CHAPTER 1
INTRODUCTION
Meaning of cost, costing and cost accounting
Cost : It means the total of all expenditures incurred on the production of an
article.
Costing: It is the techniques and process of ascertaining costs. it enable the
management to know the total cost and each elements of cost of a product. It
has been defined by Wheldon as, “ the classifying, recording and appropriate
allocation of expenditure for the determination of the costs of products or
services, and the presentation of suitably arranged data for purposes of
control and guidance of management.
Cost accounting: It is the accounting system set up for recording costs. It
begins with the recording of income and expenditure and ends with the
preparation of statements and reports of costs.
Object of costing :
The important objects of costing are:1.
To ascertain the costs.
2.
To control the costs by setting standards.
3.
To provide the basic for the formulation od policies by the
management.
Advantages of costing
The advantages of costing may differ according to the type and
efficiency of the costing system adopted. Some of the important advantages
of a good system of costing are as follows:
1.
It helps the management to eliminate the less or unprofitable activities
by disclosing them.
2.
It reveals the exact cause of losses or inefficiencies and then, helps to
improve the efficiency.
3.
It provides information upon which estimates tender are made.
4
It guides future production policies.
5.
It enable the periodical determination of profits or losses without
stock taking
6
7.
8.
It helps in controlling costs by providing information for comparison
of costs and the application of standard costing and budgetary
control.
It provides an efficient check on stores, labour and machine.
It guides the management in fixing the prices properly and to take
decision regarding various matter like the profitability (1) purchase or
production of a component, (ii) acceptance of an order below cost,
(iii) proposed capital expenditure, (iv) use of different machine and
methods of manufacture.
Necessity of importance of costing:
A good costing system is an invaluable aid to the management”. This
statement is true because the costing system helps the management in
carrying out its functions by the following ways :
1.
Classification and subdivision of costs: The costs are collected and
collected and classified into various element which helps the
management to ascertain the profitability of each activity and to
control them.
2.
Control of materials, labour and overhead costs: The cost
accounting helps the management to excise control over the materials,
labour and overhead costs by the application of various techniques.
3.
Business policies : It guides the management in taking decisions
regarding various matters connected with the production and sale of
goods.
4.
Budgeting: It us a co-ordinate plan of action. it helps to correct
inefficiencies before they enter into the business.
5.
Standard costing: It provides the basis for the measurement of
efficiency and future planning.
6.
Price determination: It provides the reliable cost data to get
maximum output at minimum cost.
7.
Maximum use of resources: It provides the reliable cost data to get
maximum output at minimum cost
8.
Expansion programmers: The expansion policies can be decided
only on the basis of cost data.
9.
Instrument of control: The costing is an instrument for planning and
controlling the activities of an undertaking to achieves the desired
results.
Other factors: It also informs the management about the optimum
profitability, seasonal variations, idle time and capacity etc.
Thus, it is clear from the above that the system of cost accounting in
an organization helps the management in the formulation of policies, their
execution and comparison of actual with the estimated. Such comparison
helps to appraise the policies and to effect changes if necessary. So, it is
rightly remarked that costing is an invaluable said to the management.
Objections to costing accounting:
1.
Unnecessary: Without the help of costing industries prepared in the
past. So, it is argued that the introduction of costing is unnecessary
and waste.
2.
Inapplicability: There is no separate system of costing applicable to
all types of industries. Hence, it cannot suit the requirements of many
industries and inapplicable to such industries.
3.
Defective: It has been proved as a defective system in many cases
sine it fails to produce the desired results.
4.
Expensive: It is quite an expensive system. Therefore, big industries
alone can adopted it with advantages.
DIFFERENCE BETWEEN
Financial Accounting
1.It provides general information
about the profit or loss and financial position of a business.
2. These accounts are required by law
3. It classifies and records the expenditure accounting
accounting
to their nature
4. It does not provide any type of control.
5. It gives reports usually at the end of the yr.
6. It records the total costs.
7. It relates to trading transaction of a business.
8. It is based on actual facts and figures.
9. It show all the expenses.
10. It reveals the profit or loss of the entire business.
line of pro
11. In Brief, it is the accounting system for the whole
business.
Cost Accounting
1.It provide information to the management
for planning
execution and control of activities.
2.These accounts are kept voluntarily
3. It classifies and records the expenditures
to their purpose
4. It provides a detailed system of control.
5. It gives reports as and when required.
6. It records the unit costs also.
7. It relates to manufacturing transactions.
8. It is mostly based on estimates.
9. It shows only the production expenses.
10. It reveals the profit or loss of a particular
deducing
11. It is only a part of the financial accounts.
Installation of cost accounting
The following steps should be taken at the time of introducing a
costing system in an organization.
1.
The nature of business and the process of operations carried on should
studied.
2.
The costing system should be designed in such a manner to suit the
specific requirements of the business.
3.
The degree of accuracy desired and frequency and regularity of
supplying cost data to the management should also be determined
before designing the costing system.
4.
The system of costing should be simple and easily understood by the
operators.
5.
Before it is put into effect, its benefits should be clearly explained to
all the people connected with it to obtain their co-operation.
6.
It should be introduced gradually and smoothly without much
disturbance to the existing organization.
7.
The relative profitability of the amount to be spent and the benefits to
be obtained from the introduction of a costing system should also be
considered.
8.
The cost department should function independently. It should have
easy access to the other departments which helps it to understand their
problem and to take corrective action.
Problem in installing a costing system and suggestion to overcome them
1.
2.
3.
4.
Lack of support from top management: In most of the cases, this
system has been introduced without the full co-operation of the
management. As a result, it has not been implemented successfully. In
order to overcome this difficulty, the cost accountant must obtain the
full support of the management before its introduction.
Resistance from the existing staff: The existing staff may feel that
the introduction of a new system may effect their importance and
hence, they cannot support it. In such cases, the new opportunities that
they will get from its introduction should be well explained to them.
Shortage of trained staff: There may be shortage of staff trained in
cost accounting at the time of to introduction. Such shortage can be
avoided by giving proper training to the existing staff.
Heavy cost of operation: The cost of operating this system is heavy
unless it is designed accounting to the specific needs of a concerns.
5.
After installation os a costing system, there must be proper
supervision. The cost accountant should also take as much effect as possible
to make the system successful and to achieve the desired results.
Method of costing
1.
Job Costing: This system is adopted in industries where each job has
a separate identity and are produced against specific orders. The costs
are collected for each job separately under this system. it is also
knowas lot costing, Specific or production order.
2.
Construct Costing: It is similar to job costing. But requires a long
period for completion. It is applied in industries engaged in
construction works. Under this system, a separate account is opened
for each contract and each contract is considered as a separate cost
unit.
3.
Batch costing: This method is adopted in industries where the goods
are produced for stock and for sale to the customers in general. Under
this method, the costs are computed for a batch or lot instead of a job
in job costing. The unit cost is calculated by dividing the total cost of
a batch by the number of units produced in that batch. it is suitable for
industries producing components and spare parts for assembling
finished products.
4.
Process costing: The system adopted to ascertain the cost of each
process of production is known as process costing. It is suitable for
industries where a product passes through different processes for
completion. In other words, it is a system adopted in industries where
the finished product of one process is the raw materials of the next
process. This system is suitable for industries like cotton textile,
paper, sugar, chemical and mining.
5.
Unit or output or Single costing: This method is suitable for
industries where manufacturing is continuous and the units are
identical. It is applied in industries like mines, quarries, oil drilling,
breviaries, brick works etc. The unit cost is determined by dividing
the total cost by the number of units produced.
6.
Operating costing: This system is employed in undertakings
performing service rather than producing goods like transport and
power supply companies, hospitals, hotels etc. This method is used to
ascertain the cost of performing the service.
7.
Multiple costing or composite costing: This method is the
combination of two or more costing methods. This is suitable for
industries where a number of component parts are separately
produced and subsequently assembled into aa final product e.g.,
industries manufacturing cycles, automobiles, radius, typewriters etc.
Type of costing:
1.
Uniform Costing: When the same costing principle and practices are
used by several concerns for the common control or comparison of
costs, it is know as uniform costing.
2.
Marginal costing: it means the ascertainment of marginal cost by
differentiating between fixed and variable costs and of the effect on
profit due to changes in volume or type of output.
3.
Standard costing: It is the preparation of standard costs and applying
them to measure the carnations from standards. it analyses the causes
of variations with a view to maintain maximum efficiency in
production.
4.
Historical Costing: Under this costing the costs are not
predetermined but are ascertained after their occurrence. Therefore,
hte costs are not available in time to correct inefficiencies and to
control costs.
6.
Direct costing: The practice of charging all direct costs to the
products in know as direct costing. Under this system, the indirect
costs are written off against the profit of the period.
ELEMENTS OF COSTS
Direct materials: All those materials which can be easily identified as
chargeable to a particular product, job or process, are know as direct
materials. Examples: Timber used in furniture’s, paper used in note books
etc.
Direct Labour: All those laborers who can be easily identified as
attributable to a particular job, production process are know as direct labour.
The wages given to them are known as direct wages. Example: Workers
directly engaged on production.
Direct or chargeable expenses: All those expenses which are incurred
specifically for a particular job, product or process are know as direct
expenses. Examples : Expenses on drawings, models, design, excise duty,
royalty etc.
Overhead: Indirect materials, indirect labour and indirect expenses are
collectively know a “Overhead”
The students are advised to render the chapter “Overhead” for details.
Concept of cost
Cost unit : It is a unit product or service or time in terms of which costs may
be computed, e.g., per tonne in case of coal, per meter in case of cloth etc.
Cost centre : It is a part of an undertaking for which costs may be
ascertained. So, it bay be location like a department or an area or an item of
equipment like lathe or a person like salesman, foreman.
CLASSIFICATION OF COSTS
1)
According to variability :
1.
Fixed costs or period costs are those costs which remains
constant irrespective of the volume of output e.g., factory rent,
insurance etc.
2.
Variable costs or product costs are those costs which will vary
in direct proportion to the output, e.g., direct materials, direct
labour, power etc.
3.
Semi-variable costs are those costs which are partly fixed and
partly variable, e.g., telephone charges.
2)
Accounting to controllability :
1)
Controllable costs are those costs which are not within the
control of management e.r., rent of building
3)
According to normality
i)
Normal cost : It is normally incurred at a given level of output
and it forms part of the of cost production.
ii)
Abnormal cost : It is not normally incurred at a given level of
output and therefore, it is charges to costing profit and loss
account.
4)
According to managerial decision :
i)
Marginal cost : It is the total variable cost comprising of prime
cost and variable overheads.
ii)
Out of pocket cost : It is a cost which gives rise to cash
expenditure.
iii) Differentials cost : It is the change in costs due to change in the
level of activity or method of production.
iv) Sunk costs : It is a cost which cannot be recovered due to the
permanent closure of a plant.
v)
Shut down costs : It is the cost incurred on the plants kept idle
due to the temporary suspension of activities.
vi)
Imputed costs or notional cost : It is the cost in respect of which
no actual expenditure is incurred e.g., rent of won building,
interest on capital etc. Therefore, it appears only in the cost
accounts.
Replacement cost : It is the cost at which an asses can be
vii)
replaced.
viii) Opportunity cost : It is the cost which may be earned from the
alternative use of a productive capacity.
ix) Avoidable cost : It is the cost which can be eliminated on the
discontinuation of a product or department, e.g., salary of clerks
in that department.
x)
Unavoidable cost : It is the which cannot be eliminated on the
discontinuation of a product or department, e.g., salary factory
manager.
Expenses and incomes excluded from cost accounts :
The total cost of a product should include only those items of
expenses which are a charge against profits. The other items of expenses
which are relating to capital assets, capital losses, distribution of profits and
items of pure financial nature should not form part of the cost.
The following items of expenses and revenuers are to be excluded
from the cost accounts:
Expenses :
1.
Abnormal waste of materialism idle time, bad debts and other
abnormal expenses.
2.
Interest on capital and borrowings.
3.
Loss on sale of capital assets.
4.
Discount and commission on issue of shares and debentures.
5.
Preliminary expenses.
6.
Fines and penalties.
7.
Dividend paid.
8.
Income –tax and super taxes.
9.
Goodwill written off.
10. Charitable donations.
Revenues:
1.
Profits from the sale of fixed assets.
2.
Transfer fee received.
3.
Rent received.
4.
5.
Dividends received.
Interest on back deposits.
Cost sheet/Statement of cost/production statement
It is a statement showing the total cost of a product or job in detail. It
also shows the various elements of cost and cost per unit.
Advantages of cost sheet
1.
It helps in fixing up the selling price
2.
It is useful for determining the estimated prices for tenders or
quotations.
3.
It enable the manufacturer to control and minimize the cost.
4.
It is useful for the formulation of production policies.
Specimen of a cost sheet or statement of cost (and profit) for the period ending ...............
Particular
Direct material:
Opening stock of raw materials
add purchases
add Purchases expenses
Less purchases
Direct labour
Direct expenses
Prime cost
Add factory overhead or works overhead
(Factory on cost or works on cost)
......................
.....................
.....................
Less Scrap realised
Details
Cost per unit
Rs.
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
---
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
Add opening stock of work in progress
Less closing stock of work in progress
Factory cost or works cost
Add office and administrative overheads
......................
.....................
.....................
Total Cost
Rs.
XXX
XXX
XXX
---
Cost of production
Add Opening stock of finished goods
Less Closing stock of finished goods
Cost of goods sold
Add Selling and distribution expenses
Cost of sales or total cost
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
-XXX
--XXX
XXX
XXX
Profit
Sales
XXX
XXX
XXX
XXX
Notes :
1.
Unit cost column is to be provided only when it is requires to showt he cost per unit. Otherwise it
is not necessary.
2.
Cost per unit is to be calculated for all the figures papering in the total cost column except the
opening and closing stock items.
3.
Cost per unit of each item.
upto cost of production = Cost of the concerned item
No. of units produced
4.
Cost/profit per unit from cost of goods sold to sales = Cost / amount of the concerned items
No. of units sold
5.
When the value of closing stock of finished goods is not given, it is to be calculated in the
following manner:
6.
6.
Cost of production
x No of units in closing stock
No. of units produced
Meaning of scrap : It is the residue from the materials used in the process of manufacture. The
scrap may be realized without further processing. Such realized value of scrap is credited to profit
and loss account or job account.
Meaning of spoilage : The loss due to defective goods which cannot be rectified economically is
known as spoilage. If spoilage is normal, it is treated value of scrap is credited to profit and loss
account or job account.
Quotation or tender
It is a statement quoting the price for a job or product which is to be produced to show the cost of
production of the products currently manufactured in a factory. IN brief, quotation is a statement prepared
to show the price to be quoted for the supply oof commodities in future.
I Quotation for a Product
Generally the direct items will be given for the preparation of this statement. But the indirect
items/overheads will not be given. Therefore, they have to be absorbed on the following bases.
1.
Factory overhead is to be absorbed on direct wages i.e., in the following manner :
Factory overhead in the cost sheet X Wages in the quotation
Wages in the cost sheet
2.
Office, selling and distribution overheads are to be absorbed on work cost i.e., in the following
manner :
Office, Selling overhead in the cost sheet X Works cost in quotation
Works cost in the cost sheet
II Quotation for a different quantity of the same product produced at present
For the preparation of this statement, the various elements of cost are to be absorbed in the
following ways:
1. Fixed Cost : The same amount given in the cost sheet is to be taken,
2.
Variable cost :
Concerned cost in the cost sheet X No. of units for which the price to be quoted
No of units produced at present
Note : Direct materials, direct labour and direct expenses are always 100% variable. Only n
overheads there may be fised or variable cost.
3.
Semi-Fixed or Semi-Variable cost : The fixed portion of this cost will be given fixed treated and the
variable part will be given variable treatment.
Production Account : The details of cost or production are given in an account form i.e., in ‘T’ form. It is
know as production account.
CHAPTER II
MATERIALS
Purchasing : It means procurement of materials, supplies machines, tools and services required for the
equipment, maintenance and operation of a manufacturing concern.
Purchasing Procedure
1. Preparation of purchase requisition :
The purchase requisition is prepared by the head of the department in need of materials and then
to the purchasing department. Usually, it contains the name of the department requiring materials,
description of materials i.e., the quality and quantity, time and place of delivery.
2. Obtaining quotation : On the basis of purchases requisitions, the purchasing department should make
arrangements for getting quotations from various suppliers.
3. Placing of orders :After comparing the quotations, the order should be placed with the supplier who
offers favorable terms. The order should contain the price, quality, quantity, time and mode of delivery
of goods and the grounds for rejections.
4. Follow up an inspection : Follow up is an act of reminding the supplier in fulfilling his terms of sale.
When materials are delivered, they should be inspected as to their quality and other specifications
continued in the purchase order. If there is any difference, that should be returned or intimated to the
supplier.
Importance of purchasing :
i)
The careful purchase of goods will leads to efficient working of the concern.
ii)
The purchase of goods at low prices reduce the cost of production which in turn will increase the
sales and profits.
iii)
The plant capacity can be utilized fully due to the uninterrupted supply of materials.
Store – keeping :
In any organization, there is a time gap between purchases and production and then, production
and sales. During that period, the materials or goods should be protected from fire, theft and obsolescence.
For which, they should be kept in a safe place which is know as store keeping. It also includes issue of
materials in proper way. The term stores refers to the materials, supplies, tools and finished goods.
Duties of store keeper:
1. He should receive the materials and other items required for production from the purchase manager
and the finished goods.
2. He should keep the stores safely and issue them whenever they are required.
3. He should maintain proper records for the receipt and issue of stores.
4. He should issue the stores only against a properly authorized requisition.
INVENTORY OR MATERIALS CONTROL
Meaning
Inventory control means the safeguarding and maintaining of inventories at optimum level by
taking into consideration the production requirements and the financial resources of the business. The term
inventory includes all materials in stock like raw materials finished and semi-finished goods, crap etc. the
proper control over materials will reduce the cost of production since it forms major proportion of cost of a
product. This control over materials is normally, exercised over purchases, storage and consumption of
materials.
Objects
1. To ensure minimum utilization of financial resources without affecting the operational needs.
2. To avoid break down in production dur to shortage of materials.
3. To reduce the risk of loss through obsolescence, theft, fire and damage.
4. To male purchases economically.
5. To ensure prompt delivery of finished goods ordered.
6. To submit accurate materials reports to the management in time.
ABC Analysis
The ABC method is an analytical method of stock control. It aims at concentrating efforts on those
items where attention is needed most.
Under this system, the materials stocked may be classified into a number of categories according
to their importance. Their importance is determined on the basis of their value and frequency of
replacement during a period. The first category called as ‘A’ items may consists of only a small percentage
of total items handled but of high value. The second category called as ‘B’ items, may be relatively less
important. In the third category called as ‘c’ items all the remaining items of stock may be included.
Advantages :
1. Closer and stricter control of those items which represent a major portion of total stock value.
2. Investment in inventory can be regulated and funds can be utilized in the best possible manner.
3. Saving in stock carrying costs.
4. Helps in maintaining enough safety stock for ‘C’ category of items.
5. Scientific and selective control helps in the maintenance of high stock turnover.
LEVEL OF INVENTORY
1. Maximum level : It is the level above which the stock of any item should not generally be allowed to
go. The formula for computing this level is as follows:
Maximum level = Re-order level + Re-order quantity – (Minimum consumption x Minimum
re-order period)
2. Minimum level : It is the level below which the stock should not normally be allowed to fall.
Minimum level = Re-order level – (Normal consumption x Normal re-order period)
3. Ordering level or re-order level : It is the level of material at which a new order for material is to be
placed.
Re-order level – (Maximum consumption x Maximum re-order period)
4. Danger level : It is the level at which the normal issue of materials should be stopped and the issuers
should be made only under special orders.
Danger level = (Average consumption x Maximum time for emergency purchases)
5. Average stock level : It can be calculated by adopted the following formula:
Average stock level = Minimum level + Maximum Level
2
or
Minimum level +1/2 re-order quantity.
Economic order quantity or Re-order quantity:
It is that size of the order which gives maximum economy in purchasing any materials and
ultimately contributes towards maintaining the materials at the optimum level and at the minimum cost.
EOQ = 2AB
CS
EOQ = Economic order quantity
A = Annual Consumption
B = Buying cost per order
C = Cost per unit of material
S = Rate of storage and carrying cost.
Perpetual inventory system
It is a method of recording stores balance after every receipt and issue to facilitate regular
checking to avoid closing down for stock taking. It facilitates the maintenance of upto date stock records
and continuous stock taking.
1.
2.
3.
It is carried out with the following three ways
Bincard : A card is attached to each bin, drawer or shelf containing materials. It is know as Bin card.
It shows quantities of materials received, issued and in stock and other details of materials. It helps
easy reference.
Stores ledger :This ledger contains and account for each item of materials in stock. It gives a
continuous information of materials received, issued and in hand at any time in quantity as well as in
value.
Continuous stock – taking : Under this system, a certain number if items are verified physically every
day. The items for checking should be selected in such a way that each item of materials gets checked
upo in a year. The verification will be done by counting the items actually and comparing them with
the bin-cards and stores ledger.
Advantages of perpetual inventory system
1. It avoid the delay and heavy cost involved in stock taking at the end og the yr.
2. The difference are easily located and rectified.
3. Due to continuous checking, it keeps the staff regular and honest.
4. Since the stocks are kept within the limits, the working capital is not affected or blocked in stores.
5. Over stocking and under stocking can be avoided.
6. It serves as system of internal check and facilitated the continuous checking of stores.
Turnover of materials or inventory :
It indicates the rate of consumption of materials. It enables to locate the slow or non moving
materials and to avoid the stocking of the same. The following formulas are to be considered in this respect.
Materials turnover = Materials consumed during the period
Average inventory
Materials consumed = opening stock + purchases – closing stock
Average inventory = opening stock + closing stock
2
Pricing the issue of materials
The materials may be issued at actual cost or at standard cost or at market price.
I Standard cost
The important method by which the materials issues are priced at actual cost are as follows :
1) Specific cost method : When materials are issued to the jobs for which they have been purchased, they
are priced at the exact cost. Such pricing of materials is know as specific cost method.
2) Average cost method : Under this method, materials issues are valued at the average of the unit cost
of materials in the different lots in hand. Although it is a simple method, it often shows inventories at
absurd values.
3) Weighted average method : Under this method, the average price of materials for pricing the issues is
computed in the following manner :
Average price = Value of materials in hand + Value of materials received
Number of units in hand + Number of units received
This method stabiles the costs when the prices fluctuated and therefor it is widely accepted. But
the draw is that it does not reflect the current condition and it requires detailed clerical work.
4) FIFO method : Under this method, materials issued are priced at the cost of the oldest consignment of
materials on hand as if the materials first purchased are issued first. Then the quantity issued is not
covered entirely by the oldest consignment on hand then the cost of the next oldest consignment can be
used for the uncovered part of the issue.
It is a simple method and it makes the cost of production fluctuating from to time and some times
shows the inventories at higher figures.
The demerit of this is that it makes the cost of production fluctuating from to time and some times
shows the inventories at higher figures.
5)
LIFO method :Under this method, the issues are priced at the unit cost of the most recently
purchased lot. If such lot is exhausted, the issues are prices at the unit cost of the immediately
preceding lot and so on.
The cost of goods manufactures will represent the current market price. But the inventories will
not represent the current prices. This method may result in increase or decrease in profit due to the decrease
or increase in the price. But the inventories will not represent the current prices. This method may result in
increase or decrease in profit due to the decrease and increase in the price levels.
5) HIFO Method : Under this method, materials issued are prices at the highest cost of the materials on
hand. This method is not widely accepted.
6) Base stock method : It is a method conjunction with anyone of the above methods. But in this method,
a certain quantity of stock will be kept as base stock and shown in the balance of each day. In other
words, this base stock should be shown as balance without utilizing it for the issue of materials.
II. Standard cost :
It is a predetermined price fixed for a particular period after taking into account certain factors like
the trend of prices, normal quantity ti be purchased etc. it is only an estimated price and therefor it should
be revised as and when necessary to correspond with the actual costs.
III. Replace or market cost :
In this case, the material issues are priced at the market rate on the date of their issues. So it may
result in an unrealized profit or loss. The determination of replacement price is also a difficult task under
this case.
Materials loss
1. Wastage : The materials lost in the process of manufacture without any realizable value is
know as wastage. It includes the loss of materials due to evaporation, shrinkage and
unrealizable residues. Examples : Unrealizable gas, smoke and residue etc. It may be normal
or abnormal wastage. For details about normal and abnormal wastage, refer the chapter
‘Process costing’
2. Scrap : Refer
3. Spoilage : Refer
4.
Defectives : The defective materials which can ne economically rectified are known as
defectives. The expenses incurred for such rectification should be added with the cost of
production.
SPECIMEN FORMS
1.
Purchase requisition
It is prepared by the head of the department in need of special materials and by the stores-keeper
for regular materials and then forwarded to the purchasing department.
Standard Motors Ltd.
Purchase Requisition
Department or Job no : Requisition No:
Date
Serial Description of
No.
Articles
Requested by …………………..
Stores
Code no
Quantity
required
Remark
Approved by ……………..Purchase officer
2.
Purchase order
After receiving the purchase requisition, the purchase manager should invite quotations from
different suppliers. Then, he should select a supplier and issue a purchase order to him in the following
form.
RequistionNo :
Quotation No :
Standard Motor Ltd.
Purchase order
Order No :
Date :
To
…….. (Name and address of the supplier)
Please supply the following items of materials in accordance with the terms and condition on the
reverse of this order:
Serial No
Description
Quantity
Rate
Amount
Dater of deliver………….
Place of delivery ………..
Terms of payment………
Purchase officer…………
3.
Goods received note
The goods / materials supplied by the supplier will be received and checking by the ‘Receiving
and Inspection department’ or by the store-keeper. Then, the details of materials received will be entered in
the stores or goods received note
Standard Motors Ltd
Purchase order no:
Name of the Supplier:
Delivery note no.
Date of delivery
SL No
Description
Goods Received Note
GRN No:
Date :
Code No
Received By ………
Inspected by……….
Quantity
Rate
Amount
Remarks
Posted by…………
Approved by…………..
4.
Materials or stores requisition
The materials will be issued by the store-keeper only against stores requisitions prepared and
submitted by the production departments in need of materials.
Standard Motors Ltd.
Stores Requisition
Department or job no:
SI No
Description
No:
Date :
Code No.
Qty
For cost office use
Rate
Amount
Remarks
Authorized by…………….. Received by…………….Bincard No………………
Issued by…………………. Checked by……………. Stores ledger Folio………………….
5.
Bill of materials
It is a list of various materials required by the production department for a particular job. At the
time of starting a job, all the materials required to complete the job are listed in this bull and sent to the
production department. It is a kind of master requisition. It servers as a specific materials requisition for a
given job.
Standard Motors Ltd.
Bill of materials
Job No : No :
Date :
SI No
Description
Drawing officer…………..
Code No.
Qty
For cost office use
Rate
Amount
Priced by ………….
Remarks
Received by………………
Store keeper………………
Stores ledger Folio………………..
6.
Materials return note
The surplus materials from a job or department will be returned to the store accompanied by a
materials return note. It is similar to stores requisition. Therefor, it is printed in a different colour paper to
identify it.
7.
Materials transfer note
When surplus materials of one job is to be transferred to another job, a materials transfer note
should be prepared by the department where there is such surplus.
Standard Motors Ltd.
Materials Transfer Note
Issuing Dept/Job No:
Receiving Dept./Job No :
SI No
Description
No:
date :
Code No.
Qty
Authorized by……………..
Issued by…………….
For cost office use
Rate
Amount
Remarks
Received by………….
Priced by ……………
8.
Materials abstract
In order to ascertain the materials cost of each job. All the stores requisition stores returned notes
and materials transfer notes are analyzed at the end of each period. There documents are classified
according to the departments and shown in a separate document. This document is know as materials
analysis sheet or materials abstract.
Materials
requisition
or transfer
note or
return note
no.
Jon Nos.
151 Rs.
152 Rs.
153 Rs.
154 Rs.
155 Rs.
Total
9.
Bin Card
For details, refer page no : 24
Standard Motors Ltd.
Bin card
156 Rs.
Over
Heads
Total
Rs
Rs.
Name of the Article
Code No
Unit
Stores Ledger Folio
Re-order Level
Date
Receipt
G.R.N
No
:
:
:
:
:
Bin Card No
Bin No
Maximum Level
Minimum Level
Re-order Quantity
Balance
Verification
Issues
Qty
S.R
No
Qty
Qty
Date
Remarks
:
:
:
:
:
Goods on order
No. and
Date of
Date of
Qty
goods
order
received
11. Stores Ledger
For details, refer page no :
Standard Motors Ltd.
Stores Ledger
Name of the Article
Code No
Unit
Re-order Level
Date
:
:
:
:
Receipt
G.R.N
No
Bin No
Maximum Level
Minimum Level
Re-order Quantity
Issues
Qty
S.R
No
Balance
Qty
Qty
Verification
Date
Remarks
:
:
:
:
Goods on order
No. and
Date of
Date of
Qty
goods
order
received
CHAPTER III
LABOUR
Labour Cost
It includes the following items of expenditure incurred on workers by the employer.
a) Monetary benefits : It includes basic wages dearness allowance, employer’s contribution to provident
fund and E.S.I. Scheme, production bonus, profit bonus, pension, retirement gratuity.
b) Fringe benefits : It includes subsidized food and housing to the workers, subsidized education to their
children, medical facilities, holidays, pay and recreational facilities.
Types of labour
Direct labour : It is the labour directly engaged in the production of goods. It can be easily allocated to a
particular job, product or process. The cost of this labour forms part of prime cost.
Indirect Labour : It is the labour which indirectly helps the direct labour engaged in production. Its cost
cannot easily be allocated or identified. The cost of this labour will be included in the overhead. E.g.,
supervisors, storekeeper, watchmen etc.
Control over labour costs
The ascertainment of cost of production and the recovery of overheads are wholly based on the
labour cost. Therefore, the control of labour cost is an important object of management. The achievement
of this object depends upon the proper employment and efficient utilization of labour force.
1.
2.
3.
4.
5.
The labour costs are controlled by the co-ordinated efforts of the following departments:
Personnel department which is concerned with the selection, training and placement of the labour
force.
Time recording department which is concerned with the recording of time of each worker for the
purpose of time keeping and time booking.
Engineering department which maintains control over working conditions and production methods for
each job and department.
Pay roll department which prepares and maintains the accounts for labour costs.
Cost accounts department which is responsible for the accumulation, classification and analysis of all
labour costs.
Time booking
It means the recording of time spent by a worker on each job or work order during the period of
attendance in the factory. It objects are,
1) to ensure that the time for is properly utilized,
2) To find out the labour cost of each job
3) To ascertain and control the idle time.
The time booking is normally done by the use of, a) Daily time sheet (b) Weekly time sheets (c)
Job tickets or job cards.
Time keeping
It means recording the time of presence of each worker inside the factory. It is useful for the
calculation of wages and for maintaining discipline over the attendance of workers.
Methods of time keeping
Manual methods:
1) Attendance register or Muster Roll :It is a register kept at the factory gate for entering the time of
arrival and departure of workers. It may be filled up by the workers or by the time keeper. It is only a
simple method adopted in small factories. It may lead to dishonest practices.
2) Token or disc method : Under this method each worker is allotted a disc or token bearing his
identification number. All these discs are hung on a board kept at the gate. As and when every worker
enters the gate, he removes his disc and place it in a box kept for the purpose. The box is removed
immediately after the scheduled time. The late comers will have to report to the time keeping office for
recording the exact time of his arrival. The disc still left on the board represent the absentees. Then ,
the attendance is recorded in a register with the help of disc in the back. This method is also defective
and create the chances of fraud and mistakes.
Mechanical methods :
1. Times clock method : Under this system, every worker is identified by a card. The attendance is
recorded by the use of time clocks on the cards.
2. Dail recorder system : Under this system, the time is recorded on an attendance form by pressing the
dial arm into a hole which denotes the number of a particular worker.
3. Key recorder system : Under this system, the attendance is recorded by inserting a key bearing the
number of a worker in the key hole.
Pay roll accounting
It is a part of accounting system in an organization. It is concerned with the determination of
wages for the workers and recording them in the books of accounts. In large concerns, there is a separate
pay roll department for the purpose of computation and payment of wages. The main function of this
department is to prepare the payroll or wage sheet showing the gross and net wages payable to the workers
along with the deduction made.
Idle time
Idle time may be defined as that time for which wages are paid but no production is obtained. It
represents loss of time due to lact ok materials, break down of machinery, power failure etc.
Causes of Idle Time:
a) Productive cause :
The productive causes which results in idle time are,
i)
Machine break down
ii)
Power failure
iii)
Waiting for the work
iv)
Lack of materials and tools
v)
Lack of proper instructions
vi)
Setting up of machines.
These productive causes can be avoided by way of proper planning in advance.
b) Administrative causes :The surplus capacity of plant and machinery may also results in idle time.
c)
Economic Causes :The seasonal nature of industries is also one of the reasons for idle time. This isle
time cannot be controlled.
Treatment of Idle Time cost :
The normal idle time cost is accounted by the inflation of wages rates. But the abnormal idle time
is charges to the costing profit and loss account.
Labour Turnover
Labour turnover may be defined as the number of workers left during the period in relation to the
average number of workers employed during the period. It denotes the change in labour force.
Measurement of labour turnover:
a) Separation rate method : Labour Turnover =
Number of separations in a period
Average number of workers in the period
x100
b) b) Replacement rate method : Labour Turnover = Number of separations in a period x100
Average number of workers in the period
c)
c) Flux rate method =
Number of separations + Number of replacement x100
Average number of workers in the period
Causes of labourturnover :
A minimum labour turnover is common and is good for all industries. But an excessive or high
labour turnover is dangerous. Such labour turnover may be dure to following reasons.
Avoidable causes
1) Seasonal fluction.
2) Lack of proper planning
3) Dissatisfaction with the job
4) Lack of proper amenities and benefits to workers.
5) Strained relationship.
Unavoidable causes:
1) Ratirement or death
2) Charge of workers for better performance.
Effects of high labour turnover:
The high labour turnover will increase the cost of production by two ways,
1. Preventive cost
2. Replacement cost
Preventive costs refer to all those expenses incurred by a firm to keep the labour force.
Replacement costs refer to all all the losses arising due to new labour force and the cost of recruitment and
training of the new workers.
Labour productivity:
The labour productivity indicated the efficiency of workers. It denotes the power to produce
goods. It is normally calculated by dividing the total output by the total man – hours.
Overtime works:
It is a work beyond the normal working time. And extra payment at double the rate of normal
wages will be given for overtime work. It will increase the cost of production. Therefore, it should be
avoided as far as possible. Generally, overtime cost is charged to costing profit and loss account.
Casual Labour :
Casual labourers are the temporary workers appointed for short period to,
a) Increase the production temporarily
b) Fill up the vacancies arising out of leave taken by the workers.
Out workers :
These workers perform their work for the factory outside the factory premises. They get their
remuneration on the basis of finished goods produced by them out of the materials taken from the factory.
Therefore, proper control control must be exercised on them regarding the supply of materials, quality of
finished goods and delivery of work within the scheduled time.
Time study
The time study is an art of observing and recording the time required to do each detailed element
of an industrial operation. This analysis involves the following points:
1)
2)
3)
4)
The worker for this purpose should have average efficiency.
The standard cost fixed may change and differ from industry to industry.
The person who observes the time study must be very careful.
The standard cost should include necessary rest, accidental and unavoidable delays.
The time study finds out the differences between efficient and inefficient workers and then
provides solution for the improvement of inefficient workers.
Motion study
The method employed in determining the best way to handle the work is know as motion study.
There are 17 fundamental motion which are alwayus combines with every human activity. Such study helps
the elimination of unnecessary movements of workers and avoids the wastage of energy.
Job evaluation
It means scientific assessment of the content of each job and the demands made by it on a normal
worker. In other words, the value of each job depends on certain factors. Therefor, job evaluation involves
the measurement of these factors. The values assigned to all these factors in each job are added up. On the
basic of such values, the difference in basic wage rate for different types of jobs are determined.
The important methods of job evaluation are as follows:
1) Ranking method : Under this method, the jobs are arranged in the order of importance.
2) Job classification method : this method involves the establishment of job classes or grades for each
grade or classes, there is a different rate of pay.
Advantages of job Evaluation :
1)
It provides a rational wages structure.
2)
The information collected through job analysis facilitates merit rating, selection, training,
improvement of working conditions and control of labour cost.
3)
It simplifies wage administration.
4)
It helps to settle the disputes and grievance regarding individual rates of wages.
5)
It brings out uniformity in wage rates.
Merit Rating
Merit rating is a systematic evaluation of the personality and performance of each employee by his
supervisors or some other qualified persons. In other words, it rates or grades employees on their jobs on
the basis of an objective by a comparative review of their individual performances.
1)
2)
3)
4)
5)
The following factors are considered for rating the workers.
Ability to perform the work assigned.
Knowledge about his job, engineering and manufacturing a operations.
Work habits and personal characteristics.
Special qualities
Supervising ability.
Advantages of merit rating :
1.
It provides the basic for judging the conduct and performance of each worker.
2.
It brings to light the efficient and in efficient workers.
3.
It can be used as a fair and scientific basis for transfer promotion and discharge of workers.
4.
To develops a sense of competition among workers which is a right way for superior achievement.
Methods of labour remuneration
Time rate system
Under this system, wages are fixed and paid to the workers on the basis of time which may be
hourly, daily, weekly or monthly. (Wages = Time Taken x Time rate). This may be applied under the
following methods :
1) Time rates at ordinary levels : Under this system, wages are paid at a rate on the basis of time
irrespective of the work done by the worker.
2) Time rate at high levels : under this system, a time rate which is higher than the rate prevailing in that
area or industry is adopted to provide an incentive to the workers.
3) Graduated time rate : Under this method the wages rate may vary according to the changes in the
cost of living index.
Advantages
1)
If gives the workers a sense of security
2)
It simplifies the calculation of wages.
3)
It ensures the quality of goods produced.
Piece Rate system
Under this system, wages are pais at a fixed rate per unit of production without taking into account
the time taken to complete the work. (Wages = No. of units produced X rate per unit).
It is of the following types:
1) Straight Piece Rates : Under this method a fixed amount per unit of production is given to a worker
irrespective of time taken by him.
2) Piece Rate with guaranteed day rate : Under this method, a minimum wage is guaranteed to a
worker. Therefore,
Wages = Minimum guaranteed Wages
Whichever is higher
Or
Piece rate
Differential piece Rates :Under this method the rates of wages vary according to the level of output.
Advantages
i)
ii)
iii)
iv)
It ensure fairness to every worker.
It brings out the efficient and inefficient workers.
The cost of production can easily be calculated.
It does not require strick supervision
Incentives
All those things which may induce the workers to perform their duties efficiently are called
incentives. They may be in the form of money or in kind. Such incentives are given in addition to the
normal wages.
Kinds of Incentives
There are two kinds of incentives. They are explained as follows:
1.
Pecuniary or Financial Incentives:
Incentives given in the form of money are called pecuniary incentives. They may be direct or
indirect. The examples for direct pecuniary are additional wages, bonus etc.
2. Non-Pecuniary or Non-financial Incentives:
All the non – monetary benefits offered to the workers to encourage their activities are called nonpecuniary incentives. Such incentives are important for motivating the workers to carry out their duties
well. For example, provision of welfare facilities to the worker.
Incentives Plans of Wage Payments
1) Halsey Premium Plan :
This system is a simple combination of time wage and piece wage systems. The main features of
this system are,
a) A minimum wages to all the workers.
b) Standard time is fixed for the completion of a job.
c) Bonus or premium will be given to the workers for the time saved. It is fixed at certain
percentages in between 30% and 50%.
Illustration :
Problem :
Standard Time
=
10hours
Rate
=
Rs. 2- per hour
Rate of premium
=
50% of the time saved
Solution :
Total wages = (Time taken x Hourly Rate) + Premium.
Premium = Percentage of Premium x Time saved x Hourly rate
= 50/100 x 4 x 2 = Rs.4/then the worker will get (6x2)+4 = Rs.16/That is, he gets Rs.4/- more than he would have earned in the absence of this plan.
Advantages:
a. It is easy to understand
b. It encourages efficiency
c. It creates a feeling of security among workers.
d. The profit dure to increased efficiency id shard by both employees and employers.
2) The Rowan plan :
It is slightly different from Halsey plan. Its important features are –
a. A minimum wages to all the workers.
b. Standard time is fixed for the completion of a job.
c. Premium is given on the basis of time saved. But its calculation will differ from the Halsey
plan. here, the bonus or
Premium - Time saved x Time taken x Hourly
Standard Time
Premium = 4/10 x 6 x 2 = Rs. 4.80
Thus, the worker gets 80 paise as excess premium than the Halsey plan.
Advantages:
1. It is more liberal than Halsey plan as it provides a higer premium.
2. It puts an automatic check on production through the formula. The advantages of Hasey plan
also apply to it.
Taylor’s Differential piece Rate system:
The important features of this plan are as follows:
a. Standard output is fixed after a careful study
b. Two or differential piece rates are fixed for the efficient and inefficient workers.
Illustration :
If a worker completes a standard output of 10 pieces within the allotted time, he will be given Rs.
1/- per piece or more as the case may be. On the other hand, if a worker completes less than 10pieces
within the allotted time, he will be given only 80paise per piece or less as the case may be. Suppose, if he
completes only 8units, he will get 8x80 paise i.e., Rs.6.40 and not Rs.8/-.
The efficient workers are properly rewarded under this system. But it is opposed by the workers
and trade unions because if affects the inefficient workers. Hence, it is only theoretical but not practical.
4)
Gant Bonus Plan:
It is otherwise known as Task Bonus System or Progressive Rate System. Its main features are,
a. It guarantees the day wage to all the workers.
b. Standard task is fixed after a careful study.
c. Bonus is paid to the worker who show 100% efficiency or more. The bonus will be in
between 20% and 50% of time taken.
Illustration :
Standard time
8hours
Hourly Rate
Re.1/Bonus
25% of the standard time.
Suppose, id a worker takes 9hours for completing te task he will not get any bonus, because he
failed to show his 100% efficiency. He will be paid 9x1 = Rs.9/- i.e.,
Time taken x hourly Rate.
At the same time, if a worker completes the task within 8hours, he will be given Rs.10/- which is
calculated as follows:
Total wages = (Time taken x Hourly Rate)+bonus
= (8x1)+(25/100x8)
= 8+2 = 10Rs.
Emerson’s Efficiency plan:
In this, a standard time is fixed for each job. A daily wages rate is guaranteed and a certain
standard output is fixed as representing 100% efficiency. The daily wages rate is paid without bonus to
those who show less than two third of efficiency or 66.66% of efficiency. Beyond this, bonus is paid on a
graded scale in a fixed ratio to increased output. For instance, persons who are 90% efficient may be paid a
bonus of 10% of the daily wage persons with 100% efficiency 60% bonus and so on. The merit of this
system is it encourages workers increasing their efficiency.
5)
6) Merrick Differential or Multiple piece Rate system :
Under this system, there will be three piece rates instead of two in the case of taulore’s scheme.
Here, the time wages are not guaranteed but the standard output is fixed. If a person produces less than 83%
of the standard output he will be paid the lowest piece rate (say 20paise per piece). If a person produce
more than 93% and less than the standard output, he will be paid secured piece rate which is higher by 10%
i.e 22 paise. Id a person reaches the standard or produces more than the standard output. He will be paid the
highest rate. The rate will be 20% higher than the lowest rate i.e 24paise. Thus under this system, the
efficient workers are paid more and the others are encouraged to improve their efficiency.
7) Group Incentive plans or collective bonus system:
Under this plan the worker is done by a group of persons and hence the incentives is provided to
the group as a whole. In other words, the premium or bonus is calculated for the group and disturbed to the
individuals on the fair and just basis. It encourages the spirit of teams work and co-operation. The difficulty
is that inefficient and efficient workers are getting the same. Hence, it fails to satisfy the efficient workers.
It also encourages shouldering habit which will not conclude the given task. The important schemes of this
plan are priestman scheme. The collective cost premium bonus system, the town gain sharing system and
the scansion plan.
Profit sharing
Profit sharing is an agreement under which the workers get a share in the net profits of the
business. But it is not a method of wages payment. The reason is a share in the profits is over and above
regular wages.
Features:
a. It is paid in addition to the normal wages
b. The worker., share in the profit is a predetermined one.
c. It is given only out of net profits when the net profit exceeds a certain limit.
d. It is usually given to all types of workers except a few at the top level.
Co-partnership
Co-partnership in an industry means the expansion of the idea of profit sharing to jointly
ownership. In otherwords, co-partnership is a scheme under which the workers are given are given not only
a share in the profits but also a share in the management.
SPECIMAN FORMS
1.
Wages abstract : It is a periodical statement prepared to chow an analysis of wages paid during that
period in relation to the time spent by the workers on different jobs.
Wages abstract
No:
Week ending………
Job no.
Job No
Job No
Job No.
Job No.
Cost
No. of
Overheads
Total
101
102
103
104
105
Ledger
Worker
Rs
Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
Folio
Prepared by……………………….
Posted by…………
Deductions
Wages
Earning
Gross
Wages Rs.
Hours
worked
Rates Rs.
No. of
workers
Name of
worker
2. Payroll / Wages sheet : For details, refer page no :
Payroll / Wages Sheet
Worker ………………
Foreman………………
:
:
For cost office use
Rate
Amount
Remarks
Costed by……………
Calculation of wages under various system of wage payment
I Time rate system
1. Normal Time rate system:
Earning or Wages = Time taken x Hourly rate
2. Guaranteed Time Rate System:
Wages = Time wages as above or Guaranteed wages, whichever is greater.
II Scheme of payment by result
A. Piece rate system
1. Normal piece rate system :
Wages = Output x Rate per piece.
2. Guaranteed Piece Rate system :
Wages = Wages as above (or) Guaranteed wages whichever is greater.
B. Bonus or premium or incentive system
1. Halsey Plan:
Wages = Time wages + Bonus
Note :
Time wages = Time taken x Hourly rate
Bonus = 50% of time saved x Hourly rate
Time Saced = Standard time – Time taken
2. Rowan Plan
Wages = Time wages + bonus
Note:
Bonus =
Time saved
x Time wages
Time allowed
Efficiency or standard
3. Gantt’s Task Bonus Plan
Others
Advance
recovered
Income tax
E.S.I.
P.F.
Others
D.A.
Bonus
Over time
Normal
Over
Times
Normal
3. IDLE TIME CARD : FOR DETAILS, refer Page No.
IDLE TIME CARD
Name of worker
:
Department
No. of worker
:
Period
Reasons for
Time
Idle time
From
To
Period lost
1. Waiting for materials & tools
2. Waiting for instruction
3. Power Failure
4. Machine break down
5. Other reasons
Wages
1. Below standard
2. At standard
-
3. Above standard
-
4.
Guaranteed time wage
120% x Time wages
(i.e. 100% time wages + 20% bonus)
Output x High piece rate
Emmerson’s Efficiency plan
1. Below 66 2/3% Efficiency
2. 66 2/3% to 100% efficiency
3. Above 100% efficiency
-
5. Taylor’s Diffecential Piece Rate system
1. Below Standard
2. At and above standard
(175% x Normal piece rate)
6. Merrick’s differential Piece Rate Plan
1. Below 82 ½ % efficiency
2. 83 1/3 to 100% efficiency
3. Above 100% efficiency
Normal time wages
120% x Time wages
120% + 1% bonus for every 1% efficiency
above 100% efficiency x Time wages
-
Low piece rate x Output Law piece rate
= (83# x Normal piece rate)
High piece rate x Output High Piece rate =
-
output x Normal piece rate
Output x (110% x Normal piece rate)
Output x (120% x Normal Piece rate)
7. Bedaux Point Premium System
Wages = (Point allowed + 75% of points saved) Rate per point
Note : 1.One pint or ‘B’ + One minute
2.Point saved = Points earned – Points allowed.
8. Barth Variable Bonus Plan
Wages = Rate per hour x time allowed x time taken
CHAPTER IV
OVERHEADS
The amount appoint by a concern in carrying on day today work except those on prime cost are
known as overheads. It includes indirect materials, indirect labour and indirect expenses.
Classification of Overheads
A) According to Function
1. Production or factory overhead : All indirect expenses incurred inside the factory are
treated as factory overheads. It is absorbed on this basis of direct material, direct wages, prime
cost, direct labour hours etc. Example : Repairs, depreciation, factory rent etc.
2.
Administration overhead : All indirect expenses incurred in the office for planning,
directing and controlling the activities of an organization are known as administrative
overheads. Examples : Office rent, office lighting and other office expenses.
3.
Selling overhead: All expenses incurred for the promotion of sales are known as selling
overheads. Examples : Commission, salesman, salaries, advertisement expenses etc.
4.
Distribution overhead : All the expenses incurred for the supply of finished goods to the
consumers are treated as distribution overheads. Example : Packing expenses. Ware housing
expenses, Transportation expenses etc.
B) According to element of cost:
1. Indirect materials : Fuel, Lubricants, tools for general use etc.
2. Indirect wages : Wages for maintenance and repairs, employer’s contribution of funds.
3.
Indirect expenses: Canteen expenses, depreciation, insurance, taxes, rent and rates atc.
All these three types of overheads are absorbed by or apportioned to various cost units. But these
overheads cannot be allocated.
C) According to Variability to Variability or Behavior:
1. Fixed overheads : The indirect expenses which remains constant upto a certain level of
production are known as fixed overheads. Examples : Office rent, manager’s salary etc.
However, these expenses will vary after a certain level of production or due to variation
in prices.
2.
Variable overhead: The expenses which varies according to the level of production are known
as variable overheads. According to the degree of variability there are three types of variable
overheads
i.
100% variable overhead.
ii.
Decrease in overhead when production goes up.
iii.
Increase in overhead when production goes up.
3.
Semi-variable overhead : the indirect expenses which are neither fixed nor variable in relation
to the level of production are known as semi-variable overheads. In other words, it is fixed as
well as variable (e.g) telephone Charges
Distribution of overheads
The distribution of overheads to various cost centers involves the following procedure
.
I.
Classification of overheads:
The overheads of similar nature should be grouped and classified in a convenient manner.
For this purpose, a system known as standing order number is adopted. Such number denotes particular
type of overhead. In other words, each type of overheads is given separate code number or symbol. A list of
all standing order number and their scope and details should be prepared for easy reference.
Examples of Standing order numbers:
S.O No 1. Consumable stores
S.O.No 2.Sundry materials.
II Collection of overheads:
The following are the main sources for which overhead expenses are collected.
a. Stores requisitions : It helps the collection if indirect materials from stores.
b. Job Cards : The job cards facilitate the collection of wages paid to indirect labours.
c. Vouchers and invoices : The payment to outside parties for the stores or other service is
collected through vouchers and invoices.
d. Cash book and journal entries : Other expenses like rent, interest etc., are collected normally
by examining the journal and cash book.
e. Subsidiary records : The overheads which are adjusted and which do not involve cash like
accrued expenses are collected from theses records.
III Allocation of overheads:
This is allotment of whole item of cost to cost centers or cost units. In other words, it is a process
of charging the full amount of cost to a cost center or a cost unit. The allocation can be done only when the
cost is definitely relates to a particular cost center.
(e.g.) Indirect materials, indirect labour etc.
IV Apportionment of overheads:
The expenses which cannot be allocated to cost centers are to be apportioned on some reasonable
basis. The determination of a reasonable basis depends upon the following principles:
a.
Service or use : If the service rendered by a particular item of expenses to different
departments is measurable, this method can be adopted.
b. Survey Method : Where the amount of service rendered cannot be measured, this method can
be adopted. The apportionment will be done on the basis of the survey made.
c. Ability to pay method: this method is usually applied where it is desired that overhead should
be distributed in proportion to the sales ability, income or profitability of departments,
products etc.
The basis adopted for the apportionment of overheads must ensure accuracy as far as possible. The
following are the common overhead distribution bases adopted.
Overhead Cost
1. Canteen expenses, time keeping, general welfare
expenses, compensation and other fringe benefits
2. depreciation of plants, machinery and
equipment’s, fire insurance.
3. Electric Light.
4. Electric power
5. Steam.
6. Heating, air-conditioning, rent, fire precaution
expenses.
7. Delivery expenses.
8. Tabulation.
9. Audit fees
Bases of distribution
Number of employees or wages
department.
Capital values.
for
each
No. of light pints, floor space, hours used watts.
Horse power, horse power multiplied by hours, kwh
Based on a consumption return or on potential
consumption.
Relative areas or volume of departments.
Weight, volume, ton, mile.
Hours used number of cards purchased etc.
Sales or total cost.
Apportionment of service department overheads
Apportionment to
Apportionment
Production as well as
to production
Service departments
department only
Simultaneous
Equation method
repeated distribution
Method
1.
Simultaneous equation method:
The total expenses of service departments are straight away transfer to production departments by
solving simultaneous equations under this method.
2.
Repeated distribution method :
Under this method, service department expenses are distributed to other departments, production
as well as service, on agreed percentages and this process is repeated until the figures of the service
departments comes to zero.
Absorption of overheads
The total overheads expenses of each department will be available often the apportionment of
overheads. The next stage is to find out the suitable basis for the absorption of proportionate overheads bu
the products passing through each department. The following are the usual bases or rates for the absorption
of overheads:
1. Direct materials cost percentage rate
2. Direct wages percentage rate
3. Prime cost percentage rate
4. Labour hour rate
5. Cost unit rate
6. Machine hour rate
1.
Direct Materials cost percentage rate:
It is calculated by dividing the amount of overhead to be absorbed by the direct materials cost
incurred or expected to be incurred.
Even though this method is simple, it can be adopted where the materials cost forms major parts of
the cost of production and when the materials prices are stanle. The greatest disadvantage of this method is
it ignores the time factor.
2.
Direct wages percentage rate:
It is calculated by dividing the overhead to be absorbed by the direct wages to be incurred.
This rate is suitable where the rates of pay and the grades of labours remain constant. However
this method is not suitable where the labour is not the main factor of production and where the workers are
remunerated on piece wage system.
3.
Prime cost percentage rate:
It is calculated by dividing the overheads to be absorbed by prime cost.
It is a simple method and takes into consideration both materials and labour element. Its
disadvantage is it ignores the time factor.
4.
Labour hour rate:
It is calculated by dividing the overhead to be absorbed by the labour hours expected.
It is applicable where labour is the main factor of production. It is an ideal method for absorption
of overheads because it make use of the time factor. However, it involves high cherical cost in recording
the labour hours spent on each job.
5.
Cost unit rate:
It is calculated by dividing the overheads to be absorbed by the number of units produced.
It is suitable for industries producing a single product.
6. Machine hour rate:
It is calculated by dividing the overhead to the absorbed by the number of hours a machine is used
for a particular job. In otherwords, it is the cost for running a machine per hour.
The expenses relating to the machine cost centers are allocated or apportioned on some reasonable
basis. Then, the machine hour rate is computed by dividing the total overheads for each cost center by the
machine hours.
It is the most accurate method of allotting overhead expenses. However, this method of allotting
overhead expenses. However, this method is not applicable where the operation of machines are limited.
Under or over absorption of overheads
The overheads absorbed according to predetermined rates may not be equal to the actual
overheads incurred. This will result in the under or over absorption of overheads.
When the actual overheads are more than the absorbed overheads, the overheads is said to be
under absorbed. Similarly, when the actual overheads are less than the overheads absorbed, the overheads
is said to be over absorbed.
Under or ever absorption of overheads may arise due to the following reasons:
1. Error in estimation overhead expenses.
2. Unexpected changes in the level or methods of production.
3. Seasonal fluctuations in the overhead expenses.
The under or over absorbed overheads will be adjusted in any one of the following ways:
1. Use of supplementary rates:
Under this method, the overhead distribution summary is revised by adding or deducting the under
or over absorbed overheads calculated on the basis of supplementary rates. The supplementary rate is
arrived at by dividing the amount oif over or under absorption by the actual basis i.e., total labour hours,
machine hours etc. this method is adopted when the amount of over or under absorption is large.
2. Write off to costing profit and loss account:
Under this method, the under or overabsorbed overheads are written off by transferring them to the
costing profit and loss account. This method is adopted when the difference in overhead absorption is very
small.
3. Carry over to the nest yr’s accounts:
Under this method, the under or over absorbed overheads are carried over to next year’s accounts.
It will be added to the cost of the ext period. Therefore, it is not a proper method.
Miscellaneous Topics
Control of Factory Overheads:
The overheads can be controlled by the following procedure :
1. Overheads should be classified and collected according to variability i.e., fixed, variable and
semi-variable.
2. The overheads must be budgeted for each class of cost and departments.
3. Necessary steps should to taken to find out the variation between actual and budgeted cost.
The causes for variation must be analyzed and reported to the management for corrective
action. In order to simplify this process, standard costing should be introduced.
Capacity cost:
In computing a predetermined overhead, the different levels of activities of a factory must be
determined. All such levels of activity or capacities are collectively know as capacity costs. The various
capacity costs are as follows:
1. Rate or maximum capacity : It is the maximum productivity or capability of a plant or department. It
can be achieved rarely when there is no loss of time in actual practice. Therefore, it is only an ideal or
the theoretical capacity.
2.
Practical capacity : It is the maximum capacity less unavoidable losses dur to repairs, breakdown,
holidays etc. however, is doesn’t takes into account the abnormal factors affecting production.
3.
Capacity based on sales expectancy: This is the capacity based on the sales expected and is determined
after a careful study of the market conditions.
4.
Actual capacity: This is the capacity based on the sales expected and is determined after a careful study
of the market conditions
5.
Actual capacity : It is the capacity actually achieved in a particular period
6.
Normal capacity : There are two views regarding normal capacity:
According to one view, it is the long term avcerage capacity based on expected sales. According to
another view, it is the capacity to make or produce.
The abject of normal capacity are:
a. Determination of pre-determined overheads.
b. Setting up of standards.
c. Fixation of budgets.
d. Control of costs.
e. Valuation of inventory.
7.
Idle capacity :
Idle capacity is that part of the capacity of a machine or equipment which cannot be utilized
profitably. In otherwords, it is the difference between the practical capacity and capacity based on expected
sales. For example, if the practical capacity of a machine is 100 units per hour and it produces only 75units
per hour, there is an idle capacity of 25 units per hour.
Causes of idle capacity:
1. Setting up repairs and other adjustments of machines.
2. Lack of power, materials and tools.
3. Strikes and lock outs/
4. Seasonal fluctuations.
Treatment of Idle Capacity cost:
The idle capacity cost is computed by multiplying the idle capacity by the normal rate. The idle
capacity is of two types.
1. Normal or unavoidable idle capacity, the cost of which is normally absorbed in cost account by the
inflation of rates.
2. Abnormal or avoidable idle capacity, the cost of which is charges to profit and loss account.
Administration overhead
Administration overheads are the indirect expenses incurred in formulating polcies, directing and
controlling the activities of an organization to achieve its objects. Examples : Stationery, telephone charges,
office salary, postage. Director’s fees, Auditor’s fees etc.
Treatment of Administration Overhead:
1. Transfer to profit and loss account: Under this method, the administration overhead is treated as a fixed
cost and therefore, transferred to costing profit and loss account of the period in which it ours. It is
based on the principle that the administration overheads are not directly related with production or
sales. The main drawback of this system is that ir leads to the under estimation of the cost of a product.
2.
Apportionment to manufacturing and selling division: Under this, the administration overhead is
divided between the production and sales departments on some reasonable basis. It is based on the
principle that each organization has only two functions, namely production and sales and all other
function are only incidental to these basic functions. The difficulty in this system is to find out the
basis for apportionment.
3.
Treatment as a separate item of cost: In this method, administration overhead is added separately to the
cost of a product. It is based on the assumption that the administration department in a separate
functioning department like production and sales departments
.
Selling and distribution overheads
Selling overhead:
All expenses incurred for the promotion of sales are known as selling overheads. Examples :
Commission, salesmen salaries, advertisement expenses etc.
Distribution overheads:
All the expenses incurred for the supply of finished goods to the consumers are treated as
distribution overheads. Examples : Packing expenses, warehouses expenses, transportation charges etc.
Difference between:
Selling overhead
Distribution overhead
1.
It promotes sales.
1 It moves the goods to the customer’s place.
2.
Its object is to find and retain customers.
2 Its object is to deliver the goods safely at the
required place.
Absorption of selling and distribution overheads:
These overheads may be absorbed under any one of the following methods:
i.
A percentage on the selling price:
A percentages of selling and distribution expenses to sales is determined and this
percentages is added with cost of a product.
ii.
A percentages on factory cost:
A percentage of selling and distribution expenses to factory cost is determined and this
percentages id added with the cost of a product.
iii.
Estimated rate per unit:
Under this method, the total estimated selling expenses is divided by the total number of
estimated units to be sold and thus the selling and distribution rate per unit is determined.
Control of Administration, Selling and Distribution Overheads.
The control of these overheads is possible by the use of budgets and standards. These overheads
should be classified and collected according tp their variability. The actual overheads should be compared
with their budgeted and standard figures and standard figures and deviations if any should be reported to
the management for corrective action.
CHAPTER V
JOB AND CONTRACT COSTING
Job costing
This system is adopted in industries when each job has a separate identity and are produced against specific
orders. The costs are collected for each job separately under this system. This method is also known as lot
costing, specific or production order.
Features
1. The goods are produced against customer’s order and not for stock.
2. There in no uniformity in the process of production.
3. Each job has a separate identity and needs special treatment.
4. The work in progress differs from period to period.
This system is applicable to engineering and printing works.
Advantages:
1. It enables the management to know the profitability of varioys jobs.
2. It helps the management to know the perating efficiency of different factores of production by
provideing the detailed analysis od cost and to control the same.
3. It enjoys the ennifits of budgetory control and provides the basis for future production planing.
4. It helps to redice spoilage and defective works.
Disadvantages:
1. It is expensive to record the costs for each job.
2. The jobs costing without budgetary control or standard costing is of no use in controlling costs because
it is only on actual costing or historical costing method.
CONTROL COSTING
It is similar to job costing. But requires a long period for completion. It is applied in industries
engaged in construction works. Under this system, a separate account is opened for each contract and each
contract is considered as a separate cost unit.
Work Uncertified
When any work done by the contractor has not reached a stipulated stage, the contractee’s
engineers will not certify that work. Such a work which is not so certified is known as work uncertified. It
will not be considered by the contractee while making payment to the contractor. However, the contractor
will record it on the debit side of work in progress account and credit side of contract account.
Work certified and Retention Money
The contractor receives money from to time on the basis of a certificate issued by an architect or
surveyor about the work completed. Such certified work is known as work certified.
The value of work certified will not be paid in full to the contractor. A part of it will be retained as
security as security for any defective work which may arise in future. Such retained amount is known as
retention money.
Cost plus contract
It is a contract entered into when into when the cost of materials and labour are not stable. Under
this contract, the contract price is arrived at by adding up a certain percentage of profit to the cost of work.
Advantages:
1.
2.
There is no risk of loss to the contractor as he is protected from price fluctuations. He knows
the profit expected from a contract in advance.
Since the contract price depends on cost, the contractee is ensured or reasonable price.
Disadvantages :
The contracteecannot ascertain the final price in advance. The contractor will loose the benefits
when the market conditions are favorable to him..
Escalation Clause
It is a clause provided in the contracts to cover up any change in the prices of materials, labour etc.
the object of this clause is to safeguard the interest of both the parties against unfavorable change in the
prices.
Work in Progress:
The work or contact which is incomplete is known as work in progress, in contract accounts, such
work in progress in calculated by deducting the profit kept as reserve from the cost of certified and
uncertified completed work.
Profit on incomplete contracts
To take profit into account on incomplete a contracts, the following precautions should be taken.
1. Sufficient reserves should be made for contingencies.
2. In case of contracts with government department the possibility of price refund should be considered.
3. The work which has reached a sufficiently advanced stage of completion alone should be considered.
Amount or profit to be transferred to profit and loss account.
The amount of profit to be transferred to P& L a/c during the contract in progress will be
calculated in the following manner:
1. When the contract is not reasonably advanced :
The contract is said to be not reasonably advanced when the work verified is less than ¼ of the
contract price. In such certified is less than ¼ of the contract price. In such case, no profit should be
transferred to profit and losses account.
2.
When the contract is reasonably advanced :
A contract is said to be reasonably advanced when the work certified is ¼ or more of the contract
price. In this case, the profit to be transferred to profit and loss account will be calculated by using the
following formulas:
1.
If the work verified is between ½ and 1.2 of the contract price : Estimated profit x 1/3 x Cash received
Work certified
2. If it is more than ½ of the contract price: Estimated profit profit x Cash received
Work certified
3. When the contract is almost complete:
In this case, the estimated profit is arrived at by debiting all the expenses 9insurred plus the
estimated future expenses) to complete the contract and by crediting the contract price to the contract
account. Then, the profit to be credited to profit and loss account will be calculated by using the following
formula:
Estimated profit x Work certified Cash received
Contract price
Work certified
National or Estimated profit
The estimated profit resulting from incomplete contracts in known as national profit. Such profits
is not an accurate profit since it is arrived at by taking into account the value of work in progress which is
based on estimates. Therefore, the national profit should not be transferred in full to the costing profit and
loss account. A part of it it must be kept as reserve in order to meet the contingencies.
Difference between Job costing and contract costing
Job Costing
Contract costing
1. It is a costing method for jobs which require only
jobs which require only a little capital and short
period for completion
2. it is suitable for industries like engineering,
printing etc.
3. It does not require elaborate accounts
4. There is no complication as regards the transfer
of profit from jobs to profit and loss account.
1. It is a costing method for jobs which require huge
capital require huge capital and long period for
completion.
2. It is suitable for construction works like
construction of buildings and bridges laying or
roads etc.
3. It requires elaborate accounts.
4. as regards incomplete contracts, there are number
of complications in determining the profit to be
transferred to profit and loss account.
CHAPTER VI
PROCESS COSTING
The system adopted to certain the cost of each process of production in known as process costing.
It is suitable for industries where a product passes through different processes for completion. In other
words, it is a system adopted in industries where the finished product of one process is the raw material of
the next process. This system is suitable for industries like cotton textile, paper, sugar, chemical and
mining.
Feature on process costing
1. The production is continuous.
2. The production is uniform.
3. The order of processing a process is specific and pre-determined.
4. The costs are collected process-wise.
5. The finished product of one process will be the raw material for the next process until the final product
is obtained.
Wastage’s or Losses
Normal Wastage or loss : It is an unavoidable loss in the process of manufacture. It may arise due to
evaporation, spoilage etc. the cost of such wastage should be absorbed by the good units produced.
Therefore, no separate treatment is necessary for normal losses in cost accounts.
Abnormal lsoss or wastage : The abnormal losses are avoidable but may arise due to negligence or
maladministration. Such wastage’s should be valued as like completed units and should be charges to
costing profit and loss account.
Abnormal gain
Sometimes, the production may exceed the expected one due to efficient and careful operation.
Such increase in production is known as abnormal gain. It will result from the reduction in normal loss.
It should also be calculated in the same manner as an abnormal loss but credited to costing P & L
a/c.
Inter_process Profit
This profit may arise then output from pone process to another process is transferred not at cost
price but at cost plus profit. The object is to make each process stand on its own efficiency and economies.
Nut this system involves unnecessary complication of accounts.
Joint product
When two or more products of equal impotence are simultaneously produced from the same raw
materials, such products are known as joint products. E.g. : Oil refining. Therefore, joint products, implies
the followings:
1.
2.
3.
They are produced from the same raw material.
They are comparatively equal importance.
They are produced simultaneously by a common process.
4.
They may require future process offer the point of separation.
By-Product
By products are products of comparatively small value that are produced simultaneously with a
product of greater value (Main product). Eg.Sugar and Molasses.
Scrape
It is the residue from the materials used in the process of manufacture. The scarp may be realized
without further processing. Such realized value of scrap is credited to profit and loss account or to the
concerned process or job account.
Spoilage
The loss due to defective gods which cannot be rectified economically is known as spoilage. If
spoilage is normal, it is treated as a part of cost of production. If the spoilage is abnormal, it should be
charged to costing profit and loss account.
Equivalent Production
It represents the production in terms of completed units. In other words, it means converting the
incomplete units into their equivalent completed units. Thus, it solves the problem of balancing work in
progress in each process. It came be ascertained by the following formula:
Equivalent units of work in progress = Actual number of units in process of manufacture x
Percentage of work completed.
CHAPTER VII
RECONCILIATION OF COST AND FINANCIAL ACCOUNTS
The accounting procedure adopted in financial accounts differ from those adopted in cost
accounts. As a result, the result or profits disclosed by these accounts may also differ. Therefore, it is
become necessary to reconcile there two accounts and to find out the reasons for the difference. Such
reconciliation ensures that no income or expenditure has been omitted or incorrectly recorded. It also
enables to that the accuracy of cost accounts.
Reasons for disagreement
1. Items recorded in differential accounts only like financial incomes (e.g) Interest and dividends in
investments and financial expenses (e.g.) interest on lean, damages paid etc. but these items will not
appear in cost accounts.
2. Items recorded in cost accounts but not in financial accounts like rent for own premises.
3. Under or over absorption of overhead expenses.
4. Adoption of different methods for stock valuation and depreciation,
Accounting procedure
Profit as per cost account
Add
: incomes omitted in cost account
Cost accounts only
Under valuation of closing stock and over valuation of opening
Stock in cost accounts
Less
: Incomes stated in cost account only
Expenses under stated or omitted in cost accounts
Over valuation of closing stock and under valuation of opening stock
Profit as per financial account
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
The above statement will be reversed when you will start with profit as per financial account.
Memorandum Reconciliation Account
When the reconciliation of cost and financial accounts is done in an account form instead of a
statement, such account is known as memorandum reconciliation account. In this account, the profit woth
which it is started should be shown as a first item on the right side. Then the items to be added with that
profit to be deducted should be written on the left side. The difference between the two sides will be a loss
or profit in the account apposite to the account with which the reconciliation account is started.