Pavan K U

GAT, Bangalore MANAGEMENT ACCOUNTING & CONTROL SYSTEMS MODULE II DETERMINING PRODUCT COSTS

1. ELEMENTS OF PRODUCT COST

Product costing refers to the technique and process of ascertaining the cost of a particular product. It is important for deriving Cost of manufacturing the product Price of the product Cost details of product at different level 2. ELEMENTS OF PRODUCT COST

Material Cost Direct Indirect

Labour cost Direct Indirect

Other expenses Direct Indirect

Overheads
Production OH Administration OH Selling OH Distribution OH

3. ELEMENTS OF PRODUCT COST

Direct Materials are present in the finished product or can be identified in the product. Eg. Cloth in dress making. Direct labour which can be identified or attributed wholly to a particular job, product or process or expended in converting raw materials into finished products, Eg. Labour engaged on the actual production of product or carrying out the necessary operations for converting the raw materials into finished product.

Direct expenses It includes all expenses other than direct material or direct labour, which are specially incurred for a particular product or process. Eg. Excise duty, royalty etc. Indirect materials which do not normally form part of the finished product. Eg. Lubricants, cotton waste etc Indirect labour are the costs which cannot be allocated but can be apportioned to or absorbed by cost units or cost centre. Eg. Supervisors, maintenance workers etc. Indirect expenses other than direct expenses. Eg. Factory rent and rates, insurance, telephone etc.

Pavan K U

GAT, Bangalore

Overheads it is the aggregate of indirect material costs, indirect labour costs, and indirect expenses. This can be grouped as Production or works overheads Administration overheads Selling overheads Distribution overheads 4. DETERMINING PRODUCT COST Product cost can be ascertained by preparing cost sheet.

Cost sheet is a document which provides for the assembly of the detailed cost of a cost centre or cost unit. Advantages Provides total and per unit cost figures Helps in cost comparison Facilitates for preparing cost estimates Facilitates cost control Helps in deriving selling price 5. COST SHEET Particulars Total cost (Rs.) Cost Per Unit (Rs.)

Direct materials Direct labour Direct expenses Prime cost Add: works overheads Works/factory cost Add: Administration OH Cost of production/Cost of Add: Selling & Distribution OH Cost of sales

XXX XXX XXX XXXX XXX XXXX XXX goods Sold XXXX XXX XXXX

XX XX XX XXX XX XXX XX XXX XX XXX

6. JOB COSTING

A job refers to a specific contract or work order wherein work is executed as per customers requirements. The output of the job generally consists of one unit or a manageable number of units

Pavan K U

GAT, Bangalore

Examples of job costing are printing press, hardware, ship building, heavy machinery, interior decoration, etc Job costing will be used in the following situations When jobs are executed for different customers according to their specifications When no two jobs are alike in all respects and each job needs special treatment When W-I-P differs from period to period on the basis of the number of jobs in hand at different degrees of completion. 7. PRINCIPLE OF ALLOCATION ABSORPTION & APPORTIONMENT

Cost allocation the term allocation implies relating overheads directly to the various departments. The estimated amount of manufacturing overheads should be allocated to various cost centers or departments. Cost absorption is the allotment of overhead to cost units. Here production department overheads are absorbed over production units. Cost apportionment the allotment of proportion of items of cost to cost centers or department on the basis of benefits received. 8. DISTINCTION BETWEEN ALLOCATION & APPORTIONMENT Allocation of OH It means the allotment of whole items of cost to cost centres or cost units Apportionment of OH It means allotment of proportion of items of cost to cost centres or cost units

It deals with the whole items of cost It deals with only proportion of items of cost Cost is directly allocated to any cost It needs a suitable basis for centre or cost units subdivision of cost by cost centres or cost units Cost is allocated when the cost Cost is apportioned when cost centre uses whole of the benefits of centres use only a proportion of the the expenses. benefits of the whole expenses It is a direct process of allotment It is an indirect process of allotment

9. ACCOUNTING OF OVERHEADS Following are the steps involved in overheads accounting -

Estimation and collection of overheads Cost allocation Cost apportionment Re-apportionment Absorption Treatment of under and over absorption of overheads

Pavan K U

GAT, Bangalore

10.BASES OF APPORTIONMENT OF PRIMARY DISTRIBUTION Basis Floor area Capital values Direct Labour Hr Machine Hrs No of Workers Technical estimate Expenses Lighting, Rent, Depreciation on building, Repairs etc Depreciation on Plant & Machinery, Maintenance of Machinery etc. Remuneration, works mgt etc. Insurance on tools jigs, power etc. Accident, canteen, personnel dept exp, etc Fire prevention, oil and grease

11.SECONDARY DISTRIBUTION Service Dept Personnel Purchasing Receiving Factory office Machine maintenance Engineering Payroll Welfare of employees Internal Transport 12.ABSORPTION OF FACTORY OH Apportionment base No. employees, labour Hrs Cost of materials, No of units, No of orders No of requisitions filled, No of units handled. No of employees Machine Hr, services rendered Machine hrs Total machine/labour hrs No of employees in Dept Weight, value, distance etc.

Absorption rate the rate which is used to charge overhead cost to the product or jobs is known as absorption rate. Various absorption rates are Percentage on Direct Materials

Factory OH

100

Direct Materials
Percentage on direct wages

Factory OH Direct Labour Cost

100

Pavan K U Percentage on prime cost

GAT, Bangalore

Factory OH Prime Cost

100

Labour hour / production hour rate

Factory OH Direct Labour Hrs

Machine hour rate

Factory OH Machine Hrs

13.PROCESS COSTING Process costing is a method of costing which helps the management in the ascertainment of cost of the process, i.e. where raw materials become finished goods in stages or operations and the output of one process becomes the input of the other. Example chemical industries, oil industries etc.

Distinctive features are RM becomes finished goods after under going several operations Costs are added in each process and there is a loss of input in every stage of processing The output of one process becomes the input of other Process accounts are simple ledger accounts and representing inputs on debit and outputs on credit side

14. PROCESS COSTING Special aspects

Normal loss it is an uncontrollable loss incurred due to the nature of materials and method of manufacturing. It is treated as a part of the cost and absorbed on the good units produced Abnormal loss it is a controllable loss, which is more than the normal loss, incurred because of faulty manufacturing process or raw material Abnormal gain if the actual production is more than the expected production or if the actual loss is less than the expected loss, the difference is treated as abnormal gain. 15.ABC COSTING

Activity Based Costing (ABC) is a costing system which focuses on activities performed to produce products.

Pavan K U

GAT, Bangalore

The ABC system, instead of using cost centers, uses activities for accumulating costs. ABC system first accumulates indirect resource costs for each of the activities and then assigns the costs of activities to the product or services or other cost objects.

Resource costs

Activities

Products

16.STAGES OF ABC COSTING

Identify the different activities within the organisation Relate the overheads to the activities Support activities are then spread across the primary activities Determine the activity cost drivers Calculate activity cost driver rate
17.COST POOL & COST DRIVER

Cost pool it means the meaningful grouping of individual costs. Costs are often pooled by departments, by jobs, or by behavior pattern. For example, overhead costs are accumulated by service departments in a factory and then allocated to production departments before multiple departmental overhead rates are developed for product costing purposes.

Cost Driver is any factor or force that causes a change in the cost of an activity. The cost driver may be Resource cost driver is a measure of the quantity of resources consumed by an activity or cost pool. Activity cost driver is a measure of the frequency and intensity of demand, placed on activities by cost objects. 18.ADVANTAGES OF ABC COSTING

More accurate costing of products/services, customers, distribution channels Better understanding overhead

Pavan K U

GAT, Bangalore

Easier to understand for everyone Utilizes unit cost rather than just total cost Integrates well with Six Sigma and other continuous improvement programs Makes visible waste and non-value added Supports performance management and scorecards Enables costing of processes, supply chains, and value streams Activity Based Costing mirrors way work is done Facilitates benchmarking 19.DISADVANTAGES OF ABC COSTING

More time consuming to collect data Cost of buying, implementing and maintaining activity based system

Makes waste visible which some executives and managers don't want their boss to see