NOVELTY POLYTECHNIC, KISHI

INSTITUTE OF MANAGEMENT SCIENCE

DEPARTMENT OF ACCOUNTANCY
ND 2, SECOND SEMESTER

LECTURE NOTE
COURSE CODE: ACC 222
COURSE TITLE: COST ACCOUNTING II

BY
ADEYEMI T.A

1
COURSE CONTENT:
1.0 Understand accounting records in cost ledgers and statement of Integrated accounting system.
2.0 Know costing methods and techniques
3.0 Know various type of budget
4.0 Know budgetary control

.
METHODS AND TECHNIQUES OF COSTING
The methods of costing are referred to the techniques and process employed in the ascertainment of costs.
The method of costing to be applied in a concern depends upon the type and nature of manufacturing
activity.

Categories of costing methods are:

JOB COSTING
A method of costing in which cost of each ‘job’ is determined is known as Job Costing. Here job refers to a
specific work or assignment or a contract where the work is performed according to the customer’s
instructions and requirements. The output of each job consists of normally one or less number of units. In
this method, each job is considered as a distinct entity, for which cost is ascertained. Job Costing is applied
when:
 The execution of the jobs is on the basis of client’s specification(s).
 All the jobs are heterogeneous in many respects, and each job requires separate treatment.
 There is a difference in WIP (Work in progress), of each period. Job Costing is best suited for the
industries where specialized products are manufactured as per customer needs and demands. Some examples
of those industries are Furniture, Ship Building,
Printing Press, Interior Decoration etc

ADVANTAGES OF JOB ORDER COSTING:

i) Profitability of each job can be individually determined.
ii) It provides a basis for estimating the cost of similar jobs which are to be taken in future.
iii) It provides the detailed analysis of the cost of material, labour and overheads for each job as and when
required.
iv) Plant efficiency can be controlled by confining attention to costs relating to individual jobs.
v) Spoilage and defective work can be identified with a specific job and responsibility for the same may be
fixed on individuals.
vi) By adopting pre-determined overhead rates in job costing, we can get all advantages of budgetary
control.
vii)Job costing is essential for cost-plus contract where contract price is determined directly on the basis of
cost

LIMITATIONS OF JOB ORDER COSTING:

1) It is expensive to operate as it requires considerable detailed clerical work.
2) With the increase in the clerical work, chances of errors are increased.
3) Job order costing cannot be efficiently operated without highly developed production control system. The
job costing requires intricate factory organization system.
4) The costs as ascertained are historical as they compiled after incidence and therefore does not provide
control of cost unless it is used with standard costing system.

ILLUSTRATION:
the following information relates to product KTK1 produced by KOBI LTD based on customer's
specification or order.
Dept AT Dept BT
Direct materials 9,000 5,400
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Direct labour hours 720 hrs 360
Labour rate per hour ₦7.2 ₦9
Production overhead per labour hour ₦7.2 ₦7.2
Admin & other overhead, 20% of production cost.
Profit margin 25% of total production cost
Require;
You are required to determine the selling price of job KTK1.

SOLUTION.
Direct materials: ₦ ₦
Dept AT 9,000
Dept BT 5,400 14,400
Direct labour:2
Dept AT (720hrs x ₦7.2) 5,184
Dept BT ( 360hrs x ₦9) 3,240 8,424
Prime cost 22,824
Production overhead:
Dept AT (720hrs x ₦7.2) 5,184
Dept BT (360hrs x ₦7.2) 2,592 7,776
Production cost 30,600
Admin & other overhead (20% x ₦30,600) 6,120
Total job cost 36,720
Profit margin 12,240
Selling price 48,960

workings:

determination of selling price

formula = cost = selling price minus profit
therefore, 36,720 = 100% - 25%
=36,720 = (4-1)x
=36,720 = 3x
3 3
therefore x = ₦12,240 ( profit margin).

ILLUSTRATION 2
ADASOBO shoemaker found that the production cost for the 2021accounting year has been as follows
Direct wages ₦8,000
Direct materials cost ₦300,000
Production overhead cost ₦240,000
Direct expenses ₦100,000
Total shoe manufactured 160,000 units
Machine time used 10,000 hours
Direct labour time used 40,000 hours

500 pair of shoes were produced during the first two weeks of the year as a single job which had direct
wages cost of ₦8,000, direct materials cost of ₦5,000 and direct expenses of ₦1,500. the company
apportioned fixed overhead cost using the percentage rate on direct wages and charges administrative
expenses and selling expenses at the rate of 15% & 10% respectively of the production cost.

require: calculate the followings,

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a. production cost of the job ordered.
b. total cost of the job.
c. cost per pair of shoe.

SOLUTION.
₦ ₦
Direct materials 5,000
Direct wages 8,000
Direct expenses 1,500
Prime cost 14,500
Fixed overhead (30% ₦8,000) 2,400
Production cost 16,900
Admin expenses (15% x ₦16,900) 2,535
Selling expenses (10% x ₦16,900) 1,690 4,225
Total production cost 21,125

a. production cost is = ₦16,900

b. Total production cost = ₦ 21,125

c. .cost per pair of shoe is = 21,125

500 = ₦42.25

BATCH COSTING
Batch Costing is the identification and assignment of those costs incurred in completing the manufacture of
a specified batch of components. Having arrived at the batch cost, the unit cost is simply derived by dividing
it by the number of components in the batch. When orders are received from different customers, there are
common products among orders; then production orders may be issued for batches, consisting of a
predetermined quantity of each type of product. Batch costing method is adopted in such cases to calculate
the cost of each such batch. Cost per unit is ascertained by dividing the total cost of a batch by number of
items produced in that batch. In order to do that a Batch Cost Sheet is prepared. The preparation of Batch
Cost Sheet is similar to that of Job Cost Sheet. This method is mainly applied in biscuits manufacture,
garments manufacture, spare parts and component manufacture, pharmaceutical enterprises etc.
Batch costing is a form of specific order costing.
 Within each batch are a number of identical units but each batch will be different.
 Each batch is a separately identifiable cost unit which is given a batch number in the same way that each
job is given a job number.
 Costs can then be identified against each batch number. For example materials requisitions will be coded
to a batch number to ensure that the cost of materials used is charged to the correct batch.
 When the batch is completed the unit cost of individual items in the batch is found by dividing the total
batch cost by the number of items in the batch.
 Batch costing is very common in the engineering component industry, footwear and clothing
manufacturing industries.
 The selling prices of batches are calculated in the s.

ILLUSTRATION 1
THY WILL COMPANY LTD. received an order to supply his customers with a delivery of cattle feed. the
job passes through three (3) departments. The collected cost for the job is as follows:
Mining Department
100 kg of owen at ₦2 per kg
50 kg of Howe at ₦1 per kg
20 kg of Benn at ₦50 per kg
10 hours of labour at ₦4 per hour

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Boiling department:.
20 hours of labour at ₦3 per hour.
60 hours of boiling machine
Cooling and skimming department:
50 hours of labour at ₦2 per hour
Hire of giant thermometer at ₦200

The job did not disrupt normal activity level which are as follows;

Department labour hour Machine hours Amount budgeted

₦
Mining 200 -- 1,600
Boiling 250 700 9,100
cooling 550 _ 4,950

Basis of apportionment: Mining dept: labour hours

Boiling dept: machine hours
cooling dept: labour hours.
Selling and admin expenses are 30% of factory cost.
Require: prepare profit or loss on job, if the agreed price is ₦2,500.

SOLUTION
THY WILL COMPANY LTD.
Statement of profit or loss on a job
Direct materials: # #
100 kg of Owen at ₦2 per kg 200
50kg of Howe at ₦1 per kg 50
20kg of Benn at ₦0.50 per kg 10
260
Direct labour:
Mining dept: (10 x ₦4) 40
Boiling dept: (20 x ₦3) 60
Cooling dept:(50 x ₦ 2) 100
200
Direct expenses (thermometer) 200
Prime cost 660
Production overhead:
Mining dept (10 x ₦8) 80
Boiling dept ( 60 x ₦13) 780
Cooling dept ( 50 x ₦9) 450
1,310
Factory cost 1970
Selling and Admin. expenses(30%x1970) 591
2,561

SUMMARY
₦
Total production cost 2,560
Agreed price (2,500)
Loss - 61

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Working:
Mining = ₦ 1,600 Boiling = # 9,100 Cooling = #4,900
200 = ₦8, 700 = ₦13 550 = ₦9

ILLUSTRATION 2

SOLUTION
BATCH NO. X44

₦ ₦
Direct materials
3280
Direct labour:
dept A (420hrs x ₦3.5) 1,470
dept B (686hrs x ₦3) 2,850 3,528
Prime cost 6,808
Production overheads
Dept A (420 x ₦8) 3,360
Dept B (686 x ₦5) 3,430 6,790
Factory cost 13,598
Gross profit 4,533
Selling price 18,131

a. selling price per unit = 18,131

1000 = ₦ 18.13

b. Total amount of admin overhead recovered = ₦1,813

c. Net profit per unit = ₦ 2,720

#1000 = ₦ 2.72

Workings:
Net profit Admin overhead
gross profit = 4,533 admin overhead = 10% of 18,131 =₦1,813
Less: admin overhead = 1,813
Net profit 2,720

calculation for gross profit:

formula = cost = sp - (minus) profit
Therefore, 13,598 = (100% - 25%)
= 13,598 = (4-1)
13,598 3x
3 x 3 = x = ₦4,533

PROCESS COSTING
Meaning
Process Costing is a method of costing. It is employed where each similar units of production involved in
different series of process from conversion of raw materials into finished output. Thus, unit cost is
determined on the basis of accumulated costs of each operation or at each stages of manufacturing a product.
Charles T. Horngren defines process costing as "a method of costing deals with the mass production of the
like units that usually pass the continuous fashion through a number of operations called process costing."
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Textiles, chemical works, cement industries, food processing industries etc. are the few examples of
industries where process costing is applied.

CHARACTERISTICS OF PROCESS COSTING

1. Continuous or mass production where products pass through distinct processes or operations.
2. Each process is deemed as a separate operations or production centres.
3. Products produced are completely homogenous and standardized.
4. Output and cost of one process are transferred to the next process till the finished product completed.
5. Cost of raw materials, labour and overheads are collected for each process.
6. The cost of a finished unit is determined by accumulated of all costs incurred in all the process divided by
the number of units produced.
7. The cost of normal and abnormal losses usually incurred at different stages of production is added to
finished goods.
8. The interconnected processes make the final output of by-product or joint products possible.

ADVANTAGES & DISADVANTAGES

Advantages :
The main advantages of process costing are:
(1) Determination of the cost of process and unit cost is possible at short intervals.(2) Effective cost control
is possible.
(3) Computation of average cost is easier because the products produced are homogenous.
(4) It ensures correct valuation of opening and closing stock of work in progress in each process.
(5) It is simple to operate and involve less expenditure
.
Disadvantages :
(1) Computation of average cost does not give the true picture because costs are obtained on historical basis.
(2) Operational weakness and inefficiencies on processes can be concealed.
(3) It becomes more difficult to apportionment of joint costs, when more than one type of products
manufactured.
(4) Valuation of work in progress is done on estimated basis, it leads to inaccuracies in total costs
(5) It is difficult to measure the performance of individual workers and supervisors

ELEMENT OF COST UNDER PROCESS COSTING.

a. Direct materials
b. Direct labour
c. Production overheads

ILLUSTRATION
Suppose that Shafa & CO. produces canned mango. the production involves two (2) processes that is,
blending and canning. During the first year, 100,000 units of fresh mangoes worth £50,000 was used as
input in the first process (blending). Direct labour cost £20,000 and production overhead cost of £20,000
were incurred in connection with the blending process.
Assuming all output from blending was transferred to the second process (canning) during the period.
Additional 10,000 units of other ingredients costing £40,000 were added. Direct labour cost £15,000 and
production overhead of £15,000 also were incurred.
Require: prepare process account for the two (2) processes and determine the cost per unit of the finished
product.

SOLUTION
SHAFA & CO.
PROCESS 1 ACCOUNT (BLENDING)
Particulars Units Amount Particulars Units Amount
₦ ₦

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 Direct materials 100,000 50,000 Transfer to 100,000 90,000
process 2
Direct labour -------- 20,000 ---------
Direct overhead ------- 20,000 ---------
Total 100,000 90,000 Total 100,000 90,000

PROCESS 2 ACCOUNT (CANNING)

Particulars Units Amount Particulars Units Amount
₦ ₦

Direct material 100,000 90,000 Transfer to 110,000 160,000

from process 1 finished goods
Direct materials 10,000 40,000 --------- ----------
Direct labour -------- 15,000 ---------- ------------
Production -------- 15,000 ----------- ---------
overhead
Total 110,000 160,000 110,000 160,000

PROCESS LOSSES
Process Losses may be defined as the unavoidable loss of material occur at different stages of manufacturing
process. It is logical and equitable that the amount of such loss is included as part of other cost of
production. this is because, in the production of goods unit, normal loss occurs. The following are the types
of losses unavoidable during the course of processing operations such as:
(1) Normal Process Loss
(2) Abnormal Process Loss
(3) Abnormal Process Gain
(4) Spoilage
(5) Defectives

(1) Normal Process Loss: The cost of normal process loss in practice is absorbed by good units produced
under the process.
This is known as Normal Process Loss or Normal Wastage. For example, evaporation, scrap, stamping
process etc. The amount realized by the sale of normal process loss units should be credited to process
account.

(2) Abnormal Process Loss: The cost of an abnormal process loss unit is equal to the cost of good unit. .
The total cost of abnormal process loss is credited to process account from which it arises. This is known as
Abnormal Process Loss. Such loss may be caused by breakdown of machinery, false production planning,
lack of effective supervision, substandard materials etc., Cost of abnormal process loss is not treated as
cost of the product. In fact, the total cost of abnormal process loss is debited to Costing Profit and Loss
Account.

(3) Abnormal Process Gain: Abnormal Process Gain may be defined as unexpected gain in production
under normal conditions.
The process account under which abnormal gain arises is debited with abnormal gain. The cost of abnormal
gain is computed on the basis of normal production
.
(4) Spoilage: Normal Spoilage (i.e., which is inherent in the operation) costs are included in costs either by
charging the loss due to spoilage to the production order or by charging it to production overhead so that it is
spread over all the products. Any
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value realized from the sale of spoilage is credited to production order or production overhead account as the
case may be. The cost of abnormal spoilage is charged to Costing Profit and Loss Account. When spoiled
work is the result of rigid specification, the cost of spoiled work is absorbed by good production while the
cost of disposal is charged to production overhead.

(5) Defectives: Defectives that are considered inherent in the process and are identified as normal can be
recovered by using the following method.
 Charged to goods products
 Charged to general overheads
 Charged to departmental overheads
 If defectives are abnormal, they are to be debited to Costing Profit and Loss Account.

ILLUSTRATION.
THE THRONE operates manufacturing process account, in a given period, the following data were
recorded.
Input materials 10,000 units
Cost incurred ₦45,000
Output 9,000 units
Loss at normal level 1,000 units
Required:
Determine the cost of output in the following operation conditions.
a. where expected or normal loss is 10% of input.
b. where there is no expected loss, so that the entire loss of 1,000 units was unexpected.

SOLUTION.
a. where expected or normal loss is 10%
Units
Direct materials 10,000
Less: normal loss (10%) (1,000)
Expected output 9,000
Actual output (9,000)
Abnormal loss/Abnormal gain NILL

PROCESS ACCOUNT
Particulars Units Amount Particulars Units Amount
₦ ₦

Direct materials 10,000 45,000 Normal loss 1,000 ---------

Transfer to 9,000 45,000

finished goods

Total 10,000 45,000 Total 10,000 45,000

b. where there is no expected loss.

Units
Direct materials 10,000
Less: normal loss -----
Expected output 10,000
Actual output (9,000)
Abnormal loss 1,000

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 PROCESS ACCOUNT
Particulars Units Amount Particulars Units Amount
₦ ₦
Direct materials 10,000 45,000 Normal loss -------- ---------
Transfer to finish 9,000 40,500
goods
Abnormal loss 1,000 4,500
Total 10,000 45,000 Total 10,000 45,000

Workings:
cost per unit = Total production cost
Expected output = ₦45,000
10,000 = ₦4.5

Dr Abnormal loss account Dr

₦ ₦

Process Account 4,500 Profit & loss account 4,500

Illustration
OGO OLUWA operates manufacturing process account, in a given period, the following data were
recorded:
Input materials: 10,000 units
Cost incurred ₦45,000
Output 9,000 units
Loss at normal level 1,000 units

Required:
Determine the cost output in the following operation conditions:
a. Actual output is 8,600 and actual loss 400
b. Actual output is 9,200 and actual loss is 800 units
SOLUTION
(a)
Units
Input materials 10,000 .
Less normal loss (10%) (1000)
Expected output 9,000
Actual output 8,600
Abnormal loss 400

PROCESS ACCOUNT
Particulars Units Amount Particulars Units Amount
₦ ₦
Direct materials 10,000 45,000 Normal loss 1,000 ----------
Abnormal loss 400 2,000
Transfer to finished 8,600 43,000
goods

Total 10,000 45,000 Total 10,000 45,000

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Dr Abnormal loss account Cr
₦ ₦
Process Account 2,000 Profit and Loss Account 2,000

Workings:
Total production cost Abnormal loss = 400 x ₦5 = ₦2,000 Expected output Expected output
= Cost per unit
= ₦45,000 Finished goods = 8,600 x ₦5 = ₦43,000
9000 units = ₦5

(b) ABNORMAL GAIN

Units
Input materials 10,000
Less: normal loss (10%) 1,000
Expected output 9,000
Actual output 9,100
Abnormal gain 100

PROCESS ACCOUNT
Particulars Units Amount Particulars Units Amount
₦ ₦

Direct materials 10,000 45,000 Normal loss 1,000 ------

Abnormal loss -------- -------
Abnormal gain 100 500 Transferred to 9,100
finished goods
Total 10,100 45,500 Total 10,100 45,500

ABNORMAL GAIN ACCOUNT

₦ ₦
Profit and loss account 100 Process account 100

ILLUSTRATION.
HAWAL is a production company that produces a product called T & T in one process. An expected normal
loss is 10% and all scrap unit are sold for ₦3. The company's operating information is given as follows:

Units 3,000
Direct materials cost ₦19,400
Direct labour ₦10,000
Production overhead is 120% of direct labour
Transfer goods to finished goods department is 8,600 units

Required: a. prepare the process account for product T&T.

b. prepare scrap account and
c. prepare abnormal gain/loss account

SOLUTION
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Units
Input materials 3000
Less: normal loss (10%) 300
Expected output 2,700
Actual output 2,800
Abnormal gain 100

PROCESS ACCOUNT
Particulars Units Amount Particulars Units Amount
₦ ₦
Direct materials 3000 19,400 Normal loss 300 900
Direct labour ------ 10,000 Transfer to 2,800 42,000
finished goods
Production overhead 12,000 -----------
Abnormal gain 100 1,500 ----------
Total 3,100 42,900 Total 3,100 42,900

Workings
Scrap value = 300 units x ₦3 = ₦900

Cost/ unit = Total production cost minus scrap value

Expected output =₦41,400 - ₦900
₦2,700 = ₦15.
Abnormal gain scrap value = 100 units x ₦3 = ₦3,00

Scrap Account
₦ ₦
Process (abnormal loss) 900 Abnormal gain 300
Cash/bank 600
900 900

Abnormal gain account

₦ ₦
Scrap value 300 Process Account 1,500
Profit & loss 1,200
1,500 1,500

Equivalent Production
Equivalent Production represents the production of a process in terms of completed units. In other words, it
means converting the uncompleted production into its equivalent of completed units. The term equivalent
unit means a notional quantity of completed units substituted for an actual quantity of incomplete physical
units in progress, when the aggregate work content of the incomplete units is deemed to be equivalent to that
of the substituted quantity, (e.g. 100 units of 70% completed = 70 completed units).
The principle applies when operation costs are being apportioned between work- in-progress and completed
output. Thus in each process an estimate is made of the percentage completion of any work-in-progress. A
production schedule and a cost schedule will then be prepared. The work-in- progress is inspected and an
estimate is made of the degree of completion, usually on a percentage basis. It is most important that this
estimate is as accurate as possible because a mistake at this stage would affect the stock valuation used in
the preparation of final accounts. The formula of equivalent production is: Equivalent units of work-in-
progress = Actual no. of units in progress of manufacture X Percentage of work completed For example, if

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70% work has been done on the average on 200 units still in process, then 200 such units will be equal to
140 completed units. The cost of work-in-progress will be equal to 140 completed units.

Calculation of Equivalent Production:

Following steps are worth noting in its calculation under different methods:
Method I:
Under this method opening work-in-progress is stated in equivalent completed units by applying the
percentage of work needed to complete the unfinished work of the previous period. Then number of units
started and completed (i.e. units started less
closing stock) are added. Further equivalent completed units of closing work-in-progress are also added to
get the equivalent production.

Method II
Under this method units completed during the period (i.e. units started + opening stock units—closing stock
units) are added to the units of closing stock completed during the period and out of the total units, opening
stock units completed in previous year are deducted to get the units of equivalent production.

Method III:
Under this method units of uncompleted input are added to the units of incomplete work in opening stock
and out of the total units, incomplete work in closing stock are deducted to have units of equitant production.
Often in a continuous process there will be opening as well as closing work-in-progress which are to be
converted into equivalent of completed units for apportionment of process costs. The procedure of
conversion of opening work-in-progress will vary depending upon which method of valuation of work-in-
progress is
used. valuation of work-in-progress can be made in the following ways depending upon the assumptions
made regarding the flow of costs:
(a) Average Cost Method,
(b) FIFO,
(c) LIFO and
(d) Weighted Average Method.

ILLUSTRATION 1
FACE 2 FACE Ltd. is a manufacturing company. The operation result of the firm in 2009 is give as follows:
₦
Direct materials (5,000 units) at 3.3 per unit
Production overhead 5,580
There was no opening stock. 4000.units were completed during the period which subsequently was
transferred to the next process. The closing stock of 1000 units was only 60% competed with respect of
materials and conversion cost.
Required: using Average cost method,
a. determine the equivalent units.
b. determine the cost per unit of the equivalent units.
c. statement of equivalent unit.
d. process Account

Solution

a. Equivalent units

Cost element Equivalent unit in W.I.P Total effective units Total cost Cost/unit
₦ ₦

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materials 60% x 1,000 = 600 + 4,000 = 4,600 16,500 3.6
Conversion 60% x 1,000 = 600 + 4,000 = 4,600 12,940 2.8
6.4
Statement of Evaluation
Units Cost/unit Total
₦ ₦
Completed units 4,000 6.4 25,600
Closing W.I.P:
Materials 600 3.6 2,160
Conversion 600 2.8 1,680 3,840
29,440

PROCESS ACCOUNT
Element Units Amount Element Units Amount
₦ ₦
Direct materials 5,000 16,500 Transferred to finished 4000 25,600
goods
Direct labour 7,360 W.I.P c/f 1000 3,840
Production overhead 5,580
Total 5,000 29,440 29,440

ILLUSTRATION 2
The production and cost data of Harith for the month of June of year 2008 wereb as follows:
₦
Materials 422,400
Labour 395,600
Production overhead 225,000
Total cost 1,043,000
Production was 8,000 fully completed units and 2,000 partly completed. The degree of completion of the
2,000 units work in progress was:
Materials 80%
Labour 60%
Production overhead 50%
Required: calculate the following:
a. The value of completed production.
b. The value of work-in-progress.
c. Statement of evaluation.
d. Process Account.
SOLUTION
Cost element Equivalent unit in W.I.P Total effective units Total cost Cost/unit
₦ ₦
Materials 80% X 2,000 = 1,600 + 8,000 = 9,600 422,400 44
Labour 60% X 2,000 = 1,200 + 8,000 = 9,200 395,600 43
P/Overhead 50% X 2,000 = 1,000 + 8,000 = 9,000 225,000 25

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Statement of Evaluation
Units Cost/unit Total
₦ ₦ ₦
Completed units 8,000 112 896,000
Materials 1,600 44 70,400
Labour 1,200 43 51,600
P/overheads 1,000 25 25,000 147,000
1,043,000
PROCESS ACCOUNT
Element Units Amount Element Units Amount
₦ ₦
Direct materials 10,000 422,400 Transferred to finished 8,000 896,000
goods
Direct labour 395,600 W.I.P c/f 2,000 147,000
Production overhead 225,000

Total 10,000 1,043,00 10,000 1,043,000

0

COSTING TECHNIQUES
MARGINAL COSTING AND ABSORPTION COSTING.

MARGINAL COSTING
Marginal Costing could be defined as the accounting system in which variable cost are charged to cost unit
and fixed cost for the period are written off in full against the aggregate the aggregate contribution. It is a
technique of controlling by bringing out the relationship between profit & volume.

The ICMA has defined the marginal cost as “the amount at any given volume of output by which aggregate
costs are changed if the volume of output is increased or decreased by one unit.
Thus it is clear that increase/decrease in one unit of output increases / reduces the total cost from the existing
level to the new level. This increase / decrease in variable cost from existing level to the new level is called
as marginal costing words marginal cost means the change in the total costs due to change in output y one
unit – single unit.
Marginal costing is also known as direct costing, contributory costing & incremental costing.

FEATURES OF MARGINAL COSTING

• Elements of cost are differentiated between fixed costs & variable costs
• Only the variable or marginal cost is considered while calculating product cost
• Stock of F/G & WIP are valued at variable cost
• Contribution is the difference between sales & marginal cost
• Fixed cost do not find place in the product cost
• It is a technique of cost recording and cost reporting
• Profitability of various products is determined in terms of marginal contribution

Advantages of Marginal Costing

Constant in Nature – marginal cost remains constant per unit of output whereas fixed cost remains constant
in total.
Pricing Decisions – It assists the management in fixing the prices based on marginal costing.
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Determination of Profits – It is very important in determination of profits especially in export oriented
firm.
Break Even Point – The point where neither profits nor losses have been made is known as BEP. It can be
determined only on the basis of marginal costing.
Fixing responsibility – Responsibility cab be fixed easily using the technique of marginal costing.
Cost Control – Marginal costing helps management in cost control. Classification of costs in to fixed and
variable helps in greater control in costs
Cost reporting – the reporting of the management is more meaningful as the reports are based on sales
figures rather than production.
Decision making – Marginal costing helps the management in taking a number of business decisions like
make or buy, discontinuance of a particular product, replacement of machines etc

LIMITATIONS OF MARGINAL COSTING

Difficult to separate fixed and variable cost- marginal costing needs costs to be classified in to fixed and
variable. Now there are many costs, the classification of which is difficult. The segregation becomes
difficult and cannot be done with precision

Over emphasis on sales – this technique depends upon sales and does not consider production. However
business depends upon production and sales.

Fixed costs ignored – it ignores fixed costs in the value of finished goods and work in progress. The
understating of costs affects profit and loss a/c and also the balance sheet

Not suitable for long term - Marginal costing is suitable for short run. It is desirable that in long term profit
should be based of full cost basis and not on marginal costs
.
Cost control – at times marginal costing is not an effective tool for cost control. In fact budgetary control
and standard costing are more effective tools in controlling costs

Not applicable to contract costing – marginal costing is not applicable to contract costing, since it ignores
fixed cost in valuation of work in progress. This will not serve the purpose.

Not acceptable for tax – Income tax authorities does not accept the financial statement prepared on
marginal costing for tax computation.

ABSORPTION COSTING TECHNIQUES

Absorption costing or otherwise known as full costing is a costing techniques in which all cost either fixed
or variable are absorbed by the total unit produced. it not only includes the cost of materials and labour, but
also both variable and fixed manufacturing overhead costs. it is mainly used for reporting purposes i.e. for
financial and tax reporting.
Components of Absorption costing.
Under the absorption method of costing ( a.k.a. full costing) the following cost go into the product.
Direct material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead.
Advantages of Absorption Costing
1. It provides a more complete picture of the total cost of a product by including both direct and indirect
costs.
2. Helps in determining the total actual cost of goods sold and the cost of inventory on balance sheet.
3. Allows a company in to understand the full cost of each product or service it provides.

Disadvantages.

16
1. It may not accurately reflect the incremental costs associated with producing an additional unit of a
product, as it includes fixed overhead costs that do not vary with production volume.
2. It can lead to distorted cost data if there are significant changes in production volume.
3. May not provide as much information for management decision-making as variable costing.

COMPARISON BETWEEN MARGINAL COSTING AND ABSORPTION COSTING.

Comparison chat
Basis for Comparison Marginal Costing Absorption Costing
Meaning Marginal costing is a Absorption costing is a
technique that assumes only technique that assumes both
variable costs as product variable costs and absorption
cost. and fixed costs as product
cost.
What it's all about? Variable cost is considered as Both fixed costs and variable
product cost and fixed costs costs is considered as product
is assumed as a cost for the cost.
period
Nature of overheads Fixed cost and variable cost In the case of absorption
overheads, costing, production,
distribution and selling &
administration.
Most important aspect Contribution per unit Net profit per unit
Purpose To show forth the emphasis To show forth the accuracy
of contribution to product and fair treatment of product
cost cost.
How is it presented? By outlining the total Most conveniently for
contribution. financial and tax reporting
Determines The cost of next unit The cost of each unit.
Opening & Closing stock Since the emphasis is on the Since emphasis is on each
next unit, change in unit, change in opening/
opening/closing stock does closing stocks affects the cost
not affect the cost per unit. per unit.

ILLUSTRATION.
In a period, 2000 units of A/Z were produced and sold. cost and revenue of product A/Z were recorded as
follows:
₦
Sales 100,000
Production cost:
Variable cost 35,000
Fixed production cost 15,000
Admin and selling overhead:
Fixed overhead cost 25,000

Required: prepare income statement base on:

a. Marginal costing
b. Absorption costing.

SOLUTION

a. Income Statement (Using Absorption costing technique)

₦ ₦
Sales 100,000
17
Less: production cost:
Fixed production cost 15,000
Variable production cost 35,000 50,000

Gross profit 50,000

Less admin and selling overhead 25,000

Net profit 25,000

b. Income Statement (Using Marginal costing techniques)

₦ ₦

Sales 100,000
Less production cost:
Variable cost of production 35,000
Contribution Margin 65,000
Less fixed cost:
Fixed production cost 15,000
Fixed admin & selling overhead 25,000 40,000
Net profit 25,000

ILLUSTRATION 2
SILVER & CO. manufactures and sells flash-light.
The following data were given for the year ended 31/05/2011
₦
Selling price per flash-light 10
Direct cost per flash-light:
Direct labour cost 1.5
Direct expenses 1
Direct material cost 3.5
Fixed production cost 6,864
Fixed selling and Distribution 1,560
Total number of flash-light produced during the period was 3,432 units.
Variable Selling & Distribution is 4% of sales revenue.

Required: prepare income statement of SILVER & CO. using:

a. Absorption costing technique.
b. Marginal costing technique.

Workings
Unit sold is = unit produced minus closing inventory = 3,432 - 312 = 3,120

Cost per unit = production cost

Unit produced = ₦27,456
3,432 = ₦8
Variable selling & Distribution
4/150 x 31,200/1 = ₦ 1,248 Cost per unit of closing inventory= 20,592
3,432 = ₦6
18
Under and Over Absorption of Fixed Production Overhead
If the firm operating cost differs from it normal capacity ( i.e. capacity variance)
then the issue of over and under absorption of fixed production or factory overhead will arise. Under the
marginal costing techniques, under and over absorption of fixed factory overhead has no relevant because
fixed cost is consider as a periodic cost therefore charged to contribution margin. However, under the
absorption costing techniques, under and over absorption of fixed factory is adjusted against the cost of
goods sold ( i.e. before determining the gross profit). If capacity variance is favourable (i.e. over absorption),
the amount is deducted from the total cost of goods manufactured and sold. But where the variance is
unfavourable (under absorption) the amount is added back.

The rate of fixed production overhead is determined as follows:

Rate = Fixed Production Overhead
Normal Activity Level
Illustration
Lamesco is a manufacturing company that produces wrist-watch. The normal annual level of production on
which the fixed production overhead is absorbed is 9,600 units. Previous operating data of the company is
given below:

Number of Wrist-watch produced = 10,000 units.

Number of Wrist-watch sold = 9,000 units
Selling price per single watch = ₦12
Variable manufacturing cost = ₦7
Selling and Admin expenses:
Fixed cost ₦5,000
Variable cost is 5% of total sales
Fixed production overhead budgeted and incurred is ₦20,160

Required.
Prepare Income statement of Lamesco company for the year ended 30/6/2013, using,
A) Marginal costing technique.
B) Absorption costing techniques.

SOLUTION
Lamesco Company Ltd
Income statement for the year ended. (Using marginal costing technique)

₦ ₦
Sales (₦12 x 9,000) 108,000
Less: variable cost of production:
Variable cost of sales (₦7 x 10,000 units) 70,000
Less: closing stocks ((₦7 x 1,000) 7,000
63,000
Add: variable selling & Admin expenses (5%x ₦108,00) 5,400 68,400
Contribution margin 39,600
Less: total fixed cost
Selling & Admin fixed cost 5,000
Manufacturing fixed cost 20,160 25,160
Net profit 14,440

Absorption Costing
₦ ₦

19
Sales 108,000
Less: cost of sales:
Variable cost of sales 70,000
Fixed production overhead (₦ 2.1 x 10,000) 21,000
Less: closing inventory (₦9.1 x 10,000) 9,100
81,900
Less: over absorption (₦ 2.1 x 400) 840 81,060
Gross profit 26,940
Less: selling & admin expenses;
Fixed selling & admin expenses 5,000
Variable selling & admin expenses 5,400 10,400
Net profit 16,540

Workings
1. Fixed production per unit = ₦20,160
9,600 = ₦ 2.1

2. Determination of over/ under absorption

Budgeted units = 9,600
Actual production = 10,000
400 = over absorption.
3. Price per closing inventory
Total production cost ₦91,000
Unit produced = 10,000 units = ₦9

ILLUSTRATION 2
Makera Feeder Ltd. which manufactures breastfeeding material (Feeder) started operation this year. The
budget for the two (2) quarters of the year is given below.
₦ ₦
Sales (20,000 units) 400,000
Manufacturing cost of goods sold:
Variable cost of production 240,000
Fixed production overhead 60,000 300,000
Gross profit 100,000
Selling and admin expenses:
Fixed cost 20,000
Variable ( 3% of sale revenue) 12,000 32,000
Net profit 68,000

The following information were also available

Period 1st quarter 2nd quarter
Production 24,000 units 18,000 units
Sales 18,000 units 21,000 units

You are required to prepare operating statement for each of the periods on the following basis:
a) Where all fixed cost are treated as period cost.
b) Where fixed manufacturing overhead is absorbed into product at the rate and selling and administrative
costs are treated as period cost.

SOLUTION
MAKERA FEEDER LIMITED.
Income Statement for the 1st Quarter of the Year (using marginal costing technique)
₦ ₦

20
Sales (₦ 20 x 18,000) 360,000
Less: variable cost of sales (₦12 x 24,000) 288,000
Less: closing stock (₦12 x 24,000) 72,000
216,000
Add: variable selling & admin ( 3% x ₦36,000) 10,800 226,800
Contribution margin 133,200
Less: total fixed cost;
Fixed manufacturing 60,000
Fixed selling & Admin 20,000 80,000
53,200

Absorption Costing
₦ ₦

Sales 36,000
Less: cost of sales:
Variable production cost 288,000
Fixed production overhead (₦3 x 24,000) 72,000
360,000
Less: closing stocks (₦15 x 600) 90,000
270,000
Less: over absorption (₦3 x 4,000) 12,000 258,000
Gross profit 102,000
Less: selling & admin expenses:
Fixed cost 20,000
Variable cost of selling 12,000 32,000
Net profit 70,000

WORKINGS:
Fixed production overhead per unit = ₦60,000
20,000 = ₦3

Over absorption = budgeted unit = 20,000

Actual production = 24,000 = 4,000 units
Cost per unit of closing inventory = 288,000
24,000 = ₦12

Operating Statement of the 2nd of The Year ( Absorption costing method)

₦ ₦
Sales (₦20 x 21,000) 420,000
Less: cost of sale
Opening stock (₦15 x 6000) 90,000
Variable manufacturing cost (₦12 x 18,000) 216,000
Fixed production overhead (₦3 x 18,000) 54,000
360,000
Less: closing stocks (₦15 x 3,000) 45,000
315,000
Less: over absorption 6,000 309,000
Gross profit 111,000

Less: selling & admin expenses:

Fixed selling & admin expenses 20,000
Variable selling & admin expenses (5% x 420,000) 12,600 32,600

21
Net profit 78,400

Marginal Costing 2nd Quarter

₦ ₦
Sales (₦20 x 21,000)
420,000
Less: Variable cost of production
Variables 216,000
Add: opening stock (₦12 x 6,000) 72,000
288,000
Less: closing stock (₦12 x 3,000) 36,000
252,000
Add: variable selling (5% x 420,000) 21,000
273,000
Contribution margin 147,000

Less: Total fixed costs 60,000

Fixed selling & admin 20,000 (80,000)

Net profit 67,000

INTEGRATED AND NON-INTEGRATED ACCOUNTING SYSTEM.

INTEGRATED (INTEGRAL) ACCOUNTING SYSTEM

Integral or Integrated system is a system of accounting under which only one set of account books is
maintained to record both the Cost and Financial transactions. The system implies the merger of both cost
and financial accounts in one set of books.
The two sets of account books merge into a composite system. CIMA, London defines Integral system as a
system in which the financial and cost accounts are interlocked to ensure that all relevant expenditure is
absorbed into the cost accounts.

The system of accounting has the following advantages:

(i) There is no need for reconciliation because there will be only one figure of profit or loss as there is only
one set of books.
(ii) This system is economical because it avoids duplication of recording the transactions in two separate set
of books.
(iii) Accounting information is readily available and the correctness of the data is automatically checked.
(iv) It enables the introduction of mechanised accounting.
(v) A better understanding exists among the staff.

Basic Features of Integral System:

(a) There is no need for cost ledger because all control accounts are maintained in the financial ledger.
(b) There is no need to open a Cost Ledger Control Account because both the aspects (i.e., debit and credit)
of all transactions are recorded in respective accounts.
(c) Subsidiary ledgers i.e., Stores Ledger, Work-in-Progress Ledger and Finished goods ledger are
maintained as is done in non-integrated accounting. In addition, a Sales Ledger (containing personal
accounts for each customer) and a Purchase Ledger (containing personal accounts for each supplier) are also
maintained.
Overhead ledger is maintained to contain separate accounts for factory, administration and selling and
distribution overhead.
(d) A control account for each subsidiary ledger is maintained in the general ledger.

22
The important control accounts are as follows:
(i) Stores Ledger Control Account;
(ii) Work-in-Progress Ledger Control Account;
(iii) Finished Goods Ledger Control Account;
(iv) Wages Control Account;
(v) Factory Overhead Control Account;
(vi) Administrative Overhead Control Account;
(vii) Selling and Distribution Overhead Control Account;
(viii) Sales Ledger Control Account;
(ix) Purchase Ledger Control Account.
(e) The balances of overheads Control Accounts represent under or over absorption of overheads which are
transferred to Profit and Loss Account.
(f) The profit or loss as per Profit and Loss Account is transferred to Profit and Loss Appropriation Account.
(g) The degree of integration must be determined in advance. Some business firms may integrate the cost
and financial accounts up to the stage of prime cost or factory cost while other firms integrate the two
completely.
(h) A suitable coding system is generally developed to serve the purposes of both cost accounts as well as
financial accounts.
(i) There should be an agreed accounting procedure in respect of treatment of provision for accruals, prepaid
expenses and other adjustments necessary for preparing interim accounts.

Essential Prerequisites for Integrated Accounting System:

The essential prerequisites for integrated system include the following:

(a) Degree of Integration:
The degree of integration of the two sets of accounts should be determined. It is the management which has
to decide on full or partial integration. Full integration changes the entire accounting records.
(b) Suitable Coding System:
A suitable coding system must be developed to serve the accounting purposes of both financial and cost
accounts.
(c) Accounting Policy:
An agreed routine with regard to the treatment of provision for accruals, pre-paid expenses, other
adjustments necessary for the preparation of interim accounts.
(d) Co-ordination:
Prefect co-ordination should exist between the staff responsible for the financial and cost aspects of the
accounts and an efficient processing of various accounting documents should be ensured
.
ILLUSTRATION

GOODNESS Manufacturing Ltd. operates Integrated Accounting system. An operational information for
2006 provided the following information.

Opening and Closing Balances

30/11/06 31/12/06
₦ ₦
Raw Materials 8,600 7,580
Work-in Progress 2,800 2,375
Finished goods stock 5,250 6,045
Debtors 4,600 5,570
Creditors for raw materials 3,800 4,710
Fixed assets at book value 3,000 2,500
Bank transaction for the month of December 2006 are:
₦
23
Bank balance as at 30/11/06 750
Receipts from debtors 13,780
Payments made:
Direct labour 3,200
Creditors for raw materials 4,480
Production Overhead 2,700
Admin overhead 350
Selling and distribution overhead 1,150
Production overhead is absorbed into the cost of production on the basis of a budgeted rate of 80% of direct
labour cost, and finished stocks are valued at factory cost.

Required: You are required to:

1. write up the following control Account. (a) Raw material stock (b). W.I.P (c) Finished goods (d)
Production overhead.
2. Prepare the profit/loss Account and Balance Sheet.

SOLUTION
Dr Raw material Account Cr
₦ ₦
Balance b/d 8,600 W.I.P 6,410
Creditors 5,390 Balance c/d 7,580

13,990 13,990

Dr Work in progress Account Cr

₦ ₦
Balance b/d 2,800 Finished goods 12,595
Bank 3,200
Production Overhead 2,560
Raw materials 6,410 Balance c/d 2,375

14,970 14,970

Dr Debtors Account Cr
₦ ₦
Balance b/d 4,600 Bank 13,780
Sales (profit/loss) 14,720 Balance c/d 5,570

19,320 19,320

Dr Creditors Account Cr
₦ ₦
Bank 4,480 Balance b/d 3,800
Balance c/d 4,710 Raw material purchased 5,390

9,190 9,190

Dr Fixed Asset Account Cr

24
 ₦ ₦
Balance b/d 3,000 Depreciation ( profit/loss) 500
Balance c/d 2,500

3,000 3,000

Dr Finished Goods Account Cr

₦ ₦
Balance b/d 5,250 Cost of sale (profit/loss) 11,800
W.I.P 12,595 Balance c/d 6,045

17,845 17,845

Dr Bank Account Cr
₦ ₦
Balance b/d 750 W.I.P 3,200
Creditors 4,480
Production Overhead 2,700
Administration Overhead 350
Selling & Distribution Overhead 1,150
Balance c/d 2,620

14,500 14,500

Dr Administration Overhead Cr
₦ ₦
Bank 350 Profit/Loss 350

Dr Production Overhead Account Cr

₦ ₦
Bank 2,700 Work-In-Progress 2,560
Production Overhead Absorbed (p/l) 140

2,700 2,700

Dr Selling and Distribution Account Cr

₦ ₦
Bank 1,150 Profit/Loss Account 1,150

Profit & Loss Account

₦ ₦
Sales 14,720
Less: cost of sales (11,800)
Gross profit 2,920
Less: depreciation 500
Admin overhead 350
Selling & Distribution overhead 1,150 (2,140)
Net profit 780

25
BALANCE SHEET AS AT 32/12/2008
₦ ₦
Fixed Assets 2,500
Current Assets:
Raw materials 7,850
W.I.P 2,375
Finished goods 6,045
Debtors 5,570
Bank 2,620
24,190
Less: Current Liabilities (4,710) 19,480
21,980
Financed by:
Capital 21,200
Net profit 780
21,980
Workings : Ascertainment of capital =
Raw materials 8,600
W.I.P 2,800
F.G 5,250
F.A 3,000
Bank 750
25,000
Less liabilities 3,800
21,200

NON INTEGRATED ACCOUNTING SYSTEM

Non integral system is a system of accounting where two separate sets of account books are maintained; one
recording costing transactions and the other financial transactions.

CIMA London defines Non – Integral system as, “a system in which the cost accounts are distinct from the
financial accounts, the two sets being continuously kept in agreement by the use of control accounts or made
readily reconcilable by other means.” Under this system cost accounts restricts it’s recording to only those
transactions which relate to the product or service being provided. Hence items of expenses which have a
bearing with sales or, production or for that matter any other items which are under the factory management
are the ones dealt with in such accounts.

Non Integrated Accounting Systems contain fewer accounts when compared with financial accounting
because of the exclusion of purchases, expenses and also Balance Sheet items like fixed assets, debtors and
creditors. Items of accounts which are excluded are represented by an account known as cost ledger control
account.

The important ledgers to be maintained in cost accounting department are:

(a) Cost Ledger –This is the principle ledger of the cost department in which impersonal accounts are
recorded and made self-balancing by maintaining therein a Control Account for each subsidiary ledger.

(b) Stores Ledger – It contains an account for each item of stores entries for which are made from the
invoice, goods received note, material requisitions, material received note etc. Accounts in respect of each
item of stores show receipt, issue and balance in physical as well as in monetary terms.

(c) Work-in-Process Ledger – This ledger is also known as job ledger, it contains accounts of unfinished
jobs and processes. All material costs, wages and overheads for each job in process are posted to the
26
respective job account in this ledger. The balance in a job account represents total balance of job/work-in-
process.

(d) Finished Goods Ledger – It contains an account for each item of finished product manufactured or the
completed job. If the finished product is transferred to stores, a credit entry is made in the work-in-process
ledger and a corresponding debit entry is made in this ledger.

PRINCIPAL LEDGERS
The subsidiary books maintained under non-integrated system of accounting are:
(1) Stores ledger: It is used to record both the quantity and amount of receipts, issues and balance of
materials and supplies. It consists of all store accounts.

(2) Payroll and wage analysis book: It is used to record the wages. The basis for recording the transactions
are (a) clock cards,(b) time tickets, and (c)piece work tickets.

(3) Job ledger: It is used to record the material cost, wages, and overheads incurred in respect of a job.

(4) Finished goods stock ledger: It is used to record the receipt of finished goods from production
department, the sale and stock of finished goods both in terms of quantity and value.

(5) Standing order ledger: It is used to record overheads incurred.

(6) Debtors’ Ledger: It contains personal accounts of all trade debtors.

(7) Creditors’ Ledger: It contains personal accounts of all trade creditors.

CONTROL ACCOUNTS

The following important accounts are maintained under non-integrated accounting system:

 General ledger adjustment account: It is also known as cost ledger control account or nominal
ledger control account. In this account transactions with only one entry is recorded and contra
appears in financial book. All transactions of income and expenditure which originate in the financial
Accounts must be entered in the ledger for eventual transfer to Cost Accounts and total of this
account will be equal to total of all the balance of the impersonal accounts.

On the CREDIT SIDE of this account are recorded

 Opening Balance of materials, work in progress and finished stock
 Expenses of material, wages, direct expenses & all types of overheads
 Profit transferred from Costing P&L A/c

On the DEBIT SIDE of this account are recorded

 Returns of materials to supplier
 Sales income and
 Balancing entries of P&L account(Loss) and closing stock values.

(2) Stores ledger control account: It is debited with purchase of materials for the stores and credited with
issues of material.

(3) Wages control account: In this account the wages accrued and paid and allocation of wages in this
account are recorded.

27
(4) Work in progress control account: It includes of all direct materials, direct wages, direct expenses,
special purchases and expenses.

(5) Finished goods stock ledger control account: This account represents finished goods stock ledger
transactions in total form.

(6) Selling, distribution, and administration overhead control account: This account represents selling,
distribution and administration overheads.

ENTRIES TO RECORD TRANSACTIONS UNDER NON-INTEGRATED SYSTEM

 Materials purchased
Stores Ledger Control account Dr
To General Ledger Adjustment a/c

 Material purchased for a special job

Work in Progress Control a/c Dr
To General Ledger Adjustment a/c

 For issue of direct materials to production department

Work in Progress Control a/c Dr
To Stores Ledger Control account

 For issue of indirect materials to production departments

Production Overhead Control a/c Dr
To Stores Ledger Control a/c

 For returning materials to supplier

General Ledger Adjustment a/c Dr
To Stores Ledger Control a/c

 For materials returned from production department

Stores Ledger Control a/c Dr

To Work in Progress Control a/c

 For materials transferred from Job- 1 to Job- 2

No entry is passed in control account but in work in progress ledger the following Entry is passed
Transferee Job- 2 a/c Dr
To Transferor Job- 1 a/c

 For total salary and wages paid

Wages Control a/c Dr
To General Ledger Adjustment a/c


 For allocation of direct and indirect labour
Work in Progress Control a/c (DL) Dr
Overhead Control a/c (IDL) Dr
To Wages Control a/c

 For recording direct expenses

28
Work in Progress Control a/c Dr
To General Ledger Adjustment a/c

 For recording overhead incurred and accrued

Overhead Control a/c Dr
To General Ledger Adjustment a/c
(12) Carriage Inward (Direct to Factory)
Production Overhead Control A/c Dr
To General Ledger Adjustment a/c

LIMITATIONS OF NON-INTEGRATED ACCOUNTING

1. The Financial transactions other than cost incurred are not recorded in the system.
2. Transactions involving payment other than that of cost are not included in the system E.g.: loss on
fixed assets.
3. There is always a difference between the profits reported as per the cost accounting system and the
Financial Accounting System.

ILLUSTRATION

A company operates interlocking financial and cost accounting book keeping system. The following
balance and data relates to cost ledger.

₦ ₦
Opening balance
Financial ledger control account 24,283
WIP control account 10,652
Raw Material control account 9,318
Finished goods control account 4,313
24,283 24,283

The following data concerns the period operations

₦
Raw materials purchase 41,286
Direct wages 20,444
Indirect wages 6,135
Selling & Distribution salaries 5,157
Admin salaries 9,106
Admin expenses 7,213
Production expenses 8,680
Selling & distribution expenses 5,217

Store Issues ( raw materials):

Production 36,291
Factory maintenance 2,958
Office maintenance 1,307
Production overhead absorbed 19,800
Admin overhead absorbed by finished goods 17,200
Selling & Dist. overhead absorbed by sale 10,100
29
Factory cost of finished goods 78,280
Cost of finished goods sold 92,500
Sales 143,67

Required: (a) Write up all the necessary accounts.

(b) Prepare the costing profit & loss Account.
(c) Prepare the closing trial balance.

Solution:

Financial Ledger Control Account

₦ ₦
Sales (P & L) 143,670 Bal b/d 24,283
Raw materials cost 41,286
Admin overhead expenses 7,213
Production overhead expenses 8,680
Selling & Distribution overhead 5,217
Wages 26,579
Salaries 14,263
Bal c/d 26,248 Profit /Loss 42,377
169,898 169,898
Balance c/d 26,248

Raw Materials Account

₦ ₦
Bal b/d 9,318 WIP 36,291
Production overhead 2,958
Admin overhead 1,307
Financial ledger account 41,286 Bal c/d 10,048

50,604 50,604
Bal b/d 10,048

Work-In-Progress Control Account

₦ ₦
Bal b/d 10,625 Finished goods 78,280
Wages 20,444
Raw materials 36,291
Production overhead 19,800 Bal c/d 8,907

87,187 87, 187

Bal c/d 8,907

Finished goods control Account

₦ ₦
Bal b/d 4,313 Cost of sales 92,500
Admin overhead 17,200
WIP 78,280 Bal. b/d 7,293

30
 99,730 99,730
Bal b/d 7,293

Wages Control Account

₦ ₦
Financial Ledger Account 26,579 WIP Account 20,444
Production overhead 6,135

26,579 26,579

Admin Overhead Control Account

₦ ₦
Salaries 9,106 Finished Goods 17,200
Financial Ledgers Account 7,213 Overhead Adjustment 446
Raw Material 1,307

17,646 17,646

Salaries Control Account

₦ ₦
Financial Ledger Account 14,263 Selling & Distribution O/H 5,157
Admin Overhead 9,106

14,263 14,263

Profit & Loss Account

₦ ₦
Cost of sales 102,600 Financial Ledger Account 143,656
Financial ledger b/d (P&L) a/c 42,377 Overhead Adjustment Account 1,307

144,977 144,977

Selling & Distribution Account

₦ ₦
Salary Control Account 5,157 Cost of sale 10,100
Financial Ledger Account 5,217 Selling & Distribution Overhead 274

10,374 10,374

Production Overhead Account

₦ ₦
Wages 6,135 W.I.P 19,800
Financial Ledger Account 8,680
Raw Materials 2,958
Overhead Adjustment Account 2,027

19,800 19,800

Overhead Adjustment Account

₦ ₦
Selling & Distribution Overhead 274 Production Overhead 2,027
31
 Admin Overhead Account 446
Profit & Loss Account 1,307

2,027 2,027

Cost of Sales Control Account

₦ ₦
Selling & Distribution Account10,100 Profit & Loss Account 102,600
Finished Goods Account 92,500

102,600 102,600

Closing Trial Balance

₦ ₦
Financial Ledger Account 26,248
Raw material 10,048
W.I.P 8,90
Finished goods 7,293
26,248 26,248

BUDGET AND BUDGETARY CONTROL.

INTRODUCTION
Budgets are an important tool of profit planning. The main purpose of budgetary control is to present a
general view of budgeting as a device of planning and the preparation of various types of budgets. Let us
study in this chapter how the technique of
Budgetary control is employed to control cost.

OBJECTIVES
The first stage in planning and control system is setting the objectives which are defined as the broad and
long range desired state or position in the future. They are motivational or directional in nature and are
expressed in qualitative terms. The fundamental
objectives are identification of the line of business, customer satisfaction, employees welfare and so on.
Thus, they are the basic policies.
The second stage in the planning process is specifying the goals. The term goal, as an element in planning,
represents targets, specific in quantitative terms to be achieved in a specific period of time.

DEFINITION
CIMA has defined budgets as - “financial and / or quantitative statement, prepared and approved prior to a
defined period of time of the policy to be pursued during that period for the purpose of attaining a given
objective, it may include income,
expenditure and the employment of capital.

TYPE OF BUDGET
With reference to planning and control refers to a comprehensive and coordinated budgets generally known
as master budget. In operational terms overall budgets has several components. A master budget normally
consists of three types of budgets.
i) Operating budgets
ii) Financial budgets
iii) Special decision budgets
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Another classification of a master budget is -
1) Fixed / static budget and
2) Flexible / variable / sliding budgets.

i) Operating budgets - It relates to the physical activities / operations of a firm such as sales, production,
purchasing, debtors collection and creditors payment schedules. In specifics terms, on operating budget has
the following components -
1) Sales Budget
2) Production Budget
3) Purchase budget
4) Direct labour budget
5) Manufacturing expense budget and
6) Administrative and selling expenses budget and so on.

ii) Financial budgets - It is concerned with expected costs receipts / disbursement, financial position and
results of operation. It has the following components :
1) Budgeted income statement
2) Budgeted statement of retained earnings
3) Cash Budget and
4) Budgeted balance sheet

a) Operational Budgets
1) Sales Budget - The Sales Budget is the most important budget and forms on the basis on which all other
budgets are build up. This budget is a forecast of the quantities and values of sales to be achieved in a budget
period. Every effort should be made to ensure that its figure are as made to ensure that its figure are as
accurate as possible because this is usually the starting budget on which all the other budgets are built up.
The Sales Manager should be made directly responsible for the preparation and executive of this budget.
While preparing sales budget, the following factors are to be taken into consideration -
1) Past sales figures and trends
2) Relative Products Profitability
3) Pricing policies
4) Production capacity
5) Market Research studies

Single Product Sales Format

Product Qty to be produced Selling price/ unit Sales value
A XX XX XX
B XX XX XX
C XX XX XX

2) Production budget :
Production budget is a forecast of the total output of the whole organization broken down into estimates of
output of each type of product with a scheduling of operations by weeks and months to be performed and a
forecast of the closing finished stock. The budget may be expressed in quantitative. i.e. weights, units etc. or
financial rupees or both. This budget is prepared after taking into consideration the estimated opening stock,
the estimated sale and the desired closing finished stock of each product.

3) Purchase Budget : When we prepared the production budget, it is necessary to determine the different in
puts required to carry out the production activities. The purchase budget shows the number of units of
material either direct or indirect and the services to be purchased during the budget period. It also contains
the monetary value of units of materials to be purchased for producing the goods and services as per the
production budget. The following factor has to consider while preparing the purchase budget.
1) Sales and Production budgets
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2) Expected changes in prices of raw materials
3) Storage facilities
4) Inventory level, economic ordering quantity.
5) Nature of availability of raw material.

4) Direct Labour Budget - This budget shows the number of employees and or number of labour hours i.e.
skilled, semi-skilled, unskilled for the production required to produce or sell, the budgeted output and or
budgeted sales. The following Factors are to be considered while preparing direct labour budget as -
1) Output and sales
2) Capital expenditure programmes
3) Research and Development activities.
This budget also provides the monetary value of labour as well as appropriate wages rate are used.
5) Manufacturing expenses Budget : This budget gives an estimate for the work overhead expenses to be
incurred in a budget period to achieved the production target. It includes the cost of indirect labour indirect
material and indirect work expenses. It may be classified into fixed cost, variable cost and semi variable cost
also. In preparing this budget, fixed overheads can be estimated on the basis of past information, and
variable expenses are estimated on the basis of budgeted output.
6) Administrative and selling expenses Budget : The administrative budget provides an estimate of the
expenses of all the central offices and of management salaries. It can be prepared with the help of past
experience and anticipated changes. Such expenses may be fixed and related to the different executives.
Selling expenses budget is a forecast of selling and distribution expenses for the company’s products during
the budget period. This budget is closely connected with the sales budget as the selling and distribution
expenses will be in proportion to sales.
ii) Financial Budget :

Cash Budget : This budget provides an estimate for the anticipated receipts and payments of cash during
the budget period. This budget is prepared by the Chief Accountant under the guidance of management
because whenever there is any
requirement of financial help arranged by the management people to meet the production and sales
programmes. This budget is prepared in two parts i.e. (i) Receipts and (ii) Payment.) Receipts include cash
sales, collection from debtors, dividend received, & any other receipts.
ii) Payments include payment to creditors, cash purchases, income tax paid, purchase of assets and any other
miscellaneous expenses.

FORMAT OF CASH BUDGET

Particulars January February March April
₦ ₦ ₦ ₦
Opening balance Xxx
A Receipts:
Sales income Xx Xx Xx xx
Other income Xx Xx Xx xx
Loan Xx ------ ------ -----
Total estimated cash Xxx Xxx Xxx xxx
receipts
B Disbursement
Raw materials purchase Xx Xx Xx Xx
Operating expenses Xx Xx Xx Xx
Machinery purchase Xx Xx Xx Xx
Loan payment & interest Xx Xx Xx Xx
Total estimated cash Xxx Xxx Xxx xxx
payment
C Net Cash Flow ( A - B) Xxx Xxx Xxx xxx
Add: opening balance Xx --------- ------- -------
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 Closing balance Xxx Xxx Xxx xxx

Illustration 1
A company has a cash balance of ₦27,000 at the beginning of March and you are required to prepare a cash
budget for March, April and May having regard to the following information.
 Creditors gives one month credit
 Salaries are paid in the current month.
 Fixed cost are paid one month in arrears and include depreciation charges of ₦5,000 per
month.
 Credit sales are settled as follows: 40% in the month of sale, 45% in the subsequent month
and 12% in the following month. the balance is treated as trade discount.

Additional information

Loan received at 20th March is ₦25,000. Interest is to be paid at 30% of the principal in every month.

Month Cash sales Credit sales Credit purchase Salaries Fixed overhead
₦ ₦ ₦ ₦ ₦
January ------- 74,000 55,200 9,000 30,000
February ------- 82,000 61,200 9,000 30,000
March 20,000 80,000 60,000 9,500 30,000
April 22,000 90,000 69,000 9,500 30,000
May 25,000 100,000 75,000 10,000 32,000

Required:
a) Calculate the amount of direct purchase in each of the month of March, April and May.
b)Prepare cash budget for March, April and May.

Solution

CASH BUDGET

MARCH APRIL MAY

₦ ₦ ₦
Opening balance 27,000 -------- -------
A) Receipts:
Cash sales 20,000 22,000 25,000
Credit sales 77,780 81,840 90,100
Loan 25,000 --------- --------
Total estimated receipts 149,780 103,840 115,100
B) Disbursement:
Purchase 61,200 60,000 69,000
Salaries 9,500 9,500 10,000
Fixed overheads 25,000 25,000 27,000
Interest paid on loan ------ 625 625
Total disbursement 95,700 95,125 106,625
Net Cash-flow (A-B) 54,080 8,715 8,475

ILLUSTRATION 2.
ABC LTD. has the following transaction record for the month of June, July, and August.

June July August

₦ ₦ ₦
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Sales 45,000 50,000 60,000
Wages 12,000 13,000 14,500
Overhead 8,500 9,500 9,000

Information in regard to direct materials is as follows:

June July August September
₦ ₦ ₦ ₦
Opening stock 5,000 3,500 6,000 4,000
Materials usage 8,000 9,000 10,000 -------

a. Only 10% of sale is in cash and the balance is to be received in the following month. ₦29,500 was
received in June as sales proceed for the month of May.
b. Wages are paid in the month they are incurred.
c. Overhead includes ₦1,500 per month for depreciation and they are settled in arrears. ₦6,500 was paid in
June for May.
d. Payment for direct materials are made in the month of purchase.
e. Opening cash balance in June is ₦11,750
f. A tax liability of ₦25,000 is to be paid in July.

Require:
1. Calculate the amount of direct purchase in each of the month of June, July and August.
2. Prepare the cash budget for the month of June, July, and August.

Solution.
Computation of direct purchase.
June July August
₦ ₦ ₦
Materials usage 8,000 9,000 10,000
Add: closing stock 3,500 6,000 4,000
11,500 15,000 14,000
Less: opening stock (5,000) (3,500) (6,000)
Purchase 6,500 11,500 8,000

CASH BUDGET
June July August
₦ ₦ ₦
Opening balance 11,750 ------- --------
Receipts:
Cash sales 45,000 50,000 60,000
Credit sales (90%) 29,500 40,500 45,000
Total estimated receipts 86,250 90,500 105,000
Disbursement:
Wages 12,000 13,000 14,500
Overhead ( -1,500/month as dep.) 6,500 7,000 8,000
Purchase 6,500 11,500 8,000
Tax bill ------- 25,000 ------
Total disbursement 25,000 56,500 30,500
Closing balance 61,250 34,000 74,500

VARIANCE ANALYSIS
Variance represents the difference between Actual cost and Standard cost. If actual cost (AC) is less than
(SC) standard cost, this sign of efficiency and the difference is termed as “favourable” variance (F). IF the

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AC is more than SC this is sign of inefficiency and the difference is turned as “unfavourable” variance (A) /
adverse. They need not necessarily be good or bad from the point of view of firm. Such a qualitative
evaluation can be made only after the underlying cause of the variance has been determined.
Variance as a control device, are calculated to assign responsibility for deviations from the standard cost and
thus, to control the cost. For the purpose of control, variances are classified as controllable and
uncontrollable cost variances. If a variance can be traced with the responsibility of a particular individual, it
is said be a controllable variance. If variance stems from causes beyond the control of responsible
individual, it is said to be uncontrollable.
The three elements of the costs of such enterprises.
i) Material variances
ii) Labour variances
iii) Overhead Variances

Cost variances
Material Variances :
1) Material Cost Variances (MCV) -
Material Cost variances is the difference between the standard cost of materials that should have been
incurred in manufacturing the actual output and the cost of materials that has been actually incurred. It is
nothing but the difference between the standard cost of material specified for the output achieved and the
Actual Cost of direct material used.
MCV = SP X SQ - AP X AQ

2) Material Price Variance (MPV)

Material Price Variance is that portion of material cost variance which is due to the difference between the
standard price specified for the Actual Output and the actual price paid. MPV will occur when then the
actual price paid for the purchase of materials
is different from the standard price.

MPV = AQ( SP- AP) OR (SP X AQ) - (AP X AQ)

3) Material Usage Variance (MUV)

Material usage variance is that portion of material cost variance, which is due to the difference between the
standard quantity specified for the actual output and the actual quantity used for actual output. It is the
second component of MCV it measures how well the material are utilised in production. This variance
occurs when actual usage of material differ from standard usage.

MUV = SP ( SQ - AQ) OR (SP X SQ) - (SP X AQ)

4) Material Mix Variance (MMV) :

Material Mix Variance is that portion of material usage variance which is due to difference between the
standard mixture specified for actual output and the Actual Mixture. It is possible that a product may use
more than one type of raw material or combination of materials. This combination is called as Material Mix.
It is necessary to compute standard mixture of each input for actual output known as Revised Standard
Quantity(RQ).
5) Material Yield Variance (MYV) :
Material Yield Variance is that portion of material usage variance which is due to the difference between
standard yield specified and the actual yield.
MYV= Standard Quantity - Revised Quantity ×Standard Price

ILLUSTRATION
ORIADE Corporation produces product called ''Oroki''. The data below relate to its standard and actual
result of an operation for a particular period.

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Standard price of materials, ₦10 per kg.
Standard usage (consumptions) per unit of output is 5kg of materials.
Actual price of materials, ₦12 per kg.
The actual production for the period is 100 units, while the actual materials consumed is 450 kg.

Required, Calculate, a) Materials Cost Variance (b) Materials Price Variance (c) Materials Usage Variance.

SOLUTION

KEYS:
SP = ₦10
SQ = 5kg
AP = ₦12
AQ = 450 kg.
Unit produced = 100 units. Therefore,

(a) Material Cost Variance (MCV) = SP X SQ - AP X AQ

= ₦10 x 500kg - ₦12 x 450kg
= ₦5,000 - ₦5,400
= ₦400 (Adverse)

(b) Materials Price Variance = AQ (SP- AP) OR (SP X AQ) - (AP X AQ)
= 450kg (₦10 - ₦12)
= 450kg (₦ -2)
= ₦900 (Adverse)

(c) Materials Usage Variance = SP ( SQ - AQ) OR (SP X SQ) - (SP X AQ)

= ₦10 (500kg - 450kg)
= ₦10 (50kgs)
= ₦600 (Favourable)
1) Labour Cost Variances -
It is the second component of standard cost. Labour cost variance is the difference between the standard cost
of labour specified for output achieved and the actual cost of direct labour used.

It is calculated as SR X SH - AR AH
Where,
SH = Standard Hours
SR = Standard Rate
AH = Actual Hours
AR = Actual Rate

When the actual cost of labour is less than the standard cost then LCV is favourable and when the actual cost
is more than the standard cost then LCV is adverse. This variance is caused by the variation in the efficiency
of labour and wage rate. LCV is further divided in 2 points.
- Labour Efficiency Variance (LEV)
- Labour Rate Variance (LRV)
2) Labour Efficiency Variance (LEV) (Time Variance) :
LEV is that portion of LCV which is due to the difference between the standard hours specified for the
actual output and the actual hours used for the production of actual output.
LEV = SR (SH - AH)

When the actual hours is less than the standard hours then LEV is favourable and vice-versa. The labours are
used for production purpose either it is of one kind or may be different kinds. If only one kind of labour is

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used and the variance show the difference then it is due to yield. On the other hand if different kinds of
labour is used and the variance shows the difference due to the mix. Therefore labour efficiency variance is
again divided into
- Labour Yield Variance
- Labour Mix Variance
3) Labour Rate Variance (LRV)
Labour Rate Variance is that portion of labour cost variance which is due to the difference between the
standard rate specified for the actual output and the actual rate paid.
LRV = AH (SR - AR) OR (SR X AH) - (AR X AH)

When the actual rate is less than the standard rate then LRV is favourable and when the actual rate is more
than the Standard Rate the LRV is adverse. LRV may be caused by several factors such as changes in basic
wage rate, different method of wage payment, overtime and so on.
4) Labour Mix Variance (LMV) :
Labour Mix Variance is that portion of the Labour Efficiency Variance which due to the different between
the Standard Mix Specified for the actual output and the Actual Mix. Mostly this variance is arises when two
or more types of workers are used. It is necessary to compute the standard mix of each type of worker.
Which is known as Revised Standard Hour, before calculating the actual variance. It is assumed that to
produce a material 3 types of labour are
required A, B & C.
Revised Hours of A= Total Hours of Actual Mix ×Standard Hours of A
Total Hours of Standard Mix
LMV= Revised Hours - Actual Hours ×Standard Rate
= RH  AH  SR

ILLUSTRATION 2
The following information relates to product ''Double-Decker'' of SKY Manufacturing Company Limited.
Standard rate of wages per hour is
Standard hours is 300 hours
Actual rate of wages per hour is ₦12
Actual Hours Worked is 200 hours.
Required:
Compute the (3) three variance that may arise from the information above.

Solution.
KEY
SR = ₦10
SH = 300 hours
AR = ₦12
AH = 200 hours
(a) LCV = SR X SH - AR x AH
= ₦10 x 300 hrs - ₦12 x 200 hrs
= ₦3,000 - ₦2,400
= ₦600 favourable

(b) LRV = AH (SR - AR) OR (SR X AH) - (AR X AH)

= (₦10 x 200 hrs) - (₦12 x 200 hrs)
= ₦2,000 -₦ 2,400
= ₦400 Adverse

(c) LEV = SR (SH - AH)

= ₦10 (300 hrs - 200 hrs)

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= ₦10 (100hrs)
= ₦1000 Favourable

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