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METHODS OF ACCOUNTING
Methods of costing are the procedures of ascertaining costs of output,
process or operation. Since the nature of industry differs from one another,
the methods of costing also differ. Important methods of costing are as
follows:
Job order costing: Thismethods is used to gathers and accumulates costs
for each job order or work order received from customers. Since each job
order is specific and terminates after it is completed, therefore all costs that
are incurred in the job or order are accumulated after its termination.
Process costing: The costing method that ascertains the cost of each
process or stage of producing output is called process costing. Under this
method, a separate account is opened for each process to which all costs
incurred thereon are charged.
Service costing: The method of costing which is used for ascertaining the
costs of service rendered is known as service costing. Under this method,
the cost of per unit of service rendered such as cost per passenger
kilometre, cost per ton kilometre, cost per kilo-watt, or cost per patient day
is determined. Therefore, this method is popular in industries and institutions
that provide services instead of manufacturing products.
Contract costing: This costing refers to the form of specific order costing,
which applies, where work is undertaken to customer requirements and each
order is long duration as compared to job order costing. A job, which is big
and spreads over long periods of time is known as a contract. The method of
costing which is used in a contract is called contract costing. This method is
used by builders, civil engineering contractors and construction firms.
Batch costing: A batch consists of a lot of common units. Therefore, a
number of identical units/articles manufactured on lot basis is called batch.
A uniform size of product is produced in each batch. The costing method
used to determine cost of products produced on lot wise basis is called
batch costing.
Multiple costing: An ascertainment of cost of product by using more than
one costing method is defined as multiple costing. It is also called composite
costing. It is adopted in those industries where several components are used
to produce a final product.
CONCEPT OF COST
Cost is frequently used word. Since all use the word cost as per their own
need and purpose, therefore the meaning of cost differs depending upon the
need and purpose. An accountant, economist, engineer and a manager define
it according to their need. Therefore, it is not easy to define the term “cost”.
However, in simple words, cost is defined as an amount of money spent for
obtaining any thing, goods or service. Cost is a resource foregone or
sacrifice in monetary terms, to achieve particular objectives.
According to U.S.A., it is defined as an exchange price, the foregoing, a
sacrifice made to source some benefits.
CONCEPT OF COSTING
The process of fixing costs of activity is defined as costing. The activity
refers to manufacture products/articles or services rendered, or function
performed. Each activity needs cost. The procedure applied to ascertain unit
cost of product or service is costing. So, costing comprises of collection,
classification and analysis of cost for ascertaining unit cost of product and
services. Manufacturing and service industries follow costing to ascertain
cost of products or services.
According to W.H. Wheldon, costing is the classifying, recording and
appropriate allocation of expenditure for the determination of the costs of
products or services, and for the presentation of suitability arranged data for
purpose of control and guidance of management.
Classification of costs
Classification of cost refers to the division of cost on the basis of
characteristics of costs. it is concerned with dividing cost into different
types. it is fact grouping of cost according to their common characteristics.
A suitable classification of cost is important to identify cost by product,
process or operation. Cost can mainly be classified on the following bases:
1.Element/Nature
2.Functions or activities
3.Variability or behaviour
4.Controllability
Elements/ Nature
Cost of product of an industry comprises of material cost, labour cost and
expenses. Therefore, cost appears into material cost, labour cost, expenses
under the classification of costs based or physical characteristics. Cost has
three main elements such as raw materials, labour and other expenses. It
can be classified into materials, labour and expenses based on physical
characteristics.
Material cost
Material cost represents the total of costs of main raw materials,
components, consumable stores and packing materials. Materials cost also
includes import duties, dock charges, transport cost, storing cost receiving
and inspection cost, and other costs associated with the materials
purchased.
Labour cost
Labour cost is the total of wages incurred for the effort or services made by
labours in the productions of goods and services. Therefore, wages paid to
the workers are termed as labour costs.
Expenses
Expenses are the total of costs incurred for production, administration and
selling and distributing operations. Such expenses include the cost of
drawing, cost of special tools, cost of trial production, royalties, rent, lighting
and welfare expenses.
All the three elements of cost can further be divided or grouped into two
types based on their nature such as direct and indirect costs.
Direct costs
Direct costs are those materials, labour and other expenses which can easily
be attributed or identified with a unit of product, process or operation. The
cost of raw materials, productive labour, and carriage of materials paid are
the examples of direct cost. The total of direct cost is termed as prime cost.
Indirect costs
Indirect costs are those types of cost, which cannot easily be attributed to or
identified with a unit of product, process or operation. Therefore, the total of
costs of indirect materials, indirect labour and indirect expenses is referred
to as indirect costs. They are also called overhead costs. The examples of
indirect costs are repair charges, salaries, rent, telephone and water.
Direct materials cost: The cost of materials having physical identity with the
end product is defined as direct materials cost. Main raw materials and
necessary components are a few examples of direct materials.
Indirect materials cost: Materials are not used as inputs of product are
called indirect materials. Cost of materials incurred for repair of a machine
used for printing of textbook is defined as indirect materials cost.
Direct labour cost:Labour or wages incurred for the operative workers
engaged in production process are categorized as direct labour cost. Wages
paid to the workers involved in production and handling materials, workers
engaged in productive operation by way of supervision and maintenance etc
is direct labour costs.
Indirect labour cost: Smooth operation of an organization needs operation of
account department, marketing department, and internal transport also
besides production department. Indirect labour cost mean salary paid to
staff.
Direct expenses: Direct expenses are charged directly to finished product
like direct materials cost. It is also called designed chargeable expenses.
These include special layout cost, drawing and designed charges, royalties
and so on.
Indirect expenses:
The cost which is not directly connected with finished product but occur on
account of operation are termed as indirect expenses. Indirect expenses are
also more frequently called on cost or overheads and include expenses such
as canteen expenses, lighting, heating charge, rent, insurance and so on.
Components of indirect materials: Production supplies and consumable
stores, greases, waste, Non-durable tools and equipment, maintenance
material and supplies, inspection and testing materials.
Components of indirect labour: Managerial salary, supervisory salary,
foremen salary, clerical salary, general labour, unallocated times wages,
over-time wages and so on.
Components of indirect expenses: factory rent, electricity, lighting,
conveyance and travelling, postage and telegrams, insurance, depreciation
of plants and machinery.
Functions or activities
The classification of costs based on the functions like manufacturing,
administrative, selling and distribution is called functional classification.
Functional classification of cost focuses on the different activities and
segregate costs accordingly. Production (manufacturing) and non-production
(non-manufacturing) costs are the major costs division made after prime cost
under this classification.
Prime cost known as Basic, Flat or Direct cost comprises direct material,
direct labour, direct expenses. They are attributable to and are identified to
particular finished goods.
Production Cost
Production cost is the sum of the cost incurred for realizing finished goods. It
includes direct material cost and conversion cost needed to convert such
direct material into finished goods. So, it is the sum of Prime cost plus
manufacturing expenses or factory overhead or work overhead. It is also
called manufacturing cost or factory cost or work cost.
Manufacturing expenses include indirect materials, indirect labour and
indirect expenses associated with manufacturing operations. Conversion
cost includes direct labour cost and manufacturing expenses need to convert
input material into finished goods.
Process cost
Production cost depending upon the stage of production operation can be
categorized into different costs.The output of one process becomes input
cost of immediate next process. Costs of each individual process are
collected separately and are term as cleaning process cost, cooking process
cost and so on. Each process cost is divided by the number of units produced
by the same process. It goes on cumulating and total manufacturing cost
equals the sum of all cost accumulated at the final process. The cost so
accumulated is divided but the number of units produced to ascertain cost
per unit of finished goods.
Administrative overheads
The expenses incurred for administrative work like planning, coordinating,
directing, controlling, are called administrative overheads. It is also called
office cost.
Selling overheads
The expenses incurred for selling finished goods to customers are termed as
selling expenses.
Variability or Behaviour
Knowledge of variability or behaviour of cost is essential for decision making
and forecasting of cost. This helps to study how costs react with volume
changes. Management needs to identify costs from their behaviour to
formulate forward planning and select profitable course of action.
Variable Cost
Cost which change proportionality with volume of output or services are
called variable costs. They increase or decrease in total amount with the
increase or decrease in volume of output. However, the per unit variable cost
is constant. Variable manufacturing cost are also called product cost and
include direct material, direct labour and fluctuating indirect materials,
labour and manufacturing overheads.
Fixed Cost
Cost that does not change with output is cost. It remains fixed for a
stipulated period and for a specific capacity output. Fixed cost is called
constant or capacity cost. It is also called create cost as it remains
unchanged for a stipulated period. Fixed cost in total amount remains
constant whereas fixed cost per unit changes inversely with output changes.
Therefore, increase in output decreases fixed cost per unit and decrease in
output increases fixed cost per unit. For example: depreciation, rent and
salaries.
Semi-variable cost
Those cost which do not change proportionately like variable costs but their
increase will be less than proportionate unlike the variable costs is termed
as semi-variable cost. The examples of semi-variable costs are salary of
supervisors, travelling salesman salary, repair and maintenance costs etc.
such costs contain fixed and variable portions. So, semi variable cost is also
called mixed costs.
Controllability
Controllability may be defined in terms of change or alternation of costs. An
effective cost control requires knowledge of cost controllability. A sharp
division of cost into controllable and uncontrollability cost is a relative one
and is influenced by the action of a person at management hierarchy. The
term controllable cost should not be used as synonymous of variable cost
and direct costs. Knowledge of controllability of cost is important to control
cost.
Cost under controllability may be categorized into controllable and
uncontrollable costs.
Uncontrollable costs: Costs that are not subject to influence by the action of
manager is called uncontrollable costs. These costs remain unchanged or
unaltered. Example: managerial salaries, staff salaries, depreciation after
purchase of equipment, rent. Some costs may be controllable in the short run
but not in the long run.
Introduction
Commodities which are used in the production of finished product are called
materials. All those items, which are used in the process of producing goods
or rendering services, are called materials. It includes all raw materials and
supplies like lubricants, fuel and loose tools. Sometimes materials are also
denoted by the term inventory of stores.
Materials are of two types as direct and indirect materials
Direct materials:
Direct materials cost means the cost of materials that can be identified with
and allocated to cost centre or cost units. Cost of paper used to print
textbook is direct cost since it is main input of textbook. Thus, main raw
materials, and necessary components are a few examples of direct
materials.
Indirect materials:
Indirect materials cost refers to the material costs, which cannot be
allocated but can be apportioned to or absorbed by cost centres or cost
units. Cost of materials incurred for repair or a machine used for printing of
text is defined as indirect materials cost. Fuel, lubricating oil, materials used
for repair, coal, maintenance work etc. are few examples of indirect
materials.
Material control
The systematic and regular control over purchasing, storing and
consumption of materials is material control. Material control involves the
planning, operating, organizing and controlling the purchasing, storing and
using of materials so as to achieve the objectives of minimizing possible cost
of materials and uninterrupted production. In other words, it is a system,
which helps to provide the right quality of materials in the right quantity at
the right time and right place with the right amount of investment. Effective
control also requires the systematic preparation of periodic summaries and
reports. It can be defined as a systematic control over purchasing, storing
and consumption of materials. It helps to maintain a regular and timely
supply of materials by avoiding over and under stocking.
STORE ROUTING
The process set by a manufacturing company to control materials is called
store routing. It consists of all the processes involved in proper purchasing,
storing and issuing of materials to the concerned departments. The store
routing can be summarized as follows:
1.Purchasing and receiving of materials
Request for purchase of materials
Inquiry and tender quotation forms issued to potential suppliers
Selecting a suitable supplier
Placing the order
2.Storing of materials
Classification and codification of materials
Keeping records of the materials in Bin Cards, Store ledger and so on.
3.Issuig of materials
Requition form
Pricing of materials issued
Purchasing
Purchasing involves acquiring materials of right quality, at right quantity, at
right time from right source, and at a reasonable price. A separate purchase
department should be established to perform purchasing activities. The
department which performs purchasing activities in the manufacturing
concern in the managed way is termed as purchasing department. The
purchasing department plays a very important role in an organization
because purchasing has its effect on every vital factor concerning the
manufacture, quality, cost efficiency and prompt delivery of goods to
customers.
Purchase control
A manufacturing company is required to invest a huge amount of money in
purchasing materials. It is, therefore, essential to exercise proper materials
and purchase control. Purchase control refers to the purchase of materials of
right quality in right quantity at a reasonable price and at a right time. It
requires a good amount of attention to the purchasing procedures of
materials relating to cost, quality, volume, time and delivery of materials.
Centralized purchasing
Centralized purchasing refers to the purchase of materials by a single
purchase department. This department is headed and managed by a
purchasing manager. Under centralized purchasing, all purchase s are made
by the purchase department to avoid duplication, overlapping and the non-
uniform procurements. Under this system, the purchasing department
purchases the required materials for all the departments and branches of the
company.
Advantages
It uses the specialized knowledge and skill by appointing specialized and
expert purchasing staff.
It brings about economics of bulk purchase.
It facilitates the standardization of materials.
It facilitates effective control over purchases, by maintaining an efficient
system of ordering, receiving inspection, accounting etc.
It ensures consistent policy with regard to purchase such as terms of
payment, cost of delivery etc.
It brings about economics of centralized accounting of purchase.
a)When there is only one plant or
b)Several plants are not located far away from each other and are using
same materials.
Disadvantages
It is expensive due to increase in administration cost of a separate
purchase department.
It is not suitable when plants of departments are located far away from one
another or are using different materials.
Decentralized purchasing
Decentralized purchasing refers to purchasing materials by all departments
and branches independently to fulfil their needs. Such a purchasing occurs
when departments and branches purchase separately and individually. Under
decentralized purchasing, there is no one purchasing manager who has the
right to purchase materials for all departments and divisions. The defects of
centralized purchasing can be overcome by the decentralized purchasing
system. It helps to purchase the materials immediately in case of an urgent
situation.
Advantages:
It avoids unnecessary cost of setting up a purchasing department.
It avoids delay in purchasing because the required material can be easily
purchase as and when required.
Department can get the benefit of localized purchasing.
Due to then provision of purchase of material by the concerned department
the material may be purchased in right quantity and quality.
Disadvantages:
There is chance of overstocking and blocks the capital of the company.
The benefits of a bulk purchase cannot be obtained.
Fewer chances of effective control of materials.
Lack of proper cooperation and coordination among various departments.
There may be lack of special knowledge about the purchasing with
purchasing staff.
3.Purchase order
After completion of the above procedure, the purchase department prepares
a purchases order for the supply of materials. The purchase order is a
contractual agreement with the suppliers for the supply of materials. It is
prepared in five copies, the original copy is sent to the supplier, the second
copy for receiving department, third for account department, fourth for
imitating department and the fifth one is retained in the purchasing
department for reference.
Store-keeping
Store keeping refers to the act of storing materials for their safe custody till
these are issued to the production and other departments. It involves
receiving, storing and issuing of materials. The place where materials are
kept is known as 'store'. The term 'stores' has wide meaning and includes
raw materials used in production, consumable store such as oil, grease etc,
tools, patterns, maintenance materials etc, stock of work in progress and
stock of finished goods.
Objectives of storekeeping
All of proper place for every item of store
Keep every item of store in fixed place
Maintain proper and upto date records
Issuing materials quickly to department
Classify and codify the materials for easy identification
Types of stores
1.Centralized stores
A centralized stores is that store which receives materials for and issue
them to all departments divisions and production floors of the company. Such
a store is only one in the company which receives materials for and issues
them to all who need them. The materials required for all the departments
and branches are stored and issued by only one store.
Advantages:
Economy in cost
Better supervision of store
Better layout and control of stores
Minimum investment in store
Less space is occupied
Better safety and security of stock
Disadvantages:
Delay in sending materials to the department and branch.
increase in the material handling cost.
Greater risk of loss by fire.
Not suitable for a large company.
2.Decentralized Stores
Decentralized stores is that type of store which receives materials for and
issues them to only one department and not to the whole company. The
decentralized store may be many in the company, as each department has
its own such store. Purchasing and handling of materials are undertaken by
each and every department separately. Each and every branch has their own
store for operation of production activities.
Advantages:
Saving in material handling cost
Prompt issue of material is possible
Storing and control will be easy and effective
Smooth production will be possible
Risk of loss by fire can be minimized
Disadvantages:
Higher cost of supervision.
More space is required for individual departments.
Higher amount of investment is required.
More time for stock taking and checking.
Higher cost for staff and stationery.
Improved technique is less possible for controlling of materials.
Storekeeper
A manufacturing company appoints a person for careful storing and
safeguarding materials in a store who is called storekeeper. A storekeeper is
a person who is the chief of the stores and who is given the responsibility of
store management. He is responsible for safeguarding the materials and
supplies in proper place until they are required for production activities. A
storekeeper should be well-experienced, well-trained, honest and familiar
with the tricks of storekeeping.
The main functions of storekeeper are as follows;
To maintain a proper record of materials relating to the receipt and issue of
materials.
Checking the physical quantity of materials and verify with a bin card.
To prevent unauthorized entrance into the storeroom.
To maintain the stock registers, entering therein all receipts, issues and
balance of materials.
To check and control losses due to evaporation, leakage, theft, and so on.
To arrange for physical verification of store items periodically.
To keep the stores always neat clean and tidy.
To supply information of materials, stock position, and so on whenever
needed.
ISSUE OF MATERIALS
Preparation and treatment of requisition form
The storekeeper receives materials and other items, stores them carefully
and finally issues them for the purpose of production. But, the storekeeper
must not issue materials unless a properly authorized materials requisition is
presented to him. Request for the issue of materials should be made to the
storekeeper in the prescribed form signed by the person demanding them.
The document, which authorizes and records the issues of materials, is
known as material requisition from.
Advantages
This method is appropriate for matching cost and revenue.
This method is simple to operate and easy to understand.
It facilitates complete recovery of material cost.
It is most suitable when prices are rising.
Disadvantages
Inventory valuation does not reflect the current prices and therefore are
useless in the context of current conditions.
Due to variation of prices, comparison of cost of similar job is not possible.
Calculations become complicated and cumbersome when rates of receipts
are highly fluctuating.
It involves considerable clerical work.
Stock level
Inventory refers to the stock maintained by the manufacturing concern and
trading organization to meet their future requirement for smooth production
and sales. It refers to the different level of stocks, which are required for an
efficient and effective control of materials and to avoid over and under
stocking of materials. The purpose of materials control is to maintain the
stock of raw materials as low as possible and at the same time they may be
made available as and when required.
In a scientific system of inventory system of inventory control the following
levels of materials are fixed.
Re-order level
Minimum level(Safety stock)
Maximum level
Average stock level
Re-order quantity
Re-order level
It is that level of inventory which the store keeper should initiate the
purchase procedure for fresh supplies of inventory. Re-order point is the
quantity or level of the inventory on hand that triggers a new purchase order.
It is the level at which storekeeper initiates purchase requisition purchase
for fresh supplies of material. Fresh order should be placed before the actual
stock reaches the minimum level to continue the business activities
properly.
It is calculated by,
Re-order level= Minimum level (Safety stock) + (Average lead time X
average consumption)
Or,
Re-order level=Maximum consumption X Maximum re-ordering period
Re-order quantity
First of all company determines the quantity or size to be ordered at a time.
Thereafter, it places the order for purchasing materials by the same size or
quantity, which is known as re-order quantity. In other words, the quantity of
single purchase order while purchasing any materials is called re-order
quantity.
It is calculated by,
Re-order quantity= (Max stock level - ROL) + (Min. consumption X Min. period)
Ordering cost
All the cost, which is related with placing an order and secure the supplied
are called ordering cost .in others it refers to the cost related to the
purchase related activities. The ordering cost is the repurchase cost and is
repeated in nature. Purchasing of large quantities of materials helps reduce
the ordering cost. The following costs are included in the ordering cost.
Cost of staff appointed in the purchasing, inspection and payment
departments.
Cost of stationary purchases, telephone charge, email charge, faxes charge
etc.
Formula of EOQ,
EOQ =
A= Annual requirement
O = Ordering cost
C = Carrying cost
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Indirect cost
The cost, which is not easily identified and not vary with level of
production.It is that labour which cannot be easily identified with a specific
product or job. It includes all labour indirectly involved in converting raw
materials into finished goods or in altering the construction, consumption or
condition of the product. For example: labour employed in repair and
maintenance, time keeping, cost accounting, store department etc.
Remuneration paid to indirect labour is termed as indirect labour cost and it
treated as part of overheads. Payments made to the sweepers, watchmen,
cleaners, supervisors and accounting personnel are the examples of indirect
cost.
The need of labour cost control arises to fulfil the following purposes:
To obtain better quality output with the least effort and time of the workers.
To reduce the cost of production of the products manufactures or services
rendered.
To ensure the satisfaction of the workers by creating a good working
environment in the factory.
To adopt a fair system of wage payment and to minimize labour turnover.
To minimize wastage of materials by workers, idle time and unusual overtime
work.
To maintain safe environment.
To increase the profitability and competitiveness of the organization.
Departments involved in controlling labour cost
In a large manufacturing concern, the following department are set up for
proper accounting and controlling of labour cost:
Personnel department
The personnel department concerned with the recruiting, training, placing
and promoting the workers for the jobs to which they are best suited. It
executes the employees policies laid down by the board of directors of the
company. It keeps complete records of the employees and reports to the
management regarding labourutilisation, labour efficiency, labour turnover
and absenteeism.
Personnel department starts the recruitment of workers immediately after
receiving the labour requisition from the concerned departments. The labour
requisition is also known as employee requisition or employee placement
requisition. Personnel department keeps complete records of each
employees working in the organisation in a card known as employee's history
card.
Engineering department
The engineering department involves in preparing plans and specifications
for each job. This department is established with the view of determining the
production procedure and working technique and creating sound working
condition for each workers. It inspects the jobs being done at different
production stages to ensure that they are being done as per plans and
specification.
Its main functions are as follows:
Making job analysis.
Setting piece rate.
Preparing the performance evaluation.
Creation of safe environment to minimize the risk of accident.
Preparing of plans.
Time and motion study department
This department works properly coordinating with personnel, engineering
and cost department. This department performs the following functions of
making of time and motion studies of labour.
Motion study
A worker or a machine makes various moments of the part of his body while
performing a job or a work. It is a study of moments of workers in performing
a job or work for the propose of eliminating useless, ill directed and
inefficient motions to improve the productivity. It is conducted while the
worker in the job. Motion study is also known as methods study because its
main objectives are to find out the best method of completing the job.
Time study
It is conducted after the motion study. The main objectives of the time study
is to determine the required time for performing the job or work. Various
methods are used for the determination of basic time. Standard or basic time
is fixed for a job or operation providing allowances to worker for drinking
water, smoking and other so on selecting an average workers as model
rather than exceptionally fast or slow workers.
Time-keeping department
This department is related with the recording of time of each worker
engaged in the factory to know the attendance and ascertainment of wages.
The main objective of this department is to prepare pay roll, meeting the
statutory requirements, maintaining discipline in attendance, recording of
each worker's time 'in' and 'out' of the factory making distinction between
normal time. Over time, late attendance and early leaving and to provide
basis for the distribution of overheads when overheads are absorbed on the
basis of labour hours.
To record the time of each worker properly, either an attendance register or
time card can be used.
Time booking
It is concerned with recording the time spent by each worker in the factory
on different jobs is work orders. It determines the exact time spent by the
worker in different departments or processes or products or jobs for the
purpose of calculating the correct amount of labour cost. When the workers
spends his time on several jobs or work orders then the need of time
booking arises for the purpose of cost analysis and apportionment.
Pay-roll department
The pay-roll department involves in verifying the time of the workers,
calculating wages due to each worker and preparing the pay roll or wage
sheet. It prepares the pay roll or wage sheet for each department separately
and distributed wages and salaries to the workers.
Pay slip
It is prepared for each worker showing the net payable amount of wages. Pay
roll is prepared for each department but pay slip is prepared for each worker.
Pay slips of a worker, in fact, is the copy of the pay roll.
Introduction
A manufacturing concern incurs different items of costs while converting raw
materials into finished outputs. Such costs can be classified on different
bases. One such basis is the directness of the costs to the product unit or
identification of costs with a particular product unit. The direct portion of the
total costs is called known as prime cost and the indirect portion is called
overheads.
Allocation of overheads
Meaning
Allocation of overheads is the process of charging overhead costs to a
particular department or cost centre. It is the allotment or assignment of an
overhead cost to a particular cost unit. If the overhead cost is associated
with a single department or cost centre, the whole amount is charged or
distributed among the units of output of that particular department. For
example, the whole amount of repair and maintenance expenses for a
machine is charged pr allocated to that department where the machine has
been installed.
Apportionment of overhead
Distribution of an overhead cost to several department or cost centre is
known as apportionment of overheads. It is the process of charging or
apportioning costs to a number of cost centres or cost units. If a given cost
is common to two or more departments or cost centres, such cost should be
apportioned or divided among theses departments on an equitable basis. For
examples, the amount of factory rent should be apportioned to all the
departments. Similarly, the amount of remuneration to the general manager
should be distributed to the production, administration and marketing
departments, as the general manager is associated with all these
departments.
Differences between allocation and apportionment of overheads
Allocation Apportionment
It involves a particular department or cost It involves two or more department of=r cost
centre. centres.
The process of charging the costs to a The process of charging the costs to a
particular department or cost centre is number of departments or cost centres is
allocation of overheads. apportionment of overheads.
It is distributed on some equitable bases like
It is based on direct distribution. direct labour hours, number of workers,
machine hours and space and area occupied.
It is applicable when the overhead cost is It is applicable when the overhead cost is
associated with a single department or cost associated with two or more departments or
centre. cost centres.
Allocation of overhead is done when the Apportionment of overhead is done when the
most centre uses while of the benefits of the cost centres use only a portion of the benefits
expenses. of the whole expenses.
Absorption of overhead
The absorption of overheads is also called the recovery of the overhead
costs. It is the process of sharing the overhead costs by all products of a
particular department. It is the application of overheads to each unit of
output. In other words, the process of ascertaining the total overhead costs
if each unit of output or job by using overhead rate is known as the
absorption of overhead. Thus, the distribution of the overhead expenses
allotted to a department over the units produced in that department is
absorption of overheads.
Unit or Output Costing
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Introduction
A manufacturing concern converts raw materials into finished products and
sells them at a certain price. In the manufacturing process, it incurs different
types of expenses such as manufacturing, administrative and selling and
distribution expenses.
Prime cost
Prime costs of product are the sum of direct costs, which varies in proportion
to volume of production. Prime cost includes direct expenses like cost of
materials, direct labour and direct expenses. These costs are directly
identifiable with the product and constitute the major part of total cost of the
product.
Factory cost
Factory cost are the total of prime costs and factory expenses. Factory
expenses are also as factory, manufacturing or works overheads. They
includes indirect expenses which are incurred inside the work place where
manufacturing takes place.
Factory cost= prime cost + factory overhead
Cost of production
Cost of production includes factory costs and office and administrative
overheads. Office overheads include all expenses incurred in performing
administrative activities like planning, coordinating, staffing and controlling.
Cost of production = Factory cost +Office overheads
Total costs
Total costs are the sum of costs of production and selling and distribution
overheads. Selling and distribution overheads are necessary for the
promotion of sales.
Stock of work-in-progress
The stocks of work-in-progress are those units of commodities on which
some work has been done but are in process of completion. These units can
neither be treated as raw materials nor finished product, because such units
requires further process to be completely finished products. Stock of work-in-
progress may be both opening and closing.
Manufacturing account
Manufacturing account is the alternative method of determination of total
cost and fixation of selling price. The manufacturing needs to ascertain the
cost of goods manufactured and manufacturing profit or loss during the year.
Therefore, an account is prepared for the purpose, which is known as
manufacturing account. Generally, it is prepared by such concerns which do
not have cost office and maintain any cost account.