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CHAPTER-I BASIC CONCEPT OF COST ACCOUNTANCY

1. DEFINITION: Cost Accountancy Applications of Costing and Cost Accounting principles, methods and technique to the art, science and practice of cost control and ascertainment of profitability. It includes presentation of information derived there-from for the purpose of managerial decision-making. 1.1 PRINCIPLES Maintaining Professional Competency, Integrity, Confidentiality and Objectivity Continuous development of knowledge & skill. Refrain from disclosing or misusing confidential information. Refrain from engaging in or supporting any activity that would discredit the profession. Communicate information fairly and objectively. 1.2 OBJECTIVE Application of right Methods or ways of correct cost findings at variant situations, Application of suitable Techniques of cost control and assessing operational profitability. Development of Art of presentation for quick and easy interpretation of performance. Enhancing Professional expertise to the best use of Management.

1.3

METHODS Costing has been stated as method of classifying, recording and charging of cost to the products and services through appropriate and logical process or system depending on the nature of industry, Costing methods have been broadly divided into the following categories, viz.

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1.3.1 JOB COSTING for jobbing industries engaged in production on specific order of customer and 1.3.2 PROCESS COSTING for process industries engaged in production of repetitive nature of products in a continuous process. 1.3.3 Variants of those broad methods of costing. i) Contract or Terminal Costing: This is a variant of JOB Costing. This method is followed in huge single contract like, Building, Bridge, and Road etc. Separate accounts are being opened for different contracts. ii) Batch Costing: This is an extension of Job costing. When a number of units of homogeneous type are produced in a batch, the said batch is being treated as a job. Cost arrived at for the batch as a whole in the card is divided by the number of units in that in order to arrive at the average cost per unit in that batch. Such method is followed in Cycle Industry. iii) Single or output Costing: This is a method of costing being followed where the output is single like Coal Industry. iv) Multiple/ Composite Costing: Different kinds components, subassemblies are produced in batches or through a continuous process for ultimate use in the main Job order. Different method of costing is applied for each segment and job costing for the main job undertaken as per specific order of the customer. Boiler industry is an example of application of such method v) Operation Costing: This is an extension of Process Costing. In certain Process industries, when a process is divided into certain operations and Management need to have thorough costing of each and every operation for the purpose of control and decision-making. Food products and Chemical industry can be ideal examples for application of such costing. vi) OPERATING COSTING for operating industries rendering services; viz., Transport Industries 2. COSTING TECHNIQUES Besides such methods of assessment of cost of a job or a process, certain costing techniques followed for the purpose of cost control and management decision. 2.1. a) Standard Costing: This is a technique to assess standard cost of the product, recording the actual, comparing the actual with that of the standard, finding out the variation with reasons for ultimate control or revision of standard, if necessary. This technique can be well use of in cases standard and repetitive nature of work having all kinds of standard facilities.
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2.2. b) Marginal Costing: This is a technique to assess marginal cost (Prime Cost and variable overhead) of products and contribution there-of by deducting marginal cost from sales. Fixed cost is kept away from cost structure. Profitability of each product is assessed through a ratio of contribution to sale (P/V ratio). The main idea behind this technique is assessment of true profitability of each product. Arbitrary distribution of fixed overheads, in absence of suitable bases makes it difficult to calculate correct profitability of the various products. Cost Accountants can assist management in various decision making areas like Optimum product mix, pricing, make or buy and a host of other decisions in day to day business in a competitive world. 2.3. c) Uniform Costing: This is a technique of cost control by applying method of costing uniformly in various production units of homogeneous type so that it makes possible to compare the product-wise cost incidence of each unit. This is a technique to control cost through Inter firm comparison. 2.4. d) Differential Cost Analysis: This is a technique applied to find out optimum capacity utilization by comparing incremental revenue with that of differential cost at different level of capacity. This is a contribution of Cost Accountant in managerial decision- making where there is a limitation of Marginal Costing. 3. COST ACCOUNTING As defined, Cost Accounting is a process of accounting for the cost from the point at which it is incurred or committed to the establishment. Cost accounting necessarily starts from the same original sources like vouchers and primary document. Cost accounts relates to the operational side of the business. It classifies accounting information and records, arranges and interprets such expenses by the cost elements like materials, labour and expenses. As in the case of general accounting system, transactions relating to factory operations, to be finally reflected in cost accounts, are recorded in the books of original entry. Summaries of these books are initially journalized and posted in the general ledger, which contains control accounts and subsidiary books. In Ordnance factories PRINCIPAL LEDGER with 30 heads serves the purpose of Cost Accounting.

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4. Activity Based Costing A latest technology incorporated by many organizations with their scientific and updated cost accounting system. ABC has its genesis in the growing incidence of indirect expenditure in the manufacturing operations with the increasing trend of management cost consciousness to ensure its survival in the global competition. This is, specifically, a process of distribution of indirect cost amongst the various products and services more accurately and scientifically.

4.1. What it aims Overcome the problem of inaccurate cost findings and cost reporting due to wrong selection of bases of cost distribution. Identification of no value added activities and improvement in performance and activities. Cost cutting and down-sizing (Indirect cost). Activity based Budgeting. Target Costing

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5.

COST STRUCTUR

Direct Material+ Direct Labour+ Direct Prime Cost + Expenses=


Indirect Production Expenses
Indirect Material Indir. Labour Indirect Expenses

Works or Factory Overhead = Works Cost or Factory Cost +

Consumable stores Lubricant and others Incidental materials attributable to Production activity

Wages paid Shop labour, elpers, Supervisors, workers in repair & maintenance

Rent, Rates, Taxes, Electricity, Insurance, Power Depreciation, etc.

Indirect office Expenses


Office rent, Heating, Cooling, Postage, Stationary, Salaries of Executive and Staff, Cost of Office Appliances, Audit fee, Legal and Secretarial expenses.

+ Administrative Overhead=
Production Cost or Cost of Finished Products + + Selling and Distribution Overhead
= COST OF SALES + Profit /Loss =

Expenses on Selling & Distribution


Selling Expenses: Salaries paid to Salesmen, Staff, Managers, Peon etc. Stationary and Printing, & other sales office expenses Distribution Expenses: Secondary packing for transport, Warehouse Cost, Transportation or shipment cost.

VALUE OF SALES

5.1. Alternative style of Cost structure Total Cost = = = = = = Cost of Labour + Cost of Material Other Expenditure Cost of (Dir. Labour+ Ind. Labour) + Cost of (Dir. Material +Ind. Material) + Cost of (Dir. Expenses+ Ind. Expenses) Cost of (Dir. Labour+ Dir. Material+ Dir. Expenses) + Cost of (Ind Labour + Ind Material+ Ind. Expenses) Prime Cost + (Production Overhead+ Admin Overhead+ Selling & Distribution Overhead) (Prime Cost + Production Overhead) + Admin Overhead+ Selling & Distribution Overhead) (Works Cost+ Admin. Overhead) + Selling & Distribution Overhead)
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= = = 6. COST SHEET

(Cost of Finished output+ Selling & Distribution Overhead) Total Cost of Sales + Sales Value Total Cost of Sale+ Mark up

This is a statement setting out the cost of a product giving details of all the elements of cost. There should be clear indication of Prime Cost, Works Cost, Cost of Production, Cost of Sales and Profit unless information is lacking. 6.1 Different parts of cost should be shown in logical sequence.

Cost sheet should have the columns like: a) Total Expenditure, b) Percentage of each element to the total cost of production, e.g., % of Material to the total cost, c) Element-wise cost per unit, d) Provision for comparison with the previous year. In case, the organization has applied Standard Costing technique, the standard cost with necessary element-wise break up can be incorporated in the Cost sheet. In case organization is following Marginal Costing technique in their product costing, cost of the product will reflect the marginal cost only. Fixed cost will be shown separately. There may not be uniformity or universality of format of Cost sheet. It depends on type of the products/ services, process of manufacture & volume of the organization.

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6.2 A typical example of Job cost sheet is given below: Bishwajit, Tapan and Sharbani carry on a partnership business sharing profits & loss equally. Bishwajit devotes to the business only according to his time permits. Tapan acts as Works Manager and Sharbani as office manager. Details of business Amou September2005 were as follows: during Transactions Transactions Amo
nt Purchase of Stores Works wages ----Direct Indirect Office salaries Carriage In Carriage out Sales Stock as on 1st Sept. Stores Finished goods (600 units) Work-in-progress Traveling expenses Interest on capital: Biswjit Tapan Sharbani 49500 32000 4000 9390 300 2800 16000 17500 4500 6500 1200 1500 800 700 Advertising Power Income Tax Agents Commission Maintenance of plant Rates, light, Insurance (9/10 for Works) Bad debts Sundry Expenses---Works ----Office Building Repair Partners salariesTapan ---Sharbani Depreciation------Plsnt ------Building Sale of Scrap unt 3000 1050 9500 4500 3660 1000 500 1400 2600 100 1200 1000 1900 100 400

On 30th Sept. Stores on hand total Rs.19000 and WIP on that day was Rs.7700. Finished stock outstanding was 700 units out of 15000 units produced. The building was owned by the firm and assessed by the Municipality was Rs.14400 per year. Prepare a COST SHEET and Statement of Profit.

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6.3 Statement of Profit & Loss


Unit Value

Sales (a) Less Cost of Sales (b): Opening Finished Goods Add Cost of Production Less Closing F.G Selling & Distribution Expenses: Carriage outward Traveling Expense Advertising Agents commission Bad debt Profit (a)-(b)

14900 600 15000 15600 700 14900 2800 1200 3000 4500 500

160000 4500 108000 112500 5040 107460

12000 119460 40540

Income tax and interest on capital not included as the same are not chargeable to the production.

7.

Practices in Ordnance Factory Accounts

OPENING OF COST CARD/ SHEET, COST COMPILATION & CONTROL 7.1. OPENING OF COST CARD Cost Card is a subsidiary record of compiling cost. Costing Section of Accounts Office opens this on the authority of warrant. This will be opened under the signature of S.O. with date of opening. 7.1.1 Each Cost Card will contain: a) Extract no. & Warrant No. b) No. of the Standard Estimate, c) Quantity ordered & completed, d) Sections on which warrants have been placed, e) Nomenclature of different element of cost.

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7.1.2 On the back of the Card, it will contain 1. Replacement Expenditure against the Replacement Warrants, if any. 2. Statement of Comparative Cost between Estimated and Actual 8. Cost Compilation & Control Cost under each element is compiled in the relevant Cost Card based on the following documents: 8.1. Labour & Overhead Abstracts is prepared monthly, by the EDP section, based on labour punching media. This will show the labour cost incurred and overheads (Fixed & Variable) to be charged against each of warrant. 8.2. Material Abstracts: EDP section, based on Material punching media, prepares this monthly. This will show the material cost charged, based on average ledger rates against each of warrant. 8.3. Transfer Voucher/ Allocation Sheet is also prepared by EDP for transfer or allocating certain charges to the correct warrant/ work order previously booked erroneously. 8.4 Component Abstracts are prepared from the Red Demand Notes and Return Notes showing the value of Components to each work order by sections and warrants. 8.5 Posting in the Cost Cards will be done concurrently giving priority in the following cases: i) ii) iii) Warrants, declared as complete, and Warrants of special interest to GM, to whom a monthly report is to be submitted, indicating progressive expenditure. Regular review is done on correct posting in the Cost Cards.

9. CLOSING OF COST CARD This is done on receipt of the list of completed warrants in the Costing section and the following actions are being taken: 9.1. Obtaining completed shop copies of warrants duly paired with Accounts copies of Manufacturing and Material from Labour and Material sections respectively. 9.2. In cases of running warrants from previous year, inclusion of opening balance is to be ensured. Further, Replacement warrants and warrants for tools/ gauges, manufactured on parent work orders, are annexed to the main cost cards.

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9.3 Posting to the Cost Cards are to be reconciled with all documents and records as stated above in order to ensure correctness. 9.4. At the end of the year Value of avoidable rejections is to be determined as per laid down procedure (para-679) and deducted from total expenditure charged. Value of closing unfinished semi is to be ascertained, at the year end, to assess the cost of production Comparison of Actual Cost with Estimated Cost. While preparation of Standard Estimates is the 1st step towards cost control, comparison of the actual with that of standard is the 2nd step towards the goal. 10. Accounts office will carry out the following checks i) The cases of variations in Material and Labour more than 10%. ii) Warrants pertaining to estimated value more than 10,000. iii) All civil trade warrants. iv) Warrants, having abnormal rejections. v) Warrants presenting unusual features More detail scrutiny with reference to the original documents, viz., PW/DW cards, Demand & Return notes, NRRs/ NRMs, Replacement warrants etc. may sometimes be essential for tracing the reasons for variation. 11. Process Cost Statements Such monthly statements are prepared in process factories like CF, Aruvankadu, HEF Kirkee, & OF Bhandara where Process Costing Method is applied The following statements are prepared monthly to arrive at the cost of production and issue rates: Statement-I: Statement of Raw Material Cost Showing the value of exact cost of material consumed. Statement-II: Statement of allocated overhead, i.e., the Sectional Variable Charges.

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Statement-III Statement of Cost of Production, this includesi) Material Cost as per Statement I, ii) VOH as allocated through Statement II, iii) Common VOH distributed based man-hour utilization and iv) FOH based on a pre-fixed % on the quantity of production. Evaluation of production per unit is done based on Weighted Average Method. Pricing of issues from the process are done based on production cost of the previous quarter.

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CHAPTER-II

12. Labour Cost Control & Accounting 12.1 Employment Control: 12.1.1. The Industrial workers are classified as: Unskilled Semi skilled Skilled High skilled Master Craftsman

13. The jobs are grouped into different trades: Trade test is necessary for: Promotion to higher grade in the same trade, Transfer to a different trade in the same grade, Promotion to higher grade under different trade Fresh appointment as tradesman Detailed specification of the trade test for each grade and trade are fixed by OFB. 14. Tools of control are: Authorized Strength Statement Furnished by Management. Scale audit report generated by BAO Trade Test report. Factory Order. 15. Classification Control: 15.1. Day Worker: Workers on monthly rate of pay. 15.2. Piece Worker: Workers on Piece rate of wages. After correlation of Piece work rate with Vth CPC scale of pay the definition has changed to Workers paid on Piece rate of hours evaluated on the minimum of the scale of pay of the individual worker. They are further subdivided into Individual and Gang Piece Worker.

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16. Attendance Control: Payment of wages Act 1928 states that: Worker should be paid for hours not less than the hours he is present for the day The same was controlled by physical closure of the gate. The philosophy behind marking attendance as part of 15 minutes is that it divides a day into 32 parts and a rupee was equal to 64 paise. This had enabled quick division even without any machine. After computerization of calculation of wage the attendance is controlled by EARS instead of by physical closure of the gate. Attendance is recorded on the basis of actual attendance and not as a block of 15 minutes. Factory Act 1948 states that No adult worker is required to work in a factory for more than 48 hours a week or 9 hours a day. For any work beyond 48 hours a week or 9 hours a day the individual is put to overtime. Under Departmental rules the duty hours of a week has been fixed as 44.75 hours. This means that IEs are entitled to 48 hours of pay for working 44.75 hours. For working beyond 44.75 hours a week IEs are entitled to overtime under Departmental Rule. 17. Tools of control: Casualty Report. Gate Pass Late Memo Overtime Note Shift note Leave order Manufacturing Warrant Supplementary work Order draft. Piece Work card Day Work Card

18. Method of Remuneration: Duty pays at basic monthly rate for day workers. Piece work earning for Piece Workers. Other elements of pay like idle time, overtime, leave, holiday pay, injury pay, etc. Overtime pay and night shift bonus, Night duty Allowance , for day workers
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Certain other allowances like dearness allowance, House rent allowance, city compensatory allowance admissible under Section 2(vi) (a) of the payment of wages act 1936. 18.1. Tools of Control: Govt. Orders issued from time to time. Govt. order issued from time to time which governs the rate of allowance. 19. Disbursement Control: Factory Management is provided with an amount of cash to meet the requirement during the month. Previously it was based on passed data. After computerization the amount is restricted to the net amount of the wage roll after Govt deduction, professional tax amount and any other amount deducted but need to be deposited by the GM in cash. This amount is booked to a Code 01/805/03. Wage roll when passed for payment no separate punching medium is prepared unless any extra amount is passed for making payment to absentees or to make payment of any supplementary rolls. Proforma-C is prepared to indicate the head wise summery of the amount appearing in the Wage Roll. Transfer Entries (TEs) are made to show the expenditure under different unit of control code. In the CCO2 summery under 01/805/03 exhibits total payment to IES and subtotals under different control codes indicate payment under different element. Agreement Form of Labour (AFL) is prepared on the basis of detail in Proforma-C. Management fills the recovery side of the Agreement Form and also prepares the Disbursement certificate to indicate the amount received as advance, amount of payment made out of the advance including absentee payment, recoveries made, amount deposited to bank through MRO. 19.1Tools of Control: Passed Wage Roll Passed Supplementary Roll Punching Medium PW Cards Manufacturing Warrant Govt. Orders AFL DC
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Cost Accounting of Labour


Time Wage On Min.on Pay OT Wage on Min. of Pay Prime Labour DA HP IP Time Wage Of DW Profit OT Wage Of DW Incremental Pay

Leave Pay
HRA Direct Labour

OT Bonus NS Bonus DOT

CCA

Overhead

Cost Accounting of Labour


Time Wage On Min.on Pay OT Wage on Min. of Pay Prime Labour DA HP IP Time Wage Of DW Profit OT Wage Of DW Incremental Pay

Leave Pay
HRA Direct Labour

OT Bonus NS Bonus DOT

CCA

Overhead

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Cost Accounting of Labour


Time Wage On Min.on Pay OT Wage on Min. of Pay Prime Labour DA HP IP Time Wage Of DW Profit OT Wage Of DW Incremental Pay

Leave Pay
HRA Direct Labour

OT Bonus NS Bonus DOT

CCA

Overhead

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Cost Accounting of Labour


Time Wage On Min.on Pay OT Wage on Min. of Pay Prime Labour DA HP IP Time Wage Of DW Profit OT Wage Of DW Incremental Pay

Leave Pay
HRA Direct Labour

OT Bonus NS Bonus DOT

CCA

Overhead

Cost Accounting of Labour


Time Wage On Min.on Pay OT Wage on Min. of Pay Prime Labour DA HP IP Time Wage Of DW Profit OT Wage Of DW Incremental Pay

Leave Pay
HRA Direct Labour

OT Bonus NS Bonus DOT

CCA

Overhead

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CHAPTER-III ROLE OF ACCOUNTS ON MATERIAL COSTING 20. Control over holding of Stock Different methods are adopted to control over holding of stock and its usage. Extraction of Ledger Balance for reconciliation with PSA balance. Analysis of stock. ABC Analysis Review of unorthodox balance. Checking of Material Warrant with relevant standard estimates and DN/RN. Pricing documents/information for Receipts and Issue of Store including Prod Store Receipt Method Receipt
LP CP Coal Coke ODD including transfer from Deposit Stock. Prod of own Fy. -do- Timber/Leather Other Factory. Other than Defence. Return of surplus Material/scrap. Surplus in stock taking. Transfer from stock Pile/Capital. Miscellaneous Receipt. To shop on DN. To other Fys on I.Vr or stock Transfer note of factories located in same area. To AF, Navy & R&D on payment. MES To capital Losses-DD Voucher To other cases on payment

Method
S.O rate including ST/ED excluding Railway Freight /transport. Paid bills/AT order. Prov. Priced w.r.t SO & Labour, department Central cess & S.T. Stock book rate/priced vocabularies COP Standard Prod. Rate (Diff with actual shown as P/L in AA) .Priced Copy of Consignor or latest receipt rate/estimate. .Priced copy of Voucher receipt. .Ledger rate. .Ledger rate. .Value taken from ledger of SP/Cap Block Register. .Rate given by Factory Mgt. ALR ALR ALR (No. department. Ch.) ALR+DC5% ALR ALR ALR + DC5% + Additional Ch 5%.

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ALR is also adopted for pricing of Material provided in a) b) c) d) e) f) Standard estimates. SWOD Replacement Warrant. Non-recurring Revisions to Material. Semi Statement Receipt from ODD (When PVOS rates are not available)

21. PRODUCTION STORE To Army (Prod Store) To other Factory To own Factory stock To Capital To Navy/Air Force/ODD (other than MES) To MES OFB Price list. OFB Price list. COP COP OFB Price list.

COP(debit raise through DEA)

21.1. Flow of cost to cost card Cost of Material is posted in Cost Card from Material Abstract relating to each warrant which is prepared on the basis of data/information available from Demand Note/Return Note. DN/RN is priced w.r.t. Average ledger rate. ALR is worked out after posting of every receipt voucher which is priced w.r.t S.O etc rate.

27.2. Accounting Control Accounting control is carried out through maintenance of Bin Card and Priced store ledger, Monthly priced store Account, Production account and Principal ledger and by various methods /instruments adopted right from procurement w.r.t Production Programme /budget provision up to issues to the consignee/users. Unlinked payments (DVs) for want of Receipt Vouchers are accounted as Assets outstanding. Similarly unlinked Receipt Vrs. where materials received but payments yet to be made are accounted as liability outstanding. For this purpose Asset and liability register are maintained by Br. Accounts Offices. 27.2. Financial compilation Correctness in Financial compilation depicts the true picture of financial performances of Ordnance Factory. It not only shows the correctness of booking of
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Receipts and Expenditure under proper head of Account but also ensures trend of expenditure against various nature of transaction including store etc. as designed by different unit control codes on several types of transaction. This also helps budgetary control under different categories of expenditure, recoveries and issues from Ord. Factory. Care must be taken for proper identification of stores while incorporating classification code during placement of order (i.e. cost debitable) to avoid mismatch and misclassification. 28. Material Cost Accounting & Control- Role of Accounts

28.1. Objectives to Be Achieved Under a Proper System of Material Control i) ii) iii) iv) v) Provision of The required quantity of the right material and at right place Minimum amount of Capital should be booked in Working Stock Comparing Actual Utilisation of Materials with Estimates for ensuring corrective actions. Purchase of Materials of right quality and right quantity at favourable Prices Prompt action for utilisation / disposal of Scrap & other Stores which are considered as surplus Provisioning policy Lead Time Direct Material Source Importe d Indigeno us Period of Utilization Total

Indire Direct Indirect Direct Indirect ct Material Materia Materia Material Materi l l al

12

12

12

24

18

12

12

18 BACK

18

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29. INVENTORY LEVEL Group of Factories AV OEF Others Over-all SIH Inventory (Maximum) 6 Months 3 Months 4 Months

30. MATERIALS ON STOCK CHARGE a) raw materials b) manufactured products / components / processed materials in other factories/ tools gauges, packing materials c) miscellaneous materials MATERIAL ON PRODUCTION CHARGE a) Inventory control b) Stock-pile 30.1. SISTER FACTORIES COMPARED a) cost of manufacturing b) material usage 31.2. Case study 1: Procurement of quantity more than SHIS Qty One Ordnance Factory forwarded a proposal for procurement of 4mm steel rod used for manufacturing pin firing of INSAS rifle. SHIS was vetted for 2000 kg. Tenders were issued to 6 reputed firms. Value of case being Rs.26.67 Lakhs (@ Rs.475 basic + 8 % ED +4 % ST) on resultant single tender, it exceeded powers of GM. The firm offered for min order quantity 5000 Kg. Earlier the same firm supplied less than 2000 kg on two occasions because SO qty were 2000 & 1500 kg. Factory TPC recommended purchasing 5000 kg in spite of the facts that Finance member advised to put up to higher level of TPC which was not done. Factory placed LOI / SO. Fin div was requested to vet the sanction which was refused.-IFD for 2000 Kg was placed on MSF @ Rs.2074.41 Kg. Member/ Fin sent a note to the DGOF highlighting (a) availability of alternate material (b) other factory had 6 sources whereas RFI had one (c) Min order qty not justified since supplies were less than 2000 KG (d) Supplier was not asked to supply against previous orders. (e) No SHIS existed. Factory prepared a covering SHIS for 5000 Kg. A BoE was constituted by the DGOF in Sep 05. Report was awaited as on 3/6/06
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32.2. Case Study 2: Procurement of excess qty Piercing the veil A proposal was forwarded by one Fy for procurement of 2279 Kg of Tungsten alloy cubes used for manufacturing 40 mm PFFC ammunition. Requirement was worked out as under: Wt of a cube 0.40 +/- 0.02 Gram No of cubes / shell = 525 Wt of cubes / shell = 525 * 0.42 = 220.5 gm Rejection allowance = 10 % Proof 2 % Fy was asked to clarify why 10 % UAR. Why always + 0.02 grams. Fy replied that UAR can be reduced to 5% including proof now and further in subsequent years. Qty reduced by 472 Kg costing Rs 18.32lakhs in that case. In next case, fy proposed 11066 Kg. Requirement against import order for 15000 no shells were also included. Final approval was given for7530 Kg only. 32.3. Case Study 3: quantity lost and found An ordnance factory, while deciding vendors for issuing tenders for 854 MT of Strong Nitric Acid noted as following:It has been observed that a Board of Enquiry is under progress for a deficit quantity of 600 MT which is not available in stock. At the stage of forwarding the proposal to OFB, no mention was made of the outcome of the BoE. Fy GM stated that the missing acid was successfully located. The report of the BoE was not forwarded as the enquiry did not take place. It was contended by Fy that demand notes were not forwarded to LAO. 32.4. Case Study 4: Procurement & cost structure An Ordnance factory sent a proposal for procurement of extractor Qty- 127,420. 4 firms quoted same rate Rs.87 + 4 % CST Cost Analysis for production in Fy per unit was as below: a) Direct labour b) VOH (137.95 %) c) FOH (203.95 %) d) MaterialTotal: Rs.38.5662 Rs.53.2020 Rs.78.6557 Rs.0.2485 Rs.170.67

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FINANCE MEMBER REMARKED: Procedure has been followed. Commercial terms & conditions have been vetted by me. Regarding rate, Member (user) / Fy to certify reasonability by verifying estimates etc as the value addition and cost involved are beyond my comprehension. 32.5. Case Study 5: Procurement & code heads
Procurement & code heads Following importation proposals were received for deliberation in OFB
Sl no

Item Torque wrench for fuse Torque wrench for Heat shell Torque wrench for Warhead Torque wrench for Ballistic Cap Test equipment elect equipment Gauge Grease gun Truing gauge Calibration tool for torque wrench Truing tool Torque wrench for Piezo TOTAL

Value in SEK

Value in Rs 6818018 6818018 6818018 6818018 8561437 4950067 1419642 3580237 560385 865483 280192 47489515

1 2
3 4 5 6 7 8 9 10 11

1095000 1095000 1095000 1095000 1375000 795000 228000 575000 90000 139000 45000 7627000

Earlier Fy had submitted supplementary RR plan 2005-06 for 19 machines / equipments, in which 18 machines were meant for 84mm HEAT 551. It was decided at OFB that some of those m/c would be purchased under NC. Fy had floated 11 separate TEs on the same firm for procurement on PAC basis under LP for converting SKDs / CKDs to complete rounds of 84mm HEAT 551.

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Case Study 5: Procurement & code heads contd...

Sl no 1 2 3 4 5 6 7 8 9 10 11

Similar Item proposed under LP( revenue head ) Torque wrench for fuze Torque wrench for Heat shell Torque wrench for Warhead Torque wrench for Ballistic Cap Test equipment elect equipment Gauge Grease gun Truing gauge Calibration tool for torque wrench Truing tool Torque wrench for Piezo

Similar equipment proposed under RR 2005-06

Torque machine for HEAT Shell Torque machine for Assy of Ballistic cap on warhead body Ballistic cap assy with equipment of delay unit complete

Gause & Truing gauge with calibration tool Equipment for applying Silicon Grease Gun Truing tool for complete round with calibration tool Truing tool for complete round with calibration tool Truing tool for complete round with calibration tool Piezoelectric Generator assy

The firm wanted advance payment of 20 %.Total value of 11 proposals - Rs.4, 74, 89,515.00 on PAC

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CHAPTER-IV

33. OVERHEAD COST ACCOUNTING 33.1. WHAT IS OVERHEAD COST? Overhead cost is a part of total cost of production. This is defined as aggregate of a) In-direct material, b) Indirect wages, and c) Indirect expenses. Overhead cost can otherwise be termed as Indirect cost also. Indirect cost is, therefore by its term, not directly chargeable to a unit of products or a process. This is a matter of in depth analysis, why and under what circumstances an item of expenditure is declared as overhead. Further, such categorization also caused due to management policy and accounting convenience.

33.2. IMPACT OF OH COST

OVERHEAD COST EFFECT


Overhead to COP Human Resurce Cost (-) DLC to Overhead Power & Fuel to Overhead Cost Repair & Maintenance to Overhead Cost

.02-03
24.71% 72.03% 22.1% 6%

.03-04
26.11% 73.28% 20.4% 6%

HUMAN RESOURCE COST ANALYSIS Direct Lab. Cost to HRC 27.90% Ind. Lab. Cost to HRC 31.8%
Supervisory OFB HQR. ACCOUNTS & AUDIT OTHERS(Superan.ch.& gpf)
32.3% 2.1% 2.8% 4.5%

28.79% 31.0% 30.6% 1.7% 2.7% 4.0%

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33.3. IMPORTANCE OF O.H. COST High incidence of Overhead Cost. Increasing trend of such cost with rapid mechanisation by replacing hand labour. The area of cost control and cost reduction. Difficulties in distribution of overhead cost to products & services for correct cost finding. 33.4. STAGES OF OVERHEAD COSTING First Stage: Collection, Classification and Codification Second stage: Allocation, Apportionment & Re-apportionment Third and final stage: Absorption/ Levy/ Recovery/ Charging 33.5. CLASSIFICATION OF OVERHEAD COST Element-wise classification: Cost of Power, Water, Rent, Rates, Taxes etc. for convenience of Budget and Budgetary control. Nature-wise classifications: a) Indirect Material, b) Indirect labour, c) Indirect Expenses for the purpose of Accounting & Control. Function-wise classification: a) Production, b) Administration, and c) Sales/ Issue for the purpose of management functional control of Overhead cost. Behaviour-wise classification: (a) Fixed Overhead (FOH) and (b) Variable Overhead (VOH). Such classification is very much for the purpose of management decision-making and there-by control.

33.6 ALLOCATION, APPORTIONMENT, ABSORPTION Allocation of overhead cost means direct charging. As and when it can be directly attributable to the particular cost centre. Examples of such OHC are: Ind. Material & Labour, Depreciation, Salaries & wages of the person attached to the Activity Centre. Apportionment of such overhead cost means distribution of common cost amongst the centres on some suitable, logical and available basis. Examples of such expenditures are cost of Power, Water, Rent, Rates, Taxes etc which are common for different centres and jointly incurred.
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Re-apportionment of Overhead cost means distribution of cost of Service Cost Centres to the Production Cost Centres Absorption/ Levy/ Recovery/ Charging This is the final stage of overhead costing. After completion of departmentalization to the production ends, the overhead cost need to be charged to the products passing through the respective departments. There is another exercise to find out the suitable base, which would enable to distribute the departmentalized overhead cost amongst the various kinds of products passing through the departments. 33.7 NOTE on methods followed in OFs 33.7.1 Apportionment & Re-apportionment: Amongst the various methods available, STEP LADDER METHOD is followed for Ordnance Factories. Under this method, arrangements of Service & Production Cost Centres are most important step towards maximum correctness in distribution of Overhead cost. Amongst the various methods available, STEP LADDER METHOD is followed for Ordnance Factories. Under this method, arrangement of Service & Production Cost Centres is most important step towards maximum correctness in distribution of Overhead cost. 33.7.2 Absorption or Levy: This is distribution of overhead cost of Production Cost Centres to the products pass through the production processes. DIRECT WAGE method is followed for product costing in Ordnance Factories. 33.7.3 Example of OH costing Overhead Expenditures in respect of a factory during a month were as follows: Indirect Material Production deptt. A. 4000 Production deptt.B. 6000 Production deptt.C. 2000 Service Deptt. X. 1200 Service Deptt. Y. 1600 Service Deptt. Z. 0600 Total: 15400
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Indirect Labour & Supervision charges Production deptt. A. Production deptt.B. Production deptt.C. Service Deptt. X. Service Deptt. Y Service Deptt. Z 4200 5800 5400 3700 1500 2200

Total: 22800

Common Overhead cost


Rent & Tax: Depreciation (15%) Light & Heat 10000 30000 4000 Insurance : Power TOTAL 2000 9000 93200

Other Operating information are as follows


Deptt
Area( Sq. Mtr) Book Value of Machine Effective HP

Productive Capacity
D L Hrs.

DLC 45000 30000 25000

M. H 80000 120000

A B C X Y Z[
TOTAL

1000 750 1500 500 750 500 5000

50000 90000 20000 30000 5000 5000 200000

50 40

150000 150000 100000

10

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Common Overhead cost


Rent & Tax: Depreciation (15%) Light & Heat 10000 30000 4000 Insurance: Power TOTAL 2000 9000 93200

Other Operating information are as follows


Deptt
Area( Sq. Mtr) Book Value of Machine Effective HP

Productive Capacity
D L Hrs.

DLC 45000 30000 25000

M. H 80000 120000

A B C X Y Z[
TOTAL

1000 750 1500 500 750 500 5000

50000 90000 20000 30000 5000 5000 200000

50 40

150000 150000 100000

10

II. Re-apportionment & Absorption

Basis
Direct Lab Ind. Mat. MH

Z
Clerical
-5000

Y
Store
-6000

X
TOOL
1000 545 -13545 0

A
1800 1818 5418 32536 45000 72%

B
1200 2727 8127

C
1000 910 0 0 0

0 DIRECT WAGES Recovery rates/DW

43954 16710 93200 30000 25000 147% 67%

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II. Re-apportionment & Absorption


Basis
Direct Lab Ind. Mat. MH

Z
Clerical

Y
Store

X
TOOL

A
1800 1818 5418

B
1200 2727 8127

C
1000 910 0 0 0

-5000 -6000

1000 545 -13545

0 DIRECT WAGES Recovery rates/DW


Point to consider.

0 32536 45000 72%

43954 16710 93200 30000 25000 147% 67%

Is the system, presently followed, giving fairly correct result?

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CHAPTER-V 34. PRINCIPAL LEDGER: Principal Ledger is maintained:-By the concerned Br AOs attached to Ord Fys for the purpose of preparation of Consolidated Manufacturing Accounts viz. Production A/c, Finished Stock A/c, Capital A/c etc. 34.1 Following the principles of Double entry system: Through Principal Ledger: Cost of Production of articles manufactured in the factory is arrived at. Reconciliation of Cost and Financial Accounts is effected. Different Heads in the Principal Ledger are so arranged as to provide information required for the Compilation of the Consolidated Manufacturing Accounts viz. Production A/c, Finished Stock A/c, and Capital A/c etc. Posting into Principal Ledger are generally made month-wise. Transactions are first journalized from the source documents, then posted into concerned Heads of Accounts against relevant Dr/Cr entry. 34.2 Source documents are: Priced Store A/c (Showing category / PSA code-wise Issues and Receipts of Stores) Cash Compilation (Showing Summary of Financial Code-wise Receipts and Expenditure for the month) Cost tabulations (viz. Labour Abstract, Material Abstract, T.V. Abstract etc) Manufacturing A/c Statement A&B. Data in respect of certain transactions are made available to Br AO annually i. e. after closure of financial year e. g. Share of Central Administration (Fys) Share of Central Administration (A/cs) Share of cost of Ord Factory News On receipt of above data, transactions are journalized and posted. Principal Ledger is required to be closed annually. For which balances of each head of account (other than Balance A/c) are struck at the year end and transferred directly or finally through Subsidiary account(s) to the Balance A/c.
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Debit balances of Balance A/c represent Assets while Credit balances exhibit liabilities of the

Factory as on the closing day of the year and sum of all such debit entries should tally with sum of all the credit entries of Balance account. Such agreement of totals of Dr. and Cr. side of Balance A/c proves the arithmetical accuracy of posting made into various heads of accounts of Principal Ledger. Following heads of Accounts (Total 29) are at present maintained in the Principal Ledger: 1. Custom Duty A/c 2. Stores Cash Purchase A/c 3. Stores Supplied by other Factories Act. 4. Transportation charges A/c 5. Stores A/c 6. Sale of Stores (Surplus & Waste) A/c 7. Issue of Stores on Payment A/c 8. Wages A/c 9. Supervision Charges A/c 10.Misc. Charges A/c 11.Overhead Exp. A/c 12.Misc. Credit A/c 13.Work-in-Progress A/c 14.Rent, Rates, Water and Electricity charges Recoverable A/c 15.Payment Services A/c ( Other than Defence Services) 16.Manufacture of own Fys. Stock A/c. 17.Services to other Fys. A/c 18.Services for Capital Assets A/c 19.Payment Issues for Defence Services A/c 20.Profit & Loss A/c 21.Capital Assets A/c 22.Capital Assets (Stock Pile) A/c 23.Cash Ledger A/c 24.Preliminary Exp. A/c 25.Deferred Revenue Exp. A/c 26.O/s Assets A/c 27.O/s Liabilities A/c 28.Capital Outlay A/c. 29.Balance A/c

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34.3 DESCRIPTION OF SOME ACCOUNTS Stores Account - contains opening balance of stock, receipts, issues under various categories and closing stock. Wages Account - Contains Pay and Allowances of all categories. In addition liabilities for Pay and Allowances for March, unclaimed wages as on 31st March. Deduction is made for Pay and Allowances of previous March paid in April of current year. Direct and Indirect Labour as per Labour Abstracts, Balance represents Supervision charges. Overhead expenses A/c Debit items represent various items of overhead expenses like Indirect Labour, Indirect Material, Supervision Charges, Miscellaneous Charges, etc. Credit items represent indirect receipts, Misc. credits, variable and fixed overhead expenses transferred to Work-in-Progress A/c etc. Work-in-progress A/c contains Opening value, Direct Material, Direct Labour and overhead leviable. Credit side contains Cost of Production, Cost of abnormal rejection. Under/Over absorbed variable/Fixed charges are shown in credit/debit side. Closing work in Progress is shown in credit side. Capital Assets A/c - Debit side contains opening balance, payments, transfers in and amounts outstanding. On the credit side depreciation, transfers, issues, outstanding and closing value are shown. O/s Assets & O/s Liabilities A/c - Contains details of opening and closing outstanding Assets/Liabilities. Capital Outlay A/c - Main Control Account. This account is debited for expenditures incurred and credited for receipts and recoveries. Balance A/c - Details the closing value of various assets and liabilities. Balance should agree with the balance as per "Capital outlay Account".

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Work-in-progress Account Dr 1. Capital Outlay Account:Cost of work-in-progress (excluding Capital semi) on 1st April B/F (a) Labour (b) Material (c) variable Overhead (d) Fixed overhead. 2. To Capital Outlay Account:Cost of uncompleted Capital Work-in-progress on 1st April included in Capital Assets Account. (a) Labour (b) Material (c) Variable Overhead (d) Fixed overhead 3. To Stores Account:(a) Direct material issued to Shops less return. (b) Issues to other than Defence Department private bodies, firms and contractors for manufacture of garments or fabrication of stores. 4. To Wages Account: Direct Labour 5. To Overhead Expenses Account:(a) Variable overhead expenses. (b) Fixed overhead expenses. 6. To Profit and Loss Account:(a) Variable overhead expenses over absorbed. (b) Fixed overhead expenses over absorbed. TOTAL Cr 1. By Miscellaneous Charges Account:Departmental material utilized on indirect work orders. 2. By payment services Account (Other than Defence Services):Cost of manufacture during the year. 3. By manufacture for factorys own stock Account:Cost of manufacture during the year. 4. By Services to other Factories Account:Cost of manufacture during the year. 5. By Services for Capital Assets Account:Cost of Services during the year. 6. By Payment Issues for Defence Services Account:Cost of manufacture during the year for Army, Navy, Air Force and other Defence Departments. 7. By Profit and Loss Account:(a) Variable overhead expenses under absorbed. (b) Fixed overhead expenses under absorbed. 8. By Capital Outlay Account:Cost of abnormal rejections (not chargeable to production) 9. By Balance Account:Cost of work-in-progress (excluding Capital semi) on 31st March. (a) Labour (b) Material (c) Variable Overhead (d) Fixed Overhead. 10. By Capital Outlay Account:Cost of uncompleted Capital Work-in-Progress on 31st March (included in Capital Assets Account). (a) Labour (b) Material (c) Variable Overhead (d) Fixed Overhead. TOTAL

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34.4 RECONCILIATION OF COST AND FINANCIAL ACCOUNTS 34.4.1 OBJECTIVE OF RECONCILIATION To ensure that: Data presented are correct. All financial data have correctly been accounted for. No item of expenditure/receipt is left out 34.4.2 MECHANISM OF RECONCILIATION To facilitate reconciliation: Integrated system of Accounting is followed whereby the financial and cost accounts are fully integrated. Capital outlay Account is the main control A/c through which reconciliation is made. Vouchers, through which financial transaction takes place, are classified in accordance with the budget heads they pertain to and a consolidation of such financial compilations with details are sent monthly to each Branch Accounts Office. These transactions are journalised by Dr. or Cr. to Capital Outlay A/c and posted in the Principal Ledger. On the other hand, expenditure on labour, Material and other charges compiled to Cost of Manufacture through Cost documents like D.W. and P.W. Cards, Demand/Return Notes, Allocation Sheets etc. are all posted in Principal Ledger to the debit/credit of the respective Subsidiary accounts like Wages accounts, Store A/c, Supervision charges A/c, Misc. charges A/c etc. to be finally transferred to the Work-in-progress A/c and there from to the Capital Outlay A/c. Thus figures from both ends are finally booked to Capital outlay A/c and the fact that all expenditure which has appeared in financial compilation has been incorporated in Cost Accounts is automatically verified by Capital Outlay A/c which balances to itself.

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CHAPTER-VI 34.5 PRICING OBJECTIVES To recover all cost of product To earn some profit in order to get reasonable return on capital invested 34.6 PRICING SITUATION Customized manufacture based on customers specifications Mass manufacture of known specification 34.7 WHY PRICING DECISION For introducing new product in market Review of existing price for stimulating market demand/market share or earning higher profit For quotations against customers enquiry 34.8 PRICING METHODOLIGIES Use of estimates based on historical data as adjusted for current/anticipated conditions When historical data not available by requirement analysis as to material, labour, direct charges & overhead. 34.9 PRICE COMPONENTS When market can absorb total cost +profit, sale price = cost + profit When market is competitive sale price less than cost plus profit Use of estimates based on historical data as adjusted for current/anticipated conditions When historical data not available by requirement analysis as to material, labour, direct charges & overhead Although dominant but cost alone does not determine price 34.10. PRICING FACTORS Although dominant but cost along does not determine price 34.11. NON COST FACTORS Industry nature Product characteristics Intensity of competition Buying capacity of population Market influences through demand-supply relation
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Price agreements Alternative/substitutes products Governmental interference/ strategy Capacity utilisation

34.12. COST BASED PRICING METHODS Price fixed above total cost Price to recover processing charges & profit on processing charges when material supplied by customers Price to recover cost plus return on capital employed Price based on marginal costing technique Price based on differential cost Price based on standard cost 34.13 COSTING AS TOOL FOR DECISION MAKING Cost accounting enables cost determination, planning & cost control, cost reduction and providing information for decision making Costing to assist important decision making for cost control, profit planning and performance evaluation 34.14 SPECIFIC DECISION AREAS Pricing decision, make or buy decisions, evaluation of capital expenditure proposals, choosing profitable product mix, alternative use of production facilities 34.15 PRICING DECISION use of costing methods (job costing or process costing) for ascertaining cost incurred pricing based on analysis of cost behaviour into variable cost & fixed cost 34.16 MAKE OR BUY DECISION Costing method/technique employed to ascertain cost of making parts/components for comparison with cost of buying from outside source use of marginal costing technique. 34.17 EVALUATION OF CAPITAL EXPENDITURE PROPOSALS Use of costing method/ technique for ascertaining expenditure required for capital expenditure proposals for compare with estimated benefits flowing there from.
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34.18 CHOOSING PROFITABLE PRODUCT MIX Ascertaining product-wise contribution to decide on optimum product mix for multi-product manufacturing units. Application of product-wise contribution concept. Use of contribution technique for finding most profitable methods of manufacture or use of plant facilities. 34.19 WHAT IT IS? Additional cost incurred to make one more additional unit Proper appreciation of cost behaviour by segregating cost into variable portion and fixed portion. Variable cost considered as relevant cost & expressed as per unit cost. Fixed costs considered as period cost. Carry over of fixed cost from one period to another not allowed. Excess of sale value over marginal/ variable cost termed as contribution. Fixed cost being sunk cost not taken into account for computing contribution. Contribution computed per unit of limiting factor as profitability index. 34.20 COST CONTROL Marginal or variable cost being proportional to output is amenable to management control. Fixed cost being policy dependent not controllable in short term.

34.21 PROFIT PLANNING Enables profit planning on rational basis by use of contribution technique, costvolume profit analysis & break even analysis. 34.22 PERFORMANCE EVALUATION Enables performance evaluation on comparative scale by product-wise contribution or contribution per unit of limiting factor 34.23 PRICING DECEISION Marginal cost provides the limit for pricing under recessionary or competitive market conditions as short term measure for survival. 34.24 MAKE OR BUY Marginal cost of manufacture vis--vis market price provides basis for make or buy decision when capacity exists for own manufacture.
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34.25 EVALUATION OF CAPITAL EXPENDITURE PROPOSAL Assessing investment proposals by use of marginal cost concept/ contribution analysis. 34.26 PRODUCT MIX Selecting most profitable product mix by use of product-wise contribution analysis.

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CHAPTER

35. Standard Costing and Variance Analysis 35.1 Standard Costing: 35.1.1 Specification and Uses: Standard cost Accounting is a development of the early 20th century. It grew out of a feeling among business executives that the backward look at cost provided by the historical cost system was inadequate. It become apparent that actual costs were not useful enough for price setting, planning or controlling operations. Something more was needed to reflect current operating deficiencies and, consequently, the standard cost system emerged. Its first description appeared in the U.S.A. in 1908, a little after the introduction of scientific management of F.W. Taylor, Gantt, etc. Standard costing signifies an organized set of procedures for using scientifically determined estimated costs as statistics for comparison against actual costs. 35.1.2 Definition Standard costing is a technique or a principle which uses standards for costs and revenues. The purpose is control of costs through variance accounting. A standard is a predetermined measurable quantity set in defined conditions. It is a benchmark or norm. It follows, therefore that standard costs are formal estimates of cost. 35.1.3 General Purposes The two general purposes of a standard cost system are: (i) to provide data for product costs, and (ii) to provide information for planning and control decisions. Standard costing emphasizes product costing. In addition, standard costs provide a budgetary benchmark against which actual performance can be compared. Actual costs are compared with standard or target costs, and differences are analyzed to provide guidance for management. 35.1.4 Mere Tool Standard cost accounting will not itself exert control over costs. It is only a management tool. The control must emanate from management through analysis and interpretation of the standard cost data. Standard costing provides the fact the indices of performance. Management must follow through with the corrective action required.

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36. Budgeted vs. Standard costs A mature costing system is the combination of budgeting and standard costs. The combination gives the expected cost of production under normal operating conditions. A plan of budgetary control is successful install in concerns having standardized production processes and operating under a standard cost accounting system. While standards are closely related to budgets, the two are not identical. A budget is a comprehensive forecast of probabilistic future results that has been formalized into a plan. A budget is obtained by multiplying standard costs by the planned level of output. A standard is a cost level that should be achieved by efficient working under prevailing conditions. Budget is a concept, but standard is an unit concept. A standard cost is a predetermined unit cost, while a budget refers to total cost. A standard cost is a unit measurement, literally a basic building block of manufacturing budgets. That is, while a budget is prepared for an organization as a whole and its each department and section and as such is a financial plan; standard cost is set for each unit of production. Budgets are statements of expected costs, while standard show what costs could be if desired performance was attained.

37. Setting Cost Standards Standard product cost specifications are established for all the three major components of cost. These relate to raw materials used in making a product, direct labour needed to perform a manufacturing operation, and manufacturing overhead applied to an unit of output. But they may also be laid down for the output of certain non-manufacturing activities such as sales and administration as well as for the output of some service departments in the manufacturing area.

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Chart Showing Construction and Subsequent Use of Standard Costs


Engineering department releases drawing to
Manufacturing Department Tools & Layout Production Control Specifications Purchasing Quotations Operating Standard Time and Methods Accounting Department Accounting Information

Standard Cost Committee Calculates Standard Material Cost, Standard Labour Cost, Application of Proper Overhead, Application of Normal Allowances Result: Standard Cost Budget Committee Setting Prices and Production

Sales Department

Manufacture Divisions

Estimating Department

Accounting Department Costing and Computing Variances

38. STANDARD COST CARD At the heart of a standard cost system is the standard cost card or sheet the scientifically predetermined estimate of what one unit or product should cost if efficiently produced. It includes detailed estimates of material quantities and prices, labour quantities and rates, and Factory overhead quantities and rates. These details serve as the benchmarks of efficiency against which actual quantities and costs are compared. This focus upon the efficient cost of producing one unit requires and emphasis on the relevant range of activity concept. The type of standard cost card used varies with the requirements of the individual firm; hence no uniform format can be presented. But these cards are so arranged that they may be revised from time to time and that the revisions can be shown in columns adjoining the column containing the original standard estimates. 38.1 Types or Levels of Standards 38.1.1 Theoretical Standards: These assume operational perfection and the highest levels of goal attainment. They suggest that resource acquisition and use occurs under the most favourable conditions with regard to prices, production efficiency, and capacity utilization. Personnel and physical facilities are expected to perform at peak level.

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38.1.2 Currently Attainable Standards: These are reasonable estimates of what costs should be in a short period of time. 38.1.3 Basic Standards: These signify the standards which are established for use over a business cycle or a long period of time. These are based upon certain assumed levels of efficiency, economic conditions and other factors of a durable nature. Basic standards are set up on the basis of normal capacity volume that is not expected to change over a relatively long period. 38.1.4. Historical Standards: Historical standards are set on past experiences. These are established on some average of past production costs and are based upon what might be termed normal capacity. 39. Advantages and Uses The term standard has an inherent psychological value which induces people to reach goals. It has more qualitative appeal and impact than the words budget or plan. When a standard is specified, individuals may be expected to associate it with the need for some required-effect. All standards attempt to monitor costs and measure efficiency. The main purpose of standard costing is to provide bases for control through variance accounting. As such, standard costs confer several benefits to the organization which could be spelled out as bellow: 1. 2. 3. 4. 5. 6. Simplification of cost calculations and record-keeping. Surrogate for performance evaluation. Cost control and education. Informed decision-making. Facilitates integration of accounts
Effective delegation of authority:

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Top management (delegates) Authority (assigns) Responsibility (requires) Accountability

VII. Builds Budgets. Standard costing furnishes valuable data to management for formulating future production forecasts. VIII. Motivation. Standard costs are potentially effective as motivational devices. They can be used to improve company performance as they are easily understood. IX. Principle of exception. The last but not the least advantage of standard cost system is the adoption of the principle of exception. This principle assumes that only those activities are worthy of executive attention which fail to come up to standard. Management may establish acceptable tolerances, and then investigate only the important off standard conditions.

40. Limitations and Objections: a. b. c. d. Difficult to practice Expensive start-up Revision expensive and troublesome. Dysfunctional consequences.

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41. STANDARD COSTING AND VARIANCE ANALYSIS 41.1. VARIANCE ANALYSIS The deviation of the actual from the standard is known as Variance. The variance may be favourable or unfavourable (i.e., adverse) depending upon the circumstances. For example, in case of cost variances, if the actual cost is more than the standard cost, it is something unfavourable and, therefore, it will be said that there is an adverse variance. In a reverse situation, where the standard cost is more than the actual cost, the variance will be termed as favourable. However, in case of sales variances, things are different. If the actual sales are more than the budgeted sales, the variance will be termed as favourable. On the other hand, if the budgeted sales are more than the actual sales, the variance will be termed as adverse.

COST VARIANCES
The Cost Variances can be put in the form of the following chart:

Cost Variances

Direct Material Cost Variance (DMCV)

Direct Labour Cost Variance (DLCV)

Overhead Cost Variance (OCV)

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DIRECT MATERIAL VARIANCES


Direct Material Cost Variance It is the difference between the standard cost of direct materials specified for the output achieved and the actual cost of direct materials used. Direct Material Cost Variance (DMCV)

Direct Material Price Variances (DMPV)

Direct Material Usage Variances (DMUV)

Direct Material Price Variance It is that portion of the direct material cost variance which is due to the difference between the standard price specified and the actual price paid. Direct Material Quantity or Usage Variance It is that portion of direct material cost variance which is due to the difference between the standard quantity specified (for the output achieved) and the actual quantity used.

Direct Material Usage Variance (DMUV)

Direct Material Mix Variance (DMMV)

Direct Material Yield Variance (DMYV)

Direct Material Mix Variance Material mix variance represents the variations in cost arising as a result of change in the ratio in which the different materials are used, compared to the standard fixed for the purpose. Material Yield Variance It is that portion of direct material usage variance which is due to the difference between the standard yield specified and the actual yield obtained.
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DIRECT LABOUR VARIANCES


Direct Labour Cost Variance It is the difference between the standard direct wages specified for the activity achieved and the actual direct wages paid.

Direct Labour Cost Variance (DLCV)

Direct Labour Rate Variance (DLRV)

Direct Labour Efficiency Variance (DLEV)

Direct Labour Efficiency (Time) Variance


It is that portion of the direct labour (wages) variance which is due to the difference between the standard labour hours specified for the activity achieved and the actual labour hours expended.
Direct Labour Efficiency Variance (DLEV)

Direct Labour Mix Variance (DLMV)

Direct Labour Yield Variance (DLYV)

Direct Labour Mix (or Gang Composition) Variance. This variance arises if during a particular period, the grades of labour used in production are different from those budgeted. Labour Yield Variance. It is the variance in labour cost on account of increase or decrease in yield or output as compared to the relative standard.

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Total Direct Labour Efficiency Variance


In those cases where there is an idle time variance together with mix variance and efficiency variance, the classification of Direct Labour Efficiency may be done as given in the following chart Total Direct Labour Efficiency Variance (TDLEV)

Direct Labour Efficiency Variance (DLEV)

Idle Time Variance (ITV)

Direct Labour Mix Variance (DLMV)

Direct Labour Yield Variance (DLYV)

OVERHEAD VARIANCES

Overhead Cost Variance (OCV)


It is the difference between standard overheads for actual output, i.e., Recovered Overheads and Actual Overheads. Overhead Cost Variance (OCV)

Fixed Ov. Cost Variance (FOCV) Variable Overhead Cost Variance (VOCV). It is the difference between Standard Variable Overheads for actual output (or Recovered Variable Overheads) and Actual Variable Overheads. Fixed Overhead Cost Variance (FOCV). It is the difference between Standard Fixed Overheads for actual output (or Recovered Fixed Overheads) and Actual Fixed Overheads.

Variable Ov. Cost Variance (VOCV)

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Variable Overhead Cost Variance (VOCV) Variable Overhead Expenditure Variance (VOEXPV) Variable Overhead Efficiency Variance (VOEFFV)

Variable Overhead Expenditure or Spending or Controllable Variance (VOEPXV). This variance is due to the difference between variable overhead rate and actual variable rate for the actual time taken. Variable Overhead Efficiency Variance (VOEFFV). This variance is due to the difference between standard hours for actual output and the actual hours taken at the standard variable overhead rate.

Fixed Overhead Cost Variance (FOCV

Fixed Overhead Expenditure Variance (FOEXPV)

Fixed Overhead Volume Variance (FOVV)

Fixed Overhead Expenditure or Budget or Controllable Variance (FOEXPV). This variance is due to the difference between Budgeted Fixed Overheads and the Actual Foxed Overheads incurred. Fixed Overhead Volume Variance (FOVV). This variance arises on account of difference between standard and actual output resulting in under or over-recovery of fixed overheads.

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Fixed Overhead Volume Variance (FOVV)

Fixed Overhead Efficiency Variance (FOEFFV)

Fixed Overhead Capacity Variance (FOCAPV)

Fixed Overhead Efficiency Variance (FOEFFV).

FOEFFV

= Std. Fixed Ov. Rate per hour

Std. actual Hours for production

Actual Hours

Or

= Recovered

Fixed Overheads Standard Fixed Overheads.

Fixed Overhead Capacity Variance (FOCAPV)


FOCAP Or = = Std. Fixed Ov. Rate per hour

Actual Hours Worked

Budgeted Hours

Standard Overheads Budgeted Overheads.

Calendar Variance. It is a part of capacity variance. Std. Rate per hour or per day Excess or deficit hours or day worked. Revised Capacity Variance. Revised Capacity Variance = Capacity Variance Calendar Variance

Alternatively, Revised Capacity Variance = Standard Overheads

Possible Overheads

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SALES VARIANCES
The sales are affected by two factors: (i) the selling price and (ii) the quantum of sales. Sales variances can be understood with the help of the following chart: Sales Variances

With reference to Turnover Value Variance Price Mix Volume


Qty.

With reference to Profit Value Variance Price Mix Volume


Qty.

41.2 With reference to turnover 41.2.1 Value Variance: The difference between budgeted sales and actual sales results in value variance. 41.2.2 Price Variance: It is on account of the difference in actual selling price and the standard selling price for actual quantity or sales. 41.2.3 Volume: The variance is as a result of difference in budgeted and actual quantities of goods sold.

41.2.4 Mix Variance: When more than one product is manufactured and sold, the budgeted sales of different products are in a given ratio. If the actual quantities sold are not in he same proportion as budgeted, it would cause a mix variance.
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41.2.5 Quantity Variance: It is the difference between budgeted sales and the revised standard sales.

42. WITH REFERENCE TO PROFIT Value Variance: Value Variance = Budgeted Profit Actual Profit Price Variance: Price Variance = Standard Profit Actual Profit Volume Variance: Volume Variance = Budgeted Profit Standard Profit Mix Variance: Mix Variance = Revised Standard Profit Standard Profit Quantity Variance: Quantity Variance = Budgeted Profit Revised Standard Profit In case the revised standard profit is more than the budgeted profit, it shall be a favourable variance and vice versa.

43. CONTROL OF VARIANCES After the variances have been analyzed, they shall be reported to management as to the extent of favourable and unfavourable due to various causes. Cost reports presented to management would clearly indicate where the scope for action lics. Management would take corrective action so as to control the adverse variances. Responsibility shall be assigned to persons concerned in case of adverse variances resulting because of factors which were within the control of business. The factors like changes in market conditions, demand and supply position, etc., are beyond the reach of management and hence responsibility cannot be placed for such uncontrollable factors. The management would try its level best to bring down the actual costs to the level of standard costs and will apply a system of strict inspection and supervision for effecting cost control.
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CONTROL OF VARIANCES In case of controllable factors, the responsibility can be assigned as shown below to the different departments for different reasons of variances. Variances Materials Price Quantity or Grade Waste, Scrap or Spoilage Wages Rate for difference in rates for work requiring higher rates of pay Time- lack of proper supervision Overheads Volume Efficiency higher rates of indirect workers higher prices of indirect materials
higher consumption of indirect materials

Department to be held responsible

Purchasing Department Stores Purchase or Process Deptt., as the case may be Production Department (for lack of proper supervision) Personnel Department Production Department Production Department

Excessive expenditure in factory Excessive expenditure for selling and distribution Sales Price and Volume

Sales Department Production Department Expenditure: Personnel Department Purchasing Department Production Department Production Department Selling Department

Selling Department

Mchkm07

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