good units. The abnormal loss is
charged against the profits of the current period and does not form part of cost of production.
When more than one type of output results from a single / common processing operation, it is
known as joint products. For purposes of inventory valuation and income measurement, common
processing costs should be allocated among the joint products. Among the methods most
commonly used as the basis for such allocation are the net realizable value minus normal profit
method when products are homogeneous and the weighted average method in the case of
heterogeneous products. When one of the many joint outputs is of relatively smaller value, it is
classified as a by - product. If the by - product is sold at the split - off point, the net realisable
value minus normal profit method should be used. For further processing, the reversal cost
method is the most appropriate.
260
13.11 Key Terms

 Equivalent production
 Job costing
 Inter process profit
 abnormal gain

1. What is job costing? Bring out its advantages and disadvantages.
2. Describe briefly the main features of process costing.
3. Distinguish between job costing and process costing.
4. What do you mean by Inter - process Profit? What purpose does it serve?
5. What is meant by equivalent production? Discuss its importance in valuing WIP.
6. What are joint products ? Enumerate the methods which may be employed in costing
joint products.
261
MODEL QUESTION PAPER

B.COM.- GENERAL
COST ACCOUNTING
Time : Three hours Maximum : 75 marks
Part - A (10 x 2 = 20 marks)

Answer any TEN of the following in 50 words
1. Define cost accounting.
2. Bring out any two differences between cost accounting and financial accounting.
3. What is cost sheet?
4. Write short notes on bin card.
5. How idle time is treated?
6. List out the methods of reapportionment
7. What do you mean by absorption of overhead?
8. From the following prepare stores ledger under FIFO method
Jan 2 - purchased 4,000 units @ Rs. 4 per unit: jan 20 - purchased 500 units @ Rs. 5 per
unit; Fed 5 - issued 2,000 units; Feb 10 - purchased 6,000 units @ Rs 6 per unit; Feb 12
- issued 3,000 units.
9. A factory requires 1500 units of material per month, each costing Rs. 27. The cost per
order is Rs. 150 and the inventory carrying charges 20%. Find Economic Order Quantity.
262
10. From the following particulars, calculate labour cost per day.
a) Monthly salary in Rs. 1350.
b) Leave salary 5% of salary.
c) Employer’s contribution to P.F. is 8.5% of (a) and (b)
d) Employer’s contribution to State Insurance is 3% of (a) and (b)
e) Expenditure on amenities to labour Rs. 75 per head per month.
f) Number of working hours in a month 200.
11. Calculate labour turnover from the following.
Total number of employees at the beginning of the month is 2010.
Total number of employees at the end of the month is 1990.
Number of employees recruited 30.
Number of employees left 50.
12. What is Semi-variable overhead?
Part - B (5 x 5 = 25 marks)
Answer any FIVE questions.
All questions carry equal marks.
13. Explain the classification of overheads.
14. Discuss the features of job costing.
15. From the following particulars, prepare a cost sheet.
Raw materials Rs. 9,100
Labour Charges Rs. 4,000
Factory expenses 80% of labour charges

263
Office overheads 10% of labour charges
Selling and distribution expenses Rs. 2 per unit sold
Units produced and sold 10,000
Percentage of profit - 20% on selling price
16. From the following daa, find out Economic Order Quantity: Annual usage 6,000 units.
Cost per unit Re.0.30
Buying cost Rs. 7 per order
Carrying cost 15% of average inventory holding
17. Calculate the total earnings and the rate earned per hour of two workmen under the
Halsey and Rowan plans. Standard time 20 hours, hourly rate of wages Rs. 4 Time taken
by A - 16 hours and B - 10 hours.
18. Ram Kumar company gives the following information:
No. of. employees on 1.1.2020 - 240
No. of. employees on 31.12.2020 - 310
No. of. employees resigned - 26
No. of. employees discharged - 5
No. of. employees replaced - 25
Calculate the annual labour turnover rate of the company.
19. Calculate machine hour rate from the following; Cost of machine Rs. 16,000 estimated
scrap value Rs. 1,000, effective working life 10,000 hours running time 160 hours, repairs
Rs. 120, standing charges Rs. 40, power used by the machine 4 units per hour at a cost
of 5 paise per hour.
264
Part - C (3 x 10 = 30 marks)
Answer any THREE questions.
All questions carry equal marks.
20. Prepare a cost sheet from the following information Rs.
Raw materials consumed Rs. 1,60,000
Direct wages Rs. 80,000
Factory overheads Rs. 16,000
Office overheads 10% of factory cost
Selling overheads Rs. 12,000
Units produced 4,000
Units sold 3,600
Selling price per unit Rs. 100
21. The following is an extract of the record of receipts and issues of sulphur in a chemical
factory during Nov. 2018
Nov. 1 Opening Balance 500 tonnes @ Rs. 200
3 Issue: 70 tonnes
4 Issue: 100 tonnes
8 Issue: 80 tonnes
13 Received from supplier 200 tonnes @ Rs. 190
14 Returned from department 15 tonnes
16 Issue: 180 tonnes
20 Received from Supplier 240 tonnes @ Rs. 190
27 Returned from department 35 tonnes

265
Issues are to be priced on the principal of ‘ First in First Out’. The Stock Verifier of the
factory had found shortage of 10 tonnes on the 22nd and left a note accordingly. Draw up
priced Stores Ledger Card for the material, showing the above transactions.
22. Calculate (a) EOQ (b) Maximum level (c) Minimum level and (d) Reordering level from
the following data:
Reorder period - 4 to 6 weeks
Maximum consumption - 100 units per week
Minimum consumption - 50 units per week
Normal consumption - 75 units per week
Annual consumption 36,000 units
Cost per unit Re. 1
Ordering cost Rs. 25
Inventory carrying cost is 20% of unit value.
23. Calculate the earnings of workers X and Y under the Straight Piece Rate system and
Taylor’s Differential Piece Rate system. Standard production - 10 units per hour, normal
time rate Rs. 5 per hour. X produced 80 units in a day of 10 hours and Y produced 110
units in a day of 10 hours.
24. A company is producing 3 types of products A,B and C. The sales territory of the company
is divided into 3 areas X, Y and Z.
The estimated sales for the year are as under:
Territory
Product X Y Z
Rs. Rs. Rs.
A 50,000 20,000 -
B 30,000 - 50,000
C - 70,000 40,000
266
The budgeted advertising cost is as under:
x y z Total
Rs. Rs. Rs. Rs.
Local cost 3,200 4,500 4,200 11,900
General - - - 5,800
You are required to find advertising cost per cent on sales for each product and territory
showing how you will present the statement to management.

SUCM301 Cost Accounting

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

SUCM301 Cost Accounting

Uploaded by

Copyright:

Available Formats

SUCR 301 / SUCC 301/ SUCM 301

CORE PAPER - IX / CORE PAPER - XI

INSTITUTE OF DISTANCE EDUCATION

It is with a great pleasure to welcome you as a student of Institute of Distance

With best wishes from mind and heart,

Dr. R. PANCHALAN Dr. P. HEMAVATHY

Institute of Distance Education Institute of Distance Education

© UNIVERSITY OF MADRAS, CHENNAI 600 005.

THIRD YEAR - FIFTH SEMESTER

CORE PAPER - IX / CORE PAPER - XI

UNIT III LABOUR

Importance of Labour Cost Control- Various Methods of Wage Payments - Calculation of

UNIT IV OVERHEADS: (Factory, Administration, Selling and Distribution)

Definition and Meaning of Overheads – Classification – Apportionment of Overheads –

UNIT V METHODS OF COSTING

1. B.K.Bhar – Cost Accounts

2. Jain & Narang – Cost and Management Accounts

3. S.N.Maheshwari – Cost & Management Accounts

4. S.P.Iyengar – Cost and Management Accounting

5. T.S. Reddy and Y. Hari Prasad Reddy – Cost Accounting

THIRD YEAR - FIFTH SEMESTER

CORE PAPER - IX / CORE PAPER - XI

Sl.No. Title Page

1. Fundamentals of Cost Accounting 001

2. Cost Analysis 014

3. Output Costing 022

4. Reconciliation of Cost and Financial Accounts 044

5. Materials - Purchase Control 058

6. Materials - Inventory Control 077

7. Materials - Issue Control 100

8. Materials - Lossess 128

9. Labour Cost Computation 139

10. Labour - Remuneration and Incentives 167

11. Overheads 191

12. Overheads (Contd.) 223

13. Costing Methods 242

After studying this lesson, you should be able to:

• Understand the objectives of cost accounting

• Highlight the essentials of good costing system

• Describe the installation of good costing system in a firm.

1.3 Essentials of Good Costing System

1.4 Installation of Good Costing System in a Firm

1.6 Key Words

1.7 Review Questions

1.8 Answers to Check Your Progress

a) to take constant effort to improve the quality of the products.

1.2.2 Cost Accountancy

Scope of Cost Accountancy

4) Budgetary control : slt is the establishment of budgets relating to the responsibilities

1.2.3 Cost Accounting

b) cost presentation and

c) cost control and reduction

Objectives of Cost Accounting

d) Matching cost with revenue : The determination of profitability of each product, ce

f) Facilitates preparation of financial and other statements : Cost accounting helps

1) to operate the business at a high level of efficiency.

2) to have a frequent review of production, sales and operating results

3) to see the volume of units produced and its accumulated costs

Advantages of Cost Accounting

a) Advantages to the management

1) Helps in price fixation

2) Helps in the periods of trade depression and trade competitions

3) Helps to channel the products on the right way