+3 commerce -costaccting - unit - 1 &2

8/20/2019 +3 commerce -COSTACCting - UNIT - 1 &2

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Cost Accounting ( Unit -1)

1. What do you mean by cost accounting? Describe the objectives, advantages and limitation of cost

accounting?

Cost accounting examines the cost structure of a business. Cost accounting is mostly concerned with developing an

understanding of where a company earns and loses money, and providing input into decisions to generate profits in the

future.

“Cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets information for three

major purposes: in! "perational planning and control # ii! $pecial decision# and iii! %roduct decision.& 'Charles T

Horngren

Chartered Institute Of anagement !ccountants “Costing is the technique and process of ascertaining cost&

Cost management describes the approaches and activities of managers in short'run and long'run planning and control

decisions. (hese decisions increase value of customers and lower costs of products and services Cost management is an

integral part of a company)s strategy

Cost accounting process begins with the recording of income and expenditure or the bases on which they are calculated

and ends with the preparation of periodical statements and reports for the purpose of ascending and controlling costs.

CO"T, CO"T !CCO#$TI$% & CO"T !CCO#$T!$C' ()

*. Cost) *t is a sacrificed resource to obtain something, costing is a process of determining costs. Cost is commonly

defined as anything which is measurable in terms of money. +or example, cost of preparing one pizza which in itself

include various other costs lie cost of flour, other ingredients, labor, electricity and other overheads. -ust the same

way, cost of production of any product or service can be determined from cost.

+. Cost !ccounting) Cost accounting is that part of accounting which is helpful to calculate the cost. *n cost

accounting, we deeply study the variable cost, fixed cost, overheads and capital cost. Cost accounting involvesanalyzing relevant costing data, interpret it and present various management problems to management. *t deals with

classifying, recording and appropriate allocation of expenditure for the determination of the costs of products or

services, the relation of these costs to sales values, and the ascertainment of profitability.

. Cost !ccountancy) *t is 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. *t includes the presentation of

information derived there from for purposes of managerial decision maing. (hus, cost accountancy is the science, ar

and practice of a cost accountant.

*t is science because it is a body of systematic nowledge having certain principles which a cost accountant should

possess for proper discharge of his responsibilities. *t is an art as it requires the ability and sill with which a cost

accountant is able to apply the principles of cost accountancy to various managerial problems.

O-/CTI0/" O1 CO"T !CCO#$TI$%

Cost accounting aims at systematic recording of expenses and analysis of the same so as to ascertain the cost of eachproduct manufactured or service rendered by an organization. *nformation regarding cost of each product or service would

enable the management to now where to economize on costs, how to fix prices, how to maximize profits and so on

(hus, the main objectives of cost accounting are the following.

*. (o analyze and classify all expenditure with reference to the cost of product and operations.+. (o arrive at the cost of production of every unit, job, operation, process, department or service and to develop cost

standard.. (o indicate to the management any inefficiencies and the extent of various forms of waste, whether of materials, time

expenses or in the use of machinery, equipment and tools. nalysis of the causes of unsatisfactory results may

indicate remedial measures.2. (o provide data for periodical profit and loss accounts and balance sheets at such intervals, e.g. weely, monthly or

quarterly as may be desired by the management during the financial year, not only for the whole business but also by

departments or individual products.3. (o reveal sources of economies in production having regard to methods, types of equipment, design, output and

layout. /aily, 0eely, 1onthly or 2uarterly information may be necessary to ensure prompt constructive action.4. (o provide actual figures of costs for comparison with estimates and to serve as a guide for future estimates or

quotations and to assist the management in their price fixing policy.5. (o show, where $tandard Costs are prepared, what the cost of production ought to be and with which the actual costs

which are eventually recorded may be compared.6. (o present comparative cost data for different periods and various volume of output and to provide guidance in the

development of business. (his is also helpful in budgetary control.7. (o record the relative production results of each unit of plant and machinery in use as a basis for examining its

efficiency. comparison with the performance of other types of machines may suggest the necessity for replacement.*8. (o provide a perpetual inventory of stores and other materials so that interim %rofit and 3oss ccount and 4alance

$heet can be prepared without stoc taing and checs on stores and adjustments are made at frequent intervals.



lso to provide the basis for production planning and for avoiding unnecessary wastages or losses of materials and

stores.

!D0!$T!%/" O1 CO"T !CCO#$TI$%

1. 1i9ation of selling :rice: 5enerally cost regulates selling price. Cost ccounting determines actual or calculated cost

of production. dding a margin of profit to the cost, price can be f ixed.

2. ;re:aring estimates:6 Cost ccounting accumulates statistical information regarding manufacture and sale. l

expenditure in the factory, office and7 sales department can be nown in advance and it is possible to mae reasonable

estimates for preparing quotations and submitting tenders.

3. /valuating :rofitability: (he preparation of schedules of comparative cost of different jobs under different conditions of

manufacture is facilitated to detect the profitable method of manufacture. *t also reveals unprofitable methods of

manufacture with their causes and remedial measures.4. /stablishes standard: $tatistical data regarding cost and income help management to fix standard for different items o

cost and income and to detect variances, if any, for corrections.

5. Controlling and reducing cost) Cost ccounting reveals expenses contributing towards production cost. *t also

detects weanesses of the organization and checs wasteful expenditure of material and labour due to inefficient

wormanship and management.

6. !scertainment of im:ortance) *t helps in ascertaining the degree of importance each element of cost has in the tota

cost of production and the scope for economy in operation.

7. Control over financial records: Cost ccounting helps to locate the exact cause of decrease or increase in profit or

loss, reflected by financial accounting to exercise control over them.

8. Inventory Control: *t has an efficient store accounting system for effective chec on inventories ' material, wor in

progress, finished goods, stores and spares.

9. Com:arison: *nstallation of uniform costing system helps management to mae inter'firm and intra'firm comparison on

various aspects of operation.

10.!id to %overnment: *t provides data to government for price control, wage fixation and settlement of labour disputes.

11.Decisions and ;olicies: Cost ccounting provides facts and figures for formulating policy and taing decisions on the

matters lie: a. 3evel of output: 2uantity to be produced, b. 1ae or buy requisite material and assets, c. cceptance o

special order, c. 8eplacement of labour with machinery, d. *ntroduction of new product, e. 8eplacement or

modernization of old equipment, f. $hut down or continue production during depression,

DI"!D0!$T!%/" O1 CO"T !CCO#$TI$%1. -ased on estimates: *ndirect costs are not charged fully to a product or process. *t is charged to all the products and

processes on the basis of estimates. ctual cost varies from estimated cost. /ue to these limitations, all cost

accounting results are taen as mere estimates.

2. <ac= of uniformity: %rocedures of cost accounting followed by different organizations are different for differentproducts. (here is no uniformity. (here is also possibility of difference in pricing material issues for production. ll

these lead to different cost results for the same operation.

3. any conventions: (here are many conventions for classification of costs, pricing of material issues, apportionment

of indirect costs, adoption of marginal or standard cost, etc. (hese create difficulty in determining the exact cost,

because no one type of cost is suitable for all. %urposes and in all circumstances.

4. /9:ensive: Cost accounting is expensive. *t involves lots of clerical won for maintaining various costing records for

different purposes. +or medium and small size concern, the benefit derived from costing system may not justify the

cost involved.

5. >esult reuires reconciliation: *nformation and results provided b# financial accounting and cost accounting may be

different for the as activity. (his requires reconciliation to find out correctness of the two before taing any decision.

6. De:endent: *t is not an independent system of accounting. *t depends on other accounting systems.

7. Does not include all items of e9:ense and income: *tems of purely financial nature such as interest, financiacharges, discount and loss on issue of shares and debentures, etc. are not taen into consideration in Cost

ccounting.



2. Distinguish between in!nci!" Accounting # Cost Accounting$

%oint o& Di&&e'ences in!nci!" Accounting Cost Accounting

1 e!ning

Recoding of transactions is part of

financial accounting. We make

financial statements through these

transactions. With the help of

financial statements, we analyze

the profitability and financial

position of a company.

Cost accounting is used to calculate

cost of the product and also helpful in

controlling cost. In cost accounting,

we study about variable costs, fixed

costs, semifixed costs, overheads and

capital cost.

2 %u'ose

!urpose of the financial statement

is to show correct financial

position of the organization.

"o calculate cost of each unit of

product on the basis of which we can

take accurate decisions.

3 *eco'+ing

#stimation in recording of

financial transactions is not used.

It is based on actual transactions

only.

In cost accounting, we book actual

transactions and compare it with the

estimation. $ence costing is based on

the estimation of cost as well as on the

recording of actual transactions.

4 Cont'o""ing

Correctness of transaction is

important without taking care of

cost control.

Cost accounting done with the

purpose of control over cost with the

help of costing tools like standard

costing and budgetary control.

5 %e'io+

!eriod of reporting of financial

accounting is at the end of financial year.

Reporting under cost accounting is

done as per the re%uirement of management or asandwhenre%uired

basis.

6 *eo'ting In financial accounting, costs are

recorded broadly.

In cost accounting, minute reporting

of cost is done perunit wise.

7 i,!tion o& e""ing

%'ice

&ixation of selling price is not an

ob'ective of financial accounting.

Cost accounting provides sufficient

information, which is helpful in

determining selling price.

8 *e"!tie /&&icienc

Relative efficiency of workers,

plant, and machinery cannot be

determined under it.

(aluable information about efficiency

is provided by cost accountant.

9 !"u!tion o& nento' (aluation basis is )cost or market

price whichever is less*

Cost accounting always considers the

cost price of inventories.

10 %'ocess

+ournal entries, ledger accounts,

trial balance, and financial

statements

Cost of sale of products-, addition of

margin and determination of selling

price of the product.

11 An!"sis o& %'o&it

&inancial ccounting reveals the

profit and loss of the business as a

whole at the end of a trading

period, usually a year.

"he total results, at the end of certain period, as reported by thefinancial accountant will not be of

much help to the management for

control and various other purposes

Cost ccounting discloses the result

of each operation, process and

product.

while the cost accountant reveals the profit and loss as and when the 'ob or process is completed which helps the

management in taking prompt and

effective measures.



3.h!t +o ou e!n b inst!""!tion o& costing sste$ h!t !'e &!cto's nee+ to be consi+e'e+ be&o'e inst!""ing !

cost !ccounting sste$ /,"!in the '!ctic!" +i&&icu"ties ino"e+ in inst!""ing such ! sste in ! !nu&!ctu'ing

conce'n$

nst!""!tion o& cost sste"he cost accounting system depends upon the nature of business and the product manufactured. /efore a suitable system

of cost accounting is installed it is necessary to undertake a preliminary investigation so as to know the feasibility of

installing cost accounting system to such business. While introducing a system of cost accounts it should be borne in mind

that cost accounting system must suit the business.

"here should not be any attempt to make the business suit the system. "his means the system must be simple and it must

lead to savings through the control of materials, labour and overheads when compared to expenses incurred in maintaining

it. &or the successful functioning of the costing system, the following conditions are essential0

!. "here must be an efficient system of material control.

b. sound and well designed method of wage payment must be set up.

c. "he existence of sound basis for collection of all indirect expenses and a basis for its apportionment to various

production departments.

+. "he integration of cost and financial accounts to facilitate reconciliation of profit as shown by these two systems of

accounts.

e. "he use of printed forms so as to facilitate %uick compilation of cost reports.

&. "he duties and responsibilities of cost accountant must be made clear.

!cto's Consi+e'e+ e&o'e nst!""ing A Cost Accounting ste

"he following factors are to be considered before installing a cost accounting system0A. isto' o& business unit "he history of a business unit implies the duration of its existence, position in the industry

the rate of growth, policy and philosophy of management and the like. "he history of business unit serves as the basis

for designing the cost accounts in respect of necessity, simplicity, and investment involved in installing cost accounts.

. !tu'e o& the in+ust' "he nature of business such as manufacturing, mining, trading, etc. determines the costing

techni%ues to be applied. 1imilarly, the type of product manufactured also determines the method of costing that is to

be employed. In other words, there is no all purpose techni%ue and method of costing that can be applied universally.

C. %'o+uct '!nge "he range of products manufactured and sold also determines the method of costing to be selected.

ccordingly range of products must be analysed in terms of size, models, fashions, area of market, competitors and

whether the products are made to customer*s specification or for stocking and selling.

D. echnic!" consi+e'!tions "echnical considerations that influence the installation of cost accounts are as follows 0

1ize and layout of the factory, "he existence of production and service departments

&low of production, Capacity of machines and degree of mechanization

#xistence of laboratories, Internal transport and material handling e%uipments

!roduction control techni%ues, Inspection and testing of materials and finished goods.

/. :'g!ni;!tion!" &!cto's "he problem of installing cost accounting is somewhat difficult in case of an existing

business when compared to new business. $owever, the existing set up of the organization should be least disturbed

should the need arise. In order to fix up responsibility to the executives it may be necessary to group the departments.

"he organizational factors to be considered are0 a- size and the type of organization such as line, line and staff,

functional and committee organization, b- the levels of management, viz ., top level, middle level and bottom level

management, c- extent of delegation and responsibility, d - extent of centralization and decentralization, e- extent of

departmentation, f - availability of modern office e%uipments, and g - number of managerial and supervisory staff.

. e""ing !n+ +ist'ibution etho+ "he chief factors to be considered with regard to distribution process are thewarehousing facilities, external transport, market research and other promotional measures, terms of sale and

procurement of orders from customers.

<. Accounting !sects "he factors to be considered in respect of accounting are 0 a- number of financial records, b-

existing forms, c- registers used, and d - number of copies re%uired.

. A'e! o& cont'o" to be e,e'cise+ "he areas where cost control is to be exercised is to be identified so that each

manager may take action relevant to his activities. If material control occupies significant area of control, it must be

given topmost priority for exercising control over materials.

. *eo'ting "he cost accounting system to be installed must ensure fre%uency and promptitude in reporting cost data

to all levels of management. It must also to be pointed out that duplication of reporting is to be avoided. &urther, only

those information which are relevant for the management in a particular context alone should be reported.



=. Uni&o'it "he practice of adopting uniform costing facilitates interfirm comparison among various firms

belonging to the same industry. &urther it also has the benefit of adopting common costing practice if a holding

company has number of subsidiaries.

>. Use o& e"ect'onic +!t! 'ocessing In modern days it has become a common practice to use electronic data

processing e%uipments and computers. In this situation it is essential to ensure that the e%uipment meets the needs of

the system but not the other way round.

?. %'!ctic!" consi+e'!tions "he cost accounting system to be installed must be flexible in operation and must be

capable of adaptation to changing conditions. "he system must be periodically scrutinised so as to make necessary

changes owing to development in business.

;>!CTIC!< DI11IC#<TI/" I$ I$"T!<<I$% CO"T !CCO#$TI$%*n addition to the above problems, a cost accountant will encounter the following practical difficulties at the time of

installation of cost accounting system:

a. ?!c@ o& suo't &'o !n!geent Wherever costing system is installed. It is essential to seek the support of

various departmental managers. (ery often the managers show hostile attitude towards the costing system. "hey feel

that this system will interfere in their routine work and probably as a means of checking their efficiency. 2nder such

circumstances it is better to convince them about the utility of costing system for the business as a whole.

b. *esist!nce b e,isting !ccounting st!&& (ery often the existing accounting staff resist the installation of the cost

accounting system on two grounds. &irstly, they feel that the new system of accounting might lead to excess work.

1econdly, they are afraid of their 'ob security. /ut this difficulty may be overcome by encouraging them about the

usefulness of cost accounting as a supplement to financial accounts and the generation of more employment

opportunities from the installation of cost accounting system.

c. on-cooe'!tion &'o i++"e !n+ botto "ee" !n!geent t times the middle and bottom level managers

such as foremen, supervisors and inspectors also fail to extend their wholehearted cooperation fearing additional

work which may be entrusted to them. "his problem may be overcome by suggesting them about the simplicity of

the system and the existence of a separate cost accounting department to look after costing matters. $owever, they

may be re%uired to provide necessary reports concerning their area of activity so as to enable functioning of cost

accounting department efficiently.

d. ?!c@ o& t'!ine+ st!&& "his was no doubt a problem in olden days. "oday this problem is overcome, thanks to the

establishment of "he Institute of Cost and Works ccountant of India in our country which offers professional course

in costing and also offers training facilities through various companies to the candidates undergoing the course. In

spite of this facility, it is somewhat difficult to get the competent and experienced staff at the time of installation.

"his problem can be overcome by paying attractive salaries to the cost accountants.e. e! e,enses in inst!""ing !n+ !int!ining the sste "he setting up of a separate costing department with

staff often poses a problem. In addition to installation, the operating expenses in the form of printing and stationery,

heating and lighting, depreciation and insurance, rent and rates are to be incurred. $owever, as was mentioned

earlier, the system of cost accounting must be a useful investment, i.e., benefits derived from it must be more than the

investment made on it. If this is not possible, for the time being the system must be discarded.

4. /,"!in the stes ino"e in inst!""!tion o& cost !ccounting sstes$

tes no"e+ in he nst!""!tion :& cost !ccounting sstes

"he steps involved in the installation of a cost accounting system are as follows0

1.Dete'5in!tion o& obecti.es0 "he costing system will be simple if the ob'ective is only to determine cost. Itwill have to be elaborate if the ob'ective is to have information which will help the management in

exercising control and taking decisions.2.stu+0ing the e,isting o'g!ni;!tion !n+ 'outine )'!ctice0 "he various matters to be considered in this regard

are the nature of the business, the various operations carried on, extent of responsibility and authority attached to

the various functionaries, the layout of the factory with particular reference to the manufacturing department, the

methods of dealing with wastage of materials, the system of time recording and the methods of computing and

paying wages, the system of issuing orders for production to the factory and the method of treating fixed, semi

variable and variable overheads.

3.Deci+ing the st'uctu'e o& cost !ccounts0 "his refers to deciding the system of costing based on a thoroughstudy of the manufacturing process and their ancillary services. "he structure of cost accounting should follow



the natural production line. "he se%uence can be simple, analytical or synthetic. "he designing of the system

should be such that there is gradual build up of the cost at each significant stage of production as the product

proceeds to co m p l e t i o n .

4.Dete'5ining the cost '!tes3 "his entails a thorough study of factory conditions, classification of cost into direct

and indirect, grouping of indirect costs into production, selling, administration etc., treatment of wastes of all

kinds, methods of pricing issues, methods of recovering overheads and calculation of overheads rates.

complete cost accounting code should be drawn up so that expenditure may be %uickly classified in the office as

to both source and c a u s e .

5.2nt'o+ucing the s0ste50 3o costing system can be expected to function effectively unless cooperation of

all the officials could be obtained. /efore the system is put into effect, the implications of the system should be explained to all indicating to them the benefits that will accrue to each and to the business as a whole.

$owever, instead of introducing the complete system, it should be introduced only by stages and the

existing routines and practices should be utilized unless, there are good grounds to supersede them.

6.:'g!ni;ing the cost o&&ice0 It is always better that the cost office is situated ad'acent to the factory so that delay

in routing out documents or in clearing up discrepancies and doubts is avoided. "he costing staff must be allowed

to perform their duties properly. "he size of staff would depend on the volume of work involved. "he duties of

cost office fall into the following spheres.

-to'es !ccounts.!osting of materials, receipts and stores issues in stores ledgers, preparing material

abstracts.

?!bou' !ccounting. #valuation of time sheets, 'obs cards etc., preparing labour abstracts. In some cases

preparation of actual pay rolls.

Cost !ccounts. !osting of all cost accounts, whether 'ob or process or service accounts.

Cost cont'o". !osting cost control accounts from data supplied from sections a- and b- above. !reparation

of special statistical and other information for management for carrying out special investigation and

preparation of periodical trading statements.

7. *e"!tionshi) o& cost o&&ice to othe' +e)!'t5ent0 "he cost department should function independently. "he cost

accountant being made directly responsible to the 4eneral 5anager or 5anaging 6irector. "he costing system

should be designed to serve management at all levels. "he cost accountant, therefore, should design his whole

system of records and reports7 with this end in view. $e must know and understand the problems faced in the

process of production and try to translate them into financial implications so that correct decisions may betaken.

8. Autho'it0 !n+ 'es)onsibi"it0 shou"+ be c"e!'"0 +e&ine+0 if the costing system is to be successful then authority

and reasonability need to be cleared in all respect. Costing systems should be perfect so that it will helps in the

preparation of cost of sales , valuation of inventories , helps in control and management of a company, helps in

measuring the efficiency of 8 5*s men, materials and machines-.

5. /,"!in the !'ious etho+s !n+ techniBues o& costing$

"he general fundamental principles of ascertaining costs are the same in every system of cost accounting, but the methods

of analysis and presenting the costs vary from industry to industry. 6ifferent methods are used because business

enterprises vary in their nature and in the type of products or services they produce or render. /asically, there are two

principal methods of costing, namely i- =ob Costing, and ii- %'ocess costing.1. =ob costing0 It refers to a system of costing in which costs are ascertained in terms of specific 'obs or orders

which are not comparable with each other. Industries where this method of costing is generally applied are !rinting

!rocess, utomobile 4arages, Repair 1hops, 1hipbuilding, $ouse building, #ngine and 5achine construction, etc.

+ob Costing includes the following methods of costing0

(!)Contract Costing 0 lthough contract costing does not differ in principle from 'ob costing, it is convenient to treat

contract cost accounts separately. "he term is usually applied to the costing method adopted where large scale

contracts at different sites are carried out, as in the case of building construction.

(b) Bach Costing 0 "his method is also a type of 'ob costing. batch of similar products is regarded as one 'ob and the

cost of this complete batch is ascertained. It is then used to determine the unit cost of the articles produced. It

should, however, be noted that the articles produced should not lose their identity in manufacturing operations.

(c)Terminal Costing 0 "his method is also a type of 'ob costing. "his method emphasizes the essential nature of 'obcosting, ie, the cost can be properly terminated at some point and related to a particular 'ob.



(+)Operation Costing 0 "his method is adopted when it is desired to ascertain the cost of carrying out an operation in

a department, for example, welding. &or large undertaking, it is fre%uently necessary to ascertain the cost of

various operations.

2. %'ocess Costing0 Where a product passes through distinct stages or processes, the output of one process being the

input of the subse%uent process, it is fre%uently desired to ascertain the cost of each stage or process of production.

"his is known as process costing. "his method is used where it is difficult to trace the item of prime cost to a

particular order because its identity is lost in volume of continuous production. !rocess costing is generally adopted in

textile industries, chemical industries, oil refineries, soap manufacturing, paper manufacturing, tanneries, etc.

3. Unit o' sing"e o' outut o' sing"e outut costing0 "his method is used where a single article is produced or

service is rendered by continuous manufacturing activity. "he cost of the whole production cycle is ascertained as a process or series of processes and the cost per unit is arrived at by dividing the total cost by the number of units

produced. "he unit of costing is chosen according to the nature of the product. Cost statements or cost sheets are

prepared under which various items of expenses are classified and the total expenditure is divided by total %uantity

produced in order to arrive at unit cost of production. "his method is suitable in industries like brickmaking

collieries, flour mills, cement manufacturing, etc. this method is useful for the assembly department in a factory

producing a mechanical article e.g. /icycle.

4. :e'!ting Costing0 "his method is applicable where services are rendered rather than goods produced. "he

procedure is same as in the case of single output costing. "he total expenses of the operation are divided by the units

and cost per unit of services is arrived at. "his method is employed in Railways, Road "ransport, Water supply

undertakings, "elephone services, #lectricity companies, $ospital services, 5unicipal services, etc.

5. u"ti"e o' Co"ete Costing0 1ome products are so complex that no single system of costing is applicable. It isused where there are a variety of components separately produced and subse%uently assembled in a complex

production. "otal cost is ascertained by computing component costs which are collected by 'ob or process costing and

then aggregating the costs through use of the single or output costing system. "his method is applicable to

manufacturing concerns producing 5otor Cars, eroplanes, 5achine tools, "ypewriters, Radios, Cycles, 1ewing

5achines, etc.

6. Uni&o' Costing0 It is not a distinct method of costing by itself. It is the name given to a common system of

costing followed by a number of firms in the same industry. "his helps in comparing performance of one firm with

other.

7. De!'tent!" Costing0 When costs are ascertained department by department, the method is called

96epartmental Costing:. 2sually, for ascertaining the cost of various goods or services produced by the department,

the total costs will have to be analyzed, say, by the use of 'ob costing or unit costing. In addition to the above methodsof costing, mention can be made of the following techni%ues of costing which can be applied to any one of the above

method of costing for special purposes of cost control and policy making0 !) 1tandard or !redetermined Costs. b)

5arginal Costs

/CU/- &or ascertaining cost, following techni%ues of costing are usually used0

!) Uni&o' Costing "he practice in which common methods of costing for different undertakings in the same industry

are used is known as uniform costing.

b) isto'ic!" Costing In this techni%ue, ascertainment of cost is done after they have been incurred but the utility of

this techni%ue is limited.

c) Di'ect Costing "he practice of charging all direct costs to operations, processes or products leaving all indirect

costs to be written off against profit*s in which they arise are called as direct costing.

+) Abso'tion Costing In this all costs, both variable and fixed are charged to production, operations or processes.e) !'gin!" Costing "he method of ascertaining marginal cost by differentiating between fixed and variable costs.

"his techni%ue is used to ascertain effect of changes in volume or type of output over the profits.

&) t!n+!'+ Costing "he preparation of standard costs and applying them to measure the variations from actual cost

and analyzing the causes of variations with a view to maintain maximum efficiency in production is known as

standard costing.

g) Actiit !se+ Costing /C is a system that focuses on activities as fundamental cost ob'ects and utilizes the cost

of these activities as building blocks or compiling the costs of other cost ob'ects.



#$IT(+

*. What are the objective of inventory control @ material control? /9:lain the methods and techniues of inventory contro

systems?

95aterial control ; inventory control is a systematic control over purchasing, storing and consumption of materials, so as

to maintain a regular and timely supply of materials, at the same time, avoiding overstocking.:

95aterial control refers to the management function concerned with ac%uisition, storage, handling and use of materials so

as to minimize wastage and losses, derive maximum economy and establish responsibility for various operations through

physical checks, record keeping, accounting and other devices. :

"hus material control is the proper control of material which reduces the cost of production, minimizing the investment offund in the purchases of material < increases the profitability of the organization.

//A? : A/*A? C:*:?

"he basic ob'ective of material control is to obtain re%uisite %uantity of material at right price, right %uantity, and right

%uality and from right source. "he detailed ob'ectives of material control are as follows0

1. *egu"!' su" o& !te'i!" 5aterial control ensures regular supply of material to the factory so the production may

not be held up for want of material.

2. o ossibi"it o& oe'stoc@ing !n+ un+e' stoc@ing /y fixing various stock level as minimum level, maximum level

ordering level over stocking and under stocking of material can be avoided.

3. iniu !st!ge !roper material management and control reduces wastages of material. !oor stores facilities

result deterioration, obsolescence, pilferage, theft, fire, evaporation etc. which directly affect the profitability of the

organization4. <etting !te'i!" !t 'e!son!b"e 'ices While purchasing materials, it is seen that it is purchased at reasonable low

prices but the %uality is not to be sacrificed in the plan of low prices.

5. A!i"!bi"it o& u-to-+!te in&o'!tion 2ptodated and readily material information can be made available to the

management, for planning and decision making. "he store keeper can supply information because he keeps upto

dated record of the every item of the store under proper system of material control.

6. A+otion o& inte'n!" chec@ sste Internal check system is the part of material control. 2nder this system the

employees perform their work on rotational basis by which misappropriation of material is minimized.

7. o en!b"e uninte''ute+ 'o+uction "he main ob'ect of material control is to ensure smooth and unrestricted

production. !roduction stoppages and production delays cause substantial loss to a concern.

8. o ensu'e 'eBuisite Bu!"it o& !te'i!"s "he %uality of finished products depends mainly on the %uality of raw

materials used. If %uality of the raw materials is not up to desired standards, the end product will not be of desired%uality which affects the sale of the product in the market resulting in loss of profits as well as goodwill of the

concern. It is of vital importance to exercise strict control and supervision over the purchases, storage and handling of

materials.

/:D AD /CU/ : /:* C:*:? /

Inventory consists of stock of raw materials, workinprogress, spare pa consumables for production and finished goods

for sale. "hus, inventory com includes control over raw materials, spare parts, consumables, partly finished goods, and

finished goods. "he following are the common techni%ues of inventory control0

1. 6etermination of various levels of materials

2. #conomic =rder >uantity

3. /C nalysis

4. !erpetual Inventory 1ystem

1. D//*A: : A*:U ?//? : A/*A?- "he storekeeper plays an important role in

deciding upon the various levels materials. In order to ensure that the optimum %uantity of materials is purchased

stocked neither less nor more, the store keeper applies scientific techni%ues of material management. &ixing of certain

levels for each item of materials in one of techni%ues."hese levels are not permanent but re%uire revision according to

the change in the factors which determine these levels. "he following levels are generally fixed.

!) *e-o'+e' ?ee" b) !,iu ?ee" c) iniu ?ee"



+) Ae'!ge ?ee" e) D!nge' ?ee"

!) *e-o'+e' ?ee" "his level is that level of material at which it is necessary to initiate purchase re%uisition for fresh

supplies. "his is normally the point lying between the maximum and the minimum levels. &resh orders must be placed

before the actual stocks touch the minimum level.

"his level is fixed in such a manner that the %uantity of materials represented by the difference between the reorder

level and the minimum level will be sufficient to meet the re%uirement of production till such time as the order

materialises and materials are delivered. "he following factors are taken into account for fixing the Reorder level0

*!te o& consution o& !te'i!", ?e!+ tie, i.e., time re%uired to receive the delivery of fresh purchase. *e-o'+e'

Bu!ntit, iniu "ee".

Reorder level can be calculated by applying the following formula0*e-o'+e' "ee" E iniu "ee" F consution +u'ing e'io+ 'eBui'e+ to get &'esh +e"ie'

nother formula for Reorder level is0

*e-o'+e' "ee" E !,iu consution , !,iu *e-o'+e' %e'io+

/,!"e 1- Calculate Reorder level for a material from the following information0 5inimum level ?,@@@ units

5aximum level A,@@@ units "ime re%uired to get fresh delivery ?B days. 6aily consumption of the material ?@@

units.

1olution0 Reorder level 5inimum Devel E Consumption during the period re%uired to get fresh delivery ?,@@@

units E ?@@ x ?B- F,B@@ units.

/,!"e 2- Calculate Reorder Devel from the following particulars0 5inimum consumption G@ unitsH 5aximum

consumption ?F@ units Reorder period ?@?F days

o"ution Reorder Devel 5aximum consumption x maximum Reorder period ?F@ units x ?F ?,@ units

b) !,iu ?ee" "he maximum level is that level of stock which can be held at any time. In other words, it is the

level beyond which stock should not be maintained. "he purpose is to avoid overstocking and thereby using working

capital in a proper way. "his level is fixed after taking into account the following factors0 *!te o& consution, ?e!+

tie, A!i"!bi"it o& c!it!", to'!ge c!!cit, Cost o& !int!ining sto'es inc"u+ing insu'!nce cost , !tu'e o&

coo+it, %ossibi"it o& 'ice &"uctu!tion, %ossibi"it o& ch!nge in &!shion, h!bit, etc., *est'ictions iose+ b

<ot., "oc!" !utho'it o' t'!+e !ssoci!tions, *e-o'+e' "ee" it, *e-o'+e' Bu!ntit.

!,iu "ee" c!n be c!"cu"!te+ b !"ing the &o""owing &o'u"!!,iu ?ee" E *e-o'+e' "ee" F *e-

o'+e' u!ntit - (iniu consution , iniu *e-o'+e' e'io+)

c) iniu ?ee" "his is the level below which the stock of an item should not fall. "his is known as safety or buffer

stock. n enterprise must maintain minimum %uantity of stock so that the production is not hampered due to nonavailability of materials. "his level is fixed after considering the following factors0 *e-o'+e' "ee", ?e!+ tie, *!te

o& consution.

"he formula for calculating minimum level is0 iniu "ee" E *e-o'+e' "ee" - (o'!" consution , o'!"

*e-o'+e' e'io+)

+) Ae'!ge ?ee" verage level can be calculated by applying the following formula0

!,iu "ee" F iniu "ee" Ae'!ge "ee" E ---------------------------------------------- - =r Ae'!ge "ee" E

iniu "ee" F o& *e-o'+e' u!ntit.

e) D!nge' ?ee" 2sually stock should not be lower than the minimum level. /ut if for any reason, stock comes down

below the minimum level, it is called danger level. When the stock reaches danger level, it is necessary to take urgent

action on the part of the management for immediate replenishment of stock to prevent stockout situation. "he danger

level can be calculated by applying the following formula0 D!nge' ?ee" E Ae'!ge consution , !,iu *e-

o'+e' e'io+ &o' ee'genc u'ch!ses.

2. /C::C :*D/* UA (/:)

"he economic order %uantity, known as #=>, represents the most favorable %uantity to be ordered each time fresh

orders are placed. "he %uantity to be ordered is called economic order %uantity because the purchase of this size of

material is most economical. It is helpful to determine in advance as to how much should one buy when the stock

level reaches the reorder level. If large %uantities arc purchased, the carrying costs would be large.

=n the other hand, if small %uantities are purchased at fre%uent intervals the ordering costs would be high. "he

economic order %uantity is fixed at such a level as to minimize the cost of ordering and carrying the stock. It is the

size of the order which produces the lowest cost of material ordered.



While determining the economic order %uantity, the following three cost factors are taken into consideration0 i- he

cost o& the !te'i!" ii- he inento' c!''ing cost iii- he o'+e'ing cost

C!''ing costs are the costs of holding the inventory in the stores. "hese are0

Rent for the storage space. F. 1alaries and wages of the employees engaged in store keeping department. 8. Doss due

to pilferage and deterioration. . Insurance charges. B. 1tationery used in the stores .A. Doss of interest on the capital

locked up in materials.

:'+e'ing costs are the costs of placing orders for the purchase of materials. "hese are0

!"!'ies !n+ w!ges o& the e"oees eng!ge+ in u'ch!sing +e!'tent., t!tion!'G ost!geG te"ehone

e,ensesG etc. o& the u'ch!sing +e!'tent., De'eci!tion on eBuients !n+ &u'nitu'e use+ b the

u'ch!sing +e!'tent.. *ent &o' the s!ce use+ b the u'ch!sing +e!'tent.

Dete'in!tion o& /conoic :'+e' u!ntit0

"he economic order %uantity is determined by using the following formula0

Assutions in the C!"cu"!tion o& /conoic :'+e' u!ntit

?. >uantity of the item to be consumed during a particular period is known with certainty.

F. "he pattern of consumption of material is constant and uniform throughout the period.

8. Cost per unit is constant and known and %uantity discount is not involved.

. =rdering cost and carrying cost are known and they are fixed per unit and will remain constant throughout the period.

3. AC An!"sis/C analysis is a type of analysis of material dividing in three groups called group items, /4roup items

and Cgroup items &or the purpose of exercising control over materials. 5anufacturing concerns find it

useful to divide materials into three categories. AC is s!i+ to connote HA"w!s ette' Cont'o"I. "he

basis of analyzing the annual consumption cost or usage cost- goes after the principle HA? / J *A?

AI, and the criterion used here is the money spent and not the %uantity consumed. "he following #xhibit

brings out clearly the concept of /C nalysis. n analysis of the annual consumption of materials of any

organization would indicate that a handful of top high value items less than ?@ per cent of the total number-

will account for a substantial portion of about J@ per cent of total consumption value.



?@K of total number of items carries J@K of value. - KAK g'ou ites

1imilarly, a large number bottom items over J@ per cent of the total number of items- account for only

about ?@ percent of the consumption value.

J@K of total number of items accounts for only about ?@K of consumption value - KCK-g'ou ites.

/etween these two extremes will fall those items the percentage number of which is more or less e%ual to

their consumption value.

F@K of total number of items accounts for only about F@K consumption value - KK g'ou ites.

Items in the top category are treated as LL category items. Items in the bottom category are called as LCL

category items and the items that lie between the top and the bottom are called L/L category items. 1uch an

analysis of materials is known as /C analysis or !roportional parts value analysis. =n the basis of physical

%uantities and value of arterials used, the following table illustrates the above classification0

After the items of materials are classied into A, B and C category, control can be

exercised in a selective manner as follows:

1. 4reater care and strict control should be exercised on the items of category HH as any loss or breakage or wastage

of any item of this category many prove to be very costly. #conomic order %uantity and reorder level should be

carefully fixed for such category of items.

2. 5oderate and relaxed control is re%uired for the items of category H/H.

3. "here is not much need for exercising control over the items of category HCH !eriodic or annual verification is

re%uired for this category of materials.

4. %/*%/UA? /:*

!erpetual inventory as 9a system of records maintained by the controlling department, which reflects the physical

movements of stocks and their current balance:. /in cards and the stores ledger help the management in maintaining this

system as they make a record of the physical movements of the stock on the receipts and issues of the materials and alsoreflect the balance in the stores.

"hus, it is a system of ascertaining balance after every receipt and issue of materials through stock records to facilitate

regular checking and to avoid closing down the firm for stocktaking.

"he following are the advantages of the perpetual inventory system0

*. It avoids the disruption of production for physical checking of all items of stores at the end of the year.

+. "he preparation of !rofit and Doss ccount and /alance 1heet is possible without physical verification of stock.

. detailed and more reliable control on the materials in store is obtained.

2. s the work of recording and continuous stocktaking is carried out systematically and without undue haste, the figuresare more reliable.

3. Continuous stocktaking will make the storekeeper and the stores accountant more vigilant in their work and they will

try to keep the records accurate and uptodate.

4. !lanning of production can be done without any fear of shortage as the management is constantly informed of the

stores position.

A +. Discuss +i&&e'ent etho+s o& 'icing o& issue o& !te'i!"$



5aterial price usually refers to the price %uoted and accepted in the purchase orders. 5aterials are issued from

the stores to work orders based on the material re%uisition. /ut stock of materials consists of different

consignment received at different dates and prices with varying discounts, taxes etc. /ecause of this the

problem arises as to how the material issues to production are to be valued, there are several methods for tackle

this situation. "he cost accountant should select the proper method based on following factors0

?. "he fre%uency of purchases, price fluctuations and its range.

F. "he fre%uency of issue of materials, relative %uantity etc.

8. 3ature of cost accounting system.

. "he nature of business and type of production process.B. 5anagement policy relating to valuation of closing stock.

1everal methods of pricing material issues have been evolved in an attempt to suitably answer the problem.

A. Actu!" %'ice etho+ (o') Cost %'ice etho+- ?- &irst In &irst =ut &I&=-. F- Dast In &irst =ut DI&=-.

8- 1pecific !rice 5ethod. - /ase 1tock 5ethod. B- $ighest in &irst out $I&=-.

B. Ae'!ge Cost etho+- ?- 1imple verage 5ethod. F- Weighted verage 5ethod. 8- !eriodic 1imple

verage 5ethod. - !eriodic Weighted verage 5ethod.

C. t!n+!'+ %'ice etho+

D. n&"!te+ %'ice etho+.

/. !'@et %'ice etho+ (o') *e"!ceent %'ice etho+.

1. i'st Jin J i'st out etho+ (:) It is a method of pricing the issues of materials. 2nder this method,the materials first received in the store are the first issued. In other words, the order in which the materials

are received in the store are first issued at their cost price in the same order or the items longest in stock are

issued first. "hus each issue of material only recovers the purchase price which does not reflect the currentmarket price.

"his method is considered suitable in times of failing price because the material cost charged to production

will be high while the replacement cost of materials will be low. /ut in the case of rising prices, if thismethod is adopted, the charge to production will be low as compared to the replacement cost of materials as

in the current period- in future without having additional capital resources.

he !+!nt!ges !n+ +is!+!nt!ges o& the etho+ ! be st!te+ !s &o""ows

A+!nt!ges-

!) It is simple to understand and simple to operate.b) 5aterial cost charged to production represents actual cost with which the cost of production should have

been charged.

c) In the case of falling prices, the use of this method gives better results.

+) Closing stock of material will be represented very closely at current market price.

e) "he old material is issued first. "hus, there remains no possibility of loss of material due to spoilage or

obsolescence.

Dis!+!nt!ges

!) If the price fluctuates fre%uently, this method may lead to clerical error.

b) 1ince each issues of material to production is related to a specific purchase price, the cost charged to the

same 'ob are likely to show a variation from period to period.

c) In the case of rising prices, the real profits of the concern being low, they may be inade%uate to meet the

concern*s demand to purchase raw materials at the ruling price.

2. ?!st J in J i'st out etho+ (?:) It is a method of pricing the issues of materials. "his method is

based on the assumption that the items of the last batch lot- purchased are the first to be issued. "herefore,

under this method the price of the last batch lot- is used for pricing the issues, until it is exhausted, and so

on. If however, the %uantity of issue is more than the %uantity of the latest lot than earlier lot- and its price

will also be taken into consideration.

6uring inflationary period or period of rising prices, the use of DI&= would help to ensure that the cost of

production determined on the above basis is approximately the current one. "his method is also useful



specially when there is a feeling that due to the use of &I&= or average methods, the profits shown and tax

paid are too high.

he !+!nt!ges !n+ +is!+!nt!ges o& ?: etho+ !'e !s &o""ows

A+!nt!ges

1. "he cost of materials issued will be either nearer to and or will reflect the current market price. n"hus

the cost of goods produced will be related to the trend of the market price of materials. 1uch a trend in

price of materials enables the matching of cost of production with current sales revenues.

2. "he use of the method during the period of rising prices does not reflect undue high profit in the income

statement as it was under the &I&= or average method. In fact, the profit shown here is relatively lower

because the cost of production taken into accounts the rising trend of material prices.

3. In the case of falling prices profit tends to raise due to lower material cost, yet the finished products

appear to be more competitive and are at market price.

4. =ver a period, the use of DI&= helps to level out the fluctuations in profits.

5. In the period of inflation DI&= will tend to show the correct profit and thus avoid paying undue taxes to

some extent.

Dis!+!nt!ges

1. Calculation under DI&= system becomes complicated and burdensome when fre%uent purchases are

made at highly fluctuating rates.

2. Costs of different similar batches of production carried on at the same time may differ a great deal.3. In time of falling prices, there will be need for writing off stock value considerably to stick to the

principle of stock valuation, i.e., the cost or the market price whichever is lower.

4. "his method of valuation of material is not acceptable to the income tax authorities.

5. "he closing stock is priced at a very old price which does not show the correct position of the business.

3. i"e Ae'!ge %'ice etho+ 2nder this method, materials issued are valued at average price, which is

calculated by dividing the total of all units rate by the

number of unit rate.

"his method is useful under the following circumstances0

1. When the materials are received in uniform lots of similar %uantity, otherwise, it will give wrong results.

2. When purchase prices do not fluctuate considerably.

A+!nt!ge

1. It is simple to understand and easy to operate.

2. "he method is a mixed form of market price and cost price.

3. 6ue to calculation of average of different purchase prices, the tendency of e%uality in different rates is

arrived at.

Dis!+!nt!ge

?. 5aterials issue cost does not represent actual cost price. 1ince the materials are issued at a price

obtained by averaging cost prices, a profit or loss may arise from such type of pricing.

F. In case the prices of material fluctuate considerably, this method will give incorrect results.

8. "he prices of materials issues used are determined by averaging prices of purchases without giving

consideration to the %uantity. 1uch a price determination is unscientific.

. It becomes difficult to calculate the average again and again.

4. eighte+ Ae'!ge %'ice etho+ "his method gives due weights to %uantities purchased and the

purchase price, while, and determining the issue price. "he average issue price here is calculated by

dividing the total cost of materials in the stock by total %uantity of materials prior to each issue.



he !+!nt!ges !n+ +is!+!nt!ges o& this etho+ !'e

A+!nt!ges

1. It smoothens the price fluctuations if at all it is there due to material purchases.

2. Issue prices need not be calculated for each issue unless new lot of materials is received.

3. "his method is scientific and argumentative because under this method, the total cost of the material

available in the bin is provided by the total %uantity of material. In fact, after reaching the bin, the new

and old material mix up, i.e., there remains no separate existence in the bin, of the material separately

purchased on the different dates.

4. s regards calculation work, this method is simple because the issue price once calculated continues till

the new material is purchased.

5. "his method is a mixed form of market price and cost price.

6. In this method, the balance of the closing stock is shown at appropriate price which can be used in

financial accounts also.

Dis!+!nt!ge

1. 5aterial cost does not represent actual cost price and therefore, a profit or loss will arise out of such a

pricing method.

2. If the material is purchased again and again at short intervals, the calculation work increases.

3. s the material is issued at average price, the production cost cannot be correctly estimated.

+3 commerce -costaccting - unit - 1 &2

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