Cost Accounting, B.Com. 1st Semester, Majoj in Accountancy

Unit-I: Fundamental of Principles of Cost Accounting:

Syllabus: Fundamental Principles of Cost Accounting: Meaning, Scope, Objectives, Advantages, Limitations,; Cost Accounting Vs. Financial Accounting; Elements of Cost, Cost Sheet, Cost Unit, Cost Centre.

1. Meaning/ Concept of Cost: (The term ‘cost’ has wide variety of meanings.) Generally cost refers ‘price’, but in management terminology cost refers sacrifice or expenses incurred to obtain something.

            Cost has been defined by the Chartered Institute of Management Accountants (CIMA), London as “the amount of expenditure incurred or attributed on a given thing.” It includes direct material cost, direct labour cost, direct and indirect expenses.

British Institute of Cost and Works Accountants defines, “Cost is the amount of expenditure (actual or notional-estimated) incurred on or attributable to a given thing.”

The AICPA Committee on Terminology refers to of cost as, “The amount measured in money of cash expended or other property transferred, capital stock issued, service performed, or a liability incurred, in consideration of goods or services received or to be received.”

It is cleared that the meaning and concept of cost is very broad and flexible.

Cost Accountancy:

          The cost accountancy is the science, art and practice of recording, classifying, summarizing cost information for the benefit of management for decision making and cost control.

           The Chartered Institute of Management Accountants (CIMA), London has defined Cost Accountancy as, “the application of costing and Cost Accounting principles, methods and techniques to the science, art and practice of costing and the ascertainment of profitability. It includes the preparation of information derived there from for the purpose management decision-making.”

            Thus, Cost Accountancy is the science, art and the practice of cost accountant.

Cost Accounting: The Chartered Institute of Management Accountants (CIMA), London has defined Cost Accounting as, “the process of accounting for cost from the point at which expenditure is incurred or committed to establish of its ultimate relationship with cost centre and cost units. In its usages, it embraces (relates with) the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of activities carried or planned.”

                        It is concerned with accumulation, classification, analysis and interpretation of cost data for three major purposes: (i) Ascertainment of Cost, (ii) Operational Planning and Control, and (iii) Decision-making.

                                                                                                                                                                         

Scope of Cost Accountancy/ Accounting:

            The scope of any subject refers to the various area of study included in that subject. The scope of cost accounting is very wide and includes the following:

1. Costing: Costing has been defined by the Institution as, ‘the technique and process of ascertaining cost.’                                It enables the management to know the cost of production and selling, that is the total cost of various products and services and also to know how the total cost is constituted.

This definition emphasizes two important aspects:

(i)                 The technique and process of costing: The technique of costing involve two distinct steps namely; (a) collection and classification of cost according to various elements and (b) allocation and apportionment of expenses. which cannot be directly charged to production.

(ii)               Ascertainment of Cost: It involves three steps, viz., (a) collection and analysis of expenses, (b) measurement of production at different stages and (c) linking up of production with the expenses.

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2. Cost Accounting: It is the process of accounting for cost which begins with recording of expenditure and ends with the presentation of statistical data. It is a formal mechanism by means of which costs of products and services are ascertained and controlled.   

3.       Cost Control: Cost control is the guidance and regulation by executive action of the costs of operating and undertaking. It aims at guiding the actual performance towards the line of targets; regulates the accrual if they deviate or vary from the target; this guidance and regulation is done by an executive action.

4.   Budgeting: A budget is a blue print of a plan expressed in quantitative terms. It is the monetary or/and quantitative expression of business plans and policies to be pursued in the future period of time. The term budgeting is used for preparing budgets and other procedures for planning, co-ordination and control of business enterprise. It is the technique for formulating budget

5.      Cost Audit: Cost audit means the verification of cost accounts and a check on the adherence (obedience) to the cost accounting plan. 

Function of Cost Accounting or Cost- Accountant:

            According to Blocker and Weltemer ‘Cost Accounting is to serve the management in the execution of policies and in comparison of actual and estimated result in order that the value of  each policy may be appraised and change to meet the future conditions”:

            Following are main function of cost accounting:

(i)                 To work out cost per unit of the different products manufactured by the organisation;

(ii)               To provide an accurate analysis of this cost;

(iii)             To work out the wastage in each process of manufacture and to prepare reports as may be necessary to assist in the control of wastage;

(iv)             To provide necessary data for the fixation of selling price of commodities manufactured;

(v)               To compute profit earned on each of the products and to advise management as to how these profits can be improved;

(vi)             To help management in control of inventory so that there may be minimum locking up of working capital;

(vii)           To install and implement cost control systems like Budgetary Control and Standard Costing for the control of expenditure on materials, labour and overheads;

(viii)         To advise management on future expansion.

Objectives of Cost Accounting:

The definition given by the CIMA brings out the vital point that the Cost Accounting has the following objectives:

(i)                 Ascertainment of cost and determining the selling price.

(ii)               Cost control i.e. keeping cost under check/control.

(iii)             Ascertaining profitability and profit earned on each activity including ascertaining causes that lead to a particular figure; and

(iv)              Collection and presentation of such information or statements as are required the management in its task of planning and making decision. The decisions are:

(a)          fixing prices under normal and special circumstances ;

(b)          determining priorities of the product;

(c)          deciding whether a component will be bought from the market or made within the factory itself;

(d)         deciding on the best processes of manufacture etc.

Advantages of Cost Accounting: (in brief)

The main advantages of cost accounting are given below:

(i)                 Profitable and unprofitable activities are disclosed by the cost accounting.

(ii)               It enables a concern to measure the efficiency and then to maintain it and to improve it.

(iii)             It provides information upon which estimates and tenders are based (preparation of quotation of a big tender.)

(iv)             It guided future production policies.

(v)               It helps in increasing profits.

(vi)             It enables a periodical determination of profits or losses without stock taking.

(vii)           It provides data for comparing cost   in different period, different product etc.

(viii)         Helpful to the government.( in fixing taxes and in formulating various policies)

(ix)             Helpful to the Consumers. ( by reducing cost , reducing price)

(x)               Efficiency of Public Enterprises (PSUs) (supply of at possible minimum cost)

Costing – an Aid to Management:

            Planning, decision-making, and control are three important functions of management. Cost Accounting is very helpful in performing these functions, which can be satisfactorily carried out by the Financial Accounting.

Planning: Planning is thinking in advance i.e. looking head and deciding in advance-what to do, how to do, when to do and who is to do. It is concerned with future activity and formulates budget to meet the objectives of the organisation.

Decision Making: Management has to make a choice of one course of action out of several alternative courses of action available, it involves decision making. Decision like- What should be the price, whether or not price should be reduce, whether to make or buy, whether a new product should be introduce etc. All the rational decisions are based on accounting information.

Controlling: controlling is part of management activity whereby managers compare actual performance against the planned performance, find out the deviations and take remedial steps to remove the deviations. Thus, control helps in correction. Planning and controlling are interlinked with each other because a manager cannot control unless he has planned a course of action.

            Cost accounting helps management in carrying out efficiently its functions by developing practical cost procedures that provide information useful in controlling the operations of the business enterprise. Cost accounting does this by analyzing, recording, standardizing, forecasting, comparing, reporting and recommending. Cost accounting methods supply the basis of factual information on which management can build up its planning and control. In fact, cost accounting is so closely allied to management that it is difficult to indicate where the work of cost accounting ends and managerial action begins.  

Limitations of Cost Accounting:

Cost Accounting like other branches of accounting is not an exact science but  is an art which based on reasoning and common sense. Thus, it may have some limitations. The main limitations of cost accounting are as follows:

(i)                 Dependent: Cost Accounting is not an independent system of accounts. It always depends on date provided by the Financial Accounting.

(ii)               Based on estimates: It is largely based on estimates like absorption of direct expenses or apportionment of expenses on estimate basis.

(iii)             Subjective: There is a scope for subjectivity on items like depreciation, valuation of closing stock etc.

(iv)             Ignore some important items: It dos not take into consideration of all items of expenses and incomes, e.g. items of purely financial  nature such as interest , financial changes, discount and loss on issue of shares and debentures.

(v)               Lack of uniform procedure: Different results may be arrived from the same information due to lack of uniform procedure.

(vi)             Expensive: Installation of Cost Accounting System is costly and expensive for small manufacturers.

Methods of Costing:  The methods of costing refer to the technique and processes employed in the ascertainment of costs.

1. Job costing:

2. Batch costing:

3. Process Costing:

4. Operating/Service Costing:

5. Unit/Single/Output Costing:

6. Contract Costing:

7. Multiple or composite Costing:

Techniques of Costing: The techniques of costing are the different ways of analyzing and presenting costs for the purposes of controlling costs and making managerial decisions irrespective of the methods of costing being used.

1. Marginal costing:

2. Direct Costing:

3. Absorption Costing:

4. Uniform Costing:

5. Standard Costing:

6. Budgetory Control:

7. Historical Costing:

Elements of Cost:

There are three broad elements of cost:

(i)      Material: The substance (thing, essence) from which the product is made is known as material. It may be in a raw or a manufactured formed. It refers to all commodities supplied to an undertaking. For the purpose of costing, materials may be classified into two broad categories as  Direct and Indirect Materials.  

(a)   Direct Material: Direct materials are those materials which can be conveniently identified with and can be directly allocated to a particular product, job or process. For examples: Timber in furnishing, cloth in garments, paper in books, brick and cement in building construction etc

(b)    Indirect Material: Indirect materials are those materials which can not be conveniently identified with and can not be directly allocated to a particular product, job or process.

(ii)    Labour: For conversion of materials into finished goods, human effort is needed; such human effort is called labour.  Labour can be direct and indirect.

(a)   Direct Labour: Direct Labour is that labour which can be readily identified with a specific job, contract or work order. It includes all labour directly engaged in converting raw-materials into finished product and is incurred wholly or specifically for any particular job, contract or work order.  Examples: Weaver in weaver unit, Tailor in ready made wear, Carpenter in furniture house, Baker in Bakery, Washer in dry-cleaner etc.

(b)   Indirect Labour: Indirect Labour is that labour which can not be readily identified with a specific job, contract or work order. It includes all labour indirectly engaged in converting raw-materials into finished product. Examples:. Foreman, cleaners, store keeper, supervisor, security-guard etc.  

(iii) Expenses: Cost incurred to attaint the finishing stage of the product other than material cost and labour cost.  Expenses may be direct or indirect.

(a) Direct Expenses: All direct costs other than direct material costs and direct labour costs are termed as direct expenses. These can be readily identified with and directly allocated to a particular product, job or process. Example: Excise duty, factory rent, Royalty based on production, hiring charge of machine etc.

(b) Indirect Expenses: All indirect costs other than indirect material costs and indirect labour costs are termed as indirect expenses. These can be readily identified with and directly allocated to a particular product, job or process. Example: Rent, Rates, and taxes; repair, insurance and depreciation, royalty based on sales etc.

Overhead: The term overhead includes indirect material, indirect labour and indirect expenses. Thus, all indirect costs are overheads.

Cost Unit: In preparing cost accounts it becomes necessary to select a unit with which expenditure may be identified. The quantity upon which cost can be conveniently allocated is known as a unit of cost or cost unit. The CIMA, London, defines a unit of cost as “a unit of quantity of product, services or time in relation to which costs may be ascertained or expressed”.

Cost Centre: According to the CIMA, London, cost center means “a location, person or item of equipment (or group of these) for which costs may be ascertained and used for the purpose of control.”

                                                            Thus cost centre refers to one of the convenient unit into which the whole factory has been appropriately divided for the purpose of costing.

Statement showing the methods of costing and cost unit:

Industry / Product	Method of costing	Cost unit
1. Cement	Unit/ Process	Per ton
2. Automobile	Process	Per unit
3. Chemical	Process	Per ton. Per kg.
4. Power, Electricity	Operating	Per kwh/ per unit
5. Nursing home	Operating	Per bed per day or week
6. Road transport (Goods)	Operating	Per ton per km. or per mile
7. Road Transport ( passenger)	Operating	Per passenger per km.
8. Steel	Process	Per ton
9. Coal	Single	Per ton
10. Bicycles	Multiple	Each unit
11. Bridge construction	Contract	Per contract
12. Interior decoration	Job	Per job
13. Advertising	Job	Per job
14. Furniture	Multiple	Per unit
15. Building	Job	Per square foot
16. Cable	Process	Per metre
17. Brewery	Process	Per dozen bottle/ per gallon/ per barrel
18. Gas	Process	Per cubic foot/ metre
19. Soft drinks	Process	Per bottle/ per can
20. Brick kilns	Single / output	Per 1,000 bricks
21. Pharmaceutical	Process	Per 1,000 tablets
22. Canteen	Operating	Per dish / per meal
23. Toy making	Batch	Per batch
24. Ship building	Contract	Per ship

Cost Sheet: Cost sheet is a document which provided for the assembly of the estimated details cost in respect of cost centers and cost units. It analyses and classifies in a tabular form the expenses on different items for a particular period.  Additional columns may also be provided to show the cost of a particular unit pertaining to each item of expenditure and the total per unit cost.

            Cost sheet may be prepared on the basis of actual data (Historical Cost Sheet) or on the basis of estimated data (Estimated Cost Sheet) depending on the technique employed and the purpose to be achieved.

The Objectives of a cost sheet are:

(i)            It indicates the break-up of the total cost by elements, i.e. material, labour, overheads, etc;

(ii)          It discloses the total cost and cost per unit of the units produced;

(iii)         It facilitates comparison;

(iv)         It helps the management in fixing selling prices;

(v)          It acts as guide to the management and helps in formulating production policy;

(vi)         If enables to keep control over cost of production;

(vii)        It helps the management in submitting quotations or preparing estimates for tenders.

(viii)      It is a simple and useful medium of communication of cost to the various level of management.

Specimen of a Cost Sheet

Cost Sheet for the period ………………………                        Production……….Units  

Raw Materials: Opening Stock of Raw Material Raw Materials purchases Cost of Materials available for use Less, Closing Stock of Raw Materials Cost of Raw Materials used/consumed Direct Labour/Wages Other Direct Expenses Prime Cost Factory Overheads: Indirect Materials Indirect Labour Storekeeper Salary Depreciation on Factory Building Depreciation on Factory equipments Insurance Repairs and Maintenance Power and Factory Lighting Oil and water Consumable stores Factory Rent Other Factory Overheads Gross Factory /Works Cost Add, Work-in-progress (opening) Less, Work-in-progress (closing) Factory/Works Cost Office and Administrative Overheads: Office Rent, Insurance Office Salary Office lighting Depreciation of Office premises Manager’s salary Directors’ salary Office Stationery Postage & Telephone Other Office Overheads Office Cost/ Cost of Production Add, Opening Stock of Finished Goods Less, Closing Stock of Finished Goods Cost of Goods Sold Selling and Distribution Overheads: Carries Outwards Salesmen’s salaries Traveling expenses Advertising Warehouse charges Cost of Sales/ Total Cost Add, Profit Sales	Details (Rs.)	Total Cost (Rs.)	Cost per Unit (Rs.)
	Xxxx Xxxx
	Xxxx xxxx
	Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx xxxx	xxxx Xxxx xxxx	Xx Xx Xx
		Xxxx    xxxx	Xx xx
	Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx Xxxx	xxxx Xxxx ( xxxx )	Xx xx
		Xxxx xxxx	Xx xx
	Xxx Xxx Xxx Xxx xxx	xxxx Xxx ( xxx )	Xx xx
		Xxxx xxxx	Xx xx
		xxxx	xx
		xx	x
		xxxx	xx

xxxxxxxxx

Unit –II: Material Cost and Control

Syllabus: Importance and need for material control; Material purchase procedure; Stores functions: receiving, inspecting, storing, issue of materials; materials costing- pricing  of receipts, pricing of issues: LIFO and FIFO ( and Standard price-3^rd year.) stores ledger, inventory control techniques- EOQ, level settings, ABC analysis, Perpetual (continuous) inventory system.

Materials:

            The term material simply means any commodity or substance which is processed in a factory in order to be converted into finished product. It is the first and most important element of cost. It includes: raw materials, components, tools, spare parts, consumables stores.

            Materials can be classified into two types:

(i)    Direct Material: All materials which become an integral part of the finish product and which can be conveniently assigned to specific physical unit is termed as ‘Direct Material’. These materials directly enter the production and form part of the finished product. For example, wood for furniture, bricks, stones and cement for house, cloth for garments etc.

      Direct materials include the following:

(a)    Materials specifically purchased for a job, process or order;

(b)   Parts and components used in assembling a product i.e. tyres of motor car, batteries for UPS etc.

(c)    Materials transferred from one cost centre to another;

(d)   Primary packing materials like, cartons, card-board boxes etc.

(ii) Indirect Materials: All those materials which cannot be classified as direct materials. Indirect materials cannot be directly allocated but are apportioned to the cost centres. Indirect materials are:

(a)  Consumables, lubricants, grease, oil etc;

(b)  Minor items like thread in dress making, nails in shoe making etc,

(c)  Small tools for general use.

Distinction between Direct Materials and Indirect Materials:

Direct Materials	Indirect Materials
1. It is a part of prime cost. 2. It is primary for the production. 3. It varies with changes in output. (Variable cost) 4. It can be controlled. 5. It can be identified with finished product.	1. It is a part of overheads. 2. It is supplementary for the production. 3. It remains fixed. ( Fixed Cost) 4. It cannot be easily controlled. 5. It cannot be identified with the finished product.

Material Control/ Material Cost Control:

According to the Indian Association of Materials Management, 64% of the cost of a product is constituted by the material cost. Thus, the importance of materials control lies in the fact that any saving made in the cost of materials will go a long way in reducing the cost of production and improving the profitability of a concern.

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            Material control is a system which ensures that right quality of materials is available in the right quantity at the right time and right place with right amount of investment. It is systematic control over purchasing, storing, and issuing of materials so as to have the minimum possible cost of materials. Thus, material control is exercised at three stages:-

(i)            Purchasing of materials- Purchasing control;

(ii)          Storing of materials- Store control;

(iii)         Issuing of materials- Issuing Control or material costing.

Purchase Control:

Purchase Control covers control on all aspects of purchase department. The purchase department plays a very important role in purchasing materials. The responsibilities for purchasing all types of materials are entrusted to this department.  Purchase department or purchasing may be centralized, decentralized and Centralized- Decentralized.

Centralized Purchasing: Centralized purchasing refers to purchase of materials under one purchase department headed by a competent purchase manager. All the purchases should be made by that department to avoid duplication, overlapping and the non-uniform procurement. All other departments which require materials and tools should send requisitions to the centralized purchasing department to make timely and suitable purchases.

Advantages of Centralized Purchasing:

1.           Bulk purchasing results in reduced price of materials on account of trade discount, economics in transporting;

2.           Better control on purchasing is possible;

3.           Specialized knowledge and skill personnel can be appointed;

4.           All records with regard to purchase are kept at one place under the supervision of the purchase officer.

5.           It avoids duplication and overlapping and helps in uniform purchasing.

Disadvantages of Centralized purchasing:

1. The benefits arising out of local purchase cannot be availed of;
2. Delay in purchasing and supplying;
3. Emergency purchases cannot be made under this system;
4. There are chances of misunderstanding between purchasing department and other departments;
5. It will lead to high initial cost or establishment cost of purchasing department.  

6.                                                                   

Decentralized Purchasing: Under decentralized purchasing system purchases are made by the different department independently. Decentralized purchasing is applicable to those manufacturing concerns which operate several plants in different locations manufacturing different products and each plant requiring different types of materials. Each department will have a purchasing authority who enjoys the freedom of making purchase of materials required by their department. 

Centralized-Decentralized System: Firms which have more than one plant located in and around heterogeneous products, adopt this system of purchasing. Though such plants produce different products there are some materials which are common to all plant. Under this system, purchases are partially centralized and partially decentralized but it is necessary to make clear that which type of materials are to be bought by the centralized buying officer and which type of materials by departmental buying officer.  

Procedure to be followed for procurement of materials till the payment of bill:

Storing of materials and Store control.

Meaning of store:

                          Storage refers to the act of storing materials for safe custody till these are issued to the production and others departments. The place where materials are kept is known as ‘store’. The person who is Incharge of store is known as ‘storekeeper’.

                          The ‘location’ of the store should be carefully planned out and it should be housed in a position which is very near to the Receiving Department so that transportation charges are at a minimum and should be convenient for the suppliers of materials too.

                          The ‘layout’ of the store should be divided into various racks, which should be further sub-divided into small space called ‘Bin’.

             

(II) Store Ledger Card/ Account:

(a)  Meaning: Store Ledger is kept in the Costing Department and is identical with the bin card expect that receipts, issues and balances are shown along with their money values. This contains an account for ever item of stores and makes a record of the receipts, issues and balances, both in quantity and value. Thus, this ledger provides the information for the pricing of materials issued and the money value at an time of each item in stores.

Are Bin Cards necessary at all? Explain.

                                                Some Persons argue that where a store ledger is maintained, the bin card is a duplicate record and as such it should not maintain. This is wrong and is against the basis principles of store accounting on account of the following reasons:

1. The storekeeper is responsible for the maintenance of stores and as such he should have a stock record under him.

2. The storekeeper is held responsible for the difference in the physical stock and the stock record, which can be shown by the Bin cards.

3. The store ledger is not kept up-to-date because posting of transactions are made periodically, where bin cards provide up-to-date balance of stock.

4. Bin cards and store ledger act as a cross check on each other because of stock disclosed by bin cards should be agree with the balance shown by the store ledger.

             Thus, the accuracy of both records is essential for store control.

Issuing Control or Material Costing- Issuing of Materials:

             Materials are kept in stores so that the storekeeper may issue them whenever these are required by the production departments. Materials issued from the stores should be price at the value at which they are carried in stock. But the issued materials may not be of one purchase rate. If the same purchased price is paid for all lots of a given material, no difficulty would be encountered in the valuation of that material when it is issued. But the price always changes in accordance with the market conditions. That is why it creates a problem for issuing department. There are many methods of pricing material issues, the most important being:

1.    First in First out (FIFO)

2.    Last in First out (LIFO)

3.    Highest in First out (HIFO)

4.    Next in First out (NIFO)

5.    Average Cost

6.    Inflated Price

7.    Specific Price

8.    Base Stock Method

9.    Replacement Price Method

10. Realisable Value Method

11. Standard Price Method

12. Market Price Method.

1. First in First out (FIFO): Under this method, the issues of materials are priced according to the chronological order of purchased rate of materials. The underlying principle is that purchase price of the earlier consignment is used first for issue of materials and once this consignment exhausts the price of the next consignment is taken up.   

Advantages of FIFO Method:

1. It is simple to understand and easy to operate;
2. It is suitable in the time of deflation (falling prices), due to lower replacement cost of the materials;
3. The value of closing stock will reflect current market price;
4. This method gives correct cost of materials consumed.

Disadvantages of FIFO Method:

1. Issue price do not reflect current market price;
2. If the prices fluctuate frequently, this method may lead to clerical errors;
3. During inflation, this method is not suitable due to high replacement cost of materials.

2. Last in First out (LIFO): This method is exactly the opposite of FIFO method. For pricing the materials issues the price of the latest batch or lot of materials is adopted. If this lot exhausts then the price of the earlier lot is made use of.

Advantages of LIFO method:

1. It is simple to understand and easy to operate;
2. This method is suitable during inflation (rising prices);
3. Issue price reflects current market price;
4. This method recovers cost from the production because actual cost material is charge to production.

Disadvantages of LIFO Method:

1. If the prices fluctuate frequently, this method may lead to clerical errors;
2. During deflation, this method is not suitable;
3. This method cannot be operated when the invoice price does not reach before issues are to be priced.

Techniques of Material Control:

             The important techniques used to exercise control over cost of materials are as follows:

1.    Level Setting,

2.    ABC Analysis,

3.    Economic Order Quantity (EOQ),

4.    Perpetual/ Continuous Inventory Control,

5.    VED Analysis,

6.    Input-output Ratio Analysis, etc.

1. Level Setting:

             This technique of material control is helpful in avoiding overstocking and understocking of materials in storeroom. The stock levels are fixed by the management and it is the duty of storekeeper to observe them. These levels are as follows:

(i) Re-order Level: This is the level at which a fresh order for materials are prepared and placed with a suppliers. This level is calculated by the following way:

Re-order Level = Minimum Level + ( Normal Consumption x Normal Re-order Period )

                                                                                                                                                                                                                                                                                                                                                                                                Or,  = Maximum usages x Maximum Reorder period.

(ii) Minimum Level (Safety Stock): This represent the minimum quantity of the material which must be maintained in hand at all times.

Minimum Level = Re-order Level - ( Normal Consumption x Normal Re-order Period )

(iii) Maximum Level: It is the level beyond which storage of raw materials are not allowed to go.

Maximum Level = Re-order Level + Re-order Quantity – ( Minimum Consumption x Minimum Re-order Period)

(iv) Danger Level: This level is fixed in between minimum level and zero level. This level is particularly fixed to control the materials during the period of emergency so that urgent and priority orders are not held up.

Danger Level = Average Consumption x Maximum Re-order Period for emergency purchases.

(v) Average Stock Level: The average stock level is calculated by the following formula:

Average Stock Level = ½ (Minimum Level + Maximum Level)

                                                                        or

                                    Minimum Stock Level x ½ of Re-order Quantity.

2. ABC Analysis:  (Selective Inventory Control) or Always Better Control Method:

             The concept of ABC analysis was developed by Pareto, an Italian philosopher in the nineteenth century. This analysis based on the principle of “Vital few & Trivial (worthless) many”. When this technique is used as a tool of material control, the materials are classified into three categories such as:

Category-A items: These items are small in number but high in usage value, where        these consist 8% of store but cover 75% of total cost of stores (Vital few).  

Category-B items: These items are medium in number and medium usage value, where            these consist 25% of store but cover 20% of total cost of stores (Normal item)

Category-C items: These items are high in number but low usage value, where   these consist 67% of store but cover 5% of total cost of stores (Trivial many)    

             According to this technique, a strict control is exercised over ‘A’ category materials under the supervision of an experienced person, a moderate control is exercised over ‘B’ category materials and relatively lesser degree of control over ‘C’ category materials. The object of carrying out ABC analysis is to develop policy guidelines for selective controls.

Advantages of ABC Analysis:

1. A strict control is exercised on costlier items;( in A category items)
2. It saves time & cost by exercising economic system of control over low value items (C category items)
3. It is suitable, when resources and staff are less.
4. It ensures optimum investment in inventory but placing frequent order of costlier items.
5. It helps in the maintenance of high inventory turnover rate.

3. Economic Order Quantity (EOQ):

             This technique of material control helps in deciding the purchase of most favourable quantity of materials when fresh suppliers are required. The quantity of materials to be ordered at a time is affected by two conflicting cost, termed as “Ordering cost” and “Inventory carrying cost”. The cost carrying inventory will be less when the quantity of materials bought is also less and vice-versa. Therefore, EOQ is the quantity of materials where Ordering cost of the materials and Carrying cost of the materials are minimum, hence total cost of the materials will be minimised.

             The following formula is used to calculate EOQ:

                        EOQ =                √  2AO

                                         

                                                          I

             Where,

                        A = Annual Usage/ Consumption

                        O= Ordering Cost per order.

                                                Ordering costs include:

                                         (i) Cost of  placing order,

                                                 (ii) Cost of Transportation,

                                         (iii) Cost of receiving goods,

                                         (iv) Cost of inspecting goods,

                                         (v) Cost of follow-up of orders.

                         I = Inventory Carrying Cost per unit.

                                      Inventory costs include:

(i)      Cost of store place/space;

(ii)     Cost of handling materials;

(iii)    Cost of insurance;

(iv)   Cost of investment in store;

(v)     Cost of deterioration and damage of store;

(vi)   Cost of store staff.                                       

Assumptions in EOQ:

1. The supply of goods is satisfactory, i.e. goods can be purchased whenever these are needed;
2. The quantity to be purchased by the concern is certain;
3. The prices of the goods are stable.
4. Ordering costs are constant;
5. Carrying costs are constant;
6. Lead period/ time is zero.

4. Perpetual/ Continuous Inventory control:

             This a technique of recording stores balances after every receipt and issue, to facilitate regular stock taking. Under this method the balance of materials as shown by the bin card and store ledger card is compared along with the actual quantity of materials in stock.  The book balance and the physically verified balance must agree with each other. The discrepancy if any, prompt action is taken to avoid such deficits.

             Under this system, to verify the materials on a regular basis, a team may be constituted which verifies the stock continuously throughout the year in accordance with a predetermined programme. Having verified the materials, a store audit note is prepared by the team.

Advantages of Perpetual Inventory Control:

1. The long and costly work of stock taking is avoided;
2. A detailed and reliable check on the stock is obtained;
3. It is not necessary to stop production during the period of stock verification;
4. Discrepancies are readily located and appropriate measures can be taken;
5. It helps in avoiding understocking and overstocking.

Limitations of Perpetual Inventory Control:

1. The system is expensive for a small concern;
2. The information about actual stock of a particular item on a particular day may not be available due some genuine reasons.

   

Distinction between Periodic Inventory System and Perpetual Inventory System:

Periodic Inventory System	Perpetual inventory System
1. It is periodical verification done at the end of the year.	1. It is a continuous process spread over the year.
2. It is ascertained on the basis of an actual count/ verification of materials.	2. It is ascertained on the basis of records.
3. It requires closing down of work for stock taking.	3. It does not require closing down of work for stock taking.
4. It does not facilitate the continuous stock checking.	4. It facilitates the continuous stock checking.
5. It is simple and inexpensive.	5. It is elaborate and expensive.
6. It is conducted by ordinary staff.	6. It is conducted by audit and account staff.

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Unit-III

Labour Cost and Control

Labour: Labour is a human resources and effort to convert materials into finished goods. Labour can be divided as direct labour and indirect labour.

Direct Labour: Direct labour is that labour which is directly engaged in the production of goods or services and which can be conveniently allocated to the job, process or unit.        According to ICMA, “Direct Labour cost is that cost which can be identified with and allocated to cost centres or cost units.”  For example, labour engaged in making the bricks, carpenter for making furniture etc.

Feature of direct labour:

1. Direct labour is a part of prime cost;
2. It can be attributed to finished goods;
3. Its cost can be identified with total cost of production;
4. It varies with change in output;
5. It can be controlled.

Indirect Labour: Indirect labour is that labour which is not directly engaged in the production of goods and services but which indirectly helps the direct labour engaged in production. ICMA defines indirect labour cost as “cost other than direct wages cost. For example, mechanics, supervisors, chowkidars, watchmen, sweepers, foremen etc.

Features of indirect labour:

1. It is as importance as direct labour;
2. Its cost can not be allocated but can only be apportioned;
3. It can not be identified with the finished product;
4. It does not vary with the change in production;
5. It cannot be controlled;

Its cost is treated as overheads.

Differences between direct labour and indirect labour:

Labour Cost:

             Labour cost is a second major element of cost. Research has shown that in majority cases labour cost constitute about 40% to 50% of total cost of production. It includes monetary benefits like basic wage, DA; deferred monetary benefits like pension, gratuity; non-monetary benefits ( fringe benefits) like canteen, housing; etc.

Components/ elements of Labour Cost:

             Labour costs represent the various items of expenditure incurred on workers by the employer and would include the following:

Control of Labour costs:

             Control of labour cost is not as easy as that materials cost. The human element in labour makes difficult the control of labour. Labour Laws in India are such that one can’t dispense with the labour even if not need it for some reason. Moreover, it is a perishable commodity and can’t be store like materials. Labour, once lost, cannot be recouped and is bound to increase the cost of production.

             The main aim of the control over cost is to keep labour cost per unit of out  as low as possible. Labour costs can be controlled by proper employment and there afterwards efficient utilization of labour force. Inefficiency of labour is also a cause of excessive materials and overhead costs. There are a number of departments in big industries which influence labour cost. The coordinated efforts of al such departments will be needed to control labour cost. These departments are:

1.    Personnel Department,

2.    Engineering Department,

3.    Time & Motion study Department,

4.    Time Keeping Department,

5.    Payroll Department &

6.    Cost Accounting Department.

1. Personnel Department: Personnel department is concerned with employment, transfer and discharge of employees. The department is headed by a responsible officer called Personnel Manager. The important duties of this department include recruitment, selection, training, placement, fixation of remuneration, performance appraisal. Different departments send their requisitions for placement of workers to personnel department and the department decides on the selection procedure to be followed. The department also keeps records of particulars of employees. The record is kept on a card known as Employee History Card.

             Functions of this department are as follows:

(i)            Recruitment and selection of workers.

(ii)           Training and development of workers.

(iii)         Orientation and placement of workers.

(iv)          Maintenance of personnel records.

Time Study: It may be defined as the observing time required to do a particular. It relates to fixing the standard time for doing a job under given condition. It is a means to achieve economy in time.

Motion Study: It is the study of the movement of an operator or a machine. It aims at eliminating unnecessary, ill-directed and inefficient motions of an employee or machine.

Distinction between Time Study and Motion Study :

Basis	Time Study	Motion Study
1. Meaning	It is a technique which is used to measure the time taken by a worker to perform a job.	It is the technique which involved close observation of the movement of the body and limbs to perform a job.
2. Purpose	Its purpose is to determine time normally required to perform a job and a fair day’s work.	Its purpose is to eliminate wasteful motions and determine the best way of doing a job.
3. Tools of study	It is conducted with the help of stopwatch.	It is conducted with the help of a movie camera.
4. Introducer	It was introduced by F.W. Taylor.	It was introduced by F.B. Gilberth.

Labour Turnover:

             The change in the labour force is known as labour turnover. Thus, labour turnover refers to mobility of employees from factory to factory for getting better opportunities in terms of earning and position. It denoted the percentage changes in the labour force of an organisation.

             Normal labour turnover is advantageous as it allows injection of fresh blood into the firm. But excessive turnover is not desirable because it increases cost of labour. This is because efficient and experienced workers leave the factory and new employees come and occupy their places. Naturally, the ability of such new workers is less as compared to that of the experienced workers. The desirable percentage of labour turnover is placed between 3 percent and 5 percent. 

Methods of measurement of Labour turnover:

Sometimes, flux rate can be calculated in the following way, when there is recruitment for expansion:

                               No. of separation + No. of accession

Flux rate =  ---------------------------------------------------------------- x 100

                                                                                    Average no. of employees during the year

Where,

              No. of Accession = No. of replacement + No. of new employment for expansion.

Special items in labour cost control:

1. Idle Time:

             Idle time is that time for which payment made but no direct production/ benefit is obtained by the employer. Hence, there is no production during idle time. The question of the idle time arises only when the payment is made on time basis. The difference between time booked and factory gate time is known as idle time. Therefore is calculated in the following way:

             Idle Time= Time keeping as per Time Card – Time booking as per Job Card.

Idle time is of two types:

(a) Normal Idle Time: Normal idle time is that time the wastage of which cannot be avoided; therefore the employer will have to bear the labour cost for this time. Reasons for normal idle time:

(i)    Time taken by the workers from the factory gate to reach the spot of production.

(ii)   Time leg between two consecutive works. ( for finishing one & starting the next.)

(iii)   Breaks allowed during the working hours. Such as tea , lunch break.

(iv)  Interruption of machineries.

(v)   Waiting for job, work etc,

(b) Abnormal Idle Time: It is that time the wastage of which can be avoided by taking proper precautions. Reasons:

(i)    Break down of machineries,

(ii)   Power failure,

(iii) Shortage of materials,

(iv) Unnecessary waiting for instruction, materials, tools etc.

(v)   Strikes & lock outs.

Causes of Idle Time:

(a)  Production causes:

(v)          Machine break down,

(vi)         Power failures,

(vii)        Waiting for work,

(viii)      Waiting for tools,

(ix)         Waiting for materials,

(x)          Waiting for instruction.

(b)  Administrative causes: ( due administrative decision):

(i)                                        No reduction in labour force during depression,

(ii)   Under utilization of capacity of plants.

(c)  Economic causes:

(i)     Seasonality of products,

(ii)    Non-availability of materials,

(iii)   Lack of demand,

(iv)   Period of depression.

Accounting treatment of Idle Time Cost in Cost Accounts:

1. Cost of normal idle time which is uncontrollable is treated as Direct Labour Cost for each job.
2. Cost of normal idle time which can be controlled is treated as Production Overheads.
3. Cost of abnormal idle time is not treated as part of cost and hence charged to Costing Profit and Loss Account.

Control of Idle Time Cost:

To exercise as effective control over idle time , the following steps are suggested:

1. Step: Fix the standards for normal idle time such as tea break, lunch break,
2. Step: Prepare Periodic Idle Time Report by showing reasons and cost to the management.
3. Step: Compare the actual idle time with standard idle time to find out the variance.
4. Step: Investigate the variance.
5. Step: Take the necessary corrective action promptly.

2. Overtime:

             Overtime is an extra time over and above the normal working hours. According to the Factories Act, 1949, a worker is entitled to overtime wages when he works for more than 9 hours on a day and more than 48 hours in a week. In India, overtime is to be paid at double the normal rate of wages. The additional amount paid on account of overtime is known as overtime premium.

             Overtime premium = Overtime Hours x Overtime Wage Rate.

Effects of Overtime premium on productivity:

             There are adverse effects of overtime on the productivity of the worker and on the cost of the production due to the following reasons:

(i)            Overtime is paid at a higher/double rate;

(ii)          Efficiency of the workers reduced in overtime work comparing to  normal time;

(iii)         Worker will adopt the habit of postponing the work to be done in overtime just to earn more wages, hence, fall in output during normal time;

(iv)         Regular overtime working has an adverse effect on the health of workers;

(v)          Expenses like lighting, cost of supervision, wear and tear on machinery etc. will increase disproportionately;

(vi)         It may lead to discontent (dissatisfaction) among workers if overtime is not distributed properly.

Therefore, overtime work should be avoided because jobs done in overtime cost more compared to the job done during normal hours. However, overtime cannot be totally eliminated because there are some genuine reasons when there is no other alternative but to do overtime work.

Circumstances under which overtime may arise/ Causes of overtime:

And,

Accounting treatment of overtime premium:

Circumstances/ Causes	Treatment of overtime premium
1. When it is desired at customer’s request to complete the work within specified time.	It should be charged directly to the job as Direct Labour Cost.
2. When it is required to increase the output as per general production programme.	It should be treated as Production Overheads.
3. When it is required to meet seasonal demand.	It should be treated as Production Overheads.
4. When it is required to increase the output to meet the additional market demand	It should be treated as Production Overheads.
5. When it is required to make up any short fall in production due to additional conditions such as flood, earthquake, breakdown of machinery etc.	It should not be treated as part of cost and hence charged to Costing Profit and Loss Account.

Control over Overtime Work:

             Keeping in view the disadvantages of overtime work, it is necessary that proper control should be exercised in order to keep it minimum possible level. The following steps are to be taken in this regard:

1.    A proper control should be exercised during normal hours to ensured that overtime is not allowed when normal output is not achieved during normal working hours.

2.    A statement of overtime should be prepared by showing why, where and how much overtime is required.

3.    Fix an upper limit of overtime for each category of workers.

4.    Do not allow any overtime without prior sanction from competent authorities.

5.    Compare the actual rate of output produced during the overtime period with the normal rate of output.

6.    Periodical report on overtime along with wagesheet should submit to the top management.

3. Leave with pay:

             Leave days with pay constitute unproductive working days. According to the Factories Act, workers are entitled to annual leave with full pay for specified number of days in a year. This may include casual leave, medical leave, special leave, etc. The cost of paid leave cannot be charged to any work order or cot unit, since no work is done during this period. It is, therefore, treated as indirect labour cost and charged to overheads.

             Alternatively, leave wages may be treated as direct labour cost when the wage rate is inflated (overstated). This is done by estimating in advance the amount of leave wages and spreading it over the actual number of working hours to give it an inflated hourly rate.

                                               

4. Absenteeism:

Methods of wages payments:

             The two principal methods of wages payments are as follows:

1.    Time Rate Wage System, and

2.    Piece Rate Wage System.

1. Time Rate Wage System: Under this system wages are paid on the basis of time worked by the workers. There are different type of time rate wage system, few of them are:

(i) Flat time rate: It is the oldest methods of wage payment. Under this system, workers are paid at a flat rate on the basis of time they are worked.

             Earning/ wages = Actual time worked x Time rate

(ii) High day rate: Higher rate is given to attract the efficient workers who can easily be motivated to achieve predetermined standards of efficiency which is relatively high.

(iii) Graduated time rate: Under this method wages are based on cost of living index of the workers.

Advantages of Time Rate Wage System:

1. It is easy to understand and simple to operate.
2. It provides guaranteed time wages to workers.
3. Worker can concentrate on the quality rather than the quantity.
4. There is less damage and wages of materials and tools.

Disadvantages of Time Rate Wage System:

1. It does not act as an incentive to workers.
2. It tends to increase overheads and labour cost due low production.
3. There develops a tendency to go slow during normal working hours in the hope of getting more wages by overtime.
4. High degree of supervision is required.

2. Piece Rate Wage System: Under this system wages are paid on the basis of the number of articles produced by the workers. Piece rate system can be of the following types:

(i) Straight piece rate: Under this system, each unit produced is taken as a piece. A piece rate is fixed for a unit of product produced. It can be calculated in the following way:

             Earning = No. of piece produced x Piece rate.

(ii) Piece rate with guaranteed wages: Piece rate with guaranteed wages is applicable for the new and in efficient workers. They earn meagre salary instead of paying normal piece rate and this encourages the workers to improve their efficiency gradually and there afterwards reach the standard of other workers.

(iii) Differential piece rate system: Under this system, the wages of workers vary at different stages, within a certain range of output. The two system which work under this principle are:

(a)  Taylor’s differential piece rate system, and

(b)  Merrick’s differential piece rate system.

(a)  Taylor’s differential piece rate system: This system was designed by F.W. Taylor in 1880. The features of this system of wage payment are as follows:

(i)    There is no guaranteed wages.

(ii)   Standard time is fixed for each work.

(iii) Two differential piece rates are fixed: ‘Lower piece rate’ i.e. 80% of the normal piece rate for the workers produce below the standard out. ‘Higher piece rate’ i.e. 120% of the normal piece rate for the workers produce standard output or more than standard output.  ( Some authors use 83% and 125% for lower and higher piece rate  respectively.)

(b)   Merrick’s differential piece rate system: This method is also known as ‘Multiple piece arte system’. Under this method, three grade piece rates are used instead of two as in the case of Taylor’s. The features are as follows:

(i)            There is no guaranteed wages.

(ii)          Standard time is fixed for each work.

(iii)         Slabs are:

                Upto 83 1/3  % of the standard output-                                                                                              100% of ordinary piece rate.

                Above 83 1/3 % and upto 100% of the standard output                                     -110%of                 ordinary piece rate.

                Above 100% of the standard output- 120% of ordinary piece rate.

Advantages of piece rate wage system:

1.    It is easy to understand and simple to operate.

2.    It acts as an incentive to workers to produce more to earn more.

3.    It tends to reduce overhead cost and labour cost per unit.

4.    It eliminates the tendency of workers to go slow as remuneration is directly linked with performance.

5.    Low degree of supervision is required.

Disadvantages of piece rate wage system:

1.    It does not guarantee time wage to workers and hence workers feel insecure.

2.    Workers tend to increase the quantity ignoring the quality of the products.

3.    There may excessive wastage and damage of materials and machine, tools.

4.    The calculation of piece rate is more difficult than time rate .

5.    It is usually opposed by trade union and workers.

Distinction between Time arte wage system and Piece rate wage system:

Time rate wage system	Piece rate wage system
1. Basis of payment: Workers are paid at a fixed rate per hour, per day or per month for the time devoted by them.	Workers are paid at a fixed rate per unit produced or job completed.
2.Performance and reward: There is no linkage between performance and reward.	The linkage between performance and reward motivates the workers to produce more.
3.Quality: Quality of work tends to be high.	Quality of work tends to be low.
4.Wastage & Damage: There are less chances of wastage materials and damage of and machinery , tools, equipments etc.	There are more chances of wastage materials and damage of and machinery , tools, equipments etc.
5.Supervision: Close supervision is required.	Close supervision is not required.
6.Maintenance: Cost of maintenance is low.	Cost of maintenance is high.
7.Attitude of Trade Union: Trade Unions prefer it.	Trade Unions oppose it.

                

7. It should provide for prompt payment of incentives at short intervals of time.

8. It should have approval of workers and trade union.

9. It should discourage the workers to increase spoiled work.

10. It should be flexible enough so as to introduce the necessary changes, if any

required.

Important types of incentive system:

1. Halsey Premium Plan: This system was introduced by F.A. Halsey, an engineer of America in 1891. The main features of this system are as follows:

(i)    Standard time is fixed for each work.

(ii)  It guarantees the hourly wages to workers for the actual time taken.

(iii) Bonus is paid if the time is saved.

(iv) Bonus is equal to 50% of the time wages of time saved.

Calculation of earning:

Advantages:

Disadvantages:

2. Rowan Plan: This incentive system was introduced by James Rowan of Scotland. Under this system bonus is also paid on the time saved.

Features:

Calculation of earning:

Advantages:

Disadvantages:

Collective / Group Bonus System:

            

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Unit –IV

Overheads and Control

Syllabus: Meaning and classification of overheads; allocation and apportionment of overheads; meaning and methods overheads absorption; treatment of depreciation on machinery, interest on capital, packing expenses, trade discount, cash discount , bad debts, overhead control.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             15

Meaning of Overheads:

Classification of Overheads & Control of Overheads:

             Classification of overheads is the process of grouping the various items of overheads into distinct class/ group on the basis of some common characteristics to control over them. Overheads are classified in the following ways:

             (i) Functional classification of overheads/ According to function:

                        (a) Production/ Manufacturing overheads.

                      (b) Administrative overheads.

                      ( c) Selling overheads.

                      (d) Distribution overheads.

             (ii) Behavioural classification/ According to variability:

(a)  Fixed overheads

(b)                       Variable overheads.

(c)  Semi-variable overheads.

             (iii) Element-wise classification/According to types:

(a)  Indirect materials

(b)  Indirect labour

(c)  Indirect expenses.

                                               

Behavioural classification/ According to variability: Under overheads are classified with reference to their tendency to vary with production/ sales volume or activities level.

Graphical Representation:

Advantages of classification of overheads by behaviour/ Necessity of Classification for overheads in fixed, variable and semi-variable:

            Following are the advantages of classification of overheads into fixed and variable cost:

(i)            Fixation of selling price: This distinction is helpful in determining the price policy of a concern. Sometimes, different prices are charged for the same article in different market to meet varying degree of competition. However, the lowest selling price of an article in any market should atleast cover price cost plus variable overheads. Similarly, during depression, it will be profitable for a manufacturer to sell his goods below the total cost, provided the selling price is in excess of variable cost.

(ii)          Marginal costing and Break-even charts: For the technique of marginal costing, preparation of break-even charts and study of cost-volume-profit relationship, segregation of cost into fixed and variable is quite essential.

(iii)         Decision Making: Management must know the effect of different levels of activity. Cost information cannot be effectively used, unless it is segregated into fixed and variable.

(iv)         Flexible budget: Budgets are prepared for various levels of activity for comparison with actual. Flexible budget together with standard costing become an effective tool for managerial control over costs.

(v)          Direct costing: In direct costing a product is charged with variable cost only, i.e. direct materials, direct labour and variable manufacturing expenses. Hence, it is essential to segregate cost into fixed and variable.

(vi)         Absorption of overheads: Different methods may be adopted for determination of absorption rates for fixed and variable overheads. The fixed overhead rate serves as a measure of utilization of the extent of idle capacity is indicated by under absorption.   

Segregation of semi-variable cost into fixed and variable:

         Classification of overheads into fixed and variable costs helps management to take decisions and control of expenditure. Semi-variable costs may present some problems, hence the extent to which these are fixed and variable has to be ascertained. The following methods are used for this purpose:

(i)            Comparison by period or level of activity method;

(ii)           High and low points method or Range method;

(iii)         Average method;

(iv)         Simultaneous equation method;

(v)          Analytical method;

(vi)         Scatter-graph method; and

(vii)        Least square method.

Allocation of Overheads:

                        Allocation of overheads is the process of charging the full amount of an individual item of cost directly to a cost centre for which this item of cost was incurred.

         For examples, where separate electric meters are installed in each of the department, the electricity charges on the basis of electric bills can be allocated to the respective departments. Salary and wages paid to indirect workers of each department can be allocated to the respective department.

Apportionment of Overheads:

         Apportionment of overheads is the process of charging the proportion of common items of cost to two or more cost centres on some equitable basis.

         For examples, where separate electric meters are not installed in the departments,  common electric bills can be apportioned to the respective departments on the basis of no. of light points or floor area. Factory Rent is incurred for the factory as a whole can be apportioned on the basis of floor occupied by the departments.

Distinction between Allocation and Apportionment of Overheads:

Allocation	Apportionment
1. Allocation means the allotment of full cost to a cost centre or unit.	1. Apportionment means allotment of proportion of cost to two or more cost centres and units.
2. It deals with whole items of cost.	2. It deals with only proportion of items of cost.
3. Cost is directly allocated to any cost centre or cost unit.	3. It needs a suitable basis for sub-division of cost by cost centres or cost units.
4.Cost is allocated when the cost centre uses whole of the benefits of the expenses.	4. Cost is apportioned when cost centres use only a proportion of the benefits of the whole expenses.

  

Primary Distribution of Overheads:

                                                The process of apportionment or distribution of common expense over the department (production as well as service departments) on some equitable basis is known as Primary Distribution of Overheads.

Secondary Distribution of Overheads:

                The process of apportionment or distribution of overheads of service departments among the production departments on some equitable basis is known as Secondary Distribution of Overheads.

Methods of Secondary Distribution:

             Secondary distribution can be done in the following ways:

1. Apportionment to Production Department only: Under this method, the costs of service department are directly apportioned to production departments only, ignoring benefits received by one service department from another service department.

2. Apportionment to both Production and Service Departments: Under this method the costs of service departments are apportioned to both production and service departments on some equitable basis. It can be done in the following basis:

                   (i) Non-reciprocal basis/ Step Ladder Method;

                   (ii) Reciprocal basis:

(a)  Simultaneous Equation Method

(b)  Repeated Distribution Method

(c)  Trail and Error Method.

                       

Absorption of Overheads:

                                    The method of apportionment of overhead expenses to the cost centres or cost units is known as overhead absorption (it refers levy, recovery or application of overhead).

             The basis procedure for the calculation of overhead rate is as follow:

                                  Overhead Rate =                                                                      Amount of Overhead

                                                                                         Total quantum of basis

                                                                                                             

Methods of Absorption of Production Overheads:

A. Percentage of Direct Material Cost Method:

B. Percentage of Direct Labour Cost Method:

C. Percentage of Direct Prime Cost Method:

D. Direct Labour Hour Rate:

E. Machine Hour Rate:

F. Rate per Unit of Production Rate:

Treatment of some specific items in Cost Accounting:

Depreciation on Machinery:

                        Depreciation is the diminution ( decrease) in the value of a fixed asset due to use or passage of time. The amount of depreciation may be calculated according to various methods of providing depreciation:

Interest on Capital:

                Interest on capital is a notional charge and not a charge against profit. Hence accountants feel that it should not be treated as an element of cost. However, economists think that it should be taken as cost as instead of using own capital, the entrepreneurs use borrowed capital and the interest on such borrowing is a real cost, being actually paid to the lenders.

                Arguments for inclusion of interest on capital in cost are theoretical, which are outweighed by the arguments against inclusion of interest in cost accounts which are based on practical difficulties. Hence, interest is rarely included in cost records, while making cost comparisons for managerial decision-making such as on make or buy, profitability between production by machine or hand, time consuming jobs for holding large amount of stock etc.

Trade Discount & Cash Discount

                Discount on purchase of materials may be trade discount or cash discount. Such discounts are deducted from the invoice price of the material bought, hence no place in cost records.

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            Unit-V

[Cost Records: Non-integral system and integral system- meaning and advantages, recording of transactions under non-integral and integral system. Reconciliation of cost and financial accounts.]

Ledgers maintained under Cost Books:

                 The following four important ledgers are maintained in cost books under non-integral system:

(i)          Cost Ledger/ General Ledger: - Cost Ledger Control A/c or General Ledger Adjustment A/c  

(ii)        Store Ledger: - Store Ledger Control A/c

(iii)       Work-in-progress Ledger: - WIP Ledger Control A/c

(iv)       Finished Stock/ Goods Ledger: Finished Stock Ledger Control A/c.

Accounts maintained under Cost Books:

Advantages of Cost Ledger/ General Ledger:

The following are the advantages of maintaining a cost ledger:

(i)            It helps the management in policy decisions as this ledger summarizes all detailed information regarding cost in subsidiary records.

(ii)          It provides the basis for analysis of cost preparation of accounts for each cost centre for cost ascertainment and control.

(iii)         It provides a proper control over materials and supplies, labour and overheads.

(iv)         It helps the management by submitting necessary variances accounts for control purposes.

(v)          It helps in determining the values of closing stock and work-in-progress without any delay.

(vi)         It serves as a check on the transactions and records in financial accounts.

(vii)        It facilitates prompt preparation of Costing Profit and Loss Account.

  

Accounting entries under Non-integral and Integral System:

Transaction	Non-integral System	Integral System
1. For purchase of materials, carriage inward etc.	Store ledger control a/c           Dr.                                                                                                    To Cost ledger control a/c	Store ledger control a/c           Dr.     To Cash/Creditor’s a/c
2.For direct materials issued	WIP ledger control a/c            Dr.       To Store ledger control a/c	WIP ledger control a/c            Dr.       To Store ledger control a/c
3. For indirect materials issued	Respective O/H control a/c     Dr.       To Store ledger control a/c	Respective O/H control a/c     Dr.       To Store ledger control a/c
4. For materials returned to suppliers	Cost ledger control a/c            Dr.        To Store ledger control a/c	Creditor’s a/c            Dr.        To Store ledger control a/c
5. For direct materials returned from production to store.	Store ledger control a/c          Dr.        To WIP ledger control a/c	Store ledger control a/c          Dr.        To WIP ledger control a/c
6. For indirect materials returned to store	Store ledger control a/c         Dr.      To Respective O/H control a/c	Store ledger control a/c         Dr.      To Respective O/H control a/c
7. For materials transferred from one job to another job	Transferee job a/c                 Dr.       To Transferor job a/c	Transferee job a/c                 Dr.       To Transferor job a/c
8. For normal loss of materials	Production O/H control a/c    Dr.        To Store ledger control a/c	Production O/H control a/c    Dr.        To Store ledger control a/c
9. For abnormal loss of materials	Costing Profit & loss a/c        Dr.        To Store ledger control a/c	Profit & loss a/c                    Dr.        To Store ledger control a/c
10. Payment to creditors for materials	No entry	Creditor’s a/c                          Dr.         To Cash / Bank a/c
11.For labour /wages payment	Wages control a/c                 Dr.        To Cost ledger control a/c	Wages control a/c                 Dr.        To Cash / Bank a/c
12. For allocation of direct wages	WIP ledger control a/c          Dr.        To Wages control a/c	WIP ledger control a/c          Dr.        To Wages control a/c
13. For allocation of indirect wages	Respective O/H control a/c    Dr.         To Wages control a/c	Respective O/H control a/c    Dr.         To Wages control a/c
14. For direct expense incurred/ paid	WIP ledger control a/c           Dr.      To Cost ledger control a/c	WIP ledger control a/c          Dr.         To Cash / Bank a/c
15. For O/H incurred/ paid	Respective O/h control a/c      Dr.       To Cost ledger control a/c	Respective O/h control a/c      Dr.       To Cash/ Bank  a/c
16. For absorption of production O/H	WIP ledger control a/c            Dr.      To Production O/H control a/c	WIP ledger control a/c            Dr.      To Production O/H control a/c
17. For over-absorption O/H	Respective O/H control a/c     Dr.     To Costing Profit & Loss a/c	Respective O/H control a/c     Dr.     To Profit & Loss a/c
18. For under-absorption O/H	Costing Profit & Loss a/c       Dr.     To Respective O/H control a/c	Profit & Loss a/c                    Dr.     To Respective O/H control a/c
19. For transfer of finished stock produced	Finished stock ldg. contl. a/c  Dr.     To WIP ledger control a/c	Finished stock ldg. contl. a/c  Dr.     To WIP ledger control a/c
20. For transfer of finished goods sold	Cost of sales a/c                      Dr.    To Finished stock ldg contl a/c	Cost of sales a/c                      Dr.    To Finished stock ldg contl a/c
21. For transfer of cost of sales	Costing Profit & Loss a/c       Dr.      To Cost of sales a/c	Profit & Loss a/c                     Dr.      To Cost of sales a/c
22. For sales	Cost ledger control a/c            Dr.       To Costing Profit & Loss a/c	Cash / Debtors a/c                   Dr.     To Profit & Loss a/c
23. For abnormal loss in WIP	Costing Profit & Loss a/c       Dr.       To WIP ledger control a/c	Profit & Loss a/c                    Dr.      To WIP ledger control a/c
24. For abnormal loss in Finished stock	Costing Profit & Loss a/c       Dr.     To Finished stock ldg. Cntl a/c	Profit & Loss a/c                    Dr.     To Finished stock ldg. Cntl a/c
25. For abnormal gain	Reverse of the above two entries

Reconciliation of Cost and Financial Accounts:

Needs and objectives of reconciliation:

                        In non-integral system where separate sets of books are maintained for costing and financial transactions, needs for reconciliation arises due to the followings:

1.    To fin out the reasons for the difference in the profit and loss in cost and financial accounts.

2.    To ensure the mathematical accuracy and reliability of cost accounts in order to have cost ascertainment, cost control and to have a check on the financial accounts.

3.    To contribute to the standardization of policies regarding stock valuation, depreciation and overheads.

4.    To facilitate coordination and promote better corporation between the activities of financial and cost sections of the accounting department.

5.    To place management in better position to acquaint itself with the reason for the variation in profit paving the way to more effective internal control.

Reasons for disagreement in profit:

             The various reasons or causes for the differences in the profit as shown by the cost and financial account may be outlined as under;

1. Items included in the financial accounts but not in the cost accounts:

2. Items included in the cost accounts but not in the financial accounts:

7. Expenses of abnormal nature are excluded in cost accounts.

8. Recording of costs by approximation in cost accounts in some cases.

Can a computer system avoid the reconciliation?

             It may be noted that financial accounts and cost accounts when maintained on a computer system, may show accurate and precise result but even then the profit shown by one set of books may not agree with that of the other set. Thus, under the situation of difference between the result shown by both the sets of books, the reconciliation is essential and not redundant (unnecessary) even in the modern age of computer.

Format of Reconciliation Statement:

Reconciliation Statement

Particulars	Details	Rs.
Profit as per Cost Account/ (Profit as per Financial Accounts) Add/ (Less), Items having the effect of higher profit in financial accounts / (Lower profit in cost accounts) (i)            Over-absorption of  overheads (ii)          Over-valuation of opening stocks (iii)         Under-valuation of closing stocks (iv)         Incomes excluded from Cost accounts:                                    Interest & dividend on investment                  Rent received                  Transfer fee received Less/ (Add), Items having the effect of lower profit in financial account/ (higher profit in cost accounts) (i)            Under-absorption of overheads (ii)          Under-valuation of opening stocks (iii)         Over-valuation of closing stocks (iv)         Expenses excluded from cost accounts:                   Bad Debts written off                   Preliminary expenses/ discount on issue written off                   Legal charges Profit as per Financial Account/ (Profit as per Cost Accounts)	xxxx xxxx xxxx xxx xxx .       xxx xxxx xxxx xxxx xxx xxx .      xxx	xxxx .  xxxxx .    xxxx xxxxx

Note: In case of ‘Loss’ the amount shall appear as a minus item.

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Unit-VI

[ Syllabus: Process Costing, Operating Costing and Job Costing: Process costing: meaning, application, treatment of normal and abnormal loss (excluding inter-process profit, equivalent production and accounting for by-product), preparation of process accounts. Operating Costing: meaning, features, Transport costing and Electricity Generation costing. Job-costing: meaning, features, preparation of job-cost sheet.] 

Job- Costing: Meaning, Features, Preparation of Job-Cost-Sheet.

Meaning: Job costing is a method of costing applied in industries whereby cost is complied for job or work order. The production process depends upon the number of orders received from customers. The production is against the customer’s order and not for stock. Industries where job costing is generally applied are Printing Press, Automobile Garage, Repair workshop, Ship Building, Foundry (As-Dhalai), and other similar manufacturing units which manufacture to customers’ specific requirements.

Definition: Kohler in his ‘Dictionary for Accountants’ defined job costing as. “ a methods of cost accounting whereby cost is complied for a specific quantity of product, equipment, repair or other service that moves through the production process as a continuously identifiable unit,  applicable material, direct labour, direct expenses and usually portion of the overhead being charged to a job order.”

Features/characteristics of Job Costing: The industries, which employed job costing, have the following features/characteristics:

(i)    The production is under taken against customer’s orders and not for stock.

(ii)  Each job have its own characteristics and needs special treatment.

(iii) Each job is treated as a cost unit under this method of costing.

(iv) Each job is distinctively identified by a production order throughout the production stages.

(v)  The industries need not incur selling and distribution expenses as the customers themselves come place orders and collect the goods after production.

(vi) The cost of the production of every job is ascertained after the completion of the job.

(vii)                 A separate Job Cost Sheet or Job Card is used for each job.

5. Recording of Costs: The cost s are collected and recorded for each job under separate Production Order Number, Generally, Job Cost Sheet (or Card) is maintained for each job. This is a document which is used to record direct material, direct wages and overheads applicable to respective jobs. The basic collection of costs are materials, wages and Overheads.

6. Completion of Job: On completion of a job, a completion report is sent to costing department . The expenditure under each element of cost is totaled and the total job cost is ascertained. The actual cost is compared with the estimated cost so as to reveal efficiency or inefficiency in operation.

7. Profit or Loss on Job: It is determined by comparing the actual expenditure or cost with the price obtained.

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Process Costing:

Application of Process Costing:

       Process cost system is used where it is not possible or not desirable to identify the successive jobs or lots of production for cost accumulation purposes. Under the following circumstances process costing method is most suitable/ features of process costing:

         (f) Cost of Abnormal Gain (if any)

        Items of Credit side:

Each Process Account is credited with-

(a)  Scrap value of Normal Loss (if any) with realizable amount,

(b)  Cost of Abnormal Loss (if any) with realizable amount.

        Transfer of output:

      The cost of output of each process may be transferred either directly to the next process account or to a process store account as required.

Specimen of Process Account

Process-I Account

Particulars	Units	Amount	Particulars	Units	Amount
To Basic Materials To Direct Materials To Direct Wages To Direct Expenses To Production Overheads To Cost of rectification of normal defectives To Abnormal Gain A/c (if any)	xxxxx xxx	Xxxxxx Xxxxx Xxxxx Xxxxx Xxxxx Xxxxx Xxxxx xxxxx	By Normal Loss A/c By Abnormal Loss A/c By Process-II A/c (Transferred to next process) By Process Stock A/c (Transferred to store) By P&L a/c (Output sold)	Xxx Xxx Xxxxx Xxxxx xxxxx	Xxxx Xxxx Xxxxxxx Xxxxxxx Xxxxxxx
	xxxx	xxxxxxx		xxxxx	xxxxxxx

Where,

Cost per unit =    Total cost – Scrap values of Normal Loss        

                                    Input – Units of Normal Loss

Cost of Abnormal Loss = Total cost – Scrap values of Normal Loss                X  Units of Abnormal Loss

                                                          Input – Units of Normal Loss

Cost of Abnormal Gain = Total cost – Scrap values of Normal Loss                X  Units of Abnormal Gain

                                                          Input – Units of Normal Loss

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