Syllabus B.Com. (Prog.) CBCS PAPER BC 4.3: COST ACCOUNTING Duration: 3 hours Objective: To acquaint the students with basic concepts used in cost accounting, and various methods involved in cost ascertainment systems and use of costing, data for planning, control and decision-making, COURSE CONTENTS UNIT I-Introduction: Meaning, objectives and advantages of cost accounting, difference between financial, cost and management accounting. Cost concepts and. classifications, Role of a cost accountant in an organization. UNIT IL (@) Materials: Material/inventory control—concept and _ techniques, Accounting and control of purchases, storage and issue of materials. Methods of pricing of materials issues~FIFO, LIFO, Simple Average, Weighted Average, Replacement, Standard, Treatment of Material Losses. (0) Labour: Accounting and Control of labour cost, time keeping and time booking, concept and treatment of idle time, over time, labour turnover and fringe benefits UNIT II1—Overheads: Classification, allocation, apportionment and absorption of overhea Under- and over-absorption, capacity costs, treatments of certain items in costing, like interest on capital, packing expenses, debts, research and development expenses, Activity based costing, UNIT IV—Methods of Costing: Unit costing, Job costing, Contract costing, Proce: valuation of work-in-progress, joint and by-products), costing (process losses, UNIT V~Service Costing and Accounting Systems: Service costing (only transport). Accounting Systems: Integral and non- integral systems, Reconciliation of cost and financial accounts. aoa )Cuapter 1 INTRODUCTION Q. 1. What do you mean by Cost Accounting? Discuss its objectives and limitations? ‘Ans. Cost Accounting is a branch of accounting which is concemed with ascertainment of cost of products and services. It is the process of accounting for Costs. Chartered Institute of Management Accountants (CIMA) of England has defined Costing as “te technique and process of ascertainment of cost”. According to Wheldon “Costing is the classifying, recording and appropriate allocation of expenditure for the determination of the cost of products or services; the relation of these costs to sales; values and the ascertainment of profitability.” Chartered Institute of Management Accountants of England has defined Cost, Accountancy as “The application of costing and cost accounting principles, methods and techniques tothe science, art and practice of cost and the ascertainment of profitability. It includes the presentation of information derived therefrom for the purpose of management decision making.” The terms Costing, Cost Accounting and Cost Ac interchangeably. Objectives of Cost Accounting. The main objectives of Cost Accounting are: (i) Cost ascertainment. Cost Accounting helps in arriving at cost of production of each individual unit of production or job or operation or process or department or service. Cost Accounting lays down the principles which help in evolving methods by which expenses are analysed and related to the specific unit of production or job. Thus, one very important function of a cost accountant is the cost ascertainment of each unit of production or job or process. (i) Fixation of selling price. Though there are several other factors determining the price of a product, yet one very important basis of fixing the selling price isthe cost of production. Itis because of this that many a time the pricing of the product is cone on the basis of ‘Cost plus pricing’ It is in this area where Cost Accounting plays an important role Techniques like ‘Break-even analysis’ help in this regard (ii) Helps in estimating cost. In types of business where jobs or contracts are to be carried out for which tenders or quotations are to be given, Cost Accounting is very helpful. Cost Accounting records help in such cases in estimating the cost to which the desired profit margins are added to arrive at the prices to be quoted in the tenders for the jobs or contracts. (io) Cost control. ‘Controf’ means that plans and actions should complement 1 wuntaney are often used2m Shiv Das [B.Com. (Prog) CBCS] DELHI UNIVERSITY SERIES each other. Through information available from Cost Accounting, the ‘managers at various levels in the organisation are able to control costs as well. In modern times, controlling costs is the main objective of Cost Accounting whereas cost ascertainment is only a secondary objective. This purpose of cost control is sought to be achieved through costing techniques such as Budgeting, Standard Costing etc. (©) Providing data or information, which are the bases of management accounting thereby helping the management in taking long-term as well as short-term deci of the profitability of the various alternatives and in this area, Cost ‘Accounting serves a great purpose. Limitations of Cost Accounting: Besides a number of advantages, cost accounting suffers from a number of limitations: () Cost accounting lacks a uniform procedure. It is possible that two equally. competent cost accountants may arrive at different results from the same information. Keeping this limitation in view, all cost accounting, results can be mere estimates. (i) There are a large number of conventions and flexible factors such as classification of cost into its elements, issue materials on average or standard price, apportionment of overhead expenses, arbitrary allocation of joint costs, division of overheads into fixed and variable costs, division of cost into normal and abnormal and controllable and non-controllable costs and adoption of marginal and standard costs due to which it becomes difficult to have exact costs. (ii) Cost varies with purpose. Therefore, cost called for a certain purpose will not be suitable for other purposes. (io) Cost Accounting is not an exact science. It involves inherent elements of judgment. (©) A suitable system is to be devised for each individual concern and it would be time consuming and expensive. (©) Most of Cost Accounting Techniques are based on some presumed notions. Different views are held for inclusion of certain items of cost in ascertainment of total cost (vif) Many formalities are to be observed to obtain benefit from Costing System, Small and medium concerns may not be in a position to install a costing system, (Cit) If the system is not revised as per the changing circumstances, it will become a matter of routine forms and statements. Q. 2. What are the limitations of Financial Accounting? Ans. Financial Accounting. Cost Accounting has developed mainly because of the historical nature of Financial Accounting. Financial Accounting, which is ‘mainly concerned with the past data, suffers from certain serious limitations. Limitations: () Financial Accounting does not give classified cost figures for different departments, products, processes, etc (i) Financial Accounting does not provide adequate cost figures for fixation of selling price.(Chapter 4: INTRODUCTION 3 (ii) It does not disclose any reasons for any variations in the costs of two periods. (i0) It does not provide for control of cost of material, labour and overheads. (0) Under Financial Accounting there is no provision for fixation of standards for the measurement of efficiency of the organisation. (©i) Financial Accounting is concerned only with the past activities. It does not forewarn the management about the remedial action to be taken in future, (ii) Financial Accounting does not provide adequate information to outside agencies like the Government, trade associations, banks, etc. (Cili) ICdoes not supply adequate data to the management for taking certain managerial decisions. (i2) It does not provide for full analysis of losses on account of reasons like idle time, abnormal wastage of material etc. (@) Expenses are not classified into direct and indirect items, and controllable and uncontrollable items are not shown separately. Q. 3. “Limitations of financial accounting have made the management realize the importance of cost accounting.” Comment. Or, Explain the main points of difference between Cost Accounting and Financial Accounting. ‘Ans. Financial accouting is the process of collecting, recording, summarising, and communicating financial information. It is mainly concerned with the past data. Whereas the business concern also needs to know the costs incurred in detail on production of goods or while providing services in order to ascertain the profitability Cost accounting is more useful than Financial accounting when it comes to analysing the cost of products and services and pinpointing the areas of concem. The main differences between Cost Accounting and Financial Accounting: () In Financial Accounting there is no such system by which accounts are classified, so as to give data regarding costs incurred by different departments, processes, products in the manufacturing divisions, by units of product lines and sales territories, by departments, services and functions in the administrative division. In Cost Accounting, cost data is made and analysed in accordance with managerial requirement. (i) Financial Accounting does not provide for a proper control of materials, supplies and overheads. But in Cost Accounting, systems are developed to control each element of cost (ii) Financial Accounting does not provide day-to-day cost information because financial data are summarised at the end of the accounting period. In Cost Accounting, there is a system of continuous reporting. Costs are pre-determined and this helps in taking corrective action at appropriate stages. (io) Financial Accounting provides adequate information in reports to outside agencies such as Banks, Income-tax department, Trade Associations, Insurance Companies, etc., whereas Cost Accounting is ‘mainly used to meet the informational requirements of the Management.4-m Shiv Das [B.Com. (Prog) CBCS] DELHI UNIVERSITY SERIES (o) Financial Accounting does not provide information about losses due to defective material, idle plant equipment, inefficient labour or seasonal ions. In other words, no distinction is made between avoidable and unavoidable losses. In Cost Accounting, avoidable losses are clearly distinguished from unavoidable losses and separate accounting treatment is given to each type of loss. (vi) In Financial Accounting, expenses are not classified into direct and indirect items and are not assigned to the product at each stage of production. But in Cost Accounting expenses are classified and apportioned to each process and department as required. (eit) In Financial Accounting, unlike Cost Accounting, there is no well developed system of standards to appraise the efficiency of the organisation in the use of materials, labour and overhead costs by comparing the work of labourers, clerks, salesmen and executives with what should have been accomplished in producing and selling a given number of products in an allotted period of time. (Ciii) In Financial Accounting, costs are not available as an aid in determi prices of products, services, production arders or lines of products. (éx) Financial Accounting is mainly historical and tells about the costs already incurred. In Cost Accounting, costs are pre-determined, Q. 4. “It is said that Cost Accounting is unnecessary, expensive, luxury and. hence not needed”. Comment. ‘Ans. Cost Accounting is a very useful technique but many people raise objections to the usefulness of this accounting system. 1. Cost Accounting is unnecessary. Some people feel Cost Accounting is unnecessary because it is duplication of accounting records. It is argued. that Financial Accounting provides detailed accounting information and there is no need to maintain Cost Accounts. But such an argument is out of ignorance about the utility of Cost Accounting records. Financial Accounting, information is to meet the legal necessity of providing information about the results of the ‘operations of a business to the shareholders, income-tax authority and others. But Cost Accounting is necessary to provide detailed information about the cost of cost units and cost objects to only the management so that business can be run efficiently. In today’s world of competition, it is necessary to keep control on costs and for this purpose maintaining Cost Accounts is necessary. 2. Cost Accounting is expensive. It is said that maintaining a Cost Accounting, Department is quite expensive because of the high salaries of expert Cost Accounting Staff and small firms may not be in a position to afford it. But maintaining a Cost Department should be treated as an investment and the benefits derived from the system must exceed the amount spent on it. It should not prove a burden on the finances of the company. 3. Cost Accounting is a luxury. Cost Accounting system should not be treated. sa luxury simply because it is maintained in addition to Financial Accounting. In this world of cut throat competition, in order to survive and eam profits, a business has to control costs and it is possible only when expert Cost Accountants, are employed, Maintaining a Cost Accounting Department managed by cost ing(Chapter 1: INTRODUCTION = 5 experts can help a lot to reduce and control costs. This is a necessity and not a luxury in the prevailing competitive environment. Q.5. What do you mean by Cost centre and Cost unit? Ans. Cost centre and Cost unit, ‘Cost centre” and ‘Cost unit’ are two very important terms used in connection with ‘Costing’ which itself is defined as ‘te process and technique of ascertaining cost.” ‘A Cost centre is defined by CIMA. as ‘A location, person or item of equipment (or groups ofthese) for which costs may be ascertained and used forthe purposes of cost contrat ‘A Cost unit is defined by CIMA as‘A unit of quantity of product, service or time (or a combination of these) in relation to which costs may be ascertained or expressed Ascertaining costs is the key activity in Cost Accounting, So it also becomes necessary to determine the ‘wait’ in terms of which costs are to be ascertained. Hence, a particular unit or measure of the product or service so selected or taken as the unit for costing purposes is called ‘Cost Unit’ ‘A few examples of Cost Units usually are: Product/Industry Cost unit Radio/TV. Per radio or TV. Car Per car Coal Per tonne of coal Bricks Per thousand. Hospital Per bed or Per patient per day Transport Per tonne km ot per passenger km Building Construction Per building, Steel mill Per tonne of steel Cement mill Per bag of cement Cables Per metre of cable Textile mill Per metre of cloth Similarly, the concept of ‘Cost centre’ is equally important in costing, Each identified portion of the factory, for which costs are first accumulated, forms a Cost centre. ‘The basic difference between a cost unit and a cost centre is that Cost centre is a part of the organisation like a department or a section of the department but Cost nit is something which a company provides for sale in the market like a product, service etc. Cost centres are not for sale. Q. 6. Explain the difference between a cost centre and a department. Ans. Cost centre and Department. An enterprise in modern times, especially if engaged in large scale manufacturing operations, is generally organised on a departmental pattern. A ‘department represents a distinct sphere of activity over which a manager is vested with complete authority and in respect of which he is held responsible. Such departments may also work as ‘Cost centres’ on the basis ‘of which expenses are accumulated or classified, Or alternatively, Cost centres ‘may be within the departments also. Itis usually from the point of view of better administration and control that a business or factory is divided into departments. In costing we are more concerned with the different departments created within a factory. In a factory, each department engages itself in a specific activity. Various departments are{6 m Shiv Das [B.Com. (Prog.) CBCS] DELHI UNIVERSITY SERIES created for fixing responsibility for physical control over production. It may be often that in a factory, even a particular department may be further sub-divided into smaller sections for costing purpose. These are the various sub-divisions which are actually called ‘Cost centres’. Q. 7. ‘Costs may be classified in a variety of ways according to their nature and the information needs of management.’ Explain and discuss this statement iving examples of the classifications required for different purposes. ‘Ans. Classification of costs. Costing or cost ascertainment starts with the collection of cost data. These figures of costs collected should be properly classified and presented to those who are supposed to use or process them. The need and process of proper classification of costs can be so explained: “In the entire process of Cost Accounting, all costs are arranged ana re-arranged int parious classifications, each of which helps in answering some of the questions frequently asked about these costs’ Hence, costs usually have to be arranged or classified in different ways depending on the purposes which they serve. As such, costs may be classified in different ways as under: 1, According to Identifiability. On this basis, costs may be classified into direct, or indirect costs Direct costs. These are the costs which can be conveniently identified with cost nits or cost centres. For example, wages of carpenter can be easily identified with an item of furniture manufactured. Indirect costs. These are just opposite of direct costs. It means those costs which cannot be easily identified with specific units of output are indirect costs. For example, light and power cost, rent of building, depreciation of plant, office expenses, etc. 2. According to Elements, Generally cost elements of any product are materi, labour and expenses. Elements of cost _——_ t T tL Material Labour Expenses. Material can be direct or indirect. Similarly labour cost can also be direct and. indirect. Expenses are those costs which are neither material nor labour costs. Expenses can also be direct or indirect. Thus these three elements of cost may further be direct or indirect. Direct Materials or Direct Labour / Direct Expenses (Direct costs). Direct costs, may be defined as the costs which can be easily and directly identified with a particular cost unit. For example, cost of cloth in a ready-made shirt or wages paid or payable to the tailor as stitching, charges etc. are part of direct cost. Indirect MateriaVindirect Labour/Indirect Expenses (Indirect costs). Indirect costs as opposed to direct costs, are those which can not be easily or conveniently associated with particular cost units or cost centres. These costs are of a general nature and are not incurred for a specific cost unit For example, salaries of general staff, insurance charges, depreciation of machinery, rent or depreciation of the building, etc ‘The distinction between direct and indirect costs (be it materials or labour or(Chapter 4: INTRODUCTION = 7 ‘other expenses) is done only on the basis of convenience. In some cases, even some dlirect materials (such as gum, buttons, thread, nails etc.) used in production may be treated as indirect materials simply because of the time and labour involved in ascertaining their costs for the particular cost units. The sum-total ofall indirect expenses which is called ‘overheads’ may further be classified as— * Factory overheads + Office and administration overheads + Selling and distribution overheads. 3, According to Variability. On this basis, costs may be classified as fixed, variable and semi-variable. Fixed Costs are those costs which remain fixed or constant over a certain ‘output limit. Even these costs may vary beyond that limit. So within this output limit atleast, these costs remain constant in total while the cost per unit varies with the change in output level. These costs vary with time. However, Variable Costs are those which change in total amount with the change in volume of ‘output, But amount of these cests per unit of output remains constant. As against these two, the Semi-variable Costs contain both fixed and variable costs. These costs are neither fully fixed nor fully variable. These are also known as Fixed Costs In the following figure, a fixed cost line has been shown. This line is parallel to the X-axis which shows that the fixed cost remains fixed irrespective of the volume of output. ’ , z z |, ° Units of Output * ° Units of Output P Variable Costs are those which vary in total in direct proportion to the volume of output. These costs per unit remain relatively constant with changes in production. Thus, variable costs fluctuate in total amount but tend to remain constant per unit as procluction activity changes. For example, direct material cost, direct labour cost, power, repairs etc. Variable cost line is shown in the following figure: x t a a a 0 x 9 x [| ___s, Units oF Output Tris oF Output(Chapter 4: INTRODUCTION = 9 ‘of cost which is controllable from long-term point of view and uncontrollable from short-term point of view. This is particularly so in the case of fixed cost Q. 8. Explain the classification of costs for the purpose of managerial decision making. ‘Ans. The following costs are specially computed by the management for decision making purposes: 1. Sunk cost. This is the cost which was incurred in the past and is therefore sunk and cannot be recovered. These costs are not relevant for decision making. For example, a business purchased a land and building for 720,000 in the year 1998, This cost is a sunk cost because it was incurred in the past and will not be considered whenever a decision is to be taken for the purchase of a new land and building. Despite the fact that sunk costs are not relevant in decision making, as they are historical in nature, such costs are frequently analysed in detail before any decision about future course of action is taken. It should also be understood that sunk costs are irrelevant but all irrelevant costs are not sunk costs 2. Imputed cost. This is a notional cost which is not actually paid or incurred. ‘There are certain costs which are not incurred but are specially computed by the cost accountants for special purposes. Such costs are known as imputed costs or notional costs or hypothetical costs. For example, when a building is owned by the Company, it does not have to pay rent, Therefore rent as a cost is not incurred. But in Cost Accounting, in order to know the real cost of production, a charge in lieu of rent is made. Such a charge in lieu of rent is an imputed cost. Such costs are not entered in the books of accounts but are used only for decision making purposes by the management. 3. Out of pocket costs. Out of pocket costs are those which involve cash outlay as against those costs which do not require cash payment. For example, material cost, labour cost, building rent, salaries etc. are out of pocket costs. There are certain costs which do not require cash payment. For example, depreciation of machinery is not payable in cash but isa part of the cost. It is not an out of pocket cost. 4, Differential costs. Difference in the costs of two alternatives is called differential cost. For example, two alternatives may be two levels of activity and the difference in the costs of two levels of activity is the differential cost. Such differential costs may be either incremental cost or decremental cost. When a cost under an alternative increases, it is called incremental cost and. when a cost under an alternative decreases, it is called decremental cost. 5, Replacement cost. This is the cost of replacing an asset which is being used. For example, the replacement cost of material is the present market price of material on the date of issue to the production department, Similarly, replacement cost of an asset is the price at which a particular asset will be replaced ic, its market price on the date of its purchase. 6. Opportunity cost. This is the cost of an alternative. This means opportunity cost is the advantage foregone as a result of an alternative course of action. This concept is used in problems of alternative choice. For example, when a fixed deposit in a bank is converted into debentures of a company, interest on fixed deposit in the bank will not be received but interest on debentures will be1 Shiv Das [B.Com, (Prog) CBCS] DELHI UNIVERSITY SERIES 4. Classification into Product costs and Period costs: Product costs. Product costs are those which are included in the cost of the product. These consist of direct material, direct labour and some of the factory overheads, These costs change if there is a change in the level of output. Period costs. Period costs are those which change with time and have no relation with the volume of production. These costs are not included in the cost of product and are charged to Profit & Loss Account of the period. For example, under Marginal Costing, all fixed costs are period costs and are not, included in the cost of production but transferred to Costing Profit & Loss Account. Classification into Period cost and Product cost does affect income determination of a business. That is why there may be a difference in profit under Marginal costing and Absorption costing. 5. According to Functions. Costs may be classified on this basis into production or manufacturing costs, administration costs, selling and distribution costs, research and development costs and so on. Materials, labour and expenses (both direct and indirect) alongwith primary packing materials constitute Factory or Production costs. Office salaries, rent, rates, postage, printing, stationery, depreciation, repairs, directors’ fees are all examples of ‘Office overheads.’ Advertising, bad debis, salesmen’s salaries, travelling staff's salaries, commission etc. are part of ‘Selling overheads’. Packing, rent of warehouse, wages or salaries of delivery men/vans, depreciation of delivery vans, carriage outwards etc. are examples of ‘Distribution overheads.” 6. According to Controllability. Some costs are controllable whereas others are non-controllable ones. The classification of costs into controllable and uncontrollable is based on the fact whether a cost can be influenced by the action ofa specified member of an undertaking. Controllable costs are those which can be influenced by the action of a specified member of an undertaking that is to say, costs which are ‘at least’ partly, within the control of management. An organisation is divided into a number of responsibility centres and controllable costs incurred in a particular cost centre can be influenced by the action of the manager responsible for the centre. Generally, all direct costs including direct material, direct labour and some of the overhead expenses are controllable by the lower level of management. Uncontrotlable costs on the other hand, are those which can not be influenced by the action of a specified member of an undertaking, that is to say, which are not within the control of the management. Most of the fixed costs are uncontrollable. For example, rent of the building is not controllable and neither are managerial salaries. Overhead costs, which are incurred by one serving section and apportioned to another which receives the service are also not controllable by the latter. The distinction between controllable and uncontrollable is sometimes left to individual judgement and is not sharply maintained. It is only in relation to a particular level of management or an individual manager that we may sé Whether a cost is controllable or uncontrollable. A particular item of cost, which may be controllable from the point of view of one level of management, may be uncontrollable from the point of view of another. Moreover there may be an itemoe Shiv Das [B.Com (Prog,) CBCS] DELHI UNIVERSITY SERIES received. This means interest on bank fixed deposit has been sacrificed to eam interest on debentures. So the interest on bank deposit is an opportunity cost for the investor who has purchased debentures. 7. Marginal cost. Marginal cost is the additional cost of producing an additional unit of output. The Chartered Institute of Management Accountants of England defines the term marginal cost as “the amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit.” In other words, “marginal cost is the same thing as variable cost, Marginal cost combines direct material cost, direct labour cost, direct expenses and variable overhead costs.” 8. Conversion cost. Conversion cost is the total of direct wages and factory overheads. In other words, “Total production cost minus Cost of raw materials is Known as conversion cost.” Direct wages is a part of prime cost as well as conversion cost. Direct Material Direct Labour Factory Overheads Q. 9, State the factors to be kept in mind in the installation of a cost accounting system. Apart from technical costing problems, what practical difficulties would you meet and how would you overcome them? Or, You are working with a firm of cost consultants. A client having a large manufacturing FMCG Co. comes to you for advice for installing a cost accounting system in his organisation. What are the basic considerations you would keep in mind in designing a cost accounting system for your client? ‘What are the practical difficulties you perceive on its implementation by your client and how do you propose to overcome the same? Ans. Fast Moving Consumer Goods (FMCG) are the products that are sold quickly which at relatively low prices. Examples include soft drinks, toiletries and grocery items and are generally consumed over a short period of time. For an FMCG company as a consultant I would advise a very efficient costing system not only to keep the costs in control but also to make the products competitive and profitable as well Factors in installation of a cost accounting system. While introducing, a cost accounting system, the following points should be kept in mind: ( The nature of the product should be given due consideration as it determines the type of costing system to be adopted. (ti) The objective of establishing a costing system should be kept in mind. (ii) The type of organisation required to establish the costing system and changes that may be introduced in the present organisation, (jv) As far as possible, the system should be simple and not complex. (©) The costing system should be flexible, i, the system of cost accounting, introduced should be capable of changing according to the change in environment. (vi) The system should be effective in cost control (Cii) The system should be economical to use.Chapter INTRODUCTION 11 Practical Problems. When a cost accounting system is introduced, the firm comes across a number of practical problems. Some of these problems are: (i) Shortage of trained costing personnel. Specialised costing staff is not so easy to find, Sometimes the existing staff has to be given training in order to meet the requirement. (i) Lack of management support. Sometimes the management is not in favour of introducing the costing system. If a system is introduced against their will, the system may not be a success. (ii) Resistance from the existing staff, The existing staff might also oppose the introduction of a new costing system. (io) Cost factor. A costing system is very expensive to establish. Before a yystem is set up, the result of cost benefit analysis should be kept Q. 10. What are the main advantages derived from the installation of a costing system in a company? ‘Ans. Cost Accounting is a process of collecting, recording, classifying, analyzing, summarizing, allocating and evaluating various alternative courses of action and control of costs. It's goal is to advice the management on the most appropriate course of action based on the cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future. It is a very effective tool of managerial planning and control Advantages of costing system. A concern derives many advantages from the installation of a costing system. Some of the important advantages are: () Cost accounting provides reliable cost data with regard to different elements of cost ie, material, labour and expenses. This helps the ‘management in accurately determining the value of inventory and cost of goods sold. (i) A cost system reveals unprofitable activities, losses or inefficiencies occurring in any form such as inadequate utilisation of plant and machinery, wastage of manpower ete. (ii) Introduction of a cost reduction programme combined with operational research and value analysis techniques leads to economies, (io) As costs are accumulated by jobs, processes, products and departments, the management can distinguish between profitable and unprofitable activities. Effective measures may be taken to remove or reduce the unprofitable activities, (0) Availability of accurate cost data helps in the fixation of prices and price changes to be effected with greater reliance on the outcome. (©) Costing furnishes suitable data and information to the management which serve as guidelines in taking decisions involving financial considerations. Information is provided on a number of problems such as—whether to make or buy; whether to accept orders below cost ete (it) Standard costing and budgetary control methods help in the fixation of optimum level of efficiency. Variance analysis helps in pointing out the deviations from this level so that suitable measures can be taken for plugging weak-points.{12m Shiv Das [B.Com. (Prog) CBCS] DELHI UNIVERSITY SERIES (Cili) A cost system provides ready figures for use by the government for application to problems like price fixation, price control, wage-level fixation, payment of dividends or settlement of disputes etc. (ix) Cost Accounting provides the management with valuable data for the control of costs. Comparisons may be made from period. to period of several units in the industry by employing uniform costing. Comparisons may also be made in respect of cost of jobs, processes or cost centres. (2) When a concern is not working in full capacity due to some reason, the cost of idle capacity can be easily worked out and revealed to the ‘management. (ci) The operation of cost audit system in the organisation prevents frauds and assists in furnishing correct cost data to the management as well as outside parties. (vif) Perpetual inventory system helps in exercising inventory control and. preparation of periodical Profit & Loss Account. Q. 11. Distinguish between Controllable and Uncontrollable cost. Ans. Some costs are controllable whereas others are non-controllable ones. The classification of costs into controllable and uncontrollable is based on the fact that whether a cost can be influenced by the action of a specified member of an undertaking Controllable costs are those which can be influenced by the action of a specified member of an undertaking that is to say, costs which are ‘at least’ partly within the control of management. An organisation is divided into a number of responsibility centres and controllable costs incurred in a particular cost centre can be influenced by the action of the manager responsible for the centre. Generally, all direct costs including direct materials, direct labour and some of the overhead expenses are controllable by the lower level of management. Uncontrottable costs on the other hand, are those which can not be influenced by the action of a specified member of an undertaking, that is to say, which are not within the control of the management. Most of the fixed costs are uncontrollable. For example, rent ofthe building is not controllable and neither are ‘managerial salaries. Overhead costs, which are incurred by one serving section and apportioned to another which receives the service are also not controllable by the latter. ‘The distinction between controllable and uncontrollable is sometimes left to individual judgement and is not sharply maintained. It is only in relation to a particular level of management or an individual manager that we say whether a cost is controllable or uncontrollable. A particular item of cost, which may be controllable from the point of view of one level of management, may be uncontrollable from the point of view of another. Moreover there may be an item. ‘of cost which is controllable from long term point of view and uncontrollable from short-term point of view. This is particularly so in the case of fixed costs. Q.12. “A cost accounting system that simply records costs for the purpose of, fixing sale prices has accomplished only a small part of its mission.” Explain. ‘Ans. Cost accounting system. Cost Accounting is a branch of accounting which is concerned with ascertainment of cost of products and services.(Chapter 1: INTRODUCTION m1 13, ‘Cost Accounting helps in arriving at cost of production of each individual unit of production or job or operation or process or department or service. Cost Accounting lays down the principles which help in evolving methods by which expenses are analysed and related to the specific unit of production or job. ‘Though there are several other factors determining the price of a product, yet one very important basis of fixing the selling price is the cost of production which can bbe found out by Cost Acounting. Apart from this, Cost Acounting System helps the manager in controlling the wastage, if any and making the organisation efficient and effective, Through information available from Cost Accounting the ‘managers at various levels in the organisation are able to control costs as well. Cost Accounting provides data which are the bases of management accounting thereby helping the management in taking long-term as well as short-term decisions, Q. 13. Explain the term ‘relevant range’ in cost accounting. Ans. Relevant range. The term relevant range is used in cost accounting in relation to the behaviour of fixed cost. The term fixed cost is defined as a cost which does not change within a relevant range of output. Relevant range refers to the range of output in which fixed cost remains fixed or unchanged. If output is outside the relevant range, the fixed cost will also change. Q. 14. Describe the role of the cost accountant in a manufacturing organisation. Ans. Role of the Cost Accountant. The Cost Accountant plays a very important role in a manufacturing organisation. Specifically the cost accountant does the following: () Ascertainment of the cost of various products manufactured by the company, (i) Accounting and control of material cost (ii) Accounting and control of labour cost. (io) Accounting and control of overheads cost (0) To determine the selling price of various products manufactured by the company in normal market conditions. (©) To determine the selling price of various products in times of special market conditions such as depression and in periods of low demand. (eit) To control the cost of products by the use of various techniques such as standard costing and budgeting. (iif) To provide cost information to management for various managerial decisions (i2) To help in maintaining cost records as per cost accounting record rules in operation. (2) To help in inventory control based on perpetual inventory system,Chapter INTRODUCTION 13 Cost Accounting helps in arriving at cost of production of each individual unit of production or job or operation or process or department or service. Cost ‘Accounting lays down the principles which help in evolving methods by which expenses are analysed and related to the specific unit of production or job. ‘Though there are several other factors determining the price of a product, yet one very important basis of fixing the selling price is the cost of production which can, be found out by Cost Acounting. Apart from this, Cost Acounting System helps the manager in controlling the wastage, if any and making the organisation efficient and effective. Through information available from Cost Accounting the ‘managers at various levels in the organisation are able to control costs as wel Cost Accounting provides data which are the bases of management accounting thereby helping the management in taking long-term as well as short-term decisions. Q.13. Explain the term ‘relevant range’ in cost accounting. ‘Ans. Relevant range. The term relevant range is used in cost accounting in relation to the behaviour of fixed cost. The term fixed cost is defined as a cost which does not change within a relevant range of output. Relevant range refers to the range of output in which fixed cost remains fixed or unchanged. If output is, ‘outside the relevant range, the fixed cost will also change. Q. 14. Describe the role of the cost accountant in a manufacturing organisation. ‘Ans. Role of the Cost Accountant. The Cost Accountant plays a very important role in a manufacturing organisation. Specifically the cost accountant does the following: () Ascertainment of the cost of various products manufactured by the company, (ii) Accounting and control of material cost. (ii) Accounting and control of labour cost. (io) Accounting and control of overheads cost (0) To determine the selling price of various products manufactured by the company in normal market conditions. (©) To determine the selling price of various products in times of special market conditions such as depression and in periods of low demand. (eid) To control the cost of products by the use of various techniques such as standard costing and budgeting, (Cili) To provide cost information to management for various managerial decisions. (i2) To help in maintaining cost records as per cost accounting record rules in operation. () To help in inventory control based on perpetual inventory system,{14 Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES Q. 15. How does management accounting differ from cost accounting and financial accounting? ‘Ans. Distinction between Management Accounting and Financial Accounting. ‘The main points of di inction are as follows: “Management Accounting Financial Accounting Cost Accounting 1, Users of| accounting. information Management accoun- ting is for providing information to mana- gers, ie, internal This accounting infor- mation is for external users, ie, sharehold: cers, creditors, banks, public, ete ‘Cost accounting pro- vides information about cost of produc- tion to enable the management to con- trol costs. 2 Aims ‘Aims at _analysing| whether production of a certain product in a certain quantity is to be carried on. ‘Aims at finding the profitability of a busi- Aims at finding costs and finding ways of reducing the costs, 5. Periodicity of reporting, Legal necessity Here reporting is on| a continuous basis, ie, weekly, monthly, even| daily, et. Management accoun| ting is purely! voluntary. Here reporting, ie, P&L A/e and Balance Sheet are prepared at the end of the year. Financial accounts are to be prepared under ‘Company Law, In- come Tax Law, et. Reporting is on con- tinuous basis ike management account- ing. Cost accounting i purely voluntary 5. Accout system 6. Accounting standards It is not based on| double entry system, Management accoun| ting is not bound by! any try accounting standards, Tes based on double- entry system. Financial accounts are to be prepared as per accounting standards issued by the Institute of Chartered Accoun- tants of India (CAD, Based on all the facts and information re. lated to costs ine volved. Tt is based on certain formulas and tech- niques. googCuapter 2 MATERIALS Q.1. (a) What do you mean by material control or inventory control? Explain the purposes of material control. (b) What are the important requirements for a successful system of material control? ‘Ans. (a) Material control, Materials constitute an important part of the cost of a product and thus proper control over materials becomes necessary. No system of costing is said to be complete without a proper system of material cost control. An efficient system of material cost control will lead to a significant reduction in the cost of production, The system of control should be comprehensive enough to cover the flow of materials starting from the point when someone makes a request for the purchase of materials upto the stage when materials are consumed and their costs are compiled in the cost sheet. Material control is also necessary to assume a steady supply of materials to the production department so that the production process is not interrupted. Material cost control is defined as systematised control over the procurement, storage and use of materials so as to maintain an even flow of materials and at the same time avoiding excess investment in inventories. This wide definition embraces control over purchases, storage and consumption of materials while determining the optimum level for each item of inventory. Purposes of material control. An effective system of material control should fulfil the following objectives: ( Material should be purchased at the mintimum possible price and should be of best possible quality. (ii) Material must be available as and when required by the production department. (i) Information about the avallability of material shouldbe up-to-date (iv) There should be no over-stocking of materials as it increases the cost of storage, (0) Loss of materials due to theft and fire must be minimised. (b) Requirements for a system of material control Requirements for a successful system of material control are as follows: ( Materials should be properly classified and codified (ii) Purchase of materials should be planned well in advance (iii) Materials kept in the storage must be properly safeguarded so that there is no theft. 816 wm Shiv Das (B.Com. (Prog.) CBCS] DELI UNIVERSITY SERIES (io) Purchase Department should work in cooperation and coordination with Departments like Storage Department, Production Department, etc (0) Proper records of the quantity of materials purchased and consumed in production should be maintained. (©) Perpetual inventory system and continuous stock taking should be introduced. (vif) Minimum levels, maximum levels and other levels of materials should be ‘maintained. (Cili) Loss of materials due to obsolescence, theft, spoilage, etc. should be controlled Q. 2. Explain and illustrate the meaning and importance of ‘Economic Order ‘Quantity’ (EOQ). ‘Ans. Economic Order Quantity (EOQ). It may be defined as the reorder quantity which minimises the total cost of ordering and cost of holding the stock. ‘This quantity may be determined with the help of a formula or by a graph. Formula is as follows: © = contperunit Economic Order Quantity may also be determined by a graph as shown below: swhere[ A. = Annual Consumption B= Buying Cost per order Cost Economic Order Quantity x Determination of the exact quantity of any item of material or stores to be purchased at a time is a fundamental problem faced by almost all purchase managers or purchase departments, Purchase of large quantities results in excessive stocks increasing the costs, Similarly, purchasing in small quantities, and that too frequently, results in unnecessary expenditure and also increases, chances of production schedules being disturbed due to non-availability of stock. As such, need arises to determine EOQ. Suppos Annual Consumption = 1200 units (AJ; Purchasing Cost per order = €200 (B) Cost per unit = 2100 (C); Storage/Carrying Cost = 12% (8) BAB _ [2x1,200% 200 BOQ = cs = Yao Q. 3. What is the ABC system of inventory control? Discuss its advantages. Or, Explain the ABC system of inventory control. Ans. ABC system of Inventory Control. ABC method of inventory control means “Always Best Control’ which aims at giving more attention to those items (0,000 = 200 unitsChapter 2: MATERIALS. 17 which are costliest and less attention to those materials which are used in a large quantity but are of comparatively low value. All items of materials are classified into three types—A, B and C. Items of category ‘A’ are costliest but used in the smallest quantity, Items of category ‘B’ are of middle value and middle quantity and items of category ‘C’ are those which are cheap but used in largest quantities. Example: Ttems % of Value % of Quantity A 70 10 B 20 20 c 10 70 Total 100 100 ‘The ABC analysis is an extension of the principle of “Management by Exceptions’ in the area of ‘Material Controt’. According to this, materials or items of high value are subject to stricter control than other items of lesser value. ‘This method is also known as method of ‘Selective Control. Various items of materials used in a factory are classified on the basis of their ‘weights’ assigned. as per this formula: Cost per unit of item x Quantity consumed in production Adoantages of ABC system: * Stricter control over materials is possible. + Smooth flow of production process as far as availability of materials is concerned, + Investment in inventory (of atleast high value items) is minimised which releases working capital for other requirments of business. + Cost of placing orders as well as inventory carrying costs are also minimised through proper Economic Order Quantity (EOQ), + Helps in high inventory turnover rat. Q.4. Briefly describe the purchase procedure in a large size company. Ans, Purchase procedure. Exercising control over the purchase of materials is an important part of 'Materials Control’. Actually, its the material procurement ‘which is known as Materials Purchase Function. Itis the Purchase Manager in an organisation who owns the functional responsibility of this, ie, the purchase of materials. However, from the Cost Accounting point of view, it is only the cost control aspect of this entire purchase function which is important. Usually, the organisation of the purchase department depends on the size of the organisation itself. In a large sized undertaking, a separate centralised purchase department may be created to look after the entire function of material purchase. For this, a decision has to be taken whether the purchasing of materials is to be done on centralised basis or on decentralised basis. Some organisations, may follow a centralised purchase system whereas others may follow totally decentralised system of material purchase, whereas in some cases, a middle approach may be adopted. Centralised purchasing is definitely better than the decentralised purchasing. But in some cases these two may be just considered as extremes and a via media may be adopted, i.e, for some materials (of high value and quality), centralised purchasing method may be adopted, whereas for others (of low value or quality) decentralised purchasing may be followed.18 Shiv Das [B.Com. (Prog.) CBCS] DELHI UNIVERSITY SERIES Following steps are involved in the purchase procedure: 1. Purchase Requisition Note. A purchase requisition note is a written request by the executive of the concerned department to the purchase department for the purchase of certain materials, A purchase requisition note initiates the purchase and sets the purchasing process in action. The purchase requisition note is prepared in triplicate. The original copy is sent to the Purchase Department, second copy is retained by the department making the requisition and the third copy is sent to the Costing Department. PURCHASE REQUISITION NOTE No. Date Date by which materials are required ... Serial Description ‘Stores code | Quantity | Remarks No. No. Required Requisitioned by ‘Checked by ... ‘Approved by 2, Selection of Supplier. After receiving purchase requisition, the Purchase Department investigates the market and selects a suitable supplier before placing the order, 3, Purchase Order. When the supplier has been chosen by the Purchase department, a Purchase Order is prepared and sent to the supplier. This order is prepared by the Purchase department. A Purchase Order is a written authorisation to the supplier to supply the specified material as per terms and conditions and at the price mentioned on it. This Purchase Order forms the basis of contract between the supplier and the buyer. A specimen of Purchase Order is given below: PURCHASE ORDER Purchase Requisition No. No. Date ... To vrnennnnnnerecenns SUPPLE Please supply the following material as per terms and conditions metioned overleaf: Ttem No. Description Quantity | Rate | Total Cost | Remarks @. @ Terms of delivery ‘Terms of payment Place of delivery Purchase OfficerChapter 2: MATERIALS m 19 y pected Report is prepared, On receipt of materials, a Goods Received Note is prepared as per the following proforma: GOODS RECEIVED NOTE Supplier's Name GRN.No...... Purchase Order No. .. Date Item Description Code | Quantity] Quantity | Amt. [Remarks No. Ordered | Received | _ (8) Inspected by Store Ledger Folio ..... 5. Comparison of Documents and Pa Tequisition, Purchase order, one-another to determine the then paid the amount as per t Q. 5. What do you mea difference between the two. ment. All the documents like Purchase Goods received note etc. are compared with amount to be paid to the supplier. The supplier is the terms of payment. in by bin card and stores ledger? Explain the BIN CARD Code No. Maximum Level . Name of material Minimum Level .. Location Code No Ordering Level Store-keeper Ordering Quantity . Date Receipts Issues Balance Audit GRN. | Qty, | S.Rqn.| Qty, Qty. | Remarks] Initials No No. Note: GRN. No. = Goods Received Note Number | S. Rqp. No. = Stores Requisition Number | Stores Ledger. The Stores Ledger is maintained by the Costing department. This gives an account of each item of stores, indicating all the receipts, issues and balances, both in quantity and value. The Stores Ledger provicies necessary20 m@ Shiv Das [B.Com. (Prog) CBCS] DELHI UNIVERSITY SERIES information for the pricing of materials issued. The Stores Ledger is an essential element of the ‘perpetual inventory system’ It is an aid to material control as the balances shown are physically verified from time to time. A specimen form of Stores Ledger Account is being given: STORES LEDGER ACCOUNT Re-order Quantity . Receipts Issues | Balance & |GRN] Qty. | Rate | Ami. | Sr Qty. | Rate | Amt. | Qty.] Rate | Amt. No. @ | @ [No @| & @ | @ Difference between Bin Card and Stores Ledger Bin Card Stores Ledger (9 Bin Card records only quantities | (j) Stores Ledger records quantity as of materials. well as value of the materials. (i) Bin Card is kept by the store-| (ji) Stores ledger is kept by the Cost ____ keeper in the stores. __ Accounting Department in the office. (ii) Entries in Bin Card are made| (ii) Entry in the Stores Ledger is made before the transaction of receipt| after the transaction has taken or issue of materials takes place. | __place in respect of receipt or issue of materials, Q. 6. How is periodic inventory different from perpetual inventory system? Briefly describe the perpetual inventory system and continuous stock-taking. What are the advantages of perpetual inventory system? (2015) Ans. There are two inventory systems—periodic inventory and perpetual inventory. Under periodic inventory system, stock-taking is done at the end of a specific period, usually one year. For this purpose, operations are closed for a few days, say, two-three days. As against this, in perpetual inventory system, stock- taking is done regularly throughout the year. Perpetual Inventory System, Perpetual inventory system has been defined by Wheldon as “a method of recording stores’ balances after every receipt and issue, to facilitate regular checking and to obviate closing down for stock-taking”. It is sometimes known as continuous stock-taking. In order to attain control over material, it is essential to know the level of every item of stock at all times. One method of making such information available is by means of perpetual inventory system. The balance of any account in the Stores ledger should agree with the balance shown in the bin card for the same item of material and a frequent checking of these dual records should be made alongwithChapter 2: MATERIALS 21 the actual physical quantity in stock. Closely allied to the perpetual inventory system is continuous stock-taking. Under this system a number of items are counted daily or at frequent intervals and compared with the bin cards and stores ledger by a store audit clerk ‘The usual causes of difference of balances in different records arise because of incorrect entries, breakage, pilferage, evaporation, loss in breaking the bulk, price approximation ete. Continuous Stock-taking. Stock-taking means physical verification of different items of stock. This is done through actual counting, weighing or measuring Such physical verification can be done either periodically or regularly. In periodic stock-taking, the issue of items of stocks at the end of the year remains affected or disrupted for some time which results in production schedule being disturbed. Such periodic stock-taking lacks the element of surprise checking as well. Moreover, discrepencies in stock, if any, remain almost unchecked till the end of the year. All these drawbacks do not exist in case of continuous stock-taking. In this, the stock-taking is done throughout the year and of course at surprise intervals. Advantages of Perpetual Inventory System: () Long and costly work of stock-taking is avoided, therefore closing down the factory for annual stock-taking is avoided. (i) A detailed and reliable check on stores is maintained. (ii) Experienced men can be employed to check the stock at regular intervals. (io) Discrepencies are easily located and rectified. (0) The availability of stock figures enables quick completion of Profit & Loss Account for interim periods. (vi) The moral effect on the staff tends to produce greater care, (vii) Unnecessary Capital is not blocked in inventories. Q. 7. Briefly explain and compare FIFO and LIFO methods of pricing the ‘material issues. State their merits and demerits. ‘Ans. FIFO and LIFO methods of pricing of material issues. FIFO and LIFO are the methods of pricing of the material issues on the basis of the actual cost of the material FIFO (First in First out) basis, This method is based on the principle that issues are priced in the order of the purchases made i.e, materials which are received first, are issued first and therefore the flow of cost of materials should also be in the same order. The price of the earlier consignment is taken first and when that consignment is completely exhausted, the price of the next consignment is adopted. This can be illustrated in the following way: Receipls Tssues 6 Oct. 400 kg, @ €2.00 per kg. 15! Oct. 600 kg: 10! Oct, 500 kg. @ 22.20 per kg, 400 kg, @ %2.00 per kg, 800.00 200 kg, @ 22.20 per kg, 440.00 Total issue value 1,240.00 However, the physical issues of materials may or may not be in the order shown above as it is neither always possible nor necessary to do so.2 Advantages of FIFO method: (The chief merit of the system is that itis simple to operate ifthe prices do not fluctuate often (ii) The valuation of Closing Stock tends to be nearer to current market prices as well as at cost. (i) The method is realistic in so far as it assumes that older materials will be used first and so charged according to this method. (iv) The price is based on actual cost and not on the basis of estimates or approximation; as such no profit or loss arises by using this method. Disadvantages of FIFO: () The calculations become complicated and cumbersome, if consignments are received too frequently at varying prices. (ii) For pricing on requisition, more than one prices have to be used. (ii) The costs of consecutive similar jobs will differ simply because the prior job exhausted the supply of lower price stock. This renders comparisons between jobs difficult (iv) The issue prices may not reflect current market prices and therefore in times of rising prices the charge to production is unduly low. Thus, this method tends to inflate profit. FIFO method of pricing is advantageously used when: + materials are easily identified as belonging to particular lots; and + the size and the cost of the raw material units are large; and + not more than two or three different receipts are on a material card at a particular point of time. LIFO (Last in First out) basis. This is the price paid for the material last taken, into stock from which the material to be priced could have been drawn, In this method, pricing is done in the reverse order of FIFO ie, by adopting the price of the latest available consignment first. ‘The method ensures that the materials are being issued at actual cost. Its use is based on the principle that the costs could be as closely related to current price levels as possible. According to this method therefore, cost is calculated on the basis which approximates to replacement cost. The Closing Stock arrived at, will be at actual cost Advantages of LIFO method: () Like FIFO, this is simple to operate and is quite useful where transactions are not too many (i) Production i charged at the most recent prices, so that tis based on the principle that the costs should be related to current price levels. (ii) Unrealised profit or loss is not made by using this method of pricing. (io) In times of rising prices, there is no windfall profit as would have been ‘obtained under the FIFO method. Disadoantages of LIFO method: () As in FIFO, calculations become complicated and cumbersome when rates of receipts are highly fluctuating, (ii) For pricing on requisition, sometimes more than one prices have to be adopted (ii) Comparison of cost of different jobs becomes difficult. Shiv Das (B.Com, (Prog.) CBCS] DELHI UNIVERSITY SERIESChapter 2: MATERIALS 23 During Rising and Falling Prices. During rising prices, FIFO method leads to higher profits because charge to production will be lower. But LIFO method shows lower profits when the prices are rising because charge to production will be higher. During falling prices, LIFO method shows higher profits because charge to production will by lower but FIFO method will show lower profits because prices charged to production will be higher. Q. 8. Briefly describe the various methods of pricing the material issues. Ans. The important methods of pricing are described below: 1. First in First out (FIFO) —Explained on Page 21. 2. Last in First out (LIFO)—Explained on Page 22. 3. Simple Average Price. In this method price at which materials are issued is, calculated by dividing total of unit purchase prices of different lots in stock by the number of prices used in the calculation. Thus, simple average price is the average of the prices without regard to the quantities. Though this method is very simple to operate but sometimes it gives very crude results and hence is quite unscientific. 4. Weighted Average Price. Unlike simple average price, while averaging this, method gives due weight to quantities of materials in stock. It is calculated by dividing the total value or cost of materials in stock by the total quantity of materials in hand. This method evens out the effect of widely varying prices of different consignments comprising the stock. But when receipts are numerous, this method requires a good deal of calculations. 5. Market Price Method. This is also known as Replacement Price Method. Replacement price is the price at which on the date of the issue of materials, there could be a purchase of another lot of materials identical to that whose issue is being priced. This method, therefore, does not require any calculations. The issues are also priced! at the current market prices. But the issues are not at actual cost and the value of inventory will not be at the current market prices. This method also introduces an element of unrealised profit or loss. 6, Standard Price Method. This method is used! when ‘standard costing’ is in ‘operation, Standard price is the predetermined price fixed for a particular period ‘on the basis of all the factors affecting it. The difference between actual and the standard price is disposed of through Price Variance Account. This method is simple to apply because all issues are priced at the same standard rate. But issues may not be at the current price, Moreover, this method requires careful determination of standard prices. Conclusion. For an industry, where the prices of materials are fluctuating constantly, it is suggested to use Weighted Average Prices. As already pointed ‘out, this method evens out the widely varying prices of different consignments which comprise the stock. Q. 9. Briefly describe the accounting and control of scrap, waste, spoilage and defectives. ‘Or, Explain the Material losses concept of Cost Accounting. ‘Ans. Material losses may be in the form of scrap, waste, spoilage and. defectives24 m Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES Scrap. Scrap may be defined as the incidental residue of material in the manufacturing, process which has a small value and which can be realised without further processing. Scrap is always in physical form. Examples: Pieces of wood while making furniture, scrap of metal trimmings in ‘making utensils, etc. For accounting purposes, scrap is classified into normal scrap and abnormal scrap. Causes of abnormal scrap should be investigated so that necessary steps for corrective action may be taken. For this purpose a Scrap Report should be prepared and control should be exercised (0) Proceeds of scraps, which cannot be traced to any process or job, should be credited to Overheads, as a result of which Overhead rate is reduced. (©) For seraps which are of significant value and which can be traced to any process or job, debit should be made to separate Scrap Account, credit should be made to the particular Process or Job Account and thereby transfer it to Costing Profit and Loss Account Waste. Waste is also a type of loss of materials but itis different from scrap in the sense that where scrap is always physically present, waste may or may not be in physical form, This means waste may be visible or invisible ie., it may disappear in the form of smoke or evaporation. Waste has no realisable value. Waste is also classified into normal and abnormal waste. Cost of abnormal waste is charged to Costing Profit & Loss Account. For controlling waste, a Waste Report should be prepared periodically for presentation to the appropriate level ‘of management. ‘The basic difference between waste and scrap is that waste may or may not be in physical form and it does not have sale value. But scrap is always phsically present and has some sale value. Spoilage. Spoilage may be defined as that portion of production which is below normal quality level. It is a type of sub-standard output which cannot be rectified. Spoilage can be classified into normal and abnormal. Cost of normal spoilage is taken as a part of the cost but abnormal spoilage cost is transferred to Costing Profit & Loss Account. For controlling spoilage, a Spoilage Report should be prepared periodically and causes of spoilage should be fully investigated so that it does not reoccur. Defectives. Defectives may be defined as that portion of the production which is below normal quality but which can be rectified by incurring cost of material, labour and overhead. Defectives are thus rectifiable, These may be sold as seconds if these are not rectified. Defectives are also classi (© normal and abnormal. Cost of normal defectives is a part of the cost and therefore should be included in cost. Cost of abnormal defectives is charged to Costing Profit & Loss Account. For control of defectives, a Defectives Report should by prepared and causes of defectives should be fully investigated so that corrective action may be taken. Q. 10. Write a short note on ‘Activity Based Costing’. Ans, ABC has been defined as “the collection of financial and operations performance information tracing the significant activities of the firm to product costs.” According to CIMA, London “ABC is the cost attribution fo cost units on the basis, of benefits received from indirect activities, ., ordering, setting up, assuring quality”(Chapter 2: MATERIALS 25 I system of Cost Accounting, production, administration and selling/administration overheads are allocated and apportioned to individual products on arbitrary basis. But such an approach of distribution of overheads has certain limitations, particularly in respect of accuracy of costs of products or services. In order to overcome these limitations of traditional approach, Activity Based Costing (ABC) system has come into being, ty based costing (ABC) is an accounting method that identifies the that a firm performs and then assigns indirect costs to products. An ‘ABC system recognises the relationship between costs activities and products, and through this relationship, it assigns indirect cost to products less arbitrarily than traditional methods ‘The ABC system of cost accounting is based on activities, which may be any event unit of work or task with a specific goal—such as setting up, machines for production, designing products, distributing finished goods or operating machines. Activities consume overlead resources and are considered cost objects. Unlike traditional cost measurement systems that depend on volume count such as machine hours be direct labour hows to allocate indirect or overhead costs to products, the ABC system classifies 5 broad level of activity that are to a certain extent unrelated to how many units are produced. These levels, include batch level activity, unit level activity, customer level activity ete. Q. 11. Distinguish betwen Simple and Weighted average methods of pricing of issue of materials. Ans. Simple average method of pricing. In this method price at which materials are issued is calculated by dividing total of unit purchase prices of different lots in stock by the number of prices used in the calculation. Thus, simple average method of pricing is the average of the prices without regard to the quantities bought. Though this method is very simple to operate, sometimes it gives very crude results and hence is quite unscientific. Weighted average method of pricing. Unlike simple average method of pricing, while averaging this method gives due weight to quantities of material in stock. It is calculated by dividing the total value or cost of material in stock by the total quantity of material in hand. This method evens out the effect of widely varying prices of different consignments comprising the stock. But when receipts are numerous, this method requires a good deal of calculations. gooCuapter 3 LABOUR Q.1. Explain the role of various departments in a manufacturing company in the accounting and control of labour cost. ‘Ans. In the accounting and control of labour cost, the following departments, play important functions. 1. Personnel department. This department is mainly concerned with the selection, training, recruitment, placement, promotion etc. of workers in an ‘organisation. It keeps full details of each employee regarding date of employment, date of birth, particulars of previous employment, wage rate, job specialisation, medical history etc. 2. Time keeping department. The main function of this department is to keep a record of workers’ time. Recording of workers’ time is needed not only for the purpose of attendance of workers and calculation of their wages but also for the Purpose of cost analysis of the job and apportionment of labour cost over various jobs. The time keeping department is an important part of a firm’s system of accounting and control of labour costs. Its two main functions are: (i) Time keeping (ii) Time booking, 3. Engineering department. This clepartment provides technical services and. performs the following functions: () Preparation of job specifications. (i) Conducting time study and motion study. (ii) Looking after working conditions to ensure safety of work force (io) Making job analysis. (c) Supervising various production activities and exercising quality control 4, Payroll department. The main task of the ‘Payroll department’ is the preparation of the payroll or the wage-sheets. In big enterprises this work is generally performed by a separate ‘Payroll department’. Payroll accounting is that part of the main Accounting department which is concerned with the com- ppatation and payment of wages and then recording them in the books of accounts. Functions: Usually, following are the main functions of the Payroll department: + Workers or employees are authorised to attend to work by the Personnel Department. But their work record is maintained by Payroll department. + Payroll department receives the Time Cards, Piece Work Cards or Job Cards ete. from the factory foreman. + Payroll department calculates wages (normal and overtime etc)) on the basis of these cards. + Payroll department computes gross wages, authorises dedu 26 ns fromChapter 3: LABOUR 27 wages and thus, the net wages are calculated which are payable to the workers + Payroll department also prepares wage packets or cheques, pay-slips to be given to the workers + Finally, Payroll department sends the necessary cash or pay-packets or cheques to Cost Accounting department or Payroll is sent to the Cash Department which itself arranges the payment of wages. 5. Cost Accounting department. This department plays a very important role in the control of labour costs, It helps in setting standard labour cost and helps in preparing the labour cost budget. This department prepares labour productivity reports for presentation to the management so that control on costs can be effectively exercised, Cost Accounting department also tries to control idle time and overtime. Q. 2, What do you understand by labour turnover? How is it measured? What are its causes? What is the effect of high labour turnover and what is the cost of labour turnover? ‘Ans. Labour turnover. It is often seen that factory workers change from one employment to another. This is sometimes done for better prospects, sometimes for better working conditions or sometimes they are forced to leave their jobs Such mobility of labour is called Labour turnover. In other words, change in the labour force in an organisation is called Labour turnover. Measurement: Labour turnover can be measured by the following formulae: [No.of employes leavin 1. Separation Rate = ices of spinors * 100 ("arate (Motte) of the peri ofthe period Further, Average no, of employees = \—Heperiod 1" of hep ‘Avenageno.of employees * 10 No.of employees leaving + No.of employes replaced or selected Averageno. of employees Causes of Labour Turnover. Some causes of the labour turnover are avoidable whereas some are unavoidable Avoidable causes may include reasons like: (9 Retrenchment of workers because of seasonal requirement, shortage of raw material, fall in demand, lack of planning, etc. 2. Replacement Rate = 3, Flux Rate = x 100 (jo) Dissatisfaction with the job (0) Lack of training facilities leading to stagnation Unavoidable causes can include reasons such as: ( Personal betterment avenues (ii) Retirement (iid) Sickness (io) Accident and death (2) Personal reasons, for example, pregnancy or marriage (i) Change of residenceChapter 3: LABOUR 27 wages and thus, the net wages are calculated which are payable to the workers + Payroll department also prepares wage packets or cheques, pay-slips to be given to the workers + Finally, Payroll department sends the necessary cash or pay-packets or cheques to Cost Accounting department or Payroll is sent to the Cash Department which itself arranges the payment of wages. 5. Cost Accounting department. This department plays a very important role in the control of labour costs, It helps in setting standard labour cost and helps in preparing the labour cost budget. This department prepares labour productivity reports for presentation to the management so that control on costs can be effectively exercised, Cost Accounting department also tries to control idle time and overtime. Q. 2, What do you understand by labour turnover? How is it measured? What are its causes? What is the effect of high labour turnover and what is the cost of labour turnover? ‘Ans. Labour turnover. It is often seen that factory workers change from one employment to another. This is sometimes done for better prospects, sometimes for better working conditions or sometimes they are forced to leave their jobs Such mobility of labour is called Labour turnover. In other words, change in the labour force in an organisation is called Labour turnover. Measurement: Labour turnover can be measured by the following formulae: [No.of employes leavin 1. Separation Rate = ices of spinors * 100 ("arate (Motte) of the peri ofthe period Further, Average no, of employees = \—Heperiod 1" of hep ‘Avenageno.of employees * 10 No.of employees leaving + No.of employes replaced or selected Averageno. of employees Causes of Labour Turnover. Some causes of the labour turnover are avoidable whereas some are unavoidable Avoidable causes may include reasons like: (9 Retrenchment of workers because of seasonal requirement, shortage of raw material, fall in demand, lack of planning, etc. 2. Replacement Rate = 3, Flux Rate = x 100 (jo) Dissatisfaction with the job (0) Lack of training facilities leading to stagnation Unavoidable causes can include reasons such as: ( Personal betterment avenues (ii) Retirement (iid) Sickness (io) Accident and death (2) Personal reasons, for example, pregnancy or marriage (i) Change of residence2% ‘Shiv Das [B.Com (Prog.) CBCS] DELHI UNIVERSITY SERIES (vii) Negligence, inefficiency, unauthorised long absence, criminal acts, etc. Effects of high labour turnover. Labour turnover, if high, is a big loss to the organisation apart from being a loss to the concerned worker. This results in increase in the cost of production through: + increased costs of selection of new workers and their training, + increased costs of tools as more time is lost. + increase in scrap, wastes, etc. + increase in cost of supervision, + time lost between turnover and new recruitment. + loss of output. * social security measures, ¢.., Cost of Gratuity, Pension, Provident Fund, ete. for the workers Cost of labour turnover. Cost of labour turnover is classified into the following, two categories: 1, Preventive costs. These are the costs which a company incurs to prevent the labour from leaving the job. These costs are incurred in the form of giving more and more benefits and incentives to workers like free medical facilities, transport facilities, rent-free housing, education for children of workers, etc. 2. Replacement costs. These costs are those which are incurred after the workers have left the company. Examples are=(i) Cost of advertising the post; (i) Cost of recruitment and. selection of workers; (i) Cost of accidents caused by new workers; (id) Loss of materials wasted by new workers; (0) Loss of production due to the delay in appointing new workers; and (vi) Loss of production due to the slow work by new and untrained workers. The cost of labour turnover is distributed between normal cost and abnormal cost. The normal cost will inflate the labour cost while any abnormal cost is transferred to Profit & Loss Account. Q. 3. Briefly describe the various methods of time keeping. 1, Distinguish between time-keeping and time-booking. What are the various methods of time-keeping and time-booking? Discuss briefly. ‘Ans. Difference between time-keeping and time-booking. The difference between time-keeping and time-booking is that time-keeping is concerned with recording of attendance of workers, iz, their time of arrival and departure in the factory or office. Time-keeping takes care of the total time worked. On the other hand, time-booking is the analysis of time taken by workers on different jobs so that the labour cost of different jobs can be computed and controlled, Methods of time-keeping. Different methods of time-keeping include: 1, Attendance register. The simplest form to keep attendance records is a manual register which each employee signs on arrival and departure, noting his, time-in and time-out. The names of the workers are entered in the register. There are sufficient number of columns in the register for the attendance of each worker to be recorded every day. This method is simple and inexpensive, but it cannot be used in a large organisation. Besides, the accuracy of the record depends on the honesty and integrity of the workers as well as time-keeping staff. Further, marking of lateChapter 3: LABOUR m 29 attendance, overtime, short leave etc. involves a lot of clerical work. This increases the chances of mistakes in the attendance register. 2. Metal disk method. Under this method metal tokens or discs with number written on them are provided. These numbered tokens are allotted to workers. Alll these tokens are hung on a board placed near the factory gate. When a worker arrives, he takes his token and puts it in the box which is kept there, On the basis of tokens in the box, the attendance of workers is marked. 3. Time clocks. In this method time recording clocks are used. Each worker is allotted a time card which contains his number, name etc. The card is punched in the slot of the clock at the time of coming in and going out of the factory. New digital machines are now being installed which record the entry and exit with the help of thumb-impression and retina recognition. Methods of time-booking. Some of the common methods of time-booking are: 1. Job card. In this method a job card is prepared for individual jobs in which the time of starting and finishing the job is recorded. After completion of the job, this job card is submitted to the supervisor so that labour-cost of that particular job may be computed. The proforma of a job card is given: Worker's Nam« Worker's No.: Time start Job Description Amount (2) Worker: .. (or Supervisor) 2. Time & Job card. This is a combination of a Time card & a Job card and serves the purpose of both time-keeping as well as time-booking. Its proforma is given: Time and Job Card Worker's Name: Worker's No. Day | Job No.| Clock time | Job time | Ordinary Job time From | To | From| To| time (Hrs) | (Hrs) | (Hrs) Worker: Rate of payChapter 3: LABOUR m 29 attendance, overtime, short leave etc. involves a lot of clerical work. This increases the chances of mistakes in the attendance register. 2. Metal disk method. Under this method metal tokens or discs with number written on them are provided. These numbered tokens are allotted to workers. All these tokens are hung on a board placed near the factory gate. When a worker arrives, he takes his token and puts it in the box which is kept there. On the basis of tokens in the box, the attendance of workers is marked. 3. Time clocks. In this method time recording clocks are used. Each worker is allotted a time card which contains his number, name etc. The card is punched in the slot of the clock at the time of coming in and going out of the factory. New digital machines are now being installed which record the entry and exit with the help of thumb-impression and retina recognition. Methods of time-booking, Some of the common methods of time-booking are: 1, Job card. In this method a job card is prepared for individual jobs in which the time of starting and finishing the job is recorded. After completion of the job, this job card is submitted to the supervisor so that labour-cost of that particular job may be computed. The proforma of a job card is given: Job Card Worker's Name: Job No. Worker's No. Date: Time started: Time finishe: Job Description Hours Rate (®) Amount (%) Worker: .. Foreman: L (or Supervisor) 2. Time & Job card. This is a combination of a Time card & a Job card and serves the purpose of both time-keeping as well as time-booking. Its proforma is given: Time and Job Card Worker's Nam Worker's Ni Day | JobNo.| Clock time | Job time | Ordinary | Over-time | Job ime From | To | From| To| time (Hrs.) |_ (Hrs) | _ (Hrs)30 m Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES 3. Daily or weekly time sheet. A worker may be issued a time sheet on daily. basis or weekly basis in which time spent by the worker on different jobs is recorded. 4, Piece work card. Those workers who are paid on piece basis, ie., on the basis, of quantity of work done (and not according to time spent), are issued a Piece work card for recording the work done. Q. 4. (a) What is meant by ‘Idle Time’ and state how is it treated in Cost Accounts? (b) How is idle time controlled? (c) What is the difference between idle capacity and idle time? Ans. (a) Idle time. Idle time indicates that time for which wages are paid to workers but no production is obtained during that time. Under the Time wage system of wage payment, the workers are paid on time-basis and through time- ‘booking methods of maintaining Time Cards and Job Cards. It is usually found that there is a difference between the time for which they are paid and the time they actually spend on production or the jobs. This very difference is called Idle Time out. The employer has to pay for this time though he does not derive any direct benefit of it. Such idle time is of two types: Normal idle time and Abnormal idle time ‘Normal idle time. Normal idle time is almost unavoidable and the employer hhas to bear its cost. This is the time lost in: + coming from the gate of the factory to the department in which the worker is engaged; or + going from one job to another; or * getting from the department to the factory gate at the closing time or * personal needs and tea-breaks. Such normal idle time is calculated by comparing the time card with the job card and it may be treated in any of these two ways: (i) It may be treated as an overhead expense because no particular job has benefitted out of it; or (ii) The jobs should be charged at an inflated rate ic,, higher rate than the actual rate paid to the worker in order to recover the cost of the normal idle time. Out of these the second method is better. It is so because under the first method. if the wages paid for idle time are treated as overheads then even those jobs, which have not used this class of workers, have to bear a part of the overheads. Abnormal idle time. Such abnormal idle time arises because of following, * Strikes + Lock-outs + Machinery break-down or power failure + Non-availability of jobs or materials ‘The abnormal idle time may be treated as a loss rather than as a cost. Hence, it may be charged to the Costing Profit & Loss Account. (b) Control of idle time. In order to control idle time, supervision on workers, should be tightened and idle time should be recorded separately for eachChapter 3: LABOUR a 31 department. All controllable causes of idle time should be properly investigated in detail. For example, imbalances in production should be reviewed, raw materials and tools should be made available when needed, ‘The management should consider the following points in control of idle time: (i) There should be proper production planning. (i) Tools and raw materials should reach the production site well in time so that workers donot have to wait for these. (ii) There should be very tight supervision to ensure that the workers do not waste their time (6) Idle capacity. It means the difference between the practical maximum capacity and the actual capacity utilised based on the actual expected sales or demand. Thus, the idle capacity means and represents that part of the practical maximum capacity of the plant or other facilities which remain unutilised due to lack of sales or demand, Further, the practical maxinnum capacity means: (Maximum Capacity - Unutilised capacity due to normal interruptions) Otherwise, the maximum capacity is called the physical maximum capacity ‘The normal interruptions may be those which are caused by factors such as break-downs, repairs, shortages of materials etc. As against this, the maximum (physical) capacity in relation to a plant or other facilities is that which can be achieved without interruptions of any kind. Maximum capacity is that ideal capacity which is very rarely achieved. It is also called 100% capacity Idle time relates to labour cost while idle capacity relates to the factory as a whole. Q.5. How are the payments to workers in respect of the ‘overtime’ work and the ‘set up’ time treated in the Cost Accounts? Explain. ‘Ans. The payment to workers in respect of the ‘overtime’ work and ‘set up’ time are treated in the following way: ‘Overtime wages. Sometimes workers work for extra times over and above the normal hours of work. According to the Indian Factories Act 1948, overtime is the time worked for more than nine hours per day or 48 hours per week. Usually, workers are paid at a higher rate for overtime than that for normal time. According to law, overtime has to be paid at double the normal rate of payment. ‘This coupled with the fact that overtime comes at the end of the day when fatigue hhas set in, should make it clear that the jobs done in overtime are rather costly. Overtime jobs are thus costly because of higher rate of wage payment, low productivity of workers and additional expenses on lighting ete. The Production Manager or some higher authority should authorise the overtime because there is, a danger that workers may develop this as a habit. The following treatment should be given to overtime wages in the following () Overtime required because of some abnormal conditions like floods, earthquakes, ete. should be charged to Costing Profit & Loss Account. (i Overtime when required for seasonal pressure should be taken as an item of Factory Overheads. (iii) When overtime is direct, ie, it can be identified with individual jobs, it should be charged entirely to that particular Job or Work/Order concerned.32. m Shiv Das [B.Com. (Pro) CBCS] DELHI UNIVERSITY SERIES (io) When overtime is required to make up for any shortfall in production due to some fault of management or some unexpected development, it should be charged to Costing Prafit & Loss Account. Set-up time. In factories, it is absolutely normal that some time is lost or consumed on the frequent setting up of the machines. This loss of time may be because of changes from one job to another or because of break-downs ete. This time means the time when the machines just lie idle. This is also called Making ‘machines ready time, The cost of all such hours lost in setting up of the machines (including wages of workers as well as other overheads) may be spread over the jobs actually completed. Sometimes even separate rates (Machine hour rate) are computed for running and this setting-up time. Through this method, one can ensure the full absorption of the manufacturing overheads. Alternatively, the cost of this setting-up time may be treated like Idle time dividing the same into normal setting-up time and abnormal setting-up time. Q. 6. Distinguish between Casual and Out-workers. Ans. Casual Workers, Casual workers are those workers who are not permanent employees of the company and these workers are appointed on day- to-day basis to meet the temporary requirements. In order to control the cost of labour, the management should take proper precautions in the employment of casual workers. This is because the appointment of casual workers is a very common source of fraud in the payment of wages. For this purpose, appointment ‘of casual workers should be duly authorised by the competent managers. If proper control is not exercised, some dummy names may be shown as casual workers and their wages are pocketed away by the foreman, The managers should pay surprise visits to the workplace to check the actual number of casual workers employed, Out-workers. Out-workers are those workers who work outside the factory premises on behalf of the company. For example some workers may be supplied with raw materials and tools and they work at their own place. Such workers are ‘mostly paid on piece basis because keeping a record of their time is not possible. In the work of such outworkers, the quality of finished work should be carefully inspected. ‘There is another type of Out-workers. These type of workers are sent to the site ‘or customers’ premises for performing work. For example in the sale of certain items such as TV, AC etc,, workers go to customers’ place to install the TV or AC and also to provide after-sales service during warranty period. Such workers ‘may waste a lot of time when they go out for work and it is necessary to control their time. Supervisors should pay surprise visits to the place of work and it can help in controlling the cost of such labour. Such Out-workers are issued job cards so that proper records of their work and time-spent can be kept and controlled. Q. 7. Explain the treatment of the following items in cost accounts: (8 Bonus payable to employees (ii) Idle time (iii) Leave with pay Ans. (i) Bonus payable to employees. Bonus is payable to employees under the payment of Bonus Act, 1965. Minimum amount of bonus payable is 8 perChapter 3: LABOUR m1 33 cent of wages and is payable irrespective of whether the company is earning a profit or incurring a loss. In cost accounting, such minimum bonus payable may be treated in either of the two ways + Bonus payable to direct workers is included in their wages and treated as a part of direct wages. In such a case, the rate of direct wages increases due to addition of bonus in the wages. + Alternatively, bonus payable is included in the overheads and treated as indirect wages. If a company pays to its workers a bonus over and above the minimum payable amount, such extra bonus is an appropriation of profit and is transferred to Costing Profit & Loss Account. (ii Idle time. Under the Time wage system of wage payment, the workers, are paid on time-basis and through time-booking methods of maintaining Time Cards and Job Cards. It is usually found that there is difference between the time for which they are paid and the time they actually spend on production or the jobs. This very difference is called Idle Time Out. The employer has to pay for this time though he does not derive any direct benefit out of it. Such idle time is of two types: () Normal idle time and (i) Abnormal idle time. (iii) Leave with wages. There are always certain payments made to workers Which are not directly related to production. These payments are: “Leave Pay, Holiday Pay, Sick Pay, Maternity Period Pay, Pension Scheme Payments, Employer's contribution to Provident Fund, Retirement cum Death Gratuity Payment, Medical benefits et.” These are expenses besides wages and salaries, which the management incurs by way of supplementary labour costs and these benefits are enjoyed by the industrial labour. These costs are of such a nature that these can not be allocated to any cost units directly but may be allocated to the particular department or cost centre in which the workers are/ were employed. Thus, it can be said that the cost of fringe benefits are items of departmental overheads. In many cases, the cost of these benefits to labour is not incurred uniformly in each accounting year. Therefore, benefits for the whole year are anticipated and proportionately a uniform amount is charged to each accounting, period. This helps to avoid uneven charge of these costs over different accounting periods. So far as pension benefits to workers are concemed, a reserve is usually created to meet future payments. The amount of provision created is treated as an overhead. Pension costs are usually allocated direct to a cost centre or apportionment may be made on the basis of the number of employees or total wages paid. Every worker is entitled to a certain number of leaves during a year. These include “casual leave, medical leaves, maternity leave (in case of women employees),” etc. For all these leaves workers are entitled to full wages or salaries. These are supplementary labour costs. Since no work‘Shiv Das [B.Com (Prog.) CBCS] DELHI UNIVERSITY SERIES is done during the period of leave, it cannot be charged to any job or work order. Itis, therefore, treated as indirect labour cost and included in overheads. Leave wages may also be treated as direct wages by inflating wage rate of direct workers. For this purpose, amount of leave wages is estimated in advance and included in the amount of direct wages for the purpose of computing direct wage rate. Q. 8. Briefly discuss time rate and piece rate methods of wage payment. Mention deficiencies of piece rate system. Differentiate between time rate system and piece rate system. ‘Ans. Time Rate and Piece Rate Methods. Two basic methods of wage payment are time rate method and piece rate method. Under time rate system, payment ‘of wages is made according to the time spent on the job. It may be on hourly basis, daily basis or monthly basis. Quantity of work done is not given any consideration. Wages are calculated. as follows: Wages = Number of days worked * Daily rate Or Number of hours worked * Hour rate Under piece rate system, wages are paid according to the quantity of work done and time spent by worker on a particular job is not considered. ‘Wages are calculated in the following way: Wages = Number of units produced * Rate per unit (piece) Deficiencies of Piece Rate System: * It does not guarantee minimum wages to the workers and hence no security of wage to workers. + It ays too much stress on quantity of output but ignores quality of work done. + Inaneffort to earn more by producing more, workers may spoil their health + Piece rate system is generally opposed by trade unions because it creates inequality among efficient and inefficient workers. Difference between Time Rate System and Piece Rate System Basis of Time Rate System jece Rate System Difference 1. Basis of | Wage is calculated on the basis of | Wage is calculated on the basis wages | time spent by the workers on the | of output or production jobs, 2, Idle time | There is a possiblity of excessive | There is a less chance of idle idle time in this system, time in this system, 3, Incentive | There is a lack of incentive for the | It encourages motivated workers efficient ancl honest workers to produce more and earn more. 4 Control [Control and supervision are | Control and supervision of the & Super- | needed as the workers may not | workers are required. work properly. 5. Quality | The quality of work is good as | The quality of work may not be fof work | there is no pressure to produce | good because of pressure to more goods. produce more goods. gaaaCuapter 4 OVERHEADS Q. 1. What do you mean by overheads. Why are overheads clas fixed and variable overheads? ‘Ans. Meaning of Overheads, Overheads are defined as the aggregate of indirect, ‘materials, indirect wages and indirect expenses. Factory overheads include all indirect materials, indirect labour and indirect expenses which are incurred during the manufacturing operations in a factory. Examples are depreciation, rent of factory, insurance premium, Works Manager's salary, power, light, salary of supervisors and foremen, etc. Factory overheads are also known as production ‘or manufacturing overheads or works overheads. ‘The main characteristic of factory overheads is that these cannot be debited. directly to any particular job or work but these must be allocated and apportioned. according to the arrangement based on sound principles. As factory ‘overheads cannot be directly charged to jobs, yet they constitute an expenditure for which money has been spent and must be included in the cost of the product or service, As a factory is nota charitable institution, all costs including factory ‘overheads must be recouped through the selling price of the product. Secondly, incidence of overheads is a continuous process. Most of the factory overheads are fixed and are incurred irrespective of whether production takes place or not. For example, factory rent must be paid whether production is 1,000 “units or one unit. Advantages of classifying overheads into fixed and variable: () Separation of fixed and variable costs is a basic requirement of marginal costing technique as marginal costing is based on this classification. (i Separation of fixed and variable costs also helps in the study of CVP. analysis and in the preparation of break-even charts (ii) Cost control is facilitated by classifying costs into fixed and variable. This is because fixed costs are mostly uncontrollable and management should not waste its energy controlling fixed costs. They can, therefore, concentrate on controlling the variable costs which are mostly controllable. However, it may be noted that fixed costs are controllable only at the higher levels of management. (jo) In the preparation of flexible budgets, classification of costs into fixed and variable is of immense use. (©) As fixed and variable costs behave differently with the changes in the volume of output, this classification is of great use to management in the decision-making process fied into 3536 m Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES Q. 2. What is meant by allocation, apportionment and absorption of overheads? Ans. Allocation of overheads. Allocation is the process of charging a set of overhead costs to a particular cost centre. Where the nature of expense is such that it can easily be identified with a particular cost centre, the cost centre bears the full allocation. For example, salary paid to a foreman incharge of a particular production department is fully charged to that department. Apportionment of overheads. It isa distribution of overheads which is done in case of those overheads, which cannot be wholly allocated to a particular department, example, salary paid to Works Manager or salary paid to watch and ward staff. Apportionment is the process of splitting up an item of overhead. expense and charging it to different cost centres on some equitable basis. ‘The main point of distinction between the two is that in Allocation, exact amount chargeable to a. department or cost centre can be krown but in Apportionment exact amount chargeable to a department or cost centre is not ‘known and the amount computed is based on certain assumptions, For example, Rent of the building is apportioned and cannot be allocated. Similarly indirect materials are generally allocated and not apportioned because exact quantities of indirect materials consumed in various departments can be conveniently known, Absorption of overheads. Absorption is the allotment of overheads to cost units. It refers to charging of overheads of a cost centre to different cost units in such a way that each cost unit bears an appropriate portion of its share of ‘overheads. Overhead absorption is the process of allotting the total cost of a cost centre to the products or services which that cost centre provides. Absorption of ‘overheads is also known as application or recovery of overheads. While allocation and apportionment of overheads is the distribution of overheads to production and service departments, the absorption is the distribution of overheads to cost units. Q. 3. How are service departments’ costs distributed to the production departments? ‘Ans. Secondary Distribution of Service Departments’ Costs. In a factory, service departments are departments such as Stores, Time-keeping, Canteen, Repairs and Maintenance, Power House, etc. All these departments render services to the main Production Department of the factory. Distribution of Service departments’ costs may be done by any of the following methods: * Direct distribution * Non-reciprocal di * Reciprocal distribution In direct distribution, costs of service departments are distributed to only production departments and not to any other department. Service departments’ costs or expenses have to be apportioned to the production department on the following ba: ‘Basis of Apportionment Stores Value of materials used ‘Time-keeping Number of employees Canteen/Other Welfare depts, Number of employees Power House Heat/Power used as per meter-reading Repairs and Maintenance Assets’ ValueChapter 4: OVERHEADS 37 In non-reciprocal distribution, service departments’ costs are distributed to production and service departments but here the assumption is that service departments are not inter-dependent. Therefore the costs of service departments are then reapportioned to production department. Reciprocal distribution method is used when service departments are inter dependent. In other words, each service department provides service to other service departments and also receives services of other service departments, In reciprocal distribution, the following methods are used: + Repeated distribution method imultaneous equation method + Trial and error method. Q.4. What do you mean by absorption of overheads? Ans. Absorption of Overheads. Absorption is the allotment of overheads to cost nits. It refers to charging of overheads of a Cost centre to different cost units in such a way that each cost unit bears an appropriate portion of its share of ‘overheads. Overhead absorption is the process of allotting the total cost of a cost centre to the products or services which that Cost centre provides. Absorption of ‘overheads is also known as Recovery of Overheads. While allocation and apportionment of overheads is the distribution of overheads to Production and Service departments, absorption is the distribution of overheads to Cost Units Q. 5. What is meant by actual and pre-determined overhead rates? Briefly describe the various methods of absorption of factory overheads. (Or, Explain why pre-determined overhead absorption rates are preferred to ‘overhead absorption rates calculated from factual information after the end of a financial period. (Or, Explain percentage methods and hourly rate methods of absorption of factory overheads. ‘Ans. There are three percentage methods: (9% on Direct Materials (ii) % on Direct Wages (ii) % on Prime Cost There are two hourly-rate methods: ()) Machine-hour-rate (ii) Direct labour-hour rate Overhead absorption rates may be of two types: actual rate and pre- determined rate ‘Actual rates are those which are based on actual cost while pre-determined, rates are those which are based on estimated or pre-determined cost. Pre-determined overhead absorption rates. The computation and use of such predetermined overhead absorption rates is more practical and useful because in case of such rates, the rates relating to a particular period are available for costing purposes well in advance. This helps in preparation of cost estimates and fixing prices for sales or quotation purposes etc. However, there is one limitation as well of such pre-determined rates and such rates when actually applied for absorption of the factory or other overheads, generally result in over or under absorption of the factory overheads.38 Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES Pre-determined overhead absorption rates are preferred over actual rates because of the following factors: * Pre-determined rates help in the preparation of tenders and quotations. + These help in controlling the cost + These are of greater practical utility Various methods of absorption of factory overheads are as under: (i) A percentage on direct wages, This is the oldest method and still appears to be the most popular. The rate is calculated by dividing overheads cost by the amount of direct labour. The overheads are applied by multiplying this percentage by the direct labour cost of each job or cost unit For example: Production overheads = €10,000 Direct wages = £40,000 Now the percentage of overheads to direct wages is: Direc ger 0.000 ‘This method is usually applied where: 1. Labour is the most important factor of production. 2. The grades of labour, the rates of pay and basis of remuneration do not ly differ. 3. Where type of work performed by all the workers is uniform. (i) A percentage on direct materials. This method is quite similar to @ percentage on direct wages. The only difference is that in this method instead of labour, we calculate overheads as a percentage of direct materials cerhends Dive material cot * 100 For Example: Production overheads = 210,000, Direct materials = €20,000 Overhead absorption rate = 31/4; * 100 = 50% Thus, ifa direct material cost of a job is £300, overheads absorbed by that job shall be 50% of £300, i, 2150 (i) A percentage on prime cost. This rate is calculated by divicing the production overheads to be absorbed by the prime cost Overieats Rate = ‘ais? Rate = 100 = % 100 = 25% Rate = x 100 For Example: Production overheads = 710,000, Prime Cost = %50,000 10,000 Boroon * 100 = 20% ‘Thus, if the prime cost of a job is £100, overheads absorbed will be 20% of £100, ie, 220, ‘This method takes into account both material and labour element and hence is suited where overheads are dependent on both. (io) Machine-hour rate, This is considered to be one of the most scientific methods for the absorption of factory overheads, Machine-hour rate means the Rate =(Chapter 4: OVERHEADS = 39 cost of expenses incurred in running a machine for one hour. The number of hours for which a machine has worked for a particular job is calculated and a charge is made to that job by multiplying the machine-hour rate by the number of hours worked for that job. Machine-hour rate is calculated by dividing the amount of factory overheads incurred for a machine during a particular period by the number of machine-hours during the same period, Overheads Rate = No.of machines For Example: Number of machine-hours = 2,000 Overheads for this machine = 6,000 Shy ~ @ per hour Ifa job has taken 20 hours to complete, this job will be charged with %60, ie, (20 x 3) on account of overheads Uses of Machine-hour rate: (0) It is a scientific method and is also a logically as well as theoretically sound method of absorption of factory overheads. (0) Its specially useful in those departments of the factory where work is done mainly by machines as compared to work done by labour. (0) Ieuses time as the basis of absorption of overheads: (©) Labour-hour rate. This method is similar to machine-hour rate in operation. Under this method labour-hours are taken as a basis of overhead absorption. This rate is calculated by diviciing the overheads to be absorbed by the labour-hours expended. ‘. Machine hour Rate Overheads of labour Hrs For Example: Labour-hours = 4,000 Works overheads = 71,000 71,000 7 +. Labour-hour rate = $1'n3) = 25 paise per hour Labour-hour Rat ‘Thus i 10 labourhour are spent on ajab, overhead charge for that job willbe 22.50, This method is used for those jobs where abou sth predominant factor of production Labourhour ate computed fr each grade ef abou separately (o) Arate per unitof output This'sa very simple method ands applied oly shone proction it of wnflor s The recover rte of overhead ein By aviting the amount of overheads bythe numer of uns proce Rae = eee For Example: Production oveseads = %5,000 Number of units = 1,000 _ Rate per unit = $:2 45 per unit Q. 6. What is under/over-absorption of factory overheads? How would you deat wi hens i Cont Aecounte?40 m Shiv Das (B.Com. (Prog)) CBCS] DELI UNIVERSITY SERIES Ans. Under/Over-absorption of Factory overheads. Overheads are usually charged to production at the pre-determined rates and since these pre- determined rates are based on estimated costs or expenses, the actual costs or expenses incurred are quite often found to be different from applied or estimated costs. If the actual costs are found to be more than the absorbed costs, the ‘overheads are said to be under-absorbed, Ifthe actual overheads are found to be less than the absorbed costs, then the overheads are said to be over-absorbed. In either case, the difference is the amount of overheads over/under-absorbed and itis transferred to the ‘Overheads Control Account Under-absorption has the effect of understating the cost while over-absorption has the effect of overstating the same. Such over/under-absorption of overheads may arise because of factors like: (i) Mistake in estimating the amount of overheads. (ii) Error/ mistake in estimating the level of production. (ii) Seasonal fluctuations in the overhead expenses. (io) Unforescen changes in the production capacity. () Policy changes in production plans. Treatment of over/under-absorbed overheads. They may be treated in any one of the following methods: () Transfer to Costing Profit & Loss Account, This method is followed. when the under or over-absorption of factory overheads results from certain factors beyond the control of factory management or when the amount is very small. (i) Supplementary rates. The balance amount of over or under-absorption is charged to the cost of sales and cost of inventory. Supplementary rates are computed on the basis of hours of work, unit or value of product. Correction of costs through supplementary rates must be made where prices are fixed on cost plus basis. This is also necessary, if the management likes to maintain actual costs for future comparison purposes. (iii) Absorption in the accounts of subsequent years. The amount is transferred to a Reserve maintained for Under or Over-absorbed Account on the assumption that the balance would be wiped out in due course of time. This method is based on the assumption that it has happened because of certain seasonal factors. A small balance left in this account is transferred to Costing Profit & Loss Account Q. 7. How will you treat the following in Cost Accounts: (8 Interest on Capital (ii) Leave wages (iii) Audit fees (io) Holiday with pay (0) Casual wages (vi) Bad Debts (vii) Carriage inwards. Ans. (i) Interest on Capital. There are certain items of income, expenses and. appropriations which are included in the financial accounts but do not find any place in the Cost Accounts, .g., provision for taxation, debenture interest, income ‘on investments, fictitious assets written off, dividends paid, ete. Similarly, some items belong to Cost Accounts only. These items are mostly of notional character(Chapter 4: OVERHEADS = 41 and are treated by way of opportunity costs for purposes of managerial decision making, Interest on Capital employed in the business is one such item. It may be included in Cost Accounts though no payment for this interest may have been. ‘made in actual. There are different opinions of people whether interest on capital should be included in cost or not. Some argue that interest on capital should be included while others say that it should not be included. Both type of experts, give their arguments for and against including of interest in Cost Accounts. However, the conclusion of all such arguments is that interest should not be included in cost, but if it isto be included, it should also be charged on the total capital employed including equity capital. In other words, if interest is included cost, interest actually paid alongwith notional interest should be included (i) Leave wages. There are always certain payments made to workers which are not directly related to production. These payments are: Leave Pay, Holiday Pay, Sick Pay, Maternity Period Pay, Pension Scheme Payments, Employer's contribution to the Provident Fund, Retirement cum Death Gratuity Payment, Medical benefits etc. ‘These are expenses besicles wages and salaries, which the management incurs, by way of supplementary labour costs and these benefits are enjoyed by the industrial labour. These costs are of such a nature that these can not be allocated. to cost units directly but may be allocated to the particular departments or cost centres in which the workers are/were employed. Thus, it can be said that the cost of fringe benefits are items of departmental overheads. In many cases, the cost of these benefits to labour is not incurred uniformly in each accounting year. ‘Therefore, benefits for the whole year are anticipated and a proportionately uniform amount is charged to each accounting period. This helps to avoid tuneven charge of these costs over different accounting periods. So far as pension benefits to workers are concerned, a reserve is usually created. to meet future payments, The amount of provision created is treated as an ‘overhead. Pension costs are usually allocated direct to a cost centre or apportionment may be made on the basis of the number of employees or total ‘wages paid. (ii) Audit fees. It is just like any other normal item of expense and it is, included as an expense in the Cost Accounts as well asin the Financial Accounts. In both the accounts, it may be included as an expense on accrual basis even if it hhas not been paid. This expense is part of the administration overheads and all these office or general administration overheads are absorbed or charged to the product cost at some or the other pre-determined rate, (io) Holiday with pay. Every worker is entitled to certain number of holidays, during the year for which he is paid. Holiday with pay is estimated in advance for the full year and is included in the cost. For direct workers, holiday with pay ‘may be treated as a direct cost by inflating the wage-rate. Alternatively, it may be included in production overhead. For all indirect workers, holiday with pay is treated as an overhead (@) Casual wages. Casual wages mean wages payable to casual workers Casual workers are those workers who are employed on daily basis and are not42. m Shiv Das [B.Com. (Prog) CBCS] DELHI UNIVERSITY SERIES on the regular payroll of the employer. Casual workers are mostly untrained and indirect workers. Their wages therefore become a part of production overheads (vi) Bad debts. There are different opinions on treatment of bad debis in Cost Accounts. Some accountants exclude it as itis a financial loss. But some experts say that bad debts should be included in Cost Accounts as selling overheads. Only normal amount of bad debis should be included in Cost Accounts. Abnormal amount of bad debis should not become a part of the cost but should be transferred to Profit & Loss Account. (vii) Carriage inwards. Carriage inwards is the transport expenses on the purchase of materials. It i a very common practice to include carriage inwards in the cost of materials purchased and thus treating it as a part of direct material cost or indirect material cost, as the ease may be. If carriage inward is to be treated separately, it may be included as an item of, factory overheads. Q.8. How would you deal with the following in Cost Accounts? (8) Expenses for staff welfare activities (i) Wages paid for re-operation of defectives (iii) Research and development expenses? Ans. (i) Expenses on staff welfare activities. These are also called ‘Non- monetary’ benefits extended to the staff in the form of amenities or facilities. ‘These do not offer direct cash reward to the employees. However, these benefits or facilities certainly go a long way in making the work-conditions quite lucrative as these create a huge positive psychological effect upon the employees. Some such benefits or facilities are given below: ‘Good working conditions Medical facilities for staff Education facilities for wards of staff Subsidised Canteen Recreational facilities like common room etc. Uniforms ete. for staff. Expenses incurred by the employers on all such benefits or facilities are treated as part of the factory overheads. These are apportioned over the different cost centres i.e, the departments of the factory on the basis of number of employees employed by each department. In this way, these costs are absorbed alongwith ther items of the factory overheads. (ii) Wages paid for re-operation of defectives. Defective goods are that part of the production which can be rectified with reasonable costs. Such rectification is, not possible in case of the ‘Spoilage’. Spoilage is that part of the production which, like defectives, does not come up to the standards of the normal output and it is as such rejected. Such spoiled or damaged goods can not be brought back to the normal condition even after repairs. Both of these ie., spoilage and. defectives can be controlled by classifying them first into normal and abnormal. Reports on ‘spoilage’ and ‘defectives’ can go a long way in this direction. Effective steps should be taken to reduce the quantity of the abnormal spoilage and defectives.Chapter 4: OVERHEADS m 43 Defectives may arise because of reasons such as: * defective material + poor workmanship * poor supervision + wrong design or planning + defective machines or tools. Cost of rectification of the defectives can also be classified into normal and. abnormal. Normal cost is treated as part of the factory overheads whereas abnormal costs, if any, are charged to Costing Profit & Loss Account, (ii) Research and Development expenses or costs. ‘Research cost’ includes expenses incurred on searching for new or improved products or new or improved materials or methods. This expenditure usually comprises of the wages and salaries of the research staff, materials and facilities provided in the laboratory and research department, or payments to outside “organisations ‘Development cost’ means expenses which are incurred on implementing the results of the research programmes undertaken by the organisation. Usually, all these expenses incurred on research and development activities are of the nature of pre-production costs as there is always a considerable time lag between the incurring of such expenses and actual realisation of their benefits. As there is no immediate production, therefore it may not be possible to charge these costs as, part of the factory overheads. Such expenses may be capitalised and then written off in future against actual production. However, if research and development costs are of recurring or continuous nature, then the same may be treated as part ‘of the “Factory overheads’. Similarly, if research and development costs are related to any specific job then the same may be charged exclusively to that particular job. Q. 9. Write short note on: (a) Capacity cost concepts. (6) Treatment of packing expenses (primary and secondary) Ans. (a) Capacity cost concepts. There are four types of capacity levels— (Maximum Capacity. It assumes that there is no loss of working time and perfect conditions are prevailing, (ii) Practical Capacity. ‘This level provides for unavoidable losses of operating time such as for setting up of machines, holidays, maintenance of plant ete. This means that practical capacity is maximum capacity less normal losses, (ii) Normal Capacity. This is based on long-term average of capacity that is worked out. This is, therefore, also known as average capacity. (iv) Actual Capacity. This is the actual level of capacity that is achieved during the period. This may be above or below the normal capacity. Fixed overhead rates are generally calculated on the basis of normal capacity This results in the minimum amount of under or over absorption of overheads. If during a period, the production is below normal levels of output, there may be some idle capacity. Idle capacity represents unused production capacity and idle capacity cost represents the fixed cost of maintaining the plant and machinery and permanent workers.