25 cost accounting

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BBA


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Cost Accounting Elements of Cost + Cost Concepts

Accounting and Control of Material Cost.

Labour Wage payment and incentive Labour Cost Control Labour Turnover.

Overhead Classification Allocation, Appointment and Absorption of overhead

Process Costing Process losses inter-process profits.

Standard costing Variance analysis

Cost Ledgers- Reconciliation of cost and financial profits Integral Accounting

Note : Atleast 6% of the total marks be allotted for problems.

Text and Reference Books:

1. Advanced cost Accounting : Jain and Narang.

2. Cost Accounting : N.K. Prasad

3. Cost Accounting : S.P. Iengar

4. Cost Accounting : Nigam and Sharma

5. Costing Adviser : P.V. Ratnam


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Contents

Lesson: 1 Introduction of Cost Accounting

Definition Cost Concepts Element of Cost Installation of Costing System

Lesson: 2 Material Cost

Nature Purchasing Functions Stores Control Stock Levels EOQ Pricing or Material Issues

ABC-Analysis Material houses.

Lesson: 3 Labour Cost

Nature Wage Policy Wage Payment methods Incentive schemes, Leson turnmen.Lesson: 4 Overhead Cost

Nature - Classification Allocation Apportionment of overhead cost Absorption of overhead:

methods, Machine Hom Rate method.

Lesson: 5 Job Costing and Batch Costing

Nature features Cost Sheet preparation Utilities Limitations.

Lesson: 6 Contract Costing

Features Types or Contract

Lesson: 7 Process Costing

Simple Process Costing Process with Normal and abnormal causes Inter process profit

Lesson: 8 Standard Costing and Variance Analysis

Definition Uses and Limitations Material Cost Variance Labour Cost Variance Overhead Cost

Variance and Sales Variance

Lesson: 9 Cost Ledger Accounting

Nature Control Accounts and its Uses Preparation of Cost Ledger Account

Lesson: 10 Integral Accounting

Nature Uses Preparation of Integral Accounts

Lesson: 11 Reconciliation of Cost and Financial Accounts Need for Reconciliation Steps in reconciliation

Preparation of Reconciliation Statement.


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Lesson: 1

INTRODUCTION OF COST ACCOUNTING

Cost Accountancy

It is the application of costing and cost accounting principle, method and techniques to the

science, art and practice of cost control and the ascertainment of profitability. It includes the

presentation of information derived there from for the purpose of managerial decision making.

The term Cost Accountancy includes Costing and Cost accounting. Its purposes are Cost-

control and Profitability ascertainment. It serves as an essential tool of the management for decision

making.

Cost Accounting

The process of accounting for cost from the point at which expenditure is incurred or

committed to the establishment of its ultimate relationship with cost centres and cost units. In its widest

usage it embraces the preparation of statistical data, the application of cost control methods and the

ascertainment of the profitability of activities carried out or planned Cost accounting means such

as analysis of accounting and other information as to enable management to know the cost involved in

each activity together with its significant constituent elements in order to arrive at proper decisions.Cost

accounting provides management with cost data relating to products, processes, jobs and different

operations in order to control the costs and maximize the earnings. It play a vital role in all the business

activities.

Definition of Cost Accounting

The application of costing and cost accounting principles, methods and techniques to the

science, art and practice of cost control and the ascertainment of profitability. It includes the

presentation of information derived these from for the purpose of managerial decision making.

Objects of Cost Accounting

1. To serve as a guide to price fixing of products.

2. To disclose sources to wastage in various operations of manufacture.

3. To reveal sources of economy in production process.

4. To provide for an effective system of stores and material.

5. To measure the degree of efficiency of the various departments or units of production.

6. To provide suitable means and information to the top management to control and guide the

operations of the business organisation.

7. To exercise effective control on the costs, time and efforts of labour, machines and otherfactors of production.

8. To compare actual costs with the standard costs and analyse the causes of variation.

9. To provide necessary information to develop cost standards and to introduce the system of

budgetary control.

10. It enables the management to know where to economize on costs, how to fix prices, how to

maximize profit and so on.


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TECHNIQUES AND METHOD OF COSTING

The types and techniques of costing are as follows:

1. Historial Costing:The ascertainment of costs after they have been incurred Historical costs are, therefore, postmortem

costs as under this method all the expenses incurred on the production are first incurred and them the costs areascertained.

2. Standard Costing:The preparation and use of standard costs, their comparison with actual costs and the analysis of

variance to their causes and points of incidence.

Here the standards are first set and then they are compared with actual performances. The difference

between the standard and the actual is known as the variance. The variances are analyzed to find out their causes

and also the points or locations at which they occur.

3. Marginal Costing:The ascertainment of marginal costs and of the effects on profit of changes in volumes or type of

output by differentiating between fixed costs and variable costs.

The fixed costs are those which do not change but remain the same, with the increase or decrease in the

quantum of production. The variables costs are those which do change proportionately with the change in

quantum of production.

The marginal costing takes into account only the variable costs to find out marginal costs. The

difference between Sales and Marginal costs is known as Contribution and contribution is an aggregate of

Fixed costs and Profit/Loss. So the fixed costs are deducted from the contribution to find out the profits.

Marginal costing is a technique to ascertain the effect on profits. Marginal costing is a technique to ascertain the

effect on profit by the change in the volume of output or by the change in the type of output.

4. Direct Costing:The practice of charging all direct cost to operations, process or products, leaving all the indirect costs to be

written off against profits in the period in which they arise

5. Absorption CostingThe practice of charging all costs, both variables and fixed, to operations, processes or products.

This is the traditional technique as opposed to Marginal or Direct costing techniques. Here both the fixed

and variables cost are charged in the same manner.

Methods of Costing

The methods of costing can be divided into three main groups:

1. Job Costing;

2. Process Costing; and

3. Farm Costing.


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1. Job Costing: The job costing methods are applicable where the unit of manufacture is one and

complete in itself. They include printers, job foundries, tool manufactures, contractors, etc. the

following methods are included in Job Costing:

(i) Contract Costing: This method if applied in undertakings erecting buildings or carrying outconstructional works, e.g., House buildings, ship building, Civil Engineering contracts. Here the cost

unit is one and completed in itself. The cost unit is a contract which may continue for over more than a

year. It is also known as the Terminal Costing, since the works are to be completed within a specified

period as per terms of contract or agreement executed by the contractor and contractee.

Contracts can be differentiated from fobs in as much as the contracts jobs are carried out outside

the factory and generally are of a long-term while jobs are carried out inside the factory and are

of a short duration. If an order complete in itself and meant only for the person who has placed

the order, this job-order is executed inside the press and the completion of the order takes a

short time as against the contract which may take years.

(ii) Batch Costing: In this method, a batch of similar or identical products is treated as a job. Herethe unit of cost is a batch of group of products, costs are collected and analyzed according to

batch numbers and the costs are ascertained batch wise. This method is applied in

pharmaceutical industries where medicines or injections are manufactures batch wise or in

general engineering factories producing components in convenient batches.

1. Process Costing: Process costing method is applicable to those industries manufacturing an number ofunits of output requiring processing. Here an article has to undergo two or more processes for reaching

the stage of finished goods and succeeding process till completion.

Classification of Cost

The cost-classification is the process of grouping costs according to their characteristics. The cost can

be classified into the following:

1. According to elements;

2. According to Functions or Operations;

3. According to Nature or Behaviour,

4. Accounting to Controllability,

5. According to Normality,

6. According to Relevance to decision-making and Control.

According to Elements: The cost is classified into i) Direct Cost, and ii) Indirect Cost according to

elements, viz., Materials, Labour and Expenses, the description of which occurs in the earlier pages of

this chapter.

According to Functions: the cost is classified into the following:

i) Production Cost or Manufacturing Cost,

ii) Administration Cost,

iii) Selling Cost, and

iv) Distribution Cost,


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A brief description of each these items are given below:

i) Production Cost is The cost of sequence of operation which begins with supplying materials, labour

and services and ends with primary packing of the product.

It is also known as Manufacturing of Factory Cost.

ii) Administration Cost is The Cost of formulating the policy, directing the organisation and controlling

the operations of an undertaking, which is not related directly to a production, selling, distribution,

research or development activity or function. Administration Cost comprise office andAdministration expenses.

iii) Selling Cost is The cost of seeking to create and stimulate demand (sometimes termed marketing)

and of securing order.

It is also known as Selling expenses or Selling overheads which include all the expenses of Selling

Department.

iv) Distribution Cost is The cost of sequence of operations which begins with making the packed product

available for dispatch and ends with making the re-conditioned returned empty package, if any,

available for re-use.

It is known as Distribution expenses or overheads which include expenses like packing, warehouseexpenses, cost of freight, shipping charges and also the expenses of re-conditioning the returning

empty packages for using them again.

According to Nature or Behaviour: Cost can be classified into

i) Fixed Cost ii) Variable Cost, and iii) Semi-Fixed for Semi-variable Cost.

i) Fixed Cost is A cost which tends to be unaffected by variations in volume of output. Fixed costs

depend mainly on the effluxion of time and do not vary directly with volume of rate of output.

Fixed Costs are sometimes referred to as period costs in systems of direct costing. Fixed costs or

Fixed expenses are those expenses which do not change with the increase or decrease in the

quantum of production but remain stable. They are period costs, e.g., Rent of Building, Salaries etc.

ii) Variable Cost is A cost which tends to vary directly with volume of output, Variable costs are

sometimes referred to as direct costs in systems of direct costing. Variable costs or expenses are

those which increase in direct proportion with the increase in production or which decrease in direct

proportion with the decrease in production, e.g., Direct Materials, Direct Labour, Power, Fuel etc.

iii) Semi-fixed or Semi-variable cost is A cost which is partly variable. This is a cost with changes but not

in direct proportion to the increase or decrease in the production-output, e.g., Repairs and

Maintenance, Salary of supervisors etc.

According to controllability: The cost can be divided into:

i)

Controllable Cost, ii) Uncontrollable Cost.

i) Controllable Cost: This is a cost which can be influenced by the action of a specified member of an

undertaking. The organisation is divided into departments or responsibility centres each managed by

a Head. The costs of a particular department or centre re guided by the person-in-charge of the

department. The costs which can be controlled by a specified member who is generally an

important link in the management are the controllable costs. they Head of a cost-centre or a

department ahs control over variable costs only which include Prime cost and other variable

overheads. So the controllable costs are the variable costs.


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v) Uncontrollable Costs: it is a cost which cannot be influenced by the action of a specified

member of an undertaking. Uncontrollable costs are generally the Fixed costs, the control of

which does nto lie within the province of a member of the undertaking. The change in Fixed

costs is a mater to be decided at the top level of the management depending upon the policy of

the undertaking. Another example of he uncomtrollable cost is where the cost of one department

is shared by the other department for reason that the other department is taking the benefit of

services of the department. Suppose, the cost of Power departments is shared by the Machine

Department, the cost of this share is uncontrollable as it has no control over the cost of the other

department, viz., the Power Department.

According to Normality:

The cost is classified into i) Normal cost, and ii) Abnormal cost

i) Normal Cost: It is the cost at a given level of output in the condition at which that level of output is

normally attained.

ii) Abnormal cost: it is a cost which is beyond normal cost.

According to relevance to decision-making and Control:

The costs classified on this basis are the following

i) Shut-down Cost: A cost which will still be required to be incurred even though a plant is closed or shut-

down for a temporary period, e.g., the cost of rent, rates, depreciation, maintenance etc., is known as

shut-down cost.

ii) Shun Cost: A cost which has been incurred in the past or sunk in the past and is not relevant to the

particular decision-making is a sunk cost. If it is decided to replace the existing plant; the written

down book value of the plant less the sale value of the existing plant, is a Sunk a Irrevocable cost.

iii) Opportunity Cost: The net selling price, rental value or transfer value which could be obtained at a

point in time if a particular asset or group of assets were to be sold, hired, or put to some alternative

use available to the owner at that time is the opportunity cost. The cost which are related to the

sacrifice made or the benefits foregone are opportunity costs. to take an example, if a part of thefactory building has been let out on rent and now we want to use that portion for installing a plant,

we would naturally lose the rent that we used to get. So the loss of rent is the opportunity which

would arise due to putting the part of that factory building to an alternative use available to the

owner, and this cost should be kept in view while installing the plant.

iv) Imputed cost: it is hypothetical cost required to be considered to make costs comparable. If the owner of

the factory charges rent of the factory to the cost of production to make cost comparable with that

of those undertakings which run production in rented factories, it is an Imputed cost as the rent has

actually not been paid. Some is the case with charging Interest on ones own capital.

COST-CENTRE AND COST-UNIT

Cost are ascertained according to Cost Centres or Cost Units.

Cost-centre

A Cost-Centre is a very wide term and includes the Productions. Department Processes, Work orders, Service

Department, Operations, Machine Centers, Area or regions of sales, Warehouses, Persons, etc., of which the

cost is to be ascertained. A Cost-Centre can be classified into the following four types:

1. Impersonal, 2. Personal, 3. Operation, 4. Process.


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For manufacturing operations, the cost centres may be Production cost centers, i.e., the Production Departments

engaged in producing, or the Service cost-centres, i.e., the Service Departments which help the production work

e.g., Store, Power Dept. Internal Transport Dept., Repairs and Maintenance Dept., etc.,

For sales operations, the cost-centres, all the machine or the persons operating those machines are brought

together under one cost-centre for determination and control of costs. where the work is carried on through

processes, each process is a cost centre. A machine or a group of machines can also be cost-centre. The Cost

Centres are very useful for analysis, ascertainment and control of costs.

Cost Unit

A Cost Unit is a unit of quality of product, service, or time (or a combination of these) in relation to which costs

may be ascertained or expressed.

Job is a cost unit which consists of a single order (or contract).

Batch is a cost unit which consists of a group of identical items which maintains its identity throughout one or

more stages of production.

Product Group is a cost unit which consists of a group of similar products.

Thus, cost unit is a sub-division into proper nomenclatures attributable to a unit of measurements of cost. Cost

Units are of two types: 1) Single. 2) Composite. The examples of Single Cost unit are-per tone, per meter, perkilogram etc., and the examples of composite units are-per passenger-kilometer, per tone-kilometer etc.

INSTALLATION OF COSTING SYSTEM

The need and importance of the installation and the organisation of a good system of cost accounting are being

increasingly realized presently all over the business versatility. The common experience of enthusiastic youths

climbing the business tree and falling mid-way without even collecting the leaves owes to the ignorance of he

use installation and organisatoin of accosting system, and to the infatuation that the profits could be earned

without it. A good system is the key-point governing, the mechanism of an enterprise in the field of cost

control, ascertainment of profitability, and managerial decision-making.

Installation of a cost system is not an expense but an investment as the rewards are much greater than the

expenses incurred. The cost system is for the business and not the business for a system of cost. Therefore, thesystem has to be so designed as to meet the specific needs of the enterprise.

A) General Consideration for installing Costing SystemThe general considerations to be observed in installing a costing system are as follows:

The Objective: Whether the objective of installing the costing system is limited to a specific area, e.g.

material management, or fixing selling price. Or to arrive at a certain managerial decision; or the object

is to install the system for covering all the aspects of cost affecting the business. The approach to install

the system will be dependent on its objectives.

The Area of Operation: Having decided the objective, the areas of operation of the system are to bestudied, by which the management can be best benefited. If production is slack, attention will have to be

paid to increase it; if production is good but the sales are receding, study will be made to increase the

sales and action taken according to the results of study and analysis. Such areas which require

immediate attention are to be carved out on priority basis to be handled by the cost system,

The Organisation of the Business: No system of cost installation would succeed until the organisation

structure of the business is taken into account. The organizational part would help to determine the

scope of working and improvement. If the interests of management call for certain minor changes in the

organizational structure, to its advantage, the same may have to be done.


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The Conception & Reception of the Idea: The idea of the installation of the cost system is to be placed

before the staff and the workers in a manner that it is well received and not objected to on flimsy

grounds. The success of the system would depend on the cooperation of he persons engaged in the

enterprise, and the cooperation will be forth coming only if the idea and plans are well conceived and

received. The benefits of introducing the system to all the sections should be well explained.

Collection of Data & Prompt Information: The cost data works as a base for decision-making. There

should be evolved a proper system for the collection of the required cost data and information promptly.

Secondly, there should be a system to verify the correctness of the data supplied, otherwise theconclusions drawn would be wrong and time spent in its working would go waste.

Cost Records & Cost Books: The maintenance of cost records and cost books depends on the size and

nature of the business, but the basic requirements. The manner in which the financial accounts could be

interlocked into an integral accounting system has to be studied and worked out. Decision has to be

taken if two separate set of books-one for financial accounts and other for cost accounts-have to be

maintained and thereafter the results are to be reconcile. Proper books and records are to be kept and

maintained to meet the requirements of either of the two situations mentioned above.

Control system for the Elements of Cost: System would have to be devised for recording and controlling

costs of materials, labour and overheads, in accordance with costing principles and procedures.

Type and Method of Costing: The choice of method of costing would depend on the nature ofproduction, e.g., Job Cost method or the Process Cost method. For cost control, standard costing along

with Budgetary control may have to be selected and applied. Similarly, for decision making, Marginal

and Differential costing techniques may be found useful. Preparations for the application of the

particular method and technique/type should be made initially.

Responsibility Accounting: Responsibility accounting is a technique of cost control by delegating, etc.,

known as responsibility centres. Its has to be judged whether a particular official who had been assigneda particular function, has implemented the same or not within the time allotted to him, or not, and thus

the responsibility has got to be fixed for failure-action on individual persons, for the sake of control of

cost. For this purpose, a system of responsibility accounting should be evolved.

B)

Specific considerations for installing costing system

The specific considerations as distinct from general considerations to be kept in view while installing a cost

system are as follows:

Size and Nature of Business: In a business of big size, a detailed cost system is necessary while in a

small business, the system should be within the requirements so that the expenses on the installation and

its working may not out-weigh the utility.

The cost system is good for business engaged in manufacturing or in service-rendering concerns but for

others. Even in production enterprise like colliery where the production costs are all direct costs, the

financial where the production costs are all direct costs, the financial accounts may be so designed as to

obviate the need of any cost system, unless otherwise called for.

Products: the nature of product determines the method of costing to be applied. If the material content of

the product is more valuable, the material cost records need be kept in comparatively more elaborate

manner so as to make material cost control effective. Same is the position with regard to labour and

overhead.

Organisatoin: The organizational set up for a costing system should be modeled that the control part is

exercised by the Cost Accountant, as such, the present organizational set up of the costing department

need close study to suggest necessary changes.


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Functional study: The functional divisions of an undertaking based on cost are a) Manufacturing, b)

Administration, and c) Selling & Distribution. A study of the present working of the different

departments in necessary to suggest improvements.

C) Principles for Smooth WorkingThe following principles should be kept in mind while introducing the cost system:

The system should be simple and easy to operate.

The system should be flexible, so that it may be expanded or contracted per needs of the business.

The existing pattern should be disturbed only as little as may be considered desirable.

The desired changes be introduced gradually and not in haste.

Confidence be created by the Cost accountant in the minds of management and

Executives regarding the utility of the system, so as to avoid unnecessary criticism

And to obviate obstacles.

D)Line of ActionThe following line of action is recommended for the installation of cost system.

Determination of the type of costing and the method of costing, as may be suitable for the undertaking.

To prepare forms, card, report-performs, books etc., for keeping records of all the elements of cost, viz.,

material, labour and overheads.

To decide issues regarding material cost control, i.e., purchase, storing, issue and valuation.

To decide matters regarding labor cost control, i.e., job evaluation, merit rating, appointment, time

recording, division of work, remuneration of labour and other allied problems like idle time, overtime,

labour turnover, casual workings, etc.

Where the work is carried on more by machines, proper records be kept for the machines.

To suggest a suitable system for the collection, classification and analysis of all.

Types of everheads, i.e., manufacturing, administrative, and selling & distributive.

To decide the methods of allocation and apportionment of overheads among the production departments

and Service departments which should be earlier clearly demarcated, and to decide the method of

absorption of overheads.

To decide normal capacity of production and prepare budgets and standards.

To maintain books of cost control based on double-entry principle.

To devise information system by which the costing department may communicate to other departments

and receive reports and other necessary informations promptly .


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Merit of Cost Accounting

Helpful in Planning and Decision Making: Cost information brings to light the profitable activities of the

organisation. It provided the sound and rational basis for planning, the changes in products, plants, processes

and techniques of production. The information provided by cost accounting is also useful in evaluating the

various alternatives involved in a situation before taking any final decision.

Inventory Control: As an efficient stores accounting system is essential to an adequate system of cost accounts,

in effective check is provided on all materials and stores.

Ascertainment of Costs: Cost accounting is very helpful in calculating the cost of an article being produced by

the enterprise. It helps in fixing the selling price of the product.

Standard Costs: It helps the production manger not only to find what various jobs and processes have cost but

also what they should have cost. The pre-planned standard costs are used for comparison of the cost of the

products.

Assistance in Manufacturing: Cost accounting pinpoints lapses in purchases of raw materials and other

articles, their utilization. It indicates where wastages are occurring long before the production is finished. It

helps to take immediate steps to avoid such losses and wastes.

Promotion of Sales: Cost accounting is also very helpful in the promotion of sales by adopting an appropriate

price policy. The technique of break even analysis serves as constant remember to increase the sales to the break

even point. It also seeks to control the selling and distribution coasts.

Evaluation of Profitability: It helps in elimination unprofitable activities and operations.

Profit can be Maximised: Cost accounting helps the management in maximizing profits by eliminating all

wastes and uneconomical processes. This cost accounts help in increasing points and minimizing loses.

COST SHEET

Cost Sheets are statements setting out the costs of a product giving details of all the costs. Presentation of

costing information depends upon the method of costing. A cost sheet can be prepared weekly, monthly,

quarterly or annually.

In a cost sheet besides total expenditure incurred, cost per unit of output in case of each element of cost can be

shown in a separate column. The cost sheet should give cost per unit in the previous period for the purposes of

comparison.

Advantages of Cost Sheet

1. It is a simple and useful medium of communication which gives information about costs to all levels of

management in a simple and lucid form.

2. It helps in comparative study of the various elements of costs with the past results and standard cost.

Thus it helps the management in control process.

3. It helps the management in fixing up the selling price more accurately.

4. If acts as a guide to the manufacturer and helps him in formulating a definite and profitable production

policy.

5. It enables a producer keep a close watch and control over the cost of production.

6. It shows the total cost and the per unit of the units produced during the given period.


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Problem 1

The following particulars have been extracted from the costing records of a manufacturing co., for the year

ended 30th

June, 1991.

Rs.

Raw material purchase 1,00,000

Wages

Direct 60,000

Indirect 10,000

Office Salaries 22,000

Finished Goods stock 10,000

Advertising 6,000

Agents Commission 10,000

Rent, rates & taxes etc (9/10 for works , 1/10 foroffice)

2,000

Works 4,000

Building-repairs 2,000

Salaries-plant 4,000

Depreciation Rs.

Plant Machinery 4,000

Building 2,000

Carriage inward 2,000

Carriage Outward 6,000

Sales 4,00,000

Opening Stock-

Raw material 40,000

Travelling expenses 2,000

Power 2,000

Plant Maintenance 8,000


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Miscellaneous expenses

Plant 2,000

Office 2,000

Closing Stock

Raw Materials 40,000

Finished goods 6,000

Building is occupied 9/10 by factory and 1/10 by office. Production 20,000 (Units)

You are required to prepare a detailed cost statement showing

i) Materials consumed

ii) Prime cost

iii) Works on cost.

iv) Cost of production

v) Cost of sales and

vi) Profit earned

Solution

Cost statement of the year ended 30th

June, 1991.

Particular Total Cost Cost per unit

Opening Stock of raw

material

40,000

Add Purchases 1,00,000

Add Carriage inward 2,000

1,42,000

Less Closing stock or raw

materials

40,000

i) Materials consumed 1,02,000 5.10

Direct labour 60,000 3,00

ii) Prime Cost 1,62,000 8.10

Add:Factory overheads

Indirect Wages 10,000 0.50

Power 2,000 0.10

Plant Maintenance 8,000 0.40

Rent, rates and taxes (9/10) 1,800 0.09

Misc. Expenses 2,000 0.10

Repairs Building (9/10)0.20 1,800 0.20

Salaries Plant 4000 0.20

Depreciation Plant 4,000 0.09

-Building (9/10) 1,800 34,000 1.77


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iii) Works cost 1,97,400 9.87

Add: Office Overheads

Office Salaries 22,000 1.10

Rents, Rates and Taxes (1/10) 200 0.01

Misc. expenses 4,000 0.20

Repairs Building (1/10) 200 0.01Depreciation- Building (1/10) 200 26,600 0.01 1.33

iv) Cost of Production 2,24,000 11.20

Add: Opening Stock of

finished product

10,000

2,34,000

Less: Closing stock of

finished goods

6,000

Cost of goods sold 2,28,000

Add: Selling and distribution

overheads

Carriage outwards 6,000

Travelling expenses 2,000

Advertising 6,000

Agents Commission 10,000 24,000

Cost of Sales 2,52,000

Add Profit margin 1,48,000

v) Sales value 4,00,000

Problem 2

The cost of Sale of Product A is made up as follows:

Materials used in

Manufacturing

55000 Direct Expenses 5000

Materials used in Primary

packing

10000 Indirect Expenses (factory) 1000

Materials used in selling

product

1500 Administration expenses 1250

Materials used in Factory 750 Depreciation of office building

& equipments

750

Materials used in office 1250 Dep. On factory buildings 1750

Labour required in Producting 10000 Selling expenses 3500

Labour required for factory

supervision

2000 Freight on material purchased 5000

Advertising 1250


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Assuming that all products are manufactured are sold, what should be the selling price to be obtained as a profit

of 20% on selling price?

Solution

COST SHEET

STATEMENT OF COST AND PROFIT

Direct material Rs. Rs.

Materials used in manufacturing 55000 100000

Materials used in primary packing 10000

Freight on material purchased 5000 70000Direct labour 10000

Direct expenses-factory 5000

Direct expenses-factory 85000

PRIME COST

Factory overheads 750

Labour required for factory supervision 2000

Indirect expenses factory 1000

Dept. on factory building 1750 5500

WORKS COST 90500

Administration O-H

Materials used in OH10 1250

Administration expenses 1250Dept. on office building equipment 750 3250

COST OF PRODUCTION 93750

Sellings Distribution O-H

Materials used in selling the product 1500

Selling expenses 3500

Advertising 1250 6250

COST OF SALES 100000

Profit (20% on selling price or 25% on cost) 25000

SELLING PRICE 125000

Problem 3

From the following data prepare a cost & profit statement of Vijay stoves manufacturing company for the year 1990.

Stock of materials as on

1.1.1990

35000 Establishment expense 10000

Stock of materials as on

31.12.1990

49000 Completed stock in hand

1.1.90

-

Purchase of materials 52500 Completed stock in hand

31.12.90

35000

Direct wages 95000

Factory expenses 17500 Sales 189000

The number of stoves manufacturing during the year 1990 was 1000. The company wants to quote for the contract forthe stoves to be quoted are of uniform quality and make similar to those manufacturing in the previous year. But cost of

materials has increased 15% and cost of factory labour by 10%. Prepare a statement of net profit to be quoted to give the

same percentage of net profit of turnover as was realized during the year 1990 assuming that the cost per unit of O.H.

charges will be the same as the previous year.


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Solution

COST AND PROFIT STATEMENT OF STOVES 1990

Amount Rs. Amount Rs.

Opening Stock of Materials 35000

Purchase of Materials 52500

87500

Closing stock of Materials 4900

VOLUME OF MATERIAL CONSUMED 82600 20.65Direct wages 95000 23.75

PRIME COST 177600 44.40

Factory expenses 17500 4.37

WORK COST 195100 48.77

Establishment expenses 10000 2.50

COST OF PRODUCTION 205100 51.27

Opening completed stock -

Cost of production during the prd 205100

Closing completed stock 35000

COST OF SALES 170100

PROFIT 18900

SELLING PRICE 189000

STATEMENT SHOWING QUOTATION PRICE FOR 1000 STOVES

Materials consumed 20650

15% increase 3098

23748

Factory wages 23750

10%a increase 2375

PRIME COST 26125

Factory expenses 49873

4370

WORK COST 54243

Establishment expenses 2500TOTAL COST 56743

(profit 10% of selling price of 1/9 of cost) 6305

SELLING PRICE 63058


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Lesson 2

Material Cost

The term materials refers to such commodities which are supplied to the manufacturing industry in their crude

or original forms. They are raw in nature of have to be processed further. Broadly, these may be classified in the

following groups: Raw materials, components, consumable stores, Maintenance Materials, Tools etc.

Since the underlying purpose of cost accounting is to minimize the cost of production, it is important that an

effective control is exercised over them. The storage space and storage costs re reduce thereby. Control over materials is

also necessary to prevent extra-expenses on their unnecessary purchase and improper use. A regular supply of materials

greatly helps the production schedule. It is necessary, therefore, that statements are prepared to accurately record thevalue of materials consumed by each department of job.

Material Cost Control envisages a proper organisatoin for the efficient purchasing and storing of the materials,

and for making them issued to the departments or the cost-centres in appropriate quantities. At the proper times and

valued at the right prices.

The materials cost control aims at keeping the material cost within reasonable limits, budgets or standards.

This control is exercised beginnings from the point the orders are prepared for being placed with the suppliers,

and ending at the point the materials are effectively utilized in production or are disposed off otherwise.

The following factors contribute to purchase control:

i) Determination of Quantity to be purchased

Quantities purchased in excessive number or weight block the working capital and the quantities purchased below

the reasonable limit endanger the continuous working of the factory.

ii) Determination of the Ordering Point

The ordering point of the ordering level is one at which the order for purchase of materials is to be placed with the

suppliers when the stock of that material is reduced to that point by consumption or otherwise.

iii) Determination of Price at which to be purchased

The selection of right suppliers and the best terms available out of the quotations received helps this factor.

The Purchase cycle constitutes the following:

1. Initiating the purchase;

2. Receiving of the Purchase Requisitions;

3. Deciding important factors relating to purchase;

4. Selecting the suppliers;

5. Placing purchase-orders and follow-up

6. Receiving the supply and returning unwarranted suppliers;

7. Inspecting the material received; and

8. Passing invoices for payment.

The important factors to be decided are:

a) What to purchase;

b) When to purchase; and

c) How much to purchase.

After receiving the Purchase Requisitions, the next step is to select the suppliers to whom the orders may be sent for

the supply. This is done by inviting tenders or quotations from different suppliers.

While inviting the tenders, the supplying firms should be requested to state their terms and conditions of supply,

delivery time, mode of payment, etc., clearly and to send the tenders in sealed covers.

Having accepted the tenders, the orders are place by the Purchase Department with the firms selected fro the

purchase of requisitioned materials.


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The purchaser order should be prepared on the printed form and should contain all the necessary details, so as to

leave no room for any ambiguity or doubt and so as to avoid legal complications.

Follow-up of the Purchase order if essential to keep the schedule of supply by the specified date so that

production work may not suffer.

The Receiving Department checks the supply from the copy of the Purchaser order and prepares his report of the

goods received.

The Inspection Department makes an inspection of the goods received regarding the quality and specifications.

Stores Records

1. Bin CardA Bin card, also known as Bin Tag or Stock card, is a card showing quantitative record of the receipts, issues and

closing balances of the material kept in the corresponding bin. The Bin card is placed in the bin or shelf or is hung

over the almirah or the rack otherwise known as Bin. Separate Bin cards are prepared for each item of stores and if

two different materials are kept in one almirah, two Bin cards, one for each, are prepared, treating the almirah as two

bins.

2. Stores LedgerStores Ledger is a record of stores, both in quantity and value and is maintained by the stores Accountant. It is

similar to Bin card but with the main difference that value of material is shown in the Stores ledger. Stores Ledger is

an important book and the account of each item of stores is maintained separately. While Bin cards are maintained

by store-keeper in the store, Store Ledger is maintained in the accounting department by the Stores Accountant.

Material Control and its Requirements

Material Control may be defined as the regulation of the procedures for requisitioning, buying, receiving,

storing, handling and usage of materials.

The main requirements of a system of material control are:

Planning and fixation of definite responsibility for each function of material.

Co-ordination between departments responsible for requisitioning, purchasing, receiving, inspecting, storing

and utilizing the materials,

Centralization on purchases.

Use of material purchase budget and material requirement budget.

Use of standard and uniform forms, and

Proper system of stock control.

For proper application of the material control the following steps are necessary.

1. Purchasing of materials

2. Receiving and inspecting of materials

3. Storing of materials4. Pricing material Issues

5. Accounting materials losses.

6. Keeping physical and perpetual inventory

Purchasing of Materials

In a large manufacturing concern, a separate purchase department is set up with the object of effecting all purchases.

The top management lays down the purchase department. It is the function of the purchaser department to decide: i)

What to purchaser; ii) When to purchase; iii) form where to purchase; iv) how much to purchase, and v) finally at

what price the material should be purchased.


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Maintenance of Stock Levels

The next important point after determination of EOQ is to decide as to when the order for purchase should be

placed. The answer is simple. The order for purchase should be placed when the stock is reduced by usage to the Order

Point. The Order Point is one where the order should be placed for the economic order quantity. For deciding Order

Point, two things, viz., (1) Lead time and (2) Usage during Lead time, are the determining factors. Lead time is the

supply time, or to be more specific, Lead Time is the time interval between placing an order and having materials on

the factory floor ready for production

Usage means the sue of materials by consumptions for productions, or the stock of finished goods sold.Sometimes purchase are made in large bulk in a season if the goods are seasonal, i.e., available in one season

only, or at a time when it is feared that the goods may not be found available in the near future due to some reason.

Special items for which no limit or order-points are fixed may be purchased as and when needed.

To avoid over-stocking and under stocking each items of the inventory has the Maximum Level. Minimum

Level and an Order point.

Order Point

It is also known; Ordering Level; or Recorder Point, or Reordering Level or Ordering Limit, it has been

stated earlier that Order Point is at which order for supply of materials or goods is placed. To decide the Order

Point, three factors are considered, viz., (1) Lead time (2) Usage during Lead time, and (3) Minimum Limit, or

the Safety stock.

In order to ensure that the optimum quantity of material is purchased and stocked, neither less nor more, the

storekeeper applies scientific techniques of materials management. Fixing of certain levels for each items of

materials is one of such techniques.

The following levels are generally fixed.

1. Maximum level

2. Minimum level

3. Order level

4. Danger level

1. Maximum levelThe maximum stock level indicates the maximum quantity of an item of material which can be held in stock at any

time.

The maximum stock can be calculated by applying the following formula.

Maximum level Re-order level + re-order quantity (minimum consumption X minimum re-order period)

2. Minimum levelMinimum level represents the quantity below which the inventory of any items should not allowed to fall; in other

words, an enterprise must maintain minimum quantity of stock so that the production is not hampered due to non-

availability of materials. If some buffer inventory is acting as a cushion against reasonable expected maximum

usage.

Formula:

Minimum level = Re-order level (Normal consumption x normal re-order period)

3. Re-ordering Level PointRe-ordering stock level in relation to an items of stock is the point at which it becomes essential to initiate purchase

orders for its fresh supplies. Normally, re-ordering level is a point between the maximum and the minimum levels.

Fresh orders must be placed before the actual stocks touch the minimum level.

Reorder level = maximum re-order period x maximum usage.


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4. Danger levelThe danger level is below the minimum level and represents a stage where immediate steps are taken for getting

stock replenished. When the stock reaches danger level it is indicative that if no emergency steps are taken to

restock the material, the stores will be completely exhausted and normal production stopped. Generally the danger

level of stock is fixed above the minimum level but below the re-ordering level.

Economic Order Quantity Analysis

Economic Order QuantityThis represents the normal quantity to be placed on order when the stock has reached its re-order level. Re-

ordering quantity is to be fixed taking into account the maximum and minimum stock levels. The quantity ordered must

be that which, when added to the minimum stock, will not exceed the maximum stock to be carried at any point of time.

The following factors govern the re-ordering quantity.

1. Average consumption

2. Cost of pacing order

3. Cost of storage

4. Interest on capital etc.,

Carrying cost of inventory consists of

i) The costs of physical storage, such as cost of space, handling and upkeep expenses, insurance, cost of

obsolescence etc.ii) Interest on capital invested (the opportunity cost of the capital blocked up) and

iii) Cost of placing the order each time.

Economic order quantity or economic lot size (if it relates to production) refers to the number ordered in a single

purchase or number of units should be manufactured in a single run so that the total costs-ordering or set up costs and

inventory carrying costs are at the minimum level. In other words, it is the quantity that should be ordered at one time so

as to minimize the total of

i) Cost of placing orders and receiving the goods, and

ii) Cost of storing the goods as well as interest on the capital invested. The economic order quantity can be

determined by the following simple formula.

!

EOQ = Economic order quantity or number of units in one lot.

A = Annual usage in units

S = Ordering costs for one order (or set-up costs for one set-up)

I = Inventory carrying costs per unit per year.

This formula is based in three assumptions:

i) Price will remain constant throughout the year and quantity discount is not involved.

ii) Pattern of consumption, variable ordering costs per order and variable inventory carrying charge per unit per

annum will remain the same throughout, and

iii) EOQ will be delivered each time the stock balance, excluding safety stock, is just reduced to nil.

Problem 1

Suppose the annual consumption is 675 units, 10% is the interest and cost of storing an article costing Rs. 30 per

unit, cost of placing and order is Rs. 18. Calculate the E.O.Q.


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Solution:

!

Where A = Annual usage

S = Ordering cost for one order

I = Inventory carrying costs per unit per year.

!

Problem 2

Two components A and B are used as follows:

Normal usage 50 units per week each

Minimum usage 25 units per week each

Maximum usage 75 units per week each

Re-order quantity A:300 units B:500 units

Re-order period A:4 to 6 weeks B:2 to 4 weeks

Calculate for each component:

a) Re-order level b) Minimum level

c) Maximum level d) Average stock level

Solution

Re-order level = Maximum consumption * maximum re-order period

Component A = 75*6 = 450 units

Component B = 75*4 = 300 units

Minimum level = Re-order level (Normal consumption * Normal re-order period)

Component A = 450-(50*5) = 200 units

Component B = 300-(50*3) = 150 units

Maximum level = Re-order level + Reorder Quantity

(Minimum consumption * Minimum re-order period)

Component A = 450 + 300 (25*4) = 650 units

Component B = 300 + 500 (26*2) = 750 units

Average Stock level = (Minimum level + Maximum level)

Component A =(200+650) = 425 units

Component B = (150+750) = 450 units


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Need for Inventory Control

The term Inventory is used to denote (i) goods awaiting sale (the stock items of a trading concern and the

finished stocks of a manufacturer); (ii) the goods in course of manufacture, known as work-in-progress, and (iii) goods

to be used directly or indirectly in production, i.e., raw materials and supplies.

In a manufacturing company, normally the cost of materials constitutes fifty percent of the production cost and

the cost of inventory (i.e., raw materials W.I.P., and finished good) represents about one-third of the total assets. As the

costs of materials and inventory are quite formidable but at the same time controllable, there is a great need felt forproper planning, purchasing, handling and accounting for the same, and also to organize the system of inventory control

in a manner that it may provide the maximum profitably to the management.

Objectives of Inventory Control

The objectives of inventory control as listed below:

1. To exercise proper control on the purchases and issues of inventories; proper storing; elimination of wastage;

and regulating the proper supplies to works and to customers;

2. Pricing of the inventories on suitable basis;

3. Proper recording, and scientific inventory management

4. To have proper assessment of income through the process of matching appropriate costs against revenues.

5. To maintain inventory of sufficient size for the operations to go on uninterruptedly but the size should match

with the optimum financial involvement.

Techniques of Inventory Control

The techniques or the tools generally used to effect control over the inventory are the following:

1. Budgetary techniques for inventory planning;

2. A-B-C. System of inventory control;

3. Economic Order Quantity (E.O.Q.) i.e., how much to purchase at one time economically;

4. Maintenance of Stock levels to decide when to purchase;

5. Perpetual inventory system and the system of store verification;

6. Reduction of surplus stocks and review of slow-moving or stagnant items.

7. Control Ratios.

Budgetary Techniques

For the purchase of raw materials and stocks, what we required is a purchase Budged to be prepared in terms of

quantities and values involved. The sales stipulated as per sales Budget of the corresponding period generally works out

to be the key factor to decide the production quantum during the budget period, which ultimately decides the purchases

to be made and the inventories to be planned.

A-B-C Analysis

To exercise proper control on stores, it is essential that the store items should be classified according to values

so that the most valuable items may be paid greater and due a attention regarding their safety and care, as compared to

others. The stores are divided into three categories generally, viz., A, B, and C.

In the ABC system, greatest care and control is to be exercised on the items of A list as any loss or breakage or

wastage of any items of this list may prove to be very costly; proper care need be exercised on B list items and

comparatively less control is needed for C list items. The rules relating to receipt maintenance issue and writing off

stores items should be formed in accordance with the utility and value of the items based on the above categorization.

Manufacturing organizations find it useful to divide materials into three categories for the purpose of exercising

selecting control on materials. An analysis of the material cost will show that a smaller percentage of items may

represent a smaller percentage of the value of items the percentage number of which is more or less equal to their value

of consumption. Items falling in the first category are treated as A items, of the second category and B items and

items of the third category are taken as C items. Such an analysis of materials is known as ABC analysis. This

technique of stock control is also known as stock control according to value method or always Better Control method or

Proportional parts value. Analysis method. Thus, under this technique of material control, materials are listed in A, B

and C categories in descending order based on money value of consumption.


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ABC analysis measures the cost significance of each item of materials. It concentrated on important items, so it is also

known as Control by importance and Exception.

Advantages:

1) A Strict Control is exercised on the items which represent a high percentage of the material costs.

2) Investment in inventory is reduced to the minimum possible level.

3) Storage cost is reduced as a reasonable quantity of materials, which account for high percentage of value of

consumption will be maintained in the stores.

VED Analysis:

VED Vital, Essential, Desirable analysis is used primarily for control of spare parts. The spare, parts can be

divided into three categories vital, essential or desirable keeping in view the critically to production.

Perpectual Inventory System

Perpectual Inventory is a system of records maintained by the controlling department, which reflects the

physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts

and issues of stores may be recorded immediately at the time of each transaction and the balance may be brought out so

as to show the up-to-date position.

The records used for perpectual inventory are:(1) Bin Cards;

(2) Store Ledger Accounts or Stores Record cards;

(3) The forms and documents used for receipt, issue and transfer of materials.

Advantages of Perpectual Inventory system

1. It keeps the record of stocks upto date.

2. The materials are kept within the Minimum and Maximum Limits. Non-observance of the limits fixed is

detected.

3. The materials going out of stock are easily detected and purchased at the appropriate time to avoid the risk of

closing down.

4. It acts as a moral check on the staff of the stores Department and so the possibilities of loss or theft of materials

are minimized.

5. The recording of stocks in Bin cards as well as Store Record cards minimizes the error in entering the receipts

and issues of stocks.

6. The discrepancies noted after physical counting are detected and corrective action is taken promptly to avoid

future occurrence.

7. The materials getting state or being wasted are detected and placed in right atmosphere.

8. The prompt balancing of closing stocks enables quick preparation of final accounts.

9. The slow moving inventories, obsolete or dormant stocks are brought to the notice of the Purchase Department

so that such stocks may purchased future in lesser quantities as required.

10.The availability of correct figures of stocks helps in the insurance of the stocks.

Control Ratios

The control ratios are mainly two

(1) Inventory Turnover Ratio which we have studied and

(2) Input-output Ratio.

(1)Inventory TurnoverInventory Turnover is a ratio of the value of the materials consumed during a period to the average value of

inventory held during that period.

Certain materials are slow moving. It means their consumption rate quite show and so capital remains locked up and

storing costs continue to be incurred in such materials if these materials are stored in excess of the requirement the

rate of consumptions in terms of value or in terms of days is indicated by Inventory Turnover ratio. The number of


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days in which the average inventory is consumed can be ascertained by dividing the period by the Inventory

turnover ratio.

If the inventory turnover rate in terms of value of materials is high, or if the length of the inventory turnover

period is short, the material is said to be fast moving. So if the rate of consumption is fast, or if the inventory

turnover rate is good, it is a healthy measure of efficiency of materials control, as the capital employed is properly

utilized.

2. Input-output Ratio

The Input-output Ratio is the ratio of the raw material put into manufacture and the standard raw materials contentof the actual output.

This ratio enables one to find out whether the usage of the materials is favourable or not. A standard ratio of

input of materials and output of material should be determined and the actual ratio should be compared with the

standard ratio.

Pricing of Material Issues

The pricing of issue of materials is not as simple as the pricing of receipts. As the issue are made out of the various

lots purchased at different prices, the questions arises as how to price the issues, there are several methods used for

pricing the issues and the selection of a proper method depends upon the following factors:

1. The type of work-job or process;

2. Range of price fluctuations and market trends;

3.

The Inventory turnover period and the carrying or the non-carrying cost i.e., the frequency of purchases andE.O.Q.

4. The need for maintenance of uniformity is costs of the products within the industry.

5. The nature and durability of the material whether it evaporates or shrinks, or absorbs moisture, etc.

Method of Pricing

The various methods used for pricing of the materials are:

Cost Price Methods:

1. First in First out (FIFO)

2. Last in First out (LIFO)

3. Highest in First out (HIFO)

4. Base stock price

Average price Methods:

1. Simple Average

2. Weighted Simple Average

3. Periodic Weighted Average

4. Moving Simple Average

5. Moving Simple Average

6. Moving Weighted Average

First in First out Method (FIFO):

Under this method materials received first are issued first. After the first lot of the material purchased is over,

the next lot is taken up for issue. As such, the materials are issued in the order in which they are received in the stores.

The pricing of the issue of the first lot is done at the rate of purchase of the first lot. Similarly, the pricing pattern follows

for the subsequent lots. The closing stock in this method is valued at the latest purchase price and thus it represents the

current conditions as far as possible.

Merits

1. It is simple to operate

2. The materials are charged at costs only. So the purchase price is recovered in full without showing any

profit or loss on issue.

3. This method is good where

a. The prices are falling;


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b. The consumption rates of the materials is slow

4. The Closing stock is shown at current rates.

Demerits

1. It is not suitable in the situation when the prices show a rising trend, as it will charge the material at the

lower rate than the replacement rate.

2. The same type of materials issued to two jobs at two different prices will show different costs.

3. If the prices fluctuate to much, the clerical errors may be many.

Last in First Out (LIFO):

Under this method, the material received last is issued first LIFO method and as such, pricing of issues is done

in the reverse order of purchases. In times of rising prices, this method is considered best for application, as the current

cost of materials contributes to the cost of production.

Merits

1. The material cost represents current prices except when the purchases were made long ago,

2. It is simple to operate and the pricing is done on cost basis

3. It relates current cost to current sale price, and enables the management to make correct decisions.

4. It is more useful when purchases are not too many and the prices are either steady or are rising. It is more

suitable for bulky materials with high unit prices.

Demerits

1. With high fluctuations in rates, the calculations become more complicated, and give way to more clerical

errors.

2. The work of pricing is held up if the latest receipt rate is not readily available.

3. As in FIFO, costs of different batches of production are distorted and more than one price is adopted, in

some cases, for pricing a single requisition.

4. Closing stock is valued at a cost which does not represent current conditions.

Highest in First Out (HIFO):

Under this method the material received at the highest price in the stock is issued first. This method is good

when it is desired to keep the inventory value of the materials at the lowest possible price.

Base Stock Price Method

In this method a minimum quantity of stock is always held at a fixed price as reserve in the stock. This

minimum stock is known as base stock or the safety stock and is not used unless an emergency arises. This stock is

valued at long-run normal price, while the stock in excess of this stock is priced on some other basis, usually are FIFO

or the LIFO basis. It is not an independent method in itself a it is conjoined with either FIFO or the LIFO method.

Simple Average Method

The issue is prices at an average price and not at the exact cost price as in the earlier methods. The simple

average is calculated by dividing the total of the rates of the materials in the stock from which the materials to be priced

could have been drawn, by the number of the rates of prices.

This method can be used with advantage if

(a) The purchase prices to not fluctuate considerably, and

(b) It is difficult to identify the different issues of the materials.

Weighted Average Method

Merits

1. This method irons out the wide fluctuations in the prices.

2. With every new issue, a new rate is not calculated.

3. The total value of the material issued does not behave up and down to the total value of the material received, as

is the case with Simple Average Method.


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Demerits

1. Calculations are tedious. Prices are worked out in decimals to get correct results.

2. A lot of materials purchased at a very high price at one time continues to reflect its effect in the average, for a

considerable time after it is exhausted.

Periodic Simple Average Method

This method is similar to Simple Average Method except that the average rate is calculated periodically, say

monthly or quarterly or once in the accounting period. If calculated monthly, the average of the unit prices of all the

receipts during the month is adopted as the rate for pricing issues during the subsequent month.

Periodic Weighted Average Method

This method is similar to Weighted Average Method except that the calculation is made periodically, say at an

interval or one month. The rate so arrived is used for the issues made in the next month.

Moving Simple Average Method

This represents a price which is obtained by dividing the total of the periodic simple average prices or a given

number of periods, the last of the periods being that for which the materials are to be issued, by the number of periods.

Moving Weighted Average Method

This is just similar to the Moving Simple Average Method except that the periodic average price, in this

system, is based on the weighted average.

Problem 3

1) Show the Store Ledger entries as they would appear when using

i) FIFO

ii) LIFO

iii) Weighted average method

iv) Simple average method

April 1. Balance 300 units Rs. 600/-

2. Purchase 200 units Rs. 440/-

4. Issued 150 units


11. Issued 150 units




Solution

1) Stores Ledger Account as per FIFO METHODDate Details Receipt Issued Balance

Qty Rate Amt Qty Rate Amt Qty Rate Amt

April

1

Balance 300 2/- 600 - - - 300 2/- 600

2 Purchase 200 2.20 440 - - - 300 2.00 600200 2.20 440

4 Issue 150 2.00 300 150 2.00 300

200 2.20 440

6 Purchase 200 2.30 460 150 2.00 300

200 2.20 440

200 2.30 460

11 Issue 150 2.00 300 200 2.20 440


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200 2.30 460

19 Issue 200 2.20 440 200 2.30 460

22 Purchase 200 2.40 480 200 2.30 460

200 2.40 480

27 Issue 200 2.30 460 150 2.40 360

50 2.40 120

Value of Closing Stock : 150 units at the rate of Rs. 2.40 value Rs. 360/-

2) LIFO METHODDate Details Receipt Issued Balance

Unit Rate Amt Unit Rate Amt Unit Rate Amt

April

1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 300 2.00 600

200 2.20 440

4 Issue 150 2.20 330 300 2.00 600

50 2.20 110

6 Purchase 200 2.30 460 300 2.00 600

50 2.20 110

200 2.30 460

11 Issue 150 2.30 345 300 2.00 600

50 2.20 600

50 2.30 115

19 Issue 50 2.30 115 200 2.00 400

50 2.20 110

100 2.00 200

22 Purchase 200 2.40 480 - - - 200 2.00 400

200 2.40 480

27 Issue 200 2.40 480 150 2.00 300

50 2.00 100

Value of Closing Stock : 150 units @ Rs. 2.00 value is Rs. 300/-

3) WEIGHTED AVERAGE METHOD

Date Details Receipt Issued Balance


April

1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 500 2.08 10404 Issue - - - 150 2.08 312 350 2.08 728

6 Purchase 200 2.30 460 - - 550 2.16 1118

11 Issue - - - 150 2.16 324 400 2.16 864

19 Issue - - - 200 2.16 432 200 2.16 432

22 Purchase 200 2.40 480 - - - 400 2.28 912

27 Issue - - - 250 2.28 570 150 2.28 342

Value of Closing Stock : 150 units at the rate of Rs. 2.28 value Rs. 342.00/


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4) SIMPLE AVERAGE METHOD

Date Details Receipt Issued Balance


April

1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 500 2.10 1050

4 Issue - - - 150 2.10 315 350 2.10 35

6 Purchase 200 2.30 460 - - 550 2.17 1193..50

11 Issue - - - 150 2.17 325.50 400 2.17 868

19 Issue - - - 200 2.17 434 200 2.17 434

22 Purchase 200 2.40 480 - - - 400 2.23 892

27 Issue - - - 250 2.23 557.50 150 2.23 334.50

Value of Closing Stock : 150 units at the rate of Rs. 2.23 value Rs. 334.50

Problem 4

The following is the record of receipts and issues a certain material in the factory during a week.April 1997

1. Opening Balance 50 tonnes @ Rs. 10 per tone.

Issued 30 tonnes @ Rs. 10 per tones

2. Received 60 tonnes @ Rs. 10.20 per tone.

3. Issued 25 tonnes @ Rs. 10.20 per tone (stock verification reveals loss of tone)

4. Received back from orders 10 tonnes @ Rs. 10.20 per tone

(previously issued at Rs. 9.15 per tone)

5. Issued 40 tonnes @ Rs. 10.20 per tone.

6. Received 22 tonnes @ Rs. 10.30 per tone.

7. Issued 38 tonnes @ Rs. 10.30 per tone.

Solution

Stores Ledger Account Under LIFODate Receipts Issues Balance


1 30 50 10 500

1 30 10 300 20 10 200

2 60 10.20 612 - - - 20 10 200

60 10.20 612

3 - - - 25 10.20 255 20 10 200

1 10.20 10.20 35 10.20 357

20 10 200

4 10 9.15 91.5 34 10.20 346.80

- - - 20 10 200

34 10.20 346.8010 9.15 91.50

5 - - - 10 9.15 31.50 20 10 200

3 10.20 306.0 4 10.20 40.80

6 22 10.30 226.6 20 10 200

4 10.20 40.80

7 - - - 22 10.30 226.6

4 10.20 40.80 8 10.00 80.00

12 10.00 120.0


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Closing Stock 8 tonnes @ Rs. 10 = Rs. 80/-

Stores Ledger Under FIFO

Date Receipts Issues Balance


1 30 50 10 500

1 30 10 300 20 10 2002 60 10.20 612 - - - 20 10 200

60 10.20 612

3 - - - 20 10 200

5 10.20 51 55 10.20 561

1(loss) 10.20 10.20 54 10.20 550.80

4 10 9.15 91.5 - 54 10.20 550.80

- - 10 9.15 91.50

5 - - - 40 10.20 408 14 10.20 142.80

10 9.15 91.50

6 22 10.30 226.6 - 14 10.20 142.80

10 9.15 31.50

22 10.30 226.60

7 - - - 14 10.20 142.80

10 9.15 91.50 8 10.3 82.40

22 10.30 226.60

Closing stock 8 tonnes @ Rs. 10.30 = 82.40


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Chapter 3

Labour Cost

Labour Cost, representing the human contribution to production, is an important cost factor which requires constant

control, measurement and analysis.

A rational approach to the problems of labour, fair maintenance of wage records for wage ascertainment, fair

wage policy, and the incentives for earning more wages go a long way in providing a sense of security and stability to

the workmen, in minimizing the labour turnover, and in exercising effective labour cost control.

Labour cost control aims at the control of the labour cost per unit of production and not at the reduction of the

wage rates of the workmen.

Efficiency of labour (a concept meaningless to material) has an important impact on the successful working of a

business.

Labour cost is second major element of cost. Proper control and accounting for labour cost is one of the most important

problems of a business enterprise. But control of labour cost presents certain practical difficulties unlike the control of

material cost.

Labour costs represent the various items of expenditure Such as:

Monetary Benefits:

i) Basic Wages;

ii) Dearness Allowance;

iii) Employers Contribution to Provident Fund;

iv) Employers Contribution to Employees State Insurance (ESI) Scheme;

v) Production Bonus;

vi) Profit Bonus;

vii)Old age Pension;

viii) Retirement Gratuity;

Fringe Benefits:

i) Subsidised Food;

ii) Subsidised Housing;

iii) Subsidised Education to the children of the workers;

iv) Medical facilities;

v) Holidays pay;

vi) Recreational facilities.

Economic utilization of labour is a need of the present day industry to reduce the cost of production of the products

manufactured or service rendered.

Control of labour costs is an important objective of management and the realization of this objectives depends upon the

cooperation of every member of the supervisory force from the top executive to foreman. From functional point of view,

control of labour cost is effected in large industrial concern by the coordinated efforts of the following six departments-

1) Personnel Department,

2) Engineering Department,

3) Rate or time and Motion Study department

4) Time-Keeper Department

5) Cost Accounting Department

6) Pay-roll Department


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Factors Governing a Satisfactory system of Wage Payment

The following factors should be considered while evolving a suitable and a successful system of wage payment.

a) The system should depend upon the nature of the worked and the efforts involved.

b) It should guarantee a minimum living wage to ensure a satisfactory standard of living.

c) It should be based upon a scientific time and motion study.

d) It should be capable of being understood by al the employees.

e) It should be flexible and capable of being adapted to changed circumstances.

f)

Its incidence on the cost per unit should be such that it does not form a considerable proportion of the total costper unit to deprive the employer of a fair margin of profit, given the market price of the commodity produced by

concern.

g) It should reduce the labour turnover.

h) The cost of working the system should be the least.

i) It should boost employee morale.

j) It should be acceptable to trade unions.

k) It should be correlated to the capacity of the concern to pay.

For labour-cost-control, the following factors should also be kept in view while devising the system:

1. Production Planning:Production should be so planned as to have the maximum and rational utilization of labour. The product and

process engineering, programming, routing, and direction constitute the production-planning.

2. Setting up of standardsWith the help of work study, time study and motion study are set up for production operations. The standard

cost of labour so set is compared to the actual labour cost and the reasons for variations, if any, are looked into.

3. Use of labour budgets:Labour budget is prepared on the basis of production budget. The number and type of workers needed for the

production are provided for along with the cost of labour in the Labour budget. This budget is a plan for labour

cost and is based on the past data considered in future perspective.

4. Study of the effectiveness of Wage-policy:How far the remuneration paid on the basis of incentive plan fro the departments help the managerial control on

labour and exercise labour cost control.

Characteristics of Good Wage System

1. Fair to both the Parties:The system should be such as may be acceptable gladly to the employer and the employees. for this purpose,

the employer should decide the system in consultation with the workers.

2. Easy to CalculateThe workers should be in a position to calculate their wages correctly and feel sure that they have been

correctly paid. Easy calculation will help the employer also in maintaining simple records.

3. Related to EfficiencyFair remunerations for fair output, should be the idea and remuneration should be related to the individual

efficiency of the workers.


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4. Minimum wage guaranteedThere should be a guarantee of minimum wages to the workers to enable them to maintain their basic

standards of life, and to do away with uncertainty-concept.

5. Incentive-orientedThe wage system should be such that the workers may feel encouraged to product more and earn more

wages.

6.

Quality Improvement-orientedIn the race to earn more wages with an increase in production, the chances are that the quality of the output

may deteriorate. The system should, therefore, ensure better wages for better quality.

Definite wage-base

The basis or the method of wage payment should be clearly defined and announced in advanced to the workers,

and it should not be changed frequently to suit the interest of the employer, otherwise a sense of distrust may develop in

the workers towards the scheme. A change in the system should be effected only after taking the workers into

confidence.

Labour Turnover

Labour turnover is an index denoting change in the labour force for an organisatoin during a specified period. In

every industry, works leave their job a new workers have to be appointed to replace them. The ratio of the replacedworkers to the number of works is the Labour Turnover Ratio. If more workers leave the factory, the turnover would be

high, and vice versa. A high turnover is a costly affair and must be avoided.

Causes of Labour Turnover

The workers leave the factory either by

i) Resignation, or by

ii) Discharge by the employer, or

iii) Due to a cause not within ones control.

Cause for resignation

The causes may be:

1. Low wages paid as compared to the wages paid in other factory which he is induced to join.

2. Ill health and bad working conditions;

3. Lack of safety measures;

4. Dissatisfactions due to various causes such as

a. Hours of work

b. Improper placement

c. Unfair method of promotion,

d. Bad relationship with Supervisor, or with fellow-workers in some cases.

Causes for Discharge

1. Incompetence;

2. Insubordination, disobedience, and disregard of the rules asn regulations;

3. Unpunctuality or lack of attention to duty;

4. Accidents or suffering from infectious disease;

5. Immoral character.

Causes not within control

1. Seasonal character of the industry where work is carried on during some part of the year only;

2. Death of the worker;


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Measurement of Labour Turnover

Labour Turnover is measured by applying any one of the following three Methods:

1. Separation Method

Multiplication of the formula by 100 indicated Ratio of the turnover in percentage.

2. Replacement Method

In this method, only the actual replacement are counted irrespective of the number of workers left. If new workers are

appointed for expansion programme, they are excluded from the number or replacements.

3. Flux Method

This method is the combination of Method 1 and Method 2.

Effect of Labour Turnover on Cost

The Labour Turnover in excess of normal rate is high turnover, and the turnover below the normal rate is low

turnover. It is always better to keep the turnover low, but it should nto be construed that the factories with low turnover

are always more productive. There may be low turnover in a factory for the reason that the workers engaged therein are

below standard and so they cannot find better place in other factories. Secondly, low turnover in the senior scales may

not provide promotion factories. Secondly, low turnover in the senior scales may not provide promotion opportunities to

the young and promising employees and so they may like to shift to other factories for better prospects.

A high turnover has an adverse effect on the cost of production due to the following reasons:

1. Change in workers interrupts production and the production goes down.

2. New comers take time in learning the factory procedure and the work procedure.

3. The tools and machines cannot be handled as efficiently by the new workers as hither to done by the old staff.

There are chances of more break-downs and of greater cost of repairs of machines.

4. What is true of machines is also true of material handling and usage by the new workers.

5. The rate of accidents may increase, the rate of defectives in the finished output may increase, and there may be

increased wastage of time.

6. The cost of making selections and cost of imparting training to the new entrants would further increase the cost

and reduce the profits.

Cost of Labour Turnover

There are two types of costs

i) Preventive cost andii) Replacement costs

And amenities to the workers that they may be tempted to continue at their job in the factory and not to leave it for

example:


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i) Personnel Administration: Only that portion of the cost of this department which is related to the maintenance

of good relationship between labour and management.

ii) Medical Services-Preventive as well as curative.

iii) Welfare activities and services.

iv) Miscellaneous schemes and benefits, e.g., Provident fund scheme, Pension scheme, Bonus incentives schemes,

etc.

The replacement costs are those incurred to recruit new workers and also the costs consequent or incidental toreplacement, for example:

(i) Cost in selection and appointment

(ii)Training cost

(iii)Loss of output due to delay in recruitment workers

(iv)Cost of inefficiency of new workers

(v) Cost of breakage of tools and machinery

(vi)Cost of increased spoilage and defectives

(vii) Cost of frequent accidents

The treatment of Prevention and Replacement costs is to charge them as overhead and apportion to the different

departments in the ratio of other workers.

IDLE TIME

The time when the worker does no work and remains idle, is the idle time. So the idle time cost represents the

wages paid for the time lost. The following are its causes:

1. Lack of proper planning:That the production work should go on smoothly, depends upon proper planning. If the workers do not have material at

the right time, or the machines are not kept fir for working, the time goes waste. Sometimes, delay in the proceeding

process delays the operations of the succeeding progress. Here also the workers have to wait due to faulty planning or

bad management.

2. Careless in Supervision:If the foreman of a department does not take his duty seriously, the labour working under him also becomes careless and

spoils time in the idle way.

3. Confrontation between labour management:The confrontation between labour and management arising form any cause, does waste time in discussions, dialogues,

strikes etc., and the wages paid, if any, for this period form the idle time cost.

4. Economic Factors:Trade depression, or serve competition lowers the production, and so labour remains effectively unutilized.

5. Others reasons:The electricity may fail or the machine may break down for some or more time. They make labour to remain idle for the

time being.

Idle time does not limit itself in its effect to the wages paid for the time but his wider implications. The plant, machines,

equipments, and other accessories also become idle during that period, and the fixed cost continues to be incurred. As

such, idle time need be reduced as far as possible.

Idle-time cost can be divided into two types:

(i) Normal, and

(ii)Abnormal


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Normal idle-time can be further divided into

a) Controllable, and

b) Uncontrollable.

Normal idle-time is one which is incidental to production. The cost of normal and controllable idle time should be

charged as an overhead expense to the production. If the responsibility for this type of idle-time can be fixed upon a

particular department, the cost should be charged to the overheads of that department and absorbed in the production

cost of that department.

OVER-TIME

The time worked over and above the normal hours is overtime. The remuneration usually paid for the overtime work is

at double the normal rate. The need for over time work arises due to:

1. Increase in demand for the products where the production during the normal hours falls short to meet it;

2. Shortage of workers due to absence or non-availability and so it is decided to give overtime work to the existing

staff;

3. Utilization of perishable raw materials by working overtime;

4. Execution of urgent orders, or to co

25 cost accounting

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