Professional Documents
Culture Documents
COST ACCOUNTING
UNIT I
INTRODUCTION TO COST
Accounting information is important for every business which will serve the
needs of variety of interested parties. To satisfy the needs of all interested
parties a sound accounting system is very necessary. Accounting may be
divided into three parts i. Financial accounting ii. Cost accounting iii.
Management accounting.
Cost accounting developed to help the internal management in decision
making. The information provided by cost accounting acts as a managerial
tool so that business can utilise the available resources at optimum level.
Meaning of Cost
Cost is the amount of resource given up in exchange for some goods or
services. The resources given up are money or moneys equivalent expressed
in monetary units.
The Chartered Institute of Management Accountants, London defines cost
as the amount of expenditure (actual or notional) incurred on, or
attributable to a specified thing or activity.
Costing
Costing is the techniques and processes of ascertaining costs. These
techniques consist of principles and rules which govern the procedure of
ascertaining cost of products or services. The techniques to be followed for
the analysis of expenses and the processes of different products or services
differ from industry to industry.
The main object of costing is the analysis of financial records, so as to
subdivide expenditure and to allocate it carefully to selected cost centers,
and hence to build up a total cost for the departments, processes or jobs or
contracts of the undertaking.
Cost Accounting
Cost accounting may be regarded as ``a specialised branch of accounting
which involves classification, accumulation, assignment and control of
costs.
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about the profitability and prospects of the enterprise upon the studies and
reports submitted by the cost accountant.
4. Importance to National Economy
An efficient costing system benefits national economy by stepping up the
government revenue by achieving higher production. The overall economic
developments of a country take place due to efficiency of production.
5. Data Base for operating policy
Cost Accounting offers a thoroughly analysed cost data which forms the
basis of formulating policy regarding day to day business, such as:
(a) Whether to make or buy decisions from outside?
(b) Whether to shut down or continue producing and selling at below cost?
(c) Whether to repair an old plant or to replace it?
LIMITATIONS OF COST ACCOUNTING
Like other branches of accounting, cost accounting is not an exact science
but is an art which has developed through theories and accounting
practices based on reasoning and common sense. These practices are not
static but changing with time. Cost accounting lacks a uniform procedure.
There is no stereotyped system of cost accounting applicable to all
industries. There are widely recognised cost concepts but understood and
applied differently by different industries. Cost accounting can be used only
by big enterprises.
The limitations of cost accounting are as follows:
It is expensive because analysis, allocation and absorption of overheads
require considerable amount of additional work.
The results shown by cost accounts differ from those shown by financial
accounts. Preparation of reconciliation statements frequently is necessary
to verify their accuracy. This leads to unnecessary increase in workload.
It is unnecessary because it involves duplication of work. Some industrial
units are functioning efficiently without any costing system.
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Costing system itself does not control costs. If the management is alert and
efficient, it can control cost without the help of the cost accounting.
Therefore it is unnecessary.
Differences between Cost accounting and Financial accounting
Points of
Cost accounting
Financial accounting
Differences
1. Purpose The purpose of financial The purpose of cost accounting
accounting
is
external is internal reporting, i.e., to the
reporting mainly to owners, mangement of every business.
creditors, tax authorities,
government, and prospective
investors.
2.
2. This is to be maintained Cost accounting is maintained
Obligation compulsorily by higher forms voluntarily. In some cases
to
of business organizations. government has directed some
maintain
The preparation of accounts companies to maintain cost
accounts
must be in accordance with accounts to improve efficiency.
the statutory provisions.
3.
(a)
Financial
accounting (a) Cost accounting records
Recording records transactions in a transactions in an objective
subjective
manner,
i.e., manner, i.e., according to
according to the nature of purpose for which costs are
expenditure.
incurred.
(b) In financial accounting (b) In cost accounting costs are
expenses are recorded in expressed by proper analysis
totals.
and classification in order to
(c)
Financial
accounting find out cost per unit.
records all transactions which (c) Cost accounting records
takes place in the business.
only those costs which affect
(d)
Financial
accounting production and sales.
records only historical costs.
(d) Cost accounting records
both historical and estimated
costs
4. Analysis Financial
accounting Cost accounting shows the
of profit
discloses profit for the entire profitability or otherwise of
business as a whole.
each product, process or
operation so as to reveal the
areas of profitability.
5. Control (a) It does not make use of (a) It makes use of some
any control techniques.
important control techniques
(b) It does not control such as Marginal Costing,
materials
by
using
any Budgetary Control, Standard
technique.
Costing, etc., in order to control
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UNIT II
CLASSIFICATION OF COSTS
The different bases of cost classification are:
1. By time (Historical, Pre-determined).
2. By nature or elements (Material, Labour and Overhead).
3. By degree of traceability to the product (Direct, Indirect).
4. Association with the product (Product, Period).
5. By Changes in activity or volume (Fixed, Variable, Semi-variable).
6. By function (Manufacturing, Administrative, Selling, Research and
development, Pre production).
7. Relationship with accounting period (Capital, Revenue).
8. Controllability (Controllable, Non-controllable).
9. Cost for analytical and decision-making purposes (Opportunity, Sunk,
Differential, Joint, Common, Imputed, Out-of-pocket, Marginal,
Uniform, Replacement).
10.
Others (Conversion, Traceable, Normal, Avoidable, Unavoidable,
Total).
1. Classification on the Basis of Time
(a) Historical Costs: These costs are ascertained after they are incurred.
Such costs are available only when the production of a particular thing has
already been done. They are objective in nature and can be verified with
reference to actual operations.
(b) Pre-determined Costs: These costs are calculated before they are
incurred on the basis of a specification of all factors affecting cost. Such
costs may be:
(i) Estimated costs: Costs are estimated before goods are produced; these
are naturally less accurate than standards.
(ii) Standard costs: This is a particular concept and technique. This
method involves:
(a) Setting up predetermined standards for each element of cost and each
product;
(b) Comparison of actual with standard to find variation;
(c) pin-pointing the causes of such variances and taking remedial action.
Obviously, standard costs, though pre-determined, are arrived with much
greater care than estimated costs.
2. By Nature or Elements
There are three broad elements of costs:
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(1) Material: The substance from which the product is made is known as
material. It can be direct as well as indirect.
Direct material: It refers to those materials which become a major part of
the finished product and can be easily traceable to the units. Direct
materials include:
(i) All materials specifically purchased for a particular job/process.
(ii) All material acquired and latter requisitioned from stores.
(iii) Components purchased or produced.
(iv) Primary packing materials.
(v) Material passing from one process to another.
Indirect material: All material which is used for purposes ancillary to
production and which can be conveniently assigned to specific physical
units is termed as indirect materials. Examples, oil, grease, consumable
stores, printing and stationary material etc.
(2) Labour: Labour cost can be classified into direct labour and indirect
labour.
Direct labour: It is defined as the wages paid to workers who are engaged
in the production process whose time can be conveniently and economically
traceable to units of products. For example, wages paid to compositors in a
printing press, to workers in the foundry in cast iron works etc.
Indirect labour: Labour employed for the purpose of carrying tasks
incidental to goods or services provided, is indirect labour. It cannot be
practically traced to specific units of output. Examples, wages of storekeepers, foreman, time-keepers, supervisors, inspectors etc.
(3) Expenses: Expenses may be direct or indirect.
Direct expenses: These expenses are incurred on a specific cost unit and
identifiable with the cost unit. Examples are cost of special layout, design or
drawings, hiring of a particular tool or equipment for a job; fees paid to
consultants in connection with a job etc.
Indirect expenses: These are expenses which cannot be directly,
conveniently and wholly allocated to cost centre or cost units. Examples are
rent, rates and taxes, insurance, power, lighting and heating, depreciation
etc.
It is to be noted that the term overheads has a wider meaning than the term
indirect expenses. Overheads include the cost of indirect material, indirect
labour and indirect expenses. Overheads may be classified as
(a) production or manufacturing overheads, (b) administration overheads,
(c) selling overheads, and (d) distribution overheads.
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Product costs are used for valuing inventories which are shown in the
balance sheet as asset till they are sold. The product cost of goods sold is
transferred to the cost of goods sold account.
Period Costs: Period costs are incurred on the basis of time such as rent,
salaries, etc., include many selling and administrative costs essential to
keep the business running. Though they are necessary to generate revenue,
they are not associated with production, therefore, they cannot be assigned
to a product.
They are charged to the period in which they are incurred and are treated
as expenses. Selling and administrative costs are treated as period costs for
the following reasons:
(i) Most of these expenses are fixed in nature.
(ii) It is difficult to apportion these costs to products equitably.
(iii) It is difficult to determine the relationship between such cost and the
product.
(iv) The benefits accruing from these expenses cannot be easily established.
The net income of a concern is influenced by both product and period costs.
Product costs are included in the cost of the product and do not affect
income till the product is sold. Period costs are charged to the period in
which they are incurred.
5. By Changes in Activity or Volume
Costs can be classified as fixed, variable and semi-variable cost.
Fixed Costs: The Chartered Institute of Management Accountants, London,
defines fixed cost as the cost which is incurred for a period, and which,
within certain output and turnover limits, tends to be unaffected by
fluctuations in the levels of activity (output or turnover).
These costs are incurred so that physical and human facilities necessary for
business operations, can be provided. These costs arise due to contractual
obligations and management decisions. They arise with the passage of time
and not with production and are expressed in terms of time. Examples are
rent, property taxes, insurance, supervisors salaries etc.
It is wrong to say that fixed costs never change. These costs may vary
depending on the circumstances. The term fixed refer to non-variability
related to the relevant range. Fixed cost can be classified into the following
categories for the purpose of analysis:
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(a) Committed Costs: These costs are incurred to maintain certain facilities
and cannot be quickly eliminated. The management has little or no
discretion in this cost, e.g., rent, insurance etc.
(b) Policy and Managed Costs: Policy costs are incurred for implementing
particular management policies such as executive development, housing,
etc. Such costs are often discretionary. Managed costs are incurred to
ensure the operating existence of the company e.g., staff services.
(c) Discretionary Costs: These are not related to the operations and can be
controlled by the management. These costs result from special policy
decisions, new researches etc., and can be eliminated or reduced to a
desirable level at the discretion of the management.
(d) Step Costs: Such costs are constant for a given level of output and then
increase by a fixed amount at a higher level of output.
Variable Cost: Variable costs are those costs that vary directly and
proportionately with the output e.g. direct materials, direct labour. It should
be kept in mind that the variable cost per unit is constant but the total cost
changes corresponding to the levels of output. It is always expressed in
terms of units, not in terms of time.
Management decisions can influence the cost behaviour patterns. The
concept of variability is relative. If the conditions upon which variability was
determined changes, the variability will have to be determined again.
Semi-fixed (Semi-Variable) costs: Such costs contain fixed and variable
elements. Because of the variable element, they fluctuate with volume and
because of the fixed element; they do not change in direct proportion to
output. Semi-variable costs change in the same direction as that of the
output but not in the same proportion. Depreciation is an example; for two
shifts working the total depreciation may be only 50% more than that for
single shift working. They may change with comparatively small changes in
output but not in the same proportion.
6. Functional Classification of Costs
A company performs a number of functions. Functional costs may be
classified as follows:
(a) Manufacturing/production Costs: It is the cost of operating the
manufacturing division of an undertaking. It includes the cost of direct
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materials, direct labour, direct expenses, packing (primary) cost and all
overhead expenses relating to production.
(b) Administration Costs: They are indirect and covers all expenditure
incurred in formulating the policy, directing the organisation and
controlling the operation of a concern, which is not related to research,
development, production, distribution or selling functions.
(c) Selling and Distribution Cost: Selling cost is the cost of seeking to
create and stimulate demand e.g. advertisements, market research etc.
Distribution cost is the expenditure incurred which begins with making the
package produced available for dispatch and ends with making the
reconditioned packages available for re-use e.g. warehousing, cartage etc. It
includes expenditure incurred in transporting articles to central or local
storage. Expenditure incurred in moving articles to and from prospective
customers as in the case of goods on sale or return basis is also distribution
cost.
(d) Research and Development Costs: They include the cost of discovering
new ideas, process, products by experiment and implementing such results
on a commercial basis.
(e) Pre-production Cost: When a new factory is started or when a new
product is introduced, certain expenses are incurred. There are trial runs.
Such costs are termed as pre-production costs and treated as deferred
revenue expenditure. They are charged to the cost of future production.
7. Relationships with Accounting Period
Costs can be capital and revenue.
Capital expenditure provides benefit to future period and is classified as
an asset. On the other hand, revenue expenditure benefits only the
current period and is treated as an expense. As and when an asset is
written off, capital expenses to that extent becomes cost. Only when capital
and revenue is properly differentiated, the income of a particular period can
be correctly determined. It is not possible to distinguish between the two
under all circumstances.
8. Controllability
Cost can be Controllable and Non-Controlable.
Controllable Cost: The Chartered Institute of Management Accountants
defines controllable cost as cost which can be influenced by its budget
holder.
Non-Controllable Cost: It is the cost which is not subject to control at any
level of managerial supervision.
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The difference between the terms is very important for the purpose of cost
accounting, cost control and responsibility accounting.
A controllable cost can be controlled by a person at a given organisational
level. Controllable cost are not totally controllable. Some costs are partly
controllable by one person and partly by another e.g., maintenance cost can
be controlled by both the production and maintenance manager. The term
controllable costs is often used to mean variable costs and noncontrollable costs as fixed.
Belkaoni has mentioned the following fallacies about controllable costs:
(i) All variable costs are controllable and fixed are not.
(ii) All direct costs are controllable and indirect costs are not.
(iii) All long-term costs are controllable.
Sometimes the time factor and the decision making authority can make a
cost controllable. If the time period is long enough, all costs can be
controlled. Proper delegation helps in establishing clear responsibility and
controllability. But all costs can be controlled by one or another person. The
authority and responsibility of cost control is delegated to different levels,
though the managing director is responsible for all the costs.
9. Costs for Analytical and Decision Making Purposes
(a) Opportunity Costs: Opportunity cost is the cost of selecting one course
of action and the losing of other opportunities to carry out that course of
action. It is the amount that can be received if the asset is utilised in its
next best alternative.
Edwards, Hermanson and Salmonson define it as the benefits lost by
rejecting the best competing alternative to the one chosen. The benefit lost
is usually the net earnings or profit that might have been earned from the
rejected alternative
Example: Capital is invested in plant and machinery. It cannot be now
invested in shares or debentures. The loss of interest and dividend that
would be earned is the opportunity cost. Another example is when the
owner of a business foregoes the opportunity to employ himself elsewhere.
Opportunity costs are not recorded in the books. It is important in decision
making and comparing alternatives.
(b) Sunk Costs: A sunk cost is one that has already been incurred and
cannot be avoided by decisions taken in the future. As it refers to past
costs, it is called unavoidable cost.
The National Association of Accountants (USA) defines a sunk cost as an
expenditure for equipment or productive resources which has no economic
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relevance to the present decision making process. This cost is not useful
for decision making as all past costs are irrelevant. CIMA defines it as the
past cost not taken into account in decision making. It has also been
defined as the difference between the purchase price of an asset and its
salvage value.
(c) Differential Cost: Differential cost has been defined as the difference in
total cost between alternatives, calculated to assist decision making.
Differential cost is the increase or decrease in total costs resulting out of:
(a) Producing and distributing a few more or few less of products;
(b) A change in the method of production/distribution;
(c) An addition or deletion of a product or a territory; and
(d) The selection of an additional sales channel.
The differential cost between any two levels of production is the difference
between the marginal costs at these two levels and the increase or decrease
in fixed costs, if any. These costs are usually specific purpose costs as they
are determined for a particular purpose and under specific circumstances.
Incremental cost measures the addition in unit cost for an addition in
output. This cost need not be the same at all levels of production. It is
usually expressed as a cost per unit whereas the differential cost is
measured in total. The former applies to increase in production and is
restricted to the cost only, whereas the differential cost has a
comprehensive meaning and application in the sense that it denotes both
increase or decrease.
Differential costs is useful in planning and decision making and helps to
choose the best alternative. It helps management to know the additional
profit that would be earned if idle capacity is used or when additional
investments are made.
(d) Joint Costs: The processing of a single raw material results in two or
more different products simultaneously. The joint products are not
identifiable as different types of product until a certain stage of production
known as the split-off point is reached. Joint costs are the costs incurred
upto the point of separation. One product may be of major importance and
others of minor importance which are called by-products.
Bierman and Djckman define it as: Joint costs relate to a situation in
which the factors of production by their basic nature result in two or more
products. The jointness results from there being more than one product,
and these multi-products are the result of the methods of production or the
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involve any cash expenditure. Such costs are relevant for price fixation
during recession or when make or buy decision is to be made.
10. Other Costs
(i) Conversion Cost: It is the cost of a finished product or work-in-progress
comprising direct labour and manufacturing overhead. It is production cost
less the cost of raw material but including the gains and losses in weight or
volume of direct material arising due to production.
(ii) Normal Cost: This is the cost which is normally incurred at a given level
of output in the conditions in which that level of output is achieved.
(iii) Traceable Cost: It is the cost which can be easily associated with a
product, process or department.
(iv) Avoidable Costs: Avoidable costs are those costs which under the
present conditions need not have been incurred. Example: (a) Spoilage in
excess of normal limit; (b) Unfavourable cost variances which could have
been controlled.
(v) Unavoidable Costs: Unavoidable costs are those costs which under the
present conditions must be incurred.
(vi) Total Cost: This is the sum of all costs associated to a particular unit,
or process, or department or batch or the entire concern. It may also mean
the sum total of material, labour and overhead. The term total cost however,
is not precise, it needs to be made precise by using terms that indicate the
elements of cost included.
(vii) Value Added: Strictly, it is not cost. It means the selling price of the
product/service less the cost of materials used in the product or the service.
Often depreciation is also deducted for ascertaining value added.
COST CENTRE AND COST UNIT
A cost accountant has to ascertain cost by cost centre or cost unit or by
both.
Cost Centre
According to the Chartered Institute of Management Accountants, London,
cost centre means, a production or service location, function, activity or
item of equipment whose costs may be attributed to cost units.
Cost centre is the smallest organisational sub-unit for which separate cost
collection is attempted. Thus cost centre refers to one of the convenient unit
into which the whole factory organisation has been appropriately divided for
costing purposes. Each such unit consists of a department or a subdepartment or item of equipment or, machinery or a person or a group of
persons. For example, although an assembly department may be supervised
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ton of steel, per tonne kilometre of a transport service or cost per machine
hour. The forms of measurement used as cost units are usually the units of
physical measurements like number, weight, area, length, value, time etc.
Unit selected should be unambiguous, simple and commonly used.
Following are some examples of cost unit:
Industry/Product
Cost unit
Automobile
Number
Brick works
1000 bricks
Cement
Tonne
Transport
Tonne - Kilometre
Passenger - Kilometre
Chemicals
Litre, gallon, kilogramme, tonne
Steel
Tonne
Sugar
Tonne
The selection of suitable cost centres or cost units for which costs are to be
ascertained in an undertaking depends upon a number of factors which are
listed as follows:
(i) Organisation of the factory.
(ii) Conditions of incidence of cost.
(iii) Requirements of the costing system i.e. suitability of the units of
centres for cost purposes.
(iv) Availability of information.
(v) Management policy regarding making a particular choice from several
alternatives.
PREPARATION OF COST SHEET
When costing information is set out in the form of a statement, it is called
Cost Sheet. It is usually adopted when there is only one main product and
all costs almost are incurred for that product only. The information
incorporated in a cost sheet would depend upon the requirement of
management for the purpose of control.
Cost sheet is one of the method of unit costing. The format of cost sheet is
as under:Cost Sheet for the Period___________________
Production __________ Units
Particulars
Amount
Amount
Opening Stock of Raw Material
***
Add: Purchase of Raw materials
***
Add: Purchase Expenses
***
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***
***
***
***
Prime cost (1)
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
***
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***
***
***
***
***
***
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UNIT-III
MATERIALS
The materials are a major part of the total cost of producing a product and
are one of the most important assets in majority of the business
enterprises. Hence the total cost of a product can be controlled and reduced
by efficiently using materials.
The materials are of two types, namely:
(i) Direct materials: The materials which can be easily identified and
attributable to the individual units being manufactured are known as direct
materials. These materials also form part of finished products. All costs
which are incurred to obtain direct materials are known as direct material
costs.
(ii) Indirect materials: Indirect materials, on the other hand, are those
materials which are of small value such as nuts, pins, screws, etc. and do
not physically form part of the finished product. Costs associated with
indirect materials are known as indirect material costs.
Factory supplies, office supplies and selling supplies are generally termed
as stores.
Classification and Codification of Material:
In case of large organizations the number and types of materials used is
considerable and unless each item is distinguished and stored separately it
would be impossible to find them out when they are required for production
or any other operation. It may happen that either one type of material is in
excess or another type may be altogether non-existent. It is therefore,
essential that a proper system of classification and codification.
Classified into different categories according to their nature or type, viz.,
mild steel, tool steel, brass, bronze, copper, glass, timber, etc., and then
again within such broad classification into rounds; bars, strips; angles, etc.
There are two steps in the classification and codification of materials
determination of the number of items, their nature, other characteristics
and classification of the items of comparable nature or type into suitable
groups or classes.
Various classes of coding are in practice and the common types are stated
below:
(a) Alphabetical Scheme: Alphabetics are only used for codification. Like
Mild Steel Sheets are coded as MSS.
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ladings, goods received notes, lorry receipt, goods receipt (transport delivery
notes), inspection notes have to be dealt with. It involves a lot of clerical
work.
This department has to refer to previous correspondence on purchase
orders, notes, catalogues, blue prints, price lists etc. very frequently which
makes it imperative to maintain records in appropriate manner. These
records are essential for making the day to day purchase.
11. Reporting to top management:
It is also an important function of the purchasing department to prepare
weekly, monthly, quarterly, bi-annually and yearly reports regarding
expenditures of this department and send the same to top management
along with details of purchases made and suggestions or improvements, if
any.
12. Developing coordination among departments:
A purchasing department has to fulfill the needs of other departments in
the organisation. It is the function of purchasing department to work in
close coordination and cooperation with other departments of the company.
13. Creating goodwill of the organisation in the eyes of the suppliers:
Good vendor relationship has to be maintained and developed to reflect
enterprises image and goodwill. Maintaining such relations requires mutual
trust and confidence which grows out of dealings between the two parties
over a period of time. Worth of a purchasing department can be measured
by the amount of goodwill it has with its vendors
Storekeeping: Store keeping is a service function. The storekeeper is a
custodian of all the items kept in the store. The stores should be
maintained properly and cost minimized. The main objectives of store
keeping are:i) To protect stores against losses
ii) To keep goods ready for delivery/issue
iii) To provide maximum service at minimum cost.
The duties and functions of Store-keeper can be summarized as
follows: i) Materials should be received, unloaded, inspected and then
moved to stores. The materials have to be stored in appropriate places and
records the receipts in proper books.
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(b) Stores Ledger: This ledger is kept in the costing department and is
identical with the bin card except that receipts, issues and balances are
shown along with their money values. This provides the information for the
pricing of materials issued and the money value at any time of each item of
stores.
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Transaction take place
(e) Transactions may be posted
and in total.
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(i) The maximum level is also dependent on the economic ordering quantity.
Maximum Level = Re-Order Level + Re-Order Qty (Minimum Rate of
Consumption X Minimum Re-Order Period)
b) Minimum Level:
The Minimum Level indicates the lowest quantitative balance of an item of
material which must be maintained at all times so that there is no stoppage
of production due to the material being not available.
In fixing the minimum level, the following factors are to be considered:(a) Nature of the item: For special material purchased against customers
specific orders, no minimum level is necessary. This applies to other levels
also.
(b) The minimum time (normal re-order period) required replenishing
supply: This is known as the Lead
Time and are defined as the anticipated time lag between the dates of
issuing orders and the receipt of materials. Longer the lead time, lower is
minimum level, the re-order point remaining constant.
(c) Rate of consumption (normal, minimum or maximum) of the material.
Minimum Level=Re-Order level (Normal Rate of Consumption X
Normal Re-Order Period)
c) Re-Order Level:
When the stock in hand reach the ordering or re-ordering level, store keeper
has to initiate the action for replenish the material. This level is fixed
somewhere between the maximum and minimum levels in such a manner
that the difference of quantity of the material between the Re-ordering Level
and Minimum Level will be sufficient to meet the requirements of
production up to the time the fresh supply of material is received.
The basic factors which are taken into consideration in fixing a Re-ordering
Level for a store item include minimum quantity of item to be kept, rate of
consumption and lead time which are applied for computing of this level.
Re-Ordering level= Minimum Level + Consumption during lead time
= Minimum Level + (Normal Rate of Consumption Normal Reorder Period)
Another formula for computing the Re-Order level is as below
Re-Order level = Maximum Rate of Consumption X Maximum Re-Order
period (lead time)
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d) Danger Level:
It is the level at which normal issue of raw materials are stopped and only
emergency issues are only made. This is a level fixed usually below the
Minimum Level. When the stock reaches this level very urgent action for
purchases is indicated. This presupposed that the minimum level contains
a cushion to cover such contingencies. The normal lead time cannot be
afforded at this stage. It is necessary to resort to unorthodox hasty
purchase procedure resulting in higher purchase cost.
The practice in some firms is to fix danger level below the Re-Ordering Level
but above the Minimum Level. In such case, if action for purchase of an
item was taken when the stock reached the Re-Ordering Level, the Danger
Level is of no significance except that a check with the purchases
department may be made as soon as the Danger Level is reached to ensure
that everything is all right and that delivery will be made on the scheduled
date.
Danger Level = Normal Rate of Consumption Maximum Re-OrPeriod
for emergency purchases
f) Average Stock Level
The average stock level is calculated by the following formula:
Average Stock Level = Minimum Stock Level + of Re-order Quantity.
Or (Minimum Stock Level + Maximum Stock Level)
2. Economic Ordering Quantity (EOQ)
The quantity of material to be ordered at one time is known as economic
ordering quantity. This quantity is fixed in such a manner as to minimize
the cost of ordering and carrying the stock. The total costs of a material
usually consist of:
Total acquisition cost + total ordering cost + total carrying cost.
Since the acquisition cost per unit of material is same whatever is the
quantity purchased, it is usually excluded when deciding the quantity of a
material to be ordered at one time. The only costs to be taken care of are the
ordering costs and carrying costs which vary with the quantity ordered.
Carrying Cost: It is the cost of holding the materials in the store and
includes:
1. Cost of storage space which could have been utilized for some other
purpose.
2. Cost of bins and racks
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UNIT IV
LABOUR
Labour cost is a second major element of cost. The control of labour cost
and its accounting is very difficult as it deals with human element. Labour
is the most perishable commodity and as such should be effectively utilized
immediately.
Importance of Labour Cost Control
Labour is of two types (a) direct labour, (b) indirect 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 commodity or process. For example labour engaged in spinning
department can be conveniently allocated to the spinning process.
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. The examples of indirect labour are
supervisors, sweepers, cleaners, time-keepers, watchmen etc. The cost of
indirect labour cannot be conveniently allocated to a particular job, order,
process or article.
The distinction between direct and indirect labour must be observed
carefully because payment of direct labour is a direct expenditure and is a
part of prime cost whereas payment of indirect labour is an item of indirect
expenditure and is shown as works, office, selling and distribution
expenditure according to the nature of the time spent by the indirect
worker.
Management is interested in the labour costs due to the following
reasons.
workers.
ascertaining the
cost of every product, order, or process.
t labour cost as a basis for absorption of overhead, if
percentage of direct labour cost to overhead is to be used as a method of
absorption of overhead.
To reduce the labour turnover. Hence control of labour cost is an
important objective of management and the realization of this objective
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the token without delay and put it in a tray or box kept near the board.
Immediately after the scheduled time for entering the factory, the box is
removed and the latecomers will have to give their tokens to the timekeeper
and their exact time of arrival is recorded. The tokens or disc left on the
board will represent the absentee workers. Later the timekeeper records the
attendance in the attendance register and subsequently it is passed on to
the Pay Roll Department.
Mechanical Methods
The mechanical methods that are generally used for the recording of time of
workers may be as follows:
(a) Time Recording Clocks
(b) Dial Time Records
Time Recording Clocks
The time recording clock is a mechanical device which automatically
records the time of the workers. Under this method, each worker is given a
Time Card which is kept in a tray near the factory gate and as the worker
enters the gate, he picks up his card from the tray, puts it in the time
recording clock which prints the exact time of arrival in the proper space
against the particular day.
This procedure is repeated for recording time of departure for lunch, return
from lunch and time of leaving the factory in the evening. Late arrivals and
overtime are recorded in red to attract the attention of the management.
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Time Booking
Time booking is the recording of time spent by the worker on different jobs
or work orders carried out by him during his period of attendance in the
factory. The objects of time booking are:
1. To ensure that time spent by a worker in a factory is properly utilized on
different jobs or work orders.
2. To ascertain the labour cost of each individual job or work order.
3. To provide a basis for the apportionment of overhead expenses over
various jobs or work orders when the method for the allocation of overheads
depends upon time spent on different jobs.
4. To ascertain unproductive time or idle time so as to make efforts to keep
it in limit.
5. To know the time taken to complete a particular job so that bonus can be
paid as per the incentive schemes.
6. To know the efficiency of workers, it is necessary to make the comparison
of actual time taken with time allowed for completing a particular task.
Following documents are generally used for time booking:
1. Daily Time Sheets
2. Weekly Time Sheets
3. Job Tickets or Job Cards.
Daily time sheets are given to each worker where he records the time spent
by him on each job or work order.
Weekly time sheets record the same particulars for a week and hence one
card is required for a week.
Job cards are used to keep a close watch on the time spent by a worker on
each job so that the labour cost of a job may be conveniently ascertained.
Idle Time
There is always a difference between the time booked to different jobs or
work orders and the time recorded at the factory gate. This difference is
known as idle time. Idle time is of two types.
(a) Normal Idle Time
(b) Abnormal Idle Time
Normal Idle Time: This represents the time, the wastage of which cannot
be avoided and, therefore, the employer must bear the labour cost of this
time. But every effort should be made to reduce it to the lowest possible
level. Examples of normal idle time are: time taken in going from the factory
gate to the department in which the worker is to work and back at the end
of the day, time taken in picking up the work for the day, time between the
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completion of one work and the start of another work, time taken for
personal needs like tea or toilet, time taken for machine maintenance, time
taken for waiting for instructions, printouts, machine set-up time etc.
Normal Idle Time is unavoidable cost as such should be included in cost of
production. The cost of normal idle time can be treated as an item of factory
expenses and recovered as an indirect charge or added to labour cost.
Abnormal Idle Time: It is that time the wastage of which can be avoided if
proper precautions are taken. Example: time wasted due:- to breakdown of
machinery on account of inefficiency of the works engineer, failure of the
power supply, shortage of materials, waiting for instructions, waiting for
tools and raw materials, strikes or lock-outs in the factory.
It is a principle of costing that all abnormal expenses and losses should not
be included in costs and as such wages paid for abnormal idle time should
not form part of the cost of production. Hence it is debited to Costing Profit
and Loss Account.
Over Time: - It is the work done beyond the normal working period in a day
or week. For overtime done, the workers are given double the wages for the
overtime done. The additional amount paid on account of overtime is known
as overtime premium.
Overtime increases the cost of production and should not be
encouraged as it has the following disadvantages.
1. Overtime is paid at higher rate.
2. Overtime is done at late hours when workers have become tired and
efficiency will it be as much as during the normal working hours.
3. Workers will develop the habit of working slowly during normal hours
and complete the work using overtime to earn more wages.
4. Expenses like lighting, cost of supervision, and wear and tear of
machines will increase disproportionately.
Overtime should be recorded separately and thoroughly investigated to see
that it is incurred only when genuinely required.
The treatment of overtime depends on the situation. If overtime is incurred
for because of the sequence of jobs, then normal wages is charged to labour
cost for the overtime also but if it is a rush job, then the overtime wages is
added to the cost of labour. On the other hand if overtime arises due to any
abnormal reason like breakdown of machinery or power failure, overtime
premium is excluded from the cost of production and is debited to the
Costing Profit and Loss Account
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with different levels of performance. Wages are paid at ordinary piece rate to
those workers whose performance is less than 83% of the standard output,
110% of the ordinary piece rate is given to workers whose level of
performance is between 83% and 100% of the standard and 120% of the
ordinary piece rate is given to workers who produce more than 100% of the
standard output.
This method is not as harsh as Taylors piece rate because penalty for slow
workers is relatively lower.
Premium and Bonus Plan
The object of a premium plan is to increase the production by giving an
inducement to the workers in the form of higher wages for less time worked.
Under a premium plan, a standard time is fixed for the completion of a
specific job or operation at an hourly rate plus wages for a certain fraction
of the time saved by way of a bonus. The plan is also known as incentive
plan because a worker has the incentive to earn more wages by completing
the work in less time.
This system of wage payment is in between the time wage system and piece
work system. In time wage system, worker does not get any reward for the
time saved and in piece work system, the worker gets full payment for time
saved whereas in a premium plan both the worker and the employer share
the labour cost of the time saved.
The following are some of the important premium plans.
(i) Halsey Premium Plan: Under this method, the worker is given wages for
the actual time taken and a bonus equal to half of wages for time saved.
The standard time for doing each job or operation is fixed. In practice the
bonus may vary from 33 % to 66 % of the wages of the time saved. Thus
if S is the standard time, T the time taken, R the labour rate per hour, and
% the percentage of the wages of time saved to be given as bonus, total
earnings of the worker will be:
T x R + % (S-T) R
The advantages of the Halsey Premium Plan are:
It is simple to understand and relatively simple to calculate.
1. It guarantees time wages to workers.
2. The wages of time saved are shared by both employers and workers, so it
is helpful in reducing labour cost per unit.
3. It motivates efficient workers to work more as there is increasing
incentive to efficient workers.
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(iii) Avoidable Causes: Under this head, may be grouped the causes which
need the attention of the management most so that the turnover may be
kept low by taking remedial measures. The main reasons for which workers
leave are:
(a) Unsuitability of job.
(b) Low pay and allowance.
(c) Unsatisfactory working conditions.
(d) Unhappy relations with co-workers and unsatisfactory behaviour of
superiors.
(e) Dispute between rival trade unions.
(f) Lack of transport, accommodation, medical and other factors.
(g) Lack of amenities like recreational centres, schools, etc.
The above causes may also be classified in a different manner under three
heads, viz., Financial Causes, Social and Economic Causes and
Psychological Causes relating to human relationship.
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UNIT V
OVERHEADS
Overhead may be defined as the cost of indirect material, indirect labour
and such other expenses, including services, as cannot be conveniently
charged direct to specific cost centres or cost units. It should be noted that
direct costs (materials, labour, etc.) are associated with individual jobs or
products. Indirect expenses or overheads are not associated with individual
jobs or products; they represent the cost of the facilities required for
carrying on the operations.
CIMA, London defines overhead as Expenditure on labour, materials or
services which cannot be economically identified with a specific saleable
cost unit.
Overhead Accounting
The ultimate aim of overhead accounting is to absorb them in the product
units produced by the firm. Absorption of overhead means charging each
unit of a product with an equitable share of overhead expenses. In other
words, as overheads are all indirect costs, it becomes difficult to charge
them to the product units. In view of this, it becomes necessary to charge
them to the product units on some equitably basis which is called as
Absorption of overheads. The important steps involved in overhead
accounting are as follows.
A. Collection, Classification and Codification of Overheads
B. Allocation, Apportionment and Reapportionment of overheads
C. Absorption of Overheads.
A. Collection, Classification and Codification of Overheads :I. Collection of Overheads: - Overheads collection is the process of
recording each item of cost in the records maintained for the purpose of
ascertainment of cost of each cost center or unit. The following are the
source documents for collection of overheads.
i. Stores Requisition
ii. Wages Sheet
iii. Cash Book
iv. Purchase Orders and Invoices
v. Journal Entries
vi. Other Registers and Records
For the purpose of overhead accounting, collection of overheads is very
important. It is necessary to identify the indirect expenses and the above
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handled,
weight
and
distance
travelled.
9. Transport Department
-crane hours, truck hours, truck
mileage, truck tonnage, truck tonnehours, tonnage handled, number of
packages.
10. Power House (Electric power wattage, horse power, horse power
cost)
machine hours, number of electric
points etc.
Distinction between Allocation & Apportionment
Although the purpose of both allocation and apportionment is identical, i.e
to identify or allot the costs to the cost centres or cost unit, both are not the
same.
Allocation deals with the whole items of cost and apportionment deals with
proportion of items of cost.
Allocation is direct process of departmentalization of overheads, where as
apportionment needs a suitable basis for sub-division of the cost.
Whether a particular item of expense can be allocated or apportioned does
not depends on the nature of expense, but depends on the relation with the
cost centre or cost unit to which it is to be charged.
Secondary Distribution of Production Overheads
After the primary distribution as shown above is over, the next step is to redistribute the service department costs over the production departments.
This also needs to be done on some suitable basis, as there may not be a
direct linkage between services and production activity. The products
actually do not pass through the service departments. So does it mean that
the service cost is not a part of cost of production? It very much is the part
of production cost! Hence the loading of service costs onto the production
departments is necessary. This process is called secondary distribution of
overheads.
The basis for secondary distribution is dependent on:(i) The nature of service given e.g. it may be maintenance department or
stores.
(ii) Measurement of service based on surveys or analysis.
(iii) General use indices
Methods of Secondary Distribution
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2) The estimated overhead expenses for the period should be determined for
each machine or group of machines.
3) Overheads relating to a machine are divided into two parts i.e., fixed or
standing charges and variable or machine expenses.
4) Standing charges are estimated for a period for every machine and the
amount so estimated is divided by the total number of normal working
hours of the machine during that period in order to calculate an hourly rate
for fixed charges. For machine expenses, an hourly rate is calculated for
each item of expenses separately by dividing the expenses by the normal
working hours.
5) Total of standing charges and machines expenses rates will give the
ordinary machine hour rate.
Some of the bases which may be adopted for apportioning the different
expenses for the purpose of calculation of machine hour rate are given
below.
Some of the expenses and the basis of apportionment are given below.
1. Rent and Rates - Floor area occupied by each machine including the
surrounding space.
2. Heating and Lighting - The number of points used plus cost of special
lighting or heating for any individual machine, alternatively according to
floor area occupied by each machine.
3. Supervision estimated time devoted by the supervisory staff to each
machine.
4. Lubricating Oil and Consumable Stores On the basis of past
experience.
5. Insurance Insurable value of each machine
6. Miscellaneous Expenses Equitable basis depending upon facts.
Machine Expenses
1. Depreciation cost of machine including cost of stand-by equipment
such as spare motors, switchgears etc., less residual value spread over its
working life.
2. Power Actual consumption as shown by meter readings or estimated
consumption ascertained from past experience.
3. Repairs Cost of repairs spread over its working life.
Activity Based Costing
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Meaning :- CIMA defines Activity Based Costing as, cost attribution to cost
units on the basis of benefit received from indirect activities e.g. ordering,
setting up, assuring quality.
One more definition of Activity Based Costing is, the collection of financial
and operational performance information tracing the significant activities of
the firm to product costs.
Objectives of Activity Based Costing
The objectives of Activity Based Costing are discussed below.
To remove the distortions in computation of total costs as seen in the
traditional costing system and
bring more accuracy in the computation of costs of products and services.
To help in decision making by accurately computing the costs of products
and services.
To identify various activities in the production process and further
identify the value adding activities.
To distribute overheads on the basis of activities.
To focus on high cost activities.
To identify the opportunities for improvement and reduction of costs.
To eliminate non value adding activities.
STAGES IN DEVELOPING ACTIVITY BASED COSTING SYSTEM
Step 1. IDENTIFY RESOURCES Resources represent the expenditure of an
organization. These are the same costs that are represented in a traditional
accounting, ABC links these cost to products, customers or services.
Step2. IDENTIFY ACTIVITIES Activities represent the work performed in
an organization. ABC accounts for the costs based on what activities caused
them to occur. By determining the actual activities that occur in various
departments it is then possible to more accurately relate these costs to
customers, products and services.
Step 3. IDENTIFY COST OBJECTS ABC provides profitability by one or
more cost object. Cost object profitability is utilized to identify money losing
customers to validate separate divisions or business units. Defining outputs
to be reviewed is an important step in a successful ABC implement action.
Step 4. DETERMINE RESOURCE DRIVERS Resource drivers provide the
link between the expenditure of an Organisation and activities performed
within the Organisation.
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