GURU GOBIND SINGH INDRAPRASTHA UNIVERSITY,

DELHI
BACHELOR OF COMMERCE(B.Com Hons)

BCOM 201 Cost and Management

Accounting

Rahul R. Verma
Assistant Professor
Kasturi Ram College of Higher Studies

Course Contents

Unit I
Meaning and Scope of Cost Accounting: Basic Cost Objectives and scope of cost accounting,
Cost centres and cost units, Cost classification and elements of cost, Cost behaviour pattern,
separating the components of semi-variable costs.
Materials Control: Meaning, Steps Involved, Materials and Inventory, Techniques of Material/Inventory
Control, Valuation of Inventory.
Unit II
Labour Cost: Attendance and payroll procedures, overview of statutory requirements,
overtime, idle time and incentives, Utilisation of labour, direct and indirect labour, charging of
labour cost, remuneration systems and incentive schemes;
Overheads: Functional analysis factory, administration, selling, distribution, research and
development, fixed, variable, semi variable and step cost; Factory overheads. Administration
overheads and Selling and distribution overheads.
Unit III
Cost ledgers: non-integrated accounts, integrated accounts, reconciliation of cost and
financial accounts. Costing Systems: Single Output Costing, Job Costing, Batch Costing.
Contract Costing: Progress payments, retention money, escalation clause, contract accounts,
accounting for material, accounting for plant used in a contract, contract profit and balance sheet
entries; Process Costing (including Joint Products and By-products and Inter-process Profits),
Operating/Service Costing. (Transport & Power House only).
Unit IV
Marginal Costing: meaning, advantages, marginal costing and absorption costing; CostProfit- Volume Analysis: break even point, margin of safety, P/V Ratio, concept of key factor; breakeven chart and its types; Decision making: costs for decision making, variable costing and
differential analysis as aids in making decisions fixation of selling price, exploring new market,
make or buy, product mix, operate or shut down, sell or process further decisions etc.
Budgeting and Budgetary Control: concept of budget, classification of budget, fixed and
flexible budgets, Zero Based Budgeting, budgetary control objectives, merits and limitations,
performance budgeting; Standard Costing: meaning, advantages, limitation, applications, setting of

Unit I

Basics
Cost: The amount of expenditure (actual or notional) incurred on or
attributable to a specified article, product or activity.
Costing: Costing is the technique and process of ascertaining costs.
Cost Accounting: The process of accounting for cost which
begins with the recording of income and expenditure or the bases
on which they are calculated and ends with the preparation of
periodical statements and reports for ascertaining and controlling
Costs.
Cost Accountancy: Cost Accountancy has been defined as the
application of costing and cost accounting principles, methods and
techniques to the science, art and practice of cost control and the
ascertainment of profitability. It includes the presentation of
information derived there from for thepurpose of managerial
decision making.

Objectives of Cost
Accounting
Ascertainment of Cost: There are two methods of ascertaining costs: Post
Costing: It means analysis of actual information as recorded in financial books. It
is accurate and is useful in the case of Cost plus Contracts where price is to be
determined finally on the basis of actual cost.
- Continuous Costing: It aims at collecting information about cost as and when
the activity takes place so that as soon as a job is completed the cost of
completion would be known. This involves careful estimates being prepared of
overheads. In order to be of any use, costing must be a continuous process.
- Cost ascertained by the above two methods may be compared with the
standard costs which are the target figures already compiled on the basis of
experience and experiments.
Determination of Selling Price: Business enterprises run on a profit making
basis. It is thus necessary that the revenue should be greater than the costs
incurred. Cost accounting provides the information regarding the cost to make
and sell the product or services produced. Though the selling price of a product is
also influenced by market conditions, which are beyond the control of any
business, it is still possible to determine the selling price within the market
constraints; hence cost plays a dominating role.

Cost Control: To exercise cost control, broadly the following steps should be
observed:
- Determine clearly the objective, i.e., pre-determine the desired results: The target
cost and/ or targets of performance should be laid down in respect of each
department or operation and these targets should be related to individuals who, by
their action, control the actual and bring them into line with the targets
- Measure the actual performance: Actual cost of performance should be measured in
the same manner in which the targets are set up, i.e. if the targets are set up
operation-wise, and then the actual costs should also be collected operation-wise and
not cost centre or department-wise as this would make comparison difficult.
- Investigate into the causes of failure to perform according to plan; and
- Institute corrective action.

Cost Reduction: It may be defined "as the achievement of real and permanent
reduction in the unit cost of goods manufactured or services rendered without
impairing their suitability for the use intended or diminution in the quality of the
product.
Cost reduction implies the retention of the essential characteristics and quality of the
product and thus it must be confined to permanent and genuine savings in the cost
of manufacture, administration, distribution and selling, brought about by elimination
of wasteful and inessential elements from the design of the product and from the
techniques carried out in connection therewith.
The three-fold assumptions involved in the definition of cost reduction may be
summarised as under :

 Ascertaining the profit of each activity: The profit of any

activity can be ascertained by matching cost with the
revenue of that activity. The purpose under this step is to
determine costing profit or loss of any activity on an
objective basis.
Assisting management in decision making: Decision
making is defined as a process of selecting a course of action
out of two or more alternative courses. For making a choice
between different courses of action, it is necessary to make a
comparison of the outcomes, which may be arrived under
different alternatives. Such a comparison has only been
made possible with the help of Cost Accounting information.
(e.g: Determination of Cost Volume Relationship, shutting
down or operating at loss, making or buying from outside)

Advantages of cost accounting

Cost Determination
Helping in Cost Reduction
Product Profitability Analysis
Provide information relevant for decision making
Determination of Selling price
Cost Control and Variance Analysis
Cost Comparison and Benchmarking
Compliances with statutory requirements
Identification of lacunae
Helpful in strategic decision making
Helpful in solving linear programming problems

Limitations of cost accounting

Expensive: It is expensive because analysis, allocation
and absorption of overheads require considerable
amount of additional work, and hence additional money.
Requirement of Reconciliation: The results shown by
cost accounts differ from those shown by financial
accounts. Thus Preparation of reconciliation statements
is necessary to verify their accuracy.
Duplication Work: t involves duplication of work as
organization has to maintain two sets of accounts i.e.
Financial Account and Cost Account.
Inefficiency: Costing system itself does not control
costs but its usage does.

Cost Centres
It is defined as a location, person or an
item of equipment (or group of
these) for which cost may be
ascertained and used for the purpose
of Cost Control.

Cost Units
It is a unit of product, service or time (or combination of
these) in relation to which costs may be ascertained or
expressed.
We may for instance determine the cost per tonne of
steel, per tonne kilometre of a transport service or cost
per machine hour. Sometime, a single order or a
contract constitutes a cost unit. A batch which consists
of a group of identical items and maintains its identity
through one or more stages of production may also be
considered as a cost unit.
Cost units are usually the units of physical measurement
like number, weight, area, volume, length, time and
value.

Cost classification
By Nature of Element
Material: Cost of Material used in production
(Cost of Raw Material)
Labour: Cost of Workers (Wages and Salary)
Expenses: Costs other than Material and Labour
(Power, Office Maintenance)
By Traceability to Object
Direct Costs: Which can be allocated directly to
the product (Wood in case of Furniture)
Indirect Costs: Which cannot be directly allocated to
the product (Nails used in Furniture)

By Traceability to Object
Direct Costs: Which can be
allocated directly to the product
(Wood in case of Furniture)
Indirect Costs: Which cannot be
directly allocated to the product
(Nails used in Furniture)

By Functions
Production Costs Cost of whole process of Production (Direct Materials and)
Selling Costs: Cost for creating demand of the product produced (Advertising
Expenses)
Distribution Costs: Costs starting from packing of the product till
reconditioning of empty products(Freight and Transportation Costs on Sales)
Administrative Costs: Cost of formulating policy, controlling the
organisation, costs not directly related to production (Salary of Office Staff)
Development Costs: Development Costs for trial Run (Research Costs)
Pre- Production Costs: Costs starting with implementation of decisions and
ending with the commencement of the production process (Direct Labour
and Factory Overheads)
Conversion Costs: Cost of transforming direct material into Finished
Products (Direct Labour and Overheads)
Product Costs: Costs necessary for production (Cost of purchase)

By Variability or Behaviour: According to this classification costs

are classified into three group viz., fixed, variable and semi-variable.
Fixed costs These are the costs which are incurred for a period,
and which, within certain output and turnover limits, tend to be
unaffected by fluctuations in the levels of activity (output or
turnover). They do not tend to increase or decrease with the changes
in output. For example, rent, insurance of factory building etc.,
remain the same for different levels of production.
Variable Costs These costs tend to vary with the volume of
activity. Any increase in the activity results in an increase in the
variable cost and vice-versa. For example, cost of direct labour, etc.
Semi-variable costs These costs contain both fixed and variable
components and are thus partly affected by fluctuations in the level
of activity. Examples of semi variable costs are telephone bills, gas
and electricity etc.

By Controllability: Costs here may be classified into controllable and

uncontrollable costs.
Controllable Costs: - Cost that can be controlled, typically by a
cost, profit or investment centre manager is called controllable cost.
Controllable costs incurred in a particular responsibility centre can be
influenced by the action of the executive heading that responsibility
centre. For example, direct costs comprising direct labour, direct
material, direct expenses and some of the overheads are generally
controllable by the shop level management.
Uncontrollable Costs - Costs which cannot be influenced by the
action of a specified member of an undertaking are known as
uncontrollable costs. For example, expenditure incurred by, say, the
tool room is controllable by the foreman in-charge of that section but
the share of the tool-room expenditure which is apportioned to a
machine shop is not to be controlled by the machine shop foreman.

By Normality
Normal Costs: Costs which are expected to be incurred in normal routine (Raw
Material Costs)
Abnormal Costs: Costs which are over and above normal costs (Cost of Wastes)
By Decision Making
Relevant Costs (Marginal Costs, Differential Costs, Opportunity Costs,
Out of Pocket): Costs which are relevant and useful for decision making (Cost
of Best Possible Use)
Irrelevant Costs (Sunk costs, Committed costs, Fixed costs): Costs which
are not relevant or useful to decision making (Costs incurred in the past Advance Payment)
By Cash Outflow
Explicit Costs: Costs involving immediate payment of cash (Purchase of Raw
material)
Implicit Costs: Costs not involving immediate cash payment (Depreciation)

Methods of Costing

Job Costing : In this method of costing, cost of each job is ascertained separately. It
is suitable in all cases where work is undertaken on receiving a customers order like
a printing press, motor workshop, etc.
Batch Costing : It is the extension of job costing. A batch may represent a number
of small orders passed through the factory in batch. Each batch here is treated as a
unit of cost and thus separately costed. Here cost per unit is determined by dividing
the cost of the batch by the number of units produced in the batch.
Contract Costing : Here the cost of each contract is ascertained separately. It
is suitable for firms engaged in the construction of bridges, roads, buildings etc.
Single or Output Costing : Here the cost of a product is ascertained, the product
being the only one produced like bricks, coals, etc.
Process Costing : Here the cost of completing each stage of work is ascertained,
like cost of making pulp and cost of making paper from pulp. In mechanical
operations, the cost of each operation may be ascertained separately; the name
given is operation costing.
Operating Costing : It is used in the case of concerns rendering services like
transport, supply of water, retail trade etc.
Multiple Costing : It is a combination of two or more methods of costing outlined
above. Suppose a firm manufactures bicycles including its components; the parts
will be costed by the system of job or batch costing but the cost of assembling the
bicycle will be computed by the Single or output costing method. The whole system
of costing is known as multiple costing.

Techniques of Costing
Uniform Costing : When a number of firms in an industry agree among themselves to follow the same
system of costing in detail, adopting common terminology for various items and processes they are
said to follow a system of uniform costing.
Advantages of such a system are that

A comparison of the performance of each of the firms can be made with that of another, or with the
average performance in the industry.
Under such a system it is also possible to determine the cost of production of goods which is true for
the industry as a whole. It is found useful when tax-relief or protection is sought from the
Government.

Marginal Costing : It is defined as the ascertainment of marginal cost by differentiating between

fixed and variable costs. It is used to ascertain effect of changes in volume or type of output on
profit.
Standard Costing and Variance Analysis : It is the name given to the technique whereby standard
costs are pre- determined and subsequently compared with the recorded actual costs. It is thus a
technique of cost ascertainment and cost control. This technique may be used in conjunction with
any method of costing. However, it is especially suitable where the manufacturing method involves
production of standardised goods of repetitive nature.
Historical Costing : It is the ascertainment of costs after they have been incurred. This type of costing
has limited utility.

Post Costing: It means ascertainment of cost after production is completed.

Continuous costing: Cost is ascertained as soon as the job is completed or even when the job is in
progress.

Direct Costing : It is the practice of charging all direct costs to operations, processes or products
leaving all indirect costs to be written off against profits in which they arise.
Absorption Costing : It is the practice of charging all costs, both variable and fixed to operations,
processes or products. This differs from marginal costing where fixed costs are excluded.

Materials
The general meaning of material is all
commodities/
physical
objects
supplied to an organization to be
used in producing or manufacturing
of finished or intermediate goods.

Steps Involved

Bill of Materials

Techniques of Material/Inventory
Control
1. Setting of various stock levels:
Minimum Level: It is the minimum quantity, which must be retained
in stock
=ROL- (Avg. consumption Avg. Lead time)
Maximum Level: It is the maximum limit upon which stock can be
stored at any time
=ROL + ROQ (Min consumption Min Lead Time)
Re order Level : This level lies between minimum and the maximum
levels in such a way that before the material ordered is received
into the stores, there is sufficient quantity on hand to cover
both normal and abnormal consumption situations.
In other
words, it is the level at which fresh order should be placed for
replenishment of stock. Factors affecting it are Maximum rate of
Consumption & Maximum Re-order period
=Maximum lead time Maximum Usage
Or
=Minimum level + (Average rate of consumption Average

2. ABC analysis : This system exercises discriminating control over different items of stores classified
on the basis of the investment involved. Usually the items are divided into three categories
according to their importance, namely, their value and frequency of replenishment during a
period.

(i) A Category of items consists of only a small percentage i.e., about 10% of the total items
handled by the stores but require heavy investment about 70% of inventory value, because of
their high prices or heavy requirement or both. Items under this category can be controlled
effectively by using a regular system which ensures neither over-stocking nor shortage of
materials for production. Such a system plans its total material requirements by making budgets.
The stocks of materials are controlled by fixing certain levels like maximum level, minimum level
and re-order level.
(ii) B Category of items are relatively less important; they may be 20% of the total items of
material handled by stores. The percentage of investment required is about 20% of the total
investment in inventories. In the case these items, as the sum involved is moderate, the same
degree of control as applied in A category of items is not warranted. The orders for the items,
belonging to this category may be placed after reviewing their situation periodically.
(iii) C Category of items do not require much investment; it may be about 10% of total inventory
value but they are nearly 70% of the total items handled by store. For these category of items,
there is no need of exercising constant control. Orders for items in this group may be placed either
after six months or once in a year, after ascertaining consumption requirements. In this case the
objective is to economies on ordering and handling costs.

3. Two bin system: If one bin items exhausts, new order is placed and
till the mean time quantity from the other bin is purchased.
4. Establishment of system of budgets: The exact quantity of various
types of inventories and the time when they would be required
can be ascertained in advance by preparing budgets.
5. Use
of perpetual inventory records and continuous stock
verification: Continuous stock checking is done by taking different
sections of the store in rotation
6. Determination of economic order quantity: It is the calculation of
optimum level quantity which minimizes the total cost of Ordering
and Delivery Cost and Carrying Cost.
= 2AO

C
Where, A = Annual usage units
O = Ordering cost per order
C = Annual carrying cost of one unit, i.e., carrying cost percentage
cost of one unit.

7. Review of slow and non-moving items: Disposing of as

early as possible slow moving items, in return with items
needed for production to avoid unnecessary blockage of
resources.
8. Use of control Ratios:
Input output ratio: It is the ratio of the quantity of input of
material to production and the standard material content of
the actual output.
Inventory turnover ratio =
Cost of materials consumed during the period
Cost of average stock held during the period
Average stock = 1/2 (opening stock + closing stock)

Valuation of Inventory
First-in First-out method: It is a method of pricing the
issues of materials, in the order in which they are
purchased. In other words, the materials are issued in the
order in which they arrive in the store or the items longest
in stock are issued first. Thus each issue of material only
recovers the purchase price which does not reflect the
current market price.
Last-in First-out method: It is a method of pricing the
issues of materials. This method is based on the
assumption that the items of the last batch (lot) purchased
are the first to be issued. Therefore, under this method the
prices of the last batch (lot) are used for pricing the issues,
until it is exhausted, and so on. If however, the quantity of
issue is more than the quantity of the latest lot than earlier
(lot) and its price will also be taken into consideration.

Weighted Average Price Method: It is a method of

pricing the issues of materials. This method is
based on the assumption that the items of the last
batch (lot) purchased are the first to be issued.
Therefore, under this method the prices of the last
batch (lot) are used for pricing the issues, until it is
exhausted, and so on. If however, the quantity of
issue is more than the quantity of the latest lot
than earlier (lot) and its price will also be taken into
consideration.
Weighted Average Price = Total cost of materials in stock
Total quantity of materials

The following information is extracted from the Stores Ledger:

Material X
Opening Stock Nil
Purchases :
Jan. 1 100 @ ` 1 per unit
Jan. 20 100 @ ` 2 per unit
Issues :
Jan. 22 60 for Job W 16
Jan. 23 60 for Job W 17
Complete the receipts and issues valuation by adopting the
First-In-First- Out, Last-In-First -Out and the Weighted
Average Method.

Perpetual Vs Periodic Inventory

System

Unit II

Labour Cost
Labour cost may be broadly classified as direct
labour cost and indirect labour cost.
Direct Labour Cost: Labour cost that is
expended in production of a product and easily
identified and allocated to a cost unit i.e. a
specific job, contract, work order or any other
unit of cost.
Indirect Labour Cost: Labour cost that is
expended on the wages of workmen who are
not directly engaged in the production process
and can be easily identified with a cost unit.

Attendance and payroll

procedures

Attendance and Time details: A detailed sheet of number of days or hours worked by each
employee (in case of time based payment) and units or percentage of work (in case of piece rate)
as reflected by the time keeping methods are sent to the payroll department by the time keeping
department. Further, payroll department with the help of time booking records calculate any
further incentives such as overtime payment, bonus to be paid to the employees.
List of employees and other details: A list of employees on roll and the rate at which they will
be paid is sent by the personnel/ HR department. Payroll department should ensure that no
unauthorised person can paid.
Computation of wages and other incentives: Payroll department based on the details
provided by the time keeping department and personnel department calculate wages/ salary to
be paid to the employees. Payroll department prepares pay slip for all employees authorized by
the personnel department and forward the same to the cost/ accounting department for further
deductions and payment.
Payment to the employees: Cost/ accounting department deduct all statutory deduction such
as employees contribution to provident fund and employee state insurance (ESI) scheme, TDS on
salary etc. After all deductions wages/ salary is paid to the employees.
Deposit of all statutory liabilities: All statutory deduction made from the employees
alongwith employers contributions such as provident fund and employee state insurance scheme
are paid to the respective statutory bodies.
Investigation: Should a clock card (attendance sheet) for an employee not listed on the payroll
sheet be found, investigation of its propriety is required. Likewise, there should be an explanation
for any missing clock cards deductions: After the gross earnings (that is, the total amount earned
by an employee before any deductions are taken into consideration) have been calculated for
every employee, deductions are entered on the payroll sheet, and the net pay of each employee
is determined.

overview of statutory requirements

overtime
Work done beyond normal working hours is known as
overtime work. Overtime payment is the amount of
wages paid for working beyond normal working hours.
The rate for overtime work is higher than the normal
time rate; usually it is at double the normal rates. The
extra amount so paid over the normal rate is called
overtime premium.
As per the Factories Act 1948 Where a worker
works in a factory for more than nine hours in
any day or for more than fortyeight hours in any
week, he shall, in respect of overtime work, be
entitled to wages at the rate of twice his
ordinary rate of wages.

idle time

Utilisation of labour
For identifying utilisation of labour a statement is prepared (generally weekly) for each
department / cost centre. This statement should show the actual time paid for, the
standard time (including normal idle time) allowed for production and the abnormal
idle time analysed for causes thereof.
1. Identification of utilisation of labour with cost centres : For the identification of
utilisation of labour with the cost centre a wage analysis sheet is prepared. Wage
analysis sheet is a columnar statement in which total wages paid are analysed
according to cost centre, jobs, work orders etc. The data for analysis is provided by
wage sheet, time card, piece work cards and job cards. The preparation of such
sheet serves the following purposes:

It analyse the labour time into direct and indirect labour by cost centres, jobs, work
orders.

It provides details of direct labour cost comprises of wages, overtime to be charged

as production cost of cost centre, jobs or work orders.

It provides information for treatment of indirect labour cost as overhead expenses.

2. Identification of labour hours with work order or batches or capital job: For
identification of labour hours with work order or batches or capital jobs or overhead
work orders the following points are to be noted :

The direct labour hours can be identified with the particular work order or batches or
capital job or overhead work orders on the basis of details recorded on source
document such as time sheet or job cards.

The indirect labour hours cannot be directly identified with the particular work order
or batches or capital jobs or overhead work orders. Therefore, they are traced to cost

remuneration systems & incentive

schemes
It is the simulation for effort and effectiveness by offering monetary
inducement or enhanced facilities.
Time Rate System: The amount of wages due to a worker are
arrived at by multiplying the time worked by the appropriate time
rate.
Differential Time Rate: Different hourly rates are fixed for
different levels of efficiency. Upto a certain level a fixed rate is
paid and based on the efficiency level the hourly rate increases
gradually.
Straight Piece Work: Payment is made on the basis of a fixed
amount per unit of output irrespective of time taken. It is the
number of units produced by the worker multiplied by rate per
unit.
Differential Piece Rate: For different level of output below and
above the standard, different piece rates are applicable.

Labour Turnover
Labour turnover in an organisation is the rate of change in the composition of labour force
during a specified period measured against a suitable index.
The standard of usual labour turnover in the industry or locality or the labour turnover rate for a past
period may be taken as the index or norm against which actual turnover rate is compared.
There are three methods of calculating labour turnover which are given below :
1. Replacement method : This method takes into consideration actual replacement of labour
irrespective of number of persons leaving
= Number of employees replaced 100
Average number of employees on roll
New labour appointed on account of expansion not to be included in number of replacements
2. Separation method: In this method labour turnover is measured by dividing the total number of
separations during the period by the average total number of workers on payroll during the same
period
= Number of employees separated during the year
100

Average number of employees on roll during the period

3. Flux method: This method takes into account both the number of replacements as well as the
number of separations during the period
=

Number of employees separated +Number of employees replaced

Average number of employees on roll during the period

100

Causes of Labour Turnover : The main causes of labour turnover in an organization/ industry can be broadly classified
under the following three heads :
1. Personal causes are those which induce or compel workers to leave their jobs; such causes include the following :

Change of jobs for betterment.

Premature retirement due to ill health or old age.

Domestic problems and family responsibilities.

Discontent over the jobs and working environment.

In all the above cases the employee leaves the organisation at his will and, therefore, it is difficult to suggest any
possible remedy in the first three cases.
But the last one can be overcome by creating conditions leading to a healthy working environment. For this, officers
should play a positive role and make sure that their subordinates work under healthy working conditions.
2. Unavoidable causes are those under which it becomes obligatory on the part of management to ask one or more of
their employees to leave the organisation; such causes are summed up as listed below:

Seasonal nature of the business;

Shortage of raw material, power, slack market for the product etc.;

Change in the plant location;

Disability, making a worker unfit for work;

Disciplinary measures;

Marriage (generally in the case of women).

3. Avoidable causes are those which require the attention of management on a continuous basis so as to keep the
labour turnover ratio as low as possible. The main causes under this case are indicated below :

Dissatisfaction with job, remuneration, hours of work, working conditions, etc.,

Strained relationship with management, supervisors or fellow workers;

Lack of training facilities and promotional avenues;

Lack of recreational and medical facilities;

Low wages and allowances.

Proper and timely management action can reduce the labour turnover appreciably so far as avoidable causes are
concerned.

Two types of costs which are associated with labour turnover are :
Preventive costs: These include costs incurred to keep the labour
turnover at a low level, i.e. cost of medical services, welfare schemes and
pension schemes. If a company incurs high preventive costs, the rate of
labour turnover is usually low.
Replacement costs: These are the costs which arise due to high labour
turnover. If men leave soon after they acquire the necessary training and
experience of good work, additional costs will have to be incurred on new
workers, i.e., cost of employment, training and induction, abnormal
breakage and scrap and extra wages and overheads due to the
inefficiency of new workers.
It is obvious that a company will incur very high replacement costs if the
rate of labour turnover is high. Similarly, only adequate preventive costs
can keep labour turnover at a low level. Each company must, therefore,
work out the optimum level of labour turnover keeping in view its
personnel policies and the behaviour of replacement cost and preventive
costs at various levels of labour turnover rates.

Remedial Steps To Minimise Labour Turnover - The following steps are

useful for minimising labour turnover.
Exit interview : An interview be arranged with each outgoing employee to
ascertain the reasons of his leaving the organisation.
Job analysis and evaluation : Before recruiting workers, job analysis and
evaluation may be carried out to ascertain the requirements of each job.
Scientific system of recruitment, placement and promotion: The
organisation should make use of a scientific system of recruitment, selection,
placement and promotion for employees.
Enlightened attitude of management: The management should introduce
the following steps for creating a healthy working atmosphere :

Service rules should be framed, discussed and approved among management and
workers, before their implementation.
Provide facilities for education and training of workers.
Introduce a procedure for settling workers grievances.

Use of committee: Issues like control over workers, handling their grievances
etc., may be dealt by a committee, comprising of members from management
and workers.

Overheads
Overheads are the expenditure which
cannot be conveniently traced to or
identified with any particular cost
unit.

Allocation Vs
Apportionment
The difference between the allocation and apportionment is important to understand
because the purpose of these two methods is the identification of the items of
cost to cost units or centers. However, the main difference between the above
methods is given below.
Allocation deals with the whole items of cost, which are identifiable with any one
department. For example, indirect wages of three departments are separately
obtained and hence each department will be charged by the respective amount of
wages individually.
On the other hand apportionment deals with the proportions of an item of cost for
example; the cost of the benefit of a service department will be divided between
those departments which has availed those benefits.
Allocation is a direct process of charging expenses to different cost centres
whereas apportionment is an indirect process because there is a need for the
identification of the appropriate portion of an expense to be borne by the different
departments benefited.
The allocation or apportionment of an expense is not dependent on its nature, but
the relationship between the expense and the cost centre decides that whether it
is to be allocated or apportioned.
Allocation is a much wider term than apportionment.

The
process
of
assigning
service
department overheads to production
departments is called reassignment or
re-apportionment. The re-apportionment
of the service department cost to the
production department is known as
secondary distribution. The usual bases
adopted for this re-apportionment is
given below:

The re-apportionment of service department expenses over the production

departments may be carried out by using any one of the following methods:
1. Direct re-distribution method: Service department costs under this method
are apportioned over the production departments only, ignoring the services
rendered by one service department to the other.
2. Step Method or Non-reciprocal method: This method gives cognizance to the
services rendered by service department to another service department.
Therefore, as compared to previous method, this method is more complicated
because a sequence of apportionments has to be selected here. The sequence
here begins with the department that renders maximum number of services to the
other service department(s). In other words the cost of the service department that
serves the largest number of services to the other service department(s) and
production department(s) is distributed first. After this, the cost of service
department serving the next largest number of departments is apportioned.
This process continues till the cost of last service department is apportioned. The
cost of last service department is apportioned among production departments only.
Some authors are of the view that the cost of service department with largest
amount of cost should be distributed first.

3. Reciprocal Service Method: This method

recognises the fact that where there are two or
more service departments they may render
services to each other and, therefore, these
inter-departmental services are to be given due
weight while re-distributing the expenses of the
service departments. The methods available for
dealing with reciprocal services are
Simultaneous equation method;

Repeated distribution method;

Trial and error method.

Types of Overhead Rates

1.
Normal rate: This rate is calculated by dividing the actual overheads by actual base. It is also known as
actual rate.
It is calculated by the following formula:

Normal overhead rate =

Actual amount of overheads

Actual base

2. Pre-determined overhead rate: This rate is determined in advance by estimating the amount
of the overhead for the period in which it is to be used. It is computed by the following formula:
Pre-determined rate = Budgeted amount of overhead
Budgeted base
The amount of overhead rate of expenses for absorbing them to production may be estimated on the
following three basis.
. The figure of the previous year or period may be adopted as the overhead rate to be charged to
production in the current year. The assumption is that the value of production as well as overheads will
remain constant or that the two will change, proportionately.
. The overhead rate for the year may be determined on the basis of estimated expenses and anticipated
volume of production activity.
. For instance, if expenses are estimated at `10,000 and output at 4,000 units, the overhead rate will be
` 2.50 per unit.
. The overhead rate for a year may be fixed on the basis of the normal volume of the business.

3. Blanket overhead rate: Blanket overhead rate refers to the computation of one single overhead
rate for the whole factory. It is to be distinguished from the departmental overhead rate which refers to
a separate rate for each individual cost centre or department. The use of blanket rate may be proper in
certain factories producing only one major product in a con-tinuous process or where the work
performed in every department is fairly uniform or standardised.
This overhead rate is computed as follows:
Blanket rate = Total overheads for the factory
Total number of units of base for the factory
A blanket rate should be applied in the following cases:
Where only one major product is being produced.
Where several products are produced, but
- All products pass through all departments; and
- All products are processed for the same length of time in each department. Where these conditions do
not exist, departmental rates should be used.

4. Departmental overhead rate: It refers to the computation of one single overhead rate for a
particular production unit or department. Where the product lines are varied or machinery is used to a
varying degree in the different departments, that is, where conditions throughout the factory are not
uniform, the use of departmental rates is to be preferred.
This overhead rate is determined by the following formula:
Overhead of department or cost centre
Departmental overhead rate =
Corresponding base

Treatment of Under-absorbed and Overabsorbed Overheads in Cost Accounting

Overhead expenses are usually applied to production on the basis of pre-determined rates. Production
overheads are to be determined in advance as follows for fixing selling price, quote tender price and to
formulate budgets etc.
Pre-determined overhead rate = Estimated / Normal overheads for the period
Budgeted Number of units during the period
The actual overhead rate will rarely coincide with the pre-determined overhead rate, due to variation in predetermined overhead rate and actual overhead rate. Such a variation may arise due to any one of the
following situations:
Estimated overheads for the period under consideration may remain the same or they coincide with actual
overheads but the number of units produced during the period is either more or less in comparison with
budgeted figure. In the former case actual overhead rate will be less and in the latter case, actual overhead
rate will be more than the pre-determined overhead rate, hence over-absorption and under-absorption will
occur respectively.
Similarly, if the number of units actually produced during the period remains the same as budgeted figure
but the actual overheads incurred are more or less than the estimated overheads for the period, then a
situation of under-absorption or over-absorption will arise respectively.
If changes occur in different proportion both in the actual overheads and in the number of units produced
during the period, then a situation of under or over-absorption (depending upon the situation) will arise.
If the changes in the numerator (i.e. in actual overheads) and denominator (i.e. in number of units
produced) occur uniformly (without changing the proportion between the two) then a situation of neither
under nor of over-absorption will arise.
Such over or under-absorption as arrived at under different situations may also be termed as overhead
variance. The amount of over-absorption being represented by a credit balance in the account and
conversely, the amount of under-absorption being a debit balance.

As regards the treatment of such debit or credit balances, the general view is that if the
balances are small they should be transferred to the Costing Profit and Loss Account
and the cost of individual products should not be increased or reduced as these
would be representing normal cost.
Where, however the difference is large and due to wrong estimation, it would be
desirable to adjust the cost of products manufactured, as otherwise the cost figures
would convey a misleading impression. Such adjustments usually take the form of
supplementary rates where there is a debit balance in the overhead account and a
credit in the other case.
Now, the production of any period can be identified in three forms, goods finished and
sold, goods finished but held in stock (not yet sold) and semi-finished goods (work in
progress). So far as the first category of goods is concerned, it is arguable that the
post-mortem of the costs of individual products long after they have been sold may
have some academic utility but it is frequently devoid of any practical significance.
Therefore, it is suggested that the total variance concerning goods finished and sold
should be adjusted by transferring the amount to the Cost of Sale Account, the costs
of the individual items of such goods not being affected.
As regards the variance pertaining to goods finished and held in stock (i.e. not yet sold),
it would be necessary to adjust the value of the stock; similarly the value of work-inprogress should be adjusted.
However, over or under recovery of overheads due to abnormal reasons (such as
abnormal over or under capacity utilisation) should be transferred to the Costing
Profit and Loss Account.

Methods of Absorbing Overheads

to Various Products or Jobs
1. Percentage of direct materialOverhead rate =

Total Production Overheads of a Department

Budgeted Direct Material cost of all products

2. Percentage of prime cost
3. Percentage of direct labour cost
4. Labour hour rate
5. Machine hour rate= Production overhead 100
No. of machine hours
6. Rate per unit of Output

100

Unit III

Reconciliation of Cost and

Financial Accounts
1. Items included in Financial Accounts only:

Purely Financial Expenses

Interest on loans or bank mortgages.
Expenses and discounts on issue of shares, debentures etc.
Other capital losses i.e., loss by fire not covered by insurance etc.
Losses on the sales of fixed assets and investments
Goodwill written off
Preliminary expenses written off
Income tax, donations, subscriptions
Expenses of the companys share transfer office, if any.

Purely Financial Income

Interest received on bank deposits, loans and investments
Dividends received
Profits on the sale of fixed assets and investments
Transfer fee received.
Rent receivables
2. Item included in the cost accounts only (notional expenses):
Charges in lieu of rent where premises are owned
Interest on capital at notional figure though not incurred
Salary for the proprietor at notional figure though not incurred
Notional Depreciation on the assets fully depreciated for which book value is nil

3. Items whose treatment is different in the two sets of accounts.

The objective of cost accounting is to provide information to
management for decision making and control purposes while financial
accounting conforms to external reporting requirements. Hence there are
chances that certain items are treated differently in the two sets of
accounts. For example, LIFO method is not allowed for inventory
valuation in India as per the Accounting Standard 2 issued by the Council
of the ICAI. However, this method may be adopted for cost accounts as it
is more suitable for arriving at costs which shall be used as a base for
deciding selling prices. Similarly cost accounting may use a different
method of depreciation than what is allowed under financial accounting.

4. Varying basis of valuation: It is another factor which sometimes is

responsible for the difference. It is well known that in financial accounts
stock are valued either at cost or market price, whichever is lower. But in
Cost Accounts, stocks are only valued at cost.

Procedure for reconciliation : There are 3 steps involved

in the procedure for reconciliation.
Ascertainment of profit as per financial accounts
Ascertainment of profit as per cost accounts
Reconciliation of both the profits (similar to the bank
reconciliation statement)

Circumstances where reconciliation statement can be

avoided: When the Cost and Financial Accounts are
integrated - there is no need to have a separate
reconciliation statement between the two sets of accounts.
Integration means that the same set of accounts fulfil the
requirement of both i.e., Cost and Financial Accounts.

Job Costing & Batch

Costing
Job Costing : Production/work done as
per customer specification
Batch Costing : Articles are produced
in a lot and cost are computed per
unit in a batch. Cost per unit in a
batch= Total cost of a batch/Number
of item produced.

Job Costing Vs Process

Costing

Contract Costing
Contract costing : Accounts maintained
as per contract wise.

Meaning of the terms used in

contract costing
Cost of work certified or Value of work certified: A contract is a continuous process and to know the cost or
value of the work completed at the end of the period; assessment of the work is carried out by the surveyor
or architect. Surveyor or architect based on his assessment certifies the percentage of work completion. This
portion of called value or cost of work certified.
Mathematically: Value of work certified = Value of contract x Work certified (%)
Cost of work certified = Cost of work to date (Cost of work uncertified + Material in hand + Plant at site)
Progress Payment: Contractors receive payments from the contractee periodically for the work done on the
contract. This is known as progress payment or running payment. This is paid based on the certificate issued
by the surveyor or architect.
Mathematically: Progress payment = Value of work certified Retention money Payment to date
Retention Money: A contractor does not receive full payment of the work certified by the surveyor. Contractee
retains some amount (say 10% to 20%) to be paid, after sometime, when it is ensured that there is no fault
in the work carried out by contractor. If any deficiency or defect is noticed in the work, it is to be rectified by
the contractor before the release of the retention money. Retention money provides a safeguard against the
risk of loss due to faulty workmanship.
Mathematically: Retention Money = Value of work certified Payment actually made/ cash paid
Work uncertified: It represents the cost of the work which has been carried out by the contractor but has not
been certified by the contractees architect. It is always shown at cost price. The cost of uncertified work
may be ascertained as follows:
Total cost to date

Less: Cost of work certified

Material in hand

Plant at site

= Cost of work uncertified

Cash received: It is ascertained by deducting the retention money from the value of
work certified i.e.
Cash received = Value of work certified Retention money.

Work-in-progress: In Contract Accounts, the value of the work-in-progress consists of

the cost of work completed, both certified and uncertified;

the cost of work not yet completed; and

the amount of profit taken as credit to costing P&L account.

In the Balance Sheet (for internal use purpose), the work-in -progress is usually shown
under two heads, viz., certified and uncertified. The cost of work completed and
certified and the profit credited will appear under the head certified work-inprogress, while the completed work not yet certified and the cost of labour, material
and expenses of work which has not yet reached the stage of completion are shown
under the head uncertified work-in-progress.

Notional profit: It represents the difference between the value of work certified and
cost of work certified. It is determined:
Notional profit = Value of work certified (Cost of work to date Cost of work not yet
certified)
Estimated profit: It is the excess of the contract price over the estimated total cost of
the contract.

Escalation Clause
If during the period of execution of a
contract, the prices of materials, or
labour etc., rise beyond a certain
limit, the contract price will be
increased by an agreed amount.
Inclusion of such a clause in a
contract deed is called an Escalation
Clause.

Profit/ loss on incomplete

contracts in cost accounting
To determine the profit to be taken to Costing Profit and Loss account, in the case of incomplete
contracts, the following four situations may arise:
1. Completion of contract is less than 25 per cent: In this case no profit should be taken to Costing Profit
and Loss Account.
2. Completion of contract is 25 per cent or more but less than 50 per cent: In this case one-third of the
notional profit, reduced in the ratio of cash received to work certified, should be transferred to the
Costing Profit and Loss Account. Mathematically:
1/3 Notional Profit Cash received

Work certified

3. Completion of contract is 50 per cent or more but less than 90 per cent: In this case, two-third of the
notional profit, reduced by proportion of cash received to work certified, is transferred to the Costing
Profit and Loss Account. Mathematically:
2/3 Notional Profit Cash received
Work certified
4. Completion of contract is 90 per cent or more than 90 per cent i.e. it is nearing completion: In this
case the profit to be taken to Costing Profit and Loss Account is determined by determining the
estimated profit and using any one of the following formulas:
Estimated Profit Cash received
Contract price

Operating / Service
Costing
Operating Costing : Used by those undertaking
which provide services rather than production in
commodities.
Cost units used in the following services undertaken
as below:
Transport service Passenger km., quintal km., or
tonne km.
Supply service Kwh, Cubic metre, per kg., per
litre.
Hospital Patient per day, room per day or per bed,
per operation etc.

Process Costing
Process Costing : Used in industries
where the material has to pass
through two or more processes for
being converted into a final product.

Treatment of Normal Process Loss, Abnormal

Process Loss and Abnormal Gain in Cost
Accounting
Loss of material is inherent during processing operation. The loss of material under different processes arises due to
reasons like evaporation or a change in the moisture content etc. Process loss is defined as the loss of material
arising during the course of a processing operation and is equal to the difference between the input quantity of the
material and its output.
There are two types of material losses viz. (i) Normal loss and (ii) Abnormal loss.
(i) Normal process loss: It is defined as the loss of material which is inherent in the nature of work. Such a loss can be
reasonably anticipated from the nature of the material, nature of operation, the experience and technical data. It is
unavoidable because of nature of the material or the process. It also includes units withdrawn from the process for
test or sampling.
Treatment in Cost Accounts : The cost of normal process loss in practice is absorbed by good units produced under the
process. The amount realised by the sale of normal process loss units should be credited to the process account.
(ii) Abnormal process loss: It is defined as the loss in excess of the pre-determined loss (Normal process loss). This
type of loss may occur due to the carelessness of workers, a bad plant design or operation, sabotage etc. Such a loss
cannot obviously be estimated in advance. But it can be kept under control by taking suitable measures.
Treatment in Cost Accounts: The cost of an abnormal process loss unit is equal to the cost of a good unit. The total
cost of abnormal process loss is credited to the process account from which it arises. Cost of abnormal process loss is
not treated as a part of the cost of the product. In fact, the total cost of abnormal process loss is debited to costing
profit and loss account.
(iii) Abnormal gain: Sometimes, loss under a process is less than the anticipated normal figure. In other words, the
actual production exceeds the expected figures. Under such a situation the difference between actual and expected
loss or actual and expected production is known as abnormal gain. So abnormal gain may be defined as unexpected
gain in production under normal conditions.
Treatment in Cost Accounts: The process account under which abnormal gain arises is debited with the abnormal gain
and credited to Abnormal gain account which will be closed by transferring to the Costing Profit and loss account.
The cost of abnormal gain is computed on the basis of normal production.

Inter-Process Profits
In some process industries the output of one process is transferred to the next
process not at cost but at market value or cost plus a percentage of profit. The
difference between cost and the transfer price is known as inter-process profits.
The advantages and disadvantages of using inter-process profit, in the case of
process type industries are as follows:

Advantages:

Comparison between the cost of output and its market price at the stage of
completion is facilitated.
Each process is made to stand by itself as to the profitability.

Disadvantages:

The use of inter-process profits involves complication.

The system shows profits which are not realised because of stock not sold out.

Joint Products Vs By
Products
Joint Products - Joint products represent two or more
products separated in the course of the same
processing
operation
usually
requiring
further
processing, each product being in such proportion that
no single product can be designated as a major
product.
In other words, two or more products of equal
importance, produced, simultaneously from the same
process, with each having a significant relative sale
value are known as joint products. For example, in the
oil industry, gasoline, fuel oil, lubricants, paraffin, coal
tar, asphalt and kerosene are all produced from crude
petroleum. These are known as joint products.

By-Products - These are defined as products recovered from

material discarded in a main process, or from the production of
some major products, where the material value is to be
considered at the time of severance from the main product.
Thus by-products emerge as a result of processing operation of
another product or they are produced from the scrap or waste of
materials of a process. In short a by-product is a secondary or
subsidiary product which emanates as a result of manufacture
of the main product.
The point at which they are separated from the main product or
products is known as split-off point. The expenses of processing
are joint till the split off point.
Examples of by-products are molasses in the manufacture of
sugar, tar, ammonia and benzole obtained on carbonisation of
coal and glycerin obtained in the manufacture of soap.

Distinction between Joint- Product and

By-Product: The main points of distinction
as apparent from the definitions of Joint
Products and By-Products are:
Joint products are of equal importance
whereas by-products are of small economic
value.
Joint products are produced simultaneously
but
the
by-products
are
produced
incidentally in addition to the main products.

Life Cycle Costing

Unit IV

Marginal Costing
Absorption Costing: a method of costing by which all direct cost and applicable
overheads are charged to products or cost centers for finding out the total cost of
production. Absorbed cost includes production cost as well as administrative and
other cost.
Marginal Costing a principle whereby variable cost are charged to cost units and fixed
cost attributable to the relevant period is written off in full against contribution for
that period.
Contribution (C) = Sales (S) Variable Cost
P / V Ratio = Contribution 100
Sales

Break Even Point the level of activity there is neither a profit nor a loss.
Break even point in units =
Fixed costs
Contribution per unit
Margin of Safety is the difference between the expected level of sales and the break
even sales.
= Projected Sales Break even sales

Budgets and Budgetary

Control
Budget: It is statement of an estimated performance to be achieved
in given time, expressed in currency value or quantity or both.
Budget Centre: A section of an organization for which separate
budget can be prepared and control exercised.
Budgetary Control: Guiding and regulating activities with a view to
attaining predetermined objectives, effectively and efficiently.
Budget Manual: The Budget manual is a schedule, document or
booklet which shows, in written forms the budgeting organisation
and procedures.
Budget Period: The period of time for which a budget is prepared and
used. It may be a year, quarter or a month.
Components of Budgetary Control System are Physical budgets,
Cost budgets, Profit budgets and Financial budgets
Objectives of budgeting are Planning, Directing and Controlling
Classification of Budgets : On basis of Nature - Fixed and Flexible

Standard Costing
Standard Costing: A technique which uses
standards for costs and revenues for the
purposes of control through variance analysis.
Variance:
A
divergence
from
the
predetermined rates, expressed ultimately in
money value, generally used in standard
costing and budgetary control systems.
Variance Analysis: The analysis of variances
arising in standard costing system into their
constituent parts.

Material Variance :
Material Costs Variance = (Std. qty Std. Price) (Actual qty Actual price)
Material Usage Variance = Std. price (Std. Qty. Actual qty.)
Material Price Variance = Actual qty. (Std. price Actual price)
Labour Variance :
Labour Cost Variance = (Std. time Std. Rate) (Actual time Actual rate)
Labour Efficiency Variance = Std. rate (Std. time Actual time)
Labour Rate Variance = Actual time (Std. rate Actual rate)
Overhead Variances:
O. Cost variance = Recovered Overhead Actual Overhead
O. Expenditure Variance = Standard Overhead Actual Overhead
O. Efficiency Variance = Recovered Overhead Standard Overhead
Sales Variance :
Sales Price Variance: Actual Quantity of Sales (Actual price Budgeted price)
Sales Volume Variance: Budgeted Price (Actual quantity Budgeted quantity)

Important Questions

Important Questions