BSPATIL 1

Cost Accounting

BSPATIL 2

Syllabus

Paper 3.3 Cost Accounting

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

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Contents

Lesson: 1 Introduction of Cost AccountingDefinition – Cost Concepts – Element of Cost – Installation of Costing System

Lesson: 2 Material CostNature – 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 – Absorptionof 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 ContractLesson: 7 Process Costing

Simple Process Costing – Process with Normal and abnormal causes – Inter processprofitLesson: 8 Standard Costing and Variance Analysis

Definition – Uses and Limitations – Material Cost Variance – Labour Cost Variance –Overhead Cost Variance and Sales VarianceLesson: 9 Cost Ledger Accounting

Nature – Control Accounts and its Uses – Preparation of Cost Ledger AccountLesson: 10 Integral Accounting

Nature – Uses – Preparation of Integral AccountsLesson: 11 Reconciliation of Cost and Financial Accounts – Need for Reconciliation – Steps inreconciliation – 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 andtechniques to the science, art and practice of cost control and the ascertainment ofprofitability. It includes the presentation of information derived there from for thepurpose of managerial decision – making”.

The term ‘Cost Accountancy’ includes Costing and Cost accounting. Itspurposes are Cost-control and Profitability – ascertainment. It serves as an essentialtool of the management for decision – making.

Cost Accounting

“The process of accounting for cost from the point at which expenditure isincurred or committed to the establishment of its ultimate relationship with costcentres and cost units. In its widest usage it embraces the preparation of statisticaldata, the application of cost control methods and the ascertainment of theprofitability of activities carried out or planned” Cost accounting means such asanalysis of accounting and other information as to enable management to know thecost involved in each activity together with its significant constituent elements inorder to arrive at proper decisions.Cost accounting provides management with costdata relating to products, processes, jobs and different operations in order to controlthe 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 andtechniques to the science, art and practice of cost control and the ascertainment ofprofitability. It includes the presentation of information derived these from for thepurpose 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 ofproduction.

6. To provide suitable means and information to the top management tocontrol and guide the operations of the business organisation.

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

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

9. To provide necessary information to develop cost standards and tointroduce the system of budgetary control.

10.It enables the management to know where to economize on costs, how tofix prices, how to maximize profit and so on.

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 theproduction are first incurred and them the costs are ascertained.

2. Standard Costing:

‘The preparation and use of standard costs, their comparison with actual costs andthe 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 variancesare 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 involumes 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 theincrease or decrease in the quantum of production. The variables costs are those which dochange proportionately with the change in quantum of production.

The marginal costing takes into account only the variable costs to find out ‘marginalcosts’. The difference between Sales and Marginal costs is known as ‘Contribution’ andcontribution is an aggregate of Fixed costs and Profit/Loss. So the fixed costs are deductedfrom the contribution to find out the profits. Marginal costing is a technique to ascertain theeffect on profits. Marginal costing is a technique to ascertain the effect on profit by thechange 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 theindirect costs to be written off against profits in the period in which they arise

5. Absorption Costing

‘The practice of charging all costs, both variables and fixed, to operations, processes orproducts.

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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.

1. Job Costing: The job costing methods are applicable where the unit of manufactureis 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 orcarrying out constructional works, e.g., House buildings, ship building, CivilEngineering contracts. Here the cost unit is one and completed in itself. The cost unitis a contract which may continue for over more than a year. It is also known as theTerminal Costing, since the works are to be completed within a specified period asper terms of contract or agreement executed by the contractor and contractee.

Contracts can be differentiated from fobs in as much as the contracts jobs arecarried out outside the factory and generally are of a long-term while jobs arecarried out inside the factory and are of a short duration. If an order completein itself and meant only for the person who has placed the order, thisjob-order is executed inside the press and the completion of the order takes ashort time as against the contract which may take years.

(ii) Batch Costing: In this method, a batch of similar or identical products istreated as a job. Here the unit of cost is a batch of group of products, costs arecollected and analyzed according to batch numbers and the costs areascertained batch wise. This method is applied in pharmaceutical industrieswhere medicines or injections are manufactures batch wise or in generalengineering factories producing components in convenient batches.

1. Process Costing: Process costing method is applicable to those industriesmanufacturing an number of units of output requiring processing. Here an article hasto undergo two or more processes for reaching the stage of finished goods andsucceeding process till completion.

Classification of Cost

The cost-classification is the process of grouping costs according to theircharacteristics. 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,

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

According to Elements: The cost is classified into i) Direct Cost, and ii) Indirect Costaccording to elements, viz., Materials, Labour and Expenses, the description of whichoccurs 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,

A brief description of each these items are given below:

i) Production Cost is ‘The cost of sequence of operation which begins with supplyingmaterials, 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 organisationand controlling the operations of an undertaking, which is not related directly to aproduction, selling, distribution, research or development activity or function.”Administration Cost comprise office and Administration expenses.

iii) Selling Cost is “The cost of seeking to create and stimulate demand (sometimestermed ‘marketing’) and of securing order.”

It is also known as Selling expenses or Selling overheads which include all theexpenses of Selling Department.

iv) Distribution Cost is “The cost of sequence of operations which begins with makingthe packed product available for dispatch and ends with making there-conditioned returned empty package, if any, available for re-use”.

It is known as Distribution expenses or overheads which include expenses likepacking, warehouse expenses, cost of freight, shipping charges and also theexpenses 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 withvolume of rate of output. Fixed Costs are sometimes referred to as period costs insystems of direct costing.” Fixed costs or Fixed expenses are those expenseswhich do not change with the increase or decrease in the quantum of productionbut 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, Variablecosts are sometimes referred to as direct costs in systems of direct costing.”

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Variable costs or expenses are those which increase in direct proportion with theincrease in production or which decrease in direct proportion with the decrease inproduction, 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 costwith changes but not in direct proportion to the increase or decrease in theproduction-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 specifiedmember of an undertaking. The organisation is divided into departments orresponsibility centres each managed by a Head. The costs of a particulardepartment or centre re guided by the person-in-charge of the department. Thecosts which can be controlled by a ‘specified member’ who is generally animportant link in the management are the controllable costs. they Head of acost-centre or a department ahs control over variable costs only which includePrime cost and other variable overheads. So the controllable costs are the variablecosts.

v) Uncontrollable Costs: it is a cost which cannot be influenced by the action of aspecified member of an undertaking. Uncontrollable costs are generally theFixed costs, the control of which does nto lie within the province of a memberof the undertaking. The change in Fixed costs is a mater to be decided at thetop level of the management depending upon the policy of the undertaking.Another example of he uncomtrollable cost is where the cost of onedepartment is shared by the other department for reason that the otherdepartment is taking the benefit of services of the department. Suppose, thecost of Power departments is shared by the Machine Department, the cost ofthis share is uncontrollable as it has no control over the cost of the otherdepartment, 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 thatlevel 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 plantis 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 notrelevant to the particular decision-making is a sunk cost. If it is decided to replacethe existing plant; the written down book value of the plant less the sale value ofthe existing plant, is a Sunk a Irrevocable cost.

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iii) Opportunity Cost: “The net selling price, rental value or transfer value which could beobtained 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 theopportunity cost. The cost which are related to the sacrifice made or the benefitsforegone are opportunity costs. to take an example, if a part of the factorybuilding has been let out on rent and now we want to use that portion forinstalling a plant, we would naturally lose the rent that we used to get. So the lossof rent is the opportunity which would arise due to putting the part of that factorybuilding to an alternative use available to the owner, and this cost should be keptin view while installing the plant.

iv) Imputed cost: it is hypothetical cost required to be considered to make costscomparable. If the owner of the factory charges rent of the factory to the cost ofproduction to make cost comparable with that of those undertakings which runproduction in rented factories, it is an Imputed cost as the rent has actually notbeen paid. Some is the case with charging Interest on one’s 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 beclassified into the following four types:

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

For manufacturing operations, the cost centres may be Production cost centers, i.e., theProduction Departments engaged in producing, or the Service cost-centres, i.e., the ServiceDepartments which help the production work e.g., Store, Power Dept. Internal TransportDept., Repairs and Maintenance Dept., etc.,

For sales operations, the cost-centres, all the machine or the persons operating thosemachines 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 ora 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) inrelation 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 identitythroughout 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 ofmeasurements of cost. Cost Units are of two types: 1) Single. 2) Composite. The examples of

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Single Cost unit are-per tone, per meter, per kilogram etc., and the examples of compositeunits 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 costaccounting are being increasingly realized presently all over the business versatility. Thecommon experience of enthusiastic youths climbing the business – tree and falling mid-waywithout even collecting the leaves owes to the ignorance of he use installation andorganisatoin of accosting system, and to the infatuation that the profits could be earnedwithout it. A good system is the key-point governing, the mechanism of an enterprise inthe 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 muchgreater than the expenses incurred. The cost system is for the business and not thebusiness for a system of cost. Therefore, the system has to be so designed as to meet thespecific needs of the enterprise.

A) General Consideration for installing Costing System

The 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 aspecific area, e.g. material management, or fixing selling price. Or to arrive at acertain managerial decision; or the object is to install the system for covering all theaspects of cost affecting the business. The approach to install the system will bedependent on its objectives.

The Area of Operation: Having decided the objective, the areas of operation of thesystem are to be studied, by which the management can be best benefited. Ifproduction is slack, attention will have to be paid to increase it; if production is goodbut the sales are receding, study will be made to increase the sales and action takenaccording to the results of study and analysis. Such areas which require immediateattention 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 untilthe organisation structure of the business is taken into account. The organizationalpart would help to determine the scope of working and improvement. If the interestsof management call for certain minor changes in the organizational structure, to itsadvantage, the same may have to be done.

The Conception & Reception of the Idea: The idea of the installation of the costsystem is to be placed before the staff and the workers in a manner that it is wellreceived and not objected to on flimsy grounds. The success of the system woulddepend on the cooperation of he persons engaged in the enterprise, and thecooperation will be forth coming only if the idea and plans are well conceived andreceived. The benefits of introducing the system to all the sections should be wellexplained.

Collection of Data & Prompt Information: The cost data works as a base fordecision-making. There should be evolved a proper system for the collection of therequired cost data and information promptly. Secondly, there should be a system toverify the correctness of the data supplied, otherwise the conclusions drawn would bewrong and time spent in its working would go waste.

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Cost Records & Cost Books: The maintenance of cost records and cost books dependson the size and nature of the business, but the basic requirements. The manner inwhich the financial accounts could be interlocked into an integral accounting systemhas to be studied and worked out. Decision has to be taken if two separate set ofbooks-one for financial accounts and other for cost accounts-have to be maintainedand thereafter the results are to be reconcile. Proper books and records are to bekept and maintained to meet the requirements of either of the two situationsmentioned above.

Control system for the Elements of Cost: System would have to be devised forrecording and controlling costs of materials, labour and overheads, in accordancewith costing principles and procedures.

Type and Method of Costing: The choice of method of costing would depend on thenature of production, e.g., Job Cost method or the Process Cost method. For costcontrol, standard costing along with Budgetary control may have to be selected andapplied. Similarly, for decision making, Marginal and Differential costing techniquesmay be found useful. Preparations for the application of the particular method andtechnique/type should be made initially.

Responsibility Accounting: Responsibility accounting is a technique of cost control bydelegating, etc., known as responsibility centres. Its has to be judged whether aparticular official who had been assigned a particular function, has implemented thesame or not within the time’ allotted to him, or not, and thus the responsibility hasgot 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 whileinstalling a cost system are as follows:

Size and Nature of Business: In a business of big size, a detailed cost system isnecessary while in a small business, the system should be within the requirements sothat 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 inservice-rendering concerns but for others. Even in production enterprise like collierywhere the production costs are all direct costs, the financial where the productioncosts are all direct costs, the financial accounts may be so designed as to obviate theneed of any cost system, unless otherwise called for.

Products: the nature of product determines the method of costing to be applied. Ifthe material content of the product is more valuable, the material cost records needbe kept in comparatively more elaborate manner so as to make material cost controleffective. Same is the position with regard to labour and overhead.

Organisatoin: The organizational set up for a costing system should be modeled thatthe control part is exercised by the Cost Accountant, as such, the presentorganizational set up of the costing department need close study to suggestnecessary changes.

Functional study: The functional divisions of an undertaking based on cost are a)Manufacturing, b) Administration, and c) Selling & Distribution. A study of the presentworking of the different departments in necessary to suggest improvements.

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C) Principles for Smooth Working

The 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 ofthe 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 Action

The 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 suitablefor the undertaking.

To prepare forms, card, report-performs, books etc., for keeping records of all theelements of cost, viz., material, labour and overheads.

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

To decide matters regarding labor cost control, i.e., job evaluation, merit rating,appointment, time recording, division of work, remuneration of labour and otherallied problems like idle time, overtime, labour turnover, casual workings, etc.

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

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 theproduction departments and Service departments which should be earlier clearlydemarcated, 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 toother 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 profitableactivities of the organisation. It provided the sound and rational basis for planning, thechanges in products, plants, processes and techniques of production. The informationprovided by cost accounting is also useful in evaluating the various alternatives involved in asituation before taking any final decision.

Inventory Control: As an efficient stores accounting system is essential to an adequatesystem 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 articlebeing 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 andprocesses have cost but also what they should have cost. The pre-planned standard costsare used for comparison of the cost of the products.

Assistance in Manufacturing: Cost accounting pinpoints lapses in purchases of rawmaterials and other articles, their utilization. It indicates where wastages are occurring longbefore the production is finished. It helps to take immediate steps to avoid such losses andwastes.

Promotion of Sales: Cost accounting is also very helpful in the promotion of sales byadopting an appropriate price policy. The technique of break even analysis serves asconstant remember to increase the sales to the break even point. It also seeks to control theselling 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 byeliminating all wastes and uneconomical processes. This cost accounts help in increasingpoints 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 canbe prepared weekly, monthly, quarterly or annually.

In a cost sheet besides total expenditure incurred, cost per unit of output in case of eachelement of cost can be shown in a separate column. The cost sheet should give cost per unitin 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 aboutcosts 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 resultsand 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 andprofitable production policy.

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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.

Problem 1

The following particulars have been extracted from the costing records of a manufacturingco., 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

Agent’s Commission 10,000

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

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

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Travelling expenses 2,000

Power 2,000

Plant Maintenance 8,000

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 TotalCost

Cost perunit

Opening Stock of rawmaterial

40,000

Add Purchases 1,00,000Add Carriage inward 2,000

1,42,000Less Closing stock orraw 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

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Indirect Wages 10,000 0.50Power 2,000 0.10Plant Maintenance 8,000 0.40Rent, rates and taxes(9/10)

1,800 0.09

Misc. Expenses 2,000 0.10Repairs – Building(9/10)0.20

1,800 0.20

Salaries – Plant 4000 0.20Depreciation – Plant 4,000 0.09-Building (9/10) 1,800 34,000 1.77

iii) Works cost 1,97,400 9.87

Add: Office Overheads

Office Salaries 22,000 1.10Rents, Rates and Taxes(1/10)

200 0.01

Misc. expenses 4,000 0.20Repairs – Building (1/10) 200 0.01Depreciation- Building(1/10)

200 26,600 0.01 1.33

iv) Cost of Production 2,24,000 11.20Add: Opening Stock offinished product

10,000

2,34,000Less: Closing stock offinished goods

6,000

Cost of goods sold 2,28,000

Add: Selling anddistribution overheadsCarriage outwards 6,000Travelling expenses 2,000Advertising 6,000Agent’s 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 55000 Direct Expenses 5000

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ManufacturingMaterials used inPrimary packing

10000 Indirect Expenses(factory)

1000

Materials used in sellingproduct

1500 Administration expenses 1250

Materials used in Factory 750 Depreciation of officebuilding & equipments

750

Materials used in office 1250 Dep. On factory buildings 1750Labour required inProducting

10000 Selling expenses 3500

Labour required forfactory supervision

2000 Freight on materialpurchased

5000

Advertising 1250

Assuming that all products are manufactured are sold, what should be the selling price to beobtained as a profit of 20% on selling price?Solution

COST SHEETSTATEMENT OF COST AND PROFIT

Direct material Rs. Rs.Materials used in manufacturing 55000 100000Materials used in primary packing 10000Freight on material purchased 5000 70000Direct labour 10000Direct expenses-factory 5000Direct expenses-factory 85000PRIME COSTFactory overheads 750Labour required for factory supervision 2000Indirect expenses – factory 1000Dept. on factory building 1750 5500WORKS COST 90500Administration O-HMaterials used in OH10 1250Administration expenses 1250Dept. on office building equipment 750 3250COST OF PRODUCTION 93750Sellings Distribution O-HMaterials used in selling the product 1500Selling expenses 3500Advertising 1250 6250COST OF SALES 100000Profit (20% on selling price or 25% on cost) 25000SELLING PRICE 125000

Problem 3From the following data prepare a cost & profit statement of Vijay stoves manufacturing companyfor the year 1990.

Stock of materials as on1.1.1990

35000 Establishment expense 10000

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Stock of materials as on31.12.1990

49000 Completed stock in hand1.1.90

-

Purchase of materials 52500 Completed stock in hand31.12.90

35000

Direct wages 95000Factory expenses 17500 Sales 189000

The number of stoves manufacturing during the year 1990 was 1000. The company wants to quotefor the contract for the stoves to be quoted are of uniform quality and make similar to thosemanufacturing in the previous year. But cost of materials has increased 15% and cost of factorylabour by 10%. Prepare a statement of net profit to be quoted to give the same percentage of netprofit 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 1990Amount

Rs.Amount Rs.

Opening Stock of Materials35000Purchase of Materials

5250087500

Closing stock of Materials 4900VOLUME OF MATERIAL CONSUMED 82600 20.65

Direct wages 95000 23.75PRIME COST 177600 44.40

Factory expenses 17500 4.37WORK COST 195100 48.77

Establishment expenses 10000 2.50COST OF PRODUCTION 205100 51.27

Opening completed stock -Cost of production during the prd 205100Closing completed stock 35000

COST OF SALES 170100PROFIT 18900

SELLING PRICE 189000STATEMENT SHOWING QUOTATION PRICE FOR 1000 STOVES

Materials consumed 2065015% increase 3098

23748Factory wages 2375010%a increase 2375

PRIME COST 26125Factory expenses 49873

4370WORK COST 54243

Establishment expenses 2500TOTAL COST 56743

(profit 10% of selling price of 1/9 ofcost)

6305

SELLING PRICE 63058

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Lesson 2Material Cost

The term ‘materials’ refers to such commodities which are supplied to the manufacturingindustry 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, consumablestores, Maintenance Materials, Tools etc.

Since the underlying purpose of cost accounting is to minimize the cost of production, it isimportant that an effective control is exercised over them. The storage space and storage costs rereduce thereby. Control over materials is also necessary to prevent extra-expenses on theirunnecessary purchase and improper use. A regular supply of materials greatly helps the productionschedule. It is necessary, therefore, that statements are prepared to accurately record the value ofmaterials consumed by each department of job.

Material Cost Control envisages a proper organisatoin for the efficient purchasing andstoring of the materials, and for making them issued to the departments or the cost-centres inappropriate 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 placedwith the suppliers, and ending at the point the materials are effectively utilized in production or aredisposed off otherwise.

The following factors contribute to purchase control:

i) Determination of Quantity to be purchasedQuantities purchased in excessive number or weight block the working capital and thequantities purchased below the reasonable limit endanger the continuous working of thefactory.

ii) Determination of the Ordering PointThe ordering point of the ordering level is one at which the order for purchase of materials is tobe placed with the suppliers when the stock of that material is reduced to that point byconsumption or otherwise.

iii) Determination of Price at which to be purchasedThe selection of right suppliers and the best terms available out of the quotations receivedhelps 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-up6. Receiving the supply and returning unwarranted suppliers;7. Inspecting the material received; and8. Passing invoices for payment.

The important factors to be decided are:

a) What to purchase;b) When to purchase; andc) How much to purchase.

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After receiving the Purchase Requisitions, the next step is to select the suppliers to whom theorders may be sent for the supply. This is done by inviting tenders or quotations from differentsuppliers.

While inviting the tenders, the supplying firms should be requested to state their terms andconditions of supply, delivery time, mode of payment, etc., clearly and to send the tenders insealed covers.

Having accepted the tenders, the orders are place by the Purchase Department with thefirms selected fro the purchase of requisitioned materials.

The purchaser order should be prepared on the printed form and should contain all thenecessary details, so as to leave no room for any ambiguity or doubt and so as to avoid legalcomplications.

Follow-up of the Purchase order if essential to keep the schedule of supply by the specifieddate so that production work may not suffer.

The Receiving Department checks the supply from the copy of the Purchaser order andprepares his report of the goods received.

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

Stores Records

1. Bin Card

A Bin card, also known as Bin Tag or Stock card, is a card showing quantitative record of thereceipts, issues and closing balances of the material kept in the corresponding bin. The Bin cardis 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 inone almirah, two Bin cards, one for each, are prepared, treating the almirah as two bins.

2. Stores Ledger

Stores Ledger is a record of stores, both in quantity and value and is maintained by thestores Accountant. It is similar to Bin card but with the main difference that value of material isshown in the Stores ledger. Stores Ledger is an important book and the account of each item ofstores 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

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Proper system of stock control.

For proper application of the material control the following steps are necessary.1. Purchasing of materials2. Receiving and inspecting of materials3. Storing of materials4. Pricing material Issues5. Accounting materials losses.6. Keeping physical and perpetual inventory

Purchasing of MaterialsIn a large manufacturing concern, a separate purchase department is set up with the object ofeffecting all purchases. The top management lays down the purchase department. It is thefunction 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 materialshould be purchased.

Maintenance of Stock LevelsThe 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 whenthe stock is reduced by usage to the Order Point. The Order Point is one where the order should beplaced for the economic order quantity. For deciding Order Point, two things, viz., (1) Lead timeand (2) Usage during Lead time, are the determining factors. Lead time is the supply time, or to bemore specific, Lead Time is “the time interval between placing an order and having materials on thefactory floor ready for production…”

Usage means the sue of materials by consumptions for productions, or the stock of finishedgoods 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 foundavailable in the near future due to some reason.

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

To avoid over-stocking and under stocking each items of the inventory has the MaximumLevel. Minimum Level and an Order point.

Order PointIt is also known; ‘Ordering Level’; or ‘ Recorder Point’, or ‘Reordering Level or ‘OrderingLimit’, it has been stated earlier that Order Point is at which order for supply of materials orgoods 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, neitherless 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 level2. Minimum level3. Order level4. Danger level

1. Maximum level

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The maximum stock level indicates the maximum quantity of an item of material which can beheld 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 minimumre-order period)

2. Minimum level

Minimum level represents the quantity below which the inventory of any items should notallowed to fall; in other words, an enterprise must maintain minimum quantity of stock so thatthe production is not hampered due to non-availability of materials. If some buffer inventory isacting 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 becomesessential to initiate purchase orders for its fresh supplies. Normally, re-ordering level is a pointbetween the maximum and the minimum levels. Fresh orders must be placed before the actualstocks touch the minimum level.

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

4. Danger levelThe danger level is below the minimum level and represents a stage where immediate steps aretaken for getting stock replenished. When the stock reaches danger level it is indicative that ifno emergency steps are taken to restock the material, the stores will be completely exhaustedand normal production stopped. Generally the danger level of stock is fixed above the minimumlevel 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 minimumstock levels. The quantity ordered must be that which, when added to the minimum stock, will notexceed the maximum stock to be carried at any point of time. The following factors govern there-ordering quantity.

1. Average consumption2. Cost of pacing order3. Cost of storage4. Interest on capital etc.,

Carrying cost of inventory consists ofi) 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) andiii) Cost of placing the order each time.

Economic order quantity or economic lot size (if it relates to production) refers to the numberordered in a single purchase or number of units should be manufactured in a single run so that thetotal costs-ordering or set up costs and inventory carrying costs are at the minimum level. In other

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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, andii) 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 unitsS = 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, andiii) EOQ will be delivered each time the stock balance, excluding safety stock, is just reduced to

nil.

Problem 1Suppose 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.

Solution:

Where A = Annual usageS = Ordering cost for one orderI = Inventory carrying costs per unit per year.

Problem 2

Two components A and B are used as follows:Normal usage 50 units per week eachMinimum usage 25 units per week eachMaximum usage 75 units per week eachRe-order quantity A:300 units B:500 unitsRe-order period A:4 to 6 weeks B:2 to 4 weeks

Calculate for each component:

a) Re-order level b) Minimum level

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c) Maximum level d) Average stock level

Solution

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

Component A = 75*6 = 450 unitsComponent B = 75*4 = 300 units

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

Component A = 450-(50*5) = 200 unitsComponent 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 unitsComponent B = 300 + 500 – (26*2) = 750 units

Average Stock level = ½ (Minimum level + Maximum level)

Component A = ½(200+650) = 425 unitsComponent B = ½(150+750) = 450 units

Need for Inventory Control

The term ‘Inventory’ is used to denote (i) goods awaiting sale (the stock items of a tradingconcern and the finished stocks of a manufacturer); (ii) the goods in course of manufacture, knownas work-in-progress, and (iii) goods to be used directly or indirectly in production, i.e., rawmaterials and supplies.

In a manufacturing company, normally the cost of materials constitutes fifty percent of theproduction cost and the cost of inventory (i.e., raw materials W.I.P., and finished good) representsabout one-third of the total assets. As the costs of materials and inventory are quite formidablebut at the same time controllable, there is a great need felt for proper planning, purchasing,handling and accounting for the same, and also to organize the system of inventory control in amanner that it may provide the maximum profitably to the management.

Objectives of Inventory ControlThe 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 management4. To have proper assessment of income through the process of matching appropriate costsagainst revenues.

5. To maintain inventory of sufficient size for the operations to go on uninterruptedly but thesize should match with the optimum financial involvement.

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Techniques of Inventory ControlThe 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 TechniquesFor 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 thecorresponding period generally works out to be the key factor to decide the production quantumduring the budget period, which ultimately decides the purchases to be made and the inventoriesto be planned.

A-B-C AnalysisTo 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 attentionregarding their safety and care, as compared to others. The stores are divided into three categoriesgenerally, viz., A, B, and C.

In the ABC system, greatest care and control is to be exercised on the items of ‘A’ list asany loss or breakage or wastage of any items of this list may prove to be very costly; proper careneed be exercised on ‘B’ list items and comparatively less control is needed for ‘C’ list items. Therules relating to receipt maintenance issue and writing off stores items should be formed inaccordance 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 thepurpose of exercising selecting control on materials. An analysis of the material cost will show thata smaller percentage of items may represent a smaller percentage of the value of items thepercentage number of which is more or less equal to their value of consumption. Items falling inthe first category are treated as ‘A’ items, of the second category and ‘B’ items and items of thethird category are taken as ‘C’ items. Such an analysis of materials is known as ABC analysis. Thistechnique of stock control is also known as stock control according to value method or alwaysBetter Control method or Proportional parts value. Analysis method. Thus, under this technique ofmaterial control, materials are listed in ‘A’, ‘B’ and ‘C’ categories in descending order based onmoney value of consumption.

ABC analysis measures the cost significance of each item of materials. It concentrated on importantitems, 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 materialcosts.

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 thecritically to production.

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Perpectual Inventory SystemPerpectual 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 systemof records by which the receipts and issues of stores may be recorded immediately at the time ofeach 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 system1. It keeps the record of stocks upto date.2. The materials are kept within the Minimum and Maximum Limits. Non-observance of thelimits fixed is detected.

3. The materials going out of stock are easily detected and purchased at the appropriate timeto 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 lossor theft of materials are minimized.

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

6. The discrepancies noted after physical counting are detected and corrective action is takenpromptly 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 thePurchase Department so that such stocks may purchased future in lesser quantities asrequired.

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

Control RatiosThe 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 theaverage value of inventory held during that period.Certain materials are slow moving. It means their consumption rate quite show and so capitalremains locked up and storing costs continue to be incurred in such materials if these materialsare stored in excess of the requirement the rate of consumptions in terms of value or in termsof days is indicated by Inventory Turnover ratio. The number of days in which the averageinventory 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 theinventory turnover period is short, the material is said to be fast moving. So if the rate ofconsumption is fast, or if the inventory turnover rate is good, it is a healthy measure ofefficiency of materials control, as the capital employed is properly utilized.

2. Input-output RatioThe Input-output Ratio is the ratio of the raw material put into manufacture and the standardraw materials content of the actual output.

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This ratio enables one to find out whether the usage of the materials is favourable or not. Astandard ratio of input of materials and output of material should be determined and the actualratio should be compared with the standard ratio.

Pricing of Material IssuesThe pricing of issue of materials is not as simple as the pricing of receipts. As the issue aremade out of the various lots purchased at different prices, the questions arises as how to pricethe issues, there are several methods used for pricing the issues and the selection of a propermethod 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 frequencyof purchases and E.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 PricingThe 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 Average2. Weighted Simple Average3. Periodic Weighted Average4. Moving Simple Average5. Moving Simple Average6. 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 orderin which they are received in the stores. The pricing of the issue of the first lot is done at the rateof purchase of the first lot. Similarly, the pricing pattern follows for the subsequent lots. Theclosing stock in this method is valued at the latest purchase price and thus it represents thecurrent conditions as far as possible.Merits

1. It is simple to operate2. The materials are charged at costs only. So the purchase price is recovered in full withoutshowing any profit or loss on issue.

3. This method is good wherea. The prices are falling;b. The consumption rates of the materials is slow

4. The Closing stock is shown at current rates.

Demerits1. 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.

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

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 isconsidered best for application, as the current cost of materials contributes to the cost ofproduction.

Merits1. The material cost represents current prices except when the purchases were made longago,

2. It is simple to operate and the pricing is done on cost basis3. 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.

Demerits1. With high fluctuations in rates, the calculations become more complicated, and give wayto 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 lowestpossible price.

Base Stock Price MethodIn 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 anemergency arises. This stock is valued at long-run ‘normal’ price, while the stock in excess of thisstock is priced on some other basis, usually are FIFO or the LIFO basis. It is not an independentmethod in itself a it is conjoined with either FIFO or the LIFO method.

Simple Average MethodThe 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 thestock from which the materials to be priced could have been drawn, by the number of the rates ofprices.

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 MethodMerits

1. This method irons out the wide fluctuations in the prices.2. With every new issue, a new rate is not calculated.

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3. The total value of the material issued does not behave up and down to the total value of thematerial received, as is the case with Simple Average Method.

Demerits1. 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 inthe average, for a considerable time after it is exhausted.

Periodic Simple Average MethodThis 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, theaverage of the unit prices of all the receipts during the month is adopted as the rate for pricingissues during the subsequent month.

Periodic Weighted Average MethodThis 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 thenext month.

Moving Simple Average MethodThis 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 areto be issued, by the number of periods.

Moving Weighted Average MethodThis 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 31) Show the Store Ledger entries as they would appear when usingi) FIFOii) LIFOiii) Weighted average methodiv) Simple average method

April 1. Balance 300 units Rs. 600/-2. Purchase 200 units Rs. 440/-4. Issued 150 units6. Purchase 200 units Rs. 460/-11. Issued 150 units19. Issued 200 units22. Purchase 200 units Rs. 480/-27. Issued 250 units

Solution1) Stores Ledger Account as per FIFO METHOD

Date Details Receipt Issued BalanceQty Rate Amt Qty Rate Amt Qty Rate Amt

April1

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

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

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4 Issue 150 2.00 300 150 2.00 300200 2.20 440

6 Purchase 200 2.30 460 150 2.00 300200 2.20 440200 2.30 460

11 Issue 150 2.00 300 200 2.20 440200 2.30 460

19 Issue 200 2.20 440 200 2.30 46022 Purchase 200 2.40 480 200 2.30 460

200 2.40 48027 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 AmtApril1

Balance 300 2.00 600 - - - 300 2.00 600

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

4 Issue 150 2.20 330 300 2.00 60050 2.20 110

6 Purchase 200 2.30 460 300 2.00 60050 2.20 110200 2.30 460

11 Issue 150 2.30 345 300 2.00 60050 2.20 60050 2.30 115

19 Issue 50 2.30 115 200 2.00 40050 2.20 110100 2.00 200

22 Purchase 200 2.40 480 - - - 200 2.00 400200 2.40 480

27 Issue 200 2.40 480 150 2.00 30050 2.00 100

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

3) WEIGHTED AVERAGE METHODDate Details Receipt Issued Balance

Unit Rate Amt Unit Rate Amt Unit Rate AmtApril1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 500 2.08 1040

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4 Issue - - - 150 2.08 312 350 2.08 7286 Purchase 200 2.30 460 - - 550 2.16 111811 Issue - - - 150 2.16 324 400 2.16 86419 Issue - - - 200 2.16 432 200 2.16 43222 Purchase 200 2.40 480 - - - 400 2.28 91227 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/

4) SIMPLE AVERAGE METHOD

Date Details Receipt Issued BalanceUnit Rate Amt Unit Rate Amt Unit Rate Amt

April1

Balance 300 2.00 600 - - - 300 2.00 600

2 Purchase 200 2.20 440 - - - 500 2.10 10504 Issue - - - 150 2.10 315 350 2.10 356 Purchase 200 2.30 460 - - 550 2.17 1193..5011 Issue - - - 150 2.17 325.50 400 2.17 86819 Issue - - - 200 2.17 434 200 2.17 43422 Purchase 200 2.40 480 - - - 400 2.23 89227 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 4The 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.

SolutionStores Ledger Account Under LIFO

Date Receipts Issues BalanceQty Rate Amt Qty Rate Amt Qty Rate Amt

1 30 50 10 5001 30 10 300 20 10 2002 60 10.20 612 - - - 20 10 200

60 10.20 6123 - - - 25 10.20 255 20 10 200

1 10.20 10.20 35 10.20 35720 10 200

4 10 9.15 91.5 34 10.20 346.80- - - 20 10 200

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34 10.20 346.8010 9.15 91.50

5 - - - 10 9.15 31.50 20 10 2003 10.20 306.0 4 10.20 40.80

6 22 10.30 226.6 20 10 2004 10.20 40.80

7 - - - 22 10.30 226.64 10.20 40.80 8 10.00 80.0012 10.00 120.0

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

Stores Ledger Under FIFO

Date Receipts Issues BalanceQty Rate Amt Qty Rate Amt Qty Rate Amt

1 30 50 10 5001 30 10 300 20 10 2002 60 10.20 612 - - - 20 10 200

60 10.20 6123 - - - 20 10 200

5 10.20 51 55 10.20 5611(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 10.20 142.8010 9.15 91.50

6 22 10.30 226.6 - 14 10.20 142.8010 9.15 31.5022 10.30 226.60

7 - - - 14 10.20 142.8010 9.15 91.50 8 10.3 82.4022 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 factorwhich requires constant control, measurement and analysis.”

A rational approach to the problems of labour, fair maintenance of wage records for wageascertainment, fair wage policy, and the incentives for earning more wages go a long way inproviding a sense of security and stability to the workmen, in minimizing the labour turnover, andin exercising effective labour cost control.

Labour cost control aims at the control of the labour cost per unit of production and not atthe reduction of the wage rates of the workmen.

Efficiency of labour (a concept meaningless to material) has an important impact on the successfulworking of a business.

Labour cost is second major element of cost. Proper control and accounting for labour cost is oneof the most important problems of a business enterprise. But control of labour cost presentscertain 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) Employer’s Contribution to Provident Fund;iv) Employer’s Contribution to Employee’s 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 ofproduction of the products manufactured or service rendered.

Control of labour costs is an important objective of management and the realization of thisobjectives depends upon the cooperation of every member of the supervisory force from the topexecutive to foreman. From functional point of view, control of labour cost is effected in largeindustrial concern by the coordinated efforts of the following six departments-

1) Personnel Department,2) Engineering Department,3) Rate or time and Motion Study department4) Time-Keeper Department5) Cost Accounting Department

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6) Pay-roll Department

Factors Governing a Satisfactory system of Wage PaymentThe 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 cost per unit to deprive the employer of a fair margin of profit, giventhe 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 thesystem:

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 theproduction-planning.

2. Setting up of standards

With the help of work study, time study and motion study are set up for productionoperations. The standard cost of labour so set is compared to the actual labour cost andthe 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 ofworkers needed for the production are provided for along with the cost of labour in theLabour budget. This budget is a plan for labour cost and is based on the past dataconsidered 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 themanagerial 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 theemployees. for this purpose, the employer should decide the system in consultation withthe workers.

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2. Easy to CalculateThe workers should be in a position to calculate their wages correctly and feel sure thatthey have been correctly paid. Easy calculation will help the employer also in maintainingsimple records.

3. Related to Efficiency‘Fair remunerations for fair output’, should be the idea and remuneration should berelated to the individual efficiency of the workers.

4. Minimum wage guaranteedThere should be a guarantee of minimum wages to the workers to enable them tomaintain 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 moreand earn more wages.

6. Quality Improvement-orientedIn the race to earn more wages with an increase in production, the chances are that thequality of the output may deteriorate. The system should, therefore, ensure ‘betterwages for better quality’.

Definite wage-baseThe 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 theemployer, otherwise a sense of distrust may develop in the workers towards the scheme. A changein the system should be effected only after taking the workers into confidence.

Labour TurnoverLabour 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 toreplace them. The ratio of the replaced workers to the number of works is the Labour TurnoverRatio. If more workers leave the factory, the turnover would be high, and vice versa. A highturnover is a costly affair and must be avoided.

Causes of Labour TurnoverThe workers leave the factory either byi) Resignation, or byii) Discharge by the employer, oriii) Due to a cause not within one’s control.

Cause for resignationThe causes may be:

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

2. Ill health and bad working conditions;3. Lack of safety measures;4. Dissatisfactions due to various causes such as

a. Hours of workb. Improper placementc. Unfair method of promotion,

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

Causes for Discharge1. 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 yearonly;

2. Death of the worker;

Measurement of Labour TurnoverLabour 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 orreplacements.

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 thenormal rate is low turnover. It is always better to keep the turnover low, but it should nto beconstrued that the factories with low turnover are always more productive. There may be lowturnover in a factory for the reason that the workers engaged therein are below standard and sothey cannot find better place in other factories. Secondly, low turnover in the senior scales may notprovide promotion factories. Secondly, low turnover in the senior scales may not provide

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promotion opportunities to the young and promising employees and so they may like to shift toother 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 repairsof 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 mayincrease, and there may be increased wastage of time.

6. The cost of making selections and cost of imparting training to the new entrants wouldfurther increase the cost and reduce the profits.

Cost of Labour TurnoverThere are two types of costsi) Preventive cost andii) Replacement costs

And amenities to the workers that they may be tempted to continue at their job in the factory andnot to leave it for example:

i) Personnel Administration: Only that portion of the cost of this department which is relatedto 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 orincidental to replacement, 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 apportionto the different departments in the ratio of other workers.

IDLE TIMEThe 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 workersdo not have material at the right time, or the machines are not kept fir for working, the time goeswaste. Sometimes, delay in the proceeding process delays the operations of the succeedingprogress. Here also the workers have to wait due to faulty planning or bad management.

2. Careless in Supervision:

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If the foreman of a department does not take his duty seriously, the labour working under him alsobecomes 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 indiscussions, dialogues, strikes etc., and the wages paid, if any, for this period form the idle timecost.

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

5. Others reasons:The electricity may fail or the machine may break down for some or more time. They make labourto 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, andthe 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

Normal idle-time can be further divided intoa) Controllable, andb) Uncontrollable.

Normal idle-time is one which is incidental to production. The cost of normal and controllable idletime should be charged as an overhead expense to the production. If the responsibility for thistype of idle-time can be fixed upon a particular department, the cost should be charged to theoverheads of that department and absorbed in the production cost of that department.

OVER-TIMEThe time worked over and above the normal hours is overtime. The remuneration usually paid forthe 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 fallsshort to meet it;

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

3. Utilization of perishable raw materials by working overtime;4. Execution of urgent orders, or to complete the work o9n the same day;5. Shortage of equipments, machines, or space for the completion of jobs;6. Lack of administrative control on workers, on account of which the production duringnormal hours remains less the standard output and overtime work has to be done by theworkers.

Disadvantages of overtime working

The following are the disadvantages:1. Worker’s health is adversely affected;2. The quality of the output is at a discount; and

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3. The cost of production rises due to increased labour cost.

System of Wage Payment

Strictly speaking, there are only two basic methods of wage payment, viz., wages based onthe time spent in the factory, and wages based on the quantum of work turned out. These are thusknown respectively as the ‘time wage’ and the ‘piece wage’ methods of remuneration. Since eachof these has its own advantages and disadvantages, attempts are made to combine the two, mainlywith a view to overcoming their disadvantages. We have therefore, the premium bonus or theincentive schemes which may either be considered to be merely variations of the two, or as anotherof wage payment. These three methods may also be re-classified into only two groups, viz., thetime wage system and the payment by results.

Methods of RemunerationThe methods of remuneration can be classified into:

1. Time Rate System2. Pieced Rate System3. Incentive Schemes

Time Rate System

In this system, a worker is paid on the basis of attendance for the day or according to thehours of the day, regardless of the output. This system is also known as time work, day work, dayage rate or day rate. The wage rate of the day worker may be fixed on hourly, daily, weekly,fortnightly, or monthly basis depending on the practice followed in the concern.

The basic feature of this system is that the worker is paid so much per unit of timeregardless of the output he produces. The unit of time may be an hour, a day, a week or a month.Under this method, wages depend entirely upon the time clocked, but not on the efficiency of theworker. There are three variants of this system, each differing only in so far as the fixation of thetime rate is concerned. They are:

a) Flat Time or Time Rate at Ordinary level;b) High Day Rate or Time Rate at high level;c) Measured Day work or Graduated Time Rate.

Graduated Time Rate

Under this method wages are paid at time rates which vary according to

a. Merit-rating of the workers, orb. Changes in the cost of living index.

It the cost of living goes up, the wages also go up proportionately, and vice versa. Thus the worksget the real wages. Similarly, the workers having higher merit rating get higher wages, and theworkers with lower rating get lower wages.

Differential Time Rate

Workers are paid rate accounting to their individual efficiency. They are paid normal rateupto a certain percentage of efficiency and the rate increases in steps for efficiency slabs beyondthe standard. As the efficiency is measured in terms of output, this method does not fall strictlyunder the area of time rate system.

Payment by Results-Piece-work Rate

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The payment of wages under this system is based upon the out turn of the worker. The rateis fixed per piece of work and the worker is paid according to the pieces of work completed or thevolume of work done by him, irrespective of the time taken by him in completing that work. Aworkman is free to earn as much as his ability, energy, or skill would allow to him to produce.

The various schemes falling under ‘Payment by results’ make speed as the basis of payment,instead of time. Accordingly, these schemes are just the opposite of the time wage system. Theyare so called because of the fact that wages are linked to the volume of work done regardless ofthe time taken by workers. Efficiency is recognized in all these schemes and workers get wagesaccording to their avility, efficiency, and speed. The following schemes fall under the payment byresults method of wage payment.

a. Straight Piece Rate.b. Differential Piece Rate.

Stability of the System

This system is suitable in the following cases:

1. Where the production can be measured in standard units.2. Where strict supervision is not possible.3. Where quality and precision are not of primary importance.

Advantages1. It provide initiative and incentive to the workers to product more.2. The productivity increases and cost of production per unit goes down.3. As there is little wastage of time on the part of the workers, the fixed overheads and

resources like plant, machinery and space are well utilized.4. Workers feel free to work, complete with fellow workers, exhibit their efficiency, and earn

more of wages.5. Less supervision is required over the workers, and happy relations are maintained with them.6. It is easy to calculate the labor of products.

Disadvantages1. In the race to earn more wages by producing more, the quality of products is likely to

deteriorate. So it requires strict inspection and quality control.2. Continuous and increased working for some days may cause fatigue and ill health to theworkers.

3. To speed up production, the machines, tools, and equipments are sometimes not handledwith the care that they require, and so the workers expose themselves to accidents, besidescausing loss of breakdown to the machines, equipments etc.,

4. The inefficient workers earning less of wages start feeling jealous of other workers who earnmore. This creates unhealthy atmosphere.

5. The workers feel insecure of earning during the days of ill health, holidays, etc.6. This system is not useful for quality products.

The piece rate System can be classified into:

Straight Piece Rates

It is a simple method of making payment at a fixed rate per unit for the units manufactured.Earnings = Number of units X Rate per unit

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The rate is fixed taking into considerationa. Time rate for the same class of workers, andb. Standard output during a given time.

Differential Piece Rates

Under this system, efficient workers are paid wages at a lower rate. A definite standard ofefficiency is set for each job and for efficiency below or above the standard different piece rates arepaid according to different levels of efficiency. The following two methods of wage payment arestudied under this system:

a. Taylor Differential Piece-rate Method, andb. Merrick Differential Piece rate Method

Taylor Differential Piece-Rate

F.W. Taylor thought to improve the efficiency of workers by suggesting two rates of paymentof wages:

(I) A higher rate to the workers who product equal to or more than the standard fixedfor production during the day, and

(II) A lower rate to the workers who do not achieve the standard.

Merrick Differential Piece-rate

In the Taylor Method, the effect on the wages is quite sharp in the marginal cases. Toremove this defect Merrick suggested three piece rates for a job as follows:

Percentage of Standard Output Payment under Merrick MethodUpto 83% Normal piece rateAbove 83% and upto 100% 110% of normal piece rateAbove 100% 120% of normal piece rate

Incentive Schemes

Factors for Selecting Incentive Scheme

The following factors should be considered for selecting an incentive scheme:

1. Productivity

The object of the incentive scheme is to increase productivity. Therefore, this factor is veryimportant. The increased productivity lowers the cost to the benefit of the employers.

2. Simplicity

The scheme should be simple in operations and well understood by the workers. The schemeshould be amenable to the setting up of standards and the comparison of the results with theactual.

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3. Cost Reduction

The scheme, when introduced, is bound to increase the pay-bill of the workers, and thusincrease the cost. But the simultaneous increase in production would reduce the cost per unit orproduction. The fixed overheads remain constant up to a certain limit of plant capacity. As such,the increased productivity reduces the cost of fixed overheads per unit.

4. Better Labour Psychology

The scheme should not affect worker’s health adversely, should reduce labour turnover andhelp to improve the standard of living of the workers.

Under this heading, we study the following methods:

(I) Halsey Premium Scheme;(II) Halsey Weir Scheme;(III) Rowan Premium Scheme;

Halsey Premium Scheme

Under this plan,(i) Time rate is guaranteed;(ii) Standard time is fixed for the job or operation;(iii) The workers producing more than the standard, or the workers completing the work in

less than the standard time fixed, get bonus in addition to the ordinary time wage;(iv) The bonus of the premium, by whatever name called, is 30 to 70 percent of the wages of

time saved, the usual percentage being 50%,(v) The remaining of the bonus percentage is shared by the employer.

Merits of Halsey Plan

(i) Day wage or the time rate is guaranteed. Even if output is less than the standard, onegets the time wage;

(ii) Workers get premium for the output above the standard. It provides incentive to theworkers to produce more;

(iii) As the premium is not 100% but only 50% or so, the employers feel happy about it isa they share the remaining 50%;

(iv) The scheme is very simple and understood easily by the workers.

Demerits

(i) A significant share of the bonus goes to the employers. So the workers object to it;(ii) Incentive is not so attractive as it is with the piece work;(iii) Where the workers start saving more than 50% of the time, they earn premium in

huge amounts, which the employers do not relish.

Halsey – Weir SchemeThis schedule is similar to Halsey scheme except that in this scheme the workers and

employers share the premium in 1:2 ratio.

Rowan Premium Scheme (variable sharing plan)

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Mr. James Rowan introduced this scheme in Glasgow in 1898. It is similar to Halsey schemebut the premium concept here is different. Here the premium is in the ratio of Time saved toStandard time, calculated on the ordinary wages.

Premium = Wages of time worked x Time saved / Standard Time

Or; (AT x R) TS / ST

This scheme also guarantees day wage as is done by Halsey Plan.

Problem 1

Calculate the earnings of a worker from the following information as under.

a) Time Rate Method: Standard time 30 hours Time taken 20 hours. Hourly rate of wages of Re. 1per hour plus a dearness allowance 50 paise per hour worked.

Solution

Time Rate Method:-Time Put in by workers x Rate per hour = 30 x 1 = Rs. 30

Problem 2On the basis of the following information calculate the earnings of A and B on the straight priceRate basis and Taylor’s differential piece rate system.

Standard Production 8 units per hourNormal time rate Rs. 0.40 per hour

Differential to be applied:-

80% of piece rate below standard120% of piece rate at or above standard. In a 9 hour day, A produces 54 units and B

products 75 units.

Solution

Standard production per hour 8 unitsNormal time rate per hour Rs. 0.40Piece Rate Rs. 0.40/8 = Rs. 0.05

Earnings under the straight piece rate system:-

A: 54 units @ Rs. 0.05 = Rs. 2.70B: 75 units @ Rs. 0.05 = Rs. 3.75

Differential Piece Rate:-

Low Piece rate: 80% of piece rate (0.05 x 80 / 100) = Rs. 0.04

High Piece rate: 120% of piece rate = (0.05 x 120 / 100) = Rs. 0.06

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Standard output per hour is 8 units, So Standard Output for a 9 hour day is 72 units. A producesonly 54 units which is less than the standard output of 72 units. So he is entitled to get a lowerprice rate of Rs. 0.04 per unit. On the other hand, B’s output of 75 units is more than the standardoutput of 72 units. So SA is to get higher piece rate of Re. 0.06 per unit.

A’s earning: 54 units @ Re. 0.04 = Rs. 2.16B’s earning: 75 units @ Re. 0.06 = Rs. 4.50

Problem 3

Calculate the earning of workers A,B and C under Merrick’s multiple piece system from thefollowing particulars.

Normal rate per Hour Rs. 1.80Standard time per unit 1 minute

Output per day as follows:-Worker A: 384 unitsWorker B: 450 unitsWorker C: 552 unitsWorking rows per day are 8

SolutionStandard output per minute = 1 unitsStandard Production per hour = 60 unitsStandard Production per day of 8 hour = 480 units

i.e. (60 x 8)Normal rate per hour = Rs. 1.80Normal output per hour = 60 unitsTherefore Normal piece rate = (1080/60) x 5 paise

Calculation of level of Performance:-

Standard output per day = 480 unitsWorker A’s Output per day = 384 unitsWorker A’s level of performance = (384/480) x 100 = 80%

Worker B’s Output per day = 450 unitsWorker B’s level of performance = (450/480) x 100 = 43%

Worker C’s Output per day = 550 unitsWorker A’s level of performance = (550/480) x 100 = 1150%

Earnings of workers A:-

Merrick’s multiple piece rate system:-

For 384 units @ 3 paise per unit = (384 x 3) /100 = 11.50

Normal piece rate has been applied because worker A’s level of performance is 807. Whichis below 83%.

Earning of Worker B:-

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For 450 units @ 3.3 Paise per unit = 450 x 3.3/100 = Rs. 14.85

Worker B’s level of Performance is 93.75% which is between 83% and 100%. So he is entitledto get 110% of normal piece rate.

Earning of Worker C:-

For 552 units @ 3.6 paise per unit = (552 x 3.6)/100Rs. 19.87

Worker C’s level of performance is 115% which is more than 100% of standard output. So it isentitled to get 120% of normal Piece rate.

Problem 4

Calculate the earnings of workers A and B under straight piece rate system and Taylor’s differentialpiece rate system from the following particulars.

Normal Rate per hour Rs. 2.40Standard time per unit 30 seconds

Differentials to be applied:-

80% of piece rate below standard120% of piece rate at above standardWorker A produces 800 units per day andWorker B produces 1000 units per day.

Solution

Hourly Production = = 120 units

Piece rate = = 0.005

Low piece rate:-LPR = 80% of normal piece rate

= 80% x 0.005= 0.004

High piece rate:HPR = 120 of 0.005

= 0.006

Standard Production per day = 120 units x 8= 960 units

Computation of earnings of A and B:-

A BNormal Piece Rate 0.005 0.005Production per day 800 1000

3600

1202.210

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Standard ProductionPer day 960 units 960 units

a. Straight piece Rate System 800 x 0.005 1000 x 0.005Earning Rs. 4.80 Rs. 5

b. Taylor’s Differential pieceRate 0.004 x 800 0.006 x 1000

Rs. 3.2 Rs. 6.00

Problem 5

From the following data, total monthly remuneration of three workers A, B and C under the

Gant’s Task and Bonus Scheme:-

i) Standard Production per month per worker is 1000 units.ii) Actual Production during the month A = 850 units,

B = 1000 unitsC = 1100 units

iii) Piece works rate 50 paise per unit

Solution

Standard Production per month is 1000 units and piece rate is 50 paise per unit soguaranteed monthly payment is Rs. 500 (i.e. 1000 units @ 50 paise)

Level of Performance:-

Standard output per month 1000 unitsWorker A’s Output 850 units

Worker A’s level of Performance = x 100 = 85%

Workers B’s Output:-

Worker B’s level of Performance x 100 = 100%

Workers C’s Output:-

Worker C’s level of Performance x 100 = 110%

Earning of Worker A:-

Worker A’s level of Performance is 85% which is below the standard performance so it willget Rs. 500 the guaranteed monthly payment.

Earning of Worker B:-

Worker B’s level of performance is 100% so he will get piece wages for 1000 units plus 20%bonus

8501000

1000

1100

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Piece Wages for 1000 units @ 50 paise per unit Rs. 500Add: 20% bonus i.e. (500 x 20 )/100 Rs. 100

Total earning Rs. 600

Earning or Worker C:-

Worker C’s level of Performance is 110% which is more than the standard Performance so hewill get piece wage prices 20% bonus.

Thus dis earnings are as follows:-

Price wages for 1,100 units @ 50 paise per unit Rs. 550Add: 20% bonus (550 x 20)/100 Rs. 110

Total earning Rs. 660

Problem 6

The existing incentives system of a certain factory isNormal working week – 5 days of 9 hours plus 3 rate shifts of 3 hrs each.

Rate Payment - Daywork = Re. 1 per hour- Late shift = Rs. 1.50 per hour

Additional bonus payable – Rs. 2.50 per day shiftRs. 1.50 per Late shift

Average output per operative for 54 hour week – 120 articles i.e. including 3 Late shifts

In order to increase output and eliminated overtime it was decided to with on to a system ofpayment by results the following information is obtained.

Time rate Re. 1 per hourBasic time allowed for 15 articles 5 hoursPiece work rate – Add 20% to piecePremium – Add 50% to time

You are required to show

i) Hours workedii) Weekly earningsiii) Number of articles produce andiv) Labor cost per article for one operative under the following sysem

a) Existing time rteb) Straight piece workc) Rowan systemd) Halsay weir system

Assume that 135 articles produces in a 45 hours work under (b) (c) and (d) and that the workerearns half time saved under the Halsay system. The additional bonus under the existing system willbe discontinued on the proposed incentive scheme.

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Solutiona) Existing time Rate:- Rs.

Weekly wages 45 hrs. @ Re. 1 per hour 45009 hrs @ Re. 1.50 per hour 13.50

Day shift bonus 5 x 2.50 12.50Late shift bonus 3 x 1.50 4.50

Total Earning 75.50

b) Piece rate system:-

Basic time : 5 hours for 15 articlesTherefore cost of 15 articles 5.00Add: 20% 1.00

Total Earning 6.00

Therefore Rare per article Rs. 6.00 / 15 = Rs. 0.40Articles products in a week = 45 x 15/5 = 135

Hence Earning = 135 x 0.40 = Rs. 54.00

c) Rowan Premium System:-

Basic time = 5 hrs for 15 articlesAdding 50% = 7½ has for 15 articlesTherefore time for producing one articles

= 7½ hrs / 15 = 30 minutesTherefore time allowed for 135 articles = 67 ½ hrsActual time taken for 135 articles 45 hrsTherefore time saved = 22½ hrsEarning = Time wages x (% of time saved / Standard Time) x Time wage

= 45 x 1 + (22½ / 67½) x 45 = 45 + 15 = 60

d) Halsay-Weir Premium System:-Earning = Time wage + 50% (Time saved x Time rate)

= 45 x 1 + 50% (67½ - 45) x 1= 45 + 11.25 = Rs. 56.25

The other requirements of the problems have been shown in the following table:-Methods:-a b c d

i) Hours worked 45 54 45 45ii) Weekly earning Rs. 75.50 54.00 60.00 56.25iii) Articles produces 120 135 135 135iv) Labour cost perarticle

0.629 0.400 0.444 0.417

Problem 7

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The Worker earns Rs. 2 as bonus @ 50%. So total bonus at 100% should be Rs. 4. The hourly rateof wages being Re. 1. The time saves should be 4 hours.

Standard time allowed - 10 hoursLess: time saved - 4 hours

Time taken - 6 hours

A worker completes a job in a certain number of hours. The standard time allowed for the job is 10hrs, and the hourly rate of wages (i.e. Re. 1 the worker earns at the 50% rate of bonus Rs. UnderHalsay plan.

Ascertain dis total wages under the Rowan premium plan:-

SolutionThe worker earns Rs. 2 as bonus at 50% so total bonus at 100% should be Rs. 4. The hourly

rate of wages being Re. 1 the time saved should be 4 hrs.

Standard time allowed 10 hoursLess: Time saved 4 hours

Time taken 6 hours

Earning under the roman Premium Plan:-

Earning = T x R + (S – T / S) x T x R

Where T = Time taken i.e., 6 hoursS = Standard time i.e. 10 hoursR = Rate per hour i.e. Re. 1

Therefore Earning = 6 x 1 + (10-6/10) x 6 x 1= Rs. 6 + Rs. 2.40= Rs. 8.40

Problem 8

For a certain work order the Standard time is 20 hours, wages Rs. 5 per hour the actual time takenis 13 hours and factory overhead charges are 80% of standard time.

So out a comparative statement showing the effect on paying wages Halsay plan.

Solution

Earning = A.T x T.R + 50% (T.S. x T.R)= 13 x 5 + 50% (7 x 5)= 65 + 17.5= Rs. 82.50

Problem 9

A Workman whose basic rate of pay is Re. 1 per hour of working under the ‘Rowan’ system ofpremium bonus. In addition he gets dearness allowance of Rs. 20 per week of 48 hours. Duringone week he does the following jobs.

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i) Job 101 for which 25 hours are allowed. He takes 20 hours.ii) Job 102 for which 30 hours are allowed he takes 24 hours.

During the week, his waiting time amounts to 4 hours. Find the worker’s earning and the amountsto be charged to each job and to overhead.

Solution

Workers earning form Job 101 :-Standard time 25 hoursTime taken 20 hoursRate per hour Re. 1

Wages for actual time = 20 hrs @ 1 Re.

Premium according to Roman System

= Time taken x Rate per hr. + (Time saved / Standard time) x Actual time x Rate per hr

= 20 x 1 + (5/25) x 20

= Rs. 24 Rs. 24.00

Proportion of dearness allowances:-

= 20 x (25/55)Earning from job 101 Rs. 9.09

Total Rs. 33.09

The workers earning from job 102:-

Standard time = 30 hoursTime taken = 24 hoursRate per hour = 1 Re.Earning = T x R + (T.S /Std) x A.T x R

= 24 x 1 + (6/30) x 24= 24 + 4.8= Rs. 28.80

Proportion of Dearness allowance:-= 20 x (30 / 55)= Rs. 10.91

Earning from job 102 Rs. 39.71

Total earning of the worker:-

Job 101 = Rs. 33.09Job 102 = Rs. 39.71Read = Rs. 4.00Total = Rs. 76.80

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Problem 10

The guaranteed time table is Re. 1 per how high piece rate is Re. 0.20 per unit and standard outputis 10 units per hour. In a day of 8 hours, A produces 70 units and B produces 80 units and Cproduces 90 units. Calculate the earning of A,B and C under Gantt task plan.

Solution

Standard Output at 10 units per hour is 80 units.A’s output is below the StandardB’s output is at the standard and C’s output is above the standard.

Accordingly A gets time wages, B gets a bonus of 20% of the time rate and C gets high piece rate.

Earnings: A = 8 hours x Re. 1 = Rs. 8B = 8 hours x Re. 1.20 = Rs. 9.60C = 90 hours x Re. 0.20 = Rs. 18

Problem 11

Standard output is 10 units per hour and basic wage rate is Re. 1.50 per hour. In a day of 8 hours.A produces 40 units. B 75 units and C produces 90 units. Calculate the wages of A,B and C underMerrick’s differential piece rate.

Solution

Standard output = 10 units per hourBasic wage Rate = Rs. 1.50 per hourPiece rate = 1.50 / 10 = Rs. 0.15

Percentage efficiency:-

= (Actual output / Standard output) x 100

For A = (40 x 100/80) = 50%For B = (75 x (100/80) = 93.75%For C = (90 x 100/90) = 112.5%

A’s efficiency being less than 83% he is paid the ordinary piece rate. B’s efficiency being 83% to100%. He is paid at 110% of ordinary piece rate. C’s efficiency being more than 100% he is paid at120%.

Thus: A gets 40 x Re. 0.15 = Rs. 6.00B gets 75 x 0.165 = Rs. 12.37C gets 90 x Re. 0.18 = Rs. 16.20

BSPATIL 54

Lesson – 4

OVERHEAD COST

Overhead is “the aggregate of indirect material cost, indirect wagers (indirect labor cost) andindirect expenses”.

Classification of Overheads

The Overheads can be classified according to:i) Elements;ii) Functions;iii) Behaviour;iv) Controllability;

Element-wise classification

Overhead Materials Cos is the which cannot be allocated but which can be apportioned to, orabsorbed by, cost centres or cost units. Consumable stores, lubricating oil, loose tools, cottonwaste, etc. are the examples.

Indirect Labour Cost is the cost of wages which cannot be allocated but which can beapportioned to, or absorbed by, cost centres or cost units. Salary of foremen, supervisors, worksmanager, storekeepers, etc. Wages of maintenance dept. employer’s contribution to providentFund, overtime wages, etc., are the examples.

Indirect Expenses are the expenses which cannot be allocated but which can be apportionedto, or absorbed by, cost centres or cost units. Factory rent, lighting, heating, depreciation,insurance, other factory expenses, all administrations, selling, and distribution expenses fall underthis group.

Overhead is divided according to functions into:

i) Production or Manufacturing Overhead;ii) Administration Overhead;iii) Selling Overhead;iv) Distribution Overhead

Production Overhead

It includes all overheads incurred from the stage of procurements of materials till thecompletion of the manufacture and the primary packing of the product.

1. Rent, municipal taxes, depreciation, insurance, etc., of the factory land and building.2. Depreciation insurance etc. of the factory plant, machines and equipments.3. Factory lighting, heating and air conditioning;4. Fuel and power;5. Consumable stores, small tools, etc,;6. Indirect materials, such as cotton waste, lubricating oil, brushes etc.;7. Repairs of factory building, plant, machines and equipments.8. Store-keeping expenses;9. Cost of idle time, overtime, holiday pay etc.10.Salary of foremen, timekeepers, works manager etc.;

BSPATIL 55

11.Repairs and maintenance of Power house;12.Other expenses, e.g., Worker’s training and welfare, Inspection, Research and Development,Factory telephone and Stationary etc.

Classification According to Behaviour

Fixed Overheads

Fixed overheads is one which tends to be unaffected by variation in volume of output. Thisoverhead remains constant, i.e., does not change with the increase or decrease in production,within a certain range. The fixed overheads are related to the periods, and so the fixed costs arealso known as Period Costs, e.g., the rent of the building or the salaries of the office staff.

Variable OverheadsThe variable overhead is one which tends to vary directly with volume of output. The

variable cost increases in direct proportion with the increase in production, and decrease inproduction. It is known as Direct cost.

Salesman’s Commission; Discounts to customers; Bad debts; Branch expenses; Postage;Stationery; Travelling; Salesman’s expenses; Packing charges; Carriage outward; Variable expenseson delivery vans; etc.

It means that a part of the expenses does not change while the other part of the sameexpense charges with volume of output. Generally, on costs are truly fixed or truly variable.

Classification According to Controllability

The overheads can be classified on the basis of controllability into a) Controllable, and b)Un-controllable.

The controllable cost is one which can be controlled, i.e., maintained or reduced. Thevariable costs fall under this category. The un-controllable cost is one which cannot be influencedby the action of a specified member of the undertaking.

Allocation of cost

Allocation of cost means charging the full amount a cost to a cost centre, i.e. to the job,process, or to the product etc. The nature of the expense is such that it can easily be identified andallocated to the cost centre or to the cost unit of production.

Apportionment of cost

Where the expense is a common one and it is to be allotted to different cost centresproportionately on an appropriate basis, it is known as ‘apportionment’. For example, rent of thefactory is an expense which cannot be allocated to any one department, but is to be shared by allthe production departments and service department, on suitable basis, e.g., floor area basis.

Absorption of Overhead

With the help of allocation and apportionment, the different production departments gettheir due share of the total production overheads. After that, the process of absorption starts. Theoverheads of a particular department are to be allotted to the production units of the department.

BSPATIL 56

This allotment to the unity is absorption.

Ability to Pay Principle, Efficiency or Incentive principle:

Overheads is to recover or absorb the overheads in the cost of products, individual jobs,processes, batches, or other convenient units. The overheads falling to the share of a departmentthrough the process of allocation or apportionment, is to be absorbed by the cost units of thatdepartment. This is known as ‘Absorption of overheads’.

Problem 1

The New Enterprises Ltd., has three Production Departments A,B,C and two Service Departments Dand E. The following figures are extracted from the records of the company:

Rs.Rent and rates 5,000General lighting 600Indirect Wages 1,500Power 1,500Depreciation of Machinery 10,000Sundries 10,000

The following further details are available:

Total A B C D EFloorSpace (Sq.ft)

10,000 2,000 2,500 3,000 2,000 500

Lightpoints

60 10 15 20 10 5

DirectWages(Rs.)

10,000 3,000 2,000 3,000 1,500 500

H.P. ofMachines

150 60 30 50 10 -

Value ofMachinery(Rs.)

2,50,000 60,000 80,000 1,00,000 5,000 5,000

WorkingHours

- 6,226 4,028 4,066 - -

The expenses of D and E are allocated as follows:A B C D E

D 20% 30% 40% - 10%E 40% 20% 30% 10% -

What is the total cost of an article if its raw material cost is Rs. 50, labour cost Rs. 30 and itspasses through Departments A,B and C for 4,5 and 3 hours respectively?

BSPATIL 57

SolutionStatement of Allocation and Apportionment of Overhead:

Total Production Service Rate of AppointmentRs. A B C D E

DirectWages

2000 - - - 1500 500 Actual

Rent & Rates 5000 1000 1250 1500 1000 250 Re. 0.5per sq.ft.

GeneralLighting

600 100 150 200 100 50 Rs. 10 perPoint

IndirectWages

1500 450 300 450 225 75 Rs. 0.15per Re. ofDirectwages

Power 1500 600 300 500 100 - Rs. PerH.P.

Depreciation 10000 2400 3200 4000 200 200 4% ofvalue ofmachinery

Sundries 10000 3000 2000 3000 1500 500 100% ofDirectWages

30600 7550 7200 9650 4625 1575ServiceDept. D

- 966 1449 1933 -4831

483

30600 8516 8649 11583 -206 2058ServiceDept. D

- 823 412 617 206 -2058

30600 9339 9061 1220 - -Workinghours

- 6226 4028 4066 - -

Rate perhours

- 150 225 300 - -

Ascertainment of cost of an article Rs.Material 50.00Labour Cost 30.00

80.00Overhead cost

Dept. A, 4 hrs @ 1.50 = 6.00Dept. B, 5 hrs @ 2.25 = 11.25Dept. C, 3 hrs @ 3.00 = 9.00 26.50

Rs. 106.25Note: Sundry expenses are apportioned on the basis of direct wages.

Problem 2You are supplied with the following information and required to work out the production hour rateof recovery of overhead in Department A,B, and C.

Production Departments ServiceDepartments

Total A B C P QParticulars: Rs. Rs. Rs. Rs. Rs. Rs.

BSPATIL 58

Rent 12000 2400 4800 2000 2000 800Electricity 4000 800 2000 500 400 300IndirectLabour

6000 1200 2000 1000 800 1000

DepreciationofMachinery

5000 2500 1600 200 500 200

Sundries 4500 910 2143 847 300 300Estimatedworking hrs.

1000 2500 1400

Expenses of Service Departments P and Q are apportioned asunder:

A B C P QP 30% 40% 20% - 10%Q 10% 20% 50% 20% -

BSPATIL 59

Solutiona) Repeat Distribution Method

Overhead Distribution Summary for the period……………

Total A B C P QParticulars: Rs. Rs. Rs. Rs. Rs. Rs.Rent 12000 2400 4800 2000 2000 800Electricity 4000 800 2000 500 400 300IndirectLabour

6000 1200 2000 1000 800 1000

Depreciationof Machinery

5000 2500 1600 200 500 200

Sundries 4500 910 2143 847 300 300Total Rs. 31500 7810 12543 4547 4000 2600DepartmentP

1200 1600 800 -4000 400

9010 14143 5347 - 3000DepartmentQ

300 600 1500 600 -3000

9310 14743 6847 600 -DepartmentP

180 240 120 -600 60

9490 14983 6967 - 60DepartmentQ

6 12 30 12 -60

9496 14995 6997 12 -DepartmentP

4 5 3 -12 -

Total Rs. 31500 9500 15000 7000 - -WorkingHours

1000 2500 1400

Rate perHour

9.50 6.00 5.00

b) Equation Method (alternative method)

Let x be the expenses of Service Department P; andy be the expenses of Service Department Q.

Then x = 4000 + 1/5y (since 20% of y well be apportioned to Department P) ; and

y = 2600 + 1/10x= 2600 + 1/10 (4000 + 1/5y),

substituting the value of x:= 2600 + 400 + 1/50y= 3000 + 1/50y

50y = 150000 + y49y = 150000y = 3061x = 4000 + 1/5 x 3061 = 4,612

BSPATIL 60

Overheads Distribution Summary

Production Departments Service DepartmentsA B C P QRs. Rs. Rs. Rs. Rs.

Total as givenabove

7,810 12,543 4,547 4,000 2,600

Expenses of Dept.P (Rs. 4,612)

1,384 1,845 922 -4,612 461

Expenses of DeptQ (Rs. 3,061)

306 612 1,531 612 -3.061

Rs. 9,500 15,000 7,000 - -No. of workinghours

1,000 2,500 1,400

Rate per hour 9.50 6.00 5.00

Problem 3

The following information are available for Production departments A,B, & C the Service the Dept D& E.

Particular Production Dept Service DeptTotal A B C D E

Rent 1000 200 400 150 150 100E.B 200 50 80 30 20 20Fire Ins 400 80 160 60 60 40Plant Dept 4000 1000 1500 1000 300 200Transport 400 50 50 50 100 150

The expenses of services dept D & E are apportioned as under

A B C D ED 30% 40% 20% - 10%E 10% 20% 50% 20% -

Apportion the expenses of service dept to production dept by

1) Repeated Distribution Method2) Simultaneous Equation Method

Solution

REPEATED DISTRIBUTION METHOD

Over Head Analysis Sheet

Production Departments Service DepartmentsA B C P QRs. Rs. Rs. Rs. Rs.

Rent 200 400 150 150 100E.B. 50 80 30 20 20Fire, Insur 80 160 60 60 40

BSPATIL 61

Plant Dept. 1000 1500 1000 300 200Transport 50 50 50 150 100Total Exp. 1380 2190 1290 630 510Service Dept. D% 189 252 126 630 63

1569 2442 1416 - 573Service Dept E% 57 115 286 115 573Service Dept E% 35 46 23 115 11Service Dept D% 1 2 6 2 11Service Dept D% 1 1 - 2 -Total 1663 2606 1731 -

BSPATIL 62

BY SIMULTANEOUS EQUATION METHOD

Total A B C D ETotal 1380 2190 1290 630 510D% 30% 40% 20% - 10%E% 10% 20% 50% 20% -

Let x be the total exp of D to be apportionedLet y be the total exp of E to be apportioned

x = 0.2y + 630 (1)y = 0.1x + 510 (2)

Substituting the value of x in (2)y = 0.1 (0.2y 630) + 51

= 0.02y 63 + 5100.98 y= 573

Therefore y = 585Therefore x = 747

A B C1380 2130 1290

Service Dept D 30% :40% : 20%(of 747)

224 299 149

Service Dept E (1:2:5of 585)

58 117 293

Total 1662 2606 1732

Problem 4

Superfine Ltd. has furnished the following particulars for the half year ended March 31,1982. Compute the deprs O/H rates. For the each of the productions department assuming thatthe O/H charges are recovered as a % of direct wages.

Particular Production Dept. Service Dept.A B C D E

Direct Wages 4000 6000 8000 2000 4000Direct Material 2000 4000 4000 3000 3000No. of Employee 100 150 150 50 50EB KWH 8000 6000 4000 2000 2000Light point 10 16 4 6 4Assert value 120000 80000 60000 20000 20000Area occupied(sq. meters)

150 250 100 50 50

Over Head expenses for the above period

BSPATIL 63

Motive Power 3300Lighting 400Stores exp 800Staff welfare 4800Deprecation 30000Repair 15000Rent & Rates 1200General exp 12000

Apportion the expenses of service dept D in proportion to the direct wages & that of E in theratio 5:3:2 to production dept A,B,C

Solution

OVER HEAD DISTRIBUTION SUMMARYParticular A B C D E

Direct Material - - - 3000 3000Wages 2000 4000Power 4:3:2:1:1 1200 900 600 300 300Lighting5:8:2:3:2

100 160 40 60 40

Stores exp.2:4:4:3:3(Material)

100 200 200 150 150

Staff 2:3:3:1:1 360 1440 1440 480 480Deprec.6:4:3:1:1

12000 8000 6000 2000 2000

Rent & rates3:5:2:1:1

300 500 200 100 100

Repairs (assertratio)

6000 4000 3000 1000 1000

General exp.(staff ratio)

2400 3600 3600 1200 1200

Total 23060 18800 15080 10290 2270

Abortionment ofSer. dept D inthe ratio ofwages

2287 3430 4573 - -

Abortion of E inthe ratio 5:3:2

6335 3681 2454 - -

Total 31702 25811 21907 - -

Over Head Recovery (as per the rate wages)

BSPATIL 64

Dept A = (3170.2/4000) x100

= 792.55%

Dept B = (2581.1/6000) x100

= 430.2%

Dept C = (2190.7/8000) x100

= 272.8%

Absorption of overhead cost

Absorption means allotment of overhead cost of jobs i.e., with a view to charging the sameamount of overheads in respect of the departments of cost centre where it is spent.

Methods of Absorptions

There are various methods of absorptions, some of which generally used are given below:

a) Direct Labour Cost Method.b) Direct Labour Hours Methodc) Machine Hour Rated) Prime Cost Methode) Conversion Cost Method

Machine Hour Rate Method

This Method is applicable where work is carried on mostly by the machines because the overheadsin such a case are more related to the machines. The factory overheads of the factory areppportioned to the different machines or group of machines. An individual machine is treated to bea cost centre, and sometimes a group of machines which work together in Co-operation is treatedto be a cost centre fro the purpose of apportionment. The working hours of a machine arecalculated for the period for which the machine is to run. Machine hour rate is scientific, practicaland accurate. It helps in finding out idle machines cost and also in decision making.

Problem 5

Workout the machine hour rate for the following machine, whose scrap value is nil:

BSPATIL 65

1. Cost of Machine Rs. 90,0002. Other charges e.g. freight and

installationRs. 10,000

3. Working life 10 years4. Working hours 2,000 per year5. Repair charges 50% of Depreciation6. Power – 10 units per hour, @ 10 paise per unit7. Lubricating oil @ Rs. 2 per day of 8

hours.8. Consumable stores @ Rs. 10 per day of 8 hours9. Wages of operator @ Rs. 4 per day.

BSPATIL 66

Solution

Computation of Machine Hour Rate

Machine No……..Standing Charges Per day

Rs.Per hourRs.

Lubricating Oil 2Wages 4Consumable Stores 10

16Hourly rate (16+8) 2.00

Machine Expenses

Depreciation – cost Rs. 1,00,000Yearly depreciation 10,000Hourly depreciation 10000 + 2000 5.00

Repairs 50% of depreciation 2.50Power 10 units @ 10 paise per unit 1.00

Machine hour rate (Comprehensive) 10.50

Problem 6

Compute from the following information relating to machine No. 18, machine hour rateRs.

Cost of machine 11,000Scrap value 680Repairs for the effective working life 1,500Standing charges for 4 weekly period 1,600Effective working life 10,000 hoursPower used 6 units @ 5 paise per unitHours worked in 4 weekly period 120 hours.No. of machines in the workshop is 40, of which each bears equalcharges.

Solution Computation of Machine Hour Rate

Machine No. 18Per hourRs.

Standing charges 1600 /(40x120) 33Machine Expenses

Depreciation – cost 11,000Less-scrap value - 680

Value to be written off Rs. 10,320Hourly rate = 10,320 + 10,000 1.03Repairs Rs. 1,500 for entire life

Hourly rate 1500 + 10,000 15Power consumed 6 units @ 5 paise per unit 30

BSPATIL 67

Machine Hour Rate 1.81

Problem 7

Calculate the machine hour rate from the following:Rs.

Cost of Machine 8,000Cost of Installation 2,000Scrap value after 10 years 2,000Rates and rent for a quarter for the shop 300General lighting 20 p.m.Shop supervisor’s salary 600 p.a.

quarterInsurance premium for a machine 60 p.a.Estimate repair 100 p.a.

Power 2 units per hour @ Rs. 5 per 100 unitsEstimated working hour p.a. 2,000

The machine occupier 1/4th of the total area of the shop. The supervisor is expected todevote 1.6th of his time for supervising the machine, General lighting expenses are to beapportioned on the basis of floor area.

Solution

Computation of Machine Hour RateMachine No:

Per year Per hourStanding Charges: Rs. Re.Rent and Rates 1/4th 300General lighting as per floor area 60Supervisor’s Salary 1/6th 400Insurance premium 60Total yearly Standing charges 820Hourly rate 820 + 2,000 0.40

Machine expenses

Depreciation Cost 8,000Installation 2,000Total 10,000Less Scrap value 2,000Amount to be written off Rs. 8,000 0.40Repairs etc. 0.05Power 2 units @ 5 paise perunit

0.10

Machine Hour Rate 0.96

BSPATIL 68

Problem 8Calculate the machine hour rate, for the machine No. 45 from the following particulars:

Rs.Cost of Machine 10,000Estimated scrap value 250Estimated working life 15,000

hoursHours required for maintenance 200 hoursProductive working hours p.a. 2,000 hoursSetting up time 5%Power 20 units @ 7 paise per unitCost of repairs p.a. 1,500No. of operators looking after 4machines

2

Wages of operator p.m. 150Chemical required p.m. 100Overheads chargeable to thismachine

200 p.m.

Insurance premium 1% p.a.

SolutionCalculation of Machine Hour RateMachine No. 45 Per hour

Rs. Rs.Yearly Standing ChargesOverheads Rs. 200 x 12 = 2,400Insurance 1% of 10,000 = 100Wages (2 x 150 x 12) / 4 = 900

Total 3,400Effective working hours in a year 1,900Therefore 3,400 1.79

1,900

Machine ExpensesDepreciation Rs. (10,000 – 250) /15,000

0.65

Repairs Rs. 1,500 + 1,9000.79Chemicals Rs. (100 x 12) / 1900 0.63Power 7 paise x 20 units 1.40 1.40

Machine hour rate 5.26Note: It has been presumed that the hours required for maintenance have already been adjusted inthe total yearly hours. Secondly 5% time needed in setting up, has been considered as productive,and hence has been adjusted accordingly i.e. as normal loss in terms of hours for it has alreadycaused in increase in machine hour rate. Also it is presumed that no power is used in setting upoperations.

Problem 9

Compute comprehensive machine hour rate from the following data:

(a) Total of machine to be depreciated – Rs. 2,30,000

BSPATIL 69

Life – 10 years; Depreciation on straight line.(b) Departmental overheads (annual):

Rent – 50,000; Heat and light – 20,000 ; supervision 1,30,000.(c) Departmental Area 70,000 sq. metres.Machine Area 2,500 sq. metres.

(d) 26 machines in the department.(e) Annual cost of reserve equipment for the machine Rs. 1,500.(f) Hours run on production 1800(g) Hours for setting and adjusting 200(h) Power cost Rs. 0.50 per hour of running time.(i) Labour (1) when setting and adjusting, full time attention

(2) when machine is producing, one man can look after 3 machine(j) Labour rate Rs. 6 per hour.

Using the machine hour rate as calculated value work out the amount of factory overhead to beabsorbed on the following:

Total hours Productiontime

Setting up timehrs

Job No. 605 100 80 20Job. No. 595 100 80 30

SolutionComputation of comprehensive machine hour rate

Standing chargesRent, heat and light (70,000 x 2,500) /70,000

2500

Supervision (1,30,000 ) / 26 5,000Depreciation 10% of Rs. 2,30,000 23,000Reserve equipment cost (1500/26) 58Labour cost during setting and adjustment 200 hrs @Rs. 6 = (1,200 / 31,758)Hourly Rate for standing charges 31,758 / 1800 17.64Machine chargesPower 0.50Labour (1/3 of Rs. 6) 2.00Comprehensive machine hour rate 20.14If the machine hour rate over the various jobs will be:

Job No. 605 = 20.14 x 80 = 1,611.20Job No. 595 = 20.14 x 70 = 1,409.80

User and over absorption of overhead

The amount of overhead absorbed in costs is sum total of overhead cost allotted toindividual cost units by application of overhead rates under the actual rate method, overhead costare fully charged to production so that overhead absorbed in equal to overhead incurred.

Pre-determined overhead rate is calculated on the basis of budgeted overheads and this is appliedto actual base. The amount absorbed may not be identical with the amount of overheads incurredit is called under absorption and in reverse condition it is called over absorption. This may happendue to error in esteeming expenses, error in estimating the base, major changes in methods of

BSPATIL 70

production and seasonal fluctuation of overhead.

BSPATIL 71

Lesson – 5JOB COSTING & BATCH COSTING

Job Costing is the method of costing used to determine the cost of non-standard jobscarried out according to customers’ specifications. In this method is also known are separatelyindentified and are coasted individually. Job costing is applicable to job printers, engineers,furniture makers, builders, contractors, hardware and machine manufacturing industries, repairingshops, etc.

The Costing Department prepares job cost sheet (Fig. 2) for each job, containing theproduction order No., and other details relating to the job. Where a job requires several majoroperations or components, sub-cost sheet. The job cost sheet is the document detailing the costof the job under Direct material. Direct labour, Works overheads etc., It is not prepared for aspecific period but for a specific job.

The cost of all the job in process are debited to the Work-in-Progress Control Account. Onthe completion of a job, this account is credited and Finished Goods Control Account is debitedwith its cost. The difference between the cost and the price charged is the profit or the loss on thejob.

On the completion of a job Completion Report is submitted by the production shop to theplanning Department with a copy to Costing Department. This report is an indication that furtherexpenses on the job should cease and the job cost sheet be closed.

Problem 1

Find out in the suitable cost sheets form the selling rater per tone of special papermanufacturing by a paper mill for a private firm a January 1997 under the following divisions ofcost:

a. Prime Costb. Works cost,c. Total cost,d. Selling price

The cost sheet is to be prepared with reference to the data given below:

Direct Materials

Paper plup – 1,000 tonnes @ Rs. 50 per tone.Other Miscellaneous Materials, 200 tonnes at Rs. 30 per tone.

Direct Labour

100 skilled men @ Rs. 5 per day for 20 days.50 unskilled men @ Rs. 3 per day for 20 days.

Direct Expenses

Special equipment Rs. 5,000Special dies Rs. 2,000

Works Overhead

BSPATIL 72

Variable 10% on direct wages.Fixed 60% on direct wages

Administrative overhead at 10% of works cost.Selling and distributive overhead at 15% of works cost.Profit 10% in total costFinished paper manufactured 800 tonnesSale of waste paper Rs. 1,000

There was not work in progress in the beginning or at the end of the month. The scarp value ofspecial equipment is nil after use. Work was done only for 20 days in the month. Selling price is tobe worked to the nearest rupee.

Solution:

Cost-Sheet for Special PaperRs. Rs.

Direct materialPaper pulp 1,000 tonnes @ Rs. 50 per tone 50,000Other materials 200 tonnes @ Rs. 30 pertone

6,000 56,000

Direct Labour100 skilled men at Rs. 5 for 20 days 10,00050 unskilled man at Rs. 3 for 20 days 3,000 13,000Direct ExpensesSpecial Equipment 5,000Special dies 2,000 7,000Prime Cost 76,000Works overheadVariable 100% of direct labour 13,000Fixed 60% of direct labour 7,800 20,800

96,800Less : sale of waste 1,000Works cost 95,800Office OverheadAdministrative 10% of works cost 9,580Selling and distributive 15% of works cost 14,370 23,950Total Cost 1,19,750Profit 10% 11,975Selling Price @ Rs. 164.65 or Rs. 165 for800 Tonnes

1,31,725

Problem 2

The information give below has been taken from the costing record of an Engineering Worksin respect of Job No. 303.

Materials Rs. 4,010

Wages:Dept. A – 60 hours @ Rs. 3 per hour

BSPATIL 73

B – 40 hours @ Rs. 2 per hourC – 20 hours @ Rs. 5 per hour

Overhead expenses for these three departments were estimated as follows:

Variable overheads:Dept. A – Rs. 5,000 for 5,000 labour hours

B – Rs. 3,000 for 1,500 labour hoursC - Rs. 2,000 for 500 labour hours

Fixed overheads:Estimated at Rs. 20,000 for 10,000 normal working hours. You are required to calculate the

cost of job 303 and calculate the price to give profit of 25% on selling price.

SolutionAmount AmountRs. Rs.

Direct Materials 4,010Wages – Dept. A 60 hrs. x Rs. 3 180

B 40 hrs. x Rs. 2 80C 20 hrs. x Rs. 5 100 360

Overheads – variableDept. A 60 x (Rs. 5000 / 5000 hrs.) 60

B 40 x (Rs. 3000 / 1500 hrs.) 80C 20 x (Rs. 2,000 / 500 hrs.) 80 220

Fixed overheads:120 hours @ (Rs. 20,000 / 10000

hrs)240

Total cost 4,830Profit 25% on selling price or 1/3 onCost Price

1610

Selling Price 6440

Advantages of job CostingJob Costing offers the following specific advantages:-

The cost material, labour, and overhead for every job or product in a department is availabledaily, weekly or as often as required while the job is still in progress. This enable themanagement to know the trend of the costs and this by the efficiency of operations.

On completion of a job, the cost under each element is immediately ascertained. Cost maybe compared with the selling prices of he products in order to determine their profitabilityand to decide which product lines should be pushed or discontinued or whether prices orprice quotation could be revised. The application of marginal costing techniques may beuseful in such situations.

Historical costs for past periods for each product, compiled by orders, departments, ormachines, provide useful statistics for future production planning and for estimating thecosts of similar jobs to be taken up in future. This assists in the prompt furnishing of pricequotations for specific jobs.

BSPATIL 74

The adoption of predetermined overhead rates in job costing necessitates the application ofa system of budgetary control of overhead with all its advantages.

The actual overhead costs are compared with the overhead applied at predetermined rates;thus at the end of an accounting period, overhead variances can be analyzed.

Spoilage and defective work can be easily identified with specific jobs or products so thatresponsibility may be fixed on determents or individuals.

Job costing is particularly suitable for cost-plus and such other contracts where selling priceis determined directly on the basis of costs.

BSPATIL 75

Limitations of job costing:Job costing is comparatively more expensive as more clerical work is involved in identifyingeach element of cost with specific departments and jobs.With the increase in the clerical processes, chances of errors are enhanced.The cost as ascertained, even where they are complied very promptly, are historical as theyare compiled after incidence.The cost compiled under job costing system represents the cost incurred under actualconditions of operation. The system does not have any scientific basis to indicate what thecost should be or should have been, unless standards of performance efficiency areestablished. Estimated cost, prepared by some concerns in respect of job orders, also do notserve the purpose.If major economic changes take place, comparison of cost of a job for one period with thatof another becomes meaningless. Distortion of cost also occurs when the batch quantitiesare different.

BATCH COSTING

Batch costing a modified from of job costing. While job costing is concerned with producingarticles according to customer’s requirements and specifications, batch costing is used where thearticles are manufactured in a good number in definite batches. Component parts of watches, radiosets, television sets etc., are extensively produced under batch costing, for being assembled in theproduct. If one component of a special design is ordered by a customer for manufacture, it is Batchcosting, Batch costing, therefore, is also known a “Lot Costing”.

A batch of workers is assigned to perform the task of producing a certain number ofarticles in a particular period. Thus the cost of production can be compared batch wise, andefficiency ascertained. Like job order system, one number is allotted to each batch. The materialrequisitions are prepared batch wise, labour is engaged batch wise, and the overheads are alsocharged batch wise. This it is a modified form of job costing.

The cost control in batch costing depends upon ascertainment of the optimum number ofbatch production. The Economic Batch Quantity can be decided on the same principle and sameformula as applied to Economic Order Quantity is case of materials.

Cost comparison between the two batches is possible if both batches are allowed the samefacilities, time to produce, and the same number of articles. The comparison can be fruitfully donewith the help of cost sheets of the two batches.

Problem 1A joining factory has undertaken to supply 200 pieces of a component per month for the

ensuing six months. Every month a batch order is opened against with material and labour hoursare booked at actual. Overheads are levied at a rate per labour hour. The selling price contractedfor is Rs. 8 per piece. Form the following data present the cost and profit per piece of each batchorder and overall position of the order for 1200 pieces.

Months Batchoutput

Materialcost

Directwages

Directlabourhours

Rs. Rs.January 210 650 120 240February 200 640 140 280March 220 680 150 280

BSPATIL 76

April 180 630 140 270May 200 700 150 300June 220 720 160 320

BSPATIL 77

The other Details are:

Months Chargeableexpenses

Direct labour hours

Rs. Rs.January 12,000 4,800February 10,560 4,400March 12,000 5,000April 10,580 4,600May 13,000 5,000June 12,000 4,800

Solution:

COST SHEETJan Feb. Mar. April May June Total

Batchoutput

210 200 220 180 200 220 1230

Sales ValueRs.

1680 1600 1760 1440 1600 1760 9840

MaterialCostRs.

650 64 680 630 700 720 4020

DirectWages Rs.

120 140 150 140 150 160 860

ChargeableexpensesRs.

600 672 672 621 780 800 4145

Total CostRs.

1370 1452 1502 1391 1230 1680 9025

Profit perBatch Rs.

310 148 258 49 -30 80 815

Total Costper unitRs.

6.52 7.26 6.83 7.73 8.15 7.64 7.34

Profit perunit Rs.

1.48 0.74 1.17 0.27 -0.15 0.36 0.66

Over all position of the order for 1,200 units.Sales value of 1,200 units @ 8/- per units. Rs. 9,600Total cost of 1,200 units @ 7.34 per unit Rs. 8,808

_______________Profit Rs. 792

BSPATIL 78

Lesson – 6CONTRACT COSTING

Contract is an agreement enforceable by law. It is an agreement between two parties –Contractor and the Contractee. The contractor agrees to undertake and complete the work, as perterms of contract, within a specific period and for a particular monetary consideration. The termsof contract regarding work to be undertaken, period in which to be completed, value of thecontract advances to be made by the Contractee to the contractor on the certificate of architect,compensation payable by the contractor for the breach of contract, etc., are decided upon betweenthe two parties before the work is started. These contracts related to the works of construction ofroads, buildings, bridges, dams and banks, ports, etc,

Contract costing is the technique of ascertaining cost of a contract. Here the unit of cost isone only, e.g., a building, or a bridge etc. it is similar to job in principle, and so the method ofrecording cost is the same. A Contract Ledger book is kept in which a separate account for eachcontract is opened.

The following items appear on the debit side of the Contract A/c:1. Direct Materials2. Direct Labour3. Direct Expenses4. Overheads5. Plant and Machinery6. Sub-Contract Cost7. Extra Work done

The following items appear on the credit side of the Contract A/c:1. Materials Returned2. Materials Transferred3. Materials at the end4. Plant and Tools at the end5. Work Certified6. Work done but Uncertified7. Contract Price

Work CertifiedAs per terms of the contract, the contractee advances some 80 or 90 percent of he work

done to the contractor on the basis of the work certified by the contractee’s architect or engineerperiodically. The balance of 20 or 10 percent amount is retained by the contractee, so that thecontractor may continue to work and not leave the contract if the contract is not proving to beprofitable one to him. The amount retained is known as ‘Retention of Money’.

Work done but not yet Certified

A work done by the contractor but which remains to be certified by the architect on the dateof accounting is known as work done but not yet certified.

Contract PriceThe contract price is the value of contract agreed to be paid to the contractor by the

contractee on the satisfactory completion of the contract. So on the completion of the Contract theContract A/c is credited with the contract price and ‘Contractee’s A/c’ is debited.

Cost – plus – contract

BSPATIL 79

Where a contractor feels hesitant to quote for a work of contract which is absolutely new tohim, and new to other contractors as well, and he is unable to estimate the cost of the worksoffered to him for execution. It is decided with the contract or that he would be paid the total costof work whatever it be, plus his profit as a rate percent on the total cost. Such s contract is knownas ‘Cost – plus – Contract’.

Ascertainment of Profit/Loss on Contract

The Profit/Loss on contract is ascertained as follows:a) On completion of Contract:

The excesses of credit over the debit items of the contract a/c is the profit, and the whole ofit can be taken into account. The excess of debit over the credit items is loss.

b) On incomplete Contract:Where a contract takes more one financial year for in to complete, it is usual to take intoaccount a part of the profit only to the Profit and Loss Account. If there is a loss, the wholeof the loss is transferred to the P & L A/c.

What part of the notional profit should be credited to the profit and loss account each year,depends on the practice and circumstances of the case. The general rules are:

a) If the value of certified work is less than 1/4th of the contract price, no profit is taken intoaccount, and the balance of the contract a/c is transferred to the Work-in-Progress A/c.

b) If the certified work is 1/4th or more than 1/4th, but less then ½ of the contract price, only1/3 of the computed profit as reduced to the cash basis (cash received on work certified),should be credited to the Profit and Loss Account. The formula is:

Profit = Computed profit, i.e. Cr. Balance of contract a/c x 1/3 x (cash received / work certified)

The balance of the computed profit is a reserve and is transferred to Work-in-Progress A/c.

c) If the value of certified work is ½ or more than ½ of the contract value, 2/3 of the computedprofit as reduced to the cash basis is credited to P & L A/c.

Problem 1(Where more than ½ contract is complete)

Building Contractors Ltd., undertake contracts. On 31st October, 1993 when the actual accountswere prepared, the positions of Contract No. 101 which was commenced on 1st January, 1993, wasas under:

Rs.Material purchased 37,500Material in hand 1,500Wage Paid 43,750Wage outstanding 625Proportionate share of indirect expenses 1,875Cost of plant 6,250

The value of work certified was Rs. 90,000 of which Rs. 67,500 had been received, work completedbut uncertified was valued at Rs. 2,500.

The Contract price was Rs. 1,50,000.The plant on the site was valued at Rs. 5,000 on 31st October, 1993.

BSPATIL 80

Prepare Contract No. 101 account after taking credit for Profit which you think reasonable.

BSPATIL 81

Solution:

Contract 101 Account

Rs. Rs.To Materials Purchased 37,500 By work-in-Progress

Account:To Wages 43,750 Work certified 90,000To Plant 6,750 Work done but

Uncertified 2,50092,500

To Proportionate shareof indirect expenses

1,875

To Outstanding Wages 625 By Material at site 1,500To Balance c/d 9,000 By Plant at site (dep.

Value)5,000

Total 99,000 Total 99,000To Profit and Loss A/c 4,500 By Balance c/d 9,000To Work-in-ProgressAccount

4,500

Total 9,000 Total 9,000

* Profit has been ascertained as follows:Rs. 9,000 x 2/3 x 67,500 / 90,000 – Rs. 4,500.

vi) if the contract work has sufficiently advanced, or the contract is almost complete, the profit isascertained as follows:

The expenses of the part of the contract remaining to be executed are estimated, and addedto the expenses already incurred, to give an idea of the total cost of the full contract. On deductingthe estimated total cost from the contract price, we get the notional or the computed profit. Of thiscomputed profit only that part is credited to P & L A/c as is reduced by the proportion of.

(i) ‘Work credited’ to ‘Contract Price’ or more conservatively.(ii) ‘Cash received’ to ‘Contract Price’ so:

i. Profit = Estimated Profit on completed contract x Work certified / Contract Priceii. Profit = Estimated Profit on completed contract x Cash Received / Contract Price.

An Estimated Contract A/c or Estimated Contract Statement is required to be prepared to find outthe estimated cost of the full contract and to find out the national profit for the purpose ofcalculating the Profit to be credited to the Profit and Loss Account in the main Contract A/c.

Work-in-progress and Balance Sheet

The Work-in-progress A/c is debited with the sums

(i) Work certified (valued at contract price), and(ii) Work done but not yet certified (valued at cost).

This account is credited with the balance of the notional profit not taken to the Profit and LossAccount.

BSPATIL 82

This account shows debit balance which is taken to the Balance Sheet on the Asset side. TheContractee’s A/c which shows credit balance on account of cash received in advance, is not shownon the Liability side of the Balance Sheet but is shown as a deduction from the Work-in-ProgressA/c on the Asset side of the Balance Sheet.

BSPATIL 83

Problem 2

The following information relate to Contract No. 123. You are required to prepare theContract Account and the Contractee’s Account assuming that the amount due from the contracteewas duly received.

Rs.Direct Material 20,250Direct Wages 15,500Stores Issued 10,500Loose Tools 2,400Tractor Expenses:

Running Material 2,300Wages of Drivers 3,000 5,300

Other Direct Charges 2,650

The contract price was Rs. 90,000 and the contract took 13 weeks in its completion. The values ofLoose Tools and Stores returned at the end of the period were Rs. 200 and 3,000 respectively. Theplant was also returned at a value of Rs. 16,000 after charging depreciation at 20%. The value oftractor was Rs. 20,000 and depreciation was to be charged to the contract @ 15% per annum. TheAdministration and office expenses are to be provided at 10% on works cost.Solution:

Contract 123 AccountParticulars Amount Particular Amount

Rs. Rs.To Direct Materials 20,250 By Stores Returned 3,000To Direct Wages 15,500 By Loose tolls returned 200To Stores Issued 10,500 By Plant Returned 16,000To Plant (original cost) 20,000 By Balance being 58,150To Loose Tools 2,400 Work Cost A/cTo tractor expenses:Running Materials2,300Wages of drivers 3,000 5,300To Depreciation onTractor @ 15% on Rs.20,000 for 13 weeks

750

To other DirectCharges

2,650

Total 77,350 Total 77,350

To Balance being workcost b/d

58,150 By Contractee’s A/c 90,000

To Administration andoffice expenses @ 10%on works costTo profit & Loss A/c 26,035Total 90,000 Total 90,000

Contractee’s AccountRs. Rs.

BSPATIL 84

To Contract A/c 90,000 By Bank 90,000Total 90,000 Total 90,000

The plant was depreciated @ 20% (not @ 20% annum). The depreciated value is Rs. 16,000. So theoriginal cost of the plant comes to Rs. 20,000.

BSPATIL 85

PROFIT ON INCOMPLETE CONTRACTS

Problems 3

A firm of building contractors began to trade on 1st April, 1990. The following was the expenditureon the contract for Rs. 30,00,000:

Rs.Materials issued to contract 51,000Plant used for contract 15,000Wages incurred 81,000Other Expenses incurred 5,000

Cash received on account to 31st March, 1991 amounted to Rs. 1,28,000 being 80% of the workcertified. Of the plant and materials which cost Rs. 2,500 were lost. On 31st March, 1991 plantwhich cost Rs. 3,000 and materials which cost Rs. 2,000 was returned to stores, the cost of workdone but uncertified was Rs. 1,000 and materials costing Rs. 2,300 were in hand on site. Charge15% depreciation on plant, reserve ½ profit received and prepare a Contract Account from theabove particulars.

Solution: Contract Account

Dr. Cr.Particulars Amoun

tParticulars Amoun

tRs. Rs.

To materials 51,000 By Profit & Loss a/cTo Wages 81,000 Plant Lost 3,000To Plant 15,000 Material 2,500 5,500

To Other expenses 5,000By Plantreturned tostore

2,000

To Profit to date 27,000 Less: Dep 300 17,00

By plant at site 10,000

Less: Dep 1,500 8,500

By Material at site 2,300By Work-in-ProgressA/c:Work certified 1,60,0

00Work donebutuncertified

1,000 1,61,000

Total 1,79,000

Total 1,79,000

To Profit & Loss A/c (½ 10,800 By Profit to date b/d 27,000

BSPATIL 86

of profit recd.)To Work in Progress:Reserve (½ ofprofit recd.)

10,800

Balance (20%of Rs.27,000)

5,400 16,200

Total 27,000 Total 27,000

Notes:

1. Ascertainment of Profit:Profit to date 27,000Profit received 4/5 (in the ratio of cash received towork certified)

21,600

Reserved ½ of profit received 10,800Transferred ½ of profit received to Profit & LossAccount

10,800

Balance ( 27,000 – 21,000) i.e. 20% of 27,000 5,400

2. The value of the plant on 31st March, 1991 has been ascertained as follows:

Original Value Dep. Net ValueRs. Rs. Rs.

Plant Lost 3,000 - -Plant returnedto store

2,000 300 1,700

Plant at site 10,000 1,500 8,50015,000 1,800 10,200

BSPATIL 87

Lesson – 7

PROCESS COSTING

Process costing is the type of costing applied in industries where there is continuous ormass production. The necessity for compilation of the costs of a process or a department for agiven period, as distinct from the cost of a whole job or a specific batch of production units, hasgiven rise to the concept of process cost accounting. There are many industries engaged incontinuous processing in which the end products are the results of a number of operationsperformed in sequence. In such industries, it is necessary to apply process costing.

Process costing is suitable for a large number of mining, manufacturing and public utilityindustries like mines and quarries, cotton, wool and jute textiles, chemicals, soap making, paper,plastics, distillation processes, e.g. alcohol, tanning, oil refining, screws, bolts and rivets, canning,food products, dairy, and electricity and gas undertakings.

Features of Process Costing:-

1. The production is continuous and the end product is the result of a sequence of processes.2. The product is homogeneous and the units product are identical and standardized.3. The sequence of operations for processing the product is specific and predetermined.4. The finished products of one process works as raw material for the next or process untilcompletion.

Process Costing and Job Costing:-A comparison of the basic principles of process costing with those of job costing, given

below, will assist in appreciating process costing procedures.

Job Costing Process Costing1. Production is by specifyorders

1. Production is in continuousflow, the products beinghomogeneous.

2. Costs are determined by jobsor batches of products

2. Cost are compiled on timebasis, i.e. for production for agiven accounting period, foreach process or departments.

3. The various jobs are separateand independent of each other.

3. Being manufactured in acontinuous flow, products losetheir individual entity.

4. Unit cost of a job iscalculated by dividing the totalcost incurred into the unitsproduced in the lot or batch.

4. The unit cost of a process,which is computed by dividingthe total cost for the period(after adjustment of the openingand closing work-in-process), isan average cost for the period.

5. Costs are calculated when ajob is completed.

5. Costs are calculated at theend of the cost period.

BSPATIL 88

6. There may or may not be anywork-in-progress at thebeginning or end of anaccounting period.

6. Production being continuousthere is usually somework-in-process at thebeginning as well as at the endof the accounting period.

7. There are usually no transfersfrom one job to another unlessit is necessary to transfersurplus work or excessproduction.

7. As a product moves from oneprocess to another, transfers ofcost from process to processare made.

8. As such product unit isdifferent and production is notcontinuous, more managerialattention is needed if propercontrol is to be exercised.

8. Process production isstandardized and is morestable. Hence, control ofprocess activities iscomparatively easy.

Advantages and Limitations of Process Costing:-

Process costing has the following advantages:

(i) Process cost may be determined periodically at short intervals. When predeterminedoverhead rates are in use, it may be possible to complete unit cost weekly or evendaily. This not always so under the job costing system, particularly when jobs run forlong periods and there are no significant units of completed production during thevarious accounting periods, falling between the total period of run of the jobs.

(ii) It involves less efforts and less clerical expenses as the accounting method is simplerthan that in job costing.

(iii) Detailed cost, budgeted as well as actual, are made available for each possible byevaluating the performance of each process etc.

(iv) Allocation of overhead to departments and processes can be made fairly accuratelyon definite bases.

(v) Since the material consumption ass the various operations are more or lessstandardized, more accurate cost estimates are available for price quotations.

(vi) It is easier to set effective and fairly stable standards in case of mass production orcontinuous repetitive production. Process costing situations are, therefore, moreadaptable for installing standard costing procedures.

The limitations and weaknesses of process costing systems are as follows:-

(i) Being only average costs for the accounting period, process cost cannot beconsidered to be very accurate for the purpose of detailed analysis, evaluation, andcontrol of individual performance efficiency on a day-to-day basis.

(ii) Costs obtained at the end of the accounting period are only historical and are not ofmuch use for effective control unless standard process cost are used. This is, nodoubt, true in respect of all other historical systems but the nature of processaccounting with its departmental divisions makes this disadvantage more prominent.

(iii) When different products come out of one and the same process, the common costsare prorated to the various products. Such cost of individual products are not reliableas they may, at best, be taken to be only approximations.

(iv) For the purpose of calculation of unit costs of continuous processes, work-in-processis required to be determined at the end of an accounting period. This is done mostly

BSPATIL 89

on estimated basis which introduces further inaccuracies in costs.

Process Costing Procedures:-

The procedure for costing applicable to processes or departments will very in details according tothe requirements of production methods. The various situations and problems envisaged and themethods of calculation of costs in respect of each of the situations have been discussed under thefollowing heads:

1. Single process production2. More than one process involved; output of one process transferred in full to the subsequent

process.3. Output of a process partly transferred to the next process and partly retained in stock.4. Process consisting of opening and closing stock, fully completed.5. Normal and abnormal losses occurring in process but there is no closing stock or theclosing stock is fully complete.

6. Process consisting of partially completed closing stock.7. Normal loss or abnormal loss involved-closing stock partially complete.8. Process consisting of partially completed opening stock.9. Normal and/or abnormal losses and both opening and closing work-in-processes.

Problem 1: (Process accounts with Cost sheets)

Am article has to undergo three different processes before it becomes ready for sale. Fromthe following information find out cost of production per unit of that article, if 200 units of articlewere manufactured upto 31st December, 1991.

ManufacturingProcess

RefiningProcess

FinishingProcess

Rs. Rs. Rs.Material 2000 1000 700Labour 1500 2500 1000DirectExpenses

400 200 300

The indirect expenses for the period amount to Rs. 6,000 in the factory out of which Rs.2000 is attributable to this product. There was no stock at the end in any process. The indirectexpenses should be allocated to each process on the basis of labour.

Solution:

Manufacturing Process A/c with Cost Sheet(Output : 200 units of article)

Particulars Costperunit

Amount Particulars Costperunit

Amount

Rs. Rs. Rs. Rs.To Material 10.00 2.00 By Transfer to

Refining ProcessA/c

22.50 4500

To Labour 7.50 1500To Direct 2.00 400

BSPATIL 90

ExpensesTo IndirectExpenses

3.00 600

Total 22.50 4,500 Total 22.50 4500

BSPATIL 91

Refining Process Account(Output : 200 units of articles)

Particulars Costperunit

Amount Particulars Costperunit

Amount

Rs. Rs. Rs. Rs.To Transfer fromManufacturingProcess A/c

22.50 4500 By Transfer ofFinishingProcess A/cThe cost perunit is Rs. 46.00

46.00 9200

To Material 5.00 1000To Labour 12.50 2500To DirectExpenses

1.00 200

To IndirectExpenses

5.00 1000

Total 46.00 9200 Total 46.00 9200

Refining Process Account(Output : 200 units of articles)

Particulars Costperunit

Amount Particulars Costperunit

Amount

Rs. Rs. Rs. Rs.To Transfer fromRefining ProcessA/c

46.00 9200 By FinishedStock A/c

58.25 11650

To Material 46.00 9200To Labour 3.75 750To DirectExpenses

5.00 1000

To IndirectExpenses

1.50 300

Total 58.25 11,650 Total 58.25 11650

Note: The indirect Expenses of Rs. 2000 have been allocated to the three processes in theproportion of direct labour Rs. 3 : 5: 2 (Rs. 1500 : 2500 : 1000)

Problem 2: (Treatment of Bye-product and Scrap)A particular brand of phenyl passed through three important processes. During the week ended15th January, 1952, 600 gross of bottles are produced. The cost book show the followinginformation:

Process 1 Process 2 Process 3Rs. Rs. Rs.

Material 4000 2000 1500

BSPATIL 92

Labour 3000 2500 2300DirectExpenses

600 200 500

Cost of bottles Nil 2030 NilCost of corks Nil Nil Nil

The indirect expenses for the period were Rs. 1600. The bye-products were sold for Rs. 240(Process 2). The residue sold for Rs. 125.50 (Process 3).

Prepare the account in respect of each process showing its cost and cost of production of thefinished product per gross of bottles.Solution:

Process 1 (Output 600 gross of bottles)Rs. Rs.

To Materials 4000.00 By Transfer to ProcessNo. 2 (cost per gross ofbottles Rs. 13.69approximately)

8215.38

To Labour 3000.00To Direct Expenses 600.00To Indirect Expenses 615.38

Total 8215.38 Total 8215.38

Process 2To Transfer fromProcess 1

8215.38 By Sale of Bye-Product 240.00

To Materials 2000.00 By Transfer to Processof bottles (cost pergross of bottles Rs.25.36 approximately)

15218.20

To Labour 2500.00To Direct Expenses 200.00To Indirect Expenses 512.82

2030.00

Total 15458.20 Total 15458.20

Process 3

To Transfer fromProcess 2

15458.20 By Sale of residue 125.50

To Materials 1500.00 Bu Finished productsaccount (Cost pergross of bottles Rs.33.65)

20189.50

To Labour 2300.00To Direct Expenses 500.00To Indirect Expenses 471.80To Cost of rocks 325.00

BSPATIL 93

Total 20315.00 Total 20315.00

Note: Indirect Expenses have been charged to three processes in the labour ratio of 30 : 25 :23

Abnormal Loss and Abnormal Gain:-Abnormal spoilage or defective work may arise in a process due to unforeseen factors.

The cost of such abnormal loss is not included in the cost of the process but the average cost ofthe lost units is charged to an Abnormal Loss Account which is credited with the scrap and closedto the Profit and Loss Account. Thus, in computing the abnormal loss, scrap value of the abnormallost units will be ignored but in working out the loss for charging to Profit and Loss Account, thiswill be taken into consideration.

Sometimes, when the actual loss in a process is less than the anticipated loss, the differencebetween the two is considered to be abnormal gain. The value of the abnormal gain is calculated inthe same way as described above for abnormal loss and is credited to an Abnormal Gain Accountwhich is ultimately closed. Profit and Loss Account. The scrap value of the normal anticipated lossin the process where abnormal gain occurs is credited to the process account with the result thatthe net debit to the process is the cost of abnormal gain less the value of scrap for the normal loss.

Problem 3:(Normal wastage – Loss in weight and sale of scrap)

The Bengal Chemical Co. Ltd., produced three chemicals during the months of July 1995 bythree consecutive processes. In each process 2 per cent of the total weight put in is lost and 10percent is scrap which from process (1) and (2) realizes Rs. 100 a ton and form process (3) Rs. 20 aton.

The product of three processes is dealt with as follows:

Process I Process II Process IIIPassed to nextprocess

75% 50% -

Stock kept forsale

25% 50% 100%

Process I Process II Process IIIRs. Tons Rs. Tons Rs. Tons

Raw materials 120000 1000 28000 140 107840 1348ManufacturingWages

20500 - 18520 - 15000 -

General Expenses 10300 - 7240 - 3100 -

Prepare Process Cost Account, showing the cost per ton of each product.

Solution: Process ITons Rs. Tons Rs.

To RawMaterials

1,000 1,20,000 By Loss ofweight (2% of1000 tons)

20 -

ToManufacturing

20,500 By Sales ofscrap (10% of

100 10,000

BSPATIL 94

Wages 1000 tons)To GeneralExpenses

10,300 By Transfer toWarehouse

220 35,200

By Transfer toProcess II (costper ton Rs.160)

660 1,05,60

Total 1,000 1,50,800 1,000 1,50,800

BSPATIL 95

Process IITons Rs. Tons Rs.

To Transferfrom Process I

660 1,05,600

To RawMaterials

140 28,000 By Loss ofweight (2% of800 tons)

16 -

ToManufacturingWages

- 18,520 By Sales ofscrap (10% of800 tons)

80 8,000

To GeneralExpenses

- 7240 By Transfer toWarehouse

352 75,680

By Transfer toProcess III (costper ton Rs.215)

352 75,680

Total 800 1,59,360 800 159360

Process IIITons Rs. Tons Rs.

To Transferfrom Process II

352 75,680

To RawMaterials

1,348 1,07,840 By Loss ofweight (2% of1700 tons)

34 -

ToManufacturingWages

- 15,000 By Sales ofscrap (10% of1700 tons)

170 3,400

To GeneralExpenses

- 3,100 By Transfer toWarehouse

1,496 198220

By Transfer toProcess III (costper ton Rs.215)

352 75,680

Total 1700 2,01,620 Total 1700 201620

Problem 4:(Showing Process A/cs and Abnormal Wastage A/cs)

The Imperial Manufacturing Company’s product passes through two distinct processes A and B andthen to Finished Stock. It is known from past experience that wastage occurring in the process isas under:

In process A 5% of the units entering the process.In process B 10% of the units entering the process.The Scrap Value of the wastage in Process A is Rs. 8 per 100 units and Process B is Rs. 100

units.

The Process figures are:Process A Process BRs. Rs.

BSPATIL 96

Materials consumed 3000 1500Wages 3500 2000Manufacturingexpenses

1000 1000

5,000 units were brought into Process A costing Rs. 2500.

The outputs were:Process A 4,700 UnitsProcess B 4,150 Units

Prepare Process Cost Accounts showing the cost of the output. Also show abnormal WastageAccount.

Solution:Process A Account

Units Rs. Units RsTo Unitsintroduced

5,000 2,500 By Normalwastage

250 20

To Material 3,000 By Abnormalwastage

50 105*

To Wages 3,500 By Process B 4,700 9,875To Mfg. Expense 1,000

5,000 10,000 5,000 10,000* The Value of abnormal wastage in Process A is calculated as follows:

Normal output is 5,000 – 250 = 4,750 unitsNormal cost is 10,000 – 20 = Rs. 9,980

Therefore, Normal cost of one unit is 9,980 / 4,750 = Rs. 2.10Therefore, Cost of 50 units of Abnormal wastage is 2.10 x 50 = Rs. 105.

As the Abnormal wastage is sold for Rs. 4, therefore, the amount of loss to be transferred to Profitand Loss Account shall be Rs. 105 – 4 = Rs. 101.

Abnormal Wastage A/c (Process A)Units Rs. Units Rs

To Process A 50 105 By sale of Scrap@ Rs. 8 per 100

50 4

By P & L A/c Losstransferred

101

50 105 50 105

Process B Account

Units Rs. Units RsTo Process A 4700 9875 By Normal

Wastage A/c470 47

To Materials 1500 By Abnormalwastage A/c

80 *271

To Wage 2000 By Finished StockA/c

4150 14057

BSPATIL 97

4,700 17,375 4,700 14,375

* The value of abnormal wastage in Process B is calculated as follows:

The normal cost of 4230 units is Rs. 14328Therefore, Normal Cost of one unit = 14,328/4,230 = Rs. 3.39

Therefore, the Cost of 80 units = Rs. 3.39 x 80 = Rs. 271The abnormal wastage will realize Rs. 8, therefore the loss transferable shall be Rs. 271 – 8 = Rs.263.

Abnormal Wastage A/c (Process B)

Units Rs. Units RsTo Process B 80 271 By sale of Scrap

@ Rs. 10 per 10080 8

By P & L A/c Losstransferred

263

80 271 80 271

Problem 5:

From the following details extracted form the costing records of an oil mill for a year ended 31stMarch, you are required to prepare the process cost account of

(a) Groundnut Crushing Process;(b) Refining Process; and(c) Finishing Process including casking, and determine the cost per tone of each process andthe total cost per tone of finished oil.

Purchase of 5,000 tonnes of groundnut – Rs. 48,00,000

Crushing PlantRs.

Refining PlantRs.

Finishing PlantRs.

Wages 25,000 10,000 15,000Power 6,000 3,600 2,400SundryMaterials

1,400 20,000 -

Repairs toPlant &Machinery

2,800 3,350 1,400

Steam 6,000 5,200 4,500FactoryOverheads

13,200 6,600 2,100

Cost o Casks - - 59,600

3000 tonnes of crude oil were produced; 2,500 tonnes of oil were produced by the refiningprocess; and 2,480 tonnes of refined oil were finished for delivery.

BSPATIL 98

Groundnut shells sold – Rs. 400; 1,750 tonnes of groundnut residue sold – Rs. 11,000; lossin weight in crushing – 250 tonnes; 450 tonnes of by-products obtained from Refining Process –Rs. 16,750.Solution:Groundnut Crushing Process

Tonnes Rs. Tonne Rs.Groundnut 5000 4800000 Crude oil

(C/o)3000 4843000

Wages 25000 Groundnutresidue

1750 11000

Power 6000 Groundnutshells

400

Sundrymaterials

1400 Process loss 250 -

Repairs toPlant &Machinery

2800

Steam 6000Factoryoverheads

13200

5000 4854400 5000 4854400

Cost per tone of crude oil = Rs. 1614.33

Refining ProcessTonnes Rs. Tonne Rs.

Crude oil (b/f) 3000 4843000 Refined oil(c/o)

2500 4875000

Wages 10000 By-products 450 16750Power 3600 Process loss 50 -Sundrymaterial

20000

Repairs toPlant &Machinery

3350

Steam 5200Factoryoverheads

6600

3000 4891750 3000 4891750

Cost per tone of refined oil = Rs. 1950Finishing Process

Tonnes Rs. Tonne Rs.Refined oil(b/f)

2500 4875000 Finished oil 2480 4960000

Wages 15000Power 2400 Process loss 20 -

Repairs toPlant &Machinery

1400

Steam 4500

BSPATIL 99

Factoryoverheads

2100

Cost of casks 596002500 4960000 2500 4960000

Problem 6

The product of a company passes through three distinct processes to completion. These processesare known as A,B and C. From past experience it is ascertained that wastage is incurred in eachprocess as under:

Process A 2% of inputProcess B 3% of inputProcess C 10% of input

The normal process loss occurring in the three processes is regularly sold at the rates of 50paise (Process A), Re. 1 (Process B) and Rs. 2 (Process C) per unit respectively the output of eachprocess passes immediately to the next process and the finished units are transferred from ProcessC to finished stock. The following expenses were incurred.

A B CMaterials consumed 40000 20000 15000Direct labour 42000 42600 35000Manufacturing expenses 14600 8380 13920Repairs to Plant & Machinery 2,800 3,350 1,400

20,000 units have been issued to Process A at cost of Rs. 80,000. The output from each processhas been as under:

Process A 19,500Process B 18,800Process C 16,600

There was not stock of work-in-process in any process.

Prepare the process accounts and abnormal wastage account, assuming that the abnormal wastagecollected together for all the three processes was sold in one lump and fetched a price of Rs.10000.

Solution:

For Process A:

1. Actual wastage = 20000 – 19500 = 500 units2. Normal wastage = 2% of 20000 = 400 units3. Scrap sale value = 400 x Re. 0.50 = Rs. 2004. Abnormal wastage = Actual wastage less normal

wastage = 100 units5. Prorata cost = Rs. 176000 / (20,000 – 400)

= Rs. 19,6006. Cost of abnormal wastage Rs. 176600/19600 x 100

= Rs. 900 (rounded off)

BSPATIL 100

Process AUnits Rs. Units Rs.

Units 20000 80000 Transfer toProcess B

19500 175500

Material 40000 Normalwastage

400 200

Labour 42000 Abnormalwastage

100 900

Overhead 14600

20000 176600 20000 176600

Calculations in respect of Process B and C are made in a similar manner. Process BUnits Rs. Units Rs.

Transfer fromProcess A

19500 175500 Transfer toProcess C

18800 244400

Material 20000 Normalwastage

485 585

Labour 42600 Abnormalwastage

115 1495

Overhead 8380

19500 246480 19500 246480Process C

Units Rs. Units Rs.Transfer fromProcess B

18800 244400 Transfer toFinishedstock

16000 288000

Material 15000 Normalwastage

1880 3760

Labour 35000 Abnormalwastage

920 16560

Overhead 13920

18800 308320 18800 38320

Abnormal Wastage Account

Process A 900 Sale 10000Process B 1495 Loss (Profit

and lossaccount)

8955

Process C 16560

Total 18955 Total 18955

Accounting of Inter-Process Profits:-

Inclusion of inter-process profit creates complications in the accounts. As the internalprofits remain merged in process stock, work-in-progress, and finished stock suitable adjustmentis required to be made in the Balance Sheet in order to exclude such unrealized profit.

BSPATIL 101

When inter-process profit is included in the accounts, it is advisable to have three columnsin the ledger to indicate the cost, profit, and the total. This facilitates the calculation of the profitto be provided for inclusion in closing stock in each process and in the final finished stock.

Problem 7:

A product passes through three processes before it is completed and transferred to finishedstock. The following data are available for a month.

ProcessNo.1 Rs.

ProcessNo.2 Rs.

ProcessNo.3 Rs

Opening stock (at prime cost) 2000 12000 10000Direct material 13000 20000 40000Direct Labour 10000 10500 50000Factory overhead 10000 25000 25000Closing stock (at prime cost) 5000 6000 32000

Inter-process transfers of output included profits at the following rates:

Process 1 to Process 2 - 20% on transfer priceProcess 2 to Process 3 - 25% on transfer priceProcess 3 to Finished Stock - 10% on transfer price

Inter-process profit included in the opening stock were:-

In Process 2 - Rs. 2,000In Process 3 - Rs. 2,800In Finished Stock - Rs. 10,000

Finished Stock:-Opening balance - Rs. 25,000Closing balance - Rs. 33,000Sales during the month - Rs. 3,00,000

Complete the process accounts, determine the gross profit for the month and indicate the value atwhich the closing stock will appear in the Balance Sheet on the last day of the month.

Solution:TotalRs.

CostRs.

PftRs.

TotalRs.

CostRs.

PftRs.

Stock (b/f) 2000 2000 - TransfertoProcessNo.2

37500 30000 7500

Directmaterial

13000 13000 -

DirectLabour

10000 10000 -

Less stock(c/f)

5000 5000 -

BSPATIL 102

Prime cost 20000 20000 -F.Y.Overhead

10000 10000 -

Process cost 30000 30000 -Profit @ 20%on transferprice (25%on cost)

7500 7500

37,500 30,000 7500 37,500 30,000 7500

Process No. 2 AccountTotalRs.

CostRs.

Pft.Rs.

TotalRs.

CostRs.

Pft.Rs.

Stock(b/f)

12,000 10,000 2000 TransfertoProcessNo.3

132000 90212 41788

TransferfromprocessNo. 1

37,500 30,000 7,500

Directmaterial

20,000 20,000 -

Directlabour

10,500 10,500 -

Total 80,000 70,500 9,500

Lessstock(c/f)

6,000 5,288 *712

Primecost

74,000 65,212 8,788

F.y.Overhead

25,000 25,000 -

Processcost

99,000 90212 8788

Profit at25% ontransferprice(1/3) ofcost

33,000 33,000

Total 132000 90212 41,788 132000 90212 41,788

Stock(c/f)

6,000 5,288 712

* The proportionate profits on closing in this and other processes are worked out in the followingmanner:-

BSPATIL 103

Profit = Rs. 6,000 x Rs. 70,500 / Rs. 80,000 x Rs. 6,000 – Rs. 5,288 = Rs. = 712Process No. 3 Account

TotalRs.

CostRs.

Pft.Rs.

TotalRs.

CostRs.

Pft.Rs.

Stock(b/f)

10,000 7,200 2,800 Transfertofinishedstock

250000 186562 63438

TransferfromprocessNo. 2

132000 90,212 41,788

Directmaterial

40,000 40,000 -

Directlabour

50,000 50,000 -

Total 232000 187412 44588

Lessstock(c/f)

32,000 25,850 6,150

Primecost

200000 161562 38438

F.y.Overhead

25,000 25,000 -

Processcost

225000 186562 38438

Profit at10% ontransferprice ofcost

25000 25000

Total 250000 186562 63438 250000 186562 63438

Stock(c/f)

32000 25850 6150

BSPATIL 104

Finished Stock AccountTotalRs.

CostRs.

Pft.Rs.

TotalRs.

CostRs.

Pft.Rs.

Stock(b/f)

25,000 15,000 10,000 Sales 300000 177374 122626

TransferfromprocessNo. 3

250000 186562 63438

Total 275000 201562 73,438

Lessstock(c/f)

33,000 24,188 8,812

GrossProfit

58000 58000

300000 177374 122626 300000 177374 122626

Stock(c/f)

33000 24188 8812

Provision for Profit Account

Rs. Rs. Rs. Rs.Profit andLossAccount

Balance(b/f)

Process 2 2000Process 3 2800

ProportionofProvisionnotrequiredforProcess 2

1288 Stock 10000

FinishedStock

1188 14800

Balance(c/f)

Profit &Loss A/c

Process 2 712 Loss A/cProcess 3 6150 Additional

provisionrequiredforProcess 3

3350

FinishedStock

8812

15674

BSPATIL 105

18150 18150

Balance(b/f)Process 2 712Process 3 6150FinishedStock

8812

15,674

Analysis of gross profit for the month:

Rs. Rs. Rs.Process 1 7500Process 2 33000Plus Provisionnot made

1288 34288

Process 3 25000Less Provision 3350 21650

Finished Stock 58000

Plus Provision 1188 59188*122626

* This agrees with the profit in the Finished Stock Account

Balance SheetProcess Stock 5,000Process 1 6000Process 2Less Profit 712 5,288

32000Process 3

615025850

Finished Stock 33000Less Profit 8812

24188

Problem: 8

A product passes through three processes to completion. These processes are known at A, B,C. The output of each process is charged to the next process at a price calculated to give a profitof 20% on the transfer price. The output of process C is charged to Finished Stock on a similarbasis.

There was no partly-finished work in any process on December 31, on which date thefollowing information was obtained.

Process A Process B Process CMaterialsconsumed

4000 6000 2000

BSPATIL 106

Labour 6000 4000 8000Stock on De.31

2000 4000 6000

Stock in each process were valued at Prime Cost to the process

There was no stock into finished stock, Rs. 4000 remained in hand on December 31, and thebalance has been sold for Rs. 36,000. Show Process Accounts.

Solution:Process ‘A’ Account

TotalRs.

CostRs.

ProfitRs.

TotalRs.

CostRs.

ProfitRs.

ToMaterial

4000 4000 - ByProcessB A/ctransfer

10000 8000 2000

ToLabour

6000 6000 -

Total 10000 10000 -

Less :ClosingStockc/d

2000 2000 -

Primecost

8000 8000 -

ToGrossprofit25% oncost

2000 2000

10000 8000 2000 10000 8000 2000

Tostockb/d

2000 2000 -

Process ‘B’ AccountTotalRs.

CostRs.

ProfitRs.

TotalRs.

CostRs.

ProfitRs.

ToProcessA -transfer

10000 8000 2000 ByprocessA/c

20000 14400 5800

ToMaterial

6000 6000 - 2000

To 4000 4000 -

BSPATIL 107

Labour

Total 20000 18000 2000

Less :ClosingStockc/dPrimecost

16000 14400 1600

ToGrossprofit25% oncost

4000 - 4000

20000 14400 5600

Tostockb/d

Process ‘C’ AccountTotalRs.

CostRs.

ProfitRs.

TotalRs.

CostRs.

ProfitRs.

ToProcessB -transfer

20000 14400 5600 Byfinished

ToMaterial

2000 2000 - StockA/c

30000 19520 10480

ToLabour

8000 8000 -

Total 30000 24400 5600

Less :ClosingStockc/d

6000 4880 1120

Primecost

24000 19520 4480

ToGrossprofit25% oncost

6000 - 6000

30000 19520 10480 30000 19520 10480

To 6000 4880 1120

BSPATIL 108

stockb/d

BSPATIL 109

Finished Stock A/cTotalRs.

CostRs.

ProfitRs.

TotalRs.

CostRs.

ProfitRs.

ToProcessC -transfer

30000 19520 1048 BySales

36000 16917 19083

Less :ClosingStockc/d

4000 2603 1397

26000 16917 9083ToGrossprofit

10000 - 10000

36000 16917 19083 36000 16917 19083

Tostockb/d

4000 2603 1397

(1) Calculation of Profit on Closing Stock

Formulae:

Note: The amount of cost column and Total Column are those which appear above the Closingstock line.

Process ‘A’ : No profit included

4000 – 3600 = 400

6000 – 4880 = 1120

4000 – 2603 = 1397

BSPATIL 110

(2) Actual Profit Realised

ProcessProfit

Rs.

UnrealisedProfit inClosing StockRs.

Actual Profit

Rs.Process ‘A’ 2000 - 2000Process ‘B’ 4000 400 3600Process ‘C’ 6000 1120 48880Finished Stock A/c 10000 1397 8603Total 22000 2917 **19083

** Varify this figure with that shown in the credit profit column of Finished Stock Account. It tallies.

(3) Valuation of Closing Stock for Balance Sheet

The amount of Cost Columns of Finished Stock Account will be taken to the Balance Sheet. It iscomprised of:

Cost of closing stockRs.

Process ‘A’ 2000Process ‘B’ 3600Process ‘C’ 4880Finished Stock 2603Total 13083

(4) Test Check

Individual cost of Process= Rs. 30000

‘A’ ‘B’ ‘C’= i.e. (10000 + 10000 + 10000)

Less : Cost of Sales (See Finished Stock A/c)

= Rs. 16917-----------------

Closing Stock = Rs. 13083-----------------

BSPATIL 111

LESSON – 8

STANDARD COSTING & VARIANCE ANALYSIS

STANDARD COST & STANDARD COSTING

Standard cost is a “predetermined cost which is calculated from management standard of efficientoperation and the relevant necessary expenditure.” - I.C.M.AENGLAND

Standard costing is “the preparation of standard costs their comparison of actual costs and theanalysis of variances to their causes and points of incidence” -I.C.M.A ENGLAND

Thus, it is clear from these definitions that standard costs represent the scientifically planned orpredetermined costs based on technical estimate, labour and overhead for selected period of timeand for a prescribed set of working conditions. The word ‘standard’ connotes a thing serving as abasic for comparison. Standards can be established in respect of quantitative and qualitative likematerial and labor.

OBJECTIVE OF STANDARD COSTING

The main objectives of standard costing are:

-To control the factors which affect production.

- to supply reports promptly to the management showing the progress of production and howexpenditure to date compares with estimates so that corrective actions may be taken in time, and

- To disclose the effect of temporary increase or decrease in the volume of output and sales orrevenues.

TECHNIQUES OF STANDARD COSTING

The technique of standard costing involves:- The ascertainment of standard costs.

- The use of standard costs.

- Their comparison with the actual cost and the measurements of variances.

- the location of responsibility for the variances and the corrective action to be taken.

- the analysis of variances for ascertainment the reasons for the same.

ESTABLISHMENT OF A STANDARD COSTING SYSTEM

The installation of standard costing system in a manufacturing concern involves thefollowing steps:

a) Standardization of functions i.e. all activities should be standardized and the technicalprocesses of operations should also be susceptible to planning.

BSPATIL 112

b) Establishment of cost centres.c) Classification of Accounts i.e., the different accounts can be codified and different symbols

may be used to facilitate speedy collection, analysis reporting.d) Setting up of standards: Standards may be basic (long period) and current (short period),From the point of view of efficiency level they will fall into the three broad categories.

i) Strict idealii) Attainable or expected / actual andiii) Loose

The standard should be realistic and attainable. Unrealistic standards provoke resentment anddepress performance. Loose standard leads the management to indulge in self congratulation.Normally a period of one year is more realistic as it coincides with the budget period and thenormal accounting period.

e) Setting of standard costs:

Standard costs should be determined for each element of cost separately and accurately. Like thebudget committee or standards division which will be versed with the work of the standard costs.the standard committee generally consists of all functional heads like production manager,personal manager, etc. In determining the output regard must be had to the limiting factorsaffecting sales, production etc. setting up of standard cost involves the determination of coststandards. A cost standard is a usage, price or other standard upon which a standard cost is based.

ADVANTAGES OF THE STANDARD COSTING

The utility of standard help the management in fixation of prices and in laying down productionpolicies.

1. Standards costs help the management in fixation of prices and in laying down productionpolicies.

2. The help in readily showing up and then elimination of avoidable wastages and losses.3. They provide constant and uniform bases for management on the operational efficiency ofworkers and other members of the staff.

4. Management, through the study of variances, needs to concentrate only areas and problemswhich call for its attention i.e., the system management by exception’ can be practiced.

5. Delegation of authority becomes effective the concerned men know what they have toachieve and by what standard they will be judged.

6. The whole concern in stimulated with a dynamic forward looking mentality.7. Performance of employees at all levels can be judged objectively, this enables the concern to

promote and regard the right person.8. Standards act as a ‘yardstick’ to measure the actual performance and the efficiency of labourand other factors.

9. Valuation of closing stock is facilitated by the standard cost of production.10.As standards are set for every element of cost, the costing procedures are simplified.

BSPATIL 113

LIMITATIONS OF STANDARDS COSTING

Standard costing technique has the following short comings.

1. Setting of standards is a difficult task as it involves technical skill.2. The fixation of inaccurate standards especially those that are incapable of achievementadversely affects the morale of the employees and act as hindrances to increased efficiency.

3. The system is not suitable for the jobbing type of industries producing articles according tocustomers specifications even if it is installed, the fixation of standards for type of jobbecomes difficult and expensive.

4. It is necessary to distinguish between controllable and uncontrollable variances in order tolocalize deviations and fixing responsibilities.

5. The system may not be suitable even in the case of industries that are liable to frequenttechnological changes affecting the conditions of production even if it is installed, aconstant revision of standards become necessary.

6. Small concern cannot afford this system due to higher cost associated with standard costing.7. There is no unanimity regarding the circumstances to be taken as the basis for settingstandard costs. even if there is unanimity a revision of standard is essential to suit to thechanging circumstances. The revision of standards becomes expensive. If they are notrevised, they become outmoded.

DETERMINATION OF STANDARDSFor any given product or unit the following standards must be determined.

1. Standard material costs.2. Standard labour costs.3. Standard direct costs.4. Standard variable overhead costs5. Standard Fixed over head costs.6. Standard selling prices and profit.

The standard direct material cost is found by multiplying the quantity of materials to be purchasedwith the rate of price at which they are available.Determination of standard labour cost involves fixations of

(a) Standard labour grades(b) Standards labour times i.e., standard hours through time, motion and fatigue study with thehelp of work study engineers and

(c) Standard wage rates based on the time rate, piece rate and premium plans.Standard direct cost is any expenditure which is directly to be incurred on a specific cost unit. It ischarged directly to the particular cost standard concerned.Standard overhead costs are classified as manufacturing, administration, selling, and distributionover heads. They are also classified as fixed, variable and semi variable so that current estimate foreach class may be prepared for the budget period. Standard overhead rate is determined on thebasis of past records and future trend of prices.VARIANCE ANALYSIS

BSPATIL 114

The main aim of the standard costing is the control of the cost. So the management is providedwith the information about situations where in the actual results are not as they were planned to be.Hence management is informed of only the deviations or variances from the original plans, theirfavourable or unfavorable nature and the causes of such deviations. In this context standardcosting subscribes to the principles of “management by exception”.Variance is the difference between standard cost and actual cost. It is expressed by a simpleformula as follows:variance = actual cost – standard cost.Variance analysis is therefore the process of analysis variance by dividing the total variance in sucha way that management can assign responsibility for off standard performance. If variance is toincrease the profit it is said to be favourable shown as (F). It would result when the actual cost arelower than the standard costs. It is also known as positive or credit variance and viewed only assavings. If variance is not to increase the profit it is adverse or unfavorable shown as (A) it wouldresult when actual costs exceed the standard costs. It is also known as negative or debit varianceand viewed as additional costs or losses.

1. MATERIAL NOT VARIANCE (MCV)This is the difference between the standard cost of materials specified for the output achieved andthe standard cost of the materials usedMaterial Cost Variance = Total std. – Total Actual Cost.

MCW = (SQ*SP) – (AQ * AP)Where :

SQ = Standard QuantitySP = Standard PriceAQ = Actual QuantityAP = Actual Price

a) MATERIAL PRICE VARIANCE (MPV)This is the difference between the standard price specified and the standard price paid.MPV = AQ (SP – AP)

CAUSES1. Change in basic purchase price of material.2. Change in quantity of purchase or uneconomical size of purchase order.3. Rush order to meet shortage of supply or purchase in less or more favourable market.4. Failure to take advantage of off – season price, the failure to purchase when price is cheaper.5. Failure to obtain cash and trade discounts or change in the discount rates.6. Weak purchase organisation.7. Payment of excess or less freight8. Transit losses and discrepancies if purchase price is inflated to include the loss.9. Change in quality or specification or materials purchased.

BSPATIL 115

10.Use of substitute material having a higher or lower unit price.11.Change in materials purchase, unkeep and store keeping cost (this is applicable only whensuch charges are allocated to direct material costs on a predetermined or standard costbasis.)

12.Change in the pattern or amount of taxes and duties.

b) MATERIAL USAGE VARIANCE (MUV)This is the difference between the standard quantity specified and actual quantity used.MUV = SP (SQ – AQ)Material usage variance is subdivided into

i) Material mix varianceii) Material yield variance or scrap variance

i) MATERIAL MIX VARIANCE (MMV)This is the portion of the direct material usage variance which is due to the difference between thestandard and the actual composition of a mixture.

a) When the ratio of mix is different but the total quantities of standard mix and the totalquantities of actual mix are the same.

MMV = SP (SQ – AQ)

b) When the total actual quantity and total standard quantity and the ratio of mix are different,then the standard quantity of the each material will be revised.

MMV = (RQ – AQ) * SPWhere RQ denotes Revised standard quantity, which is equal to

Total weight of actual mix--------------------------------- * Standard QuantityTotal weight of standard mix

ii) MATERIAL YIELD OR SCARP VARIANCEThis is the portion of the direct material usage variance which is due to the difference betweenstandard yield specified and actual yield obtained.MYV = SP * Abnormal Loss / Gain

OrMYV = SP (SY – AY)The difference between standard yield and actual yield is called abnormal loss or gain. If thestandard yield is less than the actual yield, the difference is called abnormal gain, and if thestandard yield is higher than the actual yield the difference is called abnormal loss.

BSPATIL 116

CAUSES FOR MATERIAL USAGE VARIANCEThe causes of material usage variance are:

1. Variation is usage of materials due to inefficient or careless use or economic use ofmaterials.

2. Change in specification or design of product.3. Inefficient and inadequate inspection of raw materials.4. Purchase of inferior material or change in quality of materials.5. Rigid technical specification and strict inspection leading to more rejections which require

more materials for rectifications.6. Inefficiency in production resulting in wastages.7. Use of substitute materials.8. Theft or pilferage of materials.9. Inefficient labour force leading to excessive utilization of materials.10.Defective machines, tools, and equipments, and bad or improper maintenance leading to

breakdown and more usage of materials.11.Yield from materials in excess of or less than that provided as the standard yield.12.Faulty materials processing. Timber for example, if not properly seasoned may be wastedwhile being used in subsequent processes.

13.Accounting errors, e.g. when materials returned from shop or transferred form one job toanother are not properly accounted for .

14.Inaccurate standards15.Change in composition of a mixture of materials for a specified output.

II LABOUR COST VARIANCE (LCV)It is the difference between standard direct specified for the activity achieved and the actual

direct wages paid.LCV – SLC – ALC (Standard Labour Cost – Actual Labour Cost)Labour cost variance is sub-divided into

1) Rate of pay variance and2) Efficiency variance, which is further sub divided into

a. Idle timeb. Calendar variancec. Mix varianced. Yield variance

1. LABOUR RATE OF PAY VARIANCE (LRV)This is that portion of labour cost variance which is due to the difference between the standardrate of pay specified and the actual rate paid.

BSPATIL 117

LRV = AT (SR - AR)= Actual time (standard rate – actual rate)

CAUSES FOR LABOUR COST VARIANCEDirect labour rate variance occur due to the following:

1. Change in basic wage structure or change in piece work rate. This will give rise to thevariance till such time the standards are not revised.

2. Employment of workers of grades and rates of pay different from those specified due toshortage of labour of the proper category, or through mistake, or due to the retention ofsurplus labour.

3. Payment of guaranteed wages to workers who are unable to earn their normal wages ifsuch guaranteed wages form part of direct labour cost.

4. Use of a different method of payment e.g. payment of day – rates while standards arebased on piece work method of remuneration.

5. Higher to lower rates paid to casual and temporary workers employed to meet seasonaldemands or urgent or special work.

6. New workers not being allowed full normal wage rates.7. Over time and night shift work in excess of or less than the standard, or where no

provision has been made in their standard. This will be applicable only if overtime andshift differential payments form that laid down in the standard.

2) LABOUR EFFICIENCY VARIANCE (LEV)This is also that portion of labour cost variance which is due to the difference between thestandard labour hours specified for the outputs achieved and the actual labour hours expended.This is otherwise known as labor time variance. Labour spending variance, labour usage variance,labour quantity variance.

LEV = SR (ST – AT)

CAUSES FOR LABOUR EFFICIENCY VARIANCEThe causes giving rise to direct labour efficiency variance as follows:

1. Lack of proper supervision or stricter supervision that specified.2. Poor working conditions3. Delay due to, waiting for materials tools, instructions etc. if not treated as idle time.4. Defective machine tools, and other equipments.5. Machine break down if not booked to idle time.6. Work on new machines requiring less tike then provided for as long as the standard is

not revised.7. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions,

incorrect scheduling of jobs etc.8. Use of non standard material requiring more or less operation wages.

BSPATIL 118

9. Carrying our operations not provided for and booking them as direct wages.10. In correct standards11. Wrong selection of workers, e.g. no employing the right type of man for doing the job.12. Increase in labour turnover.13. Incorrect recording of performances, i.e. time and output.

LABOUR IDLE TIME VARIANCE (LITV)This is that the portion of labour cost variance which is due to the abnormal idle time of

workers on account of failure of power supply, machine break – down, shortage of materials etc.LITV = IH * SR (Idle hours * standard rate per hour)

LABOUR CALENDAR VARIANCE (LCV)This arises only when workers are paid for the days for which they have not worked and for

which no provision was made while determining standards. This will happen only when somespecial public holidays be declared.

LCV = SR * Holidays

LABOUR MIX VARIANCE (LMV)It is due to the difference in the standard output specified and actual output obtained.LYV = Standard labor cost per unit (actual output – standard output)

PROBLEM 1The standard cost of the chemical mixture ‘PQ’ is as follows:40% of material P@ Rs. 400 Per k.g.60% of material Q@ Rs. 600 per kg.A standard loss of 10% is normally anticipated in production. The following particulars are availablefor the month of September 1984.A standard loss of 10% is normally anticipated in production. The following particulars are availablefor the month of September 1984.180 kgs. of material P have been used @ Rs. 360 per kg.220 kgs. of material Q have been used @ Rs. 680 per kg.The actual production of ‘PQ’ was Rs. 369 kgs.Calculate the following variance:

a. Materials price varianceb. Materials usage variancec. Materials mix varianced. Materials yield variance

BSPATIL 119

Also show the reconciliation of standard cost with actual cost with actual cost with help of theabove variance.

SolutionStandard loss is 10%Hence for productions of 90 kgs require input of 100 kgs.Therefore production of 369 kgs requires input of?369 / 90 * 410 kgs.

MCV = (Standard cost of input of (410 kgs of production) (actual cost of production of 369 kgs)

P40% of 410 = 164 kgs at 400 = 65600 P 180*360 = 64,800Q60% of 410 = 246 kgs at 600 = 147600 Q 220*680 = 149,600

----- -------------- ------- ----------Input 410 kgs 213200 400 214400Loss 41 31 ----

----- -------------- ------- ----------Production 369 kgs 213200 369 214000

1. Material Cost Variance (MCV) = SC – AC= 213200 – 214400= Rs. 1200 (A)

2. Materials Price Variance (MPV) = AQ (SP-AP)P = 180 (400 – 360) = 7200 (F)Q = 220 (600 – 680) = 17600 (A)

---------------------10400 (A)

---------------------

3. Material Usage Variance (MUV) = SP (SQ-AQ)P = 400 (164 – 180) = 6400 (A)Q = 600 (246-220) = 15600 (F)

----------------------9200 (F)

----------------------

Material Usage Variance is to be analysed into Mix Variance and yield variance as follows:

(i) Material Mix Variance (MMV) = SP (RSQ – AQ)

P = 400 (164 * 400 / 410 – 180)= 400 (160-180) 8000 (A)

BSPATIL 120

Q = 600 (246*400/410 – 220)= 600 (246-220) 12000 (F)

---------------40000 (F)---------------

Material yield variance (MY) = SYR (SY-AY)Standard Cost per unit at output = 213200/369

= Rs. 577.1778 per kg.

For an input of 410 Kgs. – Standard yield is 369 kgFor an input of 400 Kgs. – Standard yield is ?

400 / 410 * 369 = 360 kgs. Standard yield for actual inputMY = Rs. 577.1778 (360-368)=Rs. 5200(F)

(ii) Labour Efficiency Variance (LEV)= SR (SH-AHP)= 3.00 (7000-8000)= 3000 (A)

(iii)Labour Cost Variance (LCV)= SCAP – AC= 21,000 – 24160= 3160 (A)

Note:- When there is difference between actual hours paid (AHP) and Actual Hours Worked (AHW)there will be Labour Efficiency Sub-variance and Idle time Variance which are calculated as follows:

Labour Efficiency Sub Variance = SR (SH-AHW)= 3.00 (7000-8000)= Rs. 2400 (A)

Labour Idle Time Variance = SR * No. of Hours lost= 3.00 * 200= Rs. 600 (A)--------------Rs. 3000 (A)

--------------

This is reconciled with Labour Efficiency Variance as calculated above.

Reconciliation:

MUV = MMV + MYV9200(F) = 400 (F) + 5200 (F)

Final Reconciliation:MCV = MPV + MMV + MYV1200 (A) = 10400 (A) + 4000(F) + 5200(F)

PROBLEM 2

BSPATIL 121

The following details are available form the records of ABC Ltd. engaged in manufacturingArticle ‘A’ for the week ended 28th September.

The Standard Labour hours for the week 1000 hrs and rates of payment per article ‘A’ were asfollows:

Hours Rate per hour TotalRs. Rs.

Skilled Labour 10 3.00 30Semiskilled Labour 8 1.50 12Unskilled Labour 16 1.00 16

58

The actual labour hours and rates of pay per hour were given below:

Hours Rate per hour TotalRs. Rs.

Skilled Labour 9000 4.00 36000Semiskilled Labour 8400 1.50 12600Unskilled Labour 20000 0.90 18000

66,600

From the above set of data you are asked to calculate:

a. Labour Cost Varianceb. Labour Rate Variancec. Labour Efficiency Varianced. Labour Mix Variance

Solution

SCSM SCAMSM Hours Rate Amount

Rs.AM Hours Rate Amount

Rs.Skilled 1000 x

10 =10000

3,00 30000 Skilled 9000 3.00 27,000

Semi-skilled 1000 x8 =8000

1.50 12000 Semi-skilled 8400 1.50 12,600

Un-skilled 1000 x16 =16,000

1.00 16000 Un-skilled 20000 1.00 20,000

34,000 58000 37400 59,600

BSPATIL 122

(SCSM)a. Labour Cost Variance (LCV) = SC-AC

= 58000-66600= 8600(A)

b. Labour rate Variance (LRV) = AHP (SR-AR)Skilled= 9000 (3-4)= 9000(A)Semi-Skilled = 8400 (1.50 – 1.50) = NilUn-Skilled = 20,000 (1 - .90) = 7000 (A)

c. Labour Efficiency Variance (LEV)= SR (SH-AHP)= 3.00 (10000 – 9000) = 3000(F)= 1.50 (8000 – 8400) = 600(A)= 1.00 (16000 – 20000) = 4000(A)

----------------1600(A)

d. Labour Mix Variance (LMV) = SCSM – SCAM= 58000 – 59600= 1600(A)

Problem 3In the production of Finished product 50 employees were engaged at a Standard rate of Rs. 3 perhour. The standard performance was set at 200 numbers per hour. A 40 hour per week was inoperation. In a particular period of 4 weeks 35 employees were paid at the standard period of 4weeks 35 employees were paid at the standard rate, but 10 employees were paid at Rs. 3.20 perhour and 5 employees at Rs. 2.80 per hour. The factory stopped production for 4 hours due toequipment failure. Actual production was 28000 Units. Calculate the labour (i) rate and (ii)efficiency Variances.

Solution

50 employees x Rs. 3 per hour = Rs. 150

Output product = 200

Standard cost of actual production (SCAP) = 28000 x 0.75= Rs. 21,000

Actual Cost (AC)Employees

Weeks Hours

RateRs.

Amount

35 x 4 x 40 = 5600 x 3.00 = 16,80010 x 4 x 40 = 1600 x 3.20 = 5,1205 x 4 x 40 = 800 x 2.80 = 2,240

BSPATIL 123

50 8000 24,160

AHP = 8000

AHW = 8000 – Idle time of 4 hours 8000 – 200 = 7200in respect of all 50 employees

(i) Labour Rate Variance (LRV) = AHP (SR – AR)= 5600 (3.00 – 3.00) = Nil.= 1600 (3.00 – 3.20) = 320 (A)= 800 (3.00 – 2.80) = 160 (F)

-------------160 (A)

-------------OVERHEAD VARIANCE

Overhead Variance can be classified into (A) Variable Overhead Variance and (B) Fixed OverheadVariance.

OVERHEAD COST VARIANCEFixed Overhead Variance Variable Overhead Variance

ExpenditureVariance

VolumeVariance

ExpenditureVariance

EfficiencyVariance

Efficiency Capacity Calendar Seasonal

1. Variable Overhead Variance: They are caused by difference between the actual variableoverhead expenditure incurred and the standard allowed:

VOHC = SOHC – AOHC

Variable Overhead = Standard Variable Overhead Cost on Cost Variance – Actual Output –Actual Variable Overhead Cost

= (Actual output Standard Overhead Rate – Actual Overhead

Alternatively, the following variable overhead variance may be computed to make the positionmore clear:

(i) Variable Overhead Expenditure Variance (VCHE x V) CostThis is the difference between standard variable Overhead allowance of actual output, and thestandard variable overhead of actual time.

VOHE efficiency Variance = Standard Overhead Rate (Actual Time – Standard time for actualproduction)

BSPATIL 124

Total Variable Overhead = Expenditure Variance + Efficiency Variance

Fixed Overhead Cost Variance (FOHCV) : It is that portion of overhead variance which is due to thedifference between fixed overhead recovered and the actual fixed overhead cost incurred.

FOHCV = (Actual output * Standard fixed overhead Rate) – Actual Overhead

This variance is divided into (i) fixed Overhead Expenditure Variance and (ii) Fixed OverheadVolume Variance

(i) Fixed Overhead Expenditure (FOHEV) : It is the difference between actual overheadexpenditure and the budgeted expenditure.

FOHEV = Budgeted fixed Overhead – Actual Fixed Overhead= (Standard Recovery Rate * Budgeted Production) –

Actual Fixed Overheads

If the actual output is more than the budgeted output, it leads to over-recovery of overheads costsand a favourable variance results an vice versa. This variance is also known as Budget Variance orCost Variance or Spending Variance.

(ii) Fixed Overhead Volume Variance (FOHVV) : It is the difference between the standard cost ofoverhead absorbed in actual output and the standard allowance allowed for the output. Thisvariance is caused due to the difference between the budgeted output and the actual output.

FOHVV = Standard Fixed Overhead Rate (Actual Quantity – Budgeted Quantity)Or= Actual output * Standard Rate – Budgeted Fixed Overhead

If the actual output is more than the budgeted output, it leads to over-recovery of overhead costsand a favourable variables results and vice versa.

The Volume Variance can further be analysed as under –

(a) FIXED OVERHEAD EFFICIENCY VARIANCE (FOHEff.V)

It is that portion of volume variance which is due to the difference between the budgeted efficiency(in standard unit) and the actual efficiency achieved. This variance is like labour efficiency variance.

FOHEff.V = Standard Overhead Rate per unit (Actual Quantity – StandardQuantity)

When the actual output is more than the standard quantity of output.Overhead Cost Variance: Causes Controllability

A. OverheadExpenditureVariance

1. Rise in prices,wages

Uncontrollable

2. Lack of controlover Expenditure

Dept. Manager

BSPATIL 125

3. Change inproduction

ProductionManmager

4. Change in natureof service eg. Usegas in lieu ofelectricity

--do--

B. Volume Variance 1. Declining Sales(Lack of orders) orCustomer demands

Sales Manager

2. Lack of propersupervision

Foreman

3. Defect inMachinery(Breakdown)

MaintenanceEngineer

4. Low efficiency ofworker

Foreman / PersonnelManager

5. Poor qualitymaterial

Purchase Manager

6. Abnormal idletime (if not bookedas part of time spenton jobs)

Foreman /Uncontrollable

7. More or lessworking days /Calendar

Uncontrollable

8. Strikes,absenteeismincluding lateness

Personnel Manager

PROBLEM 4

The following figures have been extracted from the cost records for the month of March1997.

Standard ActualNumber of unitsproduced

7500 8000

Capacity 100% 105%Number of daysworked

25 26

Fixed overheads Rs. 22500 Rs. 23500Variable overheads Rs. 15000 Rs. 15750

Analyse the total overhead variance into(i) Fixed overhead variance,(ii) Variable overhead variance, and(iii)Sub-variances under each head

Solution

Overhead Cost Variance = Std. cost for Actual production – Actual cost= 40,000 - 38,900

BSPATIL 126

= Rs. 1,100 (F)

Overhead Cost Variance = FOHCV + VOHCVRs. 1100 (F) = Rs. 850 (F) + 250 (F)

(a) FOHCV = (AP * SOHR) – APOH= 8000 x 3 – 23150= Rs. 850 (F)

(b) Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overheads= Rs. 22500 – Rs. 23150= Rs. 650 (A)

(c) FOHVV = BOHR – AP * SOHR= 8000 x 3 – Rs. 22500= Rs. 1500 (F)Or

SOHR (Budgeted output – Actual output)= 3 x (7500 – 8000)= Rs. 1500(F)

(d) Capacity variance – Fixed Overhead Standard Rate per unit(Standard Quality for actual hours)For actual hours / days

= Rs. 3

Standard production for actual hours=

= 7875 units

(e) Calendar Variance = per unit Standard Fixed Cost –(Actual Quantity – StandardQuantity for actual capacity)

= Rs. 3 (8000-7875)= Rs. 375 (F)

=

= 7875

BSPATIL 127

FOHCV = FOHEV + FOHVV= Rs. 650(A) + Rs. 1500 (F)= Rs. 850 (F)

Proof

FOH V.V. = Cal. V. + Cap. V. + Eff. V.Rs. 1500(F) = Rs. 900(F) + Rs, 225 (F) + Rs. 375(F)

(i) Variable overheadVariance = SC – AC

Where

= Rs. 16000 – Rs. 15750= Rs. 250(F)

(ii) Variable overheadExpenditure variance = BC – AC

= 26 x 600= 15600 – 15750= Rs. 150(A)

(iii) Variable overhead efficiency varianceWhere standard overhead rate per hour / day is given

Variable overheadEfficiency variance = SR (AT – ST)

= 600 (26 – 26.67)= Rs. 400 (F)

Where standard overhead rate per unit is given:

Variable overheadefficiency variance = SR (AP – SP)

= 2 (8,000 – 7,800)= Rs. 400(F)

Check :VOHCV = VOH EX. V. + VOH Eff. V.Rs. 250(F) = Rs. 150(A) + Rs. 400(F)

Problem 5The standard cost per unit for product ‘A’ is as under :

Standard Cost : - The cost of operations to produce 1000 units during January 1971 is as under:

Rs. Rs.Material 1 Unit Rs. 10 10 Material 950 at Rs. 11 10,450

BSPATIL 128

Labour 5 hours at Rs. 2 10 Labour 4,500 hours atRs. 2.20

9,900

Overheads: Overheads:Variable 5 hours at Rs.2

Variable 11,000

Fixed 5 hours at Rs. 1 5 Fixed 6500Total cost per unit 35 Total cost of 1000 units

of product A37,850

The flexible budget for this department for normally monthly activity was called for 6,600 directlabor hours of operations. At this level the fixed indirect cost was budgeted at Rs. 6,000.

You are required to compute the various variance from the above solution.

Solution

i) Material cost variance = Standard cost of actual output – Actual cost of actual material used= Rs. 10,000 – Rs. 10450= Rs. 450 (A)

ii) Material price variance = AQ (SP-AP= 950 (10-11)= 350 (A)

iii) Material usage variance = Standard unit price (SQ-AQ)= Rs. 10 (1,000 – 950)= Rs. 500 (F)

Verification :

Material cost variance = Materials price variance + material usage variance

Rs. 450(A) = Rs. 950(A) + Rs. 500 (F)

iv) Labour cost variance = SLC – ALC= 5,000 * Rs. 2 – 4,500 * Rs. 2.20= Rs. 10,000 – Rs. 9,900= Rs. 100 (F)

v) Labour rate of pay variance = Actual time (Standard rate – Actual rate)= 4,500 (2 – 2.20)= Rs. 900 (F)

vi) Labour Efficiency variance= Standard rate (Standard time – actual time)= Rs. 2(5,000 – 4,500)= Rs. 1000 (F)

Check : LCV = LRV + LEVRs. 100(F) = Rs. 900 (A) + Rs. 1000 (F)

BSPATIL 129

vii) Variable over headVariance = (Actual output * standard rated of fixed overheads) – Actual fixed over

head incurred= (1,000 x 5) - 6,500= Rs. 1,500 (A)

Proof

Overhead Cost Variance = Variable overhead variance + fixed overhead variance

Rs. 2,500 (A) = Rs. 1,000 (A) + Rs. 1,500 (A)

SALES VARIANCE

The cost variance so for explained ultimately affects profit favourably or adversely. Budgetedprofit may be affected due to increase or decrease i) in the selling price and ii) the quantum ofsales.

The are two distinct method of computing and presenting sales variance.

i) Sales value or turnover method andii) Sales margin profit method.

The first method shows the effect of variance in terms of turnover. The second shows the effect interms of profit.

Sales Value Method

(i) Sales Value Variance:It is difference between standard

Or

Budgeted sales and the actual sales

Sales Value Variance = Standard sales – Actual sales

Note: Standard Sales = Standard sales * Actual quantities of sales

If actual sales are more than the budgeted or standard sales, a favourable variance would resultand vice versa.

SALES VALUE VARIANCE

Price Variance Volume Variance

Mix Variance QuantityVariance

BSPATIL 130

ii) Sales Price Variance:

If is that portion of the sales value variance which is due to the difference between standardprice specified and the actual price charged.

Sales Price Variance = Actual quantity Sold (Standard Price – Actual Price)

iii) Sales Volume Variance

This is the difference between the budgeted sales and the standard value of the actual mixof sales.

Sales Volume Variance = Standard Price (Actual Quantity – Standard Quantity)

Or= Budgeted Sales – Standard Sales

If actual sales at standard price exceed the budgeted sales, there is a favourable variance and viceversa.

Thus, Sales Value Variance = Price Variance + Volume Variance

The volume variance can further be analyzed into(a) Mix Variance and(b) Quantity Variance

(a) Mix Variance:

It is that portion of the sales value variance which is due to the difference between the standardand the actual interrelationship of the quantities of each product or product group of which salesare composed, where products are homogeneous.

- Standard Cost of Actual Mix

Sales Margin Quantity Variance:

This is the difference between sales margin volume variance and sales margin mix variance.

Margin Quantity Variance = Standard Margin Rate (Standard Quantity – Actual Quantity)

Sales Margin Due to Sales Allowance:

It is that portion of total margin variance which is due to the difference between thebudgeted rebates, discounts, etc., allowance on those sales:

Profit (or Loss) Variance:

BSPATIL 131

It is the difference between the budgeted profit (or Loss) and the actual profit (or loss).

Types Causes ControllabilityA. Sales PriceVariance

1. UnexpectedCompetition2. Rise in general pricelevel3. Poor quality ofmaterial

Uncontrollable- Do –

- Do -

B. Sales VolumeVariance

1. UnexpectedCompetition2. Ineffective SalesProportion3. Ineffective Supervisionand control of salesman

UncontrollablePublicity Manager

Sales Manager

DISPOSAL OF VARIANCES

There is difference of opinion among accountants as regards disposal of cost variance.However, the following methods are usually used to close the Standard Cost Variances:

i) Transfer to profit and loss account.ii) Allocation of finished stock, work in progress, and cost of sales;iii) Transfer to Reserve Account i.e., to carry forward to the next financial year and to be

set off in the subsequent year of years

The standard cost are also incorporated in the accounting system so as to increase its statisticalutility. The following are the methods for accounting based on standard costing.

i) Partial plan method,ii) Single plan method andiii) Dual plan method.

PROBLEM 7

From the following particulars of Sri Dhanalakshmi mills Ltd., calculate:

i) Total sales margin varianceii) Sales margin variance due to selling price.iii) Sales margin variance due to volume.

Standard Actual in (Rs.)Qty Cost

p.u.Pricep.u.

Units Cost Price

Prod X 3,000 10 12 2,200 10.50 13Prod Y 2,000 15 18 1,600 14.00 17

Solution

i) Total Sales MarginVariance = Actual quantity of sales x Actual profit per unit

- budgeted quantity of sales x Budgeted profitper unit

BSPATIL 132

(i.e. Actual profit – Budgeted profit)

Prod. X : 3,200 * Rs. 2.50 – 3000 * Rs. 2.00 = Rs. 2,000 (F)Prod. Y : 2,600 * Rs. 3.00 – 2000 * Rs. 3.00 = Rs. 1,200 (A)

-------------------Total Sales Margin Variance Rs. 800 (F)

ii) Sales Margin Variance due toSelling price = AQ (AP – SP)

Prod. X : 3,200 (Rs. 13 – Rs. 12) = Rs. 3,200 (F)Prod. Y : 1,600 (Rs. 17 – Rs. 18) = Rs. 1,600 (A)

-------------------------Total sales margin due

selling price Rs. 160 (F)

iii) Sales margin due to volume = SP (AQ – SQ)

Prod X: Rs. 2 (3,200 – 3000) = Rs. 400 (F)Prod Y: Rs. 3 (1,600 – 2000) = Rs. 1,200 (A)

--------------------------Total sales margin variance

due to volume = Rs. 800 (A)

BSPATIL 133

PROBLEM 8

For a month, the budgeted and actual figure for sales in a company were as under:

Product Qty Price

Rs.

BudgetValueRs.

Qty ActualPriceRs.

ActualvalueRs.

I 20 2 40 15 2 30II 10 1 10 15 1.50 22.50III 5 3 15 10 2.50 25IV 10 3.50 35 10 3 30

45 100 50 107.50

The budgeted costs were the different products were:

I Rs. 1.50II Rs. 0.80III Rs. 2.00IV Rs. 3.00

Calculate the sales variance based on :

a) Turnover andb) Profits verify your calculation.

Solution

a) Sales variance based on turnover:Standard Sales (SS)Actual Budget

Revised Standard Sales SS

Product Qty Price Balue Standard price per Unit ofStandard

I 15 2 30.00 Mix = 100 / 45 = 2.2222II 15 1 15.00 RSS = 50 * 2.2222 = Rs.

111.11III 10 3 30.00IV 10 3.50 35.00

50 110.00

Total sales value Variance = BS – AS= 100 – 107.50= Rs. 7.50 (F)

Sales Rate Variance (SRV) = AQ (SR – AR)

I = 15 – (2 – 2) = NilII = 15 – (1 – 1.50) = 7.50 (F)III = 10 (3 – 2.50) = 5.00 (A)IV = 10 (3.50 – 3) = 5.00 (A)

BSPATIL 134

2.50 (A)

Sales Volume Variance (SVV): = (SR – (BQ – AQ)

I = 2 (20 – 15) = 10.00 (A)II = 1 (10 – 15) = 5.00 (F)III = 3 (5-10) = 15.00 (F)IV = 3.50 (10 – 10) = Nil

10.00 (F)Reconciliation I:Total sales value Variance = SRV + SVV

7.50 (F) = 2.50 (A) + 10.00 (F)

Sales Quantity Variance (SQV) = BS – RSS= 100 – 111.11= 11.11 (F)

Sales Mix Variance (SMV) = RSS – SS= 111.11 – 110.00= 1.11 (A)

Note : if RSS is more than SS, it is adverse variance and vice versa.

Final Reconciliation:

Total Sales Value Variance = SRV + SQV + SMV7.50 (F) = 2.50 (A) + 11.11 (F) + 1.11 (A)

b) Sales Various based on Profit:

Budget ProfitProduct Qty. Rate of Profits Total Rs.

I 20 2.00 – 1.50 = 0.50 10.00II 10 1.00 – 0.80 = 0.20 2.00III 5 3.00 – 2.00 = 1.00 5.00IV 10 3.50 – 3.00 = 0.50 5.00

45 22.00

ACTUAL PROFITS AP

Product Qty. Rate of Profits Total Rs.

I 15 2.00 – 1.50 = 0.50 7.50II 15 1.50 – 0.80 = 0.70 10.50III 10 2.50 – 2.00 = 0.50 5.00IV 10 3.00 – 3.00 = Nil. Nil

50 23.00

BSPATIL 135

Standard Profit (SS)Actual Budget

Revised Standard Profit

Product Qty RateofProfit

Value Standard Margin per Unit ofStandard Mix

I 15 0.50 7.50 = 22 / 45II 15 0.20 3.00 = Rs. 0.4889III 10 1.00 10.00 RSP = 50 x 0.4889IV 10 0.50 5.00 = 24.44

50 25.50

Total sales Profit Variance = BP – AP= 22.00 - 23.00= Rs. 1.00 (F)

Sales Rate of Profit

Variance (SRPV) = AQ (SRP – ARP)I = 15 (0.50 – 0.50) = NilII = 15 (0.20 – 0.70) = 7.50 (F)III = 10 (1.00 – 0.50) = 5.00 (A)IV = 10 (0.50 – Nil) = 5.00 (A)

2.50 (A)

Sales Volume Variance (SVV) : = (SRP – (BQ – AQ)

I = 0.50 (20 – 15) = 2.50 (A)II = 0.20 (10 – 15) = 5.00 (F)III = 1.00 (5 – 10) = 5.00 (F)IV = 0.50 (10 – 10) Nil

3.50 (F)

Reconciliation 1:Total sales Profit Variance = SRPV + SVV

= 2.50 (A) + 3.50 (F)= Rs. 1.00 (F)

Sales Quantity Variance (SQV) = BP – RSP= 22.00 – 24.44= Rs. 4.44 (F)

Sales Mix Variance (SMV) = RSP – SP= 24.44 – 25.50= 1.06 (F)

Reconciliation II:

BSPATIL 136

SVV = SQV + SMV3.50 (F) = 2.44 (F) + 1.06 (F)

= 1.00 (F)

CONTROL RATIOS

The management wants to know whether performance of its business is going as perestimated schedule or not. This can be identified with the help of control ratios. If the ratio aremore than 100% then the performance will be favourable but if these ratios are less than 100% thenthe performance will be unfavourable or unsatisfactory. The formula for computing certain controlratios are given below.

The ratio indicates how much budgeted hours have been actually utilized. If the ratio if 80% then itmeans that 80% budgeted hours have been utilized and the remaining 20% capacity remain idle.

This ratio shows the level of activity attained during the period.

This ratio shows the level of efficiency attained during a particular period. If this ratio is 130% thenit shows that the efficiency is more by 30% or it has gone up by 30%.

This ratio shows whether actual working days available are more or less than the budgeted workingdays. If the ratio is more than 100% then actual working days are more than the budgeted numberof working days and vice versa if the ratio is less than 100%.

Example

Product X takes 5 hours to make and Y requires 10 hours. In a month of 25 effective days of8 hours a day, 1000 units of X and 600 units of Y were produced. The company employees 50workers in the production department. The budgeted hours are 1,02,000 for the year. Calculatecapacity ratio, activity ratio and efficiency ratio.

Solution

Standard Hours for Actual Production:

Product X : 1000 x 5 = 5000 HoursProduct Y : 600 x 10 = 6000 Hours

---------------11000 Hours

BSPATIL 137

---------------

Budgeted Hours (Monthly = 1,02,000 / 12= 8500 Hours

Actual Hours Worked = 50 x 25 x 8= 10,000 Hours

= 117.65%

= 129.41%

= 110.41%

Since al the there control ratios are more than 100% organisation is performing well in producingthe products X and Y.

BSPATIL 138

LESSON 9

COST LEDGER ACCOUNTING

Cost accounting system can be introduced in an organization in two ways. They are:

1. Cost Leger Accounting2. Integral Accounting.

Cost Leger Accounting: Under this method separate set of cost accounts have to be maintained soas to derive cost details. It will differ from general financial accounting system adopted in theorganisation. Hence, it requires two weparate set of accounts. It can be called inter-locking system.Under cost Ledger Accounting the books are kept only for the impersonal accounts. To make thissystem self-balancing certain set of control accounts have to be prepared.

As in the case of general accounting system, transactions relating to factory operationswhich are ultimately reflected in the cost accounts are recorded in the books of original entry.Summaries from these books are journalized and posted in the general ledger which containcontrol accounts and subsidiary books. The following ledger accounts in this system.

Stores Ledger:In consists of accounts of individual items of raw materials, components and consumable stores.Receipts are posted into the stores ledger on the basis of stores received notes and issues arerecorded on the basis of requisition slip. The balance of this account shows the stock in hand.

Work in Progress Ledger:It consists of accounts of each job pending on the floor. Each job accounts is debited with all

direct costs charged to the job and a share of overheads. It is credited with the values transferredto finished stock ledger and when job is completed.

Stock ledger:It contains item wise accounts in respect of finished stock intended for sale. A separate

account is opened is for each finished product or job.

Cost Ledger:

It is the main ledger of the costing department. It contains control accounts in respect ofeach ledger like store ledger, stock ledger and work in progress ledger. In addition, it containsgeneral ledger control accounts, wages control accounts and overhead control accounts.

Control accounts:

A control account is maintained in the cost ledger so that double entry in the cost ledgermay be completed and make it self – balancing. These control accounts are nothing but totalaccounts or adjustment accounts, summarizing mass of information contained in the subsidiaryledgers. These control accounts are posted with the totals of items which have been debited orcredited in detail to the accounts in the ledgers to which they relate. The balance in controlaccounts represents the total of balances in a number of accounts of similar nature maintained inthat subsidiary ledger to which the control relates.

Advantages of Control accounts:Control accounts helps

BSPATIL 139

- to provide a check for ensuring that all expenditure are recorded.- provides a basis for reconciliation with financial accounts.- provided ready means of preparing monthly or periodical financial statements.

Types of Control Accounts:A brief description about different control accounts are given below:

Stores Ledger Control Accounts:

This accounts reveals the value of stores received, issued and balances in hand. Receipts areposted from goods received posted on the basis of material requisition in the credit side of theaccount. The balance of this account represents the total balance of stock which should agree withaggregate of the balance of individual accounts in the stores ledger.

Wage Control Account:

This accounts records labour transactions in aggregate. It is debited with gross wagesshown in wages analysis sheet. It is closed by transfer of direct labour to work in progress andindirect labour to overhead.

Work-in-progress Control Account:It represents the total WIP at any time. It is debited with the totals of materials, wages and

overheads as transferred from the respective control accounts. The completed job will be creditedin this account. Thus, this account shows the shows the total value of unfinished jobs.

Works Overhead Control Account:

It deals with factory overhead expenses in aggregate. It is debited with the amount ofindirect material, indirect material analysis and wage analysis sheets. It is credited with the amountof overheads, recovered, as obtained from the applied overhead analysis sheets. The balancerepresents under or over absorption which is transferred to overhead adjustment account.

Administrative Overhead Control Account:

It is debited with the administration overhead incurred and credited with the amount ofadministrative overhead absorbed by finished goods. The balance represents under or overabsorption of administrative overhead which is transferred to overhead adjustment account.

Setting and Distribution Overhead Control Account:

It is debited with the amount of selling and distribution overhead incurred and credited withoverhead aabsorbed by cost of sales. Balance represents under / over absorption.

Cost of Sales account:

It is debited with the cost of goods sold by transfer from finished goods ledger control andalso by the selling distribution overhead absorbed. It is closed by transferring its balance tocosting profit and loss account.

Costing Profit and Loss Account:

BSPATIL 140

It is debited with the cost of sales, abnormal losses and under absorbed overhead andcredited with sales value, abnormal gain and over-absorbed overhead. Balance represents profit orloss which is transferred to cost ledger control account.

Cost ledger control account or General ledger Adjustments A/c:

It is maintained to make the cost ledger self-balancing. The main object of this account isto complete double entry in cost accounting. All the financial transactions on account of materialpurchases, wages, salaries and miscellaneous expenses are credited to cost ledger control accountby contra debit to various control accounts. All financial receipts are debited to this account. Thebalance is this represents the total of the balance of all personal accounts in the financial ledger.

Problem 1.

From the following data write up the various accounts as you envisage in the cost ledger andprepare a trial balance as on 31st March 1984.

a) Balance as on 1.4.83: Rs. (thousands)Material control 1240Work – in – progress 625Finished goods 1240Production overhead 84Administration overhead 120 (credit)Selling & Distribution overhead 65General ledger control 3134

b) Transactions for the year ended 31.3.84 : Rs. (thousands)Materials :Purchases 4,801Issued to:

Jobs 4,774Maintenance works 412Administration office 34Selling departments 72

Direct wages 1,493Indirect wages 650Carriage inward 84Production overhead :

Incurred 2,423Absorbed 3,591

Administration overhead:Incurred 740Absorbed 529Allocated to sales 148

Sales overhead:Incurred 642Absorbed 820

Finished goods produced 9,584Finished goods sold 9,773

BSPATIL 141

Sales realization 12,430

Solution:

Cost LedgerGeneral Ledger Adjustment Account

Dr. CrRs. Rs.

To costing P/LAccount (sales) 12,430 By balance 3,134

By material control a/c 4,801To balance c/d 3,226 By wages control a/c 2,143

By production overheadcontrol a/c (carriage)

84

By production overheadcontrol a/c

2,423

Admini. Overheadcontrol a/c

740

By selling & dis.Overhead control a/c.

642

By closing P/L a/c 1,689

15,656 15,656

Material Control AccountTo Balance b/d 1240 By WIP control A/c 4774To General LedgerAdjustment a/c

4801 By Production OverheadControl A/c

412

By Administrationoverhead control a/c

34

By selling & disoverhead control a/c

72

By balance c/d 749

6041 6041

Wages Control AccountTo General LedgerAdjustment a/c

2143 By WIP Control A/c 1493

By production overheadControl a/c

650

2143 2143

Production Overhead Control Account

BSPATIL 142

To balance b/d 84 By WIP Control a/c 3591To Material Control a/c 412 By Balance c/d 62To General LedgerAdjustment account

84

To Wages Control a/c 650To General LedgerAdjustment a/c

2423

3653 3653

Work – in – Progress Control AccountTo Balance b/d 625 By Finished Goods

Control A/c9584

To Material Control a/c 4774 By Balance c/d 899To wage Control a/c 1493To Production OverheadControl A/c

3591

10483 10483

Administration Overhead Control AccountTo Material Control a/c 34 By Balance b/d 120To General LedgerAdjustment a/c

750 By Finished GoodsControl a/c

529

To Balance c/d 23 By Cost Sales a/c 148

197 197Finished Goods Control Account

To Balance b/d 1240 By Cost of sales a/c 9773To AdministrationOverhead Control a/c

529 By Balance c/d 1580

To WIP Control a/c 9584

11353 11353

Selling and Distributions Overhead Control AccountTo Balance b/d 65 By cost of sales 820To Material control a/c 72To General LedgerAdjustments a/c

642

To Balance c/d 41

820 820

Cost of Sales AccountTo Finished goodsControl a/c

9773 By Costing P/L a/c 10741

To Selling & Dis.Overhead Control a/c

820

To admin. OverheadControl a/c

148

BSPATIL 143

10741 10741

Costing Profit and Loss AccountTo Cost of Sales a/c 10741 By General ledger

Adjustment a/c (Sales)12430

To General LedgerAdjustments a/c

1689

12430 12430

BSPATIL 144

Trial Balance as on 31.3.1984Dr. Cr.Rs. Rs.

Material Control Account 749WIP Control Account 899Finished goods ledger control account 1580Production overhead control account 62Administration overhead control account 23Sales & Distribution overhead control a/c 41General Ledger Adjustment account 3226

Problem : 2

From the following balances and transactions extracted from the Cost. Books of GuptaEngineering Co., journalise and write up the accounts in the Cost Ledger and prepare a TrialBalance as at 31st Dec. 19… Also show the profit or loss for the month.

Balance as at 1-12-19…Dr. Cr.Rs. Rs.

Worn-in-Progress Account 5200Finished Goods Account 2300Factory Overhead Suspense Account 50Office Overhead Suspense Account 30Store Ledger Control Account 1150General Ledger Adjustment Account 8730

8730 8730

Transactions for the months were; Rs.Direct Wages 7500Indirect Wages 500Works Overhead absorbed in production 2200Office Overhead absorbed in production 1200Stores issued to production 4900Goods finished during the months 18000Finished Goods Sold 21000Stores Purchased 5000Stores issued to factory repair orders 200Carriage inwards on stores issued forProduction

80

Factory Expenses 1450Office Expenses 1170

BSPATIL 145

Solution: JournalDate Dr. Cr.19… Rs. Rs.Dec.1 Work-in-Progress Ledger Control

A/cDr. 5200

Finished Goods Ledger Control A/c Dr. 2300Factory Overhead Suspense A/c Dr. 50Office Overhead Suspense A/c Dr. 30Stores Overhead Suspense A/c Dr. 1150To General Ledger Adjustment A/c 8730

19…Dec.1

Stores Ledger Control a/cTo General Ledger Adjustment

A.c(Being stores purchased)

Dr. 50005000

W.I.P. Ledger Control A/cTo stores Ledger Control A/c

(Being the stores issued toproduction Rs. 4900 and carriageinward on stores issued Rs. 80)

Dr. 49804980

Factory Overhead Control A/cTo stores Ledger Control A/c

(Being stores issued to factoryrepairs)

Dr. 200200

W.I.P. Ledger Control A/cTo Wages Control A/c

(Being indirect Wages charged tofactory overhead)

Dr. 75007500

Factory Overhead Control A/cTo Wages control A/c

(Being the total wages brought intoCosting Books from financial books)

Dr. 500500

Wages control A/cTo General Ledger Adjustment

A/c(Being the total wages brought intoCosting Books from financial books)

Dr. 80008000

Factory Overhead Control A/cTo Factory Overhead suspense

A/c(Being the latter transferred toformer A/c reversing the entry

Dr. 5050

BSPATIL 146

Factory Overhead Control A/cTo General Ledger adjustment

A/c(Being the actual factory expensesbrought into costing books)

Dr. 14501450

W.I.P. Ledger Control A/cTo Factory Overhead Control

A/c(Being the overheads charged toproduction)

Dr. 22002200

Office Overhead Control A/cTo office Overhead Suspense

a/c(Being Suspense A/c transferred toformer reversing the entry)

Dr. 3030

Office Overhead Control A/cTo General Ledger Adjustment

A/c(Being the actual office overheadsbrought into costing books)

Dr. 11701170

W.I.P. Ledger Control A/cTo Office Overhead Control

A/c(Being the office overheads chargedto production)

Dr. 12001200

Finished Goods Control A/cTo W.I.P. Ledger Control A/c

(Being the finished goods transferredto former account)

Dr. 1800018000

Cost of Sales A/cTo Finished Goods Control

A/c(Being the Finished Stock transferredto former account)

Dr. 2030020300

General Ledger Adjustment A/cTo Costing Profit & Loss A/c

(Being the amount of sales broughtinto costing P&L A/c)

Dr. 2100021000

Costing Profit & LossTo General Ledger Adjustment

A/c(Being the amount of Profit)

Dr. 700700

BSPATIL 147

COST LEDGERGeneral Ledger Adjustment Account

Rs. Rs.To Costing P & L A/c(Sales)

21000 By Balance b/d 8730

To Balance c/d 4050 By Stores LedgerControl A/c

5000

By Wages Control A/c 8000By Factory OverheadControl A/c

1450

By Office OverheadControl A/c

1170

By Costing P & L A/c 700

25050 25050

Stores Ledger Control AccountRs. Rs.

To Balance b/d 1150 By W.I.P Ledger ControlA/c

4980

To General LedgerAdjustment A/c

5000 By Factory OverheadControl A/c

200

By Balance c/d 970

6150 6150

To Balance b/d 970

Wages Control AccountTo General LedgerAdjustment A/c

8000 By W.I.P. Ledger ControlA/c

7500

By Factory OverheadControl A/c

500

8000 8000

Factory Overhead Control AccountRs. Rs.

To Stores LedgerControl A/c

200 By W.I.P. Ledger ControlA/c

2200

To Wages Control A/c 500To Factory OverheadControl A/c

50

To General LedgerAdjustment A/c

1450

2200 2200Office Overhead Control Account

Rs. Rs.To Office OverheadSuspense A/c

30 By W.I.P. Ledger ControlA/c

1200

BSPATIL 148

To General LedgerAdjustment A/c

1170

1200 1200

Work-in-Progress Ledger Control AccountRs. Rs.

To Balance b/d 5200 By Finished GoodsControl A/c

18000

To Stores LedgerControl A/c

4980 By Balance c/d 3080

To Wages Control A/c 7500To Factory OverheadControl A/c

2200

To Office OverheadControl A/c

1200

21080 21080To Balance b/d 3080

BSPATIL 149

Finished Goods Control AccountRs. Rs.

To Balance b/d 2300 By Cost of sales A/c 20300To W.I.P. Ledger Control 18000

20300 20300

Cost of Sales AccountRs. Rs.

To Finished Goodscontrol A/c

20300 By Costing P & L A/c 20300

20300 20300

Costing Profit and Loss AccountRs. Rs.

To Cost of Sale A/c 20300 By General LedgerAdjustment A/c (sales)

21000

To General LedgerAdjustment A/c (profit)

700

21000 21000

Trial Balance (As at 31st December ………..Rs. Rs.

To Stores LedgerControl A/c

970 General Ledger ControlA/c

4050

Work-in-ProgressLedger Control

3080

4050 4050

Problem : 3The following balances are extracted from the costs books of Ajith Traders Ltd., for the year ended31st Dec. 1995

Dr. Cr.Rs. Rs.

Stores in Hand 16000 24500Stock of Finished Goods 24600 26100Work-in-Progress 32000 33500Purchases - 76000Carriage Inwards - 500Stores Issued - 68000Wages – Direct - 67200Wages - - Indirect - 22000Work Expenses 69200Cost of Finished Goods 240000Cost of Finished Goods sold 238500

BSPATIL 150

Selling Expenses 6100Office & Administration Expenses 14000

The Cost Journal shows that Rs. 92700 and Rs. 13900 were allocated to Work-in-Progress forworks overheads and office overheads respectively. Prepare Cost Ledger Account and a TrialBalance from the above information as at 31st Dec. 1995.Solution:

Rs. Rs.To Balance c/d 327600 By Balance b/d 72600

By Stores LedgerControl A/c

76000

By Stores Ledger controlA/c (Carriage)

500

By Wages Control A/c 200By Production OverheadControl A/c

69200

By AdministrationOverhead Control A/c

14000

By Selling andDistribution OverheadControl A/c

6100

327600 327600By Balance b/d 327600

Store Ledger Control AccountRs. Rs.

To Balance b/d 16000 By Work-in-ProgressLedger Control A/c

68000

To General LedgerAdjustment A/c(Purchases)

76000 By Balance c/d 24500

To General LedgerAdjustment A/c(Carroage)

500

92500 92500

To Balance b/d 24500

Wages Control AccountRs. Rs.

To General LedgerAdjustment A/c

89200 Work-in-ProgressLedger Control A/c

67200

Production OverheadControl A/c

22000

89200 89200

Production Overhead Control AccountRs. Rs.

To Wages Control A/c 22000 By W.I.P. Leger Control 92700

BSPATIL 151

A/cTo General LedgerAdjustment A/c

69200

To OverheadAdjustment A/c

1500

92700 92700

Administration Overhead Control Account

Rs. Rs.To General LedgerAdjustment A/c

14000 By W.I.P. Ledger ControlA/c

13900

By OverheadAdjustment A/c

100

14000 14000

Selling and Distribution Overhead Control AccountRs. Rs.

To General LedgerAdjustment A/c

6100 By Cost of Sales A/c 6100

6100 6100

Work-in-Progress Ledger Control AccountRs. Rs.

To Balance b/d 32000 By Finished GoodsControl A/c

240000

To Stores LedgerControl A/c

68000 By Loss in ProductionA/c

300

To Wages Control A/c 67200 By Balance c/d 33500To Production OverheadControl A/c

92700 To AdministrationOverhead Control A/c

13900

273800 273800To Balance b/d 33500

Finished Goods Control AccountRs. Rs.

To Balance b/d 24600 By Cost of Sales A/c 238500To W.I.P. Ledger ControlA/c

240000 Balance c/d 26100

264600 264600

Cost of Sales AccountRs. Rs.

To Finished GoodsControl A/c

238500 By Balance c/d 244600

To Selling &Distribution Overhead

6100

BSPATIL 152

Control A/c

244600 244600To Balance b/d 244600

Overhead Adjustment Account

Rs. Rs.To AdministrativeOverhead Control A/c

100 By Production OverheadControl A/c

1500

To Balance c/d 1400

1500 1500By Balance b/d 1400

Loss in Production AccountRs. Rs.

To W.I.P. Ledger ControlA/c

300 By Balance c/d 300

300 300

Trial Balance(As at 31st December 1995)

Dr. Cr.Rs. Rs.

General Ledger Adjustment A/c 327600Stores Ledger Control A/c 24500Work-in-Progress Ledger ControlA/c

33500

Finished Goods Control A/c 26100Cost of Sales A/c 244600Overhead Adjustment A/c 1400

Loss in Production A/c 300

329000 329000

Rs. Rs.To Cost of Sales A/c 20300 By General Ledger

Adjustment A/c (Sales)21000

To General LedgerAdjustment A/c (profit)

700

21000 21000

Trial Balance

BSPATIL 153

(As at 31st December ………….)Dr. Cr.

General Ledger Control A/c 4050Stores Ledger Control A/C 970Work-in-ProgressLedger Control A/c 3080

4050 4050

Problem : 3The following balances are extracted from the coasts books of Ajith Traders Ltd., for the

year ended 31st Dec., 1995.1-1-1975 31-12-1975Rs. Rs.

Stores in Hand 16000 24500Stock of Finished GoodsWork-in-ProgressPurchasesCarriage InwardStores- DirectWages-DirectWages-IndirectWorks ExpensesCost of Finished GoodsCost of Finished Gods soldSelling ExpensesOffice & Administration Expenses

The Cost Journal shows that Rs. 92700 and Rs. 13900 were allocated to Work-in-Progress forworks overheads and office overheads respectively. Prepare Cost Ledger Account and a TrialBalance from the above information as at 31st Dec. 1995.

Solution:General Ledger Adjustment AccountRs. Rs.

To Balance c/d 327600 By Balance b/d 72600By Stores LedgerControl A/c

76000

By Stores LedgerControl A/c (Carriage)

500

By Wages Control A/c 89200By Production OverheadControl A/c

69200

By AdministrationOverhead Control A/c

14000

Overhead Control A/c 6100

327600 327600

By balance b/d 327600

Stores Ledger Control Account

BSPATIL 154

Rs. Rs.To Balance b/d 16000 By Work-in-Progress

Ledger Control A/c68000

To General LedgerAdjustment A/c(Purchases)

76000 By Balance c/d 24500

To General LedgerAdjustment A/c(Carroage)

500

92500 92500

To Balance b/d 24500

Wages Control AccountRs. Rs.

To General LedgerAdjustment A/c

89200 By Work-in-ProgressLedger Control A/c

67200

By Production OverheadControl A/c

22000

89200 89200

Production Overhead Control AccountRs. Rs.

To Wages Control A/c 22,000 By W.I.P. Ledger Controla/c

92700

To General LedgerAdjustment A/c

69200

To OverheadAdjustment A/c

1500

92700 92700

Administration Overhead Control AccountRs. Rs.

To General LedgerAdjustment A/c

14000 BY W.I.P Ledger ControlA/c

13900

By OverheadAdjustment A/c

100

14000 14000

Selling and Distribution Overhead Control AccountRs. Rs.

To General LedgerAdjustment A/c

6100 By Cost of Sales A/c 6100

BSPATIL 155

6100 6100

Work-in-Progress Ledger Control Account

Rs. Rs.To Balance b/d 32000 By Finished Goods

Control A/c240000

To Store LedgerControl A/c

68000 By Loss in ProductionA/c

300

To Wages Control A/c 67200 By Balance c/d 33500To ProductionOverhead Control A/c

92700 To AdministrationOverhead Control a/c

13900

273800 273800

To Balance b/d 33500

BSPATIL 156

Finished Goods Control AccountRs. Rs.

To Balance b/d 24600 By Cost of Sales A/c 238500To W.I.P. LedgerControl A/c

240000 Balance c/d 26100

264600 264600

Cost of Sales AccountRs. Rs.

To Finished GoodsControl A/c

238500 By Balance c/d 244600

To Selling &Distribution OverheadControl A/c

6100

244600 244600To Balance b/d 244600

Overhead Adjustment AccountRs. Rs.

To AdministrativeControl A/c

100 By Production OverheadControl A/c

1500

To Balance c/d 1400

1500 1500

Loss in Production AccountRs. Rs.

To W.I.P. LedgerControl A/c

300 By Balance c/d 300

300 300

Trial Balance(As at 31st December, 1995)

Dr. Cr.Rs. Rs.

General Ledger Adjustment A/c 327600Stores Ledger Control A/c 24500Work-in-Progress Ledger Controla/c

33500

Finished Good Control a/c 26100Cost of Sales A/c 244600Overhead Adjustment A/c 1400

Loss in Production A/c 300

329000 329000

BSPATIL 157

Lesson 10

Integral AccountingIntegral accounting system is defined as a single set of accounts which provides both financial andcost accounting information. Cost and financial accounts are kept in one self contained ledgerwhich is known as integrated ledger. This system does not recognize the need for separate set ofaccounts. Hence, there is no need for reconciliation of cost and financial accounts.

Advantages is Integral systems:

An integrated accounting system has the following advantages.1. There is not problem of reconciliation as there will be only profit amount.2. This system is economical and easy to understand.3. Duplication of work and labor is avoided.4. Cost data can present promptly and regularly.5. All cost data and accounts are automatically checked and thus cost figures are accurate.6. In broaden the outlook of accountant and his staff.

Problem 1. Journalize following transactions assuming cost and financial accounts are integrated.

Raw materials purchases 40000Direct materials issued toproduction

30000

Wages and (30% indirect) 24000Direct wages charged toproduction

16000

Manufacturing expensesincurred

19000

Manufacturing overheadcharged to production

18400

Selling and distribution costs 4000Finished products at cost 40000Sales 58000Closing stock ---Receipts from debtors 13800Payments to creditors 22000

Solution:1. Stores ledger control a/c

To Bought ledger control a/c4000

40002. Work-in-progress control a/c

To stores ledger control a/c30000

300003. Wage control a/c

To bank a/c24000

240004. Factory overhead a/c

To wages control a/cDr. 7200

72005. Work-in-progress ledger control a/c

To wages controlDr. 16800

168006. Factory overhead a/c

To bank a/cDr. 19000

190007. Work-in-progress ledger control a/c

To Factory overhead a/cDr. 18400

18400

BSPATIL 158

8. Selling & distribution overhead a/cTo Bank a/c

Dr. 40004000

9. Finished stock ledger control a/cTo Work-in-progress control a/c

Dr. 4000040000

10. Cost of sales a/cTo finished stock ledger control a/cTo selling & distribution control a/c

Dr 44000400004000

11. Sales ledger control accountTo cost of sales A/c

Dr. 5800058000

12. Bank A/cTo Sales ledger control a/c

Dr. 1380013800

13. Bought ledger control a/cTo Bank a/c

Dr. 22002200

Note: It has been assumed that all manufactured units have been sold and selling and distributionoverhead have been charged to cost of sales.

Problem 2:

The following are the balances of A co. Ltd. in its integrated ledger on 1st January:Dr. Cr.

Stores Control Account 36000Work-in-progress Account 24000Finished Goods Account 26000Cash at bank 20000Creditors Control Account 16000Fixed Assets Account 110000Debtors Control Account 24000Share capital Account 160000Depreciation Provision Account 10000Profit & Loss Account 64000

250000 250000

Transactions for the twelve months ended 31st December were:Dr. Cr.

Wages-direct 174000Wages-Indirect 10000Stores purchased on credit 200000Stores issued to repair order 4000Stores issued to production 220000Goods finished during the period atcost

430000

Goods sold at cost 440000Production overhead recovered 96000Production overhead 80000Administration overhead 24000Selling and Distribution overhead 28000Depreciation (works) 2600Payments to suppliers 202000Payments from customers 580000Rates prepaid included in productionoverhead incurred

600

BSPATIL 159

Purchases of fixed assets in cash 4000Charitable Donations 2000Fines paid 1000Interest on bank loan 200Income-tax 40000

You are required to write upto the account in the integral ledger and take out a trial balance. Theadministration overhead is written off to profit and loss account.

Solution:

In the Integral Ledger of A Co. Ltd.Stores Control Account

Dr. Cr.Date Particular Amt. Date Particular AmountJan1

To Balance b/d 36000 Dec31 ByWork-in-Progressa/c

220000

Dec.31

To CreditorsControl A/c

200000 Dec31 By Productionoverhead ac

4000

Dec.31 By Balance c/d 12000

236000 236000Jan1 To Balance b/d 12000

Work control AccountDec.31

To Bank 184000 Dec.31

ByWork-in-ProgressA/c

174000

Dec.31 By Productionoverhead a/c

10000

184000 184000

Production Overhead Account

Rs. Rs.Dec.31 To Wages Control 10000 Dec.

31By Pre-paidexpenses A/c(Rent)

600

Dec.31 To Stores ControlA/c

4000 Dec.31

ByWork-in-progressA/c

96000

Dec.31

To DepreciationProvisions A/c

2600

966000 96600

Administration Overhead AccountRs. Rs.

Dec.31 To Bank 24000 Dec.31

By Cost ofSales A/c

24000

BSPATIL 160

24000 24000

Selling and Distribution Overhead AccountRs. Rs.

Dec.31

To Bank 28000 Dec.31 By Cost of SalesA/c

28000

28000 28000

BSPATIL 161

Work-in-Progress AccountRs. Rs.

Jan1 To Balance b/d 34000 Dec.31

By FinishedGood A/c

430000

Dec.31

Wages Control a/c 174000 Dec.31 By Balance c/d 94000

Dec.31

To Stores Controla/c

220000

Dec.31 To ProductionOverhead A/c

96000

524000 524000Jan 1 To Balance b/d 94000

Finished Goods AccountRs. Rs.

Jan1 To Balance b/d 26000 Dec.31

By Cost of Sales 440000`

Jan.1 ToWork-in-progressA/c

430000 Dec.31 By Balance c/d 16000

456000 456000Jan 1 To Balance c/d 16000

Cost of Sales AccountRs. Rs.

De. 31 To FinishedGoods A/c

44000 Dec.31

By DebtorsControl A/c

600000

Dec.31 To S & DOverhead a/c

28000

Dec.31 To Costing P & LA/c

132000

Jan 1 To Balance b/d 6,00,000 6,00,000Costing P & L Account for the year ending 31st December

Rs. Rs.De.31

AdministrationOverhead A/c

24000 Dec.31

By Cost ofSales

132000

Dec.31

To P & L 108000

132000 132000

P & L for the year ending 31st DecemberRs. Rs.

Dec.31

To CharitableDonations

2000 Jan1

By Balance b/d 64000

To Fines 1000 Jan1 By Costing P & 108000

BSPATIL 162

L A/cTo interest on

Bank Loan2000

To Income-tax 40000To Net Profit 128000

172000 172000

Pre-paid expenses accountRs. Rs.

Dec.31 To ProductionA/c

600 Dec.31

By Balance c/d 600

600 600Jan 1 To Balance b/d 600

Depreciation Provision Account

Rs. Rs.Dec.31

To Balance c/d 12600 Jan.1 By Balance b/d 10000

Dec.31

By ProductionOverhead A/c

2600

12600 12600Jan.1

By balance b/d 12600

Debtors Control AccountRs. Rs.

Dec.31

To Balance b/d 24000 Dec.31 By Bank 580000

Dec.31 To cost ofsales a/c

600000 Dec.31 By Balancec/d

44000

Jan 1 To Balance b/d 624000 624000Jan1 To Balance b/d 44000

Creaditors Control AccountRs. Rs.

Dec.31

To Bank 202000 Jan1 By Balanceb/d

16000

Dec.31 To Balance c/d 14000 Dec.31 By StoresControl A/c

200000

216000 216000Jan1 By Balance

c/d14000

BSPATIL 163

Share AccountRs. Rs.

Jan.1 To Balance b/d 20000 Dec.31

By WagesControl

184000

Dec.31 To DebtorsControl A/c

580000 Dec.31 By FixedAssets A/c

Dec.31 ByProductionoverhead a/c

80000

Dec31 By admin.Overhead

24000

Dec.31 S&Doverhead

28000

Dec.31 By creditorscontrol a/c

202000

Dec.31 By Fines A/c 1000Dec.31 By Charitable

Donations2000

Dec.31 By intereston BankLoan

200

De.31 ByIncome-tax

40000

Dec.31 By balancec/d

34800

600000 600000Jan.1 To Balance b/d 34800

To Trial Balance as on 31st December

Head of Account Dr. Bal Cr. BalRs. Rs.

Stores Control A/c 12000Work-in-progress A/c 94000Finished goods A/c 16000Prepaid expenses A/c 600Depreciation Provision A/c 12600Debtors Control A/c 44000Creditors Control A/c 14000Fixed Assets A/c 114000Bank A/c 34800Share Capital A/c 160000Profit & Loss A/c 128800

Total 315400 315400

BSPATIL 164

Lesson 11

Reconciliation of Cost and Financial Accounts

When the Cos Ledger Accounting system is adopted in an organizations the results shown by theaccounting records i.e. financial accounting and cost ledger accounting differ from each other.Hence, it becomes necessary to reconcile the profit or loss shown by the two sets of records.

Need for Reconciliation:

1. It is necessary to find out the reasons for the differences in the profitability of both therecords.

2. Reconciliation enables to test the reliability of cost accounts. Costing figures in total shouldagree with the financial records.

Reasons for disagreement:The difference in the profitability of cost and financial records may be due to the following reasons.

1. Items included in the financial accounts but not in cost accounts.a. Purely financial income- such as interest received on bank deposits, interest and

dividend on investments, rent receivables, transfer fee received, profit on the sale ofassets etc.

b. Purely financial charges – such as losses due to scraping of machinery, losses on thesale of investments and assets, interest paid on the bank loans, mortgages,debentures etc., expenses of company’s transfer office, damages payable at law etc.

c. Appropriation of profit – the appropriation of profit is again a matter which concernsonly financial accounts. Items like payment of income tax and dividends, transfer toreserve, heavy donations, writing off of preliminary expenses, goodwill and patentsappear only in profit and loss appropriation account and the costing profit and lossa/c is not affected.

2. Items included in cost accounts only:

There are certain items which are included in cost accounts but not in financial accounts.They are: Charges in lieu of rent where premises are owned, interest on capital employed inproduction but upon which no interest is actually paid.

3. Under/Over absorption of overhead expenses:

In cost accounts, overheads are absorbed at predetermined rates which are based on past data. Inthe financial accounts the actual amount incurred is taken into account. There arise a differencebetween the actual expenses and the predetermined overheads charged to product or job.

If overheads are not fully recovered, which means that the amount of overheads absorbed in costaccounts is less than the actual amount, the shortfall is called as under recovery or underabsorption. If overhead expenses recovered in cost accounts is more than that of the actuallyincurred, it is called over absorption. Thus, both the over and under recovery may cause thedifference in the profits of both the records.

4. Different basis of stock valuation:

In cost accounts, the stock of finished goods are valued at cost by FIFO, LIFO, average rate, etc. But,in financial accounts stocks are valued either at cost or market price, whichever is less.

BSPATIL 165

The valuation of work-in-progress may also lead to variation. In financial books only prime costmay be taken into account for this purpose whereas in cost accounts, it may be valued at primecost plus factory overhead.

5. Different basis of depreciation adopted:The rates and methods of charging depreciation may be different in two sets of accounts.Method of reconciliation of profits:

The are two alternative forms of presentation of reconciliation of profits revealed by cost andfinancial accounts, namely

Statement formAccount form

In the statement form it is known as Reconciliation Statement and in the accounts form it is knownas Memorandum Reconciliation Account.In both forms, the profits as per one set is taken to start with and addition / adjustments are madeto arrive at the profit of another set of books.

Memorandum Reconciliation Accounts:It is an account form of reconciling the profitability of two records. The amount of profit as percost records is credited to the Memorandum account. The items to be deducted are debited andthose to be added are credited to this amount. The balancing figure is profit/loss of financialaccounts.The process of preparing reconciliation statement is worked out here in the form of problems.A proforma Memorandum Reconciliation Account is give below:

Memorandum Reconciliation Account(As on ……………….)

Rs. Rs.To Loss as per Cost Book By Profit as per Cost Books…To Items of expensesshown in Finance booksbut not in Cost books

By Items of expenses shownin cost but not in Fin. Books…

To Items of expensesundercharged in CostBooks or overcharged inFin. Books.

By items of over charges inCost Books…

To items of incomeover-charged in CostBooks or not included inFin. Books…

By Over – valuations ofopening stock in CostBooks…

To Over-valuation ofopening stock in Fin.Books

By Under-valuation of closingstock in Cost Books

To Under-valuation ofclosing stock in Fin.Books..,.To Depreciationunder-charged in CostBooks or over charged inFin. Books…

By Depreciation over-chargedin Cost Books…

To Profit as per FinancialBooks…

BSPATIL 166

Problem : 1

The profit as per cost accounts is Rs. 150000. The following details are ascertained on comparisonof cost and financial accounts.

Rs. Rs.a. Opening Stock:

MaterialsFinished goods

1000018000

1500016000

b. Closing Stock:MaterialsFinished goods

1200020000

1300017000

c. Interest charged but not paid Rs. 10000d. Write of preliminary expenses Rs. 500; Goodwill Rs. 1500e. Dividend on UTI received Rs. 1000f. Indirect expenses charged in financial accounts Rs. 80000 but

Rs. 75500 recovered in Cost Accounts.Find out the profit as per financial accounts by drawing up aReconciliation statement.

Solution: Reconciliation Statement

Rs. Rs.Profit as per Cost accounts 150000Add : Opening stock of finished goodsover valued in cost accounts

2000

Closing stock of materials underrecovered in cost accounts

1000

Interest charged only on cost accounts 10000Dividend on UTI not included in costaccounts

1000 14000

164000

Less : Opening stock of material undervalued in cost accounts

5000

Closing stock of finished goods overvalued in cost accounts

3000

Preliminary expenses written off infinancial accounts

500

Goodwill written off in Final accounts 1500Indirect expenses under recovered incost accounts

4500 14500

Profit as per financial accounts 149500

Alternatively, the above information may also be presented in the form of an account known asMemorandum Reconciliation Account.

Memorandum Reconciliation AccountRs. Rs.

BSPATIL 167

To Opening stock ofmaterial under valued incost A/c

5000 By profit as per CostAccount

150000

To Closing stock offinished good overvalued in cost account

3000 By Opening stock offinished goods overvalued in cost a/c

2000

To Preliminary expenseswritten off

500 By closing stock ofmaterial under valued incost accounts

1000

To Goodwill written off 1500 By interest charged onlyin cost A/c

10000

Overheads underrecovered

4500 By dividend received 1000

To Profit as per financialAccounts (balancing fig)

149500

164000 164000

Problem: 2

Following are the figures available in financial accounts of the year ended 31.3.76.Direct Material consumption 250000Direct Wages 100000Factory overheads 380000Admini. Overhead 250000Selling and Dis. Overhead 480000Bad debts 20000Preliminery expenses 10000Legal charges 5000Dividend received 50000Sales (120000 units) 700000Interest on deposit received 10000Closing Stock:

Finished stock 40000 units 1,20,000.Work-in-progress

80000

The cost account reveal direct materialconsumption as

280000

Factory overhead recovered at 20% on pricecost.Administration overhead at Rs. 2 per unit or production. Sellingand distribution overheads at Rs. 4 per unit sold, prepare

1. Costing profit and loss account2. Statement reconciling the profits disclosed by the costing profit and loss account and

financial profit and loss account.

Solution

Closing Profit and Loss account for the year ending 31.3.96

Rs. Rs.

BSPATIL 168

To direct materials 280000 By Sales 700000To direct wages 100000 Closing stock: Finished

goods120000

To factory overhead 76000 Work-in-progress 80000To administrationoverhead

480000 By net loss 516000

To selling & Dis.Overhead

480000

1416000 1416000

Profit & Loss Account as per Financial BooksRs. Rs.

To direct materials 250000 By sales 700000To direct wages 100000 By dividend received 50000To Factory overhead 380000 By Interest received 10000To Administrationoverhead

250000 By Closing stock:

To Selling & Dis. 480000 Finished goods 120000To Bad debts 20000 Work-in-progress 80000To Preliminary expenses 10000 Net loss 535000To legal charges 5000

1495000 1495000

Reconciliation StatementLoss as per cost account 516000Less:a. Over charging of materials in Costaccounts

30000

b. Over absorption of administrationoverhead in cost account

230000 260000

256000Add:a. Under absorption of factory overhead 304000b. Bad debts not included in cost accounts 20000 324000

580000Less :Adjustment of income items not included incost accounts

50000

Interest on deposit received 10000 60000

520000

Add:Adjustments not shown in cost accountsPreliminary expenses 10000Legal Charges 5000 15000

Net loss as per financial books 535000

BSPATIL 169

Notes:1. In the costing profit and loss account factory overheads have been calculated as 20% of Rs.

(280000 + 100000 – 76000)2. Administration overhead at Rs. 3 per unit of production. Number of units produced = sales –

120000 + closing stock of 40000 units)

Problem : 3

From the following particulars, prepare(a) A statement of cost of manufacture for the year.(b) A statement of profit as per cost accounts and(c) Profit and loss account in the financial books and a reconciliation of the difference in the

profits as shown by (b) and (c) above:

Rs.Opening stock of raw materials 100000Closing stock of raw materials 150000Opening stock of finished product 200000Closing stock of finished product 50000Purchase of raw materials 600000Wages 250000

Calculate factory overhead at 25 percent on prime cost. Office overhead will be levied at 75 percenton factory overhead. Actual works expenditure amounted to Rs. 193750 and actual office expensesamounted to Rs. 152500. The selling price was fixed at 25% above cost price.

BSPATIL 170

COST LEDGER ACCOUNTING

Cost of manufacture Rs. Rs.a) Raw materials

Opening stockAdd purchasesLess closing stock

100000600000150000 550000

Wages 250000Factory overhead (25% on Prime cost) 200000Office overhead (75% on Fy. Overhead) 150000

Cost of manufacture 115000

Statement of Profit (Cost Accounts)Rs.

b) Opening Stock of Finished goods 200000Cost of manufacture 1150000Less Closing Stock of Finished goods 50000

Cost of sales 1300000Profit (25% of cost) 325000

Sales 1625000

Profit and Loss AccountRs. Rs.

To opening Stock 200000 By sales 1625000To Raw materials: By Closing

Stock50000

To Opening Stock 100000To Purchase 600000Less Closing Stock 150000 550000To Wages 250000To Factory overhead 193750To office overhead 152500To Profit 328750

1675000 1675000Reconciliation Statement

Profit as per Cost Accounts 325000Add Over-absorption of F.Y.overhead

200000-193750 6250

Less under-absorption of officeoverhead

152500-150000 2500

Profit as per Financial Accounts 328750

Problem 4:

A company’s net profit as per the cost books was RS. 23063 whereas the audited finalaccounts showed a profit of Rs. 16624. With the help of the following data, you are required to

BSPATIL 171

prepare a reconciliation statement, and explain the reason for the difference between the twofigures.

Profit and Loss AccountYear ended 31st March, 19….

Rs. Rs.Opening Stock 247179 Sales 346500Purchase 82154

329333Closing Stock 75121 254212Direct Wages 23133FactoryOverhead

20826

Gross profitc/d

48329

Total 346500 346500

Administrationexpenses

9845 Gross profitb/d

48329

Sellingexpenses

22176 Miscellaneousincome

316

Net Profit 16624

Total 48,645 48645

The costing records show:(a) Stock balance of Rs. 78179(b) Direct wages absorbed during the year – Rs. 24876(c) Factory overhead absorbed – Rs. 19714(d) Administration expenses charged @ 3 per cent of selling prices.(e) Selling expenses charged @ 5 per cent of value of sales(f) No mention of miscellaneous income

Solution

Rs. Rs.Profit as per Cost Accounts 23063Less : Difference in valuation ofclosing stock

7819775121 (-)

3076Factory overhead under absorbed 20826

19714 (-)1112

Selling expenses under-absorbed 2217617325 (-)

4851Add: Wages over-absorbed 24867

23133 1734Administration overhead 10395

BSPATIL 172

over-absorbed 9845 550Sundry income not shown inCosting Profit

316

Profit as per financial accounts 16624.MODEL QUESTION PAPER

B.Com.,Cost Accounting

Maximum:100 marks PART – A

Answer any FIVE questions

1. What are the objectives of cost accounting?2. What do you mean ABC analysis? Explain it with an illustration.3. What do you mean by labour turnover? What are its causes?4. What are the different methods of allocation of joint costs to joint products.5. What are the advantages and limitations of standard costing?6. From the following particulars, calculate the economic order quantity and find out thenumber of orders to be placed in a year:

Annual requirements : 1600 unitsCost of material per unit : Rs. 40Cost of placing and receiving onorder

: Rs. 50

Annual carrying cost of inventoryvalues

: 10% ininventory

7. A furniture manufacturer uses sunmica tops of tables. From the following information, findout price variance, usage variance and cost Variance:

Standard quantity of sunmica pertable

: 4 sq. metre

Standard price per sq. metre ofsunmica

: Rs. 5

Actual production of tables : 1000Sunmica actually used : 4300 sq. meterActual purchase price of sunmica : Rs. 5.50 per sq.

meter

PART – B ( 4 x 15 ) = 60

Answer any FOUR questions8. What are the objectives and advantages of cost audit? How is it different form managementaudit?

9. What do you mean by non-integrated accounting? What are the causes for reconciliation ofcost and financial profits?

10.An engineering works, the standard time for a job is 16 hours and the basic wage is Rs. 1per hour.A bonus scheme is instituted so that worker is to receive his normal rate for hours actuallyworked and 50% for the hours saved.

BSPATIL 173

Materials for the job cost Rs. 20 and overheads are charged on a basis of Rs. 2 per labourhour.Calculate the wages and effective rate of earning per hour if the job is completed (i) in 12hours and (ii) in 14 hours. Also ascertain factory cost of the job on the same basis.

11.The following information relates to the activities of a production departments for a certainperiods in a factory:

Materials use : Rs. 72000Direct wages : 60000Hours of machine operations : 20000Labour hours worked : 24000Overheads vhareable to thedepartment

: 48000

On one order carried out in the departments during the period, the relevant data were:

Hours Rs.Materials used 4000Direct wages 3300Labour hours 1650Machine hours 1200

Prepare a comparative statement of cost of this order by using the following three methods ofrecovery of overheads:

a) Direct labour hour rate methodb) Direct labour cost methodc) Machine hour rate method

12.A product is obtained after passing it through three processes. The following information iscollected for January 1989.

ProcessI II III

Direct materials (Rs.) 5200 3879 4329Direct wages (Rs.) 4000 5989 2987Units produced 879 456 234Normal loss 5% 10% 15%Values of scrap per units(Rs.)

4 8 10

1000 Units at Rs. 6 Each was introduced in process. The indirect expenses for the month Rs.18000. Prepare process accounts.

13.From the information given below, prepare (a) a statement showing profit or loss and (b)another statement reconciling the costing profit with those shown by financial accountsTrading and Profit and Loss Account for the year 1989

Rs. Rs.Materialconsumed

150000 Sales (150000units)

320000

Direct wages 75000

BSPATIL 174

Factoryexpenses

45000

Officeexpenses

13000

Sellingexpenses

9000

Net Profit 27500320000 320000

The normal output of the factory is 125000 units. Factory expenses of a fixed nature re Rs. 25000.These expenses are for all practical purposes constant. Selling expenses are constant to the extentof Rs. 3000 and the balance varied with sales.

14.Calculate overhead variance form the following data:Standard(Rs)

Actual(Rs.)

Fixed overheads 8000 8500Variable overheads 12000 11000Output in units 4000 3800