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CHAPTER-I
BASIC CONCEPT OF COST ACCOUNTANCY
1. DEFINITION: Cost Accountancy
Applications of Costing and Cost Accounting principles, methods and
technique to the art, science and practice of cost control and ascertainment of
profitability. It includes presentation of information derived there-from for the
purpose of managerial decision-making’.
1.1
PRINCIPLES
 Maintaining Professional Competency, Integrity, Confidentiality and
Objectivity
 Continuous development of knowledge & skill.
 Refrain from disclosing or misusing confidential information.
 Refrain from engaging in or supporting any activity that would discredit the
profession.
 Communicate information fairly and objectively.
1.2
OBJECTIVE
 Application of right Methods or ways of correct cost findings at variant
situations,
 Application of suitable Techniques of cost control and assessing operational
profitability.
 Development of Art of presentation for quick and easy interpretation of
performance.
 Enhancing Professional expertise to the best use of Management.
1.3
METHODS
Costing has been stated as method of classifying, recording and charging of
cost to the products and services through appropriate and logical process or
system depending on the nature of industry, Costing methods have been
broadly divided into the following categories, viz.
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1.3.1 JOB COSTING for jobbing industries engaged in production on specific order
of customer and
1.3.2 PROCESS COSTING for process industries engaged in production of
repetitive nature of products in a continuous process.
1.3.3 Variants of those broad methods of costing.
i)
Contract or Terminal Costing: This is a variant of JOB Costing. This
method is followed in huge single contract like, Building, Bridge, and Road etc.
Separate accounts are being opened for different contracts.
ii)
Batch Costing: This is an extension of Job costing. When a number of
units of homogeneous type are produced in a batch, the said batch is being treated as
a job. Cost arrived at for the batch as a whole in the card is divided by the number of
units in that in order to arrive at the average cost per unit in that batch. Such method
is followed in Cycle Industry.
iii) Single or output Costing: This is a method of costing being
followed
where the output is single like Coal Industry.
iv) Multiple/ Composite Costing: Different kinds components, subassemblies are produced in batches or through a continuous process for ultimate use
in the main Job order. Different method of costing is applied for each segment and
job costing for the main job undertaken as per specific order of the customer. Boiler
industry is an example of application of such method
v)
Operation Costing: This is an extension of Process Costing. In certain
Process industries, when a process is divided into certain operations and Management
need to have thorough costing of each and every operation for the purpose of control
and decision-making. Food products and Chemical industry can be ideal examples for
application of such costing.
vi) OPERATING COSTING for operating industries rendering
services;
viz., Transport Industries
2. COSTING TECHNIQUES
Besides such methods of assessment of cost of a job or a process, certain costing
techniques followed for the purpose of cost control and management decision.
2.1. a) Standard Costing: This is a technique to assess standard cost of the product,
recording the actual, comparing the actual with that of the standard, finding out the
variation with reasons for ultimate control or revision of standard, if necessary. This
technique can be well use of in cases standard and repetitive nature of work having
all kinds of standard facilities.
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2.2. b) Marginal Costing: This is a technique to assess marginal cost (Prime Cost
and variable overhead) of products and contribution there-of by deducting marginal
cost from sales. Fixed cost is kept away from cost structure. Profitability of each
product is assessed through a ratio of contribution to sale (P/V ratio). The main idea
behind this technique is assessment of true profitability of each product. Arbitrary
distribution of fixed overheads, in absence of suitable bases makes it difficult to
calculate correct profitability of the various products. Cost Accountants can assist
management in various decision making areas like ‘Optimum product mix, pricing,
make or buy and a host of other decisions in day to day business in a competitive
world.
2.3. c) Uniform Costing: This is a technique of cost control by applying method of
costing uniformly in various production units of homogeneous type so that it makes
possible to compare the product-wise cost incidence of each unit. This is a technique
to control cost through ‘Inter firm comparison’.
2.4. d) Differential Cost Analysis: This is a technique applied to find out optimum
capacity utilization by comparing incremental revenue with that of differential cost at
different level of capacity. This is a contribution of Cost Accountant in managerial
decision- making where there is a limitation of Marginal Costing.
3. COST ACCOUNTING
As defined, Cost Accounting is a process of accounting for the cost from the
point at which it is incurred or committed to the establishment. Cost accounting
necessarily starts from the same original sources like vouchers and primary
document. Cost accounts relates to the operational side of the business. It classifies
accounting information and records, arranges and interprets such expenses by the cost
elements like materials, labour and expenses.
As in the case of general accounting system, transactions relating to factory
operations, to be finally reflected in cost accounts, are recorded in the books of
original entry. Summaries of these books are initially journalized and posted in the
general ledger, which contains control accounts and subsidiary books.
In Ordnance factories PRINCIPAL LEDGER with 30 heads serves the purpose
of Cost Accounting.
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4. Activity Based Costing
A latest technology incorporated by many organizations with their scientific and
updated cost accounting system. ABC has its’ genesis in the growing incidence of
indirect expenditure in the manufacturing operations with the increasing trend of
management cost consciousness to ensure its’ survival in the global competition.
This is, specifically, a process of distribution of indirect cost amongst the various
products and services more accurately and scientifically.
4.1. What it aims
 Overcome the problem of inaccurate cost findings and cost reporting due to
wrong selection of bases of cost distribution.
 Identification of no value added activities and improvement in performance
and activities.
 Cost cutting and down-sizing (Indirect cost).
 Activity based Budgeting.
 Target Costing
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5.
COST STRUCTUR
Direct Material+ Direct Labour+ Direct Prime Cost +
Expenses=
Indirect Production Expenses
Indirect Material
Indir. Labour
Indirect Expenses
Consumable stores
Lubricant and others
Incidental
materials
attributable to Production
activity
Wages
paid
Shop labour,
elpers,
Supervisors,
workers
in
repair
&
maintenance
Rent, Rates,
Taxes,
Electricity,
Insurance, Power
Depreciation, etc.
Indirect office Expenses
+ Administrative
Overhead=
Office rent, Heating, Cooling, Postage, Stationary,
Salaries of Executive and Staff, Cost of Office
Appliances,
Audit fee, Legal and Secretarial expenses.
Expenses on Selling & Distribution
Selling Expenses:
Salaries paid to Salesmen, Staff,
Managers, Peon etc.
Stationary and Printing,
& other sales office expenses
Works or Factory
Overhead =
Works Cost or
Factory Cost
+
Distribution Expenses:
Secondary
packing
for
transport,
Warehouse Cost,
Transportation or shipment
cost.
Production Cost or
Cost of Finished
Products
+ and
+ Selling
Distribution
Overhead
=
COST OF SALES
+
Profit /Loss
=
VALUE OF SALES
5.1. Alternative style of Cost structure
Total Cost =
=
=
=
=
=
Cost of Labour + Cost of Material Other Expenditure
Cost of (Dir. Labour+ Ind. Labour) + Cost of (Dir. Material
+Ind. Material) + Cost of (Dir. Expenses+ Ind. Expenses)
Cost of (Dir. Labour+ Dir. Material+ Dir. Expenses) + Cost
of (Ind Labour + Ind Material+ Ind. Expenses)
Prime Cost + (Production Overhead+ Admin Overhead+
Selling & Distribution Overhead)
(Prime Cost + Production Overhead) + Admin Overhead+
Selling & Distribution Overhead)
(Works Cost+ Admin. Overhead) + Selling & Distribution
Overhead)
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=
=
=
(Cost of Finished output+ Selling & Distribution Overhead)
Total Cost of Sales + Sales Value
Total Cost of Sale+ Mark up
6. COST SHEET
This is a statement setting out the cost of a product giving details of all the elements
of cost.
There should be clear indication of Prime Cost, Works Cost, Cost of Production, Cost
of Sales and Profit unless information is lacking.
6.1
Different parts of cost should be shown in logical sequence.
Cost sheet should have the columns like: a) Total Expenditure, b) Percentage of each
element to the total cost of production, e.g., % of Material to the total cost, c)
Element-wise cost per unit, d) Provision for comparison with the previous year. In
case, the organization has applied Standard Costing technique, the standard cost with
necessary element-wise break up can be incorporated in the Cost sheet. In case
organization is following Marginal Costing technique in their product costing, cost of
the product will reflect the marginal cost only. Fixed cost will be shown separately.
There may not be uniformity or universality of format of Cost sheet. It depends on
type of the products/ services, process of manufacture & volume of the organization.
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6.2
A typical example of Job cost sheet is given below:
Bishwajit, Tapan and Sharbani carry on a partnership business sharing
profits & loss equally. Bishwajit devotes to the business only according
to his time permits. Tapan acts as Works Manager and Sharbani as office
manager. Details of business Amou
during September2005
were as follows:
Transactions
Transactions
Amo
nt
Purchase of Stores
Works wages ----Direct
Indirect
Office salaries
Carriage In
Carriage out
Sales
Stock as on 1st Sept.
Stores
Finished goods (600 units)
Work-in-progress
Traveling expenses
Interest on capital:
Biswjit
Tapan
Sharbani
49500
32000
4000
9390
300
2800
16000
17500
4500
6500
1200
1500
800
700
unt
Advertising
Power
Income Tax
Agent’s Commission
Maintenance of plant
Rates, light, Insurance (9/10 for Works)
Bad debts
Sundry Expenses---Works
----Office
Building Repair
Partners’ salaries—Tapan
---Sharbani
Depreciation------Plsnt
------Building
Sale of Scrap
3000
1050
9500
4500
3660
1000
500
1400
2600
100
1200
1000
1900
100
400
On 30th Sept. Stores on hand total Rs.19000 and WIP on that day
was Rs.7700. Finished stock outstanding was 700 units out of
15000 units produced. The building was owned by the firm and
assessed by the Municipality was Rs.14400 per year.
Prepare a COST SHEET and Statement of Profit.
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6.3
Statement of Profit & Loss
Unit
Sales (a)
Less Cost of Sales (b):
Opening Finished Goods
Add Cost of Production
Less Closing F.G
Selling & Distribution Expenses:
Carriage outward
Traveling Expense
Advertising
Agent’s commission
Bad debt
Value
14900
160000
600
15000
15600
700
14900
4500
108000
112500
5040
107460
2800
1200
3000
4500
500
Profit (a)-(b)
12000
119460
40540
Income tax and interest on capital not included as the same are not chargeable to the
production.
7.
Practices in Ordnance Factory Accounts
OPENING OF COST CARD/ SHEET, COST COMPILATION & CONTROL
7.1. OPENING OF COST CARD
 Cost Card is a subsidiary record of compiling cost.
 Costing Section of Accounts Office opens this on the authority of warrant.
 This will be opened under the signature of S.O. with date of opening.
7.1.1 Each Cost Card will contain:
a) Extract no. & Warrant No.
b) No. of the Standard Estimate,
c) Quantity ordered & completed,
d) Sections on which warrants have been placed,
e) Nomenclature of different element of cost.
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7.1.2 On the back of the Card, it will contain
1. Replacement Expenditure against the Replacement Warrants, if any.
2. Statement of Comparative Cost between Estimated and Actual
8. Cost Compilation & Control
Cost under each element is compiled in the relevant Cost Card based on the following
documents:
8.1. Labour & Overhead Abstracts is prepared monthly, by the EDP section, based
on labour punching media. This will show the labour cost incurred and overheads
(Fixed & Variable) to be charged against each of warrant.
8.2. Material Abstracts: EDP section, based on Material punching media, prepares
this monthly. This will show the material cost charged, based on average ledger rates
against each of warrant.
8.3. Transfer Voucher/ Allocation Sheet is also prepared by EDP for transfer or
allocating certain charges to the correct warrant/ work order previously booked
erroneously.
8.4 Component Abstracts are prepared from the Red Demand Notes and Return
Notes showing the value of Components to each work order by sections and warrants.
8.5 Posting in the Cost Cards will be done concurrently giving priority in the
following cases:
i)
ii)
iii)
Warrants, declared as complete, and
Warrants of special interest to GM, to whom a monthly report is to be
submitted, indicating progressive expenditure.
Regular review is done on correct posting in the Cost Cards.
9. CLOSING OF COST CARD
This is done on receipt of the list of completed warrants in the Costing section and the
following actions are being taken:
9.1. Obtaining completed shop copies of warrants duly paired with Accounts
copies of ‘Manufacturing’ and ‘Material’ from ‘Labour’ and ‘Material’ sections
respectively.
9.2. In cases of running warrants from previous year, inclusion of opening balance
is to be ensured. Further, Replacement warrants and warrants for tools/ gauges,
manufactured on parent work orders, are annexed to the main cost cards.
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9.3 Posting to the Cost Cards are to be reconciled with all documents and records
as stated above in order to ensure correctness.
9.4. At the end of the year
 Value of avoidable rejections is to be determined as per laid down procedure
(para-679) and deducted from total expenditure charged.
 Value of closing unfinished semi is to be ascertained, at the year end, to assess
the cost of production
 Comparison of ‘Actual Cost’ with ‘Estimated Cost’. While preparation of
Standard Estimates is the 1st step towards cost control, comparison of the
actual with that of standard is the 2nd step towards the goal.
10. Accounts office will carry out the following checks
i) The cases of variations in Material and Labour more than 10%.
ii) Warrants pertaining to estimated value more than 10,000.
iii) All civil trade warrants.
iv) Warrants, having abnormal rejections.
v) Warrants presenting unusual features
More detail scrutiny with reference to the original documents, viz., PW/DW cards,
Demand & Return notes, NRRs/ NRMs, Replacement warrants etc. may sometimes
be essential for tracing the reasons for variation.
11. Process Cost Statements
Such monthly statements are prepared in process factories like CF, Aruvankadu, HEF
Kirkee, & OF Bhandara where Process Costing Method is applied
The following statements are prepared monthly to arrive at the cost of production and
issue rates:
Statement-I:
Statement of Raw Material Cost Showing the value of exact cost of material
consumed.
Statement-II:
Statement of allocated overhead, i.e., the Sectional Variable Charges.
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Statement-III
Statement of Cost of Production, this includesi)
Material Cost as per Statement I,
ii)
VOH as allocated through Statement II,
iii) Common VOH distributed based man-hour utilization and
iv) FOH based on a pre-fixed % on the quantity of production.
 Evaluation of production per unit is done based on Weighted Average
Method.
 Pricing of issues from the process are done based on production cost of
the previous quarter.
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CHAPTER-II
12. Labour Cost Control & Accounting
12.1 Employment Control:
12.1.1. The Industrial workers are classified as:
 Unskilled
 Semi skilled
 Skilled
 High skilled
 Master Craftsman
13. The jobs are grouped into different trades:
Trade test is necessary for:
 Promotion to higher grade in the same trade,
 Transfer to a different trade in the same grade,
 Promotion to higher grade under different trade
 Fresh appointment as tradesman
Detailed specification of the trade test for each grade and trade are fixed by OFB.
14. Tools of control are:
 Authorized Strength Statement Furnished by Management.
 Scale audit report generated by BAO
 Trade Test report.
 Factory Order.
15. Classification Control:
15.1. Day Worker: Workers on monthly rate of pay.
15.2. Piece Worker: Workers on Piece rate of wages. After correlation of Piece work
rate with Vth CPC scale of pay the definition has changed to “Workers paid on Piece
rate of hours evaluated on the minimum of the scale of pay of the individual worker.
They are further subdivided into Individual and Gang Piece Worker.
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16. Attendance Control:
 Payment of wages Act 1928 states that:
 Worker should be paid for hours not less than the hours he is present for the
day
 The same was controlled by physical closure of the gate.
 The philosophy behind marking attendance as part of 15 minutes is that it
divides a day into 32 parts and a rupee was equal to 64 paise. This had enabled
quick division even without any machine.
 After computerization of calculation of wage the attendance is controlled by
EARS instead of by physical closure of the gate. Attendance is recorded on the
basis of actual attendance and not as a block of 15 minutes.
 Factory Act 1948 states that “No adult worker is required to work in a factory
for more than 48 hours a week or 9 hours a day.”
 For any work beyond 48 hours a week or 9 hours a day the individual is put to
overtime.
 Under Departmental rules the duty hours of a week has been fixed as 44.75
hours. This means that IEs are entitled to 48 hours of pay for working 44.75
hours. For working beyond 44.75 hours a week IEs are entitled to overtime
under Departmental Rule.
17. Tools of control:
 Casualty Report.
 Gate Pass
 Late Memo
 Overtime Note
 Shift note
 Leave order
 Manufacturing Warrant
 Supplementary work Order draft.
 Piece Work card
 Day Work Card
18. Method of Remuneration:
 Duty pays at basic monthly rate for day workers.
 Piece work earning for Piece Workers.
 Other elements of pay like idle time, overtime, leave, holiday pay, injury
pay, etc.
 Overtime pay and night shift bonus, Night duty Allowance , for day
workers
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 Certain other allowances like dearness allowance, House rent allowance,
city compensatory allowance admissible under Section 2(vi) (a) of the
payment of wages act 1936.
18.1. Tools of Control:
 Govt. Orders issued from time to time.
 Govt. order issued from time to time which governs the rate of allowance.
19. Disbursement Control:
 Factory Management is provided with an amount of cash to meet the
requirement during the month. Previously it was based on passed data. After
computerization the amount is restricted to the net amount of the wage roll
after Govt deduction, professional tax amount and any other amount deducted
but need to be deposited by the GM in cash.
 This amount is booked to a Code 01/805/03. Wage roll when passed for
payment no separate punching medium is prepared unless any extra amount is
passed for making payment to absentees or to make payment of any
supplementary rolls.
 Proforma-C is prepared to indicate the head wise summery of the amount
appearing in the Wage Roll. Transfer Entries (TEs) are made to show the
expenditure under different unit of control code. In the CCO2 summery under
01/805/03 exhibits total payment to IES and subtotals under different control
codes indicate payment under different element.
 Agreement Form of Labour (AFL) is prepared on the basis of detail in
Proforma-C.
 Management fills the recovery side of the Agreement Form and also prepares
the Disbursement certificate to indicate the amount received as advance,
amount of payment made out of the advance including absentee payment,
recoveries made, amount deposited to bank through MRO.
19.1Tools of Control:
 Passed Wage Roll
 Passed Supplementary Roll
 Punching Medium
 PW Cards
 Manufacturing Warrant
 Govt. Orders
 AFL
 DC
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Cost Accounting of Labour
Time Wage
On Min.on Pay
HP
IP
Time Wage
Of DW
Profit
OT Wage
Of DW
OT Wage on
Min. of Pay
Incremental
Pay
Prime
Labour
DA
Leave Pay
OT
Bonus
Overhead
NS
Bonus
Direct
Labour
HRA
CCA
DOT
Cost Accounting of Labour
Time Wage
On Min.on Pay
HP
IP
Time Wage
Of DW
Profit
OT Wage on
Min. of Pay
OT Wage
Of DW
Incremental
Pay
Prime
Labour
DA
HRA
CCA
Leave Pay
OT
Bonus
Overhead
NS
Bonus
Direct
Labour
DOT
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Cost Accounting of Labour
Time Wage
On Min.on Pay
HP
IP
Time Wage
Of DW
Profit
OT Wage on
Min. of Pay
OT Wage
Of DW
Incremental
Pay
Prime
Labour
DA
HRA
Leave Pay
OT
Bonus
Overhead
NS
Bonus
Direct
Labour
CCA
DOT
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Cost Accounting of Labour
Time Wage
On Min.on Pay
HP
IP
Time Wage
Of DW
Profit
OT Wage on
Min. of Pay
OT Wage
Of DW
Incremental
Pay
Prime
Labour
DA
Leave Pay
OT
Bonus
Overhead
NS
Bonus
Direct
Labour
HRA
CCA
DOT
Cost Accounting of Labour
Time Wage
On Min.on Pay
HP
IP
Time Wage
Of DW
Profit
OT Wage on
Min. of Pay
OT Wage
Of DW
Incremental
Pay
Prime
Labour
DA
HRA
Leave Pay
OT
Bonus
Overhead
NS
Bonus
Direct
Labour
CCA
DOT
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CHAPTER-III
ROLE OF ACCOUNTS ON MATERIAL COSTING
20. Control over holding of Stock
 Different methods are adopted to control over holding of stock and its usage.
 Extraction of Ledger Balance for reconciliation with PSA balance.
 Analysis of stock.
 ABC Analysis
 Review of unorthodox balance.
 Checking of Material Warrant with relevant standard estimates and DN/RN.
Pricing documents/information for Receipts and Issue of Store including Prod Store
Receipt Method
Receipt
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Method
LP
CP
Coal Coke
ODD including transfer from Deposit
Stock.
Prod of own Fy.
-do- Timber/Leather
Other Factory.
Other than Defence.
Return of surplus Material/scrap.
Surplus in stock taking.
Transfer from stock Pile/Capital.
Miscellaneous Receipt.
To shop on DN.
To other Fys on I.Vr or stock
Transfer note of factories located in
same area.
To AF, Navy & R&D on payment.
MES
To capital
Losses-DD Voucher
To other cases on payment
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
S.O rate including ST/ED
excluding Railway Freight
/transport.
Paid bills/AT order.
Prov. Priced w.r.t SO & Labour,
department Central cess & S.T.
Stock book rate/priced
vocabularies
COP
Standard Prod. Rate (Diff with
actual shown as P/L in AA)
.Priced Copy of Consignor or
latest receipt rate/estimate.
.Priced copy of Voucher receipt.
.Ledger rate.
.Ledger rate.
.Value taken from ledger of
SP/Cap Block Register.
.Rate given by Factory Mgt.
ALR
ALR
ALR (No. department. Ch.)
ALR+DC5%
ALR
ALR
ALR + DC5% + Additional Ch
5%.
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ALR is also adopted for pricing of Material provided in
a)
b)
c)
d)
e)
f)
Standard estimates.
SWOD
Replacement Warrant.
Non-recurring Revisions to Material.
Semi Statement
Receipt from ODD (When PVOS rates are not available)
21. PRODUCTION STORE
•
•
•
•
•
To Army (Prod Store)
To other Factory
To own Factory stock
To Capital
To Navy/Air Force/ODD
(other than MES)
To MES
•
•
•
•
•
OFB Price list.
OFB Price list.
COP
COP
OFB Price list.
COP(debit raise through DEA)
21.1. Flow of cost to cost card
Cost of Material is posted in Cost Card from Material Abstract relating to each
warrant which is prepared on the basis of data/information available from Demand
Note/Return Note. DN/RN is priced w.r.t. Average ledger rate. ALR is worked out
after posting of every receipt voucher which is priced w.r.t S.O etc rate.
27.2. Accounting Control
Accounting control is carried out through maintenance of Bin Card and Priced store
ledger, Monthly priced store Account, Production account and Principal ledger and
by various methods /instruments adopted right from procurement w.r.t Production
Programme /budget provision up to issues to the consignee/users. Unlinked payments
(DVs) for want of Receipt Vouchers are accounted as Assets outstanding. Similarly
unlinked Receipt Vrs. where materials received but payments yet to be made are
accounted as liability outstanding. For this purpose Asset and liability register are
maintained by Br. Accounts Offices.
27.2. Financial compilation
Correctness in Financial compilation depicts the true picture of financial
performances of Ordnance Factory. It not only shows the correctness of booking of
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“Receipts” and “Expenditure” under proper head of Account but also ensures trend of
expenditure against various nature of transaction including store etc. as designed by
different unit control codes on several types of transaction. This also helps budgetary
control under different categories of expenditure, recoveries and issues from Ord.
Factory. Care must be taken for proper identification of stores while incorporating
classification code during placement of order (i.e. cost debitable) to avoid mismatch
and misclassification.
28.
Material Cost Accounting & Control- Role of Accounts
28.1. Objectives to Be Achieved Under a Proper System of Material Control
i)
ii)
iii)
iv)
v)
Provision of The required quantity of the right material and at right place
Minimum amount of Capital should be booked in Working Stock
Comparing Actual Utilisation of Materials with Estimates for ensuring
corrective actions.
Purchase of Materials of right quality and right quantity at favourable
Prices
Prompt action for utilisation / disposal of Scrap & other Stores which are
considered as surplus
Provisioning policy
Source
Lead Time
Direct Material
Period of
Utilization
Total
Indire Direct
Indirect Direct
Indirect
ct
Material Materia Materia Material
Materi
l
l
al
Importe
d
12
6
12
12
24
18
Indigeno
us
6
6
12
12
18
18
BACK
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29. INVENTORY LEVEL
Group of Factories
AV
OEF
Others
Over-all SIH Inventory
(Maximum)
6 Months
3 Months
4 Months
30. MATERIALS ON STOCK CHARGE
a) raw materials
b) manufactured products / components / processed materials in other
factories/ tools gauges, packing materials
c) miscellaneous materials
MATERIAL ON PRODUCTION CHARGE
a) Inventory control
b) Stock-pile
30.1. SISTER FACTORIES COMPARED
a) cost of manufacturing
b) material usage
31.2. Case study – 1: Procurement of quantity more than SHIS Qty
One Ordnance Factory forwarded a proposal for procurement of 4mm steel rod used
for manufacturing pin firing of INSAS rifle. SHIS was vetted for 2000 kg. Tenders
were issued to 6 reputed firms. Value of case being Rs.26.67 Lakhs (@ Rs.475 basic
+ 8 % ED +4 % ST) on resultant single tender, it exceeded powers of GM. The firm
offered for min order quantity 5000 Kg. Earlier the same firm supplied less than 2000
kg on two occasions because SO qty were 2000 & 1500 kg. Factory TPC
recommended purchasing 5000 kg in spite of the facts that Finance member advised
to put up to higher level of TPC which was not done. Factory placed LOI / SO. Fin
div was requested to vet the sanction which was refused.-IFD for 2000 Kg was placed
on MSF @ Rs.2074.41 Kg. Member/ Fin sent a note to the DGOF highlighting (a)
availability of alternate material (b) other factory had 6 sources whereas RFI had one
(c) Min order qty not justified since supplies were less than 2000 KG (d) Supplier
was not asked to supply against previous orders. (e) No SHIS existed. Factory
prepared a covering SHIS for 5000 Kg. A BoE was constituted by the DGOF in Sep
05. Report was awaited as on 3/6/06
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32.2. Case Study – 2: Procurement of excess qty – Piercing the veil
A proposal was forwarded by one Fy for procurement of 2279 Kg of Tungsten alloy
cubes used for manufacturing 40 mm PFFC ammunition. Requirement was worked
out as under:
Wt of a cube – 0.40 +/- 0.02 Gram
No of cubes / shell = 525
Wt of cubes / shell = 525 * 0.42 = 220.5 gm
Rejection allowance = 10 %
Proof – 2 %
Fy was asked to clarify why 10 % UAR.
Why always + 0.02 grams.
Fy replied that UAR can be reduced to 5% including proof now and further in
subsequent years.
Qty reduced by 472 Kg costing Rs 18.32lakhs in that case.
In next case, fy proposed 11066 Kg.
Requirement against import order for 15000 no shells were also included. Final
approval was given for7530 Kg only.
32.3. Case Study – 3: quantity lost and found
An ordnance factory, while deciding vendors for issuing tenders for 854 MT of
Strong Nitric Acid noted as following:“It has been observed that a Board of Enquiry” is under progress for a deficit quantity
of 600 MT which is not available in stock”. At the stage of forwarding the proposal to
OFB, no mention was made of the outcome of the BoE. Fy GM stated that the
missing acid was successfully located. The report of the BoE was not forwarded as
the enquiry did not take place. It was contended by Fy that demand notes were not
forwarded to LAO.
32.4. Case Study – 4: Procurement & cost structure
An Ordnance factory sent a proposal for procurement of “extractor” Qty- 127,420.
4 firms quoted same rate Rs.87 + 4 % CST
Cost Analysis for production in Fy per unit was as below:
a) Direct labour b) VOH (137.95 %) c) FOH (203.95 %) –
d) MaterialTotal:
Rs.38.5662
Rs.53.2020
Rs.78.6557
Rs.0.2485
Rs.170.67
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FINANCE MEMBER REMARKED:
“Procedure has been followed. Commercial terms & conditions have been vetted by
me. Regarding rate, Member (user) / Fy to certify reasonability by verifying estimates
etc as the value addition and cost involved are beyond my comprehension.”
32.5. Case Study – 5: Procurement & code heads
Procurement & code heads
Following importation proposals were received for deliberation in OFB
Sl
no
Item
Value in SEK
Value in Rs
1
2
Torque wrench for fuse
1095000
6818018
Torque wrench for Heat shell
1095000
6818018
3
Torque wrench for Warhead
1095000
6818018
4
Torque wrench for Ballistic Cap
1095000
6818018
5
Test equipment elect equipment
1375000
8561437
6
Gauge
795000
4950067
7
Grease gun
228000
1419642
8
Truing gauge
575000
3580237
9
Calibration tool for torque wrench
90000
560385
10
Truing tool
139000
865483
11
Torque wrench for Piezo
45000
280192
TOTAL
7627000
47489515
Earlier Fy had submitted supplementary RR plan 2005-06 for 19 machines /
equipments, in which 18 machines were meant for 84mm HEAT 551. It was decided
at OFB that some of those m/c would be purchased under NC. Fy had floated 11
separate TEs on the same firm for procurement on “PAC basis” under LP for
converting SKD’s / CKD’s to complete rounds of 84mm HEAT – 551.
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Case Study – 5: Procurement & code heads –contd...
Sl no
Similar Item proposed under LP(
revenue head )
Similar equipment proposed under RR 2005-06
1
Torque wrench for fuze
2
Torque wrench for Heat shell
Torque machine for HEAT Shell
3
Torque wrench for Warhead
4
Torque wrench for Ballistic Cap
Torque machine for Assy of Ballistic cap on
warhead body
Ballistic cap assy with equipment of delay unit
complete
5
Test equipment elect equipment
6
Gauge
Gause & Truing gauge with calibration tool
7
Grease gun
Equipment for applying Silicon Grease Gun
8
Truing gauge
9
Calibration tool for torque wrench
10
Truing tool
11
Torque wrench for Piezo
Truing tool for complete round with calibration
tool
Truing tool for complete round with calibration
tool
Truing tool for complete round with calibration
tool
Piezoelectric Generator assy
The firm wanted advance payment of 20 %.Total value of 11 proposals - Rs.4, 74,
89,515.00 on PAC
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CHAPTER-IV
33. OVERHEAD COST ACCOUNTING
33.1. WHAT IS OVERHEAD COST?
 Overhead cost is a part of total cost of production.
 This is defined as aggregate of
a) In-direct material,
b) Indirect wages, and
c) Indirect expenses.
 Overhead cost can otherwise be termed as Indirect cost also. Indirect cost is,
therefore by its term, not directly chargeable to a unit of products or a
process.
 This is a matter of in depth analysis, why and under what circumstances an
item of expenditure is declared as overhead.
 Further, such categorization also caused due to management policy and
accounting convenience.
33.2. IMPACT OF OH COST
OVERHEAD COST EFFECT
.02-03
Overhead to COP
Human Resurce Cost (-) DLC to Overhead
Power & Fuel to Overhead Cost
Repair & Maintenance to Overhead Cost
.03-04
24.71%
72.03%
22.1%
6%
26.11%
73.28%
20.4%
6%
HUMAN RESOURCE COST ANALYSIS
Direct Lab. Cost to HRC
27.90%
Ind. Lab. Cost to HRC
31.8%
28.79%
Supervisory
OFB HQR.
ACCOUNTS & AUDIT
OTHERS(Superan.ch.& gpf)
31.0%
32.3%
30.6%
2.1%
1.7%
2.8%
2.7%
4.5%
4.0%
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33.3. IMPORTANCE OF O.H. COST
 High incidence of Overhead Cost.
 Increasing trend of such cost with rapid mechanisation by replacing hand
labour.
 The area of cost control and cost reduction.
 Difficulties in distribution of overhead cost to products & services for correct
cost finding.
33.4. STAGES OF OVERHEAD COSTING
First Stage:
Collection, Classification and Codification
Second stage:
Allocation, Apportionment & Re-apportionment
Third and final stage:
Absorption/ Levy/ Recovery/ Charging
33.5. CLASSIFICATION OF OVERHEAD COST
Element-wise classification: Cost of Power, Water, Rent, Rates, Taxes etc. for
convenience of Budget and Budgetary control.
Nature-wise classifications: a) Indirect Material, b) Indirect labour, c) Indirect
Expenses for the purpose of Accounting & Control.
Function-wise classification: a) Production, b) Administration, and c) Sales/
Issue for the purpose of management functional control of Overhead cost.
Behaviour-wise classification: (a) Fixed Overhead (FOH) and (b) Variable
Overhead (VOH). Such classification is very much for the purpose of
management decision-making and there-by control.
33.6 ALLOCATION, APPORTIONMENT, ABSORPTION
 Allocation of overhead cost means direct charging. As and when it can be
directly attributable to the particular cost centre. Examples of such OHC are:
Ind. Material & Labour, Depreciation, Salaries & wages of the person attached
to the Activity Centre.
 Apportionment of such overhead cost means distribution of common cost
amongst the centres on some suitable, logical and available basis. Examples of
such expenditures are cost of Power, Water, Rent, Rates, Taxes etc which are
common for different centres and jointly incurred.
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 Re-apportionment of Overhead cost means distribution of cost of Service
Cost Centres to the Production Cost Centres
 Absorption/ Levy/ Recovery/ Charging
 This is the final stage of overhead costing. After completion of
departmentalization to the production ends, the overhead cost need to be
charged to the products passing through the respective departments. There is
another exercise to find out the suitable base, which would enable to distribute
the departmentalized overhead cost amongst the various kinds of products
passing through the departments.
33.7 NOTE on methods followed in OFs
33.7.1 Apportionment & Re-apportionment:
Amongst the various methods available, ‘STEP LADDER METHOD’ is followed for
Ordnance Factories. Under this method, arrangements of Service & Production Cost
Centres are most important step towards maximum correctness in distribution of
Overhead cost. Amongst the various methods available, ‘STEP LADDER METHOD’
is followed for Ordnance Factories. Under this method, arrangement of Service &
Production Cost Centres is most important step towards maximum correctness in
distribution of Overhead cost.
33.7.2 Absorption or Levy:
This is distribution of overhead cost of Production Cost Centres to the products pass
through the production processes. DIRECT WAGE method is followed for product
costing in Ordnance Factories.
33.7.3 Example of OH costing
Overhead Expenditures in respect of a factory during a month were as follows:
Indirect Material
Production deptt. A.
4000
Production deptt.B.
6000
Production deptt.C.
2000
Service Deptt. X.
1200
Service Deptt. Y.
1600
Service Deptt. Z.
0600
Total: 15400
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Indirect Labour & Supervision charges
Production deptt. A.
Production deptt.B.
Production deptt.C.
Service Deptt. X.
Service Deptt. Y
Service Deptt. Z
4200
5800
5400
3700
1500
2200
Total: 22800
Common Overhead cost
Rent & Tax:
Depreciation (15%)
Light & Heat
10000
30000
4000
Insurance :
Power
TOTAL
2000
9000
93200
Other Operating information are as follows
Deptt
Area(
Sq. Mtr)
Book
Value of
Machine
Effective
HP
Productive Capacity
D L Hrs.
DLC
M. H
A
1000
50000
50
150000
45000
80000
B
750
90000
40
150000
30000
120000
C
1500
20000
100000
25000
X
500
30000
Y
750
5000
Z[
500
5000
TOTAL
5000
200000
10
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Common Overhead cost
Rent & Tax:
Depreciation (15%)
Light & Heat
10000
30000
4000
Insurance:
Power
TOTAL
2000
9000
93200
Other Operating information are as follows
Deptt
Area(
Sq. Mtr)
Book
Value of
Machine
Effective
HP
Productive Capacity
D L Hrs.
DLC
M. H
A
1000
50000
50
150000
45000
80000
B
750
90000
40
150000
30000
120000
C
1500
20000
100000
25000
X
500
30000
Y
750
5000
Z[
500
5000
TOTAL
5000
200000
10
II. Re-apportionment & Absorption
Basis
Z
Clerical
Direct Lab
Ind. Mat.
MH
Y
X
A
B
Store
TOOL
-6000
1000
545
-13545
1800
1818
5418
1200
2727
8127
0
0
32536
45000
72%
-5000
0
DIRECT WAGES
Recovery rates/DW
C
1000
910
0
0
0
43954 16710 93200
30000 25000
147%
67%
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II. Re-apportionment & Absorption
Basis
Z
Clerical
Direct Lab
Ind. Mat.
MH
Y
X
Store
TOOL
-5000
-6000
0
DIRECT WAGES
Recovery rates/DW
0
1000
545
-13545
A
B
C
1800
1818
5418
1200
2727
8127
1000
910
0 32536
45000
72%
0
0
0
43954 16710 93200
30000 25000
147% 67%
Point to consider…….
Is the system, presently followed, giving fairly correct result?
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CHAPTER-V
34. PRINCIPAL LEDGER:
Principal Ledger is maintained:-By the concerned Br AOs attached to Ord Fys
for the purpose of preparation of Consolidated Manufacturing Accounts viz.
Production A/c, Finished Stock A/c, Capital A/c etc.
34.1 Following the principles of Double entry system:
Through Principal Ledger:
 Cost of Production of articles manufactured in the factory is arrived at.
 Reconciliation of Cost and Financial Accounts is effected.
 Different Heads in the Principal Ledger are so arranged as to provide
information required for the Compilation of the Consolidated Manufacturing
Accounts viz. Production A/c, Finished Stock A/c, and Capital A/c etc.
 Posting into Principal Ledger are generally made month-wise.
 Transactions are first journalized from the source documents, then posted into
concerned Heads of Accounts against relevant Dr/Cr entry.
34.2 Source documents are: Priced Store A/c (Showing category / PSA code-wise Issues and Receipts of
Stores)
 Cash Compilation (Showing Summary of Financial Code-wise Receipts and
Expenditure for the month)
 Cost tabulations (viz. Labour Abstract, Material Abstract, T.V. Abstract etc)
 Manufacturing A/c – Statement A&B.
Data in respect of certain transactions are made available to Br AO annually i. e. after
closure of financial year e. g.
 Share of Central Administration (Fys)
 Share of Central Administration (A/cs)
 Share of cost of Ord Factory News
On receipt of above data, transactions are journalized and posted.
Principal Ledger is required to be closed annually. For which balances of each head
of account (other than Balance A/c) are struck at the year end and transferred directly
or finally through Subsidiary account(s) to the Balance A/c.
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Debit balances of Balance A/c represent Assets while Credit balances exhibit liabilities of the
Factory as on the closing day of the year and sum of all such debit entries should tally
with sum of all the credit entries of Balance account.
Such agreement of totals of Dr. and Cr. side of Balance A/c proves the arithmetical
accuracy of posting made into various heads of accounts of Principal Ledger.
Following heads of Accounts (Total 29) are at present maintained in the Principal
Ledger: 1. Custom Duty A/c
2. Stores Cash Purchase A/c
3. Stores Supplied by other Factories Act.
4. Transportation charges A/c
5. Stores A/c
6. Sale of Stores (Surplus & Waste) A/c
7. Issue of Stores on Payment A/c
8. Wages A/c
9. Supervision Charges A/c
10.Misc. Charges A/c
11.Overhead Exp. A/c
12.Misc. Credit A/c
13.Work-in-Progress A/c
14.Rent, Rates, Water and Electricity charges Recoverable A/c
15.Payment Services A/c ( Other than Defence Services)
16.Manufacture of own Fys. Stock A/c.
17.Services to other Fys. A/c
18.Services for Capital Assets A/c
19.Payment Issues for Defence Services A/c
20.Profit & Loss A/c
21.Capital Assets A/c
22.Capital Assets (Stock Pile) A/c
23.Cash Ledger A/c
24.Preliminary Exp. A/c
25.Deferred Revenue Exp. A/c
26.O/s Assets A/c
27.O/s Liabilities A/c
28.Capital Outlay A/c.
29.Balance A/c
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34.3 DESCRIPTION OF SOME ACCOUNTS
 Stores Account - contains opening balance of stock, receipts, issues under
various categories and closing stock.
 Wages Account - Contains Pay and Allowances of all categories. In addition
liabilities for Pay and Allowances for March, unclaimed wages as on 31st
March. Deduction is made for Pay and Allowances of previous March paid in
April of current year. Direct and Indirect Labour as per Labour Abstracts,
Balance represents Supervision charges.
 Overhead expenses A/c – Debit items represent various items of overhead
expenses like Indirect Labour, Indirect Material, Supervision Charges,
Miscellaneous Charges, etc. Credit items represent indirect receipts, Misc.
credits, variable and fixed overhead expenses transferred to Work-in-Progress
A/c etc.
 Work-in-progress A/c – contains Opening value, Direct Material, Direct
Labour and overhead leviable. Credit side contains Cost of Production, Cost of
abnormal rejection. Under/Over absorbed variable/Fixed charges are shown in
credit/debit side. Closing work in Progress is shown in credit side.
 Capital Assets A/c - Debit side contains opening balance, payments, transfers
in and amounts outstanding. On the credit side depreciation, transfers, issues,
outstanding and closing value are shown.
 O/s Assets & O/s Liabilities A/c - Contains details of opening and closing
outstanding Assets/Liabilities.
 Capital Outlay A/c - Main Control Account. This account is debited for
expenditures incurred and credited for receipts and recoveries.
 Balance A/c - Details the closing value of various assets and liabilities. Balance
should agree with the balance as per "Capital outlay Account".
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Work-in-progress Account
Dr
1. Capital Outlay Account:Cost
of
work-in-progress
(excluding Capital semi) on 1st
April B/F
(a) Labour
(b) Material
(c) variable Overhead
(d) Fixed overhead.
2. To Capital Outlay Account:Cost of uncompleted Capital
Work-in-progress on 1st April
included
in
Capital
Assets
Account.
(a) Labour
(b) Material
(c) Variable Overhead
(d) Fixed overhead
3. To Stores Account:(a) Direct material issued to Shops
less return.
(b) Issues to other than Defence
Department private bodies, firms
and contractors for manufacture of
garments or fabrication of stores.
4. To Wages Account:
Direct Labour
5.
To
Overhead
Expenses
Account:(a) Variable overhead expenses.
(b) Fixed overhead expenses.
6. To Profit and Loss Account:(a) Variable overhead expenses
over absorbed.
(b) Fixed overhead expenses over
absorbed.
TOTAL
Cr
1. By Miscellaneous Charges Account:Departmental material utilized on indirect work
orders.
2. By payment services Account (Other than
Defence Services):Cost of manufacture during the year.
3. By manufacture for factory’s own stock
Account:Cost of manufacture during the year.
4. By Services to other Factories Account:Cost of manufacture during the year.
5. By Services for Capital Assets Account:Cost of Services during the year.
6. By Payment Issues for Defence Services
Account:Cost of manufacture during the year for Army,
Navy, Air Force and other Defence Departments.
7. By Profit and Loss Account:(a) Variable overhead expenses under absorbed.
(b) Fixed overhead expenses under absorbed.
8. By Capital Outlay Account:Cost of abnormal rejections (not chargeable to
production)
9. By Balance Account:Cost of work-in-progress (excluding Capital semi)
on 31st March.
(a) Labour
(b) Material
(c) Variable Overhead
(d) Fixed Overhead.
10. By Capital Outlay Account:Cost of uncompleted Capital Work-in-Progress on
31st March (included in Capital Assets Account).
(a) Labour
(b) Material
(c) Variable Overhead
(d) Fixed Overhead.
TOTAL
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34.4 RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
34.4.1 OBJECTIVE OF RECONCILIATION
To ensure that:  Data presented are correct.
 All financial data have correctly been accounted for.
 No item of expenditure/receipt is left out
34.4.2 MECHANISM OF RECONCILIATION
To facilitate reconciliation:
 Integrated system of Accounting is followed whereby the financial and cost
accounts are fully integrated.
 Capital outlay Account is the main control A/c through which reconciliation is
made.
Vouchers, through which financial transaction takes place, are classified in
accordance with the budget heads they pertain to and a consolidation of such
financial compilations with details are sent monthly to each Branch Accounts Office.
These transactions are journalised by Dr. or Cr. to Capital Outlay A/c and posted in
the Principal Ledger. On the other hand, expenditure on labour, Material and other
charges compiled to Cost of Manufacture through Cost documents like D.W. and
P.W. Cards, Demand/Return Notes, Allocation Sheets etc. are all posted in Principal
Ledger to the debit/credit of the respective Subsidiary accounts like Wages accounts,
Store A/c, Supervision charges A/c, Misc. charges A/c etc. to be finally transferred to
the Work-in-progress A/c and there from to the Capital Outlay A/c. Thus figures from
both ends are finally booked to Capital outlay A/c and the fact that all expenditure
which has appeared in financial compilation has been incorporated in Cost Accounts
is automatically verified by Capital Outlay A/c which balances to itself.
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CHAPTER-VI
34.5 PRICING OBJECTIVES
 To recover all cost of product
 To earn some profit in order to get reasonable return on capital invested
34.6 PRICING SITUATION
 Customized manufacture based on customers’ specifications
 Mass manufacture of known specification
34.7 WHY PRICING DECISION
 For introducing new product in market
 Review of existing price for stimulating market demand/market share or
earning higher profit
 For quotations against customers’ enquiry
34.8 PRICING METHODOLIGIES
 Use of estimates based on historical data as adjusted for current/anticipated
conditions
 When historical data not available by requirement analysis as to material,
labour, direct charges & overhead.
34.9 PRICE COMPONENTS
 When market can absorb total cost +profit, sale price = cost + profit
 When market is competitive sale price less than cost plus profit
 Use of estimates based on historical data as adjusted for current/anticipated
conditions
 When historical data not available by requirement analysis as to material,
labour, direct charges & overhead
 Although dominant but cost alone does not determine price
34.10. PRICING FACTORS
 Although dominant but cost along does not determine price
34.11. NON COST FACTORS
 Industry nature
 Product characteristics
 Intensity of competition
 Buying capacity of population
 Market influences through demand-supply relation
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



Price agreements
Alternative/substitutes products
Governmental interference/ strategy
Capacity utilisation
34.12. COST BASED PRICING METHODS
 Price fixed above total cost
 Price to recover processing charges & profit on processing charges when
material supplied by customers
 Price to recover cost plus return on capital employed
 Price based on marginal costing technique
 Price based on differential cost
 Price based on standard cost
34.13 COSTING AS TOOL FOR DECISION MAKING
 Cost accounting enables cost determination, planning & cost control, cost
reduction and providing information for decision making
 Costing to assist important decision making for cost control, profit planning
and performance evaluation
34.14 SPECIFIC DECISION AREAS
• Pricing decision, make or buy decisions, evaluation of capital expenditure
proposals, choosing profitable product mix, alternative use of production
facilities
34.15 PRICING DECISION
 use of costing methods (job costing or process costing) for ascertaining cost
incurred
 pricing based on analysis of cost behaviour into variable cost & fixed cost
34.16 MAKE OR BUY DECISION
 Costing method/technique employed to ascertain cost of making
parts/components for comparison with cost of buying from outside source use
of marginal costing technique.
34.17 EVALUATION OF CAPITAL EXPENDITURE
PROPOSALS
 Use of costing method/ technique for ascertaining expenditure required for
capital expenditure proposals for compare with estimated benefits flowing
there from.
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34.18 CHOOSING PROFITABLE PRODUCT MIX
 Ascertaining product-wise contribution to decide on optimum product mix for
multi-product manufacturing units. Application of product-wise contribution
concept.
 Use of contribution technique for finding most profitable methods of
manufacture or use of plant facilities.
34.19 WHAT IT IS?
 Additional cost incurred to make one more additional unit
 Proper appreciation of cost behaviour by segregating cost into variable portion
and fixed portion.
 Variable cost considered as relevant cost & expressed as per unit cost.
 Fixed costs considered as period cost. Carry over of fixed cost from one period
to another not allowed.
 Excess of sale value over marginal/ variable cost termed as contribution.
 Fixed cost being sunk cost not taken into account for computing contribution.
 Contribution computed per unit of limiting factor as profitability index.
34.20 COST CONTROL
 Marginal or variable cost being proportional to output is amenable to
management control.
 Fixed cost being policy dependent not controllable in short term.
34.21 PROFIT PLANNING
 Enables profit planning on rational basis by use of contribution technique, costvolume profit analysis & break even analysis.
34.22 PERFORMANCE EVALUATION
 Enables performance evaluation on comparative scale by product-wise
contribution or contribution per unit of limiting factor
34.23 PRICING DECEISION
 Marginal cost provides the limit for pricing under recessionary or competitive
market conditions as short term measure for survival.
34.24 MAKE OR BUY
 Marginal cost of manufacture vis-à-vis market price provides basis for make or
buy decision when capacity exists for own manufacture.
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34.25 EVALUATION OF CAPITAL EXPENDITURE PROPOSAL
 Assessing investment proposals by use of marginal cost concept/ contribution
analysis.
34.26 PRODUCT MIX
 Selecting most profitable product mix by use of product-wise contribution
analysis.
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CHAPTER
35. Standard Costing and Variance Analysis
35.1 Standard Costing:
35.1.1 Specification and Uses:
Standard cost Accounting is a development of the early 20th century. It grew out of a
feeling among business executives that the backward look at cost provided by the
historical cost system was inadequate. It become apparent that actual costs were not
useful enough for price setting, planning or controlling operations. Something more
was needed to reflect current operating deficiencies and, consequently, the standard
cost system emerged. Its first description appeared in the U.S.A. in 1908, a little after
the introduction of scientific management of F.W. Taylor, Gantt, etc. Standard
costing signifies an organized set of procedures for using scientifically determined
estimated costs as statistics for comparison against actual costs.
35.1.2 Definition
Standard costing is a technique or a principle which uses standards for costs and
revenues. The purpose is control of costs through variance accounting. A standard is
a predetermined measurable quantity set in defined conditions. It is a benchmark or
norm. It follows, therefore that standard costs are formal estimates of cost.
35.1.3 General Purposes
The two general purposes of a standard cost system are: (i) to provide data for
product costs, and (ii) to provide information for planning and control decisions.
Standard costing emphasizes product costing. In addition, standard costs provide a
budgetary benchmark against which actual performance can be compared. Actual
costs are compared with standard or target costs, and differences are analyzed to
provide guidance for management.
35.1.4 Mere Tool
Standard cost accounting will not itself exert control over costs. It is only a
management tool. The control must emanate from management through analysis and
interpretation of the standard cost data. Standard costing provides the fact – the
indices of performance. Management must follow through with the corrective action
required.
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36. Budgeted vs. Standard costs
A mature costing system is the combination of budgeting and standard costs. The
combination gives the expected cost of production under normal operating
conditions. A plan of budgetary control is successful install in concerns having
standardized production processes and operating under a standard cost accounting
system. While standards are closely related to budgets, the two are not identical. A
budget is a comprehensive forecast of probabilistic future results that has been
formalized into a plan. A budget is obtained by multiplying standard costs by the
planned level of output. A standard is a cost level that should be achieved by efficient
working under prevailing conditions.
Budget is a concept, but standard is an unit concept. ‘A standard cost is a predetermined unit cost, while a budget refers to total cost’. A standard cost is a unit
measurement, literally a basic building block of manufacturing budgets. That is,
while a budget is prepared for an organization as a whole and its each department and
section and as such is a financial plan; standard cost is set for each unit of production.
Budgets are statements of expected costs, while standard show what costs could be if
desired performance was attained.
37. Setting Cost Standards
Standard product cost specifications are established for all the three major
components of cost. These relate to raw materials used in making a product, direct
labour needed to perform a manufacturing operation, and manufacturing overhead
applied to an unit of output. But they may also be laid down for the output of certain
non-manufacturing activities such as sales and administration as well as for the output
of some service departments in the manufacturing area.
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Chart Showing Construction and Subsequent
Use of Standard Costs
Engineering department releases drawing to
Manufacturing
Department
Tools & Layout
Production
Control
Specifications
Purchasing
Quotations
Operating
Standard
Time and
Methods
Accounting
Department
Accounting
Information
Standard Cost Committee Calculates Standard Material
Cost, Standard Labour Cost, Application of Proper
Overhead, Application of Normal Allowances
Result: Standard Cost
Budget Committee Setting Prices and Production
Sales
Department
Manufacture
Divisions
Estimating
Department
Accounting Department
Costing and Computing
Variances
38. STANDARD COST CARD
At the heart of a standard cost system is the standard cost card or sheet the
scientifically predetermined estimate of what one unit or product should cost if
efficiently produced. It includes detailed estimates of material quantities and prices,
labour quantities and rates, and Factory overhead quantities and rates. These details
serve as the benchmarks of efficiency against which actual quantities and costs are
compared. This focus upon the efficient cost of producing one unit requires and
emphasis on the relevant range of activity concept. The type of standard cost card
used varies with the requirements of the individual firm; hence no uniform format can
be presented. But these cards are so arranged that they may be revised from time to
time and that the revisions can be shown in columns adjoining the column containing
the original standard estimates.
38.1 Types or Levels of Standards
38.1.1 Theoretical Standards:
These assume operational perfection and the highest levels of goal attainment. They
suggest that resource acquisition and use occurs under the most favourable conditions
with regard to prices, production efficiency, and capacity utilization. Personnel and
physical facilities are expected to perform at peak level.
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38.1.2 Currently Attainable Standards:
These are reasonable estimates of what costs should be in a short period of time.
38.1.3 Basic Standards:
These signify the standards which are established for use over a business cycle or a
long period of time. These are based upon certain assumed levels of efficiency,
economic conditions and other factors of a durable nature. Basic standards are set up
on the basis of normal capacity volume that is not expected to change over a
relatively long period.
38.1.4. Historical Standards:
Historical standards are set on past experiences. These are established on some
average of past production costs and are based upon what might be termed normal
capacity.
39. Advantages and Uses
The term “standard” has an inherent psychological value which induces people to
reach goals. It has more qualitative appeal and impact than the words “budget” or
“plan”. When a standard is specified, individuals may be expected to associate it with
the need for some required-effect. All standards attempt to monitor costs and measure
efficiency. The main purpose of standard costing is to provide bases for control
through variance accounting. As such, standard costs confer several benefits to the
organization which could be spelled out as bellow: 1.
2.
3.
4.
5.
6.
Simplification of cost calculations and record-keeping.
Surrogate for performance evaluation.
Cost control and education.
Informed decision-making.
Facilitates integration of accounts
Effective delegation of authority:
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Top management (delegates)
Authority (assigns)
Responsibility (requires)
Accountability

VII. Builds Budgets. Standard costing furnishes valuable data to
management for formulating future production forecasts.
VIII. Motivation. Standard costs are potentially effective as
motivational devices. They can be used to improve company
performance as they are easily understood.
IX.
Principle of exception. The last but not the least advantage of standard cost
system is the adoption of the “principle of exception”. This principle assumes
that only those activities are worthy of executive attention which fail to come
up to standard. Management may establish acceptable tolerances, and then
investigate only the important off standard conditions.
40. Limitations and Objections: a.
b.
c.
d.
Difficult to practice
Expensive start-up
Revision expensive and troublesome.
Dysfunctional consequences.
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41. STANDARD COSTING AND VARIANCE ANALYSIS
41.1. VARIANCE ANALYSIS
The deviation of the actual from the standard is known as “Variance”. The
variance may be favourable or unfavourable (i.e., adverse) depending upon the
circumstances. For example, in case of cost variances, if the actual cost is more
than the standard cost, it is something unfavourable and, therefore, it will be
said that there is an adverse variance. In a reverse situation, where the standard
cost is more than the actual cost, the variance will be termed as favourable.
However, in case of sales variances, things are different. If the actual sales are
more than the budgeted sales, the variance will be termed as favourable. On the
other hand, if the budgeted sales are more than the actual sales, the variance
will be termed as adverse.
COST VARIANCES
The Cost Variances can be put in the form of the following chart:
Cost Variances
Direct Material
Cost Variance
(DMCV)
Direct Labour
Cost Variance
(DLCV)
Overhead Cost
Variance
(OCV)
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DIRECT MATERIAL VARIANCES
Direct Material Cost Variance
It is the difference between the standard cost of direct materials
specified for the output achieved and the actual cost of direct
materials used.
Direct Material Cost Variance (DMCV)
Direct Material
Price Variances (DMPV)
Direct Material
Usage Variances (DMUV)
Direct Material Price Variance
It is that portion of the direct material cost variance which is due to
the difference between the standard price specified and the actual
price paid.
Direct Material Quantity or Usage Variance
It is that portion of direct material cost variance which is due to the
difference between the standard quantity specified (for the output
achieved) and the actual quantity used.
Direct Material Usage Variance (DMUV)
Direct Material
Mix Variance (DMMV)
Direct Material
Yield Variance (DMYV)
Direct Material Mix Variance
Material mix variance represents the variations in cost arising as a
result of change in the ratio in which the different materials are
used, compared to the standard fixed for the purpose.
Material Yield Variance
It is that portion of direct material usage variance which is due to the
difference between the standard yield specified and the actual yield
obtained.
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DIRECT LABOUR VARIANCES
Direct Labour Cost Variance
It is the difference between the standard direct wages specified for
the activity achieved and the actual direct wages paid.
Direct Labour Cost Variance (DLCV)
Direct Labour
Rate Variance (DLRV)
Direct Labour Efficiency
Variance (DLEV)
Direct Labour Efficiency (Time) Variance
It is that portion of the direct labour (wages) variance which is due
to the difference between the standard labour hours specified for the
activity achieved and the actual labour hours expended.
Direct Labour Efficiency Variance (DLEV)
Direct Labour
Mix Variance (DLMV)
Direct Labour
Yield Variance (DLYV)
Direct Labour Mix (or Gang Composition) Variance. This variance
arises if during a particular period, the grades of labour used in
production are different from those budgeted.
Labour Yield Variance. It is the variance in labour cost on account
of increase or decrease in yield or output as compared to the relative
standard.
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Total Direct Labour Efficiency Variance
In those cases where there is an idle time variance together with
mix variance and efficiency variance, the classification of Direct
Labour Efficiency may be done as given in the following chart
Total Direct Labour Efficiency Variance (TDLEV)
Direct Labour
Efficiency Variance (DLEV)
Direct Labour Mix Variance
(DLMV)
Idle Time Variance
(ITV)
Direct Labour Yield
Variance
(DLYV)
OVERHEAD VARIANCES
Overhead Cost Variance (OCV)
It is the difference between standard overheads for actual
output, i.e., Recovered Overheads and Actual Overheads.
Overhead Cost Variance (OCV)
Variable Ov. Cost Variance
(VOCV)
Fixed Ov. Cost
Variance
(FOCV)
Variable Overhead Cost Variance (VOCV). It is the difference
between Standard Variable Overheads for actual output (or
Recovered Variable Overheads) and Actual Variable Overheads.
Fixed Overhead Cost Variance (FOCV). It is the difference between
Standard Fixed Overheads for actual output (or Recovered Fixed
Overheads) and Actual Fixed Overheads.
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Variable Overhead Cost Variance (VOCV)
Variable Overhead Expenditure
Variance (VOEXPV)
Variable Overhead
Efficiency
Variance (VOEFFV)
Variable Overhead Expenditure or Spending or
Controllable Variance (VOEPXV). This variance is due
to the difference between variable overhead rate and
actual variable rate for the actual time taken.
Variable Overhead Efficiency Variance (VOEFFV). This
variance is due to the difference between standard hours
for actual output and the actual hours taken at the
standard variable overhead rate.
Fixed Overhead Cost Variance (FOCV
Fixed Overhead Volume
Variance (FOVV)
Fixed Overhead Expenditure
Variance (FOEXPV)
Fixed Overhead Expenditure or Budget or Controllable
Variance (FOEXPV). This variance is due to the difference
between Budgeted Fixed Overheads and the Actual Foxed
Overheads incurred.
Fixed Overhead Volume Variance (FOVV). This variance
arises on account of difference between standard and actual
output resulting in under or over-recovery of fixed overheads.
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Fixed Overhead Volume Variance (FOVV)
Fixed Overhead Efficiency
Variance (FOEFFV)
Fixed Overhead Capacity
Variance (FOCAPV)
Fixed Overhead Efficiency Variance (FOEFFV).
FOEFFV
= Ov.
Std. Fixed
×
Rate per hour
Std. Hours for
 actual
production
– Actual Hours

= Recovered
Fixed Overheads – Standard
Fixed Overheads.
Or
Fixed Overhead Capacity Variance (FOCAPV)
= Std. Fixed Ov.
Rate per hour
FOCAP
Or
=
×

Actual Hours
Worked
–
Budgeted
Hours
)
Standard Overheads – Budgeted Overheads.
Calendar Variance. It is a part of capacity variance.
Std. Rate per hour or per day × Excess or deficit hours or day worked.
Revised Capacity Variance.
Revised Capacity Variance = Capacity Variance – Calendar Variance
Alternatively,
Revised Capacity
Variance
=
Standard
Overheads
–
Possible
Overheads
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SALES VARIANCES
The sales are affected by two factors:
(i)
the selling price and
(ii)
the quantum of sales.
Sales variances can be understood with the help of the following
chart:
Sales Variances
With reference to Turnover
With reference to Profit
Value Variance
Value Variance
Price
Volume
Mix
Price
Qty.
Volume
Mix
Qty.
41.2 With reference to turnover
41.2.1 Value Variance:
The difference between budgeted sales and actual sales results in value
variance.
41.2.2 Price Variance:
It is on account of the difference in actual selling price and the standard selling
price for actual quantity or sales.
41.2.3 Volume:
The variance is as a result of difference in budgeted and actual quantities of
goods sold.
41.2.4 Mix Variance:
When more than one product is manufactured and sold, the budgeted sales of
different products are in a given ratio. If the actual quantities sold are not in he
same proportion as budgeted, it would cause a mix variance.
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41.2.5 Quantity Variance:
It is the difference between budgeted sales and the revised standard sales.
42. WITH REFERENCE TO PROFIT
Value Variance:
Value Variance = Budgeted Profit – Actual Profit
Price Variance:
Price Variance = Standard Profit – Actual Profit
Volume Variance:
Volume Variance = Budgeted Profit – Standard Profit
Mix Variance:
Mix Variance = Revised Standard Profit – Standard Profit
Quantity Variance:
Quantity Variance = Budgeted Profit – Revised Standard Profit
In case the revised standard profit is more than the budgeted profit, it shall be a
favourable variance and vice versa.
43. CONTROL OF VARIANCES
After the variances have been analyzed, they shall be reported to management as to
the extent of favourable and unfavourable due to various causes. Cost reports
presented to management would clearly indicate where the scope for action lics.
Management would take corrective action so as to control the adverse variances.
Responsibility shall be assigned to persons concerned in case of adverse variances
resulting because of factors which were within the control of business. The factors
like changes in market conditions, demand and supply position, etc., are beyond the
reach of management and hence responsibility cannot be placed for such
uncontrollable factors. The management would try its level best to bring down the
actual costs to the level of standard costs and will apply a system of strict inspection
and supervision for effecting cost control.
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CONTROL OF VARIANCES
In case of controllable factors, the responsibility can be assigned as shown below to
the different departments for different reasons of variances.
Variances
Materials
Price
Quantity or Grade
Waste, Scrap or Spoilage
Wages
Rate – for difference in rates for
work requiring higher rates of pay
Time- lack of proper
supervision
Overheads
Volume
Efficiency
higher rates of indirect workers
higher prices of indirect materials
higher consumption of indirect materials
Excessive expenditure in factory
Excessive expenditure for selling
and distribution
Sales
Price and Volume
Department to be held responsible
Purchasing Department
Stores Purchase or Process Deptt., as the
case may be
Production Department (for lack of
proper supervision)
Personnel Department
Production Department
Production Department
Sales Department
Production Department Expenditure:
Personnel Department
Purchasing Department
Production Department
Production Department
Selling Department
Selling Department
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