Direct vs Indirect Costs "Direct costs are those costs that are directly attributable to the production of a product

t or service. Indirect costs are those that are directly attributable to a specific product or service.Direct costs are anything that benefits a particular project, i.e. project personnel and material. Indirect costs benefit more than one project, i.e. headquarters staff, office supplies.Expenditures for direct costs vary with each unit of production (one must buy more steel to manufacture more cars, for example). Indirect costs tend to be less effected by variances in production and are usually fixed costs.Examples of costs usually allocated indirectly include, rent, utilities, administrative staff.Examples of costs usually include, project supplies, project staff, consultants.Examples of cost that can be either charged directly or allocated indirectly include: travel, telephone charges, computers clerical personnel, training, postage, miscellaneous office supplies." Direct costs are costs that can easily be traced to a specific project or activity. Indirect costs are costs that can not be easily traced to a specific project or activity. Direct costs are those that are directly attributable to a project of the manufacture of a product or a project.. For instance if you are in the highway construction business and you got a bid to build a new highway, direct costs would be the materials like asphalt and the cost of labor. Thats actually a variable cost and its easier to track. An indirect cost would be administrative expenses, and the depreciation and maintenance costs for equipment like trucks and road graders and scrapers. Those are actually more fixed costs and more difficult to track and assign to a particular project.

Various Types Of Costs (A) Actual Cost Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or service. The actual costs or expenditures are recorded in the books of accounts of a business unit. Actual costs are also called as "Outlay Costs" or "Absolute Costs" or "Acquisition Costs". Examples: Cost of raw materials, Wage Bill etc. (B) Opportunity Cost Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second best use of the firms resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input. Opportunity cost is also called as "Alternative Cost". If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account. But the firm has an opportunity cost of using the land, which is equal to the rent forgone by not letting the land out on rent. (C) Sunk Cost Sunk costs are those do not alter by varying the nature or level of business activity. Sunk costs are generally not taken into consideration in decision - making as they do not vary with the changes in the future. Sunk costs are a part of the outlay/actual costs. Sunk costs are also called as "Non-Avoidable costs" or "Inescapable costs". Examples: All the past costs are considered as sunk costs. The best example is amortization of past expenses, like depreciation. (D) Incremental Cost Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity in the activity, they are also called as "Avoidable Costs" or "Escapable Costs". More ever incremental costs resulting from a contemplated change is the Future, they are also called as "Differential Costs" Example: Change in distribution channels adding or deleting a product in the product line. (E) Explicit Cost

Explicit costs are those expenses/expenditures that are actually paid by the firm. These costs are recorded in the books of accounts. Explicit costs are important for calculating the profit and loss accounts and guide in economic decision-making. Explicit costs are also called as "Paid out costs" Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc. (F) Implicit Cost Implicit costs are a part of opportunity cost. They are the theoretical costs ie., they are not recognised by the accounting system and are not recorded in the books of accounts but are very important in certain decisions. They are also called as the earnings of those employed resources which belong to the owner himself. Implicit costs are also called as "Imputed costs". Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity capital etc. (G) Book Cost Book costs are those business costs which don't involve any cash payments but a provision is made in the books of accounts in order to include them in the profit and loss account and take tax advantages, like provision for depreciation and for unpaid amount of the interest on the owners capital. (H) Out Of Pocket Costs Out of pocket costs are those costs are expenses which are current payments to the outsiders of the firm. All the explicit costs fall into the category of out of pocket costs. Examples: Rent Payed, wages, salaries, interest etc (I) Accounting Costs Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm. Examples: All Sunk costs are accounting costs (J) Economic Costs Economic costs are related to future. They play a vital role in business decisions as the costs considered in decision - making are usually future costs. They have the nature similar to that of incremental, imputed explicit and opportunity costs. (K) Direct Cost Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs are related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as "Traceable Costs" Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs. (L) Indirect Costs Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary ie., they may or may not be variable in nature. However, the nature of indirect costs depend upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs. Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour etc. (M) Controllable Costs Controllable costs are those which can be controlled or regulated through observation by an executive and therefore they can be used for assessing the efficiency of the executive. Most of the costs are controllable. Example: Inventory costs can be controlled at the shop level etc. (N) Non Controllable Costs

The costs which cannot be subjected to administrative control and supervision are called non controllable costs. Example: Costs due obsolesce and depreciation, capital costs etc. (O) Historical Costs and Replacement Costs. Historical cost or original costs of an asset refers to the original price paid by the management to purchase it in the past. Whereas replacement costs refers to the cost that a firm incurs to replace or acquire the same asset now. The distinction between the historical cost and the replacement cost result from the changes of prices over time. In conventional financial accounts, the value of an asset is shown at their historical costs but in decision-making the firm needs to adjust them to reflect price level changes. Example: If a firm acquires a machine for $20,000 in the year 1990 and the same machine costs $40,000 now. The amount $20,000 is the historical cost and the amount $40,000 is the replacement cost. (P) Shutdown Costs The costs which a firm incurs when it temporarily stops its operations are called shutdown costs. These costs can be saved when the firm again start its operations. Shutdown costs include fixed costs, maintenance cost, layoff expenses etc. (Q) Abandonment Costs Abandonment costs are those costs which are incurred for the complete removal of the fixed asset from use. These may occur due to obsolesce or due to improvisation of the firm. Abandonment costs thus involve problem of disposal of the asset. (R) Urget Costs and Postponable Costs Urgent costs are those costs which have to be incurred compulsorily by the management in order to continue its operations. If urgent costs are not incurred in time the operational efficiency of the firm falls. Example: Cost of material, labour, fuel etc Postponable costs are those which if not incurred in time do not effect the operational efficiency of the firm. Examples are maintenance costs. (S) Business Cost and Full Cost Business costs include all the expenses incurred by the firm to carry out business activities. Costs Include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment. Full costs include business costs, opportunity costs, and normal profits. Opportunity costs is the expected return/earnings from the next best use of the firms resources like capital, land and building, owners efforts and time. Normal profits is necessary minimum earning in addition to the opportunity costs, which a firm must receive to remain in its present occupation. (T) Fixed Costs Fixed costs are the costs that do not vary with the changes in output. In other words, fixed costs are those which are fixed in volume though there are variations in the output level.. If the time period in volume under consideration is long enough to make the adjustments in the capacity of the firm, the fixed costs also vary. Examples: Expenditures on depreciation costs of administrative, staff, rent, land and buildings, taxes etc. (U) Variable Costs Variable Costs are those that are directly dependent on the output ie., they vary with the variation in the volume/level of output. Variable costs increase in output level but not necessarily in the same proportion. The proportionality between the variable costs and output depends upon the utilization of fixed facilities and resources during the production process. Example: Cost of raw materials, expenditure on labour, running cost or maintenance costs of fixed assets such as fuel, repairs, routine maintenance expenditure. (V) Total Cost, Average Cost and Marginal Cost

Total cost (TC) refers to the money value of the total resources/inputs required for the production of goods and services by the firm. In other words, it refers to the total outlays of money expenditure, both explicit and implicit, on the resources used to produce a given level output. Total cost includes both fixed and variable costs and is given by TC = VC + FC Average Cost (AC) , refers to the cost per unit of output assuming that production of each unit incurs the same cost. It is statistical in nature and is not an actual cost. It is obtained by dividing Total Cost(TC) by Total Output(Q) AC= TC/Q Marginal costs(MC), refers to the additional costs that are incurred when there is an addition to the existing output level of goods ans services. In other words, it is the addition to the Total Cost(TC) on account of producing additional units. (W) Short Run Cost and Long Run Cost Both short run and long run costs are related to fixed and variable costs and are often used in economic analysis. Short Run Cost: These costs are which vary with the variation in the output with size of the firm as same. Short run costs are same as variable costs. Broadly, short run costs are associated with variable inputs in the utilization of fixed plant or other requirements. Long Run Cost: These costs are which incurred on the fixed assets like land and building, plant and machinery etc., Long run costs are same as fixed costs. Usually, long run costs are associated with variations in size and kind of plant. Cost Driver A "cost driver" is the unit of an activity that causes the change of an activity cost. A factor that can causes a change in the cost of an activity.An activity can have more than one cost driver attached to it. For example, a production activity may have the following associated cost-drivers: a machine, machine operator(s), floor space occupied, power consumed, and the quantity of waste and/or rejected output. A cost driver is any activity that causes a cost to be incurred. Cost driver is a cost accounting term. A business engages in many different activities. The cost driver for an activity is the factor that influences the amount of the resources that will be consumed by a particular activity. A cost driver is designed to allocate the activity cost pool (or related costs) to the cost objects. 1. The activity is the work that is done. 2. The resource is what the activity uses to do the work, i.e., people, equipment, services. Resources cost money. 3. The cost of the activity depends on the quantity of resources used to accomplish the activity. 4) The cost object is whatever it is you wish to cost. It could be a product, service, process, job or customer. Example: One part of the Ace Trucking's business operation involves making deliveries by truck. The activity is delivering goods. The costs of this activity include the truck drivers wages, fuel, depreciation of the truck, insurance, etc. The quantity of the resources that will be consumed by this activity are influenced by the number of deliveries made per year. Hence the cost driver could be the number of deliveries. A cost driver is the reason why the cost is incurred in other words, the cost is incurred in producing the driver. Cost accumulation - Collection of costs in an organized fashion by means of a cost accounting system. There are two primary approaches to cost accumulation: JOB ORDER and PROCESS COSTING. Under a job order system, the three basic elements of manufacturing costs - direct materials, direct labour, and factory overhead are accumulated according to assigned job numbers. Under a process cost system, manufacturing costs are accumulated according to processing department or cost centre. MARGINAL COSTING Statement of profit:-

Particulars Sales Less:-Variable cost Contribution Less:- Fixed cost Profit

Amount *** *** *** *** ***

1) Sales = Total cost + Profit = Variable cost + Fixed cost + Profit 2) Total Cost = Variable cost + Fixed cost 3) Variable cost = It changes directly in proportion with volume 4) Variable cost Ratio = {Variable cost / Sales} * 100 5) Sales Variable cost = Fixed cost + Profit 6) Contribution = Sales * P/V Ratio 7) Profit Volume Ratio [P/V Ratio]: {Contribution / Sales} * 100 {Contribution per unit / Sales per unit} * 100 {Change in profit / Change in sales} * 100 {Change in contribution / Change in sales} * 100 8) Break Even Point [BEP]: Fixed cost / Contribution per unit [in units] Fixed cost / P/V Ratio [in value] (or) Fixed Cost * Sales value per unit (Sales Variable cost per unit)

9) Margin of safety [MOP] Actual sales Break even sales Net profit / P/V Ratio Profit / Contribution per unit [In units] 10) Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit 11) Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio 12) At BEP Contribution = Fixed cost 13) Variable cost Ratio = Change in total cost Change in total sales 14) Indifference Point = Point at which two Product sales result in same amount of profit = Change in fixed cost Change in variable cost per unit (in units) * 100

= Change in fixed cost Change in contribution per unit = Change in Fixed cost Change in P/Ratio = Change in Fixed cost Change in Variable cost ratio

(in units)

(in Rs.)

(in Rs.)

15) Shut down point = Point at which each of division or product can be closed = Maximum (or) Specific (or) Available fixed cost P/V Ratio (or) Contribution per unit If sales are less than shut down point then that product is to shut down. Note :1) When comparison of profitability of two products if P/V Ratio of one product is greater than P/V Ratio of other Product then it is more profitable. 2) In case of Indifference point if Sales > Indifference point --- Select option with higher fixed cost (or) select option with lower fixed cost. STANDARD COSTING Method one of reading:Material:SP * SQ (1) (2) SP * AQ (3) = (4) (1) (4) (2)(4) (1) (2) (3) (2) (1) (3) SP * RSQ AP * AQ

a) Material cost variance

b) Material price variance = c) Material usage variance = d) Material mix variance =

e) Material yield variance = Labour :-

SR*ST SR*AT (paid) SR*RST AR*AT SR*AT(worked) (1) (2) (3) (4) (5)

a) Labour Cost variance b) Labour Rate variance

= =

(1) (4) (2) (4) (1) (2) (3) (5) (5) (2)

c) Labour Efficiency variance = d) Labour mix variance =

e) Labour Idle time variance = Variable Overheads cost variance :-

SR * ST SR * AT AR * AT (1) (2) (3) = (1) (3) (2) (3) (1) (2)

a) Variable Overheads Cost Variance

b) Variable Overheads Expenditure Variance = c) Variable Overheads Efficiency Variance =

[Where: SR =Standard rate/hour = Budgeted variable OH Budgeted Hours Fixed Overheads Cost Variance:SR*ST (1) (2) SR*AT(worked) (3) (4) (5) = = = = = = (1) (5) (4) (5) (1) (2) (1) (4) (2) (3) (3) (4) SR*RBT SR*BT AR*AT(paid) ]

a) Fixed Overheads Cost Variance b) Fixed Overheads Budgeted Variance c) Fixed Overheads Efficiency Variance d) Fixed Overheads Volume Variance e) Fixed Overheads Capacity Variance f) Fixed Overheads Calendar Variance Sales value variance:Budgeted Price*BQ (1) (2) (3) = = BP*AQ (4)

BP*Budgeted mix

AP*AQ

a) Sales value variance b) Sales price variance

(4)(1) (4) (2)

c) Sales volume variance = d) Sales mix variance =

(2) (1) (2) (3) (3) (1)

e) Sales quantity variance = Note :-

i) Actual margin per unit (AMPU) = Actual sale price selling cost per unit ii) Budgeted margin per unit (BMPU) = Budgeted sale price selling price per unit Sales margin variance :BMPU*BQ (1) (2) BMPU*AQ (3) (4) = = = = (4) (1) (4) (2) (2) (1) (2) (3) (3) (1) BMPU*Budgeted mix AMPU*AQ

a) Sales margin variance b) Sales margin price variance c) Sales margin volume variance d) Sales margin mix variance

e) Sales margin quantity variance = Control Ratio :-

1) Efficiency Ratio = Standard hours for actual output * 100 Actual hours worked 2) Capacity Ratio = Actual Hours Worked * 100 Budgeted Hours 3) Activity Ratio = Actual hours worked * 100 Budgeted Hours Verification: Activity Ratio = Efficiency * Capacity Ratio STANDARD COSTING Method two of reading:Material:a) Material cost variance = SC AC = (SQ*AQ) (AQ*AP) b) Material price variance = AQ (SP AP) c) Material usage variance = SP (SQ AQ)

d) Material mix variance = SP (RSQ AQ) e) Material yield variance = (AY SY for actual input) Standard material cost per unit of output f) Material revised usage variance (calculated instead of material yield variance) = [standard quantity Revised standard for actual output quantity ] * Standard price Labour :a) Labour Cost variance = SC AC = (SH*SR) (AH*AR) b) Labour Rate variance = AH (SR - AR) c) Labour Efficiency or time variance = SR (SH AH) d) Labour Mix or gang composition Variance = SR(RSH-AH) e) Labour Idle Time Variance = Idle hours * SR f) Labour Yield Variance = [Actual Output Standard output for actual input] * Std labour cost/unit of output g) Labour Revised Efficiency Variance (instead of LYV) = [Standard hours for actual output Revised standard hours] * Standard rate Notes :- i) LCV = LRV + LMV + ITV + LYV ii) LCV = LRV + LEV + ITV iii) LEV = LMV, LYV (or) LREV Overhead variance :- (general for both variable and fixed) a) Standard overhead rate (per hour) = Budgeted Overheads Budgeted Hours b) Standard hours for actual output = Budgeted hours * Actual Output Budgeted output c) Standard OH d) Absorbed OH e) Budgeted OH f) Actual OH g) OH cost variance = Standard hrs for actual output * Standard OH rate per hour = Actual hrs * Standard OH rate per hour = Budgeted hrs * Standard OH rate per hour = Actual hrs * Actual OH rate per hour = Absorbed OH Actual OH

Variable Overheads variance :a) Variable OH Cost Variance = Standard OH Actual OH

b) Variable OH Exp. Variance = Absorbed OH Actual Variable OH c) Variable OH Efficiency Variance = Standard OH Absorbed OH = [Std hrs for actual output hrs Actual hrs] * Std rate for variable OH Fixed Overheads variance :a) Fixed OH Cost Variance = Standard OH Actual OH b) Fixed OH expenditure variance = Budgeted OH Actual OH c) Fixed OH Efficiency Variance = Standard OH (units based) Absorbed OH (Hours based) d) Fixed OH Volume Variance = Standard OH Budgeted OH = [Standard hrs for actual output Budgeted hrs ] e) Fixed OH capacity variance = Absorbed OHBudgeted OH f) Fixed OH Calendar Variance = [Revised budgeted hrs Budgeted hrs] * Standard rate/hrs Note:- When there is calendar variance capacity variance is calculated as follows :Capacity variance = [Actual hours (Revised) Revised Budgeted hrs] * Standard rate/hour :i) variable OH cost variance = Variable OH Expenditure variance + Variable OH Efficiency variance ii) Fixed OH cost variance = Fixed OH Expenditure variance + Fixed OH volume variance iii) Fixed OH volume variance = Fixed OH Efficiency variance + Capacity variance+ Calander variance Sales variances :Turnover method (or) sales value method :a) Sales value variance = Actual Sales Budgeted Sales b) Sales price variance = [Actual Price Standard price] * Actual quantity = Actual sales standard sales c) Sales volume variance = [Actual-Budgeted quantity] *Standard price Verification * standard rate

= Standard sales Budgeted sales d) Sales mix variance = [Actual quantity Revised standard quantity] * Standard price = Standard sales Revised sales e) Sales quantity variance = [Revised standard variance Budgeted quantity] * Standard price = Revised Standard sales Budgeted sales Profit method:-

a) Total sales margin variance = (Actual ProfitBudgeted price) = {Actual quantity * Actual profit per unit}{Budgeted quantity * Standard profit per unit} b) Sales margin price variance=Actual profitStandard profit = {Actual Profit per unit Standard profit per unit} * Actual quantity of sales c) Sales margin volume variance = Standard profit Budgeted Profit = {Actual quantity Budgeted quantity} * Standard profit per unit d) Sales margin mix variance = Standard profit Revised Standard profit = {Actual quantity Revised standard quantity} * Standard profit per unit e) Sales margin quantity variance = Revised standard profit - Budgeted profit = {Revised standard quantity Budgeted quantity} * Standard profit per unit

Reconciliation:-

Reconciliation statement is prepared to reconcile the actual profit with the budgeted profit

Particulars Budgeted Profit : Add Favorable variances Less Unfavorable variances Sales Variances : Sales price variance Sales mix variance Sales quantity variance Cost variance :Material : Cost variance Usage variance Mix variance Labour : Rate variance Mix variance Efficiency variance Idle time variance Fixed overhead variance : Expenditure variance Efficiency variance Fixed overhead variance :

Favorable

Unfavorable

(Rs)

Expenditure variance Efficiency variance Capacity variance Calendar variance STANDARD COSTING

Diagrammatic Representation: Material Variance: -

Material cost variance = SC AC = (SQ*AQ) (AQ*AP)

Labour Variances:-

Labour Cost variance = SC AC = (SH*SR) (AH*AR) Fixed Overhead Variance : a) Standard OH b) Absorbed OH c) Budgeted OH = Standard hrs for actual output * Standard OH rate per hour = Actual hrs * Standard OH rate per hour = Budgeted hrs * Standard OH rate per hour

d) Actual OH

= Actual hrs * Actual OH rate per hour

e) Revised Budgeted Hour = Actual Days * Budgeted Hours per day (Expected hours for actual days worked) When Calendar variance is asked then for capacity variance Budgeted Overhead is (Budgeted days * Standard OH rate per day)

Revised Budgeted Hour (Budgeted hours for actual days) = Actual days * Budgeted hours per day Variable Overhead Variance : -

Sales Value Variances : -

Sales value variance = Actual Sales Budgeted Sales Sales Margin Variances : -

Total sales margin variance = (Actual ProfitBudgeted price) = {Actual quantity * Actual profit per unit}{Budgeted quantity * Standard profit per unit}

[Where :- SC = Standard Cost, SP = Standard Price, AP = Actual Price, AY = Actual Yield, RSQ = Revised Standard Quantity, ST = Standard Time AT = Actual Time BP = Budgeted Price, RBT = Revised Budgeted Time BMPU = Budgeted Margin per Unit

AC = Actual Cost SQ = Standard Quantity AQ = Actual Quantity SY = Standard Yield SR = Standard Rate, AR = Actual Rate, RST = Revised Standard Time, BQ = Budgeted Quantity

Budgetary Control

Budget Ratios:-

1) Capacity usage Ratio = . Budgeted Hours

* 100

Maximum possible working hours in budget period

2) Standard Capacity Employed Ratio = Actual Hours Worked * 100 Budgeted hours 3) Level of Activity Ratio = Standard Hours for Actual Production Standard Hours for Budgeted Production

* 100

4) Efficiency Ratio = Standard Hours for Actual Production Actual Hours

* 100

5) Calendar Ratio = Actual Working days Budgeted working days Zero Base Budgeting:

100

The name zero base budgeting derives from the idea that such budgets are developed from a zero base: that is, at the beginning of the budget development process, all budget headings have a value of ZERO. This is in sharp contrast to the incremental budgeting system in which in general a new budget tends to start with a balance at least equal to last year's total balance, or an estimate of it. Definition of Zero Base Budgeting (ZBB) A method of budgeting whereby all activities are reevaluated each time a budget is set. Discrete levels of each activity are valued and a combination chosen to match funds available. Objectives and Benefits of ZBB What zero base budgeting tries to achieve is an optimal allocation of resources that incremental and other budgeting systems probably cannot achieve. ZBB starts by asking managers to identify and justify their area(s) of work in terms of decision packages (qv). An effective zero base budgeting system benefits organisations in several ways. It will

Focus the budget process on a comprehensive analysis of objectives and needs Combine planning and budgeting into a single process Cause managers to evaluate in detail the cost effectiveness of their operations

Expand management participation in planning and budgeting at all levels of the organisation

Cost Sheet CLASSIFICATION OF COSTS: Manufacturing costs according to the three elements of cost:a) Materials b) Labour c) Expenses Product and Period Costs: We also classify costs as either Product costs: the costs of manufacturing our products; or Period costs: these are the costs other than product costs that are charged to, debited to, or written off to the income statement each period. The classification of Product Costs:Direct costs: Direct costs are generally seen to be variable costs and they are called direct costs because they are directly associated with manufacturing. In turn, the direct costs can include:Direct materials: plywood, wooden battens, fabric for the seat and the back, nails, screws, glue. Direct labour: sawyers, drillers, assemblers, painters, polishers, upholsterers. Direct expense: this is a strange cost that many texts don't include; but (International Accounting Standard) IAS 2, for example, includes it. Direct expenses can include the costs of special designs for one batch, or run, of a particular set of tables and/or chairs, the cost of buying or hiring special machinery to make a limited edition of a set of chairs. Total direct costs are collectively known as Prime Costs and we can see that Product Costs are the sum of Prime costs and Overheads. Indirect Costs: Indirect costs are those costs that are incurred in the factory but that cannot be directly associate with manufacture. Again these costs are classified according to the three elements of cost, materials labour and overheads.Indirect materials: Some costs that we have included as direct materials would be included here.Indirect labour: Labour costs of people who are only indirectly associated with manufacture: management of a department or area, supervisors, cleaners, maintenance and repair technicians Indirect expenses: The list in this section could be infinitely long if we were to try to include every possible indirect cost. Essentially, if a cost is a factory cost and it has not been included in any of the other sections, it has to be an indirect expense. Here are some examples include: Depreciation of equipment, machinery, vehicles, buildingsElectricity, water, telephone, rent, Council Tax, insurance.Total indirect costs are collectively known as Overheads.Finally, within Product Costs, we have Conversion Costs: these are the costs incurred in the factory that are incurred in the conversion of materials into finished goods. The classification of Period Costs: The scheme shows five sub classifications for Period Costs. When we look at different organisations, we find that they have period costs that might have sub classifications with entirely different names. Unfortunately, this is the nature of the classification of period costs; it can vary so much according to the organisation, the industry and so on. Nevertheless, such a scheme is useful in that it gives us the basic ideas to work on. Administration Costs: Literally the costs of running the administrative aspects of an organisation. Administration costs will include salaries, rent, Council Tax, electricity, water, telephone, depreciation, a potentially infinitely long list. Notice that there are costs here such as rent, Council Tax, that appear in several sub classifications; in such cases, it should be clear that we are paying rent on buildings, for example, that we use for manufacturing and storage and administration and each area of the business must pay for its share of the total cost under review.Without wishing to overly extend this listing now, we can conclude this discussion by saying that the costs of Selling, the costs of Distribution and the costs of Research are all accumulated in a similar way to the way in which

Administration Costs are accumulated. Consequently, our task is to look at the selling process and classify the costs of running that process accordingly: advertising, market research, salaries, bonuses, electricity, and so on. The same applies to all other classifications of period costs that we might use.Finance Costs: Finance costs are those costs associated with providing the permanent, long term and short term finance. That is, within the section headed finance costs we will find dividends, interest on long term loans and interest on short term loans.Finally, we should say that we can add any number of subclassifications to our scheme if we need to do that to clarify the ways in which our organisation operates. We will also add further subclassifications if we need to refine and further refine out cost analysis. COST SHEET FORMAT

Particulars Opening Stock of Raw Material Add: Purchase of Raw materials Add: Purchase Expenses Less: Closing stock of Raw Materials Raw Materials Consumed Direct Wages (Labour) Direct Charges Prime cost (1) Add :- Factory Over Heads: Factory Rent Factory Power Indirect Material Indirect Wages Drawing Office Salary Factory Insurance Factory Asset Depreciation Works cost Incurred Add: Opening Stock of WIP Less: Closing Stock of WIP Works cost (2) Add:- Administration Over Heads:Office Rent Asset Depreciation General Charges Audit Fees Bank Charges Counting house Salary Other Office Expenses Cost of Production (3) Add: Opening stock of Finished Goods Less: Closing stock of Finished Goods Cost of Goods Sold Add:- Selling and Distribution OH:Sales man Commission Sales man salary Traveling Expenses Advertisement Delivery man expenses Sales Tax Bad Debts

Amount *** *** *** *** *** *** *** *** *** *** *** *** *** *** ***

Amount

***

Supervisor Salary

*** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** ***

Cost of Sales (5) *** Profit (balancing figure) *** Sales *** Notes:-1) Factory Over Heads are recovered as a percentage of direct wages 2) Administration Over Heads, Selling and Distribution Overheads are recovered as a percentage of works cost.

Performance budget - 1. a budget format that relates to both the input of resources into something and the output of services of that thing for each unit within an organisation. Sometimes this may be called a program budget. Or 2. a medium- to short-range budget used in governmental accounting. A budget that reflects the input of resources and the output of services for each unit of an organization. This type of budget is commonly used by the government to show the link between the funds provided to the public and the outcome of these services.

Integrated Accounting System : An overview Integrated Accounting is a distinguished accounting system in which the accounts are integrated and only a single set of accounts are maintained. Essentially it avoids maintenance of Accounts under cost accounting & financial accounting. This enables a firm to eliminate separate Profit & Loss Accounts under financial accounting and cost accounting systems & only one Profit & Loss Accounts are prepared. The benefits of Integrated Accounting System are as follows: 1. No need for reconciliation :As only single set of accounting records is kept, the need for reconciliation between the profits shown by the two records stands eliminated. 2. Simple to understand :The method is quite simple to understand and easy to operate. It tends to eliminate unnecessary complications. 3. Less Costly :The method avoids duplication of work & thus cost of operating this system is reduced. Hence the method can be treated as Cost Effective. 4. Cross Checking :There is a cross checking of various figures in cost as well as financial accounts. This ensures accuracy of figures of cost & financial data. 5. Availability of Cost & financial Data :The system assures that cost data becomes available promptly and regularly 6. Use of Mechanized Accounting Methods :Use of Mechanized Accounting System can be made. 7. Time Saving :The Integrated Accounting System can be considered as Timesaving Accounting System because it saves lot of time. 8. Holistic View :Integrated Accounting System gives a Holistic View about the accounting system of a company. 9. User Friendly :The Integrated accounting system is a user friendly system & can be understood even by a layman. 10. Saves Accountants Efforts :The Integrated Accounting Systems saves the accountants efforts as only the Integrated Accounting Systems are to be maintained.

As we know, cost & financial accounts are said to be interlocked, when independent set of books are maintained for each of them. These accounts are interlocked through control accounts maintained in the two sets of books. Cost Ledger Control Accounts is maintained in the financial books and General Ledger Adjustment Account is maintained in costing books. In this manner, connection between two sets of books is maintained. In costing books, all entries relating to assets are booked in General Ledger Adjustment Account as an accounting effect. However when it is desired to integrate the two trial balances into single trial balance, the Cost Ledger Control Account and General Ledger Adjustment Account can be omitted because they are maintained on contra principle. Following accounts are maintained under the Integrated Accounting System as a regular Practice: a. Stock Control Accounts including Raw material, WIP & Finished Goods b. Cost of Sales Accounts to ascertain the cost of sales c. Debtors & Creditors Control Account to ascertain the quantum of transaction connected with debtors & creditors d. Prepaid Expenses & Outstanding Expenses Account to record the expenses which are due but not paid and paid but not due. e. Direct Wages & Overhead Cost Control Accounts to determine the flow of Direct Wages & Overheads f. Cost Centre Account to be separately maintained for each department g. Cash Account to record all cash receipts & cash Payments The main benefit of integration is elimination of two sets of records. However due to some practical difficulties in implementation of accounting system , Interlocking of accounts is preferred. However Following are some practical limitations of Integrated Accounting System. a. Size of Business enterprise may not suite for Integrated Accounting System b. Lack of Qualified Personnel c. Volume of transactions may be too much to cope up with the Integrated Accounting system d. Lot of accounts to be maintained e. Difficulties may arise about posting of certain items like discount allowed or bad debts incurred etcHence to sum up, we can state that Integrated Accounting System is a specialized type of accounting system which focuses on integration of cost & financial accounts and carries a sizable number of advantages coupled by a few practical limitations. Use value or functional value is the perceived value of goods or services to a customer because the goods/services do what they are supposed to do in the way they do it. Thus a vacuum cleaner that cleans better than another has higher functional value - most customers would be willing to pay more for it, Esteem value is the value of goods or servcies according to the status they afford to the buyer/user. Thus, many customers will pay more for a branded item of clothing because they want to 'wear the name' - they feel it gives them some status a non-branded item would not. Value engineering (VE) is a systematic method to improve the "value" of goods or products and services by using an examination of function. Value, as defined, is the ratio of function to cost. Value can therefore be increased by

either improving the function or reducing the cost. It is a primary tenet of value engineering that basic functions be preserved and not be reduced as a consequence of pursuing value improvements.[1] Distinction Between Standard Costing And Budgetary Control Although budgetary control and standard costing both are based on some common principles; both are pre-determined, comparison will be made with the actual costs and both system need a revision of the standards or the budget, these two systems have certain differences which are as follows: 1. Budgetary control deals with the operation of a department or the business as a whole in terms of revenue and expenditure. Standard costing is a system of costing which makes a comparison between standard costs of each product or service with its actual cost. 2. Budgetary control covers as a whole in terms of revenue and expenditures such as purchases, sales, production, finance etc. Standard costing is related to a product and its cost only. 3. Budgetary control is applicable to utmost all business organizations. Standard costing is applicable to manufacturing concerns producing standard products and services. 4. Budgetary control is concerned with a specific period and is based on the totals of amounts. Standard costing is concerned with the standard costs, which are worked out generally per unit of production. 5. Budgetary control is not based on standard costing system. Standard costing cannot exist in the absence of a budgetary control system.

Standard Costing and Budgeting Budgeting may be defined as the process of preparing plans for future activities of the business enterprise after considering and involving the objectives of the said organisation. This also provides process/steps of collection and preparation of data, by which deviations from the plan can be measured. This analysis helps to measure performance, cost estimation, minimizing wastage and better utilisation of resources of the organisation. Thus, budgets are prepared on the basis of future estimated production and sales in order to find out the profit in a specified period. In other words Budget is an estimate and a quantified plan for future activities to coordinate and control the uses of resources for a specified period. According to Institute of Cost and Works Accountants, A budget is a financial and / or quantitative statement prepared prior to a defined period of time, of the Policy to be pursued during that period for the purpose of attaining a given objective. Budgeting is a process which includes both the functions of budget and budgetory control. Budget is a planning function and budgetory control is a controlling system or a technique. You might have already studied the budgeting in detail in Block 3, under Unit-8: Basic Concepts of Budgeting. The objective of the standard costing and budgeting is to achieve maximum efficiency and cost control. Under both the systems actual performance is compared with predetermined standards, deviations, if any, are analysed and reported. Budgeting is essential to determine standard costs while standard costing is necessary for planning budgets. Both are complimentary in nature and in determining the results. Besides similarities there are certain differences between standard costing and budgeting which are as follows:

1. 2.

3. 4.

Standard costing Standard costing is based on technical information and is fixed scientifically. Standard costs are used mainly for the manufacturing function and also for marketing and administration functions. Therefore, it does not require functional coordination. Standard costs emphasises the cost levels which should be reduced In standard costing variances are usually revealed through accounts.

1. 2.

Budgeting It is based on standard cost, historical costs and estimates. Budgets are prepared for different functional departments such as sales, purchase, production, finance, personnel department. Therefore, it requires functional coordination. Budgets emphasises cost levels which should not be exceeded. In Budgeting, variances are not revealed through accounts and control in exercised by putting budgeted

3. 4.

5. 6. 7. 8. 9. 10.

In standard costing, a detailed analysis is needed in case of variances. Standard costing sets realistic yardsticks and therefore, it is more useful for controlling and reducing costs. Standard cost is revised only when there is a change in the basic assumptions and basis. Standard costs are based on the basis of standards set by management. Standard costing cannot be used partially. Standards will have to be set for all elements of cost. Standard cost is a projection of cost a/c

5. 6. 7. 8. 9. 10.

figures and actual side by side. No further analysis is required if costs are within the budget. Budgets generally set maximum limits of expenditure without considering the effectiveness of expenditure. Budgeting is done before the beginning of each accounting period. Budgets are set on the basis of present level of efficiency. Budgeting can be done either wholly or partly. Budgeting is a projection of financial accounts.

Standard Cost and Estimated Costs Estimates are predetermined costs which are based on historical data and is often not very scientifically determined. They usually compiled from loosely gathered information and therefore, they are unsafe to use them as a tool for measuring performance. Standard costs are predetermined costs which aims at what the cost should be rather then what it will be. Both the standard costs and estimated costs are used to determine price in advance and their purpose is to control cost. But, there are certain differences between these two costs as stated below:

The following are some of the important differences between standard cost and estimated cost: Standard Cost Standard cost emphasizes as what the cost should be in a given set of situations. Standard costs are planned costs which are determined by technical experts after considering levels of efficiency and production It is used as a devise for measuring efficiency Standard costs serve the purpose of cost control Standard costing is part of cost accounting process It is a technique developed and recognised by management and academecians It can be used where standard costing is in operation Concept of Standard Costing Standard costing is a technique used for the purpose of determining standard cost and their comparison with the actual costs to find out the causes of difference between the two so that remedial action may be taken immediately. The Charted Institute of Management Accountants, London, defines standard costing as the preparation of standard costs and applying them to measure the variations from actual costs and analysing the causes of variations with a view to maintain maximum efficiency in production. Thus, standard costing is a technique of cost accounting which compares the standard cost of each product or service, with the actual cost, to determine the efficiency o f Estimated Cost Estimated cost emphasizes on what the cost will be. Estimated costs are determined by taking into consideration the historical data as the basis and adjusting it to future trends. It cannot be used as a devise to determine efficiency. It only determines expected costs. Estimated costs do not serve the purpose of cost control. Estimated costs are statistical in nature and may not become a part of accounting. It is just an estimate and not a technique It may be used in any concern operating on a historical cost system.

the operation. When actual costs differ from standards the difference is called variance and when the size of the variance is significant a detailed investigation will be made to determine the causes of variance, so that remedial action will be taken immediately. Thus, standard costing involves the following steps: 1. Setting standard costs for different elements of costs 2. Recording of actual costs 3. Comparing between standard costs and actual costs to determine the variances 4. Analysing the variances to know the causes thereof, and 5. Reporting the analysis of variances to management for taking appropriate actions wherever necessary. The system of standard costing can be used effectively to those industries which are producing standardised products and are repetitive in nature. Examples are cement industry, steel industry, sugar industry etc. The standard costing may not be suitable to jobbing industries because every job has different specifications and it will be difficult and expensive to set standard costs for every job. Thus, standard costing is not suitable in situations where a variety of different kinds of tasks are being done. Variance Analysis After the standard costs have been set, the next step is to ascertain the actual cost of each element and compare them with the standard already set. The difference of actual from the standard is Variance. While setting standard specific method of production is to be kept in mind. If a different method of production is adopted, it gives rise to a different amount of cost, thereby causing variance, known as method variance. In standard costing, Variance means the difference between a standard cost and the comparable actual cost incurred during a period. Variance analysis is the process of analysing variances by sub-dividing the total variance in such a way that management can assign responsibility for any off-standard performance. Thus, variance analysis means the measurement of the deviation of actual performance from the desired performance. Variance may be favourable or unfavourable depending upon whether the actual cost is less or more than the standard cost. If the actual cost is less than the standard cost, the variance is termed as favourable and if the actual cost is more than the standard cost, variance is called as unfavourable or adverse variance. The effect of favourable variance increases the profit and it is a sign of efficiency of the organisation. On the other hand, unfavourable variance refers to the loss of the business and it is a sign of inefficiency of the organisation. Controllable and Uncontrolled Variances The variance may be classified as Controllable and Uncontrollable. Variance is said to be controllable if it is identified as the primary responsibility of a particular person or department. The excessive use of materials or labour hours than the standards can be attributable to a particular person. When the variations are due to the factors beyond the control of the concerned person or department, it is said to be uncontrolled. The rise in prices of materials, increase in wage rates, Govt. restrictions etc., are the examples of uncontrollable variance. These factors are not within the control of the management and the responsibility of the variance cannot be assigned to any particular person or division. The division of variance into controllable and uncontrollable is important from the view point of management as it can place more emphasis on controllable variance and thus facilitates to the principle of management by exception. Standard costing to be more realistic, sometimes the standards set are to be revised on account of changes in uncontrollable factors like wages, materials etc. To take into account these factors into variance, a revised variance is created and the basic standard is allowed to continue. This revision variance is the difference between the standard cost originally set and the revised standard cost.

Classification of Variances Variances may be classified into two categories viz., 1. Cost variances and 2. Sales variances. The cost variance may again be sub-divided into variances for each element of cost as shown in the following chart: