Cost Theory - Professional Course

BIEE Cost Accounting Theory - CA –PCC biee@sify.
com 1
COSTACCOUNTING TERMS
1. Define cost object and give three examples
Cost object is defined as “Anything for which a separate measurement of cost is desired”. The
term cost object and cost objective is synonymous. Cost object may refer to a process, a cost centre,
and cost units.
Cost unit is a quantitative unit of product or service in relation to which cost are ascertained.
Cost centre is a location, function or item of equipment in respect of which cost are
ascertained.
2. Define cost accumulation and cost assignment
Cost accumulation refers to the process of collecting cost data through an accounting system.
Usually costs are collected under general ledger accounting headings, which follow natural
classifications, such as materials, labour, power, electricity, fuel etc.
Cost assignment is a general term used to cover 1. Tracing of costs to cost objects, 2.
Apportionment of costs to cost objects, and 3. Application of costs to cost objects often termed as cost
absorption.
3. Define Cost apportionment and Cost absorption.
Cost apportionment is “The allotment to two or more cost centres of proportions of the
common items of cost on the estimated basis of benefit received.”
Cost Absorption is a method of assigning cost to cost units. Cost which cannot be allocated
to cost units are assigned to them on some equitable basis. Normally it shall be assigned at a
predetermined basis like machine hour rate, labour cost etc.
4. How the cost is classified?
The costs are classified according to the basis of relationship to the production unit as direct
cost and indirect cost. The cost incurred direct in manufacture of a product in respect of each and
every unit is called direct costs. These include direct material cost; direct labour cost and direct
chargeable expenses. The expenses that are normally incurred to a production centres irrespective of
production are called indirect costs. These include indirect materials, indirect labour and other indirect
expenses.
Based on the variability of the costs they are classified as fixed costs, Variable cost and semi-
variable cost. The expenses, which are constant for a particular period or for a particular level of
productivity, are fixed costs. These costs have no-direct relationship to the actual production and
incurred irrespective of actual production. Semi-variable costs include an element, which is directly
proportionate to the production, and other element, which has no relation to the production. Normally
these expenses assumes the function y = a+bx or y= a + bx + cx2.
Based on the financial accounting principle these can be classified as capital costs or revenue
cost. Capital cost is those expenses that result in increase in productivity. E.g. purchase of machinery.
The cost incurred in producing or aids in such production are the revenue costs. E.g. Materials, rent,
power, electricity etc.
5. Define the term cost driver.

A cost driver is a factor, which influences the cost of a cost object. It is often used to describe
the factors, events of forces that are the significant determinants of the cost object. For example, cost
of issuing materials is determined by the number of times materials being issued to production cost
centres and also by the size of the and the weights of materials. Similarly the cost of operating the
BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

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BIEE Cost Accounting Theory - CA –PCC biee@sify.com 2
purchases department is determined by the variety of materials being used and also the number of
purchased orders being issued.
6. What do you mean by step costs?
Step costs are those which increase in steps. These costs remain constant over various levels
of small ranges of output. These cost increase by discrete amounts as activity moves from one range to
next. Example: the amount of depreciation will remain constant till 100% productivity is achieved and
will increase considerably where the output increases above 100%.
7. Define notional cost.
Notional cost is one, which is not actually incurred but ascertained and allocated on some
basis. For example the rent for one premise can be charged which is not actually incurred but
ascertained based on actual rental value etc. These costs will not result in outflow of cash.
8. Define imputed cost, sunk cost and relevant cost.
Imputed cost – It is a historical cost and does not involve actual cash outlay, and, as a
consequence does not appear in the financial records. Imputed cost is similar to the notional cost and is
considered only in cost accounts in ascertaining the cost of a product.
Sunk cost – It represents historical cost which is irrecoverable in a given situation. For
example, while considering the replacement of asset the capital loss or depreciated book value of the
existing asset may not be taken into account on the ground that this portion of the cost having been
already incurred in the past and has no relevance to the present decision.
Relevant cost – Costs appropriate to aiding the making of specific management decisions are
called relevant cost. These are expected future costs that will differ under alternatives. Future variable
costs generally become relevant in a decision context while fixed costs may be irrelevant if they do not
change in total. However the fixed cost will also be relevant if there is a change in value immediately or
in future.
9. Define controllable cost and policy cost.
Controllable cost- costs which can be influenced by the action of an individual enterprise with
in a given time of span. But few costs are clearly under the influence of one person in any organisation
and few items of cost are susceptible to control at all levels. Another major aspect in controllability is
the time factor. With enough time virtually all cost are controllable by somebody or by some means in
an organisation.
Policy cost- the costs incurred as a result of policy decisions is called policy cost. For
example, purchase of assets will create a charge for depreciation.
10. What are the essentials of a good costing system?
An ideal system of cost accounting must posses some characteristics, which will bring the
advantages to the business. He main features of an ideal costing system are:
a. Simplicity - It must be simple, flexible and adaptable to the changing conditions. The
information must be provided in proper order, at the right time and to the right persons so as to be
utilised fully.
b. Flexibility and adaptability – The costing system must be flexible to adjust to the changing
conditions and circumstances. The expansion, contraction or changes must be adopted in the existing
system with minimum changes.

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c. Economy – The costing system must suit the availability of finance. The expenditure must
be less than the benefits derived from the system adopted.
d. Comparability – The management must be able to compare the facts and figures with past
figures, figures of other concerns or other departments of the same concern.
e. Suitability to the firms – Before accepting a costing system, the nature, requirements, size,
conditions of business etc. must be carefully studied. The system must be capable of prompt and
accurate reporting to different levels of management according to their requirements.
f. Minimum change in the existing set up – When introducing a costing system, it must
cause minimum disturbance to the existing system of business.
g. Uniformity of forms- Forms of different colours can be used to distinguish them forms must
be uniform in size and quality. Forms should contain instructions to fill, to use and for disposal.
h. Less clerical work – Printed forms will involve less labour to fill in, as the workers may be a
little educated.
i. Effective material control and wage system – There must be a proper procedure for
recording the time spent on different jobs, by workers for the purpose of payment of wages. A
systematic method of wage system will help in control of labour cost. Since the cost of materials forms
a greater part of the total cost there must be an efficient system of stores control.
j. Sound plan – There must be proper and sound plan to collect, allocate and absorption of
overhead expenses on each job or each product in order to find out the cost accurately.
k. Reconciliation – The system of costing and financial accounting must facilitate reconciliation
in an easy manner.
l. Overall efficiency of cost accountant – The work of the cost accountant under a good
system of costing must be clearly defined as his duties and responsibilities to the firm are very essential
11. You have been asked to design a system of cost accounting in a factory. Describe the
various points that should be considered before you design a system. (Installation of a costing
system)
It is very difficult to prepare a uniform method of cost applicable to each and every kind of
industry. The basic principles are fairly definite, but practical application varies from industry to industry
because of the basic nature of industries. The installation of a costing system requires careful
consideration of the following:
a. Objectives of a costing system – The expectation of the management from the costing
system should be carefully understood for a smooth adoption of costing system. One must decide the
objectives to be achieved. The system must suit the general nature of the business. The system must
be well understood to the management and the personnel.
b. Product and the business – The nature of the product and business determines the
method of costing system to be adopted. E.g. Engineering industries adopt job costing, chemical
industries process or batch costing, etc. Some industries may require more labour than more materials;
many industries may require more materials than labour, etc. Hence the cost components of the
products are to be analysed into its various constituents and their relative importance must be studied
carefully.
c. The organisation – When a new system of costing is introduced, the existing organisational
set up has to be modified. There should be minimum dislocation of existing set up. The size of the
organisation, levels of management, authority of each executive, sources of cost information, the
reports to be sent to various managerial authorities, etc. should be studied carefully. The whole

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organisation must be geared to have full co-ordination and control and of course without overlapping
and overlooking all functions.
d. Technical aspects – A careful study of manufacturing operations and process, material

control, labour control, system of wage payment, factory layout, etc. are of immense significance.
These will enable to remove inefficiencies of labour, wastage of materials, etc.
e. Standardisation – The forms to be used must be standardised so that clerical work can be
reduced to the minimum. The method of filling, the forms to be used etc. should be simple and
guidelines may be provided whenever necessary.
f. Communication – Emphasis should be put on the system of communication. A proper

system must be drawn to ensure complete and reliable cost information in the field of collection,
transmission, report making and reaching the appropriate levels of management.
g. Accounting system – Determination of unit of cost, classification of operating expenses,

coding systems of material, developing the measures of inventory control, stores accounting system,
preparation of charts, budgetary control, reconciliation of cost with financial accounts, preparation of
cost reports to managerial levels for making decisions are the general problems to be dealt with. When
all these are adopted in an existing industry the personnel may give raise to problems because of the
fact that the existing inefficiencies may be brought to light. The personnel should be convinced about
the system and their co-operation is ensured. Only then the system will be successful. Instead of rapid
introduction, gradual introduction of the cost system will reap the desired goal.
h. Elasticity and economy – The system to be adopted must be capable of being flexible and
adaptive to the changing circumstances. Care should be taken that the utility be more than the cost
paid. The system should not be complicated and expensive.
i. Regularity- Cost data and costing information must reach the person concerned regularly
and promptly. Otherwise significance of the costing system will be lost and expensive. A good system
of communication will render the communication process attainable the objective.
12. What do you mean by cost centre and what are its subdivisions?
A cost centre is a location, person or item of equipment or group of these for which cost may be
ascertained and used for the purpose of control. The cost centre may be a department or a machine or
a plant or a salesman or a particular work, etc. In certain cases the cost unit and cost centre may be
the same. Each cost centre is given charge under a personnel for controlling the cost, accumulation of
cost and its allocation. The sub divisions of cost centre are:
a. The personal cost centre – It consists of a person or group of persons; cost like salary of
works manager, storekeeper, sales manager and others may be accumulated.
b. Impersonal cost centre – It consists of a location or items of equipment.
c. Process cost centre- It consists of a specific process or a continuous sequence of

operations. The cost accumulated by each of these categories of department is a production or a
service, which can be considered as a cost centre.
13. What do you mean by ‘cost control’ and ‘cost Reduction’. Distinguish between them.
Cost control is defined as “The guidance and regulation by executive action, by costs of
operating an undertaking”. Cost control plays its part at the discretion of the management, who wish to
maintain the cost within a specific limit. It aims at improving performance efficiency to achieve the
target. Cost control can be secured through:
a. Setting up standards for expenses and production.
b. Finding out differences of actual against standards.
c. Analysing the differences with reasons.
d. Taking up corrective measures to eliminate variances.
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Cost reduction is concerned with reducing costs. It is concerned with reduction program,
which is a continuous process. It strives to achieve permanent reduction which starts where cost
control ends; cost can be reduced on account of saving in cost.
Distinction between cost control and cost reduction
s.no cost control cost reduction
1. Aims at maintaining the cost in accordance It aims at reducing cost

with standard cost
2. Seeks to attain the lowest possible cost Brings profit by challenging

under existing conditions through research standard
.
3. The function is static. The function is dynamic.
4. Emphasis is on the past and present Emphasis is on the present and

future
5. It is a preventive function It is a corrective function.
14. List out various methods of costing and explain their practical applications.
The following are the various methods of costing. a. Single or output costing, b. Process
costing, c. Multiple costing, d. Terminal costing, e. marginal costing, e. Operating costing f. Job costing,
g. Batch costing and Standard costing.
a. single or output costing – This costing system is applied where a single product is
manufactured. It requires no allocation of overheads between products. A costing per unit of product is
ascertained for a product in respect of a period. E.g. Brick-making
b. Process costing – Process costing is designed to show the cost of each process through
which raw materials pass through in their conversion into saleable products. This system is applied
where the plants are laid out in process layout. E.g. Textile industries.
c. Multiple costing – It is a system adopted in a business producing a variety of products

each of which differs from the others as to material, manufacturing process etc. the principle
characteristic of multiple costing is that a separate method of costing may be employed in respect of
each article.
d. Terminal costing – terminal costing is also called as contract costing and is used by an
undertaking which carries substantial contract the completion of which generally takes more than a
year. Under this method a major part of the expenditure is charged direct to contracts and only the
office expenses need to be allocated. The amount of such expenditure will be very less when
compared to the direct expenses charged to production, a more precise scientific method of allocation
of such expenditure is not needed. E.g. Construction of building.
e. Marginal costing – Marginal costing is a method of costing in which the allocation of

expenditure to production is restricted to those expenses which arise as a result of production. Fixed
overheads are not allocated on the ground that frequently the apportionment to cost centres or jobs
cannot be made on any scientific basis. Marginal costing is useful in manufacturing industries with
various levels of output. This system of differentiates between fixed costs and variable costs. This type
of costing is useful in taking important policy decisions such as price fixing during competition, make or
buy decisions, product mix etc.
f. Operating costing- Operating costing is a system of costing applicable to industries in which

end product is service. e.g. Transport service, power generation etc. the system is also applicable to
utility services such as canteen, hospitals, distribution services such as supply of electricity, petrol, gas
etc.
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g. Job costing – Job order costing or specific order costing means ascertainment of cost of
each job, work order or project separately. It is adopted by many undertakings both manufacturing and
non-manufacturing concerns. Manufacturing concerns adopting this method are printing press, machine
tool manufacturing units etc. Non-manufacturing units such as general engineering work shops,
automobile repair shops etc. The main objective of this type of costing is to determine profit or loss for
each job. Before accepting a job an estimation of cost is made.
h. Batch costing- batch costing is a system of costing where the production facilities are
arranged in such a way that a particular batch of production is carried out. This system is best adopted
where the products manufactured cannot be manufactured as one piece and the cost also cannot be
allocable per piece. The best example adopting this system is pharmaceuticals, biscuits and other
confectioneries.
i. Standard costing- This system is a pre-determination of how must costs be incurred under
certain specific conditions. It is built up from an assessment of the values of cost elements and
correlates technical specifications and quantification of various elements of cost to the prices and rates
expected to apply during the period in which the standard cost is intended to be used. Standard
costing, thus involves: i. Ascertainment and use of standard cost; ii. Measurement of actual costs; iii.
Comparison of standard costs and actual costs to develop variances; and iv. Analysis of variances and
taking the appropriate action where necessary.
15. Define uniform costing and when can it be applied? what are the causes for differences in
cost?
Uniform costing is not a separate method of costing. It implies the use by several undertakings of
the same costing systems i.e. the same basic costing methods, principles and techniques. It is a
set of principles and in some cases of accounting methods, which when incorporated in the
accounting systems of individual members of an industry, will result in obtaining all cost figures by
the individual members of the industry on a comparable basis.
Application of uniform costing – Uniform costing may be applied in two different

circumstances, viz. i. When an undertaking controls a number of factories firms etc. a. producing
similar products, or b. performing similar operations. When a number of firms or business are members
of a Trade Association.
Causes of differences in cost – Costs differ between firms or factories of the same
undertaking or members of an industry or Trade Association because of a. Difference in size; b.
differences in attitude of management; c. Differences in degree of mechanisation; d. The possibility of
production in more than one way and e. Differences between costing principles and procedures
adopted by different units.

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MAERIALS
1. Explain the various types of costs involved in connection with materials management?
There are five types of cost, which are relevant for materials management. They are purchase cost,
ordering cost, carrying cost , stock-out cost and quality cost.
1.Purchase cost – Purchase cost consists of price paid to suppliers and all expenses for
bringing the materials to stores including freight, insurance and transportation cost. In case of
MODVAT credit (Central Excise Law) is available, the same is deducted from the price paid to the
supplier.
2.Ordering cost – This includes expenses incurred on requisitioning, preparing purchase

order, following up with suppliers for early delivery, transportation, receiving supplies and placing the
same in stores.
3.Carrying cost – This includes opportunity cost of funds locked up in stock, storage cost,
expenses on handling, insurance, rent and rates and losses due to obsolescence. Opportunity cost in
this context refers to contribution from alternative use of fund, which the firm has foregone by investing
the same in stock.
4.Stock-out cost (Shortage cost)- When stock falls short of demand, it results in higher cost
involved in crash procurement, less efficient and uneconomic production schedule, customer
dissatisfaction and loss of sales.
5.Quality cost – Cost of quality can be classified into two i. Prevention costs which are incurred
to avoid the purchase of sub-quality of material, e.g. , the cost of vendor development; ii. Appraisal
costs which are incurred to detect sub-quality material, e.g., inspection cost; iii. Internal failure costs
which arise when defects are detected before shipment of the product to the customers, e.g., cost of
defective parts; iv. External failure costs which occur when defects are detected after shipment, e.g.,
cost of replacing the products.
2. What are the objectives and functions of purchase department?
The most important objective of purchasing department is to ensure continuity of supplies at the lowest
cost commensurate with acceptable standards of quality and delivery. It is the responsibility of
purchase department to procure, right type of material in the right quantity, and at the right price and to
provide the materials, at the right time and right place.
3. What are the advantages of a. centralised purchasing; and b. decentralised purchasing?
Advantages of centralised purchasing – a. avoids duplication of errors, b. Provides better

negotiating Power and consequently ensures better prices, terms and conditions, c. Ensures uniformity
in purchasing policies, practices and procedures, d . Develops expert purchase staffs, and e. Helps
standardisation and substitution.
Advantages of de-centralised purchasing – a. provides full liberty to the plant manager and
thus avoids problems in co-ordination and dilution of responsibility, b. Cuts down unnecessary paper
work, c. Helps to develop local vendors and develop a personal touch with the vendors, and d. Helps
purchase department staff to familiarise with the materials which are in use.
4. What are the responsibilities of a storekeeper ?

The responsibilities of a storekeeper are: i. To maintain stores in a tidy manner. 2. To prevent
entry of unauthorised persons. 3. To maintain up-to-date records of receipts, issue and balance of each

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item of material. 4. To accept materials after proper verification of documents. 5. To issue materials
against ‘Material requisition note’ signed by an authorised official only and after checking the material
requisition with ‘Bill of materials’. 6. To periodically reconcile bin-card balance with physical balances.
7. To ensure good turnover of stock i.e., he must not allow to stock to be left at the bottom of the bin
and deteriorate.
5. Write a note on ‘ Goods received note’.
Goods received note is prepared by the receiving section, which forms the basis of entries in the
stores ledger. The note is serially numbered and prepared in multiple copies. The receiving section
retains one copy. Goods along with three copies of goods received note be passed on to the Inspection
department. It inspects the goods and enters in appropriate columns in the note, the quantities
accepted and the quantities rejected. Goods are passed on to the stores along with one copy of duly
endorsed goods received note. The other copy is forwarded to the accounts department and the
inspection department retain the third copy. Following is the proforma of a goods received note.
X&Y Ltd.
Goods Received Note
Supplier Serial No.
Currior Purchase order No.
Date of delivery Advice note No.
Descriptio Code Quantity Packages Gross weight

n
Inspection report Received by

Quantity passed Rejected Remarks Required and
accepted by
Inspector……………………. . Date
6. Write notes on various documents used in stores.
a. Material Requisition Note - This is an authorisation to the store keeper to issue materials.
This is used as user’s acknowledgement for receipts of materials and forms the basis for material
accounting. This should clearly specify the job for which materials are required and the department
which gets the materials issued. Store keeper must ensure that material requisition is signed by an
authorised official and that the columns are filled in properly and legibly as any mistake will result in
wrong accounting of material issued. The material requisition note should be pre numbered. Following
is the proforma of material requisition note.
b. Material Transfer note – This document is used to record the transfer of materials from one
department to another department or job to another. This document should be prepared correctly,
otherwise the cost would be accounted for wrongly:
c. Bin card – This refers to a card which shows quantitative details of receipt, issue and
balance. Entries are made immediately on receipt or issue of materials. This card also shows the
maximum level, minimum level and reordering level of material and thus helps the storekeeper to
control material. This is known as Bin card as the cards are usually kept attached to the bins in which
materials are kept.
d. Material Return Note – This note is an authorisation to return the materials issued in excess
of the requirement or the material being defective. It is also pre numbered and be prepared to avoid
wrong accounting.

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X& Y Ltd.
Material Requisition note
Job No. Serial No.
Department Date
shop
S.no Descriptio Code No. Quantity Rate Value Remarks
n
Authorised by Stores Ledger Folio….. Bin no….. Store keeper……….

Cost office reference
X& Y Ltd.
Material Teransfer note
Issuing department Serial No.
Receiving department. date
Descriptio Code No. Quantity Rate Value Remarks
n
Transferred by: Dept. Received by : Depot.. Cost office reference
X& Y Ltd.
Material Return note
Serial No
Issuing department.. Date:
Number Description Code No. Quantity Rate Value Remarks
Transferred by: Dept. Stores Dept. Bin No.. Cost office reference
e. Store Material Control Record – Production planning and control department also
maintains quantitative record of materials. These are kept in loose-leaf forms similar to bin cards. In
this form additional columns are provided to enter details of materials in pipeline.

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f. Bill of Materials – Bill of material is a comprehensive list of all materials required for a
particular job, process or service. It shows the exact specifications of materials and quantity required
against each item. In engineering industry this document is issued by the Designs department and in
other industries by Production planning department. It is used for the following purposes: 1. As an
advance information to all concerned. 2. As an authorisation to Production department for drawing
materials. 3. As an additional check by the accounts department for material control.
7. In stores control there are four critical quantities: a. Re- order level, b. Minimum level , c.
Maximum level and d. danger level. Define these levels and what factors should be considered
in determining them?
a. Re-order level – This is the level at which storekeeper initiates purchase requisition for
fresh supplies of materials. This level takes into account the maximum usage and unexpected delay in
receiving such supplies. If it is assumed that the stock out cost is prohibitive, the firm protects itself
from any stock out situation by providing for the maximum usage and maximum lead-time. The level is
such that even with maximum usage during lead time and with unusual delay , stock does not reach
Zero level.
ROL = Max. re order period X Maximum usage.
b. Minimum level – This represents that level which the stock of a particular material will touch
just before receipt of the fresh lot provided the same is received in normal re-order period and under
normal usage. Stock level is normally not allowed to fall below this level, which is considered as ‘ buffer
stock’ for using during emergency. Fall in stock level below the minimum level will indicate potential
danger leading to stock-out position. Stock will fall below minimum level if consumption exceeds the
normal consumption or re-order period exceeds the normal re-order period or both of these happen. If
stock falls below this level extra effort have to be taken to expedite the supply.
Stock levels
Quantity Max. stock level
Re-order level
Minimum level
Danger level
period
c. Maximum level- maximum level is that level above which no stock is allowed to rise. l. Stock
normally touches this level immediately on receipt of the fresh lot. This will happen only minimum
usage is occurred and delivery is received in the minimum re-order period . This level is a control
Indicator. The factors need to be considered in fixing this limit are: 1. Storage facilities available.
2. Carrying cost. For costly or bulky materials the maximum level is generally low. 3. Nature and
properties of materials. . 4. Economy in prices. 5. Availability of funds. 6. Forecasted future
movements of prices. 7. Government restrictions on import procurements. The maximum level is
fixed as follows
Maximum Level = ROL + Re-order quantity – (Min.consumption X min.Re-order period)
d. Danger level – This level is fixed somewhere below the minimum level. Emergent
purchase actions are taken if stock falls below this level.

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8. Define Economic ordering Quantity. What are its determinants?
Economic Ordering Quantity (EOQ) is the quantity to be ordered when the stock reaches the
minimum level. It is also called as Re-ordering Quantity. It is the quantity when it is added to
minimum
stock shall not exceed maximum stick level. It focuses on trading off between ordering cost and cost of
carrying and is based on the following assumptions: 1. Demand and purchase order lead time is known
with certainty. 2. Cost per unit is unaffected by order size and, therefore, cost per unit is irrelevant in
determining EOQ.
AC
Cost
CC
CO
EOQ Quantity
3. The cost of stock out is prohibitively high and therefore stock is replenished before a stock-out
occurs. 4. Ordering cost is constant irrespective of the size of the order.
EOQ can be calculated by using the formula:
EOQ = √ 2AO / C
Where A = Annual consumption; O = Ordering cost per order and C = Cost of carrying per unit
The main factors to be considered while deciding reorder quantity are as follows: 1.
Consumption pattern . 2. Re-order period. 3. Availability of resources. 4. Nature of materials . 5. Risk
of price fluctuations. 6. Risk of obsolescence . 7. Storage space available. 8. Seasonal conditions as
to the availability and price. 9. Quantity discount and 10. Carrying cost and ordering cost.
9. Explain a. Input-output ratio and b. Inventory turnover ratio
a. Input-output ratio is the ratio of raw materials put in production and the output derived. It
enables in determining whether the usage of materials is favourable or adverse. For example, if 100
kg. Of material is put in process and the final product contained is 80 kgs, the input-output ratio is
100/80 =1.25 or 125%. This can also be ascertained by comparing the standard cost of actual output
and standard cost of standard output as :Standard cost of actual output/standard cost of standard
output. The comparison actual and standard facilitates to ascertain the performance of the firm and to
decide about the favourable or adverse usage of materials.
b. Inventory turnover ratio - It is the ratio which is useful to measure the performance of
inventory. It is the ratio of the value of materials consumed during a period to the average value of
inventory during the period. A high ratio is an indicator of fast moving stock. A low ratio indicates that
locking up of working capital in undesirable stock. The ratio is calculated as follows.
Inventory turnover = Cost of materials used / Average value of stock.

Material turnover in days = Days during the period / Inventory turnover ratio.
10. Explain the system of a. ABC analysis and b. Two-bin system.
a. ABC Analysis- This analysis is also known as Proportional Parts Value Analysis. Under this
method (Always Better Control) efficient control of store is required to give more care on costlier items.
As such, on the basis of the value of different materials, items are grouped into three categories: 1.High
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priced material (A) ; 2. Medium priced materials (B); 3. Low priced materials (C). The materials,
which are costly and form a small part of total inventory, can be grouped under A. Greater degree of
care should be taken in storing and in the use of such items marked ‘A’. For these category of
materials, high price has to be paid and the number of items is small. On the other hand, certain
materials do not require much investment but occupies a higher proportion of physical quantity are
grouped and marked ‘C’. The materials that have moderate value and represented by proportionate
stock compared to its value are grouped under ‘B’. The following is an example:
Stock item % of total items % of value

A 10 70
B 20 20
C 70 10
ABC analysis facilitates 1. Closer control on the basis of investment; 2. Development of

scientific inventory control; 3. Saving the time of management, as attention is given to high value
materials; 4. Ensures minimum cost.
b. Two bin system- The two bin system of inventory controls has many variations of the basic
procedure. Under this system, for each item two bins are maintained. In cases where materials are not
kept in the bins, two separate piles are made for each material. One of the two bins contains enough
stock for usage during the period between receipt of the fresh supply of the materials to the date of
placing the next order. The other bin contains quantity to cover normal usage during re-order period
plus ‘Safety stock’. Purchase requisition is issued immediately when the bin is tapped. The system is
simple and in addition to being helpful in inventory control, facilitates easy handling, physical counting
and control of the materials.
11. Explain the systems: a. VED analysis; b. XYZ analysis ; c. Ageing schedule of inventories
and d. Kartex system
a. VED analysis- This analysis is of the nature of ABC analysis and it is generally used in case
of spare parts. The parts are classified into three categories – Vital(V), Essential(E) and Desirable(D),
depending upon their requirements.
Vital spare parts are kept in stock in sufficient quantity to ensure uninterrupted operation of the
plant. They are vital because their non-availability at the required time may cause stoppage in
production. Essential spare parts are also kept in stock in adequate quantities. But the firm may take
reasonable risk with regard to these parts. There should be sufficient arrangement for replenishment of
these stock at short notice. Desirable spare parts are those which are readily available in the market
and hence the firm need not keep in stock such items except to provide for the lead time.
b. XYZ analysis—This analysis based on the value of stock. It is different from ABC analysis
which is based on value of materials consumed and VED analysis which is based on relative
importance of inventory in stock. X items are those whose inventory value is high while z items are
those inventory the value of which is less. Y items fall in between these two extremes. Items of
category X need greater attention as compared to items of Y items. Similarly items of category Y are
given greater importance as compared to items of category Z while taking inventory.
c. Ageing schedule of inventories – Classification of the inventories according to age helps in

identifying inventories which are moving slowly into production or sales. Based on the date of purchase
on which the inventories are purchased they will be chronologically entered and the value of stock
purchased during a period will be represented as a percentage on the total stock holding. Following is
an example.
Ageing schedule of inventories as on Dec,31

Age Date of purchase Amount (Rs.) Percentage to the
classification(days) total
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0 -15 Dec 16 8,000 20
16 –30 Dec11 4,000 10
31-45 Nov26 2,000 5
46-60 Nov10 20,000 50
61 and above Oct25 6,000 15
Total 40,000 100
The above table shows that 50% of the inventories are of age group of 40 to 60 days, while
15% is older than 60 days. In case steps are not taken to clear the inventories, it is possible that more
than 50% inventories to suffer deterioration in its value or may even become obsolete.
d. Kartex system- This technique is of recent origin. In this system a card is maintained for
each item of materials. The cards are arranged in a metallic tray and kept in Kartex cabinet, especially
manufactured for the purpose. The cards used in this system are generally of the size 21cm X 5cm or
28cm X13cm. The cards may contain columns like stores ledger for both quantity and value of
materials , receipts ,issues and balance. Colour signals may also be developed in this card to show
different levels.
12. Write about various systems of inventory systems.
There are two types of inventory systems. 1. Periodic inventory system and 2. Perpetual
inventory system.
1. Periodic inventory system - in this system, quantity and value of inventory is found out only
at the end of the accounting period after having a physical verification. The system does not provide
the information regarding the quantity and value of materials in hand on a continuous basis. The cost of
material used is obtained by adding the total value of inventory in hand in the beginning to the total
value of purchases made during the period and subtracting the value of inventory at the end of period.
Under this method no accounting is made done for losses, theft and wastage.
2. Perpetual inventory system- This system is called as automatic inventory system. I t is a

system of records maintained by the controlling department, which reflects the physical movement of
stocks and their current balance. It is a method of recording stores balances after every receipt and
issue, to facilitate regular checking and to obviate closing down for stock taking. The basic objectives of
this system is to make available details about the quantity and value of stock of each item at all times.
This system thus provides a rigid control over stock of materials as physical stock can regularly be
verified with the stock records kept in the stores and the cost office.
Perpetual inventory system requires: 1. Maintenance of both bin cards as well as stores ledger
on perpetual inventory system. Bin cards provide quantitative perpetual inventory while stores ledger
provides quantitative-cum-value of the inventory. 2. Adoption of continuous stock taking.
Advantages of perpetual inventory system – 1. The system serves as a morale check on the
stores staff. They keep the stores record up-to- date and discourage committing fraud. 2. Interim
financial accounts can be prepared with greater convenience because the long and costly work of
actual stock taking is avoided. 3. Over investment in stock can be avoided because quantity and value
of materials in stock is always known. 4. In case of destruction of stock by fire, the system helps in
satisfactorily settling the insurance claim as correct stock figures can be readily be obtained. 5. Loss of
stock due to pilferage or obsolescence etc., is detected at an early stage and suitable steps can be
taken to prevent its recurrence. 6. Timely replenishment of stock is facilitated as the management may
be informed daily of the number of units and the value of each kind of material on hand. This tends to
eliminate delays and shutdown in plant activities.
Continuous stock-taking -An essential part of perpetual inventory system is continuous

physical stock verification. This is done by an independent internal audit staff who compares the
physical quantity with the quantities shown in the bin card and the store ledger. The system has the
following advantages. 1. It does not require a shut down of business operations. It serves as a moral
check on the stores staff as they keep their records up-to-date at all times in anticipation of the
unexpected arrival of the audit staff.
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13. what are the essentials of material control policy?
The following are the essentials of a materials control policy.
1. Co-ordination – There has to be a proper co-ordination between the various departments

concerned with material control, viz., purchasing, receiving, inspection, storage and accounts
department, etc.
2. Centralised purchasing- All materials purchases should be centralised. This will result in
making bulk purchases at competitive purchases and skilled purchasing. Of course, for small
purchases the departmental heads should be given the necessary authority in order to avoid delay.
3. Classification and codification – There should be proper classification and codification of

materials to avoid delay in locating them and convenience in accounting.
4. Proper scheduling – The material requirements should be properly scheduled. Scheduling

involves a wide range of activities Viz., receiving, moving, packaging, storing and issuing of materials.
5. Inspection – In order to prevent and check purchasing of sub-standard materials, pilferage

or deterioration of materials, it is necessary to have a proper inspection of materials at appropriate time
intervals.
6. Standard forms- standard forms of purchase orders, material requisitions, issue of

materials, transfer of materials, etc., should be used. This will facilitate movement and accounting of
materials.
7. Effective internal control- materials constitute a significant part of the total cost of the
product. It is therefore necessary that the organisation follows an appropriate system of internal control
for prevention of fraud in purchase, issue or storage of materials.
8. Proper storage – There should be proper arrangement for storage of materials with
adequate shelves, racks, safeguards followed by effective supervision
9. Proper issue procedure -Materials should be issued in a manner that every job or process
gets the right time.
10. Stock-taking – Physical stock-taking should be done from time to time. This will greatly
facilitate if the organisation follows perpetual inventory system, which gives the information regarding
both quantity and value of materials on a continuing basis.
11. Levels of materials- Maximum, minimum, re-ordering and danger levels of each materials
should be fixed in order to ensure that neither there is a shortage nor there is excess of materials in the
store. Similarly, the economic ordering quantity should be fixed up in respect of each materials to have
maximum economy in purchasing of materials.
12. Valuation of materials- Both in –coming and out-going materials should be properly
valued. The adoption of a suitable method for pricing the materials issue is all the more important since
it affects the cost of a job, order or process.
13.Properinventory records- proper inventory records have to be kept in the as well as the
costing office to have effective control of materials.
14. Effective MIS-The organisation should have an effective management information system
regarding materials in order to ensure continuous flow of information about the position of materials to
the concerned managerial personnel.
14. Enumerate and explain the main bases used in cost accounting for pricing materials issued
to jobs.
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a. Where the materials can be identified with a particular purchase, it can be charged to the
production either at actual cost or market price.
Actual cost – The method ensures that each job is charged with the actual cost of materials
used in it. It is suitable where materials are specially purchased for a particular job.
Market price - This method whereby materials are charged to a job at the prices ruling at the
time of issue is appropriate where it is desired to disclose results of good or bad buying.
b. Where materials issued cannot be identified with a particular purchase, it can be charged in
different methods . The following are the methods in which it can be charged.
1. Last in first out – In this method materials received last by the stores will be issued first.
This method is advantageous in a time of rising prices as it ensures that production is charged at the
price of the latest purchase and hence the stock of material is carried forward at a mere conservative
value. It tends to prevent the overstatement of profits. Advantages- 1. Material cost represents
current price. 2. It facilitates complete recovery of material cost. 3. It is most suitable when prices are
rising. 4. There is better matching of cost and revenue. Disadvantages : 1. It involves considerable
clerical work. 2. Due to variation in prices comparison of cost of similar jobs is non-comparable. 3.
Stock of materials shown in the Balance Sheet will not reflect market prices. 4. This system is not
acceptable to income tax authorities.
2.First in first out – Under this system, materials are issued in the order in which they are
received in the stores. The materials received first will be issued first. In other words, old stocks are
issued first and latest arrivals will be issued later. As a result of this system, the closing stock of
materials will always reflect the current prices. Advantages - 1. This method is simple and easy to
operate. 2. Closing value of materials will reflect the current market prices. 3. This system is good for
slow moving materials. 4. The system is a logical system. 5. When prices are falling, this method
gives better results. 6. Deterioration and obsolescence can be avoided. Disadvantages – when price
fluctuate, calculation becomes complicated. 2. Complicated calculations will invite clerical errors. 3.
Under fluctuating prices , materials charged with higher price of earlier materials; the quotations are
less competitive. 5. When materials are returned to stores, they are treated as new purchases, for the
purpose of next issue.
3. Next in first out - The method attempts to value material issues at an actual price which is
as near as possible to the market price. Under this method the issues are made at the next price, i.e.,
the price of materials which has been ordered but not yet received. In other words, issues are at the
latest price at which the company has been committed even though materials have not yet been
physically received. This method is better than market price method under which every time when
materials are issued, their market price will have to be ascertained. In case of this method materials will
be issued at price at which a new order has been placed and this price will continue for all future issues
till a next order is placed. The value of inventory on a particular date is ascertained by deducting the
cost of material issued from the total value of materials in stock. Calculations under this method are
complicated and therefore the method is not widely used. The method may be used in case of
materials, which are not much in demand, and hence only a minimum stock is kept and simultaneously
a new order is placed for the quantity issued.
4. Base stock method – In almost all concerns, a minimum quantity of stock is always kept in
stores. A fixed minimum stock of the material is always maintained and is known as ‘safety’ or ‘base’
stock. This stock is always valued at a price at which the first lot of materials is received. This stock
will not be issued until emergency arises. The quantity in excess of this base stock may be valued
either on LIFO or FIFO basis. Since the system operates in conjunction with FIFO or LIFO method, the
advantages and disadvantages relating to those methods are equally applicable to this method also.
5. Highest in first out – Under this method materials of highest price are issued first.
According to this method the closing stock will be of the minimum price or as low as possible. In short,
materials purchased at highest price will be first issued, irrespective of the order of purchase; when the

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whole lot of the highest price is exhausted, materials purchased at the next higher price are issued.
This method is suitable for cost plus contracts.
6. Simple average method-Under this method the price is calculated by dividing the total of
unit prices of different purchase lots that are in stock by the number of such prices included in the total.
Unit prices of the latest consignment also is taken. The simple average price method is very easy to
operate. It gives satisfactory results in cases when the prices of purchases do not show marked
fluctuations. The method suffers from various disadvantages. It does not charge actual cost of
materials to production and, therefore, a profit or loss may arise because of this type of valuation. The
method is also unscientific as it does not take into account the quantity of materials purchased at
different prices. Clerical work is also considerably increased because the average price will have to be
calculated on the occasion of each issue.
7. Periodic simple average method- The method is similar to the simple average price
method with the advantage that average price is calculated periodically and not at the time of each
issue. The work of pricing materials issued is done only at the end of the period and only the quantity of
material issued be entered in the stores ledger at the time of issue. The average price is calculated by
adding the prices at which different consignments were purchased during the period (excluding the
price of opening stock) and dividing the same of these prices by the number of prices taken into
consideration for calculation of average price. The method is simple to operate and more
representative than the simple average price method. It suffers from the same disadvantages as in
simple average price method, except that tedious clerical work at the end of the period in calculating the
issue rates.
8. Weighted average price method- Under this method the issue price is calculated by
dividing the value of materials in hand by the number of units in hand. The average price to be charged
to issues will continue to be the same till a new purchase is made which will necessitate computation of
a new average. The method is more scientific than the simple average method. It also reduces the
number of calculations to be made s the old average price will continue till fresh supply of material is
obtained. Under this system on account of approximations being used while calculating the average
price a profit or loss on issue of materials may be incurred.
9. Periodic weighted average price method – This method is similar to the weighted average
price method with an advantage that average price is not calculated at the time of every new receipt of
materials but only periodically. The average price is calculated by dividing the total value of materials
purchased during the period by the total quantity purchased during the same period. The value of
opening stock and its quantity be ignored because it was purchased during the previous period. The
method is more scientific than the periodic simple average method and more simpler than the weighted
average method. In this method also since actual cost is not charged to production it may result in
some profit of loss on issue of materials. This method throws considerable burden on clerical staff at
the end of the year.
10. Moving simple average price method – The moving simple average price is the average
of the periodic simple average prices for a given number of periods. The period for which the material
issues are to be valued will be the last period. The issues are valued at the average price so
calculated. This pricing method is suitable where there are seasonal fluctuations in prices and the
monthly purchase do not vary much.
11. Moving weighted average price method - Under this method materials issues for a
period are valued at a price which is the average of the periodic weighted average prices of a given
number of periods. The price calculated under this method is more representative as it takes into
account the quantities purchased and the amount paid for each consignment over a number of periods.
12. Standard price method - This is a method of valuing the issues at a pre-determined price
of the materials taking into account the quantity purchased, market conditions, future trend of the prices
and all others matters concerned with materials. Under such circumstances, the cost of the issue of
materials will neither be at cost price nor at market price. There are two standards such as basic
standard price which remains unaltered or for a longer period, the other being current standard price
which is related to current market conditions over a shorter period. Under this method, issues had been
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made at standard price. Purchase of materials have been made at the actual price and issue prices,
at the standard price, fixed in advance. There arises a difference between the actual cost of the
materials and standard cost of the materials. The difference is known as ‘variance’ and it indicates the
efficiency of purchases, usage etc.,.
advantages - 1. It is simple to work. 2. Materials cost can be fixed in advance. 3.
Comparison of the job becomes easy. 4. Control over purchases is possible.
12. Inflated price – When purchases are made looking at invoices, one is able to understand
that the seller charges the cost of materials and expenses like packing, forwarding, freight, etc. Then
after additional expenses- storing, preservation, issuing, etc., are there. Apart from this , there may be
unavoidable losses like evaporation, deterioration in quality, shrinkage, loss of weight etc. Therefore
when issues are made, the price is to be inflated to cover the expenses and losses. The price so
calculated and charged to materials is called inflated price.
13. Market price method – This is based on the principle that materials issued to any job on a
particular day, should be charged at the rate prevalent in the market. In other words,
materials issued are valued at a price at which they can be replaced. After the issue, the
closing stock is adjusted to the net value. Advantages – 1. Latest prices are reflected in
charging the production in respect of materials. 2. Comparison between jobs in respect of
material cost is possible. Disadvantages- 1. Cost of production varies with the market
trends. 2. It is not easy to know the latest prices. 3. Difference in value arises and needs
adjustment. 4. Profit or loss may arise because of rise and fall in prices of raw materials.
15. what are the salient features of ‘International Accounting Standard –2 (IAS-) ?
The following are the salient features of IAS-2.
1. inventories should be valued at the lower of the historical cost and the net realisable cost.
Net realisable value is the actual or estimated selling price in the ordinary course of business, less cost
of completion and cost necessarily to be incurred in order to make the sale.
2. Historical and net realisable values should be compared for each item of the inventory
separately or for each group of similar items separately. For example, there are four groups A,B,C and
D with the following particulars:
If aggregate of historical cost is compared with aggregate net realisable value Rs.20,000 being
the historical cost of the inventory, will be shown in the balance sheet as the value of inventory. The
standard does not recognise this method and requires that only Rs. 19,800 be taken as stock value for
balance sheet purpose. In cost records, the value of Rs.20,000, will be shown as the historical cost of
the inventory.
GROUP HISTORICAL COST REALISABLE VALUE FOR

(Rs) VALUE(Rs) BALANCE
SHEET(Rs)
A 5,000 4,800 4,800
B 5,000 5,300 5,000
C 4,000 4,000 4,000
D 6,000 6,200 6,000
TOTAL 20,000 20,300 19,800
3. The standard recognises ‘FIFO’ and ‘weighted average cost methods’ for pricing material
issues. ‘Specific identification’ method should be used for items that are not ordinarily interchangeable.
4. The ‘Standard cost’ method may be used if the result consistently approximates the result
that would be obtained in accordance with (3) above.
5. If the ‘LIFO’ or ‘base stock’ method is used the fact should be disclosed as required under
this standard.
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6. Product cost, i.e., the cost of manufactured inventories is to be determined on absorption

costing principle. Fixed cost are to be allocated on the basis of normal level of production. Overheads
other than production overheads should be included in the value of finished goods or work -in- progress
, only if they clearly relate to putting those goods in their present location and condition.
7.Normal quantities of materials and supplies held for incorporating in the production of goods
should not be written down below historical cost if the finished goods in which they will be incorporated
are expected to be realised at or above historical cost. If historical cost of finished product exceeds the
net realisable value, such materials and supplies should be written down below cost. In that case,
replacement cost may be available measure of the net realisable value of those materials.
16. Write a note on Just-In-Time (JIT) production and JIT purchasing.
It is a management philosophy which aims at eliminating waste from every aspect of

manufacturing and its related activities. The term JIT refers to producing only what is needed. JIT is
defined as “A technique for the organisation of work-flows, to allow rapid, high quality, flexible
production whilst minimising manufacturing waste and stock levels.” (CIMA official terminology)
There are two aspects to JIT – just- in-time production and just- in-purchasing. JIT production
is defined as “A system which is driven by demand for finished products, whereby each component on a
production line is produced only when needed for the next stage.”
JIT philosophy aims at reducing waste, which is defined by Fujio Cho of Toyota as “any thing
other than the minimum amount of equipment, materials, parts, space and worker’s time, which are
absolutely required to add value to the product.” Thus waste is any resource used in excess of the
minimum amount required to add value to the product. More specifically JIT seeks to achieve the
following goals. 1. Estimation of non-value added activities. 2. Zero inventory. 3. Batch size of one.
4. A 100% on time delivery service.
The following are the key features of JIT production.
1. The production line is run on a demand pull basis, so that activity of each work station is
authorised by the demand of downstream work stations. Thus, parts move through production system
based on end unit demand, focusing on maintaining a constant flow of parts rather than batches of
WIP.
2. Set-up time and manufacturing lead time are minimised. Demand-led production may
require manufacturing small quantities of the product and producing small batches is economical only if
set up time are small.
3. The production line is stopped if parts are absent or defective work is discovered. In
absence of buffer stock emphasis is placed on ‘doing the job right the first time’. The focus is on
eliminating the root causes of defect, waste or re-work. JIT goes hand in hand with ‘total quality’.
In a JIT environment: 1. Absence of large amount of materials and work-in-progress inventory

enables to control inventory through personal observation; b. work-in-progress constitutes, a lower
percentage of total cost of production; c. there is no need for an elaborate cost accounting system of
stores requisition, material transfer notes, rework accounting and so forth. All the above provide
tremendous cost advantage to firms adopting JIT production.
Just- in- time purchasing demands working in close co-operation with vendors. Usually firms
work with a few vendors and develop a kind of partnership with them. Firms enter into long term
contracts with them and make them aware of the premium placed for on time delivery of high quality
goods in the exact quantity required. Thus the responsibility for checking quality and quantity is placed
on vendors. The shift from the policy of placing individual purchase orders up to entering into long term
contracts makes it possible for suppliers to be paid either monthly or per batch delivered rather than
against each delivery. The advocates of JIT purchasing argue that firms following conventional
purchasing policy overestimate ordering cost and underestimate holding cost of inventories. The
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argument seems to be correct if cost of quality (e.g., inspection cost of incoming materials, cost of
returning defective materials, scrap cost, rework cost, cost of idle capacity arising due to defective
materials ), cost of delayed delivery (e.g., expediting cost, contribution of lost sales, cost of idle
capacity) and cost of early delivery (e.g., incremental carrying cost) are considered. All these costs are
to be treated as derived holding cost. Operating cost has come down significantly for firms, which are
using computer, aided integrated system for production and material planning.
In a JIT environment, EOQ model has lost its relevance because the focus is on synchronising
delivery and usage. Such synchronisation requires no stock be purchased in large and kept in stores.
Should a firm adopt JIT purchasing depends on reduction in cost of quality, cost of delayed delivery,
cost of early delivery, and ordering costs. All these cost be compared with premium payable to
suppliers (by way of increase in cost of quality products for just in time supply). Firms using JIT
purchasing have reported significant saving in cost.
17. Define ‘wastage’. Distinguish between normal and abnormal wastage. How is it treated in
cost accounts?.
Wastage is ‘that portion of basic raw material lost in processing, having no value to be
recovered. Wastage is different from scrap. Wastage is a complete loss. It is a portion of the raw
materials left behind at the time of processing or operation that has no reuse value. The waste is of two
types- normal waste and abnormal waste.
Normal waste is that which is unavoidable and is bound to arise because of the nature of
materials. It may happen as a result of evaporation, shrinkage or breaking the bulk, etc. Considering
the nature of materials and type of operations, through a careful study, the amount of normal loss can
be determined. For example, a manufacturing operation needs 10 kg .of material , but when the output
is only say9.5 kg., the difference of 0.5 kg .is the normal wastage. The value of normal wastage be
borne by the balance of the products. Normal waste is unavoidable and generally uncontrollable.
Abnormal waste is avoidable and controllable. Wastages occur on account of pilferage, fire,
theft, careless handling, etc. this loss cannot be part of manufacturing cost. Such losses will be
transferred to costing profit and loss account.
18. Define scrap. How is it treated in cost accounts.
Scrap is the incidental residue from certain types of manufacture usually of small quantity and
low value recoverable without further processing. ICMA (London) defines it as: ‘it is discarded material
having some value which is usually either disposed of with or without further treatment, i.e., other than
reclamation and handling or is introduced into the production process in the place of raw materials’. It is
the incidental residue from a certain method of manufacture, recoverable without further processing.
Example of scrap are: metal from stamping operations, filing, turning, boring etc. left after completion of
manufacturing operations. These scrap materials may be sold away or reused. Scrap occurs because
of:
1. Faulty planning process. 2. Poor manufacturing methods. 3. Raw materials of low quality. 4.
Unconditional or inadequate machines and tools . 5. Defective inspection system.
Scrap are of three types. 1. Legitimate scrap – this type of scrap is unavoidable. Such losses
are bound to arise. These losses in almost all the cases are pre-determined or anticipated. 2.
Administrative scrap- This type of scrap arises because of administrative defects; for example, scrap
arising from obsolescence design, inferior quality of materials, poor workmanship, unsuited machines
and equipment etc. Such type of scrap is treated as abnormal and be transferred to costing profit and
loss account. 3. Defective scrap- This is because of inferior quality of machine or bad workmanship.
Accounting treatment – 1. When the value of the scrap is negligible, the realised value is
credited to profit and loss account. 2. If it is too large, the value of scrap may be debited to scrap
account and credited to material account or factory overheads account. The realised value be credited
to scrap account Control of scrap may be made effective through setting up standard, keeping
proper records of scrap and fixing proper responsibility.

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19. Define defectives. How are they treated in cost accounting.
Defectives are that portion of a product which in the process of manufacture developed some
imperfection and which can be rectified at an extra cost of operating on it. Defective work must be
distinguished from spoiled work. Defectives are the imperfections which by further processing be
rectified and attains saleable value. But the spoiled work cannot be reconditioned and the spoiled
products be sold at scrap or seconds or third grade products.
Accounting treatment- 1. The cost of rectification work, if identified, can be charged to the
particular job or product. 2. If the rectification work is not identifiable, the cost be charged to factory
overheads. 3. If the cost of rectification is due to abnormal reasons, it is to be transferred to costing
profit and loss account.
Defectives arise because of: 1. Poor quality of raw materials. 2. Poor workmanship. 3.
Improper maintenance of machines, tools and equipment. 4. Faulty design of products. 5. Wrong
setting of tools. 6. Lack of supervision. 7. Lapse of time. 8. Unsound working conditions. 9. Poor
manufacturing conditions. 10. Management failure, etc.
20. Define spoilage. How is it treated in cost accounts.
ICMA defines spoilage as ‘units of output which fail to reach the required standard quality and
specifications. Such faulty units may be capable of rectification; and they may be so corrected that the
cost of doing so is more than the loss in value from allowing the fault to remain uncorrected. When it is
uneconomic to rectify the fault, the article may be sold as sub-standard if it still functioning sound;
otherwise it may be disposed of as scrap; spoilage occurs when goods so damaged in the course of
manufacturing process. Generally spoilage is irreparable or un-rectifiable. It is also of two kinds- normal
and abnormal. If it is a normal spoilage the cost of it is borne by the balance of the products. If it is
abnormal the amount of such spoilage be debited to costing profit and loss account.
21. what are obsolete materials and how such losses can be minimised?
Obsolete materials are those, which are no longer required for production due to change of
fashion, technology, change of design, etc., and are not able to be pushed through sales. It happens
because of ; 1. Lack of co-operation between production department and purchase department. 2. No
report from store keeper. 3. Absence of standardisation.
The loss on account of obsolescence can be minimised by recourse to the following steps. 1.
Whenever there is a change in design, it must be made known to all the people concerned. 2. The
store keeper should send reports of slow moving items. 3. A separate register for obsolete materials
be kept. 4. The obsolete materials may be substituted to other productions. 5. If possible,
modifications may be done to create demand.6. If the scrap is of no value, be discarded.
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LABOUR COST
1. Distinguish between direct labour and in-direct labour.
According to ICMA ‘Direct labour cost is that cost which can be identified with and allocated to
cost centres or cost units’. Again , ‘the cost of remuneration for employee’s efforts and skills is applied
directly to a product or a saleable service.’ The labour spent in altering the construction, composition or
condition of the product is known as ‘Direct labour’. The direct labour cost can easily be identified and
allocated to cost units. It varies directly with production, thus creating closeness to production.
Indirect labour, on the other hand, cannot be conveniently identified with cost unit or cost
centre. ICMA defines indirect wages as ‘cost other than direct wages cost’. Therefore indirect labour
cost is the amount of wages paid to workmen, engaged in other than production of goods and services,
at the same time indirect labour helps the direct labour in accomplishing their goal. Examples of
indirect labour cost are wages paid to supervisors, inspectors, foremen, watchmen, timekeepers,
repairers, cleaners etc. the direct labour cost forms part of prime cost and indirect wages becomes the
part of overheads.
2. What is meant by control of labour cost control? What are the objectives and importance of
labour cost control?
The control of labour cost is very important. Engaging unfit persons in the factory results in
poor output at high cost of production; in -turn the product finds no place in the market or fetches less
price and less profits and a time arises when the factory has to be shut down. Therefore management
takes measures for effective control on the labour. Labour cost control deserves special attention in
those organisations where labour cost forms a significant portion of the total product cost. Improvement
of labour productivity results in the reduction of fixed overheads per unit. Labour cost per unit is also
reduced if increase in wages is proportionately less than the increase in output.
Importance of labour cost control – Labour cost requires constant measurement, control and
analysis because: 1. It represents human contribution to production. 2. Labour is different from other
factors of production in the sense that it is not subject to any technical limitations, which restrict
productivity. 3. In view of present labour laws, labour cost is a committed cost than discretionary cost.
Labour is now a days no more a variable overhead based on production. 4. Labour productivity
significantly influence cost per unit.
Accounting and control of labour cost requires: 1. Strict control on labour requirements. 2.
Correct time keeping , i.e., recording of the total actual time spent in the factory. 3. Time booking –
i.e., analysis of time in terms of departments, operations and production orders or jobs. 4. Generation
of adequate and effective manpower performance reports indicating productivity and efficiency of
labour. 5. Constant endeavour to improve productivity and efficiency through improvement in the
methods of remuneration, conversion of indirect labour into direct labour etc.
3. Which are the various departments involved in labour cost control?

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The following departments are involved in exercising effective labour control
1. The personnel department - this department is responsible for manpower planning, hiring
and firing of personnel on the recommendations of other functional heads. It is also responsible for
management of human resources including training and development of personnel.
2. The engineering department- This department is responsible for preparation of production

plans and specification for each job, supervision of all the production activities, time and motion studies,
job analysis etc.
3. Time keeping department – This department is primarily responsible for collecting data in
respect of total and specified time worked on a job, product, process or in a department.
4. Pay roll department - This department is responsible for computing total and net earnings
of each worker, preparation of pay rolls and maintenance of records.
5. cost accounting department – This department collects and classifies all cost data of
which labour cost is one of the most important elements. It charges jobs, products, processes or
departments with the relevant cost as evidenced by various factory documents.
4. Describe the tools under scientific management in control of labour.
Under scientific management through a careful study, determine a standard task for every
worker. The standard is the quantity of work to be done by an average worker, under standard
condition. The fixation of standard can be done by a careful analysis of job called ‘Work-study’.
Work-study means the application of systematic analysis to the work of men and machines so
as to improve methods and establish time values for that work. It is an analysis of work processes and
work methods to improve productivity. Work study helps to increase productivity through
standardisation and simplification of work. Work study seeks to achieve the following objectives: 1.
Optimum utilisation of plant and equipment. 2. Most effective use of human effort. 3. Reasonable
work load for the workers. Work study includes method study, motion study and time study.
Method study - It involves critical examination and systematic recording of existing and
proposed ways of doing a job so as to find better and more efficient methods: method study covers the
following activities. 1. Factory layout. 2. Factory automation. 3. Material handling. 4. Motion study-
how people work. The main objectives of method study are as follows: 1. To eliminate wasteful and
inefficient motions, thereby improving production flow. 2. To remove duplication of effort. 3. To
eliminate unnecessary fatigue and thereby effect economy in human effort. 4. To improve work design
and plant layout. 5. To standardise work processes, work conditions and machinery or equipment. 6.
To optimise use of manpower, materials, machinery and other facilities. Method study helps to improve
productivity by 1. Eliminating unnecessary task. 2. Reducing the number of operations. 3. Combining
interrelated tasks. 4. Re-arranging the tasks. 5. Simplifying the process.
Motion study – Motion study is a systematic and critical analysis of the movements of men and
machines involved in the performance of a job so as to eliminate wasteful and unnecessary
movements. According to Frank Gilbreth ‘motion study is the science of eliminating wastefulness
resulting from using unnecessary, ill directed and inefficient motions. Its aim is to find out and
perpetuate the least waste methods of doing work'. It covers all aspects of work, e.g., equipment,
layout, procedures, methods etc. It helps to improve productivity and to reduce industrial fatigue.
Motion study has the following advantages and limitations: Advantages: 1. It helps faster and
better working. 2. It helps in better distribution of work, and better arrangement of work place and
tools. 3. It helps in planning the operations in a scientific manner. 4. It ultimately results in increased
productivity and reduced costs. The limitations are: 1. It is costly and time consuming. 2. It is likely to
be misunderstood by workers and may put strain worker-management relationship.
Time study –‘ Time study involves the technique of establishing an allowed time standard to
perform a given task, based upon measurement of the work content of the prescribed method, with due
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allowance for fatigue and for personal and unavoidable delay’. It endeavours to find out the time
taken by average worker, posing average skill, working under average conditions, exerting average
effort, and maintaining this effort with average consistency. In short, time study aims at the
determination of standard time required by a worker of average ability, under normal conditions to
perform a task. The main advantages of time study are: 1. It helps in establishing an incentive wage
payment scheme. 2. To set production quotas for hourly rated workers. 3. To calculate cost of
production. 4. Sets standard labour cost under a system of standard costing. 5. Helps in the process of
production scheduling, sequencing, budgeting and staffing. The limitations of time study are : 1. It lacks
mathematical accuracy because of complexity in breaking up a task into various elements and also
because of subjective element that is present in levelling or performance rating. 2. It fails to provide for
adequate measurement for jobs and tasks where quality is of prime importance. 3. Trade unions and
associations generally consider time study as an infringement on workers’ freedom of action. It is not
applicable to jobs, which are casual and not repetitive.
5. What is ‘Job Evaluation’ and what are its advantages?
Job evaluation is to determine by studying and assessing, the relative worth of each job in order
to ascertain its comparative labour worth. It is studied on the basis of job description and job analysis
comparing one job with another. The labour value of each job is calculated by considering skill,
educational qualifications, responsibilities, risk involved etc. All these characteristics are given point
value and the total of these points is the relative value of the job. It is the basis on which wages are
fixed and paid. In job evaluation it is the job and not the incumbent is rated. The advantages of job
evaluation are: 1. It helps in job classification and work simplification. 2. Helps in bringing uniformity in
wage structure. 3. Facilitates cost control. 4. Simplifies wage administration by bringing out uniformity
in wage rates. 5. There develops good relationship between the employee and employer as no scope
is left for personal bias of the employer. 6. It helps in avoiding anomalies, confusion, unrest etc.
6. Write a short notes on ‘Merit Rating’ and what are its merits?
Merit rating may be defined as systematic evaluation of an employee’s performance on the job
in terms of the requirements of the job. It aims at evaluating the performance of employee. The main
objective of merit rating is that an employee is to be rewarded suitably, on the basis of merit. It also
acts as a record for punishments. Merit rating is subjective and rates the people than the jobs.
Following are the advantages of merit rating. 1. Promotions and wage rates are based on merit rating of
individuals. 2. The employees are encouraged through a good system of reward and effort; thus
further improvement is aimed at. 3. It simplifies wages structure. 4. Labour turnover is reduced. 5 . A
sense of healthy competition in the minds of workers is developed. 6. Promotions, demotions,
transfers and punishments are justified.
7. What are the different methods of recording attendance of a worker in a factory?
Every factory maintains a Time-Keeping Department. The major function of this department is
to keep a record of workers’ arrival and departure time in the factory, and duration of engagement in the
factory. To be clearer the department has to keep records of employees’ attendance in and out of the
factory, in and out of the production department and the actual time spent on the job. The record of
times for two purposes- time keeping and time booking.
Time keeping means the recording of the time of workers’ arrival and departure from the factory
for the purpose of attendance and preparation of wage records. There are two methods of time
keeping. They are manual methods and mechanical methods.
Manual methods - The following are the methods generally used for recording the attendance.
a. Muster Roll (Attendance Register) - an attendance register is kept under the custody of
the time keeper. In it, the names of the workers, the number if any are written. As soon as the workers
arrive and when they leave they have to sign the register. The late commerce may even be asked to
sign after noting the time of their arrival. This system is an orthodox system. It is good for small firms,
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but large firms cannot adopt the system as at the arrival time there will be a crowd. Moreover fellow
workers may sign by proxy.
b. Disc Method (Check token) – All the workers are allotted some numbers, known as token
numbers and each worker is provided with a metal disc bearing this number. These discs are allowed
to hang on a board at the entrance of the factory. On arrival, the worker takes their respective discs
and place them in a tray or box, kept inside the factory. When the schedule time is over, the tray or box
is removed and another tray meant for late comers is placed. This tray shall also be removed after
some time. This system is also defective since a fellow worker can drop an absentees disc in the tray.
Mechanical devices - to overcome the defects of manual methods mechanical devices are
generally adopted by large concerns for recording the time of the workers. They are as follows:
a. Time Recording Clocks – The use of time recording clocks ensures greater accuracy and
avoids all types of disputes. The clock is a mechanical device and it automatically records the time of
the workers. Under this system, each worker is given a time card for a week or fortnight, which
contains all relevant information about the worker. These cards are serially arranged in a tray and kept
at the entrance of the factory. Workers arrive, take their respective cards and insert them in the slit of
the clock and the clock prints the time of arrival of the worker in appropriate column. The clock may
also be devised in such a way to print the late arrivals in red. The same process is repeated at the end
of the day to enter the departure time of the workers. In this method, mischief has no place, clerical
labour in recording time is reduced and wage preparation is rendered easy.
b. Dial Time Recorder- The Dial Time Recorder has a number of holes, about 160 , each of,
which bears a number corresponding to the token number. There is a radial arm mounted at the centre.
Each worker, when entering the gate, has to turn the arm and press the same into the hole bearing his
number. this automatically imprints the arrival and departure time on a paper roll mounted inside the
machine. This can be used as a pay roll also. This devise is of two types- Dial time recorder and card
time recorder
8. What is time booking? What are the different methods of time booking?
Time keeping and time booking are two different terms. The purpose of time keeping is to
denote the attendance of the workers in and out of the factory. On the other hand, the purpose of time
booking is to ascertain the time taken by a worker to complete a job or an operation. The objectives of
time booking are: 1. To ascertain the labour cost of each job. 2. To ascertain the work on which a
worker is employed. 3. To have control over wastage of time – unproductive or idle time i.e., the
difference between time keeping and time booking. 4. To provide suitable apportionment of overhead
expenses.
Methods of time booking – Time booking may be done manually or mechanically. Small firms
follow the manual system and larger firms adept mechanical systems. The following are the methods:
1. Daily Time Sheet- In a small concern every worker is provided with a daily time sheet in
which the particulars of time spent on each job are recorded daily. The worker completes the sheet
daily and hands it over to the foreman for verification and endorsement.
Merits – 1. It simple to understand and easy to operate. 2. It is a record of work done by the
worker. 3. It provides information, both job-wise and worker-wise. 3. There is a close check up, as the
foreman verifies every day.
Demerits – the correctness depends upon the supervisor. 2. Paper work becomes
voluminous.
Format of Daily Time Sheet
DAILY TIME SHEET
Name………… No:……
Date…………
Department:…………
Clock ticket No:………
Grade:…………..
Job No. Description Quantity Time Hours For cost office
st
BIEE, No 58 1 floor North Mada Street, Nungambakkam, Chennai 34 98415-
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on Off Rate Amount
Worker Foreman Costed by
2. Weekly Time Sheet- This sheet is similar to the Daily Time Sheet, but similar recordings
are made for a week. This system is an improvement over the first one. It has separate columns or
rows for each day. This sheet is used by contractors, civil engineers, etc.
Format of Weekly Time Sheet
PTO
WEEKLY TIME SHEET
Name:……………………. No:…
Date…………..
Department……………………… Week
ending…..
Day Job no. Description Work Time Hours For cost office
done
on Off Rate Amount
Mon
Tue
Wed
Thurs
Fri
Sat
Worker………… Foreman……….. Costed by………
Merits – 1. It reduces clerical work. 2. It is most suited for intermittent jobs. 3. The foreman
can verify the jobs completed.
Demerits – 1. Accuracy depends on supervision. 2. Irregularity in filling the sheet is common.
3. The method is not successful when one has to do number of jobs in a week.
9. What is idle time? How is it accounted for costing purposes? Give a proforma of an idle time
card.
When workers spend their whole time at different jobs, the time booked for jobs must agree
with gate time. Normally it will not agree. It so happens because of reasons like waiting for materials,
machine breakdown, power failure, etc. this difference between gate time and booked time is called
idle time reconciliation of gate timing and preparing an idle time card facilitates time booked. This card
shows the time lost and the reasons there of. idle time is that for which the employer pays without
benefit to him. Idle time is of two types – Normal idle time and Abnormal idle time. Normal idle time is
one, which cannot be avoided. Time taken to reach the department from gate, tea time, tool setting
time, difference between the completion of one job and start time of the subsequent job are few
examples of normal idle time. Abnormal idle time is one, which can either be avoided or minimised.
Examples of abnormal idle time are machine breakdown, power shutdown, waiting for work, waiting for
instructions, etc.
Accounting treatment- Normal idle time – The cost of normal idle time can be treat in two ways.
1. The hourly rate may be raised to the extend of the cost of idle time. For example if the daily rate for a
day of 8 hours is Rs.14, and the normal idle time is 1 hr, the rate be 14/7 =Rs2 per hour. 2. The cost of
normal idle time be calculated and included with factory on cost. In the above example a sum
equivalent to 14 x 1/8 be included with factory overheads.
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IDLE TIME SHEET

Name ……………. Date …………….
number..
Shop/ Dept………..
Reason time Time lost For cost office Remarks
From to Rate Amount
Worker ………….. Foreman…………… Costed by…………
Accounting treatment – Abnormal idle time- The cost of abnormal idle time should not be
included in the cost of the products or services. Such cost be separately calculated and debited to
costing profit and loss account.
10. What is overtime and how is it treated in cost accounts?
When a worker works for more than normal working hours, he is said to be working overtime.
According to Factories Act, 1948 overtime has to be paid to the workers at double the normal rate, if a
worker works for more than 9 hours a day or 48 hours in a week. In general unless situation compels
overtime work should be avoided because: 1. Overtime work affects the quality of performance. 2.
Double rate has to given to the period of overtime. 3. Workers are tempted to earn more by not
completing their job in normal hours and doing the same in overtime hours. 4. Overhead expenses will
also increase because of overtime. However overtime may be allowed 1. During seasonal rush. 2.
When there is a failure of power or breakdown of machine etc. 3. To finish a job in time. 4. When
there is more demand for the product.
Accounting treatment – 1. If overtime is paid on the instruction of a specific customer, such

overtime wages can straightway be charged to the concerned job. 2. The extra cost may be charged to
the department, which is responsible for delay. 3. The extra amount be charged to prime cost. 4. If
there is any abnormal reason for allowing such abnormal time, the amount so paid for such overtime
can be debited to costing profit and loss account.
11. Define Labour Turnover. What are the methods of measuring labour turnover.
Labour Turnover may be defined as the rate of change in the labour force, i.e., it denotes the
percentage of change in the labour force of an organisation. In other words, it is a term used to describe
the movement of shifting into and out of an organisation by the employees. This can be measured
under 1.Separation method, 2.Replacement method and 3.Flux method.
1. Separation method – under this method, labour turnover for any period is measured by
dividing the total number of separations by the average number of workers on the roll, then multiplied by
100.
2.Replacement method- Under this method only the actual replacement of labour during a
period into account irrespective of the number of works leaving. It is the proportion of replacements to
the average working force and represented as percentage.
3. Flux method- It is the addition of both LTOs, under separation method and replacement
method. Thus under this method the total number of separations plus replacements be divided by the
average working force and represented as percentage.
In all these methods the average working force to mean the working force in the beginning plus
at the close divided by two
12. What are the various causes of labour turnover and how labour turnover can be reduced ?
what are the cost associated with labour turnover?
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The causes of labour turnover can be divided into two categories as avoidable causes and
unavoidable causes.
Avoidable causes- 1. Dissatisfaction with the job. 2. Dissatisfaction with wages. 3. Poor
working conditions. 4. Unsuitable working hours. 5. Non-co operative attitude. 6. Lack of promotional
opportunities. 7. Unfair methods of promotions. 8. Unsympathetic attitude of management. 9.
Inadequate protection. 10. Weakness in employee-employer relationship.
Unavoidable causes – 1. Quitting the job due to inefficiency. 2. Lack of work. 3. Retirement
or death. 4. Accident or illness. 5. Marriage. 6. Dislike to the job. 7. Personal betterment. 8. Workers
roving nature. 9. National service.
Effects of labour turnover- 1. Fall in production. 2. Increasing cost of staff selection, training
etc. 3. Dislocation of even flow of production. 4. Increase of scrap, defectives, resulting in additional
cost on supervision too. 5. Higher accident rate resulting in higher medical expenses and
compensation. 6. Rough and mishandling of machines calling for higher replacement, renewal repair
and maintenance costs.7. inability of labour and their low team spirit.
Methods of reducing labour turnover- Following measures are suggested to the

management to maintain a happy and contented labour force resulting in decreased labour turnover.
1.Better working conditions may be provided to the workers. 2. Selection of candidates must
be based on scientific principles and workers must be placed on appropriate jobs. 3. Well organised
training programmes must be chalked out to increase their efficiency. 4. There must be a cordial
employer-employee relationship. 5. There must be job security and opportunities for career
advancement. 6. A good wage policy and incentive plans must be devised. 7. An effective grievance
procedure be adopted. 8. Labour participation in management must be encouraged. 9. A good working
condition conducive to health and efficiency should be provided. 10. The personal department must
prepare a periodical report, relating to causes of labour turnover and suggest remedies.
Cost of labour turnover- the cost of labour turnover can be divided into two heads- preventive
cost and replacement cost. The effect of labour turnover, when it is expressed in terms of money, can
be called the cost of labour turnover.
Preventive cost – these costs are incurred in preventing the workers from leaving the
organisation by providing the following: good working conditions, high wages, medical and housing
facilities, educational facilities to the children of workers, subsidised meals and other welfare activities.
Replacement costs are concerned with the loss of production because of delay in recruiting
new hands and cost of training, scrap, wastage, tool breakage, high cost of supervision, etc.
13.What are the requirements of an ideal wage system?
An ideal wage payment should posses 1. The wage system adopted must be simple so that the
workers may be able to understand. 2. The system must ensure satisfaction to both the employees and
the employer. 3. It should be based on scientific time and motion study. 4. It should enable an
efficient worker to earn more. 5. It should ensure minimum wage at satisfactory level. 6. It should aim
at reducing labour turnover. 7. It must be accepted by the trade unions. 8. It should increase the
morale of the workers. 9. It should be according to the capacity to pay. 10. It should be flexible to
adjust to the changes in the cost of living. 11. The cost of the scheme must be minimum. 12. It should
encourage productivity. 13. It should not be in violation of Government policies. 14. It should minimise
absenteeism.
14. Discuss about time rate system of wage payment.
This is the simplest, oldest and the most common method of wage payment. The system under
which wage payment is made to workers according to the time for which they work is known as time
wage system. The time may be an hour, a day, a week or a month, irrespective of output during the
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period turned out by the workers. It means that a definite sum is guaranteed for the specific time the
payment is calculated as Earnings = Time worked X rate per unit of time.
This method is suitable under the following cases: 1. Where quality of work is more important
than quantity of work, e.g. Precision and artistic works. 2. Where it is very difficult to measure the work
accurately, as in the case of indirect workers such as watchman, supervisory staff. 3. Where machine
restrict as the speed and the operator has got no control e.g., the flow of work is regulated by conveyor
belt. 4. Where the operation or job is not repetitive. 5. Where the work is to be completed by experts,
skilled workers etc., 6. Where the worker does the work in his own interest.
Merits – 1. It is simple to understand and easy to operate. 2. Each worker is assured of

minimum wage. 3. Standard of qualities maintained because workers are in no hurry to complete more
number of units. 4. It is preferred by trade unions. 5. There is no discrimination between workers. 6. It
benefits the average and below average workers.
Demerits – 1. Efficient and inefficient workers are paid alike. Hence efforts are not rewarded
properly. 2. Equality to all will depress the superior worker. 3. Slow worker goes further slow, thus
leading to overtime. 4. Constant supervision is needed to reduce idle time.
The system can be adapted for high levels in order to have higher performance. The high rate
is equally effective as that of other incentive plans. Under this system the levels of seniority, sincerity,
can identify the labourers and through other merit rating devices and a higher wage may be paid.. this
system will encourage sincere workers. It will also act as an impulse to other to reach such level and be
fixed at high rate.
Guaranteed time rates system - under this system the payment is at time rates, but adjusted to
the cost of living. Merit awards for personal qualities, skill, ability, punctuality etc., are also considered.
The employer is not losing, but compensates it by increasing the price of the products. In any case it is
difficult to determine the index, though the scheme is acceptable to all.
15. Discuss about piece rate system and what are its merits and demerits.
Under this system payment is based on the production. the workers are paid at a fixed rate
per unit of production . Earnings = Units produced X rate per unit. This method recognises efficiency
and hence welcomed by sincere and efficient workers. The method is applicable where: 1. Quality of
the work is not that much important. 2. Work is of repetitive nature. 3. Job rate can easily be fixed. 4.
There is a good demand resulting in large scale production. 5. The job is a standardised one.
Merits – 1. The output is increased. 2. The system works as an incentive to the workers. 3.
Efforts and rewards are correlated. 4. Efforts and rewards can be made confidentially and accurately.
5. Supervision is low. 6. Breakage of machine will reduce wages, hence machines are handled with
care. 7. Idle time has no place. 8. The worker develops skill and zeal to work. 9. The rate of fixed
overhead is reduced.
Demerits – 1. Workers are in hurry, hence accidents may happen. 2. Quality of the products
will be examined, as workers are interested in quantity; as a result overhead cost increases. 3.
Inefficient workers are penalised. 4. High speed work is injurious to the health of workers. 5. In order
to maximise production, it is possible that machines are used recklessly. 6. Breakdown of machines or
power failures will disappoint workers. 7. When there is less demand, over production may arise. 8.
Fixation of a satisfactory piece rate is a difficult task. 9. It is possible that materials may be wasted or
spoiled, as the workers are anxious of only speed.
There are three types of piece rate system. 1. Straight Piece Rate system. 2. Piece rate with
guaranteed time rates. 3. Differential Piece Rate Systems.
1. Straight piece rate system – under this system, a worker gets a flat rate per unit of output.
His earnings is equal to rate per unit X units produced.

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2. Piece rates with guaranteed time rates – under this system, a worker gets a fixed
amount of wages, and he is also paid for the performance beyond a prescribed limit. The system is
complicated one and is not widely followed.
3. Differential piece rate system – under this scheme the rate per piece is increased, as the
output level is increased. That is there is more than one piece rate system. In other words, the
increase in rates may be proportionate to the increase in output. By this system inefficient workers
encouraged to earn more, by putting more effort. This system is more suitable where 1. The work is
repetitive in nature. 2. Output can be identified with individual workers.
16. How the earnings are calculated under 1, Taylor Differential Rate System , 2. Merrick
multiple piece rate system. 3. Gantt Task and Bonus Scheme, 4. Emerson Efficiency Plan, 5.
Beadaux Point System, 6. Barth plan .
1. Taylor differential piece rate system - F.W.Taylor, the father of scientific management,
introduced this system. According to this system:
a. There are two piece rate systems – one is lower and the other is higher.
b. Lower rate is for output below the standard and higher rate is for the output above standard.
c. for each job standard time is stipulated.
This system penalises the slow worker by having low rate, because of low production, and
reward an efficient worker by giving higher rate because of higher production. The workers are paid
either at low piece rate or at high piece rate and no one is paid at actual piece rate. The system is not
guaranteeing minimum wage.
2. Merrick Multiple Piece Rate System – It is the modification of Taylor system, in order the
penalisation of slow workers. Thus every one in the organisation is encouraged. The system is as
follows: Efficiency Piece rate applicable
1. Up to 83% Basic normal piece rate.
2. From 83% to 100% 110% of basic piece rate.
3. Above 100% 120% of basic piece rate.
3. Gantt Task and Bonus Scheme- This is a system combined with time, piece rate and bonus.
Time wages are guaranteed to workers, who fail to reach the standard. The main features are.
1. Standards are set and bonus is paid, if a worker completes the work with in the standard time.
2. Day wages are guaranteed.
3. A worker who could not complete the work within the standard time is paid on time wages.
4. The remuneration is payable as:
Output Remuneration
1. Out put below standard Time rate(guaranteed)

2. Output at standard level Bonus of 20% of the time rate
3. Output above standard High piece rate on output.
4. Emerson Efficiency Plan – Under this plan hourly rate is guaranteed. Bonus payment
starts at the rate of 01% of basic wages at 66.67% efficiency and gradually increases as the
performance increases. At 90 % efficiency level the bonus is 9.91% and at 100% bonus is 20%. The
appropriate bonus percentage is read off from specially compiled tables. Above100% efficiency a
worker in addition to his wages will get a bonus of 20% plus for every one percent increase in efficiency
one percent increase in bonus.
5. Beadaux point scheme – In this system, a point or Beadaux abbreviated as ‘B’ is defined as
the work which a man should be able to perform in one minute. The standard work per minute is set
after careful time and motion studies. A task or operation can be expressed in a number of ‘Bs’
depending upon the nature of work. The standard B makes allowance for the normal rest and fatigue.
Thus B is the normal time of a normal work to be performed by a normal worker. The standard Bs are
compared with the actual time. If the actual time exceeds the standard time , the worker gets wages for
the actual time. Thus the system guarantees the day wages. If the standard B’s exceed the actual
time, the worker gets his wages for the time spent and bonus for the time saved.
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6 Barth .plan - Under this system the workers are paid as follows.
Earnings = Hourly rate X √ Standard hours X Hours worked
17. Discuss the main features, advantages and disadvantages of Halsey premium plan and
rowan premium plan.
Halsey premium plan- this system is also known as Split Bonus Plan or fifty-fifty plan. The
plan was introduced by F.A.Halsey, an American engineer. In the plan , the standard time is fixed. The
workers are paid at time rate for the time taken an d a bonus of 50 % of time saved X hourly rate as
bonus. Thus earnings be: (Time Taken X Hourly Rate) + 50% of Time Saved X Hourly Rate.
Merits – 1. It is simple to understand and easy to calculate. 2. Standard time is fixed for each
job or operation. 3. Both employer and employee get equal benefit from time saved by the worker. 4.
It can be introduced in any modern industry. 5. It provides incentives to efficient workers at the same
time below average workers are not penalised. 6. Saving in time reduce both labour cost and
overhead expenditure. 7. The system is based on time saved and not on output; thus prevents
overproduction.
Demerits – 1. Fixation of standard is very difficult. 2. If wage rate is low, incentive value may be
low. 3. Careful supervision is necessary. 4. Earnings are reduced at high level of efficiency.
Rowan Premium plan – This scheme was introduced in the year 1901 by David Rowan of
Glasgow. In this scheme also as in Halsey plan Standard Time and Hourly Rate are fixed. Workers
are paid at hourly rate for the time taken plus bonus . bonus is calculated as {(ST-AT) ÷ ST} X HR.
Merits – 1. It assures the minimum time wages. 2.Strandard time is fixed, hence basic rates will
not be changed. 3. It is suitable for learners and beginners. 4. The employer is protected even if rates
are not properly fixed. 5. The workers benefit along with the workers. 6. It pays higher bonus to workers
when compared to Halsey plan. 7. Since bonus declines at higher efficiency, the worker is not induced
to rush work.
Demerits – 1. It is difficult to understand and calculate. 2. This affects extra-ordinary efficiency,

as if the time is more than half, the total earnings start decreasing. 3. The system is more complex and
expensive.
Comparison between Halsey and Rowan premium plans -1. Under both the systems
Standard Time and Hourly rates are fixed and the workers are paid for the time taken at hourly rates
and bonus for the time saved. However, the calculation of bonus causes certain differences between
them. .
Sino Halsey Rowan

1. Bonus increases steadily through out Bonus increase upto saving in time is equal to
50% of standard time.
2. Bonus is 50% of hourly rate on time Bonus is in that proportion of time taken, which
saved. the time saved bears to the standard time.
3. Gains of efficiency are shared by Gains of efficiency are not shared equally.
employer and employee (1:1)
4. From the view point of the workers, it is At low efficiencies it pays more than Halsey and
disadvantages at low efficiencies. advantageous to workers.
5. From the view point of management , Where efficiency of workers is less than 50% of
more workers will fall under this group time saved, disadvantage to the management.
and advantageous to them
18. What are the requisites of a successful incentive system of wage payment?
For a successful working of an incentive system of payment by results the following factors
should be kept in mind. 1. The system should be simple and easily understandable by the workers.
Proper understanding and co-operation keep up workers’ morale. 2. The cost of operating the system
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should be low. 3. The scheme should be such that it be susceptible to easy supervision. 4. The
incentive should be large enough to induce workers to achieve it. 5. The time lag between the
performance of the work for which the payment of incentive is due and the actual payment should be
reduced to the minimum. 6. The system should be fair enough to meet the viewpoints of the employer
as well as the employees and it should be applied in a manner, which would be fair to both. 7. The
rates and standards fixed should be reasonable so that it shall not be incapable of performance. 8. For
work above the standard the reward should be high. 9. The system should be flexible, so that minor
changes as necessary in the method of calculation, can be easily made in order to suit changes in
production methods. Such variations should not necessarily affect the basic system of payment. 10.
The workers must be properly educated and motivated by the desire to earn more. 11. There should be
an equitable distribution of work and no worker should suffer a deduction of earnings for factors beyond
his control, such as stoppage of work due to lack of tools, materials or instructions, power cut etc.
Increasing the standard time to such extent cover such contingencies. 12. There should be a
satisfactory system, of inspection so that workers are paid only for good performance. 13. The
incentive should be conducive to the setting up of standard costs and budgetary control. 14. Working
conditions should be as uniform as practicable so that worker can fully control the rate of his output.
Factors which normally affect the output are : variations in the quality of input materials and tools,
machines of low efficiency, noise, dust ,fumes, bad lighting etc. 15. There should be no rate cutting
and no ceiling should be fixed on individual’s earnings. Standards once set should not be altered
unless there is a change in the method of production. Payment should be made in accordance with
what is agreed upon by the employer and workers. 16. The system should be introduced on a
permanent and should not be discontinued in times of financial stringency. No incentive plan or system
should be introduced only as a stop gap arrangement in order to temporarily tide over labour troubles.
17. Workers putting in the same amount of effort should get uniform incentives irrespective of job
involved. 18. Indirect workers should also be included in the incentive plans.
19. How can incentive schemes be devised for indirect workers in a factory?
As the setting up of standard time and measurement of actual is not an easy task in case of
indirect work like maintenance, internal transport, inspection, packing, cleaning, store-keeping etc.,
introduction of a system of payment by results is difficult. In spite of the difficulty involved, it becomes
necessary to provide for incentives to such workers for the following reasons:
1. Payment of time rate to indirect workers and giving incentive to direct workers who are
working side by side leads to dissatisfaction and labour unrest. 2. It is but logical to say that indirect
workers are as much entitled to bonus as direct workers.3. Payment of bonus to indirect workers
creates team spirit. 4. An incentive system for indirect workers assists in maintaining the efficiency of
important services such as plant repairs, stores maintenance and control, etc. 5. In cases where the
work of the direct workers is dependent on the service rendered by indirect workers, any deficiency of
the latter due to lack of incentive lowers the efficiency of direct workers.
The following arrangements may be made for introducing incentive systems and payment of
bonus to indirect workers: 1. For work of repetitive nature such as periodical check up, cleaning and
overhauling etc. In such cases introduction of a suitable incentive system is not difficult. 2. Where
ever possible , indirect workers like helpers, carriers of materials, packers etc., may be included in a
collective plan along with the skilled worker and paid proportionately, out of the bonus earned by the
whole group. 3. Indirect workers maybe paid bonus on the basis of output of a group of direct
workers of a production shop, or of a factory as a whole depending upon whether the indirect workers
render service to a group, to a shop or to the entire factory. For example, the maintenance staff
attached to the production department may be paid at a stipulated percentage of the total bonus
earned by all direct workers in that section. 4. Job evaluation and merit rating system to indirect
workers can arrive at the quantum of bonus. 5. Application of arbitrary methods – for example the
rate of service personnel can fixed at higher level to include the incentive can be fixed. 6. Incentives
can be based on savings of the actual expenses over the budgeted expenditure. 7. Payment of
incentive may be according to the ratio between direct and indirect labour hours.
The following are the different methods of payment of incentives to different types of indirect
labour.
1. Incentive scheme for material handling staff- Incentives may be based on the number of
items of materials handled. Standard hourly rates may be established for carrying each kind of material
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based on the time and distance involved. If such detailed accounting for measuring efficiency is not
practicable, a monthly overall bonus related to the efficiency of performance may be computed.
2. Incentive for repair and maintenance staff - In mass production work, majority of the
repairs and maintenance duties can be considered as routine and repetitive for which efficiency
percentage can be evaluated. If such evaluation is not possible , a group bonus system can be
established on the basis of reduction in breakdown or on the number of complaints.
3. Incentive to stores staff – Incentives may be based on the number of requisitions handled.
Some suitable standard may be established for it. Otherwise group bonus can be computed each
month by comparing the aggregate efficiency with the pre-determined standards.
4. Incentive for office staff – Job evaluation may be done for each item of office work and a
bonus may be fixed on the basis of performance for reduction of overtime work, for maintaining
schedules and for clearance of arrears of work.
5. Incentive for supervisors and executives – Supervisors, foremen, and executives form an
important link between the workers and the high level management. Incentive for such staff should
assist in maintaining efficiency all round and avoids idle time and excess spoilage, wastage, scrap,
defectives etc., increasing production and productivity and ultimately results in reduction of costs.
Incentives to supervisors and executives usually take the form of non monetary benefit. Where
standard costing and budgetary control system is in vogue, bonus may be calculated on the basis of
saving effected.
20. What are non- monetary incentives? Give examples.
The non- monetary incentives are also called as psychological incentives. These incentives
which are given in the form of amenities or facilities, do not offer cash rewards to the employees for any
specific or measured work. Such non-monetary benefits create a psychological effect by making
working conditions and terms of employment lucrative enough to induce the employee to increase his
efforts. The benefit goes to all employees in the undertaking and is not limited to any individual or class
or group. These benefits are also called as ‘fringe benefits’.
The following are some of the non-monetary benefits: 1. Favourable working conditions. 2.
Medical facilities for the individual and his family. 3. Educational facilities to their children. 4. Welfare
measures. 4. Cheap grains. 5. Subsidised canteen. 6. Recreational facilities. 7. Transport facilities.
8. Housing facilities. 9. Pension schemes. 10. Provident fund contributions. 11. Protective clothing
and uniforms. 12. Tea, milk etc., for especially arduous work.
Advantages – 1. Reduce labour turnover. 2. Impart satisfaction to workers and create a sense
of loyalty and co-operation in them. 3. Reduce absenteeism.4. create a reputation for the undertaking
so that the best of the labour is attracted.
21. What are the functions of pay-roll department? Give a proforma of pay-roll. How can frauds
in payment of wages be prevented.
Calculation of wages payable to the employees is the main responsibility of pay-roll

department. The major functions of pay-roll department are: 1. To maintain wage records of each
worker, department and period wise on a permanent basis. 2. To verify time shown by time cards with
that of pay-roll. 3. To calculate the correct amount payable to each worker . 4. To compute and
arrange for deductions from the gross salaries of workers and cause necessary remittances to the
proper authorities on whose behalf such deductions are carried out.
Pay-roll (Wages Sheet) – It is a detailed information of the gross, as well as the net amount
payable to each worker. The accuracy of the pay-roll should be verified with relevant records. The
specimen of a pay-roll is : PAY-ROLL

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S.No.
Worker N0.
Overtime hours
Gross
ESI
Others
Name
Time taken
Normal hours
Normal rate
Pf contribution
Net deductions
Normal wage
Overtime wage
Dearness allowance
Other allowances
Net payable
Precautions – Strict control must be exercised at the time of disbursement of wages, because
frauds are committed at this stage. Therefore to avoid frauds , proper systematic and strict procedures
are to be adopted . frauds in connection with payment of wages are of the following nature:1. Inclusion
of dummy or ghost workers in pay roll. 2. Manipulation of hours worked, in job cards. 3. Recording
bogus overtime. 4. Using wrong rates of pay in wage calculations. 5. Manipulating wage calculations.
6. Making payments to wrong persons. 7. Making a worker present who was actually absent. 8.
Omission to make authorised deductions in pay-roll. 9. Making payment to a worker twice.
Therefore, the following steps should be taken to avoid or minimise fraud. 1. The wages of
workers should be paid in the presence of the head of the department. Cash payment of wages may be
avoided. It can be paid by ‘account payee’ crossed cheque drawn in the name of the worker or the
amount may be credited to the bank account of the worker. 2. Each worker should be given a photo
identity card in which name, number, the department in which he is working, designation and other
relevant data are inscribed. 3. Entries with regard to the time of work be checked with relevant entries
in time booking cards. 4. The person who prepared the pay-roll should certify the pay-roll to its
correctness. 5. The association of cashier with pay-roll department be either avoided or minimised. 6.
Pay packets be prepared for every worker, on which all the relevant information be recorded. 7. The
terms of remuneration and bonus schemes should be clearly defined without any ambiguity. 8.
Suitable internal checking system be introduced to verify every step and calculation in preparation of
pay-roll. 9. Undistributed amount in pay packets are to be entered in the ‘Unpaid wages account’, and
there after be distributed through main cashier. 10. Outstation workers are to be paid by the head
office only.
OVERRHEADS
1. Define ‘overheads’ and how are they classified?
Overheads is the aggregate of indirect material cost, indirect labour cost and indirect expenses.
The ICMA defines overhead as ‘Total cost of indirect materials, wages and expenses’. Wheldon says,
overhead may be defined as the cost of indirect materials, indirect labour and such other expenses
including services as cannot be conveniently charged to a specific unit. Alternatively, overheads are all
expenses other than direct expenses. Blocker and Weltmer define overheads as operating costs of a
business enterprise, which cannot be traced directly to a particular unit of output.
Classification of overheads- There are various methods of classifying or grouping overheads

which greatly depend upon the objectives of classification, the type of the firm and its size. Generally
they are classified according to 1. Nature, 2. Function, 3. Variability (behaviour), 4. Normality and 5.
Control.
OVERHEADS
Nature Variability Control

1. Indirect materials 1. Fixed overhead 1 Controllable
2.Iindirect labour 2. Variable overhead 2. Uncontrollable
3.Indirect expenses 3. Semi-variable overhead
Functional
1. Production overhead
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2. Administrative overhead Normality
3. Selling overhead 1. Normal overhead
4. Distribution overhead 2. Abnormal overhead
Nature classification – according to the nature of expenses incurred the expenses are
classified as indirect materials, indirect wages and indirect expenses.
1. Indirect materials – The cost of materials, which cannot be allocated to a particular unit and
does not form directly chargeable to finished product is termed as indirect materials. E.g., consumable
stores, fuel, small tools for general use etc.
2. Indirect labour – labour charges, which cannot be allocated to a particular unit of cost, is
called indirect labour. E.g., salary of foremen, maintenance workers, idle time, salaries of supervisory
staff etc.
3. Indirect expenses – most items of expenditure are classified as indirect expenses since
they are incurred for the business as a whole, rather than in regard to a particular product. E.g., rent,
insurance, taxes, canteen, welfare expenses, lighting and heating, depreciation of plant and machinery,
buildings, advertisement, carriage on sales etc.
b. Functional classification – according to the function for which the expenditure was incurred
it can be classified as factory overheads, administrative overheads, selling overheads and distribution
overheads.
1. Factory overheads – They are also called as manufacturing overheads, works on cost,
factory on cost etc. a list of items of factory overhead are 1. Rent, taxes, depreciation on own
buildings, repairs to factory building etc. 2. Depreciation , insurance etc. of factory plant, machinery and
equipment, 3. Factory lighting, heating and ventilation, 4. Fuel and power, 5. Consumable stores,
small tools etc. 6. Indirect materials such as consumable stores, lubricant oil etc., 7. Repairs of plant
and machinery and equipment, 8. Store keeping expenses, 9. Cost of idle time, overtime, holiday pay
etc., 10. Salary of foremen, works manager etc., 11. Repairs and maintenance of power house, 12
workers training and welfare, factory telephone and stationary etc.
2. Administrative overheads – “It is the cost of formulating policy, directing and controlling the
operations of an undertaking which is not related to production , selling and distribution, research and
development activity or function’. All expenses pertaining to office administration, business
administration and management are included under this head. E.g., 1. Account office expenses, audit
fee, 2. Office salaries, 3. Postage, stationery, telegram and telephones, 4. Legal expenses, 5.
General administration expenses, 6. Depreciation. Insurance, rent, etc., of the office buildings,
equipment and furniture, 7. Bank charges, 8. Office air-conditioning and electricity expenses.
c. Selling overhead – It means the cost of seeking to create demand and stimulate demand in
securing orders for the product. These include: 1. Advertisement, general market research and analysis
expenses, 2. Bad debts, 3. Quotations and price list, 4. Salaries and commission to salesmen, selling
expenses, 5. Travelling expenses of salesmen, 6. Sales office expenses – postage, telephone,
stationery, salaries of sales manager and sales office, window-dressing, etc.
d. Distribution overhead –The expenses pertaining to delivery of sold goods to the customer
fall under this group. E.g., 1. Packing materials and expenses, 2. Carriage outwards and transport
expenses, 3. Maintenance and repairs, depreciation and insurance of delivery vans, 4. Warehouse
expenses such as rent of warehouse or depreciation of warehouse and its furnishings, salaries to
warehouse staff etc, loss of goods in transit to the extent of normal loss already provided for.
c. Classification according to behaviour – According to the behaviour all the indirect

expenses can be grouped under three heads as fixed overhead, variable overhead and semi-variable
overhead.
1. Fixed overheads- fixed overhead is one which tends to be unaffected by variation in the
volume of output. They remain constant as a totality and decreases per unit for increase in output.
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Cost FOH (Total) Cost FOH (Per unit)
Quantity Quantity
The expenses relating to fixed overhead are: A. Factory overheads –1. Rent and taxes of factory land
and building, 2. Insurance on factory plant and machinery, 3. Depreciation on plant and machinery, 4.
Salaries of supervisory staff, works manager salary etc. B. administrative overhead – 1. Managers
salary and salaries of staff, 2. Rent or depreciation of factory buildings, 3. Other expenses such as
office cleaning, watchmen salary etc. C. Selling and distribution – 1. Salaries of permanent staff, 2.
Rent or depreciation of sales office, warehouse etc., depreciation on furniture and delivery van. Etc.
2. Variable overhead – The variable overhead is one which tends to vary directly with the
volume of output. The variable cost increases in the same proportion with the increase in output. The
tendency of this kind of expenditure is to vary in total and fixed per unit.
Cost VOH (Total) Cost VOH (Per unit)
Quantity Quantity
Indirect materials, indirect labour, fuel and power, stores expenses, postage, discount to
customers etc., are few examples of variable overhead.
3. Semi- variable overhead- It is an overhead, which is partly fixed and partly variable. It
means that part of the expense does not change while the other part of the same changes with volume
of output. Generally no expenditure is truly fixed or truly variable. The semi-variable overhead may be
of the following types.
a. The fixed expenses remain constant up to a level of activity and changes when the level is
increased. The best example is depreciation , which remains constant up to 100% of capacity
utilisation and increase beyond 100% of utilisation.
b. some expenses do change with the change in volume of output but not in the same
proportion. Some expenses remain foxed for some time and slowly changes to variable in character for
some time and the cycle repeats very often.
c. Some times the part of fixed expenditure remains constant and the part of variable
expenditure varies in direct proportion to the output. It takes the form of regression Y = a + bX.
Cost Semi –fixed line Cost Semi variable line

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Quantity Quantity
Classification according to normality – According to normality overheads are classified as

normal and abnormal. Normal overheads are expected to be incurred in attaining a given output. These
are unavoidable. These can be included in production cost. Abnormal costs are those costs, which are
not expected to occur in attaining a given output. E.g., abnormal idle item, abnormal wastage, etc.
Such expenses are considered as loss and be transferred to costing profit and loss account
e. According to control – A cost may be either controllable or uncontrollable. Controllable

costs are those costs, which can be controlled by an efficient management. E.g., idle time, wastage,
etc. can be controlled. Uncontrollable costs are those which cannot be controlled. All types of fixed
expenses are the best example for uncontrollable cost.
2. What are the various methods of segregating semi-variable overheads into its components of
fixed element and variable element?
The semi-variable overhead is not a separate entity for costing. The fixed part be separated
and added to general fixed overheads, and so the variable cost. This separation is necessarily be
done where marginal costing system is adopted. The following are the methods of segregating such
expenses.
1. High and low points method - under this method, the difference between the cost for high
level of output and low level of out put be found. Similarly the difference in quantity between these two
levels be ascertained. By dividing the difference in cost by difference in quantity is the rate of variable
cost. The total variable cost is the product of the rate and output. For example the following is the
information in respect of production and relevant cost
Month units cost (Rs.)
Jan 100 1,800
Feb 200 2,600
Mar 300 3,400
Apr 500 5,000
Rat of variable overhead =(5,000 – 1,800) ÷ (500 –100) = 3,200 ÷ 400 = Rs.8.
Variable overhead for April = 8 X 500 =Rs. 4,000
Fixed overhead = 5,000 – 4,000 = Rs. 1,000
Similarly for other periods the composition of cost can be found.
2. Linear equation method – in this method the total overhead is found as Y =a +bX, where a
is the fixed cost, b is the variable cost per unit, X is the output and Y is the total cost. In the above
example
Month a + bX = Y
Jan 1,000 + (100 X 8) = 1,800
Feb 1,000 + (200 X 8) = 2,600; and so on.
The value of a, b can be found by applying statistical technique trend analysis, line of least square
method.
3. scatter graph method- the various values of output and corresponding costs are plotted in
the graph. The place at which the cost line intersects Y axis determines the fixed cost. The slop of
variable over head can be found by applying trigonometry, tanθ =Opposite side ( adjacent side
Cost R
5000 Rate of VOH = tanθ = QR ÷ PQ
= (5000 –1000) ÷ (500 – 0 )
= 8

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1000 P θ FOH Q
Quantity 500
3. What are the advantages of classifying costs according to variability?
a. Cost control _ When cost is classified as controllable or uncontrollable, generally all fixed
costs like rent, rates ,insurance, etc., fall under uncontrollable classification. The costs cannot be
controlled and remain constant even at zero level of activity. The controllable costs are variable costs.
Variable cost can be controlled by lower levels of management. By splitting the expenses one can
know the type of expenses which can be controlled. Therefore for the purpose of cost control this type
of classification according to behaviour is must.
b. Pricing policy – As far as pricing policy is concerned, this type of classification is helpful in
fixing price. It may happen sometimes that different prices are charged for the same article on the basis
of competition in different markets. IN fixing differential prices, the guiding factor is the variable cost.
That is the lowest price should cover atleast the variable cost.
c. Marginal cost - Costs are divided into fixed and variable costs. The variable cost are
taken as the marginal cost. The technique of marginal costing is widely used for various types of
decision making. Project planning, make or buy decision of component, product mix, shut down of
projects and similar decisions are taken with the help of marginal costing, which is rendered possible
only because of classification of cost according to its behaviour .
d. Decision making- Managerial decisions greatly depend upon proper classification of cost
into fixed and variable. Decisions such as fixation of price at depression, introduction of new product
lines, alternative methods of production, replacement of old machines with new ones etc.
e. Overhead absorption – There are many methods to absorb overheads: and rates are
different on fixed and variable overheads. If the absorption rates are pre-determined, there arises a
variation between the cost absorbed and the actual cost incurred, calling for further analysis and
treatment of over and under absorption of overheads. The pre-determined rates can be found only if
the expenses are properly segregated.
f. Unit cost of production - When production increases the fixed overhead cost per unit
declines and variable overheads remain constant. To analyse the cost of production and its fixation, it
is essential to find out the fixed cost and variable cost per unit, which is again facilitated only by proper
classification of expenses into fixed and variable.
4. What is meant by ‘collection of overhead’ and what are the various sources from which the
overheads can be collected?
In order to ensure uniformity and accuracy in the accumulation of overheads and classification,
a separate system is to be developed. That is standing order number is to allotted to various items of
expenses and separate code number to each department or cost centre must be given so that
collection of overhead will be an easy job.
The sources from which the overheads are collected are the following:
a. Purchase journal and invoice – the purchase journal gives information about the indirect
materials and stores purchased. Invoices for materials are entered in the material control accounts and
invoices for expenses are entered in overhead control accounts.
b. Store requisition – Store requisition prepared for the issue of indirect materials like cotton
waste, lubricants, brushes, etc., are helpful in ascertaining the overheads to be charged to the
departments to which issued.

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c. Wages analysis book – This book gives information regarding indirect wages, overtime
bonus , etc., to be treated as overhead.
d. Cash book – All expenses incurred in cash are recorded in cash book. So such overheads
as paid in cash and not entered elsewhere in the above books, can be collected from this book.
e. Journal – This book gives information about the accrued expenses , payments made in
advance, besides depreciation and other non cash charges, interest and other financial adjustments.
f. Different reports and registers – Information about depreciation can be availed from the
plant and machinery register. Reports regarding scrap, waste, spoiled material, idle time, idle machine
hours and facilities in the factory help to collect the overheads.
5. What do you mean by codification of overheads and what are the objectives of coding?
After the overheads are collected from different sources, they are grouped under different
appropriate headings. It means that the overheads of similar nature and character are placed under
the same head. In one group. This grouping is done by the method of Codification. The codification is
the method of grouping the overheads by allotting numbers, alphabets or symbols to the overheads.
The objects of codifying are the following: 1. To bring the overheads of similar nature into one
group. 2. To help the allocation and apportionment of overheads to departments or cost centres. 3. To
analyse the overheads for the purpose of planning and control. 4. To help in the operation of
mechanised accounting system. 5. To reduce the number of ledger accounts to the reasonable limit so
that the accounting may become more economical and useful.
6. What are standing order numbers and how are they prepared?
The codification is associated with the use of Standing Order Numbers and Cost Account
Numbers. The numbers provided to items of the overheads of production are known as Standing order
numbers; and the numbers provided to the items of office, selling and distribution overheads are called
as Cost account number. Thus overhead items are allotted numbers and each item is known by the
number allotted to it. As the order in which the numbers are fixed almost remains constant they are
called Standing Order Numbers. Standing order numbers as adopted by an undertaking should be
listed in a schedule or manual for easy reference. The standing order numbers can be prepared in one
of the following ways .
a. Serial Numbering System – Under this method each head of expense is given a serial
number as shown below:
S.O. No. 1 to 10 - Indirect material
S.O. No. 11 to 20- Indirect labour
S.O. No. 21 to 30- Training of workers
S.O. No. 31 - Idle time
S.O. No. 32 - Over time , and so on for every kind of expenditure.
b. Combination of number and alphabet method- Under this system it can be so designed
that the Head of expense is denoted by the alphabet, and the numbers to individuals items under the
head. For example ‘R’ stands for Repairs and maintenance, R1 to R10 for repairs and maintenance to
buildings,
R1 - Repairs to factory building
R2 – Repairs to power house
R3 – Repairs to office buildings, etc.
If R11 to R20 for repairs to plant and machinery and equipment,
R20 – Repairs to factory plant and machinery
R21 – Repairs to power and transmission plants
R22- repairs to office equipment machinery, and so on.
Likewise for every expenditure codes can be created. For example, depreciation as D, indirect
labour as IL Selling expenses as SE.

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c. Numerical codes – For mechanised accounting system, the use of alphabets is restricted
and total numerical code system is adopted. For example:
code Particular of expenditure
101200100 idle time, waiting for material
101200200 idle time, machine break-down
202300100 Depreciation, plant
202300500 Depreciation, building, etc.
7. Distinguish between allocation and apportionment of expenses.

Allocation and apportionment are two different items. Cost allocation means the allotment of
whole items of cost to cost units or cost centres. Cost apportionment to mean and involves allotment of
proportion of items of cost to cost units or centres. Further in allocation, costs are directly allocated.
But apportionment of cost needs suitable basis for the sub-division of the costs to various cost units or
centres. For instance, 1. Factory rent can be allocated to factory, but can be apportioned to
departments. 2. The maintenance cost of production shop can be allocated to the shop directly, but
can be apportioned to the various machines of the shop, on the basis of machine hours run, value of
machines etc.
Principles of apportionment – After collecting indirect expenses such as electricity, rent ,

insurance etc. they are to be apportioned on a suitable basis to the various cost centres. Selection of
suitable basis, is important and the following principles are useful in dealing with them.
a. Service or use method – under this system, overhead costs are shared by the departments
on the basis of services or benefits received therefrom. For example, insurance, electricity etc. is
apportioned to various departments on the basis of use, rent on the basis of floor space, etc.
b. Ability to bear – This principle is on the basis of earning profits among the departments. A
department, which produces costly goods or earns higher profits, shares larger part of the cost of the
service department by deliberate decision of the costing department.
c. Survey method – in certain cases, a survey method has to be used in order to understand
the benefits received by different departments. For instance, a workshop foreman may supervise two
departments and his salaries may be apportioned in the ratio of time spent by him in the two
departments, and the time spent by him in this two departments may be ascertained only by survey of
related documents regarding time booking of the foreman.
8. What is meant by departmentalisation ? What are the bases on which it can be done?
The process of assigning the expenses to departments is known as departmentalisation. In all

cases direct allocation is not possible. Certain type of expenses are there which need further sub-
division. For example factory rent is further sub-divided into or apportioned to the various departments
of the factory. Similarly the expenses of service departments are to be apportioned to the various
production departments. The process of distribution of expenses to various departments is known as
‘primary distribution’ . The allocation of service department overheads to production departments is
known as ‘secondary distribution’. The common bases used for allocation of various expenses are :
S.No Overhead Basis of distribution

1. Indirect material Direct material
2. Indirect wages Direct wages
3. Electric power Horse power of machines – KWH
4. Electric light Light points, floor space, direct(if metered)
5. Plant depreciation, repairs Value of plant
6. Delivery expenses Weight, volume, value etc.
7. Audit fee Sales or total cost
8. Supervision Number of employees
9. PF & ESI Direct wages
10 Rent, rates, depreciation, repairs- Floor space
building
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11. Storekeeping, internal transport Value of materials handled
12 Advertising, sales expenses Actual or percentage of sales
13. Personnel , time keeping and wages Number of employees or total wages
office, canteen, staff welfare, safety,
etc.
14. Miscellaneous Direct wages
9. What are the different methods of distributing service department costs?
The expenses of service departments are collected in the primary distribution summary. The
next step is to reallocate the service department expense to production departments. There are two
methods of apportioning the service department costs to the production departments. They are 1.
Apportionment only to production departments- Direct method, and 2. Apportionment to service as well
as production departments
1. Apportionment to production departments only – In this case the total of service

department expenses is distributed only to the production departments on an appropriate basis.
Generally the following bases are used to apportion such expenses. Direct labour hours, direct wages,
Machine hours, number of employees, horse power or wattage-for power department expense, weight
of materials, stores requisition –for internal transport and material handling department expenses,
capital value etc.
2. Apportionment to service as well as to production departments- in general not only the

production department but also the service departments reap benefits because of other service
departments. For example the personnel department services are enjoyed by other service
departments such as repairs shop. Hence for proper allocation it is advised to allocate the service
department expenses to the other service departments also, before allocating such department
expenses to the production departments. There are two methods in such allocation A.. Descending
departmental apportionment (Step method) and B. Inter-departmental apportionment.
A.. Step method – In this method, the cost of the most serviceable departments, i.e., the
department which serves the largest number of departments, is first apportioned to other service
departments and production departments. The next most serviceable department expenses are shared
to the remaining service departments and production departments and so on till the last service
department expenses are shared only to the production departments. For example a factory in addition
to production departments has three service departments, Timekeeping, stores and Maintenance.
Apart from sharing to production departments, first timekeeping department expenses can be shared to
stores and maintenance departments in the ratio of number of workers, then Stores department
expenses can be shared to all production departments and maintenance department in the ratio of store
requisition and finally the Maintenance department expenses can be shared only to production
departments in the ratio of value of machines or machine hours worked in each department.
B. Inter-departmental apportionment - Normally a situation may arise the service

departments may render mutual services inter-se, in which cases, the expenses are to be shared by the
departments also inter-se. There exists two method in such allocation a. simultaneous equation method
and b. repeated distribution method.
a. Simultaneous equation method – under this method algebraic equations in the form of
simultaneous equation be made and solved algebraically, which figure forms the basic for allocation in
the given ratios including to that of service department. For example , let there be two service
departments X and Y. the overhead as per primary distribution is Rs.4,000 for X and Rs 5,000 for Y,
and X to share 10% of Y department expenses and Y to share 20% of X department expenses. Let x
be the total expenditure of X department and y be the expenditure of Y department. The equation be
formed as
x = 4,000 + 0.1 y…………..(1)
y = 5,000 + 0.2x…………...(2)
By solving these equations the value of x and y can be found, which shall be distributed in secondary
distribution table in the given ratio .

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b. Repeated distribution method – if there are more than two service department
rendering services amongst themselves, the above said algebraic method will be tedious and repeated
distribution method is used. Under this method each service department expense be shared to other
departments including other service departments which gain service from them. Though initial expenses
are shared, still there will some expenditure in each service department to be shared because of
allocation of other service department expenses. The same process of sharing will continue repeatedly
till further subdivision will not improve sharing meaningfully.
10. What is meant by absorption of overheads? What are the requisites of a good absorption
rate?
Charging the overheads to individual unit or specific product is called as overhead absorption.
In other words, the method of charge or apportionment of overheads of an individual cost centre is
known as absorption or recovery. According to ICMA, overhead absorption is ‘the allotment of
overhead to cost units’.
Requisites of a good absorption rate: 1. It should not involve unnecessary clerical work. 2.
The selected method should be according to the nature of the product; e.g., if the work is done by
machines, the machine hour rate should be adopted. 3. The adopted system should not bring much
difference between recovered overhead and actual overhead. 4. The selected overhead rate must be
stable so that comparison can be made. At the same time, it must be flexible to the changing
conditions.
11. What are the different methods of absorption of overheads?
The various methods applied for absorption of overheads can be grouped under three
methods. 1. Production unit method, 2. Percentage methods, 3. Hourly rate methods.
1. Production unit method – This method is also known as ‘units of output method’ or ‘ cost
unit rate method’. This is a simple method and when the same type of products are manufactured, this
method can be used. The actual or pre-determined rate of absorption is calculated by dividing the total
overhead by the number of units produced or estimated to be produced.
Recovery rate per unit = Overhead ÷ output
2. Percentage methods: the recovery rates can be calculated as a percentage on a. Direct

materials, b. Direct labour, c. Prime cost
On direct materials = (Overhead ÷ Direct material cost) X 100
On direct labour =(Overhead÷ Direct labour cost) X 100
On prime cost =( Overhead÷ Prime cost) X 100
3. Hourly rate methods -The recovery rates can be calculated based on a. Labour hours, b.
Machine hours
On labour hours (Labour Hour Rate) = Overhead ÷ Direct labour hours during the period
On machine hours (Machine Hour Rate) =Overhead ÷ Machine hours during the period.
12. What is meant by under-absorption and over-absorption of overheads? What are the
causes? How are they treated in cost accounts?
Overheads are charged to the cost units on the basis of actual rate or pre-determined rate. The
amount of overhead charges are equal to the overheads incurred, if based on actual. But usually
because of the limitations of actual rate system, they are charged on pre-determined rates or standard
rates. Under such circumstances, there arises a difference between the actual overhead and recovered
overhead resulting in under-recovery or over-recovery.
Over-absorption or over-recovery- when actual expenses incurred are less than the
recovered overhead, it is known as over-recovery. Similarly where the actual expenses are more than
recovered overhead, the situation is known as under-recovery. Under or over recovery will result in
difference between profits as shown by cost accounting and financial accounting resulting in the need
for reconciliation between two profits.

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Causes for under or over- recovery – 1. When overhead incurred is more or less than the
estimated amount . 2. When actual hours are more or less than budgeted hours. 3. When the actual
output is more or less than the budgeted output. 4. Non-recurring nature of expenses may be incurred
during the year. 5. Fluctuations in the volume of production due to trade cycle. 6. In fixing the recovery
rates the estimation of expenditure or the base in which it is to be found is made wrongly. 7. Under or
over utilisation of capacity. 8. Changes in methods and techniques of production.
Treatment (Disposal) of under or over-recovery - In disposing the under or over-recovery of

overheads, the following methods are used
a. Use of supplementary rates – the amount of over or under-absorbed overhead is adjusted

to 1. Finished goods, 2. Work-in-progress, 3. Factory cost of sales by supplementary rates. These
supplementary rates of two types. 1. positive rates and 2. Negative rates. The amount of under-
absorbed overhead is adjusted by adding it to jobs with the help of positive supplementary rates. The
over-absorption be adjusted through negative supplementary rate. The rate is determined by
reconciling with the financial and cost books. Supplementary rate = Amount of under or over-absorbed
÷ Total base. The base may be units of production, direct labour hours, direct machine hours or any
base adopted for recovery of overheads.
b. Writing off to costing profit and loss account- If under or over-absorption is not due to
seasonal fluctuations or not deliberate or the amount is small, then it can be written off to costing profit
and loss account at the end of the year. The under recovery will be debited and over recovery will be
credited to costing profit and loss account.
c. Carry forward to the next year - in this method the balance of under or over-absorbed
overhead is transferred to ‘overhead reserve account’ or ‘suspense account’ and is carried forward to
next year and will be absorbed in that year.
13. What is machine hour rate and how is it computed?
The cost of running a machine per hour is called ‘Machine hour rate’. A separate rate for each
machine can be established, which can be related to overhead cost of the production departments. The
actual and pre-determined rates factory overhead absorption is computed by dividing the cost of
running machine by the number of hours it worked. The machine hour rate can be computed either for
one machine or a group of similar machines of a department.
Machine hour rate (MHR) = Total cost of running machine ÷ Machine hours during the period
There are two methods of computing machine hour rate 1. Ordinary machine hour rate and 2.
Composite machine hour rate.
1.Ordinary machine hour rate- Direct machine expenses are taken into account when
calculating ordinary machine hour rate. Machine expenses are of two types.1. Machine expenses
which are proportional to the operating time of the machines. These expenses are variable in nature.
Power, fuel and depreciation comes under this group and these expenses are calculated per hour
directly. 2. Expenses which have no relation to operation and which are of fixed nature, e.g., insurance
on machinery, etc., are calculated for a period and apportioned over the machine hours during the
period.
2. Composite machine hour rate – in this method, machine expenses and other general
overheads of the department like supervision, rent, lighting and heating etc., are taken into account and
they are known as standing charges. These are to be apportioned to each machine on a suitable
basis. These standing charges apportioned to each machine are divided by the number of machine
hours. This will be added to ordinary machine hour rate to get composite machine hour rate.
The following are suitable bases for apportionment of different expenses for calculation of
machine hour rate.
S.No Expense Bases
1. Rent and rates Floor space
2. Lighting and heating Floor space, number of points or direct
st
BIEE, No 58 1 floor North Mada Street, Nungambakkam, Chennai 34 98415-
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3 Supervision Time spent on each machine
4. Consumable stores and lubricant oil Stores requisition
5. Insurance Value of machines
6. Miscellaneous expenses Direct wages, value of asset, machine
hours
7. Depreciation Value of assets
8. Repairs Value of assets
9. Power Value of assets, KWH, machine hours or
direct
10. Any other item for which there is no clear Direct wages, value of asset, machine
base hours.
14. How interest on capital is to be treated in cost accounts
It is a debatable point whether interest on capital should be considered or not. Certain authors
believe that interest on capital is purely of financial nature and not to be included in cost accounts.
However there exist arguments both for its inclusion and non-inclusion in cost records.
Arguments for inclusion – 1. Just like wages is the reward for labour interest is the reward for
capital investment. Hence as wages are included in cost, interest should also be included. 2. The
profits of two firms ,one with borrowed capital and the other with own capital cannot be compared if
interest is not taken into account. 3. Even in case of own capital if interest is not charged, the profit
shown is overstated since this expenditure is not absorbed. The capital contribution seems to be
without cost, which is unreal.
Arguments against inclusion – 1.Interest on capital is a theoretical concept of economist. 2.

Cost accounts records only the actual expenses incurred and not the presumptive expenses. 3.
Normally capital block is invested in capital assets like plant and machinery, buildings etc. depreciation
is charged to these assets and if interest is also included it amounts to charging doubly and
unnecessarily increasing the cost of products.
15. Define ‘Administrative Overheads’ and what are the various approaches in accounting the
administrative overhead.
Administration overhead is the aggregate of expenses associated with the administration of an

undertaking. In other words it is the cost of formulating the policy, directing the organisation and
controlling the operations of an undertaking which are not directly related to production, selling,
distribution, research or development activity or function. Thus administrative overhead does not
include the costs of administrating manufacturing activities. For example the cost incurred in operating
time office is not treated as administrative overhead ,but as manufacturing overhead. Usually for a
multi-unit firm, only the corporate office expenses are treated as administrative overhead while
expenses relating to the administrative activities of the manufacturing units are treated as
manufacturing overheads.
Examples of administrative overheads are: Office rent and rate; office lighting; ventilation;
office cleaning; depreciation of office furniture, equipment and machinery; repairs and insurance of
office building, plant and machinery, office furniture and equipment; salaries to office staff; director’s
remuneration, audit fee, legal expenses, post and telegraph, printing and stationery etc.
Accounting of administration overheads in cost accounts - There are three different

approaches to accounting of administration overheads:
1. According to the first approach, since the major activities – manufacturing and selling – are
benefited by the administration overhead, the latter be apportioned between the two activities on some
equitable basis.
2. The second view is that administration is an important function and is as important as the
other major functions. Since, no direct relationship can be established between administration
overhead and products or jobs manufactured and sold, and because these costs are largely fixed in
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nature, they should be treated as period costs, and charged directly to costing profit and loss
account. The main criticism against the method is that if the administration overhead is eliminated from
costs of jobs, products, territories, salesmen etc., net profit for operation segment cannot be
ascertained properly. Further if administration overhead is not recovered in the cost of the product, and
if tenders, quotations etc., are based on this there exists a chance to quote low rates and resultant
losses. In spite of the limitation this method is gaining recognition . International Accounting Standard
2 recognises this method.
3. Yet another view is that administration overhead is to be added as a separate charge to the
cost of manufacturing and selling the jobs, products and services. The most difficult problem in applying
this method arises in selecting the base for allotment of these costs to units produced or units sold. The
various bases, which are used to allot administration overheads, are: 1. Net sales value. 2. Number of
units sold. 3. Selling costs. 4. Manufacturing costs. 5. Number of units manufactured. 6. Gross profit
on sales.
16. How the administrative overheads be controlled?
Control of administrative overhead requires collection of expenses under correct cost account
numbers for each administration department separately. Administration overhead is collected in the
same manner as manufacturing overhead. Overheads collected for an accounting period are
compared with: 1. Past year’s overhead. 2. Budgets. 3. Standards.
The previous year’s data does not provide the right evaluation criteria because it includes
inefficiencies of past year and fails to consider the intervening changes. Budgets provide a better
criteria for evaluation. Administration overhead budget is prepared as a part of the master budget and
actual expenses are compared with the same. Some accountants suggest the use of standards for
control of administration overhead. Many tasks can be standardised. The following are the steps
involved in standardising:
1. Classifying the tasks into those, which can be standardised, and those which cannot be
standardised. Certain expenses like audit fee, legal fee etc., are not subject to standardisation. 2.
Selecting a unit of measurement for each task. 3. Undertaking time and motion study for each task. 4.
Determining the standard cost for each operation. 5. Establishing a report system.
Standardisation has got the advantage of grouping similar activities. It standardises the
systems of operation. It provides incentives for better work. It increases the morale since every one
will be aware that their performance is measured.
Effective control requires investigation into the causes of variances calculated by comparing
actual with past data, budget or standards so that corrective actions may be taken. It must be
remembered that though administration overheads are largely fixed in nature, once the volume of
activity surpasses the higher limit of the ‘relevant range’ the expense increase. A unique feature is that
once such an overhead touches a higher level, it becomes difficult to bring down the same even when
the activity level comes down. The pre-requisite of an effective control, therefore, is to put a restraint on
the tendency to increase administration overhead.
17. Define ‘selling and distribution overhead’. Give examples. What are the accounting
treatments of ‘selling and distribution overheads’?
Selling overhead is the total costs involved in seeking to create and stimulate demand, securing
and executing orders. Cost of manufacturing and distributing the finished products are, however
excluded.
Distribution overhead is the total of the costs of moving the finished products to central and
local storage, moving finished products to the customers, moving the finished products to and from the
prospective customers as in the case of goods on sale or return basis and making the empty packages
reusable. In short, when a product is placed in a saleable condition, production function ends and
distribution function begins. Overheads related to distribution function are termed as ‘distribution
overhead’. Normally it is preferred to deal with selling and distribution overheads together.
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Examples of selling overhead are: Salaries, commission, travelling expenses of salesmen and
technical representatives, sales office expenses, bad debts, brokerage, cost of operating market
information system including market research, expenses on advertisement and publicity, cost of
catalogue and price lists, cost of maintenance of showrooms, etc.
Examples of distribution overheads are: depreciation, cost of repairs and maintenance,

insurance charges and operating cost of delivery vans; cost of secondary packing; warehousing;
expenses on insurance of finished products; wastage of finished goods; etc.
Proper accounting and control of selling and distribution overheads has assumed importance
because these are showing an increasing trend. Expenditure on advertising and on various
promotional schemes and demonstration schemes have increased. With the widening of sales
territories, distribution cost also have expanded.
Accounting of selling and distribution overheads - Accounting of selling and distribution

overheads starts with the collection of overheads under clearly defined cost account numbers. Cost
account numbers reflect the nature and objective of expenditure. The following are the examples of
account heads for selling and distribution overheads: Advertising; Commission to salesmen; bank
charges; Catalogue and price lists; Stationery and printing; After-sales service; Rent, rates and taxes;
Insurance, Postage, telephone, and telegram; Discount ; Fancy packing; Repairs of vehicles; etc.
Selling and distribution overheads may be classified under fixed, semi-variable, and variable
overheads. Analysis of expenses under these classification is essential for effective control as well as
for decision making.
The second step is to allocate and apportion these expenses to various functions and territories
. the function may be grouped under the following headings: 1. Advertisement and sales promotion; 2.
Direct selling; 3. Transportation, 4. Warehousing and storage; 5. Credit collection
It is not sufficient to allocate and apportion costs to functions. Proper accounting requires
distribution of selling and distribution costs to the central marketing organisation and territories.
Expenses allocated and apportioned to central marketing organisation are then re-apportioned to the
territories. The following is the bases of which are commonly used for distribution of selling overheads
to functions and territories.
S.No. Selling overhead Distribution base
1. Advertising expenses Sales value or physical units
2. Cost of catalogues Sales value or number of customers
3. Insurance charges Value of property
4. Depreciation Capital value of assets
Many of the expenses can be recorded for each function and territory, separately, and
therefore, can be allocated directly. The following are examples of selling and distribution expenses,
which can be allocated, directly to functions and territories.1. direct selling expenses, 2. Travelling
expenses of salesmen. 3. Sales commission. 4. Bank charges for issue of bank guarantees. 5.
Shipping costs, 6. Depreciation, cost of repairs and maintenance, insurance charges of buildings and
office equipment. 7. Depreciation, cost of repairs and maintenance, insurance charges and operating
expenses of delivery vehicles, etc.
The final step is the analysis of selling and distribution overheads by products or group of
products sold. This analysis is similar to the absorption of manufacturing overhead in the units
produced, except that unlike manufacturing overhead some of the selling and distribution overheads
can be identified directly with a specific product or group of products sold.
18. How selling and distributions overheads can be controlled?
The essential pre-requisites for controlling selling and distribution overheads are: 1.
Segregation between marketing function (basically promotional activities), selling function and
distribution function. 2. Classification of cost by behaviour pattern. As for as possible overheads need
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to be classified into variable, fixed and semi-variable overheads. 3. Collection of cost data (under
clearly defined account headings) by functions, territories, customers and product groups. The
expenses on promotional activities need to be controlled at the planning stage itself because these
expenses are influenced directly by managerial strategy, judgement and decisions.
The following methods are used for controlling these overheads:
1. Comparison with past performance – this method is suitable for small organisations, which
do not have budgetary control system.
2. Budgetary control – Flexible budgets at different levels of activity is generally used for
controlling selling and distribution overheads. Actual expenses are compared with budget provisions
and variances are investigated into for taking remedial actions.
3. Standard costing – Standards are established for salesmen, territories, products etc. and
actual are compared with these standards. Variances are investigated into and suitable corrective
actions are taken.
4. Profitability analysis – profitability analysis by customers and size of orders help to decide
the optimum size of order for each class of customers. This helps to reduce these overheads, though
not in absolute terms, but in terms of ratio to sales-value.
19. Define ‘Research and Development costs’. What are its special features and how is it
accounted for in cost accounts.
IAS 9 has defined ‘Research’ and ‘Development expenses’ as follows: ‘ Research is original
and planned investigation undertaken with the hope of gaining new scientific or technical knowledge
and understanding’. ‘ Development is the translation of research findings or other knowledge into a
plan or design for the production of new or substantially improved materials, devices, products,
processes, systems or services prior to the commencement of commercial production’.
Research activities aim at the discovery of new knowledge which can be used in developing
new products, services, a new process, technique or in bringing about a significant improvement to an
existing product or process .
Development starts where research ends. The results of a research cannot be put directly to
commercial use. It requires feasibility study, and identifying practical difficulties, which may arise in its
applications. Development activities include conceptual formulation, design and listing of
product/process alternatives, development of prototypes etc.
The research and development costs include: 1. The salaries, wages and other related costs of
personnel engaged in research and development activities. 2. The cost of materials and services
consumed in research and development activities. 3. The depreciation of equipment and facilities to
the extent that they are used for research and development activities. 4. Overheads related to
research and development activities. 5. Other costs related to research and development activities,
such as amortisation of patent and licence fee. Note: the cost of routine or periodic minor modifications
to existing products, production lines, manufacturing processes, and other ongoing as well as routine or
promotional costs of market research activities are excluded from research and development activities
Special features of research and development costs – The following are the special features of
research and development costs: 1. Most of the research and development costs are incurred in
anticipation of future production of new or improved product or future use of new or improved processes
or techniques, and therefore, it should not be charged to current production. 2. In some organisations
research and development costs are very high and benefits of a research project are received by more
than one product. 3. Till the research project is complete, it is totally uncertain whether the same would
yield fruitful results. 4. Benefits of research projects spreads over a number of future years. 5. It is
difficult to fix proper standards for research and development expenses.
collection

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Accounting for research and development costs: The of research and development costs is
very important for proper accounting and control. It is a good practice to allot a work order number to
each project. A project should be undertaken only after the proposal is approved by top management
and a work order should be issued immediately after the approval is obtained. It is preferable to issue
different work orders at the research stage and at the development stage.
Research and development costs are accumulated against work numbers. research and
development costs research and development function should be treated as a separate cost centre.
Cost, which can be identified with the cost centre, should be allocated to it. Common overheads should
be apportioned to the cost centre on some equitable basis. The allocated and apportioned amount is
then reapportioned to work orders. General overheads should not be apportioned to research projects,
which are theoretical, academic or educational nature.
IAS –9 provides that the amount of research and development costs should usually be charged
off as expenses of the period in which they are incurred. In accordance with the standard, development
costs of a project may be deferred to future periods if all the following criteria are fulfilled: 1. The product
or process is clearly defined and the cost attributable to the product or process can be separately
identified. 2. The technical feasibility of the product or process is demonstrated. 3. The management
of the enterprise has indicated its intention to produce and market or use the product or process. 4.
There is a clear indication of future market for the product or process or , if it is to be used internally
rather than to be sold, its usefulness to the enterprise is demonstrated. 5. Adequate resources exist, or
are reasonably expected to be available, to complete the project and market the product or process.
Research and development costs are likely to benefit future products and therefore, an
elaborate system of absorbing, is hardly justified. Where the research has been undertaken at the
request of a customer, it should be charged to his account. If the research is specifically designed to a
particular product, the expenditure can be charged to the product. Research undertaken for the general
interest of the firm should be treated as period cost.
20 . How the following expenses are accounted for in cost accounts : 1. Estimating and drawing
office expenses. 2. Canteen expenses. 3. Costs auxiliary to salaries and wages. 4.
Maintenance and repairs to plant and building 5. Cost of packing. 6. Bad debts. 7.
Advertisement .8. Market research cost. 9 royalty and patent fee. 10. After-sales services
1. Estimating and drawing office expense –estimating and drawing office should be treated
as a service cost centre. The overheads are usually re-apportioned to production cost centres for final
recovery. However, a portion of overheads collected under this cost centre is often treated as selling
overhead and the balance is re-apportioned to production cost centre. For example, expenses
associated with preparation of tender estimates are treated as selling overhead. In a heavy engineering
factory manufacturing specific one –off jobs, drawing hours for each job are booked, and drawing office
expenses are directly apportioned to jobs by using an hourly rate.
2. Canteen expenses – If the canteen runs on ‘no profit no loss basis’, the question of
overhead does not arise. If the canteen is subsidised, the amount of subsidy is treated as factory
overhead. The canteen is treated as a separate service cost centre and the net subsidy is re-
apportioned to production cost centres. If there is more than one canteen (e.g., Workers’ canteen,
Supervisors’ canteen), each section should be treated as a separate cost centre.
3. Costs auxiliary to salaries and wages - Costs auxiliary to salaries and wages include
contributions to PF, ESI, gratuity funds, pension funds and cost of providing fringe benefits to
employees. If possible, auxiliary costs related to direct workmen should be charged to cost units by
inflating the wage rates to be applied for the recovery of direct wages. Alternatively, these should be
treated as overheads of the respective cost centres. Auxiliary costs related to indirect workers and
other employees should always be treated as overhead and collected under different heads as factory
overhead etc.
4. Maintenance and repairs of plant and building - Maintenance and repairs of plant and
building should be analysed separately under three categories. 1. Costs on preventive maintenance. 2.
Costs on major overhaul and 3. Costs on repairing of breakdowns.
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Maintenance and repair costs include cost of maintenance spares and other materials, labour
costs and expenses of maintenance department. The method of issuing ‘service order’ authorising
each maintenance and repair work, helps to accumulate costs. Usually, repairs hours are booked
against each ‘service order’ along with costs of spares and other materials. Maintenance department
expenses are apportioned to each service order on the basis of maintenance hours. Costs accumulated
against ‘service orders’ are allocated to respective production cost centres. Cost for maintenance hours,
not accounted for by ‘service orders’, are re-apportioned to production cost centres on some equitable
basis.
Real costs of maintenance and repairs can be worked out only if costs of other services
received by maintenance cost centre and administration costs are added to maintenance cost centre
expenses. However, as the total expenditure on maintenance and repairs is in itself an overhead cost,
such precession is usually considered wasteful.
5. Cost of packing – packing may be of the following three types: 1. Primary packing –
Packing essential for protection and convenient handling of the product. 2. Secondary packing –
Packing essential for safe transportation of the product. 3. Fancy packing – Packing meant to attract
customers.
Primary packing is treated as factory overhead, secondary packing is treated as selling and
distribution cost and fancy packing is treated as advertisement cost.
Packing department is considered as separate cost centre and the total expenses are
apportioned between primary packing, secondary packing and fancy packing on the basis of some
technical estimate. Costs are apportioned to primary and then re-apportioned to production cost
centres on some equitable basis.
6. Bad debts - there are two approaches for treating bad debts in cost accounts.1. bad debt is
a financial loss only and should be excluded from cost accounts. 2. Bad debt is similar to other
expenses and should not be excluded from cost accounts and it is to be treated as selling overhead.
Abnormally heavy amount of bad debt or bad debt of exceptional nature should be excluded from cost
accounts and be charged directly to profit and loss account.
7. Advertisement - Advertisement costs should be allocated and apportioned to various

functions. For example ,1. cost of advertisement calling for tender in supply of materials be treated as
part of material cost.2. cost of advertisement for recruitment should be allocated to personnel function.
3. Cost of advertisement to create and retain demand for products and services should be allocated to
selling function. Advertisement cost is an overhead but its exact treatment, i.e., whether it should be
treated as administration overhead or selling overhead or manufacturing overhead will depend upon its
exact nature.
Advertisement costs, allocated and apportioned to selling and distribution function should be
allocated to products if these can be identified with products. Common advertisement costs should be
apportioned to various products in an equitable base, normally sales value or units sold.
Heavy advertisement cost which is likely to benefit more than one accounting period should be
treated as deferred revenue expenditure and only the portion likely to benefit the current period should
be included in selling and distribution cost for the current period. Advertisement costs which is likely to
result in long term benefit should be treated as fixed asset and depreciation there on should be treated
as selling and distribution overhead, e.g. the cost of neon light advertisement fixtures.
8. Market research cost – Market research addresses itself to specific marketing problems.
This includes the study of potential markets, customers’ behaviour, competitors’ strategy, etc. it is like a
policy cost because it does not relate to activity level, but varies with management policy on market
research.
Market research cost is treated as selling overhead. However if it is high in a particular period,
it should be treated as deferred charge. Only a portion of it should be included in the overhead for the
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current year. The balance should be carried forward to the future years for inclusion in overhead of
those years.
9. Royalty and patent fee - Royalty and patent fee may either be based on the units sold or
produced or may take the form of a periodical payment of a pre-determined sum. If royalty and patent
fee are fixed charge in the nature of rent, or are based on the number of units produced, they should be
treated as manufacturing overhead. On the other hand, if they are based on the number of units sold,
they should be treated as selling overhead. If royalty and patent fee can be identified with a specific
product, they can be treated as direct expenditure and can be charged straight away to the product.
10. After-sales service – It is a common practice to offer continued free support/ maintenance
service during a stipulated guarantee period. Cost of after sales service include: 1. Cost of direct
materials, cost of parts and components replaced. 2. Cost of indirect materials consumed – cost of
materials of small value. 3. Costs of direct labour. 4. Expenses of after-sales service department. 5.
Depreciation of tools, equipment and other assets, e.g. mobile van. 6. If after-sales service involves
repairs of the product after bringing it to factory, a fair share of manufacturing overhead should also be
included in the cost of after-sales services. Cost of transportation should also be included in the total
cost.
Treatment of cost of after-sales services in cost accounts depends upon the cause, which has
given rise to the after sales services. If it is to rectify manufacturing defects, the cost is treated as
manufacturing overhead. If design department is responsible for the defect, the cost is allocated to
design department. If then damage is caused in transit, the cost is treated as selling overhead. The
following after sales services are treated as selling overhead. 1. Cost of routine services, 2. Cost of
after-sales services rendered only to retain customers’ goodwill, even though such services are not
covered under any agreement.
Correct accounting of costs of after-sales services requires a careful analysis of the total costs.
Costs on after-sales services of an exceptional nature should be charged off to profit and loss account.
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RECONCILIATION OF COSTING AND FINANCIAL PROFIT
1. Why the profits as shown by the financial books and cost records are to be reconciled?
What are the reasons for differences between profits as shown by cost accounts and financial
accounts?
Where separate sets of books are maintained for cost accounting and financial accounting
purpose, the profits disclosed by Costing Profit and Loss Account may differ from that shown in the
Financial Account. It is therefore important that they should be reconciled with each other periodically.
The differences may be due to the following:
1. Appropriation of profit not dealt with in cost accounts: 1. Dividends . 2. Income tax and
other taxes based on profit. 3. Transfer to any other fund or reserves. 4. Additional depreciation to
cover replacement cost of assets. 5. Additional provision for doubtful debts. 6. Amount written off of
the goodwill and other intangible assets. 7. Amount written off of fictitious assets, e.g., preliminary
expenses etc.
2. Purely financial items – 1. Profit or loss on sale of investments. 2.Profit or loss of capital
assets. 3. Expenses on issues and transfers of capital stock, shares and bonds. 4. Expenses and
other losses like, discount on issue and premium on redemption of bonds, debentures. 5. Interest on
debentures and other borrowings. 6. Damages payable and paid by law, fines etc. 7. Non-operating
surplus, e.g., dividend and interest received, etc
3. Purely cost accounting matters: purely cost accounting matters like notional costs
(notional rent) are entered only in cost accounts

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4. Items which are accounted for differently in cost accounting and financial
accounting: 1. Different bases of stock valuation : in financial accounts, stock is valued at the lower
cost and net realisable value, while in cost accounts, it is valued at cost price. 2. Overheads: in financial
books overheads are debited to the extent of actual amount plus due, but in cost accounts it is
apportioned normally at pre-determined rates, causing difference. 3. Abnormal losses are excluded
from cost accounts while in financial accounts all such losses are incorporated. 4. Depreciation in cost
accounts is charged on the basis of units produced or machine hour rate, but in financial account it is a
definite charge as a percentage on the value of asset.
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JOB COSTING
1. What is job costing? What are its special features?
‘Job order costing’ or ‘specific order costing’ means ascertaining costs of each job, work order
or project separately. This method is also called as ‘production order costing’ or ‘terminal order costing’
It is adopted by many undertakings, which manufacture products against specific orders. Both
manufacturing and non-manufacturing concerns follow this method. Manufacturing concerns adopting
this method are printing press, machine tool manufacturing etc. Non-manufacturing units such as
general engineering works, auto-repair shop, etc..
The main objective of this costing is to determine profit or loss earned or suffered in executing
each job. Before accepting a job, costs are estimated. The actual costs are compared with estimated
costs. Thus correct estimation can be made and profitable and un-profitable jobs can be identified.
Features – 1. Production is carried out against customer’s order and specification. 2. The cost
of each job is ascertained. Each job has its own characteristics and so different degrees of attention
and skill are required for different jobs. 3. The nature of the job decides the process of each job in
passing from department to department, because production is not made for stock, but against orders.
4. Each job is different from others. 5. A separate cost sheet is made for each job. Each job is given a
certain number, by which it is identified. In cost sheet full details of costs are entered, the date of
commencement, completion of the job and actual and estimated costs written side by side.

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Advantages - 1. It helps to know or distinguish the profitable from unprofitable jobs. 2. It
helps in preparation of estimates while sending quotations for similar jobs. 3. It collects cost data and
detailed analysis of cost by elements and functions. 4. It helps in future production planning. 5. Cost
data under job costing help in preparing budgets for future. 6. Spoilage and defective work can be
discovered by every specific job and management can take effective steps in reducing these to
minimum. In certain cases, these responsibility of such bad work is fixed on persons or departments. 7.
The method facilitates quotations in cost + contracts. 8. It helps the management in fixing the selling
prices of special orders. 9. It is useful for statistical purposes in the determination of the trends of the
different types of the jobs and their relative efficiencies.
BATCH COSTING.
1. What do you mean by the term ‘Batch costing’? how is ‘Economic Batch Quantity’
determined?
Batch costing is a type of job costing. Batch costing is done when production consists of a
definite number of articles or production is undertaken which involves limited repetition work. In job
costing production is undertaken against specific orders, whereas in batch costing, items manufactured
are held in stock and sold on demand. This costing is followed in industries footwear factory, electrical
components manufacture, pharmaceutical industries etc. A batch is the unit of cost in batch costing. A
batch may consist of number of units. For e.g. A batch in manufacturing tablets say contain 2,50,000
tablets. The cost is collected for this batch as one batch. This batch is say packed as 10 tablets per
pack. All the packs will contain the same batch number. The cost of production per unit can be found
by dividing the batch cost by batch quantity.
Determination of Economic Batch Quantity (EBQ) - Determination of Economic Batch Quantity

is the most important function in batch costing. To determine the EBQ, cost may be grouped into
setting up costs and carrying costs. Setting up costs are fixed per batch, unit price falls with increase in
batch size. Carrying cost involves the cost of carrying large stock- cost of storage, interest on capital
blocked
etc. EBQ is determined at the point where setting up cost equals carrying cost, at which level total cost
will also be the minimum. EBQ = √2DS ÷ C , where D is annual demand, S is setting up cost and c is
cost of carrying per unit per annum.
CONTRACT COSTING
1.Define ‘contract costing’. How the various expenses accounted for in contract costing?
Contract costing is a type of job costing in which a contract constitutes a unit of cost. The
principles of job costing are applicable to contract costing and embrace some basic principles of cost
ascertainment. A contract may continue for a longer time even more than a year. Builders ,civil
engineering firms, constructional and mechanical engineering firms etc., adopt this method of costing.
this costing is also called as ‘Terminal costing’
Features of contract costing- 1. Contracts take a longer time for completion. 2. The work is
executed, generally at customers’ site. 3. Since the contracts take a number of years to complete, the
problem of finding the realised profits arise. 4.since each contract is distinct from others, all expenses of
a particular contract are directly charged to it. The indirect expenses and common expenses of central
office, salary for supervisory staff etc. are apportioned to all contracts as a percentage of materials or
labour.
Accounting procedure - A contract ledger is kept in which a separate account is opened for
each contract undertaken. It is usual to give each contract a distinguishing number. The treatment of
important expenses are as follows:
1. Materials - materials needed for the contract can either be purchase directly or drawn from
stores. When the materials are purchased for the use of contract, the total cost is debited to the related
contract. Even if drawn from stores through Materials requisition , the amount be debited to the related
contract account. Any return of stores be credited to the contract account. There can be two types of
material losses- normal and abnormal. In case of normal loss the issue rate to the contract be inflated.
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The abnormal loss if any in the contract be debited to costing profit and loss account and credited to
contract account. The material at the site at the end of the period is credited to contract account and
will be shown in the balance sheet as materials at site. This closing balance of materials at site be
transferred to the debit side as opening stock in the next period.
2. Labour – The contracts are carried out at the site of construction away from the premises
of contractor’s office. Therefore, there arises a problem of control. The labour employed on contracts
is treated as direct labour and the cost is debited to the contract account. When there are number of
contracts, a separate pay-roll is prepared for every contract. The salaries of supervisory staff,
supervising two or more contracts be apportioned suitably and debited to contract accounts.
3. Overheads – generally apportionment of overhead expenses does not arise, because most
of the expenses such as lighting, hire charges of special plants etc., are entirely charged to the
respective contract account. However some common expenses like , head office expenses are shared
amongst the several contracts in an equitable bases. These overheads are debited to contract account.
4. Plant- special types of plant like concrete mixers, are brought to the site and kept at site till
the work is complete. Where there are more than one site, a clear record is maintained about the plants
issued to the sites of various contracts. There are two methods of accounting for plant in contract
accounts. 1. The cost price of plant can be debited to the contract account in the beginning. At the end
of the period the value of plant less depreciation be credited to contract account. This balance be
brought forward to the next period in the debit side of the contract account. This procedure is followed
every year till the plant is returned to the main office or the contract is complete and executed, in which
case, the value of returned plant, as reduced by depreciation till date of return be credited to contract
account. OR 2. Every year, the depreciation alone as a % on cost or on written down value according to
the depreciation policy be debited to the contract account.
5. Subcontracts – Sometimes, the contractor gives a portion of work to subcontractors. For
instance, the work of painting, special flooring etc. may be given to another contractor. The cost of
such subcontract is debited to the concerned contract account.
6. Extra work - It is possible that the contractor may be asked to do additional work, in which
case, if the amount is less it may be debited to the contract account itself. If the amount is large, a
separate account is opened to debit the concerned expenses on account of extra work and added to
the cost at the end. How ever for such additional work, the contract price may be increase to include
the extra cost in executing such additional work.
2. Define ‘ work certified’ and ‘retention money’.
Normally the contract will be executed over a period of time ranging in years. The agreement
between the contractor and contractee may specify the terms of payment, which is based on work
certified. Work certified is the portion of work-in-progress as certified by a competent authority. At the
end of the every period the work-in-progress be valued to the extent of material, labour and overheads
content in the executed job. This shall be divided as ‘work certified’ and ‘work uncertified’. Depending
upon the terms of agreement the contractee will pay a certain percentage of work certified. The balance
of the value in work certified is the retention money. For example if the contractee pays 80% of work
certified, the balance 20% is retention money.
3. In contract accounts how the profits in the case of incomplete contracts are arrived at and
treated in books of accounts
Big contracts take several years for its completion. The exact amount of profit can be
ascertained only at the end of the completion of contract. As such no profits shall be transferred to
profit and loss account. If it is so there will be wide fluctuations in the profits of the concern . in a year
where many contracts are completed the profits will be more. Similarly if in a year where no contract is
completed the profit and loss account may show huge loss. This renders profits incomparable. Further
if it is a company form of organisation there will be wide fluctuation of share prices in the securities
market. Hence the profits of incomplete profits are anticipated every year, and a certain amount of
profit be transferred every year to general profit and loss account. Following is the procedure followed in
transferring profits: If the debit side of the contract account is more than credit, representing loss, the
entire amount be transferred to profit and loss account. However if the credit side is more than debit
side representing profit, the following procedure be adopted.

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1. if the contract is recently started and the work completed is less than one-fourth of the
total work, no profit should be transferred to profit and loss account.
2. If the contract is complete one-fourth but less than one-half, the profit to be transferred to
profit and loss account is calculated as:
Notional profit X 1/3 X cash received÷ work certified
3. If 50 % but less than 100% is complete, the profit to be transferred is arrived at as follows:
Notional profit X 2/3 X cash received÷ work certified
4. where the contract is fully completed the entire amount of profit be transferred to profit and
loss account.
In all the above first three cases, the difference in the contract account after transferring to profit
and loss account be treated as reserve to meet future contingencies such as penalties, increase in
costs etc.
4. What do you mean by 1. Escalation clause and 2. Cost plus contract
Escalation clause – It is a clause in the agreement of a contract, which provides to

compensate the contractor to accommodate the price variance in the cost of materials or labour
because of market fluctuations. This clause is included in the case of long period contracts. It
safeguards the contractor and the contractee against unfavourable changes in prices of materials and
labour.
Cost plus contracts - Certain contracts are such that their cost cannot be estimated in
advance. Under these circumstances, the contractor is assured of the actual cost to which a margin of
profit is added. The profit is in the form of a fixed amount or of a percentage in cost. The total cost
incurred is subject to scrutiny by the contractee, who possesses the right. Cost plus contract is
advantageous to both the contractor and contractee. Neither of them stands to lose. The contractor
receives a reasonable profit and the contractee is ensured of a reasonable price.
UNIT OR OUTPUT COSTING
1. What are the main features of unit costing? how the cost is collected under unit costing?
Unit costing or output costing or single costing means the ascertainment of the cost of
producing a unit of output. This method is used in industries where production is identical or uniform
and manufacturing process is continuous. This method can also be used in such concerns, where a
single article is produced in a large scale or produced in two or more grades. The output is measured
convenient physical units. The method of costing is advantageously used in undertaking like collieries,
sugar mills, brick fields, paper mills, cement factories, ship yards etc. to find out the cost per unit the
total cost is divided by number of units produced.
Cost per unit = Total cost ÷ units produced.
If only one product is produced, detailed analysis of cost is not necessary. If two or more
grades and sizes of commodities are produced , a detailed analysis of expenditure is essential.
Collection of cost-- The procedure of cost ascertainment – 1. Raw materials consumed

are charged directly. Adjustment may be needed for opening and closing stock of raw materials.
Material consumed = opening stock + purchases – closing stock. 2. Labour charges can be charged
directly from pay-rolls. 3. Direct chargeable expenses can be charged straight to the products from
concerned registers. 4. Indirect expenses are collected under three heads- factory overheads,
administrative overheads and selling and distribution overheads and be added to the cost of the
products. 5. Factory overhead is added first to get factory cost. 6. The opening and closing work –in
progress be adjusted along with factory cost. 6. The administrative overhead be added with factory
cost to get cost of production. 7. At this stage the opening and closing finished stock be adjusted to get
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Cost of Production of Goods Sold. 8. The selling and distribution overhead be added to get cost of
Cost of Sales.9. The total cost be divided by the number of units sold to get the Cost of Sales per unit.
The collection of cost are set out in the form of a statement called statement of cost or cost sheet. (A
specimen of cost sheet can be given)
2. What do you mean by “Tenders and Quotations”. How are they prepared.
Tenders and quotations are the estimates given to the prospective customer. It will denote the
price at which the producer is prepared to supply the products. Tenders and quotations are based on
past performance. Estimates are made on the basis of the past cost structure. Materials, wages and
direct chargeable expenses are variable costs and calculated per unit. For the purpose of inclusion of
overheads, they will be calculated at certain recovery rates based on certain conventional bases.
Unless to the contrary, factory overheads be found as a % on wages, administrative overheads as a %
on factory cost and selling over head as per unit sold or as a % on sales value. The tender or quotation
be prepared in the form of a cost sheet. The cost is found as said above with due adjustments for
changes in rates etc. With the cost as calculated desired profit be added and the tender price or
quotation price is fixed.
3. How the following are treated under unit costing. 1. Scrap or wastage. 2. By-products and 3.
Defective products.
1. Scrap or wastage – Materials obtained during the course of production or the residue in the
course of manufacture, which are useless for production are called scrap or wastage. Manufacturing
operations causes them. The scrap materials are sold out and this will reduce the cost of material
consumed. This scrap value will be reduced from materials or factory overheads.
2. By-products – Some by-products arise from the manufacturing process. The realisable
value of by-products is deducted from the factory overheads and there by will reduce the cost of main
product.
3. Defective products – defective products can be rectified at an extra cost. It is caused by

normal reasons, it can be included in the factory cost. If it is abnormal, it can be transferred to costing
profit and loss account or to a separate account called ‘defectives account’.

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UNIFORM COSTING
1. What is uniform costing ? what are its objectives, advantages and disadvantages?
Uniform costing is not a separate system of costing like job costing or process costing. it is
simply a system of costing designed by an industry for the use by its various firms. Uniform costing is
defined a ‘the use by several undertakings of the same costing principles and or practices’. It means
and involves that different concerns should adopt a common method of costing and apply uniformly the
principles, techniques and practices. The trade association for the benefit of its members designs a
uniform costing system. Whatever maybe the method of finding cost, the method is applied uniformly
by all the concerns of a particular trade association. Thus uniform costing is defined as ‘A common
system using agreed concepts, principles and standard accounting practice adopted by different entities
in the same industry to ensure that they all deal with accounting information in a like manner, the
objective being to facilitate inter- firm comparison’.
Objectives – 1. Comparison helps to bring uniformity in the production cost of different units of
the same industry. 2. Fixation of a common sale price is rendered possible. 3. Better and
standardised systems are available for the undertakings. 4. Inter-firm comparison facilitates further
cost control and cost reduction. 5. Elimination of unhealthy competition among different units of an
industry is possible. 6. Exchange of ideas and technological knowledge among the members is
possible. 7. Comparison of cost of production will facilitate the improvement of production capacity and
labour efficiency. 8. Determination of common policy for different firms of an industry is possible. 9.
The stability in demand for products can be achieved. 10. This system will provide reasonable price to
customers and profit to producers.
Advantages – 1. Cut throat competition is avoided. 2. Performance of individual unit can be

measured with the standard laid down. 3. Weaker participating members can improve the efficiency by
following standard methods. 4. Smaller units can reap the benefit of researches and experiment
carried on by the big firms at no expense. 5. Cost control and cost reduction are made effective. 6. It
reduces labour turnover. 7. Wage boards find it easy to fix minimum wages or fair wages. 8. Prices
fixed on uniform costing or on reliable data create confidence among consumers. 9. Uniform costing is
the base for inter-firm comparisons. 10. Reliable data of the industry facilitates the Government in
taking current decisions.
Disadvantages – 1. Firms are rarely identical and so costs may be incomparable. 2. It is

difficult to find a common basis for classification, allocation, apportionment of costs etc. 3. There is a
tendency of increasing prices. 4. The system is expensive as for as small units are concerned. 5.
Mutual trust and confidence may not continue for long, because some member units will not pass secret
information to the common pool. 6. The cost of installation of a costing system is high. 7. The
standardised terminology may be misunderstood by the member concerns. 8. The system invites
monopolistic tendency. 9. When the size and type of business differ, there arises difficulty to lay down
standard and common principles. 10. Difference in member units on account of labour forces, nature of
plant, capital investment etc. is made ineffective.
2. What do you understand by ‘inter-firm comparison’? What are the advantages and
disadvantages of inter-firm comparison.
Inter-firm comparison is the technique of evaluating the performances, efficiencies, costs and
profits of firms of an industry. Uniform costing system is a pre-requisite to an inter-firm comparison.
There is a central co-ordinating organisation, which collects data from its members analysed and
presents them in a suitable manner for the benefit of its members. Inter-firm comparison is a technique
of self control and self improvement.
The central co-ordinating organisation collects the information from its members at regular
intervals. In certain cases a questionnaire is sent and data are collected in the form of replies, generally
once in a year. On the basis of the data, a consolidated report is prepared. To maintain secrecy, the
data are not given in absolute figures, but in the form of ratios.

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Advantages – 1. Inter-firm comparison makes the management aware of its strength or
weakness in relation to others in the industry. 2. Improved method of production and technical
knowledge of the superior firm, becomes available to less efficient firms. 3. Inter-firm comparison helps
management to control the costs. 4. Production can be improved when the area of weakness or
uneconomies is located. 5. Efficient system of reporting can be developed and presented in
standardised forms. 6. It eliminates unfair competition among the firms. 7. It facilitates fullest
utilisation of available resources. 8. Cost consciousness is created among the participant firms and
they are cautious at every level. 9. It assists Government in industrial development and regulations
through appropriate policies. 10. It guards the absolute data.
Disadvantages – 1. In certain cases suitable base of comparison may not be available. 2.

Firms may not be prepared to disclose information relating to their production and cost structure. 3. In
the absence of co-operation among members, the efficient firms may not be willing to participate in the
scheme. 4. Due to lack of scientific costing system, the scheme may not be worked out properly. 5.
Information supplied by many firms may not be reliable. 6. The central agency may, sometimes, fail to
induce the firms to supply the necessary information. 7. Cost of implementing the uniform costing
system may be heavy. 8. In comparison process the time factor which is important is ignored. 9.
Before comparison is made, prices are to be adjusted for changes, to arrive at correct idea. But no
adjustments are made. Thus conclusions may be wrong.
OPERATING COSTING
Define operating costing. Mention the industries where it is applied and their cost units.
Operating costing method is one designed to ascertain and control the costs of the
undertakings, which do not produce products but which render services. Operating costing is also
known as service costing. it is that form of operation costing which applies where standardised services
are provided either by an undertaking or by a service cost centre within an undertaking. It is the cost of
rendering a service. Industries using operating costing do not provide tangible products; but useful
service is rendered. For e.g., transport services, utility services like canteens, hospitals etc., distribution
services like supply of electricity, gas etc. there is internal or external service. For e.g., repairs and
maintenance department or canteen in a factory is a n internal service.. Services rendered to
customers are called external services. E.g., hospitals, transport companies, electricity companies etc.
Cost unit – the selection of cost unit is different in operating costing. the following are few
examples.
S.No SERVICE COST UNIT
1. Passenger transport Per passenger kilometre
2. Goods transport Per tonne kilometre
3. hospital Per patient bed
4. Electricity supply Per kilowatt hour
5. Canteen Per plate meal
6. Cinema theatre Per man show
7. Gas works Per 1000 cubic feet
8. Steam production Per 1000 lbs
9. lodge Per man room
10. Institutions Per student

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PROCESS COSTING
1. Define process costing and distinguish it from job costing
Process costing is a method of costing. this method refers to costing of distinct process
involved, while converting raw materials into finished products. The layout of plant and machinery
decides the type of costing to be adopted. Where the plants doing similar functions are grouped
together in every department and the materials are allowed to move from one department to other
department, to find the cost of performance in each department, process costing is used.
Stores process1 process2 process3 warehouse
The cost is collected and ascertained and transferred to the next process. The output of one process
becomes the input of next process. The basic raw material is introduced in the first process and the
finished stock emerges out of last process.
Distinction between process costing and job costing
S.No Process costing Job costing

1. The production is a continuous flow of Production is executed against specific
stock in anticipation of demand order from customers.
2. No individual identity of products Different jobs are individually identified.
3. There is always work-in-progress both Jobs may or may not have opening and
in the beginning and at the end. closing work-in-progress.
4. Costs are accumulated for each Costs are accumulated for each job.
process for a period
5. Costs are found out at the end of the Costs are found at the completion of every
period job.
6. Costs are transferred from one process No such transfer of costs from one job to
to another process other unless there is a cost relation
between jobs.
7. Through standardised systems Since each job is different, no
managerial control is made easy standardisation calling for intensive
managerial attention.
8. Paper work is less Since every job is costed separately there
is more of paper work.
9. Since production is of standard Production is based on individual
products they are uniform specification and may differ widely.
2. What are the features, advantages and disadvantages of process costing?
features: 1. The factory is divided into a number of process cost centres or departments and in
each cost centre accounts are maintained. 2. All types of costs- direct and indirect are recorded in
each process. 3. The finished product of one process is the raw materials for the subsequent process.
And continuous to flow from one process to other in sequence till it reaches the last process from which
it will be transferred to warehouse for the purpose of stocking. 4. The cost of the previous process
along with the output be transferred to next process.5. total cost of the finished product comprises of all
costs incurred in all processes. Of course, the total cost of the last process will reveal the totality of all
costs incurred in all the processes. 6. Finished products are homogeneous.7. by-products and joint
products may arise, calling for cost allocation to such products.
Advantages – 1. The cost of different processes as well as finished goods can be computed
conveniently at short intervals, say daily or weekly. 2. Control over cost and production can be
advantageously effected as pre-determined and actual data are available for each process. 3. It
involves less clerical work because of the simplicity of cost records. 4. The average cost of
homogeneous products can be easily computed. 5. Expenses can be allocated to different processes
on rational basis and accurate cost, thus, can be ascertained. 6. It enables the correct valuation of
inventories.
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Disadvantages- 1. The cost ascertained at the end of the process is historical cost, which is of
negligible use for managerial control.2. The system of costing conceals weaknesses and inefficiencies
in processing. 3. It does not evaluate the efforts of individual workers or supervisors. 4. The valuation
of work-in-progress on the basis of degree of completion is merely a guess work, resulting in
approximations. 5. If production is not homogeneous, ( e.g. in foundries castings of different shapes
and sizes are made) the average cost may give an incorrect picture of cost.
3. How the cost is collected in process costing?
The factory is divided into distinct processes or operations and a separate account is
maintained for each process. All expenses – materials, wages, direct expenses and indirect expenses
are charged to the process concerned. The following is the method of cost collection in respect of every
process.
Materials – Materials required for each process are drawn from stores through Material
requisitions. Each process is debited with the cost of materials issued according to the requisition.
Where the finished product of one process is transferred to the subsequent process, the accumulated
cost of the transferring process is credited in its accounts and the process to which it has been
transferred shall debit the same.
Labour cost – Wages paid to workers who are engaged in a particular process are directly
allocated to the process concerned. The time booking cards will form the basis for such allocation.
Direct expenses- direct expenses such as depreciation , consumable stores etc are debited to
the concerned process accounts directly. Relevant evidences are made available through machine
booking cards, Material Requisitions etc.
Overheads- Rent, telephone, lighting, gas, water etc, which are some common expenses of
one or more processes, may be apportioned to the various processes on suitable bases. Generally,
these overheads are recovered at predetermined rates based on wages, prime cost, machine hours etc.
4. Define joint products and by-products.
Joint products – Joint products are defined as ‘two or more products separated in the course
of processing, each having a sufficiently high saleable value to merit recognition as a main product’.
Joint products are those which emerge at the end of a single process or at the end of different
processes and which are of equal importance in terms of sales value and profit. Production of joint
products depends on technology and not on managerial decisions. Joint products are not
distinguishable unless a stage called split off point is reached in processing where they get separated
from each other. E.g. In petroleum industry petrol, diesel, liquid petroleum gas, kerosene emerge as
joint products.
By-product – ‘ A product which is recovered incidentally from the material used in the
manufacture of recognised main products, such by-product having either a net realisable value or a
usable value which is relatively low in comparison with the saleable value of main products. By-products
may be further processed to increase their realisable value’. Production of by-product is incidental to
production and cannot be avoided by managerial decision. The basic difference between joint product
and by- product is that the joint product has got a high resale value similar to the main product and
hence worth treated as main product, whereas by-product has got a negligible vale and therefore can
not be treated as main product. The main product of an industry may be the by-product of another
industry. For example, in coke ovens, coke is the main product and gas is a by-product, while in gas
works, gas is the main product and coke is the by-product
5. What is the accounting treatment for by-products?

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By-products can be of two types – certain products can be sold in their original condition and
certain products need further processing after separation. By-products are produced along with main
product and the same are of comparatively of less value. In accounts they are treated in any one of the
following methods.
1.Non-cost methods (sales value method) -

a. Other income method- the value realised by the sale of by-products is treated as other
income because of its negligible value. The stock of by-product is valued at zero value for the purpose
of balance sheet.
b. crediting sales value to the process account – Under this method the value of the by-product
is credited to process account, so that the cost of them causes some reduction in the price of main
product. In this method also the cost of by-product stock is taken as nil for the purpose of balance
sheet. If any expenses incurred in selling by-products shall be deducted from its sales value and the
balance be credited to process account.
c. Crediting the actual cost to process account – in case the by-products need further
processing before sales, the cost of it is debited to the by-product account and credited to process
account.
2. cost methods
a. replacement cost – under this method, the by-products are utilised in the same industry as
raw materials and valued at the market price, the process account is credited to the value.
B .Standard price – in this method, the by-products are valued at standard cost and credit is
given to the process account.
c. Apportionment on suitable basis – where the by products are prominent, they will be treated
as joint products and as such joint cost is apportioned in a suitable basis.
6. How the joint costs are allocated to main products and joint products.
In accounting for joint products, the joint expenses incurred before separation be apportioned to
main products and joint products in a suitable basis. The following are the methods of separation of
joint expenses.
1. Average unit cost method- in this method, it is assumed that the total cost of the process is
borne by all units equally. The total process cost of pre-separation is divided by the total units including
the joint products. This method is applicable where process are common and inseparable from
products and expressed in common units, i.e., weight or volume applicable for all units, including joint
products.
2. Physical units method- in this method the joint costs are apportioned on the basis of some
physical units (raw materials) i.e in metres, tonnes etc. physical units are the units in which the basic
raw material is measured. And is determined at the point of separation of the joint products. This
method cannot be used if the products of different physical measurements.
3. Survey method (Point Value Method) – This method is adopted after a technical survey of
all factors involved in the production and distribution of products. Percentage or points value is assigned
to each product to denote its relative importance and common costs are apportioned on the basis of
total points.
4. Market value method – In this, the joint costs are apportioned on the basis of the proportion
of market price of the products. Thus products having higher price are charged with higher proportion
of the joint costs and products having lesser price get lesser share of the joint costs.
7. Define scrap and wastage.

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A loss of material due to evaporation or spoilage in process is inevitable in process industries

and therefore output from the process is less than the input. These losses may be of either scrap or
waste. Scrap is defined as ‘Discarded material which have some recovery value and which is either
disposed of without further treatment (other than reclamation and handling), or reintroduced in the
production process in place of raw material’. The spoilt material that can be sold off at below the cost is
termed as scrap. Spoilt material may sometimes be reintroduced in the process after reprocessing and
such spoilt material is also known as scrap. For example, copper off-cuts may be reprocessed for
conversion into copper strips for reintroduction in the process. Waste is defined as ‘Discarded
substances (materials) having no value.
8. Write a note on ‘Normal and Abnormal loss’.
For the purpose of accounting treatment, there should be a clear distinction between normal
and abnormal losses. In most process industries the loss of material which is unavoidable can be
estimated in advance. Unavoidable loss is treated as normal loss and it consists of 1. Losses inherent
in the material or process due to chemical changes or other physical reasons. 2. Unavoidable spoiled
quantities or units withdrawn for test or sampling. Normal loss is calculated in advance by technical
estimate or on the basis of past experience and it indicates the loss that would occur in normal
conditions. The term normal loss includes normal scrap and normal waste.
Loss in excess of normal loss is termed as abnormal loss and is usually caused by unexpected
or unfavourable conditions such as use of substandard materials, bad workmanship, accidents etc. The
term abnormal loss includes abnormal scrap and wastage also. The normal loss shall be valued at
scrap rate, but abnormal loss is valued at the rates of cost of production.
9. What is the accounting treatment for normal loss, abnormal loss and abnormal gain.
Treatment of normal loss – The normal loss shall be valued at scrap rate. The value of normal
loss shall be debited to Normal Loss Account and credited to Process Account. These units be sold, for
which cash account is debited and Normal Loss account is credited.
Process account Normal loss Account

Qty Amount qty Amt qty Amt
By NL x xx To pro x xx By cash x xx
x xx x xx
Treatment of Abnormal loss: the abnormal loss shall be valued at the cost of production, after
deducting the value of normal loss. Thus value of abnormal loss is:
Al = {(Total cost – value of normal loss) ÷ (Input- units of NL)} X AL units.
The value of abnormal loss is debited to abnormal loss account and credited to process account.
Unless otherwise stated it shall be assumed to have been sold at scrap rate of normal loss that shall be
debited to cash account and credited to abnormal loss account. The balance in abnormal loss account
will be transferred to costing profit and loss account.
Process account Abnormal Loss account

Qty Amt qty Amt qty Amt
By NL x xx To process x xxx By cash x xx
… AL x xxx .. Costing
P&L xx
x xxx x xxx

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Treatment of Abnormal gain – Abnormal gain shall also be valued like abnormal loss. The value of
abnormal gain is:
Ag = {(Total cost – value of normal loss) ÷ (Input- units of NL)} X Ag units.
The value of abnormal gain is debited to process account and credited to Abnormal Gain account.
Because of abnormal gain, the normal loss in terms of units shall stand reduced to the extent of units of
abnormal gain. Hence a sum equivalent to the proportionate value of abnormal gain at scrap rate be
transferred from abnormal gain account to normal loss account. The balance in abnormal gain account
shall be transferred to costing profit and loss account.
Process account Abnormal gain account
qty Amt qty amt qty Amt qty Amt
To AG x xx By NL x xx To NL x xx By Process x xx
To Costing P&L x xx
x xx x xx
10. Discuss equivalent production.

The average cost per unit is determined in progressing type of industries, by dividing the total
cost incurred by the total units produced during the period. But when the process is a continuous
process, there is always in complete work in the opening and closing periods of each process. In such
cases, if unit cost is arrived at on the basis of the total process cost and units produced, ignoring
incomplete units will not represent the correct cost. But the incomplete units should not bear the same
cost as fully completed units. Hence the work-in-progress is required to be converted into their
equivalent of completed units. Wheldon defines the equivalent production as ‘the production of a
process in terms of completed units’. Thus equivalent production represents the out put of a process
expressed in terms of completed units. This is done on the basis of estimate or percentage of degree
of completion in respect of every element of cost the concept calls for preparation of three statements.
1. A statement of equivalent production 2. Statement of cost per unit per element of cost and 3.
Statement of evaluation.
1. Statement of equivalent production. – in this statement every output including the WIP
shall be converted to its equivalent fully completed units in respect of each and every element of cost.
Under FIFO method opening work in progress be converted to the stage of balance of completion.
Normal loss shall be considered as nil. Abnormal loss/abnormal gain, unless other wise stated be
converted at 100%, fully completed units be converted at 100% and closing stock to the stage of
completion in respect of each and every element of cost.
Specimen of statement of equivalent production
Input Particulars Output Materials labour Overheads

% units % units % units
Opening WIP
Fully completed
N loss
A loss
Closing WIP
TOTAL

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Specimen of statement of equivalent production (with Abnormal gain)
Input Particulars Output Materials labour Overheads

% units % units % units
Opening WIP
N loss
Fully completed
Closing WIP
Less: A.gain
TOTAL
2. Statement of cost – I n this statement the cost in respect of each element of cot is divided
by its corresponding equivalent production, to arrive at the rate of cost per unit. The value of normal
loss be deducted from cost of materials before calculation of rate.
3. Statement of evaluation – in this statement, every output, opening wip, fully completed
units, abnormal loss/gain and closing work in progress be valued, in respect of every element of cost
as a product of its corresponding equivalent production and rate. The total cost of an output is the sum
of all costs as calculated in respect of each and every element of cost.
The cost of transfer to the next process will be calculated as the sum of opening value of
opening work in progress plus its proportionate cost as per statement of evaluation plus the cost of fully
completed units. Unless otherwise stated Normal loss is calculated as a percentage of production.
Production = Opening WIP + input during the period – closing WIP
11. How the evaluation is made in equivalent production under ‘Average Cost’ method.
Under this method the value of opening WIP, in respect of each and every element of cost will
be given. No distinction is made between opening WIP and fully completed units. The transfer to the
next process is treated as production and taken as 100% complete. I.e no conversion of opening wip in
terms of balance of units to be converted. In the statement of cost, the value of opening WIP in respect
of each element of cost be added up with the current period cost in respect of those corresponding
elements and the total cost is divided by the equivalent production units. In evaluation statement also
opening Wip will not be evaluated separately.
12. Discuss ‘inter process profits’
When the produced goods are transferred from one process to other and at the end from final
process to finished stock, may be transferred at cost plus some percentage of profit added to it. Under
such circumstances, the profit transferred to profit and loss account will contain an element of
unrealised profits to the extent of the profit content in the opening work in progress of all the processes.
Further the closing work in progress of each department is also overvalued to the extent of profits
added by the previous processes. Hence, the amount of unrealised profits is calculated, which shall be
deducted from the total profits in order to take into account only the realised profits. The closing stock of
work in progress in the balance sheet shall be stated only at cost price, for which purpose the amount of
unrealised profits is deducted from the value of closing work in progress.

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MARGINAL COSTING
1. What is marginal costing and what are its main features?
Marginal costing is a technique of costing which may be used in conjunction with other methods
of costing. Marginal costing is not a method of cost ascertainment like output costing, process costing
etc. Marginal costing is a method of control costing and useful to the management in managerial
decisions. The other names of marginal costing are: direct costing, differential costing, incremental
costing and comparative costing.
In marginal costing only variable items of costing alone is considered. Marginal cost = variable
cost. The variable cost includes cost of materials, labour and variable elements of overheads. Fixed
costs are not allocated to the products and are charged directly to profit and loss account. The ICWA
defined marginal cost as the amount at any given volume of output by which the aggregate costs are
changed, if the volume of output is increased or decreased by one unit.
According to Joseph Marginal costing is a technique of determining the amount of changes in

the aggregate costs due to an increase of one unit over the existing level of production. As such it
arises from the production of additional increments of output. Thus marginal cost = Increase in total
cost÷ Increase in output, which will be equivalent to Prime cost per unit + variable overheads per unit.
Features of Marginal Costing – 1. Marginal costing is a technique of costing which is used in

conjunction with other methods of costing. 2. Fixed and variable costs are kept separate at every
stage. Semi variable costs are split into variable and fixed, variable part being added with variable
overheads for treatment as marginal cost and fixed element is added with fixed overheads. 3. As fixed
costs are period costs, they are excluded from cost of production. Only variable costs are considered
as the cost of output. 4. When evaluation of finished goods and work in progress are taken into
account, they will be valued only at marginal cost. 5. As fixed costs are period costs they will be
debited in full to the P&L account and not carried forward to the next year. 6. Marginal contribution,
which is the difference between marginal income and marginal cost, is the profit against which the fixed
expenses are adjusted to find the net profit.
2. What are the advantages and disadvantages of marginal costing?
Advantages – 1. Constant in nature – variable costs fluctuates from time to time, but in the
long run, marginal costs are stable. 2. Effective cost control- It divides cost into fixed and variable.
Fixed cost is excluded from product. As such, management can control marginal cost effectively.3.
Treatment of overheads is simplified - It reduces the degree of over or under-recovery of the overheads
due to the separation of fixed overheads from production cost. 4. Uniform and realistic valuation - As
the fixed overhead costs are excluded from product cost, the valuation of work-in-progress and finished
goods becomes more realistic. 5. Helpful to management - It enables the management to start a new
line of production which is advantageous. It is helpful in determining which is profitable whether to buy
or manufacture a product. The management can take decision regarding pricing and tendering. 6.
Helps in production planning – It shows the amount of profit at every level of output with the help of cost
volume profit relationship. The break even chart is used for such types of decisions. 7. Better results –
when used with Standard Costing, it gives better results. 8. Fixation of selling price – the differentiation
between fixed costs and variable costs is very helpful in determining the selling price of the products or
services. Sometimes, different prices are charged for the same article in different markets to meet
varying degrees of competition. 9. Helpful in Budgetary Control – the classification of expenses is very
helpful in budgeting and flexible budget at various levels of activities. 10. Preparing tenders – Many
business enterprises have to compete in the market in quoting the lowest price. Total variable cost,
when separately calculated, becomes the ‘floor price’. Any price above the floor price may be quoted to
increase the total contribution. 11. Make or buy decisions – Sometimes, a decision is to be made
whether
to manufacture a component or a product or to buy it ready made from the market. The decision to
purchase it would be taken if the price paid recovers some of the fixed expenses. 12. Better
presentation – The statements and graphs prepared under marginal costing are better understood by
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management executives. The break-even analysis presents the behaviour of cost, sales, contribution
etc. in terms of charts and graphs. And, thus the results can easily be grasped.
Disadvantages- 1. Difficulty to analyse overhead – Separation of cost into fixed and variable is
a difficult problem. In marginal costing, semi-variable costs are not considered. They will be segregated
into fixed and variable, which is a difficult process. 2. Time element ignored – Fixed costs and variable
costs are different in short run; but in long run, all cost are variable depending upon the level of
operation and capacity utilisation. This factor is ignored under this system. 3. Unrealistic assumption –
Assumption of sale price will remain fixed at different levels of operation is false. 4. Difficulty in fixation
of price –Under marginal costing, selling price is fixed on the basis of contribution. In case of cost plus
contracts, it is very difficult to fix the price. 5. Complete information is not given- It does not explain the
reason for increase in production or sales. 6. Significance lost – In capital intensive industries, fixed
expenses occupy major portion in the total cost. But marginal cost covers only variable costs. As such
it looses significance in capital industries.7. unreliable stock valuation – under marginal costing stock of
work-in-progress and finished goods are valued only at variable cost. No portion of fixed overhead is
added to the value of stock. In the event of insurance claim, claim made as valued under marginal
costing is unfavourable to the organisation.
3. Distinguish between ‘Absorption Costing’ and ‘Marginal Costing’.
S.No Absorption Costing Marginal Costing

1. All costs- fixed and variable are charged Only variable costs are charged to
to products products.
2. Profit = Sales – Cost of goods sold. Contribution margin = Sales – Variable
cost, and Profit = Contribution – fixed cost.
3. It does not reveal the cost-volume-profit Cost-volume-profit relationship is
relationship. established.
4. Closing inventories are valued at full Closing stock is valued only at variable
cost. cost.
5. Since all the costs are included it may Since fixed overheads are not included in
lead to under or over-absorption of cost, there is no question of under or over-
overheads absorption of overheads.
4. Briefly explain the concept of Cost-Volume-Profit analysis.
The cost-volume-profit analysis helps or assists the management in profit planning. In order to
increase the profits, a concern must increase the output. When the output is the maximum within the
installed capacity, it adds to the contribution. In the words of Heiser, ‘the most significant single factor
in profit planning of the average business is the relationship between the volume of business costs and
profits’. Thereby cost-volume-profit analysis is the relationship among cost, volume and profit. When
the volume of output increases unit cost of production decreases, because the fixed cost per unit
decreases and vice versa. Generally total cost will not change in direct proportion to the production and
thereby a small change will affect the profit also. To understand the cost volume profit relationship a
study of the following is essential 1. Marginal cost formulae.2. Break-even analysis. 3. Profit-volume
ratio 4. Profit graph 5. Key factor and 6. Sales mix.
Marginal costing equations:

Sales = Variable cost + Fixed cost + Profit or loss
Sales – Variable cost = Fixed cost + Profit or loss
Sales – Variable cost = Contribution
∴ Contribution = Fixed cost + Profit or loss
For more profits contribution must be higher than fixed cost and to avoid loss contribution
should be equivalent to fixed cost.
5. Explain the concept of ‘Break-even analysis’ and P/V ratio.

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The break- even- point and break- even- chart are two by products of break even analysis.
In a narrow sense, it is concerned with the break even point and in the broad sense it is concerned with
break even chart. Break even analysis is also known as cost volume profit analysis. It is a tool of
financial analysis whereby the impact on profits of the changes in volume, price, cost and mix can be
estimated with reasonable accuracy.
Break-even-point: Break even point is the equilibrium point or balancing point of no profit no
loss. This is a point at which loss ceases and profit begins. This is the point where income is exactly
equal to expenditure. This is the point where sales will be equal to the total cost. The formula to
calculate BEP is:
BEP(units) = Total fixed cost ÷ contribution per unit.
BEP(Sales)= (Total fixed cost ÷ contribution per unit) X Selling price per unit.
Where information in totality instead of per unit is given:
BEP(Sales)= (Fixed cost X sales)÷ total contribution.
P/V ratio – P/V ratio is called as profit-volume ratio expressing the relationship of profit to sales.
The ratio is also denoted as contribution- sales ratio, marginal income ratio or variable-profit ratio.
P’V ratio = (contribution÷ Sales) X 100
= {(Sales – Variable cost)÷ Sales} X 100
= {( Fixed expenses + profit)÷ sales }X100
BEP(Sales) = Fixed cost ÷ P/V ratio.
Break-even-chart Graphical representation of break-even analysis is called break-even-chart.

BEC is a graph showing the amount of fixed expenses, variable expenses and sales at different
volumes of output. The point of intersection of the total cost and sales lines indicates the BEP. The
vertex drawn from the point of intersection to the x-axis indicates BEP in terms of units. And the line
drawn horizontally to denote BES. The angle created at the point of intersection of sales and total cost
lines is the slope the quantum with which the profit increases above BEP and vice versa. This is known
as θ., otherwise known as ‘Angle of Incidence’. At a particular activity level the difference between the
Break- even sales and actual sales is called as ‘Margin of safety’.
The margin of safety ratio at a particular level of activity is:

MSR = (Margin of safety ÷ actual sales) X 100
Value Sales
Total cost
θ
BEP
Fixed cost
Volume
Assumptions of break even chart: 1. Fixed costs remain the same and do not change with the
level of activity. 2. Costs are divided into fixed and variable cost. Variable cost change in accordance
to output. 3. Selling price remains the same at different levels of activity. 4. There is no change in the
product mix. 5. There is no change in the level of efficiency. 6. Policies of management do not
change 7. No change in manufacturing process due to non-static operating efficiency. 8. As the
number of units produced and sold are the same, there is no closing or opening stock.
Advantages of break-even chart-1. Total cost, variable cost and fixed cost can be determined at
various levels of activity. 2. BE output or sales value can be determined. 3. Cost-volume-profit
relationship can be studied. 4. Inter-firm comparison is possible. 5. It is useful for forecasting and

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plans. 6. The best product mix can be selected. 7. Total profits can be calculated. 8. Profitability of
different levels of activity, various products or profits etc can be known. 9. It is helpful for cost control.
Limitations – 1. Exact and accurate classification of cost into fixed and variable is not possible.
Fixed costs vary beyond a certain level of output. Variable cost per unit is constant and it varies in
proportion to the volume. 2. Constant selling price is not true. 3. Detailed information cannot be
known from the client. To know all the information about fixed cost, variable cost and selling price a
number of charts must be drawn. 4. No importance is given for opening and closing inventory. 5.
Various product mix on profits cannot be studied as the study is concerned with only one sales mix or
product mix. 6. Cost, volume and profit relation can be known; capital amount, market aspects, effects
of Government policy, which are very important in decision making cannot be considered from BEC. 7.
If the business conditions changes during a period, BEC becomes out of date as it assumes no change
in business conditions.
6. What is meant by key factor?
Firms would try to produce such commodities that fetch a higher contribution. This assumption
is based on the possibilities of selling out the product at the maximum. Sometimes it may happen that
the firm may not be able to push out all products manufactured. Some times the firm can sell all the
products it manufactured but production may be limited due to shortage of materials, labour, plant
capacity, capital, demand, etc. the key factor or limiting factor is that factor which puts a limit on
production and profit of the firm. These factors are also known as principal factors or critical factors.
When there is no limiting factor, the production on the basis of the highest P/V ratio. When two or
more limiting factors are in operation, they will be seriously considered to determine the profitability.
Profitability = Contribution ÷ Key factor (materials, labour, capital etc)
7. What are the various applications of marginal costing technique?
Marginal costing is an extremely valuable technique with the management. The cost volume
profit relationship has served as a key to lock storehouse of solutions to many situations. It enables the
management to tackle many situations, which are faced in the practical business. Marginal costing
helps the management in decision making in respect of the following areas.
1. Cost control - the two types of costs- variable and fixed- are controllable and non-
controllable respectively. The variable cost is controlled by production and the management controls
the fixed cost.
2. Fixation of selling price- Product pricing is very important function of management. One
of the purposes of cost accounting is the ascertainment for fixation of selling price. Marginal cost of a
product represents the minimum price for the product and any sales below the marginal cost would
entail a loss of cash. There are cyclic periods in business- boom, depression, recession etc. during
normal circumstances, price is based on full cost. The theory is that only those products should be
produced or sold which make the largest contribution towards the recovery of fixed costs. The selling
price fixation is also done under different circumstances. The products may be sold even below the
marginal cost when: 1. A competitor is to be driven out of market. 2. To popularise the product. 3.
Labour engaged cannot be retrenched. 4. The goods are of perishable nature. 5. To keep the plant in
running condition. 6. Here is a cut throat competition in the market. 7. The use of materials which is
about to perish. 8. The product is used to as a loss leader for the sale of another products. 9. Not to
close down the firm. 10. Fear of market, which may go out of hand. 11. To prevent the loss of future
orders. 12. To capture the foreign market.
3. Closure of a department or discontinuing a product- Marginal costing technique shows

the contribution of each product to fixed cost and profit. If a department or product contributes the least
amount, that department can be closed or its production can be discontinued for the use of the capacity
so spared for production of products yielding more contribution.
4.Selection of a profitable product mix- In a multi-product concern, a problem is faced by

the management as to which product mix or sales mix will give the maximum profit. The mix gives the
maximum contribution is to selected to maximise the profits.
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5.Profit planning- Profit planning is a plan for future operation or planning budget to attain the
given objective or to attain the maximum profit. The volume of sales required to be made to get the
planned profit is:
Desired Sales = (Fixed cost + desired profit)÷ P/V ratio.
6. Decision to make or buy - a firm may make some products, parts or tools or sometimes it
may purchase the same from outside. The management must decide which is more profitable to the
firm. If the marginal cost of the product is lower than the price at which it can be purchased from
outside, then the same will be purchased.
7. Decision to accept a bulk order or foreign order – Large scale purchasers may demand
products at less than market rate. A decision has to be taken whether to accept the order or to reject it.
By reducing the normal price, the volume of output and the sales can be increased. If the price quoted
is above the marginal cost the same can be accepted. Similarly acceptance of foreign market can also
be aimed at reduced price, provided the price is not less than the marginal cost.
8. Introduction of new product- A producing firm may add additional products with the
available facility. The new product is sold at a reasonable price, in order to sell it in large quantities. If
favourable conditions exist, the production and sales can be increased ; thus the total cost comes down
because of operation of large scale economies, and contribute towards more contribution and profits.
9. Choice of technique - every management wishes to manufacture the products at the most
economical way. For this, the marginal costing is a good guide as to the products at different stages of
production, that is to say whether the management has to adopt hand operated system or semi-
automatic system or complete automatic system. When operations are done by hand, fixed cost will be
lower than the fixed cost incurred by machines and in complete automatic system fixed costs are more
than variable cost.
10. Evaluation of performance – Marginal costing helps the management in measuring the
performance efficiencies of a department or a product line or sales division. The department, product or
the division which gives the highest P/V ratio will be the most profitable one or that is having the
highest performance efficiency.
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STANDARD COSTING AND VARIANCE ANALYSIS
1. Define ‘Standard’, ‘Standard Cost’ and ‘Standard Costing’
Standard - According to L.Kohler, ‘standard is a desired attainable objective, performance, goal

or a model’. Standard may be used to a predetermined amount or a predetermined cost’.
Standard Cost – Standard costs are predetermined cost or forecast estimate of cost. ICMA
defines standard cost as, ‘ a predetermined cost, which is calculated from management standards of
efficient operations and, which is calculated from management standards of efficient operation and, the
relevant necessary expenditure. It may be used as a basis for price-fixing and for cost control through
variance analysis’. The other names for standard cost are predetermined cost, budgeted cost,
projected cost, model cost, measured cost, specifications cost etc. Standard cost is the predetermined
cost of manufacture of one unit of output.
Standard Costing – ‘ The preparation and use of standard costs, their comparison with actual
costs and the analysis of variances to their causes and points of incidence’. Standard costing is a
method of ascertaining the costs whereby statistics are prepared to show 1.the standard cost 2.the
actual cost and 3.the difference between these costs which is termed as the variance. Thus the
technique of standard costing includes: 1. Ascertainment and use of standard cost. 2. Comparison of
actual coast with standards. 3. Controlling cost by variance analysis and 4. Reporting to management
for taking proper action to maximise the efficiency.
2. Distinguish between 1.Estimated cost and standard cost. 2. Historical cost and standard cost
and 3.Budgetary control and standard costing.
Estimated cost Vs standard cost

S.No Estimated cost Standard cost
1. It is used as statistical data and leads to It is a regular system of scientifically based
a lot of guess work accounts
2. Its objective is to ascertain what the cost The objective is to ascertain what the cost
will be. should be.
3. It gives importance to cost ascertainment It is used for effective cost control and to
for fixing the sale price take proper action to minimise cost.
4. It can be used where costing is in It can be used where standard costing is in
operation. operation.
5. It is not accurate. It is an approximation It is based on scientific analysis and
based on past experience. accurate than the estimated cost.
Historical cost Vs Standard cost
S.No Historical cost Standard cost

1. It is an after-production –recorded cost. It is a predetermined cost
2. It is actually incurred cost It is an ideal cost.
3., as it relates to the past, it is not useful for It is a future cost and will be helpful in cost
cost control control
4. It is used to ascertain the profit or loss It is used for the measurement of
incurred during the period of cost operational efficiency of the enterprise.
Similarity of standard cost and budgetary control – 1. Both aim at determination of cost in
advance2. For both of them pre-determined standards are fixed. 3. In both of them actual costs are

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compared with standards. 4. Both requires periodic cost reports. 5. Both aim at the maximisation
efficiencies and managerial costs. But they differ in scope and technique.
Budgetary control Vs Standard costing

S.N Budgetary control Standard cost
o
1. It is extensive in its application, as it It is intensive, as it is applied to
deals with the operation of department or manufacturing of a product or providing a
business as a whole service.
2. Budgets are prepared for sales, It is determined by classifying, recording and
production cash etc. allocating expenses to cost units.
3. It is a part of financial and management It is a part of cost accounting, projecting the
accounts, a projection of financial cost accounts.
accounts
4. Control is exercised by taking into Standards and actual are compared through
account budgets and actual . variances variance analysis, which reveals both
are not revealed through accounts. favourable and unfavourable variances.
5. Budgeting can be applied in parts It cannot be applied in parts.
6. It is more expensive and broad in It is not costly because it pertains to only
nature, as it relates to production, sales, elements of costs.
finance etc.
3. What are the advantages and limitations of standard costing.
Advantages – 1. Standard costing helps the management in formulating pricing and production
policies. 2. It is a yardstick of performances. Standard costs are compared with actual costs, and the
differences are analysed and effective cost control is taken. 3. It reduces avoidable wastage and
losses.4. it facilitates to reduce clerical and accounting cost and managerial time. 5. It creates cost
consciousness among the personnel, because the variance analysis fixes responsibilities for favourable
or unfavourable performances. 6. Executives become more responsible, as it clearly shows who is
responsible for cost centres. 7. The variance analysis and reporting facilitate the principle of
‘Management By Exception’. 8. It helps in budgetary control and decision-making. 9.Opening stock
and closing stock are valued at the standard price. This helps in the preparation of Profit and Loss
Account for a short period. 10. It facilitates timely cost reports to management and a forward -looking
mentalities encouraged at all levels of the management. It is a basis for the implementation of an
incentive system for employees. 11. Introduction of standard cost facilitates timely reporting and
immediate corrective action
Limitations- 1. It is costly, as the setting of standards needs high technical skill. 2. Keeping of
up-to-date standards is a difficult operation. Periodic revision of standards is a difficult task. 3.
Inefficient staff is incapable of operating this system. It calls for heavy expenditure on training. 4. Since
it is difficult to set perfect standards, it is difficult to ascertain correct variances. 5. Industries which are
subject to frequent changes in technological process or the quality of materials, the character of labour,
methods and equipment etc., need a constant revision of standard, which is highly an expensive
process requiring method study and time study. 6. For small concerns the system is cost prohibitive. 7.
Standard costing is not applicable to industries engaged in performance of non- standard tasks.
4. What are the various types of standards?
1. Basic standard – It is a fixed or bogey standard for use unaltered for an indefinite period for
forward planning. According to ICMA, London, it is ‘an underlying standard from which a current
standard can be developed’. From the basic standards, changes in current standard and actual
standard can be measured. It is not helpful for cost control and cost ascertainment.

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2. Current standard – It is a short term standard, as it is revised at regular intervals. ICMA
refers to it as ‘a standard which is established for use over a short period of time and is related to
current conditions’. This standard is realistic and helpful to business, as it is related to current
conditions of budgeted period. It is useful to cost control. But it increases the clerical work and its
associated cost. For studying long term trend of costs, it is not useful.
3. Normal standard – it is an standard, and is based on normal conditions, which prevail over a
long period of trade cycle. ICMA defines it as ‘the average standard which, it is anticipated, can be
attained over a future period of time, preferably long enough to cover one trade-cycle’. An average of
the current standard or expected standard set for different periods or years, can work as normal
standard. It is used for planning and decision-making during the period of trade cycle to which it is
related. It is very difficult to apply in practice.
4. Ideal standard-It is set up under ideal conditions. ICMA defines it as ‘the standard which
can be attained under the most favourable condition possible’. This standard is fixed and needs a high
degree of efficiency , best possible conditions capable of achievement should be taken into
consideration. It is very difficult to attain this standard.
5. Expected standard – It is a practical standard. ICMA defines it as ‘ the standard which, it is

anticipated can be attained during a future specified budget period’. For setting this standard, due
weightage is given for all the expected conditions. As such, it is more realistic than the ideal standard.
It fulfils all the features of a good standard. It is consistent and achievable.
5. What are the preliminaries that should be gone through before setting standards?
While setting standard cost the following preliminaries must be gone through: 1. There must be
a Standard Committee, similar to Budget Committee, in which purchase manager, personnel manager
and production manager are represented. The cost accountant co-ordinates the functions of the
standard committee. 2. Study of existing cost system, cost records and forms in use. If necessary the
existing system should be reviewed. 3. A technical survey of the existing methods of production should
be undertaken so that accurate and reliable standard can be established. 4. The type of standard cost
to be used should be determined. 5. Standard for each element of cost is to be fixed. 6 . Standard cost
for each element of cost be determined. 7..The responsibility of setting standards be fixed.8. The
accounts should be properly be classified so that variances can be accounted for as desired.
Comparison of actual and standards be facilitated. A proper system of follow up actions for variances
be made.
6. How the standard cost is set for different elements of cost?
Standard cost is determined for each element of cost.
A . Direct material cost- Standard material cost is equal tot he standard quantity multiplied by
the standard price. The setting up of standard cost for materials involves 1. Fixation of standard
materials quantity and 2. Standard material prices.
1. Standard material quantity - The production department consisting of production
engineers, designers, chemists and work-study practitioners develops standard quantities of direct
materials. For each product or part or process, mechanical calculations or mechanical analysis is
made. Standard may be based on technical data or past performance data. Normal wastage
allowance is made high; this allowance will conceal inefficiencies in usage, and a low allowance will
lead to adverse variance. As such, the allowance for normal loss must be fixed very carefully. Similarly,
where different kinds of materials are used as a mix for a process or product, a standard material mix is
determined to produce the desired quality of product.
Standard material price - the setting of material standard price is not an easy task. Material prices vary
from time to time. The cost accountant and the purchase manger do in setting up of material price.
The current standard is the desirable and effective standard for fixing the price Normally one year is the
period for fixation of standard price. If there are more fluctuations in material prices, revision of
standard price is necessary. Before fixing the standard, the points to be considered are: price quoted by
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suppliers, trade and cash discounts available, future prices based on statistical data and materials
price already contracted.
b. Setting Standard for direct labour- the standard labour cost is equal to the standard time
for each operation multiplied by the standard wage rate. Setting up of standard cost involves 1. Fixation
of standard time and 2. Fixation of standard rate.
1. Fixation of standard time – Standard time is fixed by time and motion study or past records
or test runs or estimates. While fixing the standard time, normal idle time is allowed for fatigue, normal
delays and for other contingencies.
2. Fixation of standard rate - With the help of personnel manager, the accountant
determines the standard rate. Fixation of standard is influenced by trade unions, demand for labour,
Government, economic conditions, methods of wage payment etc.
c. Setting standard cost for overheads - The problems to be faced in determination of

standard overhead are1. Determination of standard overhead cost, 2. Estimation of production and
computation of the overhead rate.
Overheads are divided into fixed, variable and semi-variable overheads. Standard overhead
rate is calculated for these on the basis of past records and future trend of prices. The rate is
calculated either for one unit or for one hour.
Standard overhead rate = Budgeted overhead (Budgeted production or budgeted hours. The
same is the method of calculating the standard rate for both variable and fixed overheads. The
budgeted expenditure be standardised at a particular activity level, which is the product of standard
output for a particular period and budgeted overhead rate, which shall be compared with the actual
overhead cost for the period. All products cannot be expressed in physical terms as units, pieces,
kilograms etc., in which case the calculation of standard and actual overhead be based on hours. The
standard cost of overhead is the product of standard hours and budgeted rate per hour. ICMA defines
standard hour as ‘a hypothetical hour which represents the amount of work which should be performed
in one hour under standard conditions’.
7. Write a note of ‘Revision of Standards’.
Standard costs are established for a certain period. There are no definite rules for the selection
of a particular period. If the standards are fixed for a short period, it is expensive and frequent revisions
of standards will impair the utility and purpose for which the standard is set. At the same time if
standard is set for a longer period, it may not be useful in days of high inflation or fluctuations of rates in
case of materials and labour. Standard cost is the resultant effect of a number of factors that vary from
time to time in different situation caused by both and external factors. Standard may become unrealistic
with the change in conditions of production calling for revision. If the change is of a temporary nature,
no revision be made. Current standards are reviewed every year at the beginning of the accounting
period under the following circumstances. 1. Error in setting the standards. 2. Changes in the price
level of materials, labour and overheads. 3. Change in the method of production. 4. Change in
designs or specifications. 5. Technological advances etc.
Apart from the above, basic standards are revised in the course of time under the following
circumstances, when: 1. There are permanent changes in the method of production – designs,
specifications, changes in methods due to technological change etc. 2. Change in plant capacity. 3.
There exist large variation in standards and actual.
8. What do you mean by ‘variance’ and what are its kinds?
After the standard costs have been set, the next stage in the operation of standard costing is to
ascertain the actual cost of each element and compare them with the standards already set. The
deviation of actual from standard is called the variance.
Favourable and unfavourable variances- variances may be favourable or unfavourable

depending upon whether the actual cost is less or more than standard cost. Favourable variance –
when the actual cost incurred is less than standard cost, the deviation is favourable. The effect of
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favourable variance is to increase the profit. It is also known as positive variance. Unfavourable
variance – it results when the standard cost is more than the actual cost. This variance is also called as
adverse or negative variance. This variance will result in decrease in profit or increase in loss.
Controllable and uncontrollable variance- controllable- A variance is controllable, if it can be
identified as the primary responsibility of a specified person or department. That is, it refers to the
deviation caused by internal factors, which could be influenced by the executive action. For example
variances caused by excess usage of materials excess time taken by the workers etc. uncontrollable -
uncontrollable variances are those which arise mainly out of external factors and internal factors on
which executive control can not be influenced. The increase in cost due to loss of production caused by
machine failure, power cut, increase in price of materials, wage rates etc.
9. What are the reasons for material price variance and material usage variance?
Reasons for material price variance- 1. Fluctuation in material price. 2. Non availability of
standard quality at reasonable rates. 3. Inefficiency in buying. 4. High cost of transportation and
carriage of goods. 5. Loss of discount and fraud on purchases. 6. Change in price policies. 7.
Emergency purchases leading to high cost. 8. Government interferences leading to increase in prices.
9. Incorrect setting of standard price. 10. Untimely purchase leading to increase in purchase price. 11.
Loss in transit. 12. Unexpected additional cost in purchases. 13. Failure to enter into forward
contracts, and resultant change in price.
Reason for differences in usage variance- 1. Careless handling of materials. 2. Wastage,
scrap, spoilage etc. due to inefficient production methods or by unskilled workers. 3. Changes in
design or specification of product. 4. Use of inferior materials. 5. Defective equipment and tools
causing losses. 6. Use of non0standard materials. 7. Setting improper standards. 8. Improper
inspection. 9. Use of non-standard substitutes. 10. Theft of materials. 11. Difference between
standard and actual yield. 12. Lack of proper tools and equipment.
10. What are the reasons for Labour Rate variance and Efficiency variance?
Reasons for rate variance - 1. Changes in basic wage rates. 2. Overtime at higher or lower
than standard rate.3. Faulty recruitment. 4.Overtime work at higher or lower than specified hours. 5.
Change in composition of gang at different rate from standard. 6. Higher or lower rate paid to casual
workers. 7. Improper planning of overtime hours. 8. General rise in wages. 9. Wrong setting of labour
rates. 10. Higher wages paid because of urgent work.
Reasons for efficiency variance- Favourable factors – 1. Strict supervision. 2. Use of good
quality materials. 3. Low labour turnover. 4. High morale of workers. 5. Proper working conditions. 6.
Improved tools and machines. 7. Good incentives. 8. Workers’ co-operation. 9. Right man at right
work. 10. Employment of skilled workers. Unfavourable factors- 1. Improper training to workers. 2.
Inadequate supervision. 3. Low employee morale. 4. More idle time than normal. 5. Incorrect
instructions. 6. Engaging new and unskilled workers. 7. Workers’ dissatisfaction . 8. Defective
machinery. 9. High labour turnover. 10. Bad working conditions. 11. Failure of power supply etc..
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Formats and Formulas
COST SHEET or STATEMENT OF COST
Raw Material Rs.

Opening Stock of Raw Material +++
Add : Purchase of R. M & Freight, Taxes & Duties on Purchases +++
+++
Less : Closing Stock of Raw Material ------
Sale of unsuitable Raw Material ------
Sale of scrap of Raw Material ------ -----
Cost of Raw Materials Consumed ++++
+++
Direct Labour +++
Direct Expenses/ Chargeable expenses
PRIME COST PC
Add: Works Overheads +++
GWC
GROSS WORKS COST
+++
Add : Opening Work-in-progress
++++
Less : Closing Work-in-progress ----
WORKS COST or FACTORY COST } NWC
or PRODUCTION COST or MANUFACTURING COST }
Add: Office and Administration Overheads +++
COP
COST OF PRODUCTION +++
Add : Opening stock of Finished Goods ++++
----
Less : Closing stock of Finished Goods
COST OF GOODS SOLD COGS
Add: Selling & Distribution Overheads +++
COST OF SALES or TOTAL COST COS

Add : Profit / (Less : Loss) (balancing figure) ++/---
SALES SALES
Items to be ignored while preparing cost sheet: Bad debts, Bank Charges, Interest on
debentures, Income tax, Dividend paid, Preliminary expenses w/o, Goodwill w/o,

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PRIME COST ADMINISTRATION EXPENSES

 Productive Wages  Office Salaries and Expenses
 Direct Material  Depreciation on Office Appliances
 Freight on Purchase  Office Heat, Light and Power
 Carriage on Purchase  Office Rent and Taxes
 Taxes and Duties on the material  Management Salary / Manager’s Salary /
 Direct Wages Directors’ fees
 Direct Expenses  Office Printing and Stationery
 Chargeable Expenses  Telephone charges Postage and
 Carriage Inward Telegrams
 Legal Charges and Bank Commission
 Office cleaning
FACTORY OVERHEADS SELLING & DISTRIBUTION EXPENSES

 Indirect Material  Sales Expenses
 Indirect Labour / Wages  Sales Commission
 Factory Supervision  Sales Travelling
 Factory Expenses  Sales Promotion
 Factory Stationery  Distribution Department – Salaries &
 Repairs & Maintenance Expenses
 Factory Heat, Fuel, Light and Power /  Heat, Light and Power
Electric Power  Depreciation
 Factory insurance and taxes  Salaries of Salesmen
 Factory supplies  Salaries to Travelling Agents
 Experimental expenses  Carriage Outward
 Wastage of Material  Advertising
 Wages of Foreman  Warehouse Rent and Rates
 Storekeeper’s wages  Warehouse Staff Salaries
 Oil and Water  Showroom Rent & Showroom Expenses
 Consumable Stores  Repairs and Depn of Delivery vans
 Drawing office Expenses
 Depreciation of Plant & Machinery
 Water Consumption in Factory

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Materials
Stock levels
Max. stock level
Re-order level
Quantity
Minimum level
Danger level
Period
Stock Levels
ROL = Maximum Consumption X Maximum reorder period
Max Level = ROL + ROQ – (Min. consumption X Min. Re-order period)
Min Level = ROL – (Normal Consumption X Normal Re-order Period)
Avg. Level = (Maximum Level + Minimum Level) ÷ 2
Or Min. Level X 1/2 of Re-order Quantity
Danger level = Normal Consumption X Max. Reorder period for emergency
Economic Order Quantity
It is the quantity to be ordered at which the total cost will be minimum. In other
words EOQ is the ordering quantity at which Carrying cost will be equal to ordering cost.
EOQ can be calculated by using the formula:
EOQ = √ ( 2AB) ÷ CS
Where A = Annual consumption; B = Ordering cost per order

CS = Cost of carrying and storage per unit per annum
Number of orders to be placed = A ÷ EOQ

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LABOUR
1. Taylor differential piece rate system - According to this system wages will be calculated as
follows.
a. It the output is below standard 80% of piece rate
b. If the output is at or above standard 120% of piece rate
2. Merrick Multiple Piece Rate System.

Efficiency Piece rate applicable
1. Up to 83% Basic normal piece rate.
2. From 83% to 100% 110% of basic piece rate.
3. Above 100% 120% of basic piece rate.
3. Gantt Task and Bonus Scheme

Output Remuneration
1. Out put below standard Time rate (guaranteed)
2. Output at standard level Bonus of 20% of the time rate
3. Output above standard High piece rate on output.
4. Emerson Efficiency Plan – Under this plan hourly rate is guaranteed.

• Bonus payment starts at the rate of 01% of basic wages at 66.67% efficiency and gradually
increases as the performance increases.
• At 90 % efficiency level the bonus is 9.91% and at 100% bonus is 20%.
• The appropriate bonus percentage is read off from specially compiled tables.
• Above100% efficiency a worker in addition to his wages will get a bonus of 20% plus for every
one percent increase in efficiency one percent increase in bonus.
5. Barth plan - Under this system the workers are paid as follows.
Earnings = Hourly rate X √ Standard hours X Hours worked
6. Halsey premium plan- this system is also known as Split Bonus Plan or 50-50 plan.
Earnings = (Time Taken X Hourly Rate) + 50% of Time Saved X Hourly Rate.
7. Halsey-weir premium plan.

Earnings = (Time Taken X Hourly Rate) + 30% of Time Saved X Hourly Rate.
8. Rowan Premium plan

Earnings = (Time Taken X Hourly Rate) + (Time Taken/Standard Time X Time Saved X Hourly Rate)

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Overhead Basis of distribution

1. Indirect material Direct material
2. Indirect wages Direct wages
3. Electric power Horse power of machines – KWH
4. Electric light Light points, floor space, direct (if
metered)
5. Plant depreciation, repairs Value of plant, HP of Machines
6. Delivery expenses Weight, volume, value etc.
7. Audit fee Sales or total cost
8. Supervision Number of employees
9. PF & ESI Direct wages
10 Rent, rates, depreciation, repairs- building Floor space
11. Storekeeping, internal transport Value of materials handled
12 Advertising, sales expenses Actual or percentage of sales
13. Personnel , time keeping and wages Number of employees or total wages
office, canteen, staff welfare, safety
14. Miscellaneous Direct wages
OVERHEADS
Basis of Apportionment of Common Expenses/Overheads for Primary Distribution summary
CONTRACT ACCOUNTS
Profit recognition on incomplete contracts:

Percentage of Completion Notional Profit to be transferred to P& L
The work Certified is less than one-fourth No profit should be transferred to profit and loss
of the Contract Price account.
The work Certified is 25% but less than Notional profit X 1/3 X cash received ÷ work
50% of the Contract Price certified
The work Certified is 50% but less than Notional profit X 2/3 X cash received ÷ work
100% of Contract Price certified
MARGINAL COSTING AND DECISION MAKING
Marginal cost is “Increase in total cost due to increase in one more unit of production”
Formulas
1. Contribution = [Sales – Variable cost] (OR) [Fixed Cost + Profit] (OR)

= [Units Sold x Contribution per unit] (OR) [Sales x P/V Ratio]
2. Profit = [Contribution – Fixed Cost] (OR) [Sales – Total Cost]

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3. Contribution Ratio (OR) Profit – Volume Ratio (OR) P/V Ratio
SP – VC X 100
SP
Contribution X 100 FC X 100
Sales BEP
P/V ratio When Two period information is given
Changes in profit X 100
Changes in Sales
3. Break Even Point (BEP)
Fixed cost BEP In Rupees
In units = OR
Contribution per unit SP Per Unit
Fixed Cost
In Rupees = OR BEP units x SP
P/V Ratio
OR Present Sales – Margin Of Safety
4. Margin of Safety = Present Sales – BEP
Present Profit
OR P/V Ratio
5. Sales Required to Earn a Desired Profit
Fixed cost + Desired Profit

In units = Contribution per unit
Fixed Cost + Desired Profit

In Rupees = P/V Ratio
DECISION MAKING
Key points to be noted while making decisions

1. Fixed costs are irrelevant for decision making. Only Sales Value and Variable Cost
are considered for decision making
2. While choosing a product mix, consider the mix which yields maximum profit.
3. If contribution is positive, a product should be continued
4. When Sales in Rupees is limited, then make decisions based on P/V Ratio
5. When Sales in Units is limited, then make decision based on Contribution per unit
6. When any other factors of production is available in short-supply (Key factor), then
decision is made based on Contribution per key factor

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7. In case of export decision, if buyer quotes a price above Variable Cost then accept
otherwise reject
8. While making “Make or Buy” decisions compare Variable Cost of Manufacturing and
Outside Supplier price. (If VC > Quoted Price then Purchase otherwise reject)

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Cost Theory - Professional Course

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BIEE Cost Accounting Theory - CA –PCC biee@sify.

1. Define cost object and give three examples

2. Define cost accumulation and cost assignment

3. Define Cost apportionment and Cost absorption.

4. How the cost is classified?

5. Define the term cost driver.

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

7. Define notional cost.

8. Define imputed cost, sunk cost and relevant cost.

9. Define controllable cost and policy cost.

10. What are the essentials of a good costing system?

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

d. Technical aspects – A careful study of manufacturing operations and process, material

f. Communication – Emphasis should be put on the system of communication. A proper

g. Accounting system – Determination of unit of cost, classification of operating expenses,

b. Impersonal cost centre – It consists of a location or items of equipment.

c. Process cost centre- It consists of a specific process or a continuous sequence of

s.no cost control cost reduction

1. Aims at maintaining the cost in accordance It aims at reducing cost

2. Seeks to attain the lowest possible cost Brings profit by challenging

3. The function is static. The function is dynamic.

4. Emphasis is on the past and present Emphasis is on the present and

c. Multiple costing – It is a system adopted in a business producing a variety of products

e. Marginal costing – Marginal costing is a method of costing in which the allocation of

f. Operating costing- Operating costing is a system of costing applicable to industries in which

Application of uniform costing – Uniform costing may be applied in two different

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

2.Ordering cost – This includes expenses incurred on requisitioning, preparing purchase

2. What are the objectives and functions of purchase department?

3. What are the advantages of a. centralised purchasing; and b. decentralised purchasing?

Advantages of centralised purchasing – a. avoids duplication of errors, b. Provides better

4. What are the responsibilities of a storekeeper ?

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

5. Write a note on ‘ Goods received note’.

Descriptio Code Quantity Packages Gross weight

Inspection report Received by

6. Write notes on various documents used in stores.

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

Authorised by Stores Ledger Folio….. Bin no….. Store keeper……….

Transferred by: Dept. Received by : Depot.. Cost office reference

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

Quantity Max. stock level

Maximum Level = ROL + Re-order quantity – (Min.consumption X min.Re-order period)

BIEE, No 58 1st floor North Mada Street, Nungambakkam, Chennai 34 98415-

8. Define Economic ordering Quantity. What are its determinants?

9. Explain a. Input-output ratio and b. Inventory turnover ratio

Inventory turnover = Cost of materials used / Average value of stock.

10. Explain the system of a. ABC analysis and b. Two-bin system.

Stock item % of total items % of value

ABC analysis facilitates 1. Closer control on the basis of investment; 2. Development of

c. Ageing schedule of inventories – Classification of the inventories according to age helps in

Ageing schedule of inventories as on Dec,31

12. Write about various systems of inventory systems.

2. Perpetual inventory system- This system is called as automatic inventory system. I t is a

Continuous stock-taking -An essential part of perpetual inventory system is continuous

13. what are the essentials of material control policy?

The following are the essentials of a materials control policy.

1. Co-ordination – There has to be a proper co-ordination between the various departments

3. Classification and codification – There should be proper classification and codification of

4. Proper scheduling – The material requirements should be properly scheduled. Scheduling

5. Inspection – In order to prevent and check purchasing of sub-standard materials, pilferage

6. Standard forms- standard forms of purchase orders, material requisitions, issue of